Income tax implications of incorporation

By Tolley in association with Julie Butler

The following Owner-Managed Businesses guidance note by Tolley in association with Julie Butler provides comprehensive and up to date tax information covering:

  • Income tax implications of incorporation
  • Closing year rules
  • Capital allowances
  • Stock
  • Losses

The Incorporation ― introduction and procedure guidance note summarises various tax implications of incorporating a business. This note provides further details of the income tax aspects which include:

  • closing year rules / overlap profits
  • capital allowances
  • stock
  • loss relief options

These are covered further detail below.

Closing year rules

The incorporation of a business by a sole trader or partnership brings about a cessation of trade for income tax purposes. The closing year rules will therefore need to be considered, including relief for overlap profits.

In particular, if the overlap profits are significantly greater than current profits for an equivalent time period, the cessation of the trade may trigger a substantial loss for which no relief is available. Careful choice of cessation date may help with this issue.

See Example 1 and Example 2 for illustrations of cessation planning. For more guidance, see the Basis of assessment ― closing years guidance note.

Capital allowances

If any plant and machinery is purchased in the final accounting period, no annual investment allowance (AIA), first year allowances or writing down allowances are available in that period. Where a trader has made substantial investment in capital items in the final period of trade, there is clearly an issue especially where profits are available which could be reduced by capital allowances. Consideration should therefore be given to delaying incorporation until after the end of the tax year.

For example, a trader with a year-end of 31 March 2020 who has made a substantial investment in capital items during that year looks to incorporate his business at the end of that period on 1 April 2020. However, he should consider pushing the date of incorporation into the next

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