LOSSES - 07.07.2020

Tax-efficient incorporation of a loss-making business

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

The 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.

For detailed commentary on loss relief alternatives for unincorporated businesses, visit http://tipsandadvice-tax.co.uk/download (TX 20.20.03).

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
• you own the shares
• 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. Tim’s business made a £20,000 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 £4,000 (£20,000 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 £8,000 (£20,000 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 (see The next step ).

For a more detailed example of how loss relief can be used against company income, visit http://tipsandadvice-tax.co.uk/download (TX 20.20.03).