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Goodwill Valuation Prior to April 2002, with the intention of selling on due to personal changes

Hi

I have a client who was a sole trader running a business from 1998 to 20/01/2014 at which time it was beneficial to incorporate, I have since been told that she is wanting to move away (personal reasons) (which means that she will have to sell up as her business and clients are located where she lives.)

The CG34 has not been sent to HMRC as yet, but the approach i am using to value this is taxable profits and a multiplier of 2.5.

Profits (profits + add backs - capital allowances) for the last three years are:

2011 - 37635

2012 - 43511

2013 - 51726

Average over 3 years is 44290 multiplied by the multiplier of 2.5 equals £110,727 worth of goodwill.

If this figure is agreed capital gains tax after entrepreneurs relief will be £9982.67 (110727-10900 Annual Exemption at 10%)

My concern is that do i really want the goodwill to be this high as I don't believe that my client will get anywhere close to this amount on the sale of the company and she would be paying unnesesary CGT in the event of it.

She will have losses to carry forward but will probably not use them, although having said that she has a number of properties!!!!

As she was running the company prior to April 2002, she can only get the relief on selling the business which isnt a problem providing that she can get a decent amount for it. Obviously if if the sole trader business started trading after April 2002, I would want to get as much as possible so that the client could draw on it from her DLA.

Is there anything that I have overlooked, and if you were in this position would you do anything differently?

Thanks in advance

 

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By DJKL
13th Aug 2014 15:26

Adjusted profit ?

 

If the client was active as a sole trader, doing a lot of work within the business, then the profits surely need adjusting for a reasonable notional salary to recognise her input. Using the profit without an adjustment of this sort may well vastly overstate the goodwill.

Not sure why you are calculating average profit to then arrive at goodwill on a "taxable profit" basis (capital allowances etc adjusted) I would use adjusted accounting profits.

I would take accounts profit, deduct "manager notional salary" if one would be required to operate the business, make notional adjustment if the business operated from "free premises/owned premises" and adjust for any "lifestyle" choice costs within the accounts. That would give  me normalised profits on which to base any goodwill calculation.

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13th Aug 2014 16:28

Thanks for the advice, 

Thanks for the advice, 

I used the average method as i had read this from another comment on another goodwill query on this site, what calculation would you use? 

(I may be having a blank memory moment) but!) are the taxable profits and adjusted accounting profits the same?

Thanks for the advice on the salary I hadnt thought of this and it will definately change the valuation, I will amend this for £10,000 salary each year which would be put through the company (providing NI and Tax rates, and employer allowances are still in place)

The business has rented premises so nothing would be adjusted for this.

In this instance would you want the goodwill valuation to be higher or lower and why?

Thanks

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13th Aug 2014 16:51

Reconsider the salary

A E Scott wrote:
I will amend this for £10,000 salary each year which would be put through the company (providing NI and Tax rates, and employer allowances are still in place)
£10,000 is the tax-efficient salary you might put through for an incorporated sole trader. It is not the salary that you use for a valuation. You need to think of it it the following terms. How much would you need to offer as salary to hire someone to do the same work the sole trader is doing now? If the business is a successful one, it is extremely unlikely the sole trader is only putting in the effort and skill of a £10,000 worker.
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By DJKL
13th Aug 2014 17:21

I Would ignore what was wanted and just value?

 

Not sure at £10,000 plus NIER re notional salary. You are not trying to replicate what would be the tax efficient salary through a limited company, you are trying to see what level of "super profit" beyond labour input is sustainable from this business. If you merely multiply the profits by a multiple without this you are not valuing the goodwill you are ascribing a capital value to the owner's labour .If the owner works full time in the business then £10,000 does not seem adequate to cover the cost if A N Other needed to be employed to fulfil her function.

I have no problem using the average adjusted profit, it is just that the adjustments I would make would have nothing to do with tax, I would be trying to calculate, after labour input, what average profits could be expected.

 

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By DJKL
13th Aug 2014 17:37

Sale of Business and losses you mention

 

A E Scott

In your original post you talk about losses on sale of business, which given your reference to properties, suggests to me you are thinking a CGT loss.

If the company currently owns the business, and sells the business at a loss, the loss on sale will belong to the company not the individual. If the company does not own the properties the capital loss in the company may well be wasted. If you are thinking of a  sale of the shares in the company then any gain/ loss will relate to the base price of the shares, not what the company paid for the goodwill.

