HMRC will only allow £50,000 goodwill when actual amount purchased was £376,377

HMRC will only allow £50,000 goodwill when...

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Hi

I written a comment last year (all background info is below).

Basically HMRC are not agreeing with the amount of goodwill that was purchased.  Is there a way around this?  I am not sure about the implications of just scrapping the company (if we can) as only dormant accounts have been filed for the first month.

Any info would be greatly appreciated.

Hi

My Client purchased a business (no land or buildings included) from an un-connected party,  in Feb 2011 for £436,800 and split:

Goodwill £376,377

Stock £11,483

Plant & Machinery £48,940 

The goodwill was generated over 28 years (£13,442) per year.

The first set of accounts were to 05/04/2011 - so no overlap profits.

He incorporated on in March 2012 but started trading on 01/04/2012 to co-inside with the tax year.

The purchase was financed through an interest free repayment loan over 12 years (so there is a large creditor still on the balance sheet.)

Question 1 - Goodwill

I am about to do the cessation accounts, do i add internally generated goodwill to the cessation accounts of £13,442 or just leave it at the purchased value of £376,377 (i read the 2002 CT relief for amortisation and it advised that relief on incorporation cannot be amortised however purchased goodwill can be amortised), or shall i create a separate intangible account one for purchased goodwill and one for acquired goodwill and just amortise the purchased goodwill after incorporation, also on the selling package which goodwill figure should i use? I would assume that it is £376,377+£13,442 as the business has been continuing for a further year!

Question 2 - Capital Allowances

A few of the assets have been scrapped prior to sale, i have made changes to the accounts however as the business is to be incorporated/ceased I am not sure how to action the main pool within the capital allowances section, do i allow the allowance (£6k worth) then finalise it with a balancing allowance, it may also be worth adding that one of the cars (worth £4K) will be not be transferred over to the ltd company therefore not all assets are to be transferred and rollover relief cannot be claimed. Can i still use incorporation relief?

Any help or advice would be greatly appreciated.

 
 
Comments
Paul Scholes's picture

Quick one

Paul Scholes PM | Tue, 10/07/2012 - 18:37 | Permalink

Sorry dashing off so quick thoughts:

1. Because he bought it from an unconnected party after 1 April 2002 it's a valid intangible to pass over to the company for amortisation purposes.  I'd just show the purchased goodwill in the sole trader's closing balance sheet but you bring in the full £390K value of goodwill (as a single item) into the company books 1 April dr goodwill & cr director's loan.

He declares the £13K capital gain and gets Ent relief on any taxable sum.  you don't say how you valued the £13K uplift in valuation, are you happy it can't be more?

2. Up to you, will usually depend on the best tax outcome, ie treat them as all taken out at market value for self employed CAs and bring them in (minus car) at market value for WDA in company or elect to carry the pool over (can't remember the section but he & company have to sign and submit a claim).  In this case you can still transfer them for the accounts purposes at value.

Think you may be confused by the 2 methods, you cannot use Incorp relief because not all the assets are going over  plus, these days, it is usually a better bet to go for transfer of individual assets, as proposed above.

Thanks Paul, 

A E Scott PM | Wed, 11/07/2012 - 14:44 | Permalink

Thanks Paul, 

Comments regarding point 1.

The £13k was the purchased goodwill of £376,377 divided by the 28 years that the previous owner was in business for.  This amount was agreed by previous owner and or valuer. I did not have any input on this figure and am not sure how they calculated it, but i thought i would thought if i add the same value for a period of one year HMRC could not disagree with the workings!!!!

With regards to the £390k you mentioned above, £358,509 is still owed as a creditor for the original purchase of the business (goodwill, stock and assets), so would I cr directors loan with £31,491 and cr the creditors account with the amount owing of £358,509, after all the ltd company will be paying off the loan after incorporation.  I would then make additional changes to stock and assets accordingly.

2. Thanks for the advice on comment 2, this makes sense.

Paul Scholes's picture

It's not the company's debt

Paul Scholes PM | Wed, 11/07/2012 - 16:13 | Permalink

Hi - your client has transferred the assets to the company at market value and so the company owes him not the orginal owners, they still remain his personal cerditor and so he draws from his loan account with the company and then passes the money on to them.

Normally you'd create or obtain a fresh value for the goodwill but as the two transactions were so close to each other as long as nothing significant has changed the business in between then I agree the £390 should be close enough.

You shoud ask HMRC to agree the value though now before your client enteres it as a sale on his personal return.  Go to HMRC's website and search for form CG34, this gives you details of the post transaction checking procedure to follow.

Ok, so following on from

A E Scott PM | Mon, 07/01/2013 - 13:36 | Permalink

Ok, so following on from above.

I went to HMRC and filled in the CG34 form, this was passed to the valuation office, they are advising that they cannot accept the valuation of £390k worth of goodwill as they are sure I will agree that goodwill can vary over time!!!  They advised that profits for the year 31 march 2011 were £22k which reduced to £13 in the following year, then adjusting for these figures for (non-cash) amortisation charges gives revised profits of £42k and £32K respectively.therefore the maintainable profits would be at most £32k at march 2012 which leaves very little for proprietors  salary, they then go on to say that after deducting a commercial charge for management, profits are reasonably reduced to nil.  Contrast this with the position in the lead up to acquisition when profits were sufficient to leave a balance of £50k or so after proprietors salary.

In light of the above HMRC said it is arguably the case that there is little if any by way of goodwill in existence at the date of incorporation, however they would agree to a figure of £50k for goodwill!

I called to query this, and HMRC advised that there may be a tax charge on incorporation of 10% (but i said if he has made a loss then there wouldnt be any charge!), but then she said there may be implications to CGT which she could not talk to me about - please can anyone advise me of these implications?

