Share this content
32

Acquisition individually or via existing company

An owner manager wants to expand by acquisition, but now he faces a tax dilemma

Didn't find your answer?

A client owns a successful high street outlet and is the sole shareholder/director.  He is contemplating the purchase of similar business in a nearby neighbourhood.  The business has a low cost base, so the value of fixed assets and current assets could be said to be nil.  The purchase price in this scenario is pure goodwill at £50k.

 

The company has developed a website and trade secret worth at least 10k, and the opinion of an independent valuer is that tax relief could be obtained on the goodwill.  However, the vendor has insisted on a share sale so that she can get business asset disposal relief.

Option 1)

Purchase shares as an individual, change the name of new company so that it includes brand name of existing company and run the newly named target company separately.

Drawbacks: Additional accounting costs with two year-ends;

No tax relief for goodwill;

Advantages:

Higher base cost of shares on eventual disposal.

 

Option 2)

Lend his existing company the £50k;

Purchase target company via existing company;

Hive up subsidiary company into parent.

Advantage

Tax relief on goodwill

Simplified accounting as fewer entities

Drawback

Base cost of shares nominal value

 

Let us fast-forward ten years and the target business is now worth £100,000 and the applicable tax rules have not changed. Except that there is no longer annual exemption for capital gains tax purposes.  At this stage he wants to sell up all his business at the same time.

 

With option 1) the individual realises a gain on disposal of £50k which, with business assets disposal relief, results in a tax liability of £5k

 

With option 2) the individual realises a gain on disposal of £100k, and therefore a liability of £10k.  However, in the meantime:

 

£50k x 6.5% x 10 = amortisation of £32,500 @ 19% is £6,175.

 

Reduction in distributable reserves otherwise taxed as higher rate dividend = (£32,500 – £6,175, or) £26,325 @ 32.5%, or £8,556.

 

In a third option, he buys the company individually.  The existing company then acquires the new company.  (There is no stamp on the second transaction because of acquisition relief.) Since both companies are owned by the same individual, the target company is acquired by way of director’s loan.  To simplify accounting, the trade of the subsidiary is hived up to the parent.

 

Following the third strategy is it not possible to have a higher base cost of shares and tax relief on amortisation?

 

My question is related to the following discussion: https://www.accountingweb.co.uk/any-answers/treatment-of-goodwill-0

Replies (32)

Please login or register to join the discussion.

Psycho
By Wilson Philips
23rd Nov 2020 10:30

What makes you think that amortisation would be deductible if the trade were to be hived up?

Thanks (0)
Replying to Wilson Philips:
Coman And Co
By ComanCo
23rd Nov 2020 10:47

Wilson Philips wrote:

What makes you think that amortisation would be deductible if the trade were to be hived up?


https://vimeo.com/148633056
The ICAEW link above explains the journal entries on how Goodwill is created on purchase of a company
If a company purchases another company this is precisely how goodwill is recognised.
Thanks (0)
Replying to ComanCo:
Psycho
By Wilson Philips
23rd Nov 2020 11:05

That didn't answer my question. Accounting for goodwill is one thing. Tax treatment of goodwill is quite another.

Thanks (0)
Replying to Wilson Philips:
Coman And Co
By ComanCo
23rd Nov 2020 11:08

Wilson Philips wrote:

That didn't answer my question. Accounting for goodwill is one thing. Tax treatment of goodwill is quite another.


Tax treatment for acquired goodwill changed on 1 April 2019:
https://comanandco.co.uk/tax-relief-for-goodwill
Thanks (0)
Replying to ComanCo:
Psycho
By Wilson Philips
23rd Nov 2020 11:13

I think that you perhaps need to read CTA 2009 s.775

Thanks (4)
Replying to Wilson Philips:
By Ruddles
23rd Nov 2020 12:05

I agree - see my comments on the thread linked to in the question.

Thanks (0)
Replying to Ruddles:
Coman And Co
By ComanCo
23rd Nov 2020 12:20

Ruddles wrote:

I agree - see my comments on the thread linked to in the question.

