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
Replies (15)
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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.
Reconsider the salary
£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. 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)
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.
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.
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.
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.
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
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. 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.
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.
Why the incorporation anyway?
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.
Seriously, pass this to someone else
First, stop using business and company as interchangeable. They really aren't, and your switching between them is not helping. 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 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.