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Many small business owners consider transferring their unincorporated business to a limited company to benefit from the lower corporate tax rates. However, since anti-avoidance legislation was introduced in the 2010s, the tax advantages of transferring business goodwill to a company have been restricted. Goodwill is an intangible asset representing the value of a business’s reputation, customers and other factors beyond its physical assets.
Previously, entrepreneurs could transfer goodwill to a company and pay just 10% capital gains tax on it under business asset disposal relief (BADR), known as entrepreneurs’ relief until 2020. This allowed business owners to extract the goodwill value at a very low tax cost. However, rules now prevent BADR from applying on goodwill transfers to companies.
Despite this, with careful planning, transferring goodwill at an effective 10% tax rate may still be possible. The standard capital gains tax (CGT) rates are now 10% for basic and 20% for higher-rate taxpayers. By managing taxable income levels in the years of disposal and transfer, the gain on goodwill can fall within the 10% band.
The key is to transfer the business early in a tax year before generating other taxable income. For example, Alan transferred his business, including £100,000 of goodwill, to his company on 6 April 2024. He has no other income in 2023/24. After the annual CGT exemption, 10% CGT applies on the first £50,270 gains in 2024/25 and 20% above this. So most of Alan’s gain falls within the 10% band, meaning under £11,000 of tax to pay rather than over £20,000 if the transfer was later in the year.
His company credits the goodwill payment to his director’s loan account. By drawing on this account before taking dividends or salary from the company, Alan can access the sale proceeds largely tax-free. Careful planning around the transfer date and director’s loan account use allows the extraction of goodwill at an effective 10% tax rate.
Some key points for business owners considering transferring to a company:
- Time the transfer early in a tax year when income is low to benefit from the annual CGT allowance and 10% band
- Negotiate for the company to pay for goodwill and credit it to your director’s loan account rather than taking shares
- Draw funds from your director’s loan account first before taking dividends to avoid immediate tax charges
- Seek professional advice to forecast taxes and plan the optimal transfer timing and commercial terms
- Keep records of the business valuation and sale agreement in case HMRC challenge the goodwill valuation
Transferring business goodwill to a company can still be tax-efficient with the right strategy. The restricted entrepreneurs’ relief does not eliminate the tax benefits. Planning around tax year-ends and director loan accounts can allow the extraction of goodwill at close to the original 10% rate. Seeking expert guidance is advisable to ensure the transaction complies with tax rules.