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13th Aug 2014 17:38

The business is a cleaning business, which pays staff around the minimum wage mark.  The owner also does quite a bit of the cleaning as well as manage the invoicing, clients and all other managerial works.  I had changed the 10,000 salary each year to the following (10/11 £5,720, 11/12 £7,072 & 12/13 £7,488) which is what would have been paid if the company was also limited.  The company has around 10 staff.  What would you recommend is a valid salary amount to be?  (as the amendment I made whilst waiting for comments is lower than the original and much lower than what has been commented on)

Ill amend the calculation and add in the labour before the averaging

Thanks again for all of your guidance on this

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13th Aug 2014 18:26

How much do you think she would get for business on open market?

Tupe issues here in respect of staff?
Personal issues re goodwill?

I would not go for a valuation!

Would calculate a similar figure to that she received on open market and advise the client HMRC may well challenge and if they succeed there will be tax due.

Often I find you may go for a valuation and get into unnecessary arguments but if you just put it on the return there is no challenge.

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14th Aug 2014 08:24

I really have no idea what she could get for it, she is at the top of her game i think.

With regards to her staff, she wants to sell the business as a whole as the majority have been working for her for a while and she would have to pay redundancy if she laid them off.

The goodwill valuation is the main query as I don't want to put too much in if she is unable to use it, her properties are jointly owned and the annual expetion each year is more than likely to cover the profits, so dont see the point in making the goodwill too high in order to pay more CGT.

Would HMRC ever value the goodwill higher than the request?  

I thought you had to put the CG34 in?

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14th Aug 2014 09:23

CG34 optional and other thoughts

The CG34 is optional. If you submit one, and HMRC agree it, they can no longer challenge the value on the return. Without one, any figure you put down is open to challenge. HMRC are less likely to challenge a value on incorporation if, as in your case, the goodwill is not deductible in the company.

Speaking of which, your misuse of company to refer to the sole trade, and the imminent plans to sell, have somewhat obscured the fact this valuation is for incorporation. Running the "company" prior to 2002 has no effect on whether introducing goodwill creates a credit on the DLA. It only means that amortisation on that goodwill is not a deductible expense. The director is introducing a valuable asset and gets a credit for its value. Not sure how you intended to do the double-entry without a DLA credit.

You need to be clearer on the losses you say are carried forward. If sole trade losses, any unused are lost on incorporation. If limited company trade losses, then they either stay with the company on sale of shares, or are lost when the trade is sold. If CGT losses, why not used in your hypothetical goodwill CGT calculation?

You might be better passing this to someone else. Given this and other queries you have posted, I think you are well out of your depth here.

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19th Aug 2014 14:00

Thanks for the info. After reading this again after a goods nights sleep, I can understand why you may have thought I was out of my depth.  I have overlooked a few points which have been clarified.

I think I would prefer to send one in, just so HMRC cannot come back after it is agreed.

Yes the DLA credit would be used when bringing in the asset to the company (im not sure where i have advised that I wouldn't use a DLA?)  I advised in the initial query that I would want it as high as possible so that the director could draw on it.

I have since spoke to my client and she has advised that she has been offered £50,000 for the company, she thinks she will end up selling next year.

I have amended the notional salary to £18,000 each year which i find to be adequate and more realistic.

With regards to the CGT, I had overlooked this, (I didn't even see the comment) obviously if the company is sold, we would not want to create a capital loss as this would be lost on the sale.

After reading the losses comment, i had overlooked this also (and feel stupid for doing so - no remarks please) It's obvious NOW, that the loss would be with the ltd company and not the individual.

So having said that and taken on board all of the advice already mentioned, i am, now thinking to re-evaluate the goodwill to the amount that the ltd company can sell it for, this way the LTD wouldn't make too much profit or too much loss.

Another thought was, if my client is going to sell the ltd company next year, she may not have drawn all of the DLA, I would assume that she would therefore lose out, as she would have paid more capital gains tax to acquire this amount!  Or is there something that she can do (i'm assuming nothing)

Thanks again for all of your comments.

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21st Aug 2014 17:32

Still out of your depth

My original comment about you believing it couldn't go through the DLA was based on this sentence in the OP

OP wrote:
Obviously if if the sole trader business started trading after April 2002, I would want to get as much as possible so that the client could draw on it from her DLA.
The obvious implication being you believe that this is not possible as she started trading after April 2002. Drawing from the DLA is not affected either way.

But your last paragraph shows you still don't understand what is going on with the DLA. Let me spell it out for you.

The DLA means the company owes her, as an individual, money. If she sells the company, it will still owe her, as an individual, money. The amount owed to her will just show differently in the accounts once she ceases to be a director. She doesn't give up rights to money owed, simply by resigning as a director.

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22nd Aug 2014 12:16

I see what you are saying, but if the buyer has offered her £50k for the business, and she is owed from the business £30k, in essence she will be asking for £80k from the buyer in real money as the buyer would have to pay the debts owed!  This would probably result in a no deal situation.  if she agreed the £50k which includes her part, there would be a loss for the ltd which she will not be able to use as this was the only asset.  My client really needs to be able (in my opinion) to be able to have drawn all of what she is owed prior to selling the business for it to work.  

