Tax Writer Taxwriter Ltd
Share this content

Spotlight on goodwill and entrepreneurs’ relief

5th Dec 2014
Tax Writer Taxwriter Ltd
Share this content
AIA

It’s never a good sign when a perfectly good tax relief is mentioned in the Autumn Statement, and true to form the “strengthening” of entrepreneurs’ relief (ER) George Osborne mentioned means more anti-avoidance rules, effective for transactions made on or after 3 December, says Rebecca Cave.

Since 6 April 2008 when ER was born, it has been available to reduce capital gains tax (CGT) payable on gains arising on the incorporation of a business. Some businesses find they are carrying a significant value of “goodwill” (reputation, customer relationships, value of continuing contracts) when they decide to incorporate. The goodwill is transferred to the company along with the other assets of the trade. Whether the “goodwill” is of a nature that is capable of being transferred from the individual to the company is another very contentious matter.

The company that takes over the trade (which need not be newly formed company), is unlikely to have the funds to pay the seller for the assets transferred, so it leaves the balance on an account within the company owing to the seller.

After deducting the very generous CGT annual exemption from the value of the goodwill (which normally has a zero base cost), the seller pays 10% CGT (claiming ER) on the balance. Subsequently he gradually extracts funds equal to that balance as tax-free and NI-free payments from the company – as the CGT has already been paid.

Although the company will be a related party (as defined in CTA 2009, s 835(5)) to the individual who sold the goodwill, it can claim tax relief for the cost of the goodwill under the corporate intangible assets regime (CTA 2009, Pt 8). Only where the original business was founded before 1 April 2002, and hence the goodwill is deemed to be created before that date, will the company be barred from claiming tax relief on the value of the goodwill it acquires from the related party (CTA 2009, s 882).

The government has decided that the combination of 10% tax for the business founder, plus corporation tax relief for the successor company, on a value which is difficult to prove with any accuracy, is an abuse of the tax rules.

Hence, with effect for business disposals on and after 3 December, ER can’t apply to a gain arising on the transfer of goodwill to a close company, where that company is a “related party” to the seller (again defined in CTA 2009, s 835(5)).

ER will continue to be available on incorporations – it’s just that the value of goodwill is excluded from the assets that qualify for ER on the business disposal. If the seller enters into arrangements to try to side-step this new condition applying on the transfer of goodwill – it will apply anyway (new TCGA 1992, s 169LA(5)). 

The company will also be denied tax relief on the value of goodwill acquired on and after 3 December, where the seller of the goodwill is related to the company (new CTA 2009, s 849B). 

Where a business wants to incorporate, it can use other capital gains tax reliefs to reduce or defer any capital gains arising. For example incorporation relief (TCGA 1992, s 162) will apply automatically where all the assets of the business are transferred to the company (or all assets except cash). Alternatively if section 162 is dis-applied, holdover relief can be claimed on the gains that arise on an asset by asset basis (TCGA 1992 s 165).

However, using incorporation relief or holdover relief will roll the gain into the value of the new shares of the company, or into the base-cost of the assets held by the company. In either situation there will be no balance available for the seller to drawdown tax free from the company.   

Rebecca Cave is the author of 'Capital Gains Tax Reliefs for SMEs and Entrepreneurs 2014/15' published by Bloomsbury Professional.

Replies (43)

Please login or register to join the discussion.

avatar
By Duhamel
05th Dec 2014 21:14

Excellent
I think this was a bit lacking from the autumn statement coverage, as the ER changes are probably the part that affects accountants most. This is a well explained article that fills in the 'gap' nicely.

Thanks (1)
avatar
By London boy
05th Dec 2014 21:25

Great article

Hey Rebecca

Great article. It has clarified a lot for me. We incorporated in October, but our valuation isn't due until January 2016. I'm unsure if this ultimately affects us, firstly on the ER and then the tax relief on the amortisation of the goodwill.

Could you clarify this please?

Thanks

LB

Thanks (2)
avatar
By Duhamel
07th Dec 2014 16:26

London Boy

You've not been too clear, if you incorporated and transferred your business to the company in October then the changes don't affect you.

 

If you incorporated but delayed transferring the business until 3 December or afterwards (such as January 2016), then you might have a larger CGT and CT bill than previously. 

