In addition to understanding the difference between a sole trader and limited company. There are several factors involved in making the right decision on changing structure. These include the tax you pay as a sole trader, the money you can free up in the form of a director’s loan, and the value of your existing business.
On transferring sole trader business to a company of which the sole trader is the main director and shareholder. The business made losses in the last trading period before the transfer. How can tax relief be maximised on this event?
Incorporating your business
There are different reasons why you might transfer your sole trader or partnership business to a company (usually referred to as incorporating a business). Often it’s driven by tax issues but equally you might want the protection from personal liability that companies provide. Whatever your reasons, tax is an important part of the incorporation process especially if the old business made losses for which you haven’t received tax relief.
Loss relief
There are a few generally well known ways you can claim tax relief for losses you make from a sole trader or partnership business. What’s less well known is that where you incorporate you can use any losses for which you haven’t received tax relief to reduce the tax you would otherwise pay on income you take from the company.
Tip. Claiming loss relief using the well-known methods will produce tax savings sooner but using them against income from the successor company might lead to greater savings.
Conditions
You can only claim loss relief using the transfer of business rules where:
- The transfer was mainly in exchange for shares. “Mainly” means at least 80% of the company’s share capital. In practice, HMRC apparently require shares to constitute more than 80% of the consideration received
- You own the shares
Tax relief is allowed under these provisions only if ‘the individual is the beneficial owner of the shares’ throughout the tax year (or, in respect of the year of the transfer, from the date of transfer to the following 5 April:
- The company continues the business which you transferred to it. If the company ceases the business and starts a different one you can’t use the loss relief against income derived from the new business.
Using the loss relief
The legislation says that you can use the loss relief to reduce tax on dividends or any other income derived from the company, e.g. salary, benefits in kind, etc.
Tip. A potentially big advantage to using the loss relief from your sole trader/partnership business against company income is that you can plan to use the losses for greater tax efficiency.
Example:
Larry’s business made a £10,000 loss in its final period of trading. He could use the loss to reduce tax on the previous three years’ business profits. He was a basic rate taxpayer in each of those years. The maximum tax relief he could obtain would be £2,000 (£10,000 x 20%). If instead he used the loss relief against company income he could take a salary (or dividends if the company has sufficient profits to pay them) at a level that would put him in the higher rate tax bracket and so get tax relief of up to £4,000 (£10,000 x 40%).
Don’t forget the NI. Where losses are used against salary from your company they also reduce your (but not the company’s) NI liability.
You can use losses made by your unincorporated business to reduce tax on income, e.g. salary, dividends, etc. derived from a company to which the business is transferred. Because you have more control (compared with an unincorporated business) over the income you take from a company, using the losses this way can be more tax efficient.
If you have more questions on transferring your sole trader losses to your company, please give us a call at +44 01234 712840.
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