Business incorporation - optimise relief for capital expenses

Transferring a business

Apart from potentially saving tax and NI, there can be good reasons for transferring your sole trader or partnership business to a company, known as incorporating. When this happens the special rules for calculating taxable profits (or losses) come into play for the sole trader/partnership and it is treated for tax purposes in the same way as if the business had permanently ceased.

Transfer of equipment

Plant and machinery (equipment) owned by the old business is treated as if it had been sold by the sole trader/partnership to the company at market value. This usually results in a “balancing adjustment” to the tax deductions (capital allowances (CAs)) claimed for the equipment by the old business.

Estimating the market value of equipmentcan be tricky and is something HMRC will challenge if it believes you’re trying to gain a tax advantage. The good news is the need for valuation is avoided if the sole trader/partnership and the company jointly elect to treat the equipment as sold at the “tax value” instead of the market value.

Example. Tim and Jamie are business partners. Their partnership prepares its annual accounts to 30 April. In February 2025 it buys three new vans costing £90,000 in total. On 1 May 2025, when the vans have a value of £80,000, the business was transferred to Acom Ltd, which is wholly owned by Tim and Jamie. Usually, the partnership could claim CAs for the whole £90,000 using its annual investment allowance (AIA). The trouble is the rules block the AIA for the final trading period of a business. As a result, the partnership can only claim CAs of £10,000 (£90,000 - £80,000). This adds a whopping £80,000 to the partnership’s final profit on which Tim and Jamie will pay tax at the higher rate (40%).

Worse still, another rule means that Acom is not entitled to claim CAs for the whole expenditure on vans for the tax year in which it takes over the business. Instead, it can only claim 18% of the value (on the reducing balance of value) as a CA against its corporation tax bill for its first year and subsequent years of trade.

Timing matters

Because the purchase of the vans occurred in the final trading period of the unincorporated business, Tim and Jamie missed out on CAs of £80,000 which cost them an extra £32,000 in tax. The tax relief is instead received by Acom but spread over many years.

Tim and Jamie can prevent the loss/delay of CAs by changing their accounting date so that it falls between the date they bought the vans and the date they transferred the business.

Example. The partnership changes its accounting period so that its penultimate accounts run from 1 May 2024 to 31 March 2025 and its final accounts from 1 April to 30 April 2025. The purchase of the vans falls in the partnership’s penultimate accounting period meaning that it gets CAs on the full £90,000. Tim, Jamie and Acom then elect to use the tax value, which is zero, for the transfer of the vans to Acom. The CAs trap is thereby avoided.