So, yes there was a sole trader to limited company last week. We introduced you to Prince Murphy and some of the main taxes when making the change. These included Income Tax and Corporation Tax. It was very insightful to see the tax savings over many years. We also touched on the salary that Prince would earn and some of the key payment dates. This week we’ll look at some other issues like
- Recap
- Transfer of Assets
- Director’s Current Account
- Goodwill
- Other Taxes
- Summary
Recap
To recap Prince Murphy runs a successful fruit and veg business in Waterford City. Due to increasing profits and higher tax bills, he changed from a sole trader to a limited company. The company is Little Red Courgette Ltd. and it started trading on the 1st of April 2023. Prince is on a salary of €46,000 which gives him €3,000 net per month. Enough to live on but not enough to move out of the uncle and Aunt’s house in Belair.
We looked at changing the business from a sole trader to a limited company. But what is the business? It is the staff, the customers, the suppliers, the equipment, and the shop fittings. Plus, the business can’t survive without cash so money must go in for working capital.
Transfers the Assets
Prince transfers the assets to the new company. The assets in the final set of sole trader accounts to the 31st of March 2023 are
| Fixtures & Fittings | €15,000 |
| Equipment | €10,000 |
| Stock | €5,000 |
| Debtors | €4,000 |
| Cash | €21,000 |
| Total | €55,000 |
For Capital allowances purposes, the tax written down value [twdv] of the fixtures and fittings is €17,500. The twdv of the equipment is €12,500. Prince gets a valuer to value the fixtures and fittings and the equipment. The valuer values them as follows
| Fixtures & Fittings | €20,000 |
| Equipment | €15,000 |
So, the open market value of the Fixtures and Fittings is €20,000 but the twdv is €17,500. Similarly, the open market value of the equipment is €15,000 but the twdv is €12,500. As a result, for capital allowances purposes, Prince makes a profit on the transfer of €5,000. That would result in a balancing charge of €5,000. The tax on that at 52% would be €2,600.
But there’s a way to avoid this balancing charge. Prince and the company can elect to transfer the assets at the tax written-down value. The company will then claim capital allowances on the twdv over the remaining writing-down period of the asset. What I mean by that is that you need to look at each asset. The writing down period of most assets is 8 years. If 3 years have passed, then the remaining period is 5 years.
Director’s Current Account
Think of the Director’s current account as money that the company owes you or you owe the company. If you transfer more assets than liabilities the company owes you money. That’s the position you want to be in. And you owe the company money if more liabilities than assets transfer over.
The value of the assets that Prince transfers over is
| Fixtures & Fittings | €20,000 |
| Equipment | €15,000 |
| Stock | €5,000 |
| Cash | €10,000 |
| Total | €50,000 |
Rather than bring over all the cash Prince transfers €10,000 to the company bank account. He keeps €11,000 in the sole trader bank account so there are enough funds to pay creditors and some tax bills. He’ll also collect the money he’s owed from debtors in the sole trader account.
Maximising the value of the Director’s current account on the transfer makes sense. There can be tax bills when setting up the company or Income Tax bills arising from the sole trade business.
Goodwill
Goodwill is not easy to define. But you could say it’s the value of the business over the value of the assets of the business. If you ask a business owner, would they sell their business for the value of the business assets? I am sure you’d get a hard NO.
Per Revenue guidelines
“Goodwill is composed of a variety of elements and can include things like the good name and reputation of a business, its staff, business processes, etc.”
My view is if the business has
- Staff
- A brand
- Customer base
- Good business processes
- Can run without the business owner
then there is Goodwill. But how do you value the Goodwill?
Valuing the business
When valuing the business I have a simple solution. Talk to Ger. What’s important is to get a valuation report that backs up the value of goodwill. You as the company owner are connected to the company. Any transaction between the company owner and the company must be at market value. In the case of a Revenue review, they will look for the valuation report.
