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Sole Trader to Limited Company

A client is looking to move from a sole trader to a limited company. In terms of the treatment of her sole trader capital account balance , my understanding is this will become the goodwill of the limited company (or even a Loan ?) which is the available to de drawn tax free if the client wishes. 

Is this correct ?

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Cart before the horse

If I have understood your question correctly I think you have got the sequence back to front.

Goodwill is calculated, HMRC agreement obtained, and you can then credit the Capital Account(s) to balance the debit of Intangible assets.

The capital account can then be drawn upon tax-free, but the goodwill 'sold' by the sole trader may generate a CGT liability.

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Sole Trader to Limited Company

Ok thanks, can you tell me the best way to gain HMRC agreement on the goodwill generated ? How would you go about this ?

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Rough Guide

Roughly speaking, and in very basic terms, you value the business, and there are many different ways of valuing a business. It is advisable to do two or more valuations using different methods.

A sole trader valuation will be more limited, as the goodwill may be attributed to the person, rather than the business, but can be done.

The valuation, and supporting calculations, are sent to HMRC on form CG34. It is a while since I did a valuation but HMRC responded within 1 or 2 months.

I hope this helps.

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Shirley

you can't be serious about HMRC agreement..(with apologies to "Airplane") ?

Agree with prior post with caveat that the HMRC agreement bit is not mandatory and as long as you are happy with your assessment of the goodwill and you make the client aware HMRC may have a pop not usually advisable unless the amounts are substantial..

I always draw up a contract as well.

pembo

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Pembo

Yes, that is what an FCA taught me many years ago and as I have never heard anyone say it is inadvisable I have stuck with it. Why it is not advisable?

PS. I am not 'having a go at you'. If there are reasons that now make it inadvisable I would prefer to know, rather than stick my head in the sand and carry on with outdated methods.

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on reflection

...perhaps "inadvisable" was the wrong word however if you are sure of your ground then why flag it to them unless the client wants to...this is usually only an issue with related party transactions and in particular incorporations...for substantial sums I usually get a third party valuation anyway (e.g. doing one for a pharmacist  where it was worth paying £400 for a £1.5M valuation) and with less material transactions the contract sum is always conditional to such future reassessment as may be agreed with HMRC ...

perhaps the primary consideration is the perception of your relationship with HMRC (and that of your client) ...... mine has always been that HMRC know on a need to know basis unless the client prefers otherwise ...but then again I'm also old and grumpy Shirley...no right or wrong just we all do and view things differently at times..

pembo

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Thanks Pembo

My policy is to get any potential problems out of the way as soon as possible, so it sounds like my method is best for me, but not necessarily the best for everyone.

Thanks for explaining why you choose a different method.

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HMRC Valuation of Goodwill?

I was under the impression that HMRC would not give an agreement to a valuation of goodwill. They tell you to put it on the self-assessment return (assuming it is enough to be a capital gain) and then they will look at it!

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Form CG34

Yes, they will. I have obtained agreements from HMRC on valuation of goodwill. I know of other accountants that have obtained agreement, too, so I know I am not the exception.

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Thanks ShirlyM. I knew you used to be able to do this. For some reason I thought they had stopped.

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Timing of valuation

The implication of this thread is that you can get HMRC's agreement in advance of entering into the transaction.  Is that really true?  CG34 is of course a request for a "post-transaction" valuation and I've never seen it suggested that it can be used to obtain an advance ruling.  Have I misunderstood what is being said here?

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CT charge

Just to throw into the ring that although there may be a CGT charge HMRC will look to recoup corporation tax on the amortisation charges of the goodwill ie it is a dissallowable expense unless stringent provisions regarding goodwill are met so technically speaking your client wont get all of his/her money tax free.

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Get the valuation agreed by HMRC

Unless the goodwill is obviously fairly low, it is certainly good practice to agree a valuation of the goodwill with HMRC.

In most cases you want the goodwill to be as high as you can realistically get it, in order to create the director's loan account for future use. You need to weigh up the likely CT and IT position, versus the likely level of drawings and any CGT.

