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Incorporations and existing contracts

One of my clients wishes to convert their husband and wife partnership to a limited company. The husband is the main fee earner and his wife does a bit of admin work. Being an estate agent and property consultant, most of his fees only materialise when contracts are exchanged.

When the business is incorporated there are likely to be a few ongoing contracts. As the fee income cannot be recognised until contracts are exchanged there is no accrued income to go in the cessation accounts, even if most of the work has been done, as the fee would not be payable if the sale falls through. Therefore, it forms part of the goodwill valuation and is not part of the net assets acquired.

My query is whether you can time the incorporation to take advantage of this so you can maximise the value of the goodwill for pending contracts. Would that be seen as an arrangement substantially to avoid tax or would it get by on the basis that the incorporation itself is for commercial reasons? I wouldn't have thought HMRC could interfere with timings.

The advantage of course is that the partners only pay 10% CGT with entrepreneurs relief. The company would pay 20% corporation tax when the fees become payable but can offset that with tax relief on the amortisation. True, there is a cash flow effect as we would only amortise over 4-5 years, and we would have to do some sort of risk analysis on the value of the prospective fees and discount them accordingly, but the partners would still be saving a fair bit in tax, plus class 4 NI of course.

Can anyone see any pitfalls here? Being an estate agent he's familiar with the concept of huge fees for doing very little work, so I'm hopeful of a fat fee here! I quoted him 12.5% of the tax savings on the incorporation (excluding the ongoing ones you would get through a company anyway). Good advice from that book advertised on AW by Steve Pipe: Practical Pricing for Accountants. Well worth a read.

Chris

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28th Mar 2011 08:55

Goodwill amortisation

Are you sure that the company will be allowed to claim tax relief on the amortisation of the Goodwill?  As there are rules regarding the transfer of intangibles between related parties which could prevent this.

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By blok
28th Mar 2011 09:37

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Why would you recongnise the WIP as goodwill.  Either it is included in his sales or it is not complete enough to recognise the asset.  

Goodwill is an intangible, it is the value of the business over and above the net assets, (not the debtors or WIP  that you deliberately haven't recognised in the balance sheet!)

In my opinion it appears that you are being a bit aggressive with this. 

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By cfield
28th Mar 2011 10:12

WIP and related parties

As far as I know, goodwill is only restricted on sales to related parties if it was created earlier than 6 April 2002. If that rule still existed for businesses created since then, accountants doing incorporations would not be able to charge such high value-based fees.

Re Blok's comment, the value of the fees is not actually WIP as they cannot be recognised as income until contracts are exchanged, even if instructions have been accepted and most of the work carried out. If the sale falls through, no fee would be earned. Therefore, the prospective fees are just as much goodwill as the prospects of earning more fees from the business in future. For that reason, I would try and apply some risk analysis to them based on the odds of contracts being exchanged and then deduct an appropriate discount.

What I really want to know is whether it is legit to time the incorporation to maximise the tax efficiency of these fees, as the partners would effectively only pay tax at 10% on them given that the company can claim relief on the amortisation over say 4-5 years, and thus eventually pay (almost) no corporation tax on them.

Chris

 

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28th Mar 2011 11:00

Scope for HMRC challenge

Connected to Blok's comment, I think I understand what you're saying but it seems that there is scope for HMRC challenge on the business valuation.  Typically you might use an earnings multiple.  What you are describing is something completely different, which is neither a net assets basis nor an earnings multiple.  It seems like a  weakness in than an Inspector could simply challenge your unusual valuation method and try to adjust it downwards.

That aside, I cannot see why any tax provisions would apply to prevent you choosing the most tax efficient time to incorporate a business.  That's just sensible tax planning.

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By cfield
28th Mar 2011 11:20

Method of Valuation

I should stress here that we would not be departing entirely from the usual method of valuing goodwill as we would still be using an earnings multiple for the "normal goodwill" arising from future income expectatations and discounting it by say 50% for the element attributable to the partners. The prospective fees would be treated more as a contingent asset as they are more of a "known unknown" to coin a current phrase. As the earnings multiple is usually only around 1 to 1.25 for professional firms where goodwill is based on turnover rather than profit, it seems to me that at the end of the day there would be very little difference anyway.

I think that so long as we keep the lid on these fees and don't come up with hair raising numbers, we should be OK.

Chris

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