Taking part of the value as a loan rather than shares shrinks incorporation relief proportionately, and the goodwill left in charge rarely gets the tax rate people expect.
Zazentax Incorporation Relief Series, Part 2 of 3 · Updated July 2026 · Reading time: about 6 minutes
Part 1 of this series showed the clean case: a sole trader receives shares for the full value of their business and defers the whole gain. In practice, many incorporations do not work quite so tidily. A new company often cannot afford to issue shares for the entire value of the business it is taking on, so part of the amount is left owing to the former sole trader on a director’s loan account instead, a balance they can draw down in cash later as the company can afford it. That choice, sensible as it sounds for cash flow, has a direct and calculable effect on how much tax relief survives, and it interacts with a second rule that catches out almost every unincorporated business owner who has not been warned about it.
How the Loan Account Shrinks the Relief
Incorporation relief only defers the proportion of the gain that corresponds to the shares received, out of the total value of everything the individual is given in exchange for the business. The formula is the gain multiplied by the value of shares received divided by the total consideration. Whatever fraction of the payment arrives as cash or as a loan account balance rather than shares is simply not covered, and the corresponding slice of the gain becomes chargeable immediately.
Callum runs an engineering repair business and incorporates it into Callum Engineering Ltd, transferring the premises, the goodwill, his equipment and his current assets, exactly as the rules require. The premises cost him £100,000 and are worth £260,000, a gain of £160,000. The goodwill cost nothing and is valued at £90,000, so the whole amount is gain. His equipment, valued at £25,000, is exempt under the rules for smaller machinery, and his current assets of £25,000 fall outside Capital Gains Tax entirely, as before. His total chargeable gain before relief is £160,000 plus £90,000, which equals £250,000, and the total value of everything transferred is £260,000 plus £90,000 plus £25,000 plus £25,000, which equals £400,000.
The new company offers Callum £300,000 of ordinary shares and leaves the remaining £100,000 outstanding on a director’s loan account. His incorporation relief fraction is therefore £300,000 divided by £400,000, which equals three quarters. Applying that fraction to his £250,000 gain gives £187,500 of relief, leaving £250,000 minus £187,500, which equals £62,500 chargeable straight away, in the tax year of incorporation. His base cost in the new shares is £300,000 minus £187,500, which equals £112,500.
Key point: Every pound taken as a loan account balance instead of shares reduces the relief by the same proportion across the whole gain, not just against the asset you might expect. Cash flow convenience on day one has a tax cost that lands immediately.
The Goodwill Trap: A Lower Tax Rate That Is Not Available
Callum’s £62,500 chargeable gain is where a second rule quietly changes the outcome. Business Asset Disposal Relief, usually shortened to BADR, taxes qualifying business gains at a reduced rate, 18% for 2026/27, instead of the standard rates that otherwise apply to gains once the annual exempt amount is used up. It would be reasonable to assume that incorporating your own business, keeping a substantial shareholding, and continuing to run it counts as exactly this kind of qualifying disposal.
For the premises, it does. But for goodwill specifically, a targeted anti-avoidance rule blocks BADR whenever the goodwill is transferred to a close company, broadly a company controlled by its directors or a small number of shareholders, and the person transferring it holds 5% or more of the shares or voting rights immediately afterwards. Since Callum keeps well over 5% of Callum Engineering Ltd, his goodwill gain is permanently excluded from the reduced rate, taxed instead at the standard rate that applies to his other income.
Splitting his £62,500 chargeable gain by asset in the same three quarters proportion as before, the premises contribute £160,000 multiplied by one quarter, which equals £40,000, eligible for BADR, and the goodwill contributes £90,000 multiplied by one quarter, which equals £22,500, excluded from BADR. Assuming Callum has already used his annual exempt amount against other gains earlier in the tax year, his Capital Gains Tax is £40,000 at 18%, which is £7,200, plus £22,500 at the standard higher rate of 24%, which is £5,400, giving a total of £12,600.
Action required: If your business has meaningful goodwill and you plan to keep at least 5% of the new company, budget for standard rate tax on the goodwill element of any chargeable gain at incorporation, not the lower BADR rate. This single rule is the most common source of an unwelcome tax bill in incorporation planning.
Why This Matters for the Deal You Structure
Two decisions, made before a single form is filed, control the entire outcome. First, how much of the consideration is shares versus a loan account: every pound moved from loan to shares increases the deferred proportion and reduces the immediate bill. Second, recognising that goodwill will never benefit from BADR while you retain a meaningful stake changes how the trade off between cash now and shares now should be evaluated, since the goodwill portion of any immediately chargeable gain is taxed at the full rate regardless of how the rest of the deal is structured.
Key Takeaways
- Incorporation relief only covers the proportion of the gain matching the shares received; anything paid as cash or left on a loan account is chargeable immediately.
- The formula is gain multiplied by shares received divided by total consideration, applied to the whole gain.
- Business Asset Disposal Relief at 18% can apply to the immediately chargeable gain on premises and other qualifying assets.
- Goodwill transferred to a close company you control at 5% or more never qualifies for BADR, whatever else applies, and is taxed at the standard rate instead.
- Structuring more of the consideration as shares increases deferral; structuring less increases the immediate bill, and the goodwill slice of that bill is always taxed at the higher rate.
Structuring a Loan Account Into Your Incorporation Deal?
The share-to-loan split decides how much of your gain defers, and the goodwill rule decides the rate on what is left. Zazentax can model both before you commit, so the cash flow you want on day one does not cost more than it saves.
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