Corporate Structures and Estate Planning: Incorporation and Tax Mitigation

Incorporation is the process of transferring a business or business assets into a company or trust to protect those assets and facilitate tax mitigation.

Incorporating a business sets it apart from the owner or shareholders, creating a separate legal entity. This shields those with financial ties to the business from having any personal liability for the company’s debts while also providing several benefits.

These include:

• Mortgage interest relief is still available to incorporated companies. This was restricted in April 2017-2020 for non-incorporated landlords following the 2015 Budget, making incorporation an appealing option for those with mortgaged properties in their portfolio.
• Capital Gains Tax (CGT) rollover is often available to incorporated businesses depending on the nature of the operation and its size.
• No Stamp Duty Land Tax (SDLT) is payable on properties that are incorporated as part of a partnership.
• The base costs of all incorporated properties are uplifted to their current market value.
• Taxes are restricted on surplus profits and future disposals to Corporation Tax rates only.
• Any income can be paid in the form of salaries or dividends, and split efficiently between spouses and civil partners.
• Incorporation lends itself to trust planning that supports business continuity and provides IHT protection.

Incorporation and Capital Gains Tax (CGT)

For the purposes of incorporation, it’s generally accepted that where at least 20 hours a week are spent undertaking activities in support of a venture, that venture is considered a business as opposed to a hobby.

When incorporating a business, all assets relating to the business must be included. This means with regard to property development enterprises, for example, all properties within the business’ portfolio must be incorporated into the new limited company.

It also means all activities relating to the business, such as mortgages and letting agreements, must also be moved across to form part of the limited company’s going concern.

Once completed, the base costs for all properties within the portfolio are uplifted and property portfolio gains can be rolled into the shares. Any resulting gains thereafter, such as those from the sale of a property, will be subject to Corporation Tax on the profits.

 Incorporation and Income Tax

In addition to Corporation Tax on any gains made on the sales of properties, any rental income generated by the business’ portfolio is also subject to Corporation Tax at a rate of 19-25%.

Business owners can benefit from dividends up to a value of £500 Income Tax-free. Rates increase from 0% to 8.75% for Basic Rate payers, up to 39.35% for those in the Additional Rate Band.

Incorporation and Stamp Duty Land Tax (SDLT) can be a big headache for sole traders that want to incorporate. This is because they don’t have the Schedule 15 exemption from SDLT that’s available to businesses run as a partnership.

Partnerships are defined by the 1890 Partnership Act as ‘the relation that subsides between persons carrying on a business in common with a view to profit’.

The business must be registered as a formal partnership with a Partnership Agreement and tax returns to evidence this with a period of at least 2-3 years of the partnership being in place for SDLT exception to apply.

For sole traders, this process is slightly trickier. It can be difficult to split assets in situations where sole business owners are unmarried, so forming a partnership – either an equity or non-equity partnership – and then incorporating the business after at least 3 years trading as an LLP, is the most effective way to mitigate for SDLT.

Incorporation and IHT

Incorporation alone will not reduce your IHT bill; this is because from an IHT perspective, incorporation simply means going from owning personal property of a value to owning shares in an investment company of the same value.

Problems can arise with IHT when you have assets you want to extract from a limited company to settle your IHT bill. This is because in addition to the IHT payable on company assets, any gains on sales of those assets are also subject to Corporation and Income Tax. This can amount to a huge chunk of the original value of the business’ shares and even double the overall tax bill for beneficiaries in some cases.

A more IHT-efficient way of passing on a limited business to the next generation is to place shares of the business into a gift trust for the beneficiaries. In this situation, the rental income on properties pays for the mortgage, and the net equity and shares value increases outside of the business owners’ estate.

The takeaway

There are often many more potential tax pitfalls than benefits that come with incorporating a business, particularly when it comes to IHT. A lot of business owners find they are financially better off not incorporating their business, though there are of course exceptions – primarily for higher rate taxpayers who are in a growth phase.

If your client is considering incorporation, we strongly advise you both to meet with our Private Client team. Our wealth management experts will talk you and your client through the various tax-efficient options available in their specific circumstances and provide personalised business advice.