There is a difference from the original post in this scenario, because the purchaser has a choice to purchase individually or in the name of a company that he already owns and runs. An individual purchase results in a higher base cost of the shares and therefore a CGT benefit.

I was proposing to purchase individual and then merge the two entities.

Thanks in advance.

Thanks (0)
Replying to Ruddles:
By Ruddles
23rd Nov 2020 12:33

I was talking specifically about the issue of amortisation relief on goodwill on a hive-up.

Thanks (0)
Replying to Ruddles:
Coman And Co
By ComanCo
23rd Nov 2020 12:51

Ruddles wrote:

I was talking specifically about the issue of amortisation relief on goodwill on a hive-up.


I have conceded that I cannot see a way of achieving amortisation relief on goodwill on a hive-up because of the tax neutrality on intra group transfers (ref CTA 2009 s.775) that Wilson Philips pointed out earlier today.
I was confused because my research led me to this ICAEW explainer video which shows how goodwill is created. That is an accounting treatment not anything tax deductible.

As a separate point also in the OP, the base cost of shares would be higher if he buys target company in his own name. Higher base cost provides a tax justification for a purchase individually. Takeover preserves base cost but reduces compliance because eventually everything owned by parent

Thanks (0)
Replying to ComanCo:
By Ruddles
23rd Nov 2020 13:06

I haven't looked at the detailed permutations, but I suspect that there is a flaw somewhere in your thinking. In option 2, where individual lends £50k to company, consider what would happen if he were to immediately capitalise that loan (or indeed simply subscribe for an additional £50k worth of shares in existing company to finance the acquisition).

Thanks (0)
Replying to Ruddles:
Coman And Co
By ComanCo
23rd Nov 2020 13:17

Ruddles wrote:

I haven't looked at the detailed permutations, but I suspect that there is a flaw somewhere in your thinking. In option 2, where individual lends £50k to company, consider what would happen if he were to immediately capitalise that loan (or indeed simply subscribe for an additional £50k worth of shares in existing company to finance the acquisition).


I thought about share subscription, but then he has created a share premium account. This either places a restriction on assets that can be withdrawn, or if share premium is converted to profit reserve, a personal tax liability. If he buys the share direct, no shares need to be issued an no share premium is created.
Thanks (0)
Replying to ComanCo:
By Ruddles
23rd Nov 2020 13:32

I think you are missing my point.

Individual buys shares for £50k. Company is later worth £100k. Shares sold at £50k gain.

Individual lends £50k to company to buy shares for £50k. Company is later worth £100k. But it won't be worth £100k - it will be worth only £50k due to the loan due back to the individual.

Thanks (0)
Replying to Ruddles:
Coman And Co
By ComanCo
23rd Nov 2020 14:15

On eventual sale, the individual is being pad £100k, only in one example he has £50k of cost to reduce his gain. It's the same business so it's worth the same to the eventual third party purchaser regardless.

The business will not be worth 50k less if purchased by a company:

In one option he pays £50k of personal funds, but the company balance sheet shows £1 net asset because the goodwill is internally generated.
In the other option, he paid £50k of personal funds into the company for the company to make a purchase. But the net asset is still £1, because that £50k is a director's loan account creditor.

If the existing company sold the target business in the future, he would be indifferent. However, it is the proprietor who realises the sale, so he is concerned to reduce his capital gains tax exposure.

Thanks (0)
Replying to ComanCo:
avatar
By Tax Dragon
23rd Nov 2020 14:44

Forgive me, but you appear to be saying that if you pay £50k for an asset, you have a base cost of £50k. If you pay nothing, you have a base cost of nothing.

I think everyone will agree with you, if I've understood you correctly.

But you've hardly magicked £50k base cost out of nothing in the first scenario - you have that base cost because that's what you spent.

I think this is one of those work-through-the-answers-you've-had situations.

And work through your comps again, to make sure you know what are apples and what are pears.

