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Goodwill and incorporations

Goodwill and incorporations

Here is a scenario which has not happened to me (yet!) but I have been thinking about recently.

Very profitable Business incorporates.

Accountant assists client with goodwill valuation, and a substantial directors loan account is created. The valuation utilises a multiple of owners benefit of 2-3 times.

Amortisation is claimed as a deduction in the company P&L.

Some years later the company successfully disposes of the business to a third party for eight times profits. A substantial corporation tax bill results.

The director is unhappy as he has sold the business to the company too cheaply. Overall the company and director have paid more tax than the optimum amount.

Director sues the accountant.

Comments please.

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By Locutus
01st Jan 2013 18:31

The director would struggle with the claim

If the accountant has applied a reasonable methodology for making the valuation then I can't see how the director could successfully sue the accountant several years down the line.  Nobody can predict the future.  In 10 years time a company might be sold for 8 times profits, 2 times profits or have gone bankrupt.

Also, it is entirely possible in those intervening years between the accountants valuation and the sale to the third party that a substantial amount of value had been added to the business, which necessitates the third party having to pay a premium to acquire it.

I would be sceptical of any accountants valuation that valued a small business that probably hasn't been trading for many years at 8 times profits.  More importantly so might HMRC.

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By Old Greying Accountant
01st Jan 2013 19:50

Wouldn't ...

... the the owner sell the shares and get ER on the proceeds? Or if a partial disposal hive the bit to be sold to a separate company first?

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02nd Jan 2013 09:58

"Director sues accountant" - comments please

If Director felt that accountant had been negligent he/she would approach a lawyer who would advise on the prospect of succeeding in a negligence claim against the accountant. An 'expert witness' would then normally be engaged to advise on the issue. I have fulfilled such a role in the past.

The fundamental question would be whether the accountant did all that 'a reasonably competent' accountant would have done at the time of the incorporation. This would depend on whether they can evidence a number of things - such as compliance with the Guide to Professional Conduct for those working in or advising on tax matters. This includes a statement requiring 'reasonably competent' accountants to seek input from experts when advising on issues outside of their day to day expertise.

So the likelihood of a claim succeeding would depend on whether the valuation at the time of incorporation was negligently prepared. 

I would suggest that non-expert accountants would exclude themselves from liability as to the directors' valuation at the time of the incorporation; and advise the directors to obtain a formal valuation from a specialist. If the directors do not do so then it is their valuation and the accountant has not been negligent.

Mark

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02nd Jan 2013 09:40

Passage of time a good point

One point that someone has made above is that in itself the passage of time and therefore greater maturity of the business might give rise to a higher multiple than if the business had been trading for only a short while.

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02nd Jan 2013 10:01

Use a professional valuar

Seen this before and as an accountant, it may be within our domain to provide such valuations. But to avoid future conflicts and PI issues, I always use an independent valuar. This helps in cases where HMRC may challenge the valuation of the G/W.

I would however agree with the comment above that over the passage of time conditions have changed which cannot be foreseen in valuing any business.

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02nd Jan 2013 10:31

Explain the consequences

Ignoring the increase in goodwill between incorporation and sale (which clearly wouldn't give a 'suing opportunity'!), if a valuation is undertaken correctly (and most likely agreed with HMRC) there shouldn't be a problem. More of a problem would be a sale of goodwill to the company at an undervalue (to avoid a large tax hit on incorporation which would have to be paid out of money not yet received). But a good accountant will explain the consequences to the client who can then make an informed decision. Similarly one should always explain to the client that the relief for amortisation may turn out to be only a cash flow advantage if the goodwill is ultimately sold rather than the shares being sold (and even if the shares are sold the potential CT bill on goodwill could affect the price!). That's not to say one shouldn't do it - but it is good practice to always advise clients of the possible outcomes in writing where they are making a decision based on your advice - they have a nasty habit of forgetting that you gave them different options when the one they chose turns out to be the costly one!

Cathy

[email protected]

 

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04th Jan 2013 11:02

.

When I do a valuation (typically for small values under £1 million) its WITH the client, not FOR the client. We discuss a wide range of values and factors and put together a case for CT41G purposes. I don't pluck a number and tell them this is it. Moreover the client signs off on it, just like anything else so not sure how any risk would arise. 

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