The number of firms converting to limited companies is likely to plummet following tax changes announced in chancellor George Osborne’s autumn statement, experts said today.
The changes, which took effect from Wednesday (3 December), are to a tax break known as entrepreneur’s relief introduced by the last Labour government which allowed income from the sale of goodwill in a practice to be taxed at only 10%. Goodwill is typically valued at a year's turnover.
In the statement, Osborne said: ‘The government will stop individuals and partnerships from gaining an unfair tax advantage by transferring their businesses into a company they control, and then claiming corporation tax deductions for assets linked to the business’s reputation and customer relationships.’
Following the announcement, entrepreneur’s relief will not be available on disposals of goodwill to a ‘close company’ to which a seller is related.
A close company is defined as having five or fewer participators; any number of participators if those participators are directors or one where, on winding up the business, more than half of the assets would be distributed to five or fewer participators who are directors.
Andy Poole, legal sector partner at accountants Armstrong Watson, said this would catch ‘the vast majority of law firms looking to incorporate’.
The ability of unincorporated law firms to sell goodwill to their own company, and pay only 10% tax and then subsequently withdraw the money from their loan accounts tax free, was seen by many as the icing on the cake, Poole said.
‘In future business owners will still be able to transfer goodwill to their own companies but will either have to pay full value at up to 28% capital gains tax or, more likely, merely transfer goodwill at its base cost so as not to create a taxable gain.’
Louis Baker, head of professional practices at national audit, tax and advisory firm Crowe Clark Whitehill, said: ‘This will end of the flow of firms converting to limited company status solely for tax mitigation purposes. From now on firms will choose their ownership structure and entity on purely commercial and cultural grounds.
‘Many firms will reflect that the partnership/LLP model remains the right vehicle for their firm, and there will be far fewer converting to limited company status than has been the case in recent years.’
Karen Hain, head of professional practices at MHA, the national association of independent accountants, said that another blow from the autumn statement is that the new rules will prevent any tax relief claims by the company for the amortisation of the goodwill.
‘Notwithstanding these changes we still think it is worth professional practices such as solicitors and architects considering incorporating their businesses as the income tax benefits remain intact.’