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TAX FEATURE: Capital Gains Tax - Treatment of goodwill in franchised businesses. By Nichola Ross Martin

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26th Jun 2006
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HMRC has set out its views on the implications of the Special Commissioner's decision in the case of Balloon Promotions Ltd and Other, which confirmed the existence of goodwill where HMRC have always said that there could be none.

Not surprisingly, HMRC do not feel that the decision is of general application to other cases involving the sale of franchised businesses.

Decision of Special Commissioner (SpC524) 3 March 2006: Balloon Promotions Limited (Appellant 1) and Alonso Vela-Castro, Edward Kidney and Natale Lucibello (Appellant 2) v Wilson and Rodin.

Roll-over relief and goodwill
Briefly, the facts were that the appellants were members of partnerships whose Pizza Express franchised restaurants were acquired by Pizza Express (Restaurants) Ltd for the purpose of operating them in-house. Pizza Express (Restaurants) Ltd entered into contracts with the partnerships for the purchase of the businesses and termination of the Franchise Agreements. The purchase price was allocated mainly to goodwill with only a nominal amount for the termination of the Franchise Agreements. In addition, the directors/shareholders of Balloon Promotions Ltd and Messrs Vela-Castro, Kidney and Lucibello received payments for entering into restrictive covenants that prevented them from operating pizza restaurants for certain periods of time and in certain locations.

The appellants claimed roll-over relief under S152 TCGA 1992 in respect of the chargeable gains arising on the sale of goodwill. HMRC refused the claims on the grounds that the proceeds for the sale of goodwill were, in fact, payments of compensation for the termination of the Franchise Agreements.

The Special Commissioner accepted that HMRC had the legal authority to re-apportion the sale consideration on a just and reasonable basis pursuant to S52 (4) TCGA 1992 if the appellants had erred in law in their apportionment. Furthermore, he concluded that the contention of Messrs Vela-Castro, Kidney and Lucibello that HMRC had no lawful authority to re-apportion the sale consideration after the issue of a S28 TMA 1970 Completion Notice was without foundation. HMRC's apportionment under S52 (4) TCGA 1992 did not affect the amended self-assessments and did not open new lines of enquiry.

The Special Commissioner held that the question of whether a franchisee owns goodwill is determined principally by an examination of facts and not solely by principles of law. He was satisfied on the evidence put before him that the appellants enjoyed considerable discretion in the operation of their restaurants and did not work to a prescribed business format. He found that Pizza Express was not a well-known brand until after 1994 and that each of its franchised restaurants was unique in design rather than part of a chain of outlets based on a set "get up". He concluded that Pizza Express was a "soft" brand and that it was the appellants who had established the reputation of their restaurants by the standards of customer service they provided. The Special Commissioner held that the consideration allocated to goodwill in the sale agreements was correctly described as goodwill within the context of TCGA 1992 and that the goodwill in question was attached to the appellants' businesses rather than to the Pizza Express brand.

The appellants' appeals were allowed in principle.
In reaching his decision the Special Commissioner took account of evidence that came to light during the hearing that the Franchise Agreements for the partnerships between Messrs Vela-Castro, Kidney and Lucibello were subject to termination on six months' notice by either party. In view of that evidence HMRC conceded that the rights associated with the Franchise Agreements were of minimal value.
HMRC do not intend to lodge an appeal in the High Court and accept the finding of the Special Commissioner that the question of whether a franchisee owns goodwill is principally a question of fact. Where a franchised business is disposed of as a going concern the question of whether there has been a disposal of goodwill will be determined in the light of the relevant facts. These will include a detailed consideration of the terms of the franchise agreement, the extent of control exercised by the franchisor and the terms and conditions relating to the sale. Therefore, we do not consider that the decision in these appeals is of general application to other cases involving the sale of franchised businesses.

HMRC opinion that a franchisee's rights under a franchise agreement are an asset within the meaning of S21 (1) TCGA 1992 and that they are not part of goodwill is unchanged. However, they do accept that a franchisee may be able to generate some goodwill in a franchised business. The values of franchise rights and goodwill will depend upon the precise facts of each individual case and, in particular, the level of control exercised by the franchisor.
HMRC agrees with the Special Commissioner's conclusion that, for the purposes of TCGA 1992, the term "goodwill" must be construed in accordance with the principles established by the legal authorities on goodwill and that the accountancy definition is deficient for the purposes of construing its meaning in that context.

In reaching his conclusions the Special Commissioner questioned the approach adopted by HMRC of restricting roll-over relief to specific categories of goodwill. He indicated that he considered that goodwill should be looked at as a whole to include whatever adds value to a business by reason of situation, name and reputation, connection, introduction to old customers and absence from competition.
HMRC do not accept that the term "goodwill" in TCGA 1992 embraces all of the various types of goodwill described in the CG Manual. We will continue to treat inherent and adherent goodwill as part of an asset in the form of a freehold or leasehold interest in land or buildings.
They are hoping to be in a position shortly to publish an updated version of the goodwill guidance in the CG Manual. '

Nichola Ross Martin
Source: HMRC

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By User deleted
28th Jun 2006 23:34

Yes, I agree fully.
This case was a bit of an "eye opener" in this respect. Note also the Spec's comments on the accounting concept of goodwill!

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By Dinkynick
27th Jun 2006 14:33

HMRC's Valuation Approach in Balloon
A point picked up by the Special Commissioner in Balloon was the application of the RICS 'Red Book'Guidance Note 1 and the way in which the expert witness misdirected himself. The only applicable Guidance Note in CGT and SDLT valuation cases is UK GN 3. This was specifically agreed between RICS, BPF and HMRC in 2000. The original meetings were chaired by David Varney.There is no provision in any taxing statute, or case law, as far as I know which looks at the valuation of a property asset as a going concern, and there is no justification for the arguement which says the existence of inherent or adherent goodwill precludes the existence of free goodwill. Indeed Guidance Note 1, even though not applicable in these cases makes that point. the current HMRC view, and I disagree with the suggestion this has always been their view, is based on the most tax efficent outcome [for HMRC] rather than a technically correct one.One interesting point here is how HMRC propose to prove that no free goodwill exists, it is quite hard to prove a negative.

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