I advised that I was going to seek more professional help, to which she asked if there are any changes that may happen or if I have any further information to say that the business was going to do better in the future, i advised that we had been in a recession and the new owner had a different management style from the previous owner!

She also said if it isnt resolved by 31/12/2013 then it will go to another department and it may be looked upon differently!

This will be the owners last business/employment so the loss will not be able to be offset against anything else, I therefore need to increase the goodwill dramatically as this is what he paid for .

Any help or guidance on the matter will be grately appreciated.

Replies (11)

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By johngroganjga
01st Oct 2013 10:59

I think you are saying that client purchased goodwill at arm's length from an unconnected party for £376,377 and subsequently sold the same goodwill to his own company.  Value at date of transfer to company needs to be agreed with HMRC because transferee and transferor are connected parties.  HMRC have come up with £50,000.  On the figures you quote that is on the high side and your client should bite their hand off.

£376,377 paid by your client looks ludicrously high.  Did he take advice on whether that was a fair value?

 

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By A E Scott
01st Oct 2013 11:34

Hi

Yes you are correct.

I dont think he did take any advice, he had been working at the company for many years prior to this.

HMRC have came back to me today and said the highest they can go to is £150,000 but HMRC said it was no where near worth this amount.

I didn't know whether it would be worth scrapping the company and continuing as sole trader? and if so what implications I would need to think about.

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By johngroganjga
01st Oct 2013 12:11

Why would you want to scrap the company?  If client doesn't want to trade through a company why did he form it and transfer his business to it?

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By A E Scott
01st Oct 2013 12:49

It was more tax efficient to become a company as he would be able to draw on the goodwill, however because HMRC have basically cut the value of the goodwill, he will be making a capital loss of £226,377 (purchased goodwill £376,377 - 150,000 allowable value from HMRC) he will not be able to use his losses in the future because he will not be making a profit on any capital items.

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By johngroganjga
01st Oct 2013 14:20

If it was tax efficient when you thought you could get away with a £376,377 goodwill value, why is it not tax efficient if goodwill value is only £150,000?

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Replying to Portia Nina Levin:
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By A E Scott
01st Oct 2013 21:08

Because he has actually paid 376,377 for the goodwill, so he will make a loss on the amount after 150,000.

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By johngroganjga
01st Oct 2013 21:45

But only a book loss, not an actual cash or economic loss.

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By A E Scott
14th Oct 2013 22:11

It is cash as he is already in the process of paying that amount, he actually purchased the goodwill for the aforementioned amounts, so will make a capital loss that he will not be able to offset against anything as he has not other capital items or profits forecasted!

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By Chris Smail
15th Oct 2013 01:27

A fool and his money...

...

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By cparker87
15th Oct 2013 09:19

Millstone

a £350k debt for a (allegedly) worth less than half that is a millstone I would not want around my neck. My first thought would be to review the transfer/purchase paperwork and try to wriggle out of it claiming misrepresentation by the seller.

As I see it HMRC are stating that between Feb 2011 and Mar 2012 the value of the business reduced by more than half.

It follows that what has happened is your client has incurred a Capital Loss as on incorporation he is deemed to transfer the value to the Company at Market Value (assuming Incorporation Relief disapplied).

Off the figures you state £150k is very generous. I would suggest settling at that amount.

However, if you want to justify a higher value then you need to review the reasons for the reduction in value between Feb 2011 and Mar 2012.. Loss of custom, Bankruptcy of custom? You'll need to be able to show they were temporary and that the initial valuation stacks up. Perhaps the Business has some IP that is valuable?

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By Vaughan Blake1
15th Oct 2013 13:14

Sounds like damage limitation here

Firstly the methodology in increasing the goodwill valuation is fundamentally wrong.  The length of time a business has existed is virtually irrelevant and goodwill does not increase just beacause another year of trading has been achieved.

This may answer the question as to "how on earth was the £376K arrived at?"  If this is a proprietor run business the sustainable/projected profits at purchase would have had to be around £100K.  Either the valuation is a mickey take or things have gone very wrong since the original purchase.

HMRC are correct to look at the valuation at the time the sole trader sold out to the Ltd company.  It is a shame that the business was not bought by a Ltd on day one as this problem would not then have arisen.  If the purchase had been by a Ltd company the full £376K would have been tax deductible with no argument.  In addtion if it all goes wrong the original debt would be owed by the company and not personally by your client.  Thus, the client could have bust the company and walked away.  The original vendor would have been the main creditor so maybe no tears there.

It is important to take account that the goodwill is to be valued with the known facts as at March 2012 no hindsight allowed!  If something has gone wrong that has caused such a fall in the value of the business, then you must identify when that event took place.  So take a time travel back to March 2012.  The accounts to Feb 2011 would have been done.  Management figures to March 2012 and future projections would be available.  What does the business look like? What would someone have paid at that point?  Once again the question as to why the business was worth £376K 12 months earlier rears its ugly head.  Compare and contrast!  On the facts given HMRC's £150K valuation looks very generous indeed.

As a rough rule of thumb, take the £32k adjusted profit, knock off a manager's salary & rent if applicable, then mutiply the answer by say 5.  The goodwill would be diddly.

Unless there is some IP or profitable contract not accounted for, take the £150K valuation and run.

If the purchase price was a mickey take or the business fell in value prior to March 2012 (possibly as a result of the loss of the vendors skills/contacts etc), then the client has as a matter of fact sustained a capital loss on the fall.  A bit like buying a Picasso and 12 months later finding out that it is a fake!

Going forwards if you stick with the Ltd company you will be able to claim a tax deduction on the £150K.  Not as good as £376K, but better than no write off at all, which is what would happen if you revert to a sole trader.  I would also look to w/o over no more than 5 years given the facts.

 

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