The benefits of incorporating your business
Q I AM a sole trader who wishes to transfer my business into a company. I have heard about a relief from Capital Gains Tax on incorporation. Can you explain this to me?
A There is a relief available from CGT on the transfer of a business into a company. Where a sole trader transfers a business to a company, a measure of relief is given to the extent that the sale proceeds are taken by way of shares in the new company. The relief, in effect, consists of a deferral of the tax payable on the amount of the consideration taken in the form of shares in the new company.
The relief only applies where all the conditions are complied with. There must be a transfer of a business to a company from a person who is not a company. The business must be transferred as a going concern. The whole of the assets of the business or all of those assets other than cash must be transferred. The transfer must be wholly or partly for shares in the company.
If all the assets of the business other than cash are not transferred to the company, the relief will not be available and a CGT charge may arise on those assets which are transferred to the company. This emphasises the importance of carefully identifying what constitutes as assets of the business when planning for incorporation. There is no requirement that the person making the transfer should have worked in the business. A sleeping partner is as entitled to this relief on the incorporation of a business as is a full-time worker in the business.
There are also other significant benefits to incorporating your business. One major benefit of incorporation is the limited liability status it provides. As a result of incorporation a corporate veil exists between the individual shareholder and the company and with limited liability status a company shareholder will only be liable to lose the share capital they subscribe to. This is in stark contrast to a sole trader, who is personally liable to all debts of the business. Of course the strength of limited liability status may be weakened, if banks and creditors insist on personal guarantees in respect of any debts incurred.
Another important consideration is the potential tax benefit of incorporation. The current corporation tax rate in Ireland is 12.5% for trading income and 25% for non-trading income (e.g investment income, rental income) This compares very favourably to the current marginal income tax rate to which sole traders are subject to. Crucially, Income Tax will still apply to any salary, dividends etc. taken from the company. While business losses cannot be set against personal income for tax purposes following incorporation.
While incorporation has some clear benefits, there are also some other factors which require consideration before any decision is made. Setting up a company is more expensive than trading as a sole trader. Legislative requirements may be costly and time consuming as a result of the need to prepare and file accounts with the Companies Registration Office. Also, it will be important to confirm if stakeholders in your business are agreeable to the proposed incorporation. If banks are unwilling to transfer bank loans, overdraft facilities etc to the newly incorporated company then incorporation may not be feasible at this time.
Consideration would also have to be given, to any potential taxes which may arise as a result of the transfer of your business to a company. Other than Capital Gains Tax, Capital Acquisitions tax, Stamp Duty, VAT and Income Tax may arise as a result of the proposed transfer. However with careful tax planning it may be possible to minimise these costs.