Thanks (2)
Replying to ComanCo:
By Ruddles
23rd Nov 2020 15:04

I beg to differ - and agree with Tax Dragon. If the underlying business is worth the same in both scenarios, I - the prospective purchaser - might have something to say about the fact that in one case there is a £50k liability (that doesn't exist in the other).

Put it another way - you have a choice of two companies to buy and both vendors are asking for £100k. One balance sheet shows goodwill of £100k (the agreed value of the business) and nothing else. The other balance sheet shows the "same" goodwill of £100k and a loan from director of £50k. Who are you going to hand your £100k to?

As Tax Dragon says, you are not comparing like with like.

Thanks (1)
Replying to Wilson Philips:
Coman And Co
By ComanCo
23rd Nov 2020 12:12

Wilson Philips wrote:

I think that you perhaps need to read CTA 2009 s.775


Agreed. Intangible fixed assets transfer between group companies on a tax neutral basis. Otherwise the subsidiary would be taxed at 19% on disposal of goodwill. This would be a pitfall if the parent only gets tax relief on 6.5% of the goodwill per annum.
There is a stronger case for trade purchases post 1 April 2019.
Indeed, with an asset purchase the target co would be stuck with 19% on disposal of trade in any case.

If he buys the target in his own name at least the base cost of shares is higher. Via his existing company, the base cost remains nominal value of the shares.

If he buys individually, then transfers the target company to his existing parent, via a paper for paper transfer, the base cost of shares is intact. That seems to be the better way round where the acquirer is stuck with a share purchase.

Thanks (0)
Replying to Wilson Philips:
avatar
By Tax Dragon
23rd Nov 2020 12:09

IMHO, the OP should have thanked you for putting them straight.

They seem not to have done. So I have.

Thanks (1)
Replying to Tax Dragon:
Coman And Co
By ComanCo
23rd Nov 2020 12:11

Tax Dragon wrote:

IMHO, the OP should have thanked you for putting them straight.

They seem not to have done. So I have.


Thanked as well.
Thanks (0)
avatar
By paul.benny
23rd Nov 2020 10:43

You mention potential disposal in 10 years' time. Whilst it's good to avoid creating bear traps, so much could change over that time that tax planning is virtually worthless.

FWIW, I would say that the savings arising from the simpler structure envisaged in option 2 will probably outweigh the higher tax charge on exit.

Thanks (0)
Replying to paul.benny:
Coman And Co
By ComanCo
23rd Nov 2020 10:51

paul.benny wrote:

You mention potential disposal in 10 years' time. Whilst it's good to avoid creating bear traps, so much could change over that time that tax planning is virtually worthless.

FWIW, I would say that the savings arising from the simpler structure envisaged in option 2 will probably outweigh the higher tax charge on exit.


If buying the shares individually he would have to wait at least two years to get business assets disposal relief.
The point of using 10 years in my example, was to show that the longer the goodwill is amortised the stronger the tax case for a company purchase.
For an owner managed business of this sort (rather than a contractor company) ten years is a more realistic planning horizon. It is my role to provide the best tax advice based on prevailing regs.
Thanks (0)
Replying to ComanCo:
avatar
By paul.benny
23rd Nov 2020 11:26

It's not just about tax, though.

Running two similar, relatively small businesses through two different legal entities creates needless complexity and increases cost.

Thanks (0)
Coman And Co
By ComanCo
23rd Nov 2020 17:23

Thank you for your feedback. I believe I have identified a tax saving, but I would agree that I am not comparing like with like.

Thanks (0)
Replying to ComanCo:
Psycho
By Wilson Philips
23rd Nov 2020 18:29

You don’t say where you’ve identified the tax saving but if you were in fact to compare like with like you might find that you’ve got it back to front.

Thanks (0)
Replying to Wilson Philips:
Coman And Co
By ComanCo
23rd Nov 2020 18:37

Wilson Philips wrote:

You don’t say where you’ve identified the tax saving but if you were in fact to compare like with like you might find that you’ve got it back to front.


