Answers · UK 2025/26

How does Incorporation Relief work for Capital Gains Tax?

Incorporation Relief (TCGA 1992 s.162) defers CGT when a sole trader or partnership transfers their entire business -- as a going concern -- to a limited company in exchange wholly or partly for shares. The deferred gain reduces the CGT base cost of the shares received. Goodwill transferred to a related company is excluded by separate anti-avoidance rules.

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When a sole trader or partnership decides to incorporate their business into a limited company, they are disposing of business assets -- including goodwill, stock, equipment, and property -- to the new company. Without relief, this disposal would trigger Capital Gains Tax on the difference between the market value of those assets and their original cost. Incorporation Relief under s.162 TCGA 1992 defers that CGT. The conditions are: (1) a business must be transferred to the company as a going concern; (2) all of the business assets must be transferred (you cannot pick and choose -- though HMRC accepts minor retained assets in practice); (3) the consideration must be wholly or partly in shares (i.e. you receive shares in the new company rather than just cash). If some cash is received alongside shares, the relief is proportionally reduced -- only the fraction of the consideration represented by shares qualifies for the deferral. The deferred gain is deducted from the base cost of the shares in the company, meaning the CGT is not permanently avoided but is deferred until those shares are eventually sold. Important restriction: goodwill transferred to a company that is a "related party" (i.e. where the sole trader/partner has at least a 5% interest in the company) is excluded from Incorporation Relief and from Business Asset Disposal Relief for the goodwill element, under anti-avoidance provisions introduced in 2014-15 (ITTOIA 2005 and targeted goodwill anti-avoidance). This means the goodwill gain is fully chargeable at 24% even if the other business assets qualify for the deferral. In practice, incorporation for most professional service businesses with significant goodwill now requires careful modelling of the goodwill tax cost vs. corporate tax savings to determine whether incorporation is worthwhile. Entrepreneurs may prefer to gift rather than sell goodwill to the company and use Holdover Relief under s.165, but this too is restricted for related companies since 2014. Seek specialist advice before incorporating a business with significant goodwill.