Incorporation Relief: Converting a Sole Trader to a Limited Company 2026/27
How Incorporation Relief automatically defers CGT when a sole trader transfers their business into a limited company for shares -- conditions, BADR interaction, and a worked example for 2026/27.
What Is Incorporation Relief?
When a sole trader or partnership converts their business into a limited company, the transfer of the business (including any goodwill it has built up) is a disposal for Capital Gains Tax purposes, even though no money necessarily changes hands with a third party. Without relief, this could create a significant CGT bill on the value of goodwill transferred, at a point when the business owner has received shares rather than cash.
Incorporation Relief (under section 162 of the Taxation of Chargeable Gains Act 1992) solves this by automatically deferring the gain. Instead of taxing the gain immediately, the relief reduces the base cost of the shares the owner receives in the new company. The gain is not lost -- it is rolled forward and becomes chargeable only when those shares are eventually disposed of.
This is one of the most commonly used reliefs when sole traders and partnerships incorporate, because it removes an immediate cashflow problem: paying CGT on goodwill you cannot easily realise in cash at the point of incorporation.
Qualifying Conditions
For Incorporation Relief to apply automatically, three core conditions must be satisfied:
- A business is transferred as a going concern. This means an actual trading business with ongoing operations, customers, and goodwill -- not simply a collection of assets.
- All the assets of the business are transferred to the company, with the practical exception of cash, which HMRC accepts can usually be retained without affecting the relief.
- The consideration for the transfer is wholly or partly shares issued by the company to the business owner.
If any of these conditions is not met -- for example, if the owner retains a business asset such as premises outside the company, or if the business is not genuinely transferred as a going concern -- the relief can be restricted proportionately or lost entirely.
How the Deferral Works in Practice
The value of the goodwill and other chargeable assets transferred becomes the consideration for the new shares. If that consideration exceeds the owner's original base cost in the business (which for goodwill built up organically is often close to nil), a gain arises.
Instead of charging CGT on that gain immediately, Incorporation Relief reduces the base cost of the new shares by the amount of the gain. In effect:
- Market value of assets transferred: £X
- Original base cost of those assets: £Y
- Gain arising: £X minus £Y
- Base cost of new shares received: £X minus the deferred gain (i.e., reduced back down towards £Y)
When the owner later sells or gifts the shares, the deferred gain forms part of the chargeable gain on that disposal, taxed at whatever CGT rates and reliefs apply at that future date.
Part Cash, Part Shares Consideration
Many incorporations are not funded entirely by shares. It is common for the new company to also credit a director's loan account to the owner, effectively giving part cash (or a debt owed to the owner) and part shares as consideration.
In this situation, Incorporation Relief only applies proportionately to the share-funded element. The proportion of the gain attributable to non-share consideration (cash or a loan account credit) is chargeable to CGT immediately, in the tax year of incorporation, in the normal way.
Example split: If total consideration is £200,000, made up of £50,000 credited to a director's loan account and £150,000 in shares, then 75% of any resulting gain qualifies for Incorporation Relief and 25% is taxed immediately.
Interaction with Business Asset Disposal Relief
This is where incorporation planning gets genuinely strategic. Business Asset Disposal Relief (BADR) reduces the CGT rate on qualifying gains to 18% from April 2026 (up to a £1 million lifetime limit), compared with the standard 18%/24% rates.
Because Incorporation Relief defers the gain rather than charging it at incorporation, the gain is not taxed at incorporation at all -- it is taxed later, when the shares are sold. This means:
- If BADR rates or the lifetime limit change unfavourably in future, a deferred gain could end up taxed less favourably than if it had been crystallised now.
- Sole traders who are confident they will sell the shares (or the company) within a reasonable timeframe, and who want to lock in a known BADR outcome today, sometimes elect to disapply Incorporation Relief under section 162A TCGA 1992, so the gain crystallises immediately at incorporation and BADR is tested and claimed at that point instead.
- Disapplying relief means paying CGT now (using cash from outside the business, since incorporation itself does not generate cash), which is a real practical constraint for many business owners.
Worked Example
Priya has run a consultancy as a sole trader for 8 years, building up goodwill now valued at £300,000, alongside minimal other chargeable assets. Her original base cost in the business was negligible. She incorporates, transferring the whole business (goodwill plus a small amount of equipment already relieved through capital allowances) to a new limited company, Priya Consulting Ltd, in exchange entirely for 100 ordinary shares.
- The transfer generates a gain of approximately £300,000 (market value of goodwill minus negligible base cost).
