Incorporation Relief is a valuable tax break that allows business owners to delay paying Capital Gains Tax when they transfer their business into a limited company. Rather than facing an immediate tax bill on the capital gain made at the time of transfer, the tax defers until the business owner sells the shares received from the company.
This relief makes it easier to switch from a sole trader or partnership setup to a limited company. If you meet the conditions, Incorporation Relief applies automatically, with no need to formally claim it.
Who Can Qualify for Incorporation Relief?
To qualify for Incorporation Relief, you must meet the following conditions:
- You are operating as a sole trader or within a formal business partnership
- You transfer the business as a going concern, meaning it is actively trading at the time
- All business assets (excluding cash) are transferred to the limited company
- In exchange, you receive shares in the company
If you fulfil all of these requirements, the relief applies automatically. To qualify, the business must carry on genuine trading activity.
How Does Incorporation Relief Work in Practice?
When you incorporate your business, you may realise a capital gain on assets such as goodwill or property. Instead of paying Capital Gains Tax immediately, this gain is deferred by reducing the base cost of the shares you receive.
Example
You transfer your business into a company and receive shares valued at £100,000. If you made a gain of £60,000 on the assets transferred, the base cost of your shares reduces to £40,000. When you eventually sell those shares, HMRC will tax that £60,000 gain.
What Happens If You Receive Cash As Well As Shares?
In some cases, you may receive a mix of shares and cash as payment. Incorporation Relief only applies to the portion represented by shares.
Example
Your business is worth £100,000 and you receive £80,000 in shares and £20,000 cash, with a total gain of £50,000. Incorporation Relief will then defer £40,000 (80%) and the remaining £10,000 (20%) is immediately subject to Capital Gains Tax.
Can You Choose Not to Apply Incorporation Relief?
Yes.
You can elect not to apply Incorporation Relief, which can be useful if you intend to sell your shares soon after incorporation. For instance, Business Asset Disposal Relief requires you to hold shares for at least one year. If you sell them sooner, you will not qualify.
By opting out of Incorporation Relief and paying Capital Gains Tax immediately, you might benefit from the 10% tax rate under Business Asset Disposal Relief.
You must notify HMRC of your decision to opt out through your Self Assessment tax return by the 31st January following the end of the second tax year after the transfer, or earlier if you sell the shares before then.
How to Calculate Incorporation Relief
When the consideration includes both shares and cash, use the following formula:
Incorporation Relief = Capital Gain x (Value of Shares / Total Consideration)
| Example | Calculation | Result |
| You realise a capital gain of £60,000 and receive £90,000 in shares and £10,000 in cash. The total consideration is £100,000. | £60,000 x (£90,000 / £100,000) = £54,000 deferred | £6,000 is immediately subject to Capital Gains Tax |
Also, be aware of business liabilities. If the company takes over debts, HMRC may treat this as part of the consideration. However, under Extra Statutory Concession D32, you may claim that liabilities do not count as consideration for Capital Gains Tax purposes. This is not automatic and you must explicitly make a claim to apply ESC D32.
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