If you are too cautious then potentially you are missing out on an opportunity. If you go too high then HMRC could argue the excess is something other than goodwill (maybe employment income, maybe a reduction in the DLA - which might have been spent by the time it reaches that point, leaving you with overdrawn DLA and all the relared problems!!).

So why either miss the opportunity or take the risk?

 

 

 

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When was goodwill created?

I believe goodwill amortisation is allowable for corporation tax as long as it was created post 31 March 2002 regardless of related party considerations. I think this nails it, particularly the CIRD11625 link in the 1st reply:

http://www.accountingweb.co.uk/anyanswers/goodwill-allowable-against-cor...

Regards.

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Yes, you can leave your proceeds outstanding as a loan

Goodwill is an intangible asset.

It is represented by the difference between the value of a business as a going concern and the fair value of its assets less liabilities.

Having determined whether there is goodwill, you can sell this to your new company when you incorporate your business:

Debit. Goodwill
Credit. Director/shareholder loan account

You will make a disposal for CGT purposes, this may be covered by CGT Entrepreneurs Relief.

There may be tax relief for the new company for the cost, depending on when the asset was created by you.

If you have overvalued Goodwill HMRC will not accept the tax write off in any case (think also of what it might do to your future distributable profits). If you try and draw down overvalued goodwill from your loan account HMRC will probably tax you as if you have made a distribution.

Alternatively you can gift the goodwill (s.165) or hold it over (s.162)

Virtual Tax Support for accountants: www.rossmartin.co.uk

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HMRC agreement?

What's the general opinion about obtaining HMRC agreement to the valuation?

Yes and go through the process with the CG34? Alternatively, obtain an independent valuation and rely on that?

 

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Could be more hassle than it's worth?

We applied for agreement on an Incorporation value for Goodwill for a client.

We then spent 14 months in discussions with the Revenue before agreement was reached. In the end we reduced the value slightly, simply to obtain agreement so that company accounts/tax returns could be filed on time! However, this figure was significantly higher than the Revenues inital proposals so worth the challenge in the long run. But very stressful for both us and the client and I'm not sure it was really worth the effort. Next time I'd be inclined to just put the figures on the various returns with a suitable caveat to the client.

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On a completely non tax point

You might want to bear in mind that credit refernce agencies do not take intangibles into account but do refiect the directors loan account as a liability.

A solvent business can therefor look insolvent to them and accordingly mess up its credit rating. You will nee dto be careful how you reflect the loan in the balance sheet.

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Goodwill valuation clauses

I always try and get clients to put a clause in the contract incorporating their business along the lines that the goodwill valuation remains subject to HMRC approval and may be clawed back or reduced if challenged by them. This hopefully avoids the situation where the owner manager could face an income tax liability on the excess value, as you can simply unwind the original transaction. Re CG34 this is probably more useful for high value transactions where you need to clarify the value of a business for potential investors and avoid any tax risk. For ordinary run-of-the-mill incorporations it probably isn't worth the bother. So long as you are open and transparent in the accounts and tax returns about what you have done, making full use of the white space, they only have a year to challenge it anyway. For most sole traders the goodwill is unlikely to exceed £18,180 - which coincidentally leaves a nil CGT liability after entrepreneurs relief and the annual exemption. I've never heard of HMRC challenging a figure that low although I'm sure they do in the more obvious cases. But goodwill is such a capricious thing to value anyway. Who is to say how much goodwill attaches to the propreitor and how much to the business itself. Even the smallest of one-man bands will have some non-personal goodwill if they've been going long enough, and £18k isn't really that high compared to what was being paid for dot coms about 10 years ago.

Chris F

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Sole trader to Ltd Co goodwill

Is the Entrepreneurs Relief in any way impacted by selling a STR business into a ltd co that you are the sole owner of. Despite the ltd co being a separate entity it seems to me to be related so getting a 10% CGT rate would seem to be a bit of a fiddle.

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