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By DJKL
22nd Aug 2014 12:43

Why the incorporation anyway?

A E Scott wrote:

I see what you are saying, but if the buyer has offered her £50k for the business, and she is owed from the business £30k, in essence she will be asking for £80k from the buyer in real money as the buyer would have to pay the debts owed!  This would probably result in a no deal situation.  if she agreed the £50k which includes her part, there would be a loss for the ltd which she will not be able to use as this was the only asset.  My client really needs to be able (in my opinion) to be able to have drawn all of what she is owed prior to selling the business for it to work.  

If the Company Shares are worth £50,000  because  the "business" is worth £50,000  when the company has no debt, then if company has £30,000 of debt the shares are then notionally worth £20,000. She would ask for £20,000 for the shares and a condition of sale would be that at settlement the company repaid the loan. (the purchaser injected funds into the company to enable it to repay the loan)

If the company sells the "business" for £50,000 then it uses £30,000 of the funds to repay her loan, pays any CT it may/may not be liable forand then the company possibly can be wound up distributing the remaining funds.

I really do not see in this whole exercise, if she intends to sell the business, why it is/ has been sold to the Limited Company in the first place?

A share sale seems far more complicated (and hence expensive re professional fees) with warranties etc flying around (I have yet to meet a cheap corporate lawyer) and if the company sells the business  then except for the proceeds repaying the loan account the remaining funds are stuck within the company.

I appreciate TUPE rules will likely bite if a sale of the business, but a share sale also passes to the purchaser of the shares all liability for previous errors re VAT/PAYE/ CT etc that the company may have made plus all  liabilities that may have arisen from the company's activities in the past (e.g I know of a cleaning company sued for a slip on a wet stair)

This strikes me as a classic case of "tax planning" possibly riding over the top of commercial reality. Share sales can be efficient but they can also scare away a number of prospective purchasers and therefore end up reducing the price achieved. At a business valuation of only  £50,000 a share sale may well not be the right way to go.

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23rd Aug 2014 10:49

Seriously, pass this to someone else

A E Scott wrote:
I see what you are saying, but if the buyer has offered her £50k for the business, and she is owed from the business £30k, in essence she will be asking for £80k from the buyer in real money as the buyer would have to pay the debts owed!  This would probably result in a no deal situation.  if she agreed the £50k which includes her part, there would be a loss for the ltd which she will not be able to use as this was the only asset.  My client really needs to be able (in my opinion) to be able to have drawn all of what she is owed prior to selling the business for it to work. 
First, stop using business and company as interchangeable. They really aren't, and your switching between them is not helping.

If someone offers £50k for the company, that is how they value it based on the balance sheet as it stands now. That balance sheet would include the £30k owed to the (current) director. If that creditor was not in the company, the balance sheet would show £30k more in net assets and the buyer should be offering £80k instead.

If someone offers £50k for the BUSINESS, then they are buying specific assets from the company. The director's loan account would not be one of these and would stay with the company. It would be the company and not the director who received the £50k on sale of the BUSINESS. £30k of that £50k could be drawn immediately to clear the loan.

In either case, she is not asking for £80k from the buyer. She is asking for £50k from the buyer, and £30k from the COMPANY that she is already owed. A prudent buyer will see that one of the creditors is the current director. They may insist on it being cleared prior to sale, but that is not the same as saying they should get a business worth £50k for £20k (£20k from the buyer plus £30k THE DIRECTOR IS ALREADY OWED does not make for a £50k sale value)

But this is really basic accounting. You carry on advising a client with your understanding, they are going to sell at undervalue. Sooner or later they will realise it was your advice that caused them to do this and sue you. Pass this on to someone else.

 

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27th Aug 2014 16:43

I intend to get a second opinion on this (as advised above) however if i don't try to get as much information as possible how on earth am i going to increase my knowledge base on the subject!

I was trying to plan the amount of goodwill carefully based on what the owner of the business thinks she can get when she sells the business (actual money), it makes sense to pay the directors account prior to this, my client incorporated as it was beneficial to do so at the time, there was no sign of selling the business in the near future, I thought (as did my client) that it would continue for another 13 years, it was personal circumstances that have lead to this potential change.

The concern that I had is if the goodwill is valued too high, she may not be able to pay herself the amount owed prior to selling the business (if selling quickly), this may lead to negotiations which do not benefit her, with regards to the limited company, this may lead to a loss on sale that cannot be used elsewhere and as an individual she may have paid too much in CGT to get the larger amount of goodwill which she may impact on the actual selling price for the business.

Thanks for reading and commenting.

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