Entrepeneurs Relief Qualifying Conditions
A husband and wife partnership has traded as a small engineering business for approximately 20 years turning over around £200,000 and making approximately £20,000 taxable profit per annum. Profits are shared 1/3 to the husband and 2/3 to the wife. It trades from the same rented premises as a limited company owned 100% by the husband which undertakes the same type of engineering work. Until a year ago the limited company was owned 50% by the husband and 50% by an unrelated third party who retired, resigned as a director and sold his shares to the husband. It has been suggested that the two businesses should be merged and the preferred method is to transfer the partnership business into the limited company. The main asset, possibly the only asset, for CGT purposes will be goodwill. Given that the disposal is to a related party will it qualify for entrepeneurs relief? And what pitfalls could lie in wait? Valuation of goodwill is likely to be very subjective given the relationship between the two businesses what can we do to counter challenges from HMRC?
Have you considered all the options
Since the goodwill being transferred (by a related party from a business that existed prior to 1 April 2002) to the company will not qualify under the intangibles regime, the only benefit of doing it this way is that you get to pay tax now at 10% on future profits of the combined entity up to the current value of the partnerhsip's goodwill.
Your clients would seem to be fairly mature, possibly contemplating retirement within a few years.
Unless you need to extract funds from the company that will take them fairly well into the higher rate, there's no merit in accelerating the tax liability. Dividends from post- CT profits within the basic rate band (no further tax to pay) are more efficient than a capital gain at 10% from those post-CT profits.
The alternative is that the company acquires the partnership business in exchange for shares. The base costs get carried forward in the new shares, and provided the new shares are held for a further year before any subsequent disposal, they will qualify for the same ER later on.
Excess profits can be probably be accumulated in the company for a few years without fear of breaching the substantial activities test.
The only other reason for "banking the ER that I can see is if you fear the withdrawal of ER. There doesn't seem to be such a prospect on the immediate horizon.
I'm not saying don't transfer it to the company
I'm just questioning whether it's worthwhile realising a gain in doing so.
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There is nothing to stop ER applying to disposals to connected persons, so assuming all conditions for ER are met the gain will qualify.
You could get the valuation agreed with HMRC ,its a post transaction valuation check, google CG34.
Without further info - it does sound like a decent idea and will certainly streamline the business and probably provide some tax advantages along the way.