Looking at some very basic calculations the average profit in Prince’s business in the last 3 years was €90,000. He expects these profits to increase when in the company
| Average expected profits | €90,000 |
| Less average salary Prince | €50,000 |
| Future maintainable profits | €40,000 |
| Multiplier | 4 |
| Goodwill value | €160,000 |
I know Ger will be squirming in his seat when he sees my very basic calculations. But he’ll have to allow me some creative licence!
Impact of Goodwill transfer
The main impact of goodwill transfer is that you are transferring this asset to the company. There is no cost for the goodwill, and you are disposing of this asset to the company. So, there’s Capital Gains Tax. CGT at 33% gives the business owner a liability of €52,800. When Prince sees that number he wants to hit you given he wouldn’t have enough funds to pay the liability.
However, Prince could claim Entrepreneur’s Relief on the transfer. If he gets ER, then the CGT rate is 10% and not 33%. This would create a CGT liability of €16,000. His ability to pay this will depend on where the money is. If he doesn’t have personal funds to clear the liability, then he may need to take the money from the company. Prince opts for the Goodwill transfer. As this happens in April 2023 the liability is due by the 15th of December 2023. The Director’s current account will look like this
| Assets transferred | €50,000 |
| Goodwill transfer value | €160,000 |
| Less money used to pay CGT | (€16,000) |
| Director’s current account balance | €194,000 |
Word of caution
A word of caution in two areas. Firstly, to get ER on the transfer of goodwill the business owner must meet some conditions. The reasons for the transfer must be bona-fide commercial reasons. Saving tax, while important, can’t be the main commercial reason.
For example, the owner is looking to expand and invest in the business. He wants to put in a new stocking system and open a shop in another location. To do this he’d need to borrow €100,000 from the bank. He meets the bank manager, and she tells him that he’d have a better chance of getting loan approval if the business was in a company. In effect, to get finance and expand the business a company structure is a must.
Another area of caution is personal goodwill. Back to the Revenue guidelines
“Goodwill attributable to the unique skills and personal experience of the proprietor is considered personal to the proprietor and cannot be transferred to any new proprietor. Where Revenue discovers any instances of transfers of personal goodwill, these will be thoroughly examined and fully challenged”
Revenue successfully challenged several medical consultants who transferred personal goodwill to a company.
Other Taxes
The other relevant taxes are Capital Gains Tax, VAT, and Stamp Duty.
CGT
We touched on CGT on the goodwill transfer but what about the transfer of other assets? There will be no CGT on the transfer of the Fixtures & Fittings and the equipment. That’s on the basis that the transfer value isn’t greater than the cost price. Take a piece of equipment that cost €20,000 two years ago. It’s unlikely the value of that equipment is more than €20,000 now. If it is, then there would be CGT on the excess value. Again, we’d look to see if ER could work to reduce the rate to 10%
There is no CGT on the transfer of stock or cash as they are not chargeable assets liable to CGT
VAT
There should be no VAT on the business transfer to the company. That’s because a VAT relief exists called Transfer of Business [TOB] relief. To avail of the relief the company must take over
- The complete business or
- A part of the business where the assets transferred can be operated as a business
Stamp Duty
There is no stamp duty on assets that pass by delivery. These assets can include stock, debtors, cash, equipment, and fittings. Usually, there would be no stamp duty on goodwill when passing it to your own company. Once there is no documentation, like a business transfer agreement, then there shouldn’t be stamp duty. However, you should take advice about your personal circumstances.
Summary
In summary, there’s quite a bit of work and planning to transfer from a sole trader to a limited company. We’ve done several business valuations to determine a goodwill number. We’ll advise clients to see if this is a runner or not as there’s a CGT cost and a valuation report cost too.
This can be a complex area, and other issues to focus on would be the company’s shareholding with a view to a future exit. However, we believe a corporate structure has huge benefits over a sole trader business. It gives greater flexibility and is the natural option for business growth.
If you need help setting up a company or transferring your business to a company, Start here
