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Sale of Shares / Incorporation Relief

Missed opporunity by previous accountant?

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Evening AWeb folk! Hope you can help me on the below:

Situation:

Mr & Mrs H purchase a Restaurant business for £85k in 1999. They operated this until March 2013 when the trade became a Limited Company. They then ran the limited company as equal shareholders up until May 2019 when they disposed of the company for £95k.

 

Now… the previous accountant made no accounting reference to Goodwill upon incorporation and the shares were issued to the husband and wife for £10 (£5 each). The reason this was not changed was because the client never told me about the purchase price until i told him the tax bill for selling it!

 

I believe what should have happened is that 85000 £1 shares should have been issued in March 2013, in exchange for the partnership business. However, this was not the case and as such I believe the original cost £85k is sunk upon the incorporation of the business, and cannot be used in any sort of calculation for CGT.

 

Incorporation Relief has clearly been missed but my question is what can I do retrospectively? If goodwill was created in the company it may have been possible to structure the sale of the business in such a way that the GW and shares were sold under separate transactions but as no goodwill was created upon incorporation this cannot be done. The solicitor dealt with the disposal so I have had no sight of the sale agreement.

 

Safe to say my client cannot understand why they have a circa £7k tax bill when they have made a ‘profit’ of £10k!

 

Is my understanding correct? Would you explore any other options?

Replies (11)

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By Accountant A
04th Oct 2019 21:43

Gasref95 wrote:

I believe what should have happened is that 85000 £1 shares should have been issued in March 2013, in exchange for the partnership business.

If you are indeed an accountant, and not in fact the erstwhile restaurateur, and that is genuinely your considered opinion, I would respectfully suggest that you pass this job on to someone with the requisite technical knowledge.

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Psycho
By Wilson Philips
04th Oct 2019 22:14

You need to establish, if possible, how the transfer of the business to the company was dealt with for tax purposes.

You should also think on what the current tax position would be had incorporation relief been claimed.

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By whitevanman
04th Oct 2019 22:40

Whilst sharing the sentiments expressed by AccountantA, I would point out that, what is referred to as incorporation relief (s162) is automatic. There is no claim (though one can elect for it not to apply).

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Replying to whitevanman:
Psycho
By Wilson Philips
04th Oct 2019 22:46

Agreed - I should not have referred to a ‘claim’ for section 162 relief.

It does seem, albeit based on the usual scant information (which may not be the fault of the questioner), that the previous agent made a bit of a balls-up.

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Replying to Wilson Philips:
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By whitevanman
04th Oct 2019 23:05

It is probable, in view of my earlier comments, that it is just a balls-up in the presentation.
HMRC does not consider the accounts presentation to be determinative in relation to goodwill. They recognize that goodwill attaches to the trade / business and cannot be transferred independently. So it follows that the partnership goodwill was transferred to the company on incorporation and that S162 applied at that time. It should therefore be a matter of calculating the taxable gain now on the correct basis. With the benefit of hindsight, it could be that it would have been advantageous to have elected in 2013 for S162 not to apply but one could not have known that at the time (and I haven't even tried to do the maths so could be wrong!).

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Replying to whitevanman:
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By Adam12345
05th Oct 2019 14:53

I agree. s.162 is automatic so as long as all assets were transferred (except cash) in return for shares instead of a loan account/cash etc, then incorporation relief was in fact used.

If s.162 wasn't used, was the gain on transfer reported via the sole traders tax return - I suspect not.

The only alternative would've been gift relief but a claim is needed for this.

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Replying to Adam12345:
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By whitevanman
05th Oct 2019 13:21

As often happens, the OP doesn't include all the facts we would like. Based on what is said however, I assume no gain was reported in 2013 and no amount has been credited to DLA (reasonable assumptions as the accounts don't actually reflect any goodwill). Given what I have said about goodwill being incapable of being separated from the business, the inevitable conclusion is that it was transferred. As there is no evidence of any other consideration passing, it follows the transfer was in consideration for whatever they did get and the only thing we are aware of is shares. It would be reasonable to assume / point out that the previous accountant simply got it wrong in that the goodwill has been omitted and the obvious contra is share premium. Hard to argue otherwise I should think (and why would HMRC want to?).

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Replying to whitevanman:
Psycho
By Wilson Philips
05th Oct 2019 13:52

Agreed. So if we agree that section 162 applies, regardless of any subsequent erroneous accounts presentation, the tax base cost of the shares is effectively the base cost of the assets transferred across. So it may well be the case that there is little or no chargeable gain on the sale.

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Replying to Wilson Philips:
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By whitevanman
05th Oct 2019 22:21

Agreed.

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By unearned luck
05th Oct 2019 15:29

To restate whitevanman's goodwill point, a restaurant is a 'trade related property'. This means that when a capital or rental valuation is made of a property built as or adapted to be a restaurant the profit that should be made by 'a reasonably efficient operator' is taken into account. So, for people who do not appreciate this point, the amount of goodwill that exists for most restaurants is a lot less than they think.

Among the data missing from the question is what the business consists of. Does it include a freehold or long leasehold interest in the premises.

Google this: capital-and-rental-valuation-of-public-houses-bars-restaurants-and-nightclubs-in-england-and-wales-1st-edition-rics.pdf

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Replying to unearned luck:
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By whitevanman
05th Oct 2019 23:24

Not sure I wholly agree.
A restaurant will usually be conducted from a trade related property and if relevant, a valuation of that property will be made on a basis that may include consideration of maintainable turnover etc. Valuation is a complex matter and I would leave it to the professionals.
That said, we don't have all the relevant information and things such as you refer to could be relevant considerations but I would be surprised if the cost included any property (I cannot believe the previous accountant missed off a number of different assets!).
There are very many other questions one could ask.
All we are told is that the partnership "business" was bought for £85k in 1999. We are told the "business" was transferred to the company in 2013 (no valuations given) and sold in 2019 for £95k. The only asset referred to is goodwill.
If we assume that what was transferred in 2013 and eventually sold in 2019 was what was bought in 1999 and that the price covers only items within the scope of CGT (since that is what the post is about) and does not, for example, include stock or plant or any other such items, there is a gain of £10k over the period.
Applying S162 to the transfer in 2013 could mean in effect that the cost of £85k flows through.
A gain of £10k would result in no net tax to pay and that may be enough to deal with the matter. Hence, Wilson and I agree.
This is however, all based on assumptions and it is for the OP to get all the facts and apply the rules to them (not simply guess).

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