Incorporating your business - capital allowance strategies
Incorporating your business - capital allowance strategies
On advice from your accountant you're going to transfer your sole-trader business to a company in the next year or two. In preparation for the transfer are there any dos and don'ts to ensure it's as tax efficient as possible?
Capital allowances
As you may know, tax relief for equipment you buy for your business is given as a capital allowance (CA). Depending on the type of equipment and other conditions, the tax deduction is either spread over many years ('writing down allowances') or given entirely in the accounting period in which it was purchased, known as the annual investment allowance (AIA).
Trap. Special rules affect the amount of CAs your business can claim in its final year of trading.
Transferring to a company
If a business is transferred to a company by a sole trader or partnership, it's treated as if it permanently ceases and the special CAs rules come into play. These mean that any equipment the business owns at the time of transfer is sold for its market value and the company is deemed to acquire it at the same price. This can result in a clawback of CAs the business previously claimed.
Power tip. Avoid the market valuation by making a special election (see The next step). The effect of this is that for tax purposes the value attributed to the equipment at transfer will result in no CAs being given to the old business for its final accounts. This simplifies the CA calculations.
Example. Holly and Gina are partners in a hair and beauty business which they intend to transfer to their own company, H & G Ltd, in 2025/26. Five months before the transfer, the partnership buys equipment costing £150,000. Usually it would claim the AIA for the full amount, but the rules say that the AIA can't be claimed in the final period that a business trades so the partnership gets no tax relief at all. However, that's not the end of the bad Trap. Special rules, known as the connected party
Trap. Special rules, known as the connected party rules, apply to prevent H & G Ltd from claiming the AIA for the equipment that is transferred from the partnership.
Slow tax relief
The effect of the trap is that neither the partnership nor H & G Ltd are entitled to the AIA for the £150,000 of equipment purchased. Instead, the company can claim CAs as writing down allowances. These allow a meagre tax deduction equal to just 18% of the £150,000 in the year the business is transferred, then 18% of the remainder (£123,000) in the second year, and so on. It will take more than 20 years to achieve tax relief on the £150,000.
Power tip. By shortening the final partnership accounts the £150,000 expenditure can be made to fall into the partnership's penultimate accounting period meaning that the special CAs rules don't cause CAs to be delayed. In fact, the partnership is entitled to the AIA on the entire £150,000.
Example. The final accounts for Holly and Gina's partnership end on 31 December 2025. The equipment was bought on 31 July 2025. Two sets of accounts are drawn up for the final year. The first to 31 July 2025 and from 1 August to 31 December. AIA of £150,000 can be claimed for the earlier period. The CAs election we mentioned earlier is made to prevent a clawback of the allowances.
To ensure the earliest possible tax relief for the equipment, avoid purchasing any in the final accounting period of the old business. Or, instead, divide the final period in two so that the expenditure falls into the earlier period. Follow this up with the special election that prevents the previous strategy from being unravelled.