- Because the whole business transfers and consideration is entirely shares, Incorporation Relief applies automatically.
- No CGT is due at incorporation. Priya's base cost in her 100 shares is reduced to reflect the £300,000 deferred gain.
- Five years later, Priya sells the company for £600,000. Her chargeable gain on the share sale includes both the growth since incorporation and the originally deferred £300,000 goodwill gain, assessed under the CGT and BADR rules applicable at the time of that sale.
Other Practical Considerations
- VAT: incorporating a VAT-registered business can usually be structured as a Transfer of a Going Concern (TOGC), meaning no VAT is charged on the transfer, provided conditions are met.
- SDLT: transferring property as part of the incorporation is a chargeable transaction for Stamp Duty Land Tax at normal rates on market value, even between a sole trader and their own new company.
- Goodwill amortisation: since April 2015, Corporation Tax relief for the company amortising purchased goodwill on incorporation has been heavily restricted, so the tax benefit to the company of paying for goodwill is limited -- this is a separate consideration from the CGT treatment for the individual.
- Ongoing NI position: shifting from sole trader Class 2/4 NI to a company structure changes National Insurance treatment going forward, which is a separate planning question from the CGT mechanics of incorporation itself.
Sources
Frequently asked questions
What is Incorporation Relief?
Incorporation Relief is an automatic Capital Gains Tax relief that applies when a sole trader or partnership transfers the whole of their business, including goodwill and other chargeable assets, to a limited company wholly or partly in exchange for shares. It defers the CGT that would otherwise arise on the transfer by rolling the gain into the base cost of the new shares.
Do I need to claim Incorporation Relief or does it apply automatically?
Incorporation Relief applies automatically if the qualifying conditions are met -- there is no election required. However, you can elect to disapply it (under section 162A TCGA 1992) if you would prefer to pay CGT immediately, for example to use Business Asset Disposal Relief at the point of incorporation rather than later.
What conditions must be met for Incorporation Relief to apply?
The business must be transferred as a going concern, all assets of the business (or all assets except cash) must be transferred, and the consideration received must be wholly or partly in shares issued by the company. If any of these conditions fail, such as retaining a business asset outside the transfer, the relief is restricted or lost entirely.
Does Incorporation Relief cover all business assets or just goodwill?
It covers all chargeable assets transferred as part of the business, most commonly goodwill and any business property, but not assets like plant and machinery, which typically do not generate chargeable gains in the same way and are dealt with under capital allowances rules instead.
What happens to the deferred gain when I sell my shares in the new company?
The gain rolled into Incorporation Relief reduces the base cost of the shares you receive. When you eventually sell or gift those shares, the deferred gain forms part of your chargeable gain at that point, taxed under the CGT rules in force at the time of that later disposal.
Can I still claim Business Asset Disposal Relief if I use Incorporation Relief?
Potentially, but there is a timing issue. Incorporation Relief defers the gain into your shares rather than crystallising it at incorporation. If you want to lock in the current BADR rate on the goodwill gain immediately, you may need to elect to disapply Incorporation Relief so the gain crystallises at incorporation and BADR can be claimed then, subject to meeting BADR's own qualifying conditions.
Is Incorporation Relief available if I take part cash and part shares?
Yes, but only proportionately. If the consideration is part cash and part shares, only the proportion relating to the share consideration qualifies for deferral. The proportion relating to cash consideration is treated as a normal disposal and is chargeable to CGT immediately in the tax year of incorporation.
Does Incorporation Relief apply to goodwill for all types of business?
It can apply to any unincorporated trading business, but professional practices (particularly those where personal reputation, not the business itself, generates the goodwill) can face HMRC challenge over the existence and value of transferable goodwill. Since 2015, Corporation Tax relief for goodwill amortisation on incorporation has also been heavily restricted, which is a separate but related consideration for the new company.
What if I don't transfer all the business assets to the company?
Incorporation Relief requires transfer of the whole business as a going concern. If you deliberately retain an asset, such as keeping a business property outside the company and licensing it back, that asset is excluded from relief and the relief on the remaining assets can be restricted on a just and reasonable basis, so retained assets need careful planning.
Are there National Insurance or Stamp Duty implications on incorporation?
Incorporation Relief only deals with CGT on chargeable assets. Separately, transferring property into the company can trigger Stamp Duty Land Tax (SDLT) at normal rates on the market value transferred, and VAT-registered businesses need to consider the Transfer of a Going Concern (TOGC) rules to avoid a VAT charge on the transfer.
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