Let's say he starts a new company with share capital of £1. He loans the company £50k. The £50k is used to purchase a new company (which only has goodwill, because it was a service company.) Therefore the accounts will show £50k of goodwill (that cannot be amortised) and £50k of director's loan account. Therefore still has net assets of £1. The base cost of his share is £1.

Alternatively, he buys the target company with his own funds. The target company has a net asset of £1 because there is no recognition of internally generated goodwill. However the base cost of his shares is £50k.

Thanks (0)
Replying to ComanCo:
Psycho
By Wilson Philips
23rd Nov 2020 18:52

You are failing to address the point raised by Ruddles and TD. What happens to the £50k lent to the company?

And why can’t the goodwill be amortised?

Thanks (1)
Replying to Wilson Philips:
Coman And Co
By ComanCo
23rd Nov 2020 19:09

Wilson Philips wrote:

You are failing to address the point raised by Ruddles and TD. What happens to the £50k lent to the company?

And why can’t the goodwill be amortised?


I guess if he wrote the director's loan off, he would have a £50k loss carry forward that would have the same value as a £50k base cost of the shares.
Thanks (0)
Replying to Wilson Philips:
Coman And Co
By ComanCo
23rd Nov 2020 19:23

Wilson Philips wrote:

You are failing to address the point raised by Ruddles and TD. What happens to the £50k lent to the company?

And why can’t the goodwill be amortised?


The reason goodwill cannot be amortised goes back to the start of the discussion. It is because the scenario deals with a shares purchase rather than a trade purchase.

I will have to concede that Ruddles and TD have raised a valid point and in principle a purchaser would be indifferent from a tax perspective whether to use an existing co or purchase in his own name.

Thanks (0)
Replying to ComanCo:
Psycho
By Wilson Philips
23rd Nov 2020 19:37

I think that you are again confusing accounts treatment of goodwill with tax treatment of goodwill. But that was a side point.

Writing off the loan would be one means of disposing of it. Repayment would be another. In either or any case you really do need to consider what happens to it to make a meaningful comparison - you might find that the corporate purchase with borrowed funds is the more tax-efficient.

Thanks (0)
Replying to Wilson Philips:
Coman And Co
By ComanCo
23rd Nov 2020 22:13

Wilson Philips wrote:

I think that you are again confusing accounts treatment of goodwill with tax treatment of goodwill. But that was a side point.

Writing off the loan would be one means of disposing of it. Repayment would be another. In either or any case you really do need to consider what happens to it to make a meaningful comparison - you might find that the corporate purchase with borrowed funds is the more tax-efficient.


In this case a successful high street outlet is branching into new neighbourhoods via acquisition. The company has sufficient cash reserves, and a director's loan was being used earlier in the discussion to simplify the comparison.

If the acquisition is successful the founder will probably want to hive the new company into his business. This would create a goodwill, and disposal of the target company which is by that stage a shell.

While there is no tax relief on the amortisation, the amortisation could reduce distributable reserves. The cost of acquisition to that extent would result in an income tax saving. To that extent the corporate purchase could work out more tax efficient.

I am referring to Goodwill created as per the following infomercial: https://vimeo.com/148633056
About 3:21 the video states "Goodwill is then amortised over the useful economic life."

Thanks (0)
avatar
By Tax Dragon
24th Nov 2020 07:49

Does the hive up have any effect on distributable reserves?

Thanks (0)
Replying to Tax Dragon:
Coman And Co
By ComanCo
24th Nov 2020 09:24

Tax Dragon wrote:

Does the hive up have any effect on distributable reserves?


In much the same way as the purchase of a tangible asset (such as office equipment), except for there is no impact on corporation tax.
Thanks (0)
Replying to ComanCo:
avatar
By Tax Dragon
24th Nov 2020 09:55

Maybe I have missed a step. You said you would leave the subsidiary as a 'shell'. An empty shell? What's happened to the contents? Specifically, its distributable reserves.

Thanks (0)
Share this content

Related posts