Are you considering transferring your sole-trader business to a company in the next year or two? If so, there are some dos and don’ts you should be aware of to ensure the process is as tax-efficient as possible.

Capital allowances

Tax relief for business equipment purchases is provided via Capital Allowances (CAs). Depending on the nature of the equipment and other qualifying criteria, you may claim:

• Annual Investment Allowance (AIA): Allows full tax relief for qualifying expenditure up to a limit in the year of purchase.
• Writing Down Allowances (WDA): Allows tax relief spread over multiple years on a reducing balance basis.HMRC Guide on Capital Allowances

Special rules apply in the final period of a sole trade or partnership before incorporation that may restrict or eliminate these allowances.

Transferring to a company

When a sole trader or partnership incorporates, HMRC treats this as a cessation of trade, triggering special cessation rules for capital allowances.

This means:

• Assets are deemed sold at market value for the old business
• The new company is deemed to acquire those assets at that same value

This can lead to a clawback of previously claimed capital allowances.

See HMRC CA Manual 29030

Avoiding a market value charge

To prevent a clawback of allowances, you can make a Section 266 CAA 2001 election. This allows both businesses to agree on a transfer value for tax purposes, often set so no gain or loss arises.

Election to transfer assets at tax written down value – See CA29040

Example: Ben & Holly

Ben and Holly, partners in a hair and beauty business, plan to transfer the business to a new company, B & H Ltd, in 2025/26.

Five months before the transfer, they purchase equipment costing £150,000.

Usually, this qualifies for full AIA. However:

• The AIA cannot be claimed in the final accounting period of a sole trade or partnership. See HMRC manual 23270
• The connected party rule prevents the new company from claiming AIA on transferred equipment.This leaves the company with only WDAs — just 18% tax relief in the first year and progressively less each year. It could take 20+ years to claim full relief.

A better approach

To ensure maximum tax efficiency:

• Shorten the final accounting period of the partnership so that the equipment purchase falls in the penultimate period
• Claim the AIA in that earlier period
• Make a Section 266 election to avoid any clawback of CAs

Updated example:

If Ben and Holly’s partnership has a final accounting period ending 31 December 2025, but they buy equipment on 31 July 2025, they can:

Draw up two sets of accounts:

• 1 Jan – 31 Jul 2025
• 1 Aug – 31 Dec 2025
• Claim AIA on the full £150,000 in the earlier period
• Make a Section 266 election to transfer the equipment at tax written down value to B & H Ltd.

Summary

To maximise tax relief when incorporating:

• Avoid purchasing equipment in the final accounting period
• If equipment must be bought before transfer, shorten the final period so it falls in the earlier year.
• Make a Section 266 election to avoid clawback of allowances
• Consider delaying equipment purchases until after incorporation.

If you’d like professional guidance tailored to your circumstances, please contact: kevin@kwaccounting.com