Pre-trading and Pre-incorporation Expenditure

Pre-Trading Expenditure

The scope of pre-trading expenditure for sole traders is covered in s57 Income Tax (Trading and Other Income) Act 2005 (“ITTOIA05”) and s61 of the Corporation Tax Act 2009 (“CTA09”) for companies.

The legislation is applicable to revenue expenditure which is incurred by a trader 7 years prior to the commencement of trade. The expenditure would only qualify for relief if it would be allowable if incurred after the trade had commenced. It is therefore necessary to apply the wholly and exclusively test to the expenditure in question to determine whether relief is due.

Assuming it meets these rules, then relief is claimable as if this expenditure had been incurred on the first day of trading.

For capital expenditure, we must look at s12 of the Capital Allowances Act 2001 (“CAA01”), which states that plant & machinery capital expenditure incurred before the commencement of a qualifying activity (trade) and similarly, this should also be treated as if it were incurred on the first day of trade.

The tax treatment of any qualifying capital expenditure will depend on whether the trader is using the accruals or cash basis for preparing their accounts.

Pre-Incorporation Expenditure

What if the company does not exist at the time the contract is entered into by the would-be director? To answer this, we must look at s51 of the Companies Act 2006, which states:

“51Pre-incorporation contracts, deeds, and obligations

1. A contract that purports to be made by or on behalf of a company at a time when the company has not been formed has effect, subject to any agreement to the contrary, as one made with the person purporting to act for the company or as agent for it, and he is personally liable on the contract accordingly.

2. Subsection (1) applies—

                               a. to the making of a deed under the law of England and Wales or Northern Ireland, and

                              b. to the undertaking of an obligation under the law of Scotland,

                                  as it applies to the making of a contract.”

For tax purposes, this has the effect of the individual purporting to act as an agent for the company as incurring the expense personally, and so pre-trading expenditure rules will not apply.

So how can relief be obtained for pre-incorporation expenditure?

If no trade exists prior to the new company, incorporation relief (not explained in this article) will not be available.

However, a director/shareholder can introduce assets owned personally into the company. For capital expenditure, ss13-13a CAA01 states that a person may bring the asset into the company to be used for a qualifying activity at the market value at the date the asset is transferred, unless the cost is less than the market value, in which case the qualifying expenditure is the cost less any deduction that must be made under the anti-avoidance provisions. This general rule is subject to special rules for long-funding lease assets.

No AIAs will be available as the capital asset is acquired from a connected party.

Revenue expenditure (bar that of acquiring trading stock which can then be transferred at market value into the company unless an election under s167 CTA 2009 and s177 ITTOIA 2005 is made) will attract no relief.

It is therefore important to wait until the company is incorporated before entering into contracts for goods and services.

Michael Bleyswyck
External Consultant

For more information, please contact us at: consultancy@vantagefeeprotect.com