Take part in our new Family Business Survey and have your say! Click here
Yesterday, the Chancellor surprised many by announcing changes to the tax treatment of incorporations with immediate effect.
Law firms are currently incorporating in large numbers, and there are now more law firms practising as limited companies than either partnerships or LLPs. There are many strategic reasons behind that trend, one of which is the tax advantages of both the initial transition and the ongoing practice.
Tax savings on the initial transition arose as a result of the limited company acquiring the goodwill from the individual owners of the prior practice. After applying entrepreneur’s relief (ER), the owners paid capital gains tax (CGT) at 10% on that disposal and were then able to draw down on the 90% balance tax-free. Effectively this provided a one-off bonus on amounts that would have been withdrawn anyway, but at a lower effective rate of tax.
From 3 December 2014 ER will not be available on disposals of goodwill to a close company to which a seller is related. A close company is one that is controlled by:
It therefore catches the vast majority of law firms looking to incorporate.
The Chancellor has also announced that a company will not be able to claim corporation tax (CT) relief on the amortisation of internally generated goodwill and customer related intangible assets acquired from a related business on or after 3 December.
Tax relief on the disposal and subsequent amortisation of goodwill acquired before 3 December is unaffected.
Although tax savings upon law firm incorporations will now be lower, there are still good tax reasons for incorporating a business, given the current small profits CT rate of 20% (as well as a main CT rate of 20% w.e.f. 1 April 2015).
Strategic reasons for incorporating will continue, including:
• Limited liability
• Catalyst for cultural change
• Potential investors post Legal Services Act
• Succession planning - attracting new partners
• Mergers – attracting merger parties
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. 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% CGT or, more likely, merely transfer goodwill at its base cost so as not to create a taxable gain.
Please contact me if you would like further detail on this change, or if you would like a review of your practice structure.
If you like this article and would like our FREE updates sent straight to your inbox then subscribe to our monthly newsletterSubscribe
All content © 2015 Armstrong Watson. All Rights Reserved. Website by Simon Pighills.
Armstrong Watson LLP is a limited liability partnership registered in England and Wales, number OC415608. The registered office is 15 Victoria Place, Carlisle, CA1 1EW where a list of members is kept. Armstrong Watson Accountants, Business & Financial Advisers is a trading style of Armstrong Watson LLP. Armstrong Watson LLP is regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities.
Armstrong Watson Audit Limited is registered to carry on audit work in the UK and Ireland by the Institute of Chartered Accountants in England and Wales. Registered as a limited company in England and Wales No. 8800970. Registered office: 15 Victoria Place, Carlisle, CA1 1EW
Armstrong Watson Financial Planning Limited is authorised and regulated by the Financial Conduct Authority. Firm reference number 542122. Registered as a limited company in England and Wales No. 7208672. Armstrong Watson Financial Planning & Wealth Management is a trading name of Armstrong Watson Financial Planning Limited. Registered Office: 15 Victoria Place, Carlisle, CA1 1EW