Save content
Have you found this content useful? Use the button above to save it to your profile.
AIA

Topical Tax: Goodwill and connected parties. By Paula Tallon

by
3rd Dec 2007
Save content
Have you found this content useful? Use the button above to save it to your profile.

Paula Tallon of Chiltern examines some recent questions handled by her team of specialist tax advisers.

Question:
A sole trader, Michael, has run a successful internet business since its establishment in March 2003. As the business is growing, he is considering incorporating it into a limited company. The trading business has created a significant amount of goodwill, and Michael wants to know whether the tax treatment of the amortisation of goodwill in the accounts is any different to that for depreciation.

Answer
Since 2002, companies within the charge to corporation tax are entitled to tax relief on the amortisation of goodwill. However where the goodwill has been acquired from a connected party there is a restriction: a tax deduction will only be available if the business from which the goodwill is acquired commenced on or after 1 April 2002. In this case the business commenced in April 2003 so a tax deduction is available.

The amount to be written off in the accounts should be calculated in accordance with Generally Accepted Accounting Practice and a tax deduction is available for this amount. Alternatively, Michael can make an irrevocable election to claim an annual deduction at a fixed rate of 4%. If the goodwill is eventually sold, a 'gain' will be brought into charge as a trading receipt.

The availability of this relief is very often overlooked on incorporation. This is the reason why it can be valuable to start up in business as a sole trader and to incorporate after two or more years. The company gets a write off for goodwill and the owner can sell the goodwill to the company and get full business asset taper relief (up until 5 April 2008). But remember that you must have a proper valuation for goodwill and preferably the facility to unwind part of the transaction should Shares and Asset Valuation subsequently agree a lower value.

Previous Q & A
Maximising buy to let loan interest relief
Coprporation tax deductions and EMI
Employee tax planning with share options
PPR - selling part of the garden

Tags:

Replies (8)

Please login or register to join the discussion.

avatar
By User deleted
24th Mar 2009 15:10

connected party
what if soletrader in business making losses for several years and no goodwill as at 1/4/2002

however, if goodwill exists as at say 2008 can we incorporate and get tax relief (provided valuation and UEL etc robust) and we meet other conditions

Thanks (0)
avatar
By mickeyparish
05th Dec 2007 12:28

Does the exception apply both to individuals and companies ?
Does the 2002 time limit apply to the following:

Company X has been trading since 1989. Company Y is formed to acquire X ( enabling one of X's 2 shareholders ( A & B ) to retire) and a new shareholder C to acquire a stake in the business through Y. B & C will own X through Y, B having sold all his shares in X to Y. X will continue to operate as subsid of Y. Y will have £1m goodwill as an asset as a result of the restructure. There will be a whitewash procedure, as some of X's assets will be used by Y to buy A out.

Is Y barred from the 4% goodwill write-off by the 2002 rule ? the connected parties are: B ( currently shareholder of X, and future shareholder of Y) and C who is currently an employee of A, but not a shareholder.

This restructure is in the process of design, so the answer to the question would be of great relevance. Any comments appreciated.

Thanks (0)
avatar
By AnonymousUser
05th Dec 2007 13:50

How does the goodwill arise?
Mikey

Where does the goodwill come from? You don't get goodwill from purchasing shares (only when consolidated accounts are produced) the book entry is Dr investment Cr bank/loans etc. Has Y actually separately purchased goodwill from X as well as the shares?

Thanks (0)
avatar
By mickeyparish
05th Dec 2007 17:47

Goodwill
James

Thanks for the question. Y will have purchased the shares from A and B. It will own 100% of shares of X. X has a net asset value of £1 m. However the purchase price of the shares will be £2m. Hence the difference of £1m which Y would like to write off progressively, and I have called "goodwill". If it can't, it's not a deal-breaker, but it would clearly be more prudent for Y to be able to gradually reduce the balance sheet value of assets which are possibly unlikely to be realisable if the business were one day to be wound up.

I hope the thinking is not muddled !


Mickey

Thanks (0)
avatar
By AnonymousUser
05th Dec 2007 18:42

Not goodwill in Y
If £2m is the value of x, but net assets are £1m then the difference is goodwill owned by X. It is not recognised in x's accounts as it is presumably internally generated.

It is not goodwill for Y it is part of the cost of the investment.

Y can't ammortise the cost of the investment, it should be held at cost unless it needs to be impaired. If you have a policy of revaluation then the investment could be revalued each year.

Remember that prudence has not been a fundamental accounting principle for a while now. Just because it is 'possibly unlikely' that Y may not realise £2m if X were 'one day' wound up does not effect the carrying value of the investment. You have no way of knowing what the assets will be worth at some unkown date in the future. You also don't know how the investment will be realised, the shares could be sold to a 3rd party rather than winding up x.

Thanks (0)
avatar
By mickeyparish
06th Dec 2007 15:44

Goodwill amortisation
James, that's very clear, and thank you for sorting out the muddled thinking. It remains for us to investigate whether it might be best to arrange for Y to buy goodwill and assets off X, instead of the shares in X off A and B. The question that relates to the topic then remains: if Y buys goodwill and assets off X, then is it barred by the 2002 rule from depreciating the goodwill ?

Thanks (0)
avatar
By AnonymousUser
06th Dec 2007 16:50

Goodwill
The rule with connected parties is that if the goodwill was 'new' goodwill in the hands of the transferring party then it is 'new' in the hands of the receiving company.

So if the goodwill in X was created or purchased from an unconnected 3rd party after 2002 then it is 'new' goodwill and the IFA regime applies. If not then the old capital treatment applies.

Not sure what merit there would be in transferring the assets to Y rather than the shares as you'd be creating a double tax charge (potential £1m capital gain in X).

Thanks (0)
avatar
By Omega BAS
14th Jun 2010 13:37

goodwill amortisartion

what about IFRS3 which doesn't allow amortisation of goodwill at all? There are 3 standards that treat goodwill differently (IFRS3, UK GAAP and FRS10) and I'm confused which one to use. Where does the 2002 rule come from?

Thanks (0)