Thanks (0)
avatar
By London boy
07th Dec 2014 19:27

Duhamel Appreciate the response.

To my knowledge we incorporated and transferred the business in October. I have requested clarification from our accountant on this, as there was discussion on goodwill valuations not being confirmed to January 16. Apologies for the ambiguity, I'm unclear on some elements myself. This was a big change in ER.

Thanks (0)
Northumberland flag
By MJShone
08th Dec 2014 11:38

London Boy

One possibility is that the accountant meant that the value of goodwill doesn't have to be finalised until January 2016 when the tax return that includes the incorporation in October 2014 is due?

Thanks (0)
By jon_griffey
08th Dec 2014 11:44

That really sucks

What has been overlooked is that as well as the 28% CGT on the sale of the goodwill, the company needs to earn profits to repay the loan on which 20% tax is paid.  This is punitive on small business owners who the Government purports to support.  Could they just have stopped the tax relief on the goodwill write down and leave it like that?  Instead we have 2 tax hikes, not 1.

Thanks (2)
avatar
By Wiganer Elaine
08th Dec 2014 11:52

Other Considerations

However, it's important to note that each incorporation is specific to its individuals.

If someone already has significant capital losses and/or is prepared to pay their CGT (at 18%/28%) then they can still make use of goodwill attributed to a DLA and drawdown when needed.

Thanks (0)
By Satwaki Chanda
08th Dec 2014 11:56

Corporation tax relief on goodwill

It seems that the company will be denied tax relief on goodwill even if the owners aren't intending to extract the cash in the way that HMRC object to. E.g. even on a s 162 rollover. 

One thing that is perplexing me.

I have read elsewhere that the company will be able to recover the lost tax relief when selling the business. But this would really depend on the meaning of CTA 2009 s 736(6), which says that the tax cost is:

 

"the amount of expenditure on the asset capitalised by the company for accounting purposes"

1. Is this the amount initially recognised in the balance sheet when the goodwill was acquired? - in which case one would be able to recover lost tax relief; or

2. Should this take into account that the balance sheet value decreases as the company writes off the goodwill in the accounts? (Except this time, the company cannot claim tax reliefs for the write offs).

Would be grateful for any views on this.

Thanks (0)
avatar
By Ian McTernan CTA
08th Dec 2014 12:31

Closing Abuse

The reason for this change is to close off the abuse of the provisions to artificially create a large pool of tax free funds for the shareholder to pull out of the company- indeed many firms were marketing exactly this strategy and charging large fees for the privilege.

As for the future sale of the business, hopefully ER would be available on a future disposal so the shareholder shouldn't be that much worse off (except they can no longer benefit from the large pot of goodwill upfront).

Maybe if accountants and scheme producers stopped abusing the rules we wouldn't end up with HMRC having to close off relief to all to stop the abuse of a few.

Thanks (0)
avatar
By whiteways
08th Dec 2014 13:04

So...

So, the value of Goodwill transferred by the Director from the previous S/T or Partnership no longer gets credited to his DLA but has to be capitalised instead?

Thanks (0)
avatar
By sumo69
08th Dec 2014 14:32

Relief for goodwill

If the donor sole trade commenced 1985 but only started making any money post 2002, am I automatically excluded from obtaining tax relief on the goodwill amortisation? Does the answer change if the profit stream greatly increased post 2002 due to a number of new customers?

Thanks

David

 

 

Thanks (0)
avatar
By Vaughan Blake1
08th Dec 2014 14:42

Sadly no deduction David.

It is when the trade started, rather than when profits are looking healthier. In theory you commence the creation of goodwill on the day the trade starts. 

 

 

Thanks (0)
avatar
By BKD
08th Dec 2014 15:03

I'm still bemused ...

... by the fact tat they've left the door ajar. There is nothing in the proposed legislation that prevents relief where the goodwill is transferred to a second company. They seem to be relying instead on application of either s864 or GAAR, both of which require a subjective interpretation.

Thanks (0)
7om
By Tom 7000
08th Dec 2014 15:18

As above

 

So, the value of Goodwill transferred by the Director from the previous S/T or Partnership no longer gets credited to his DLA but has to be capitalised instead?

I think the answer is No

I think it works like this....

lets say you incorporate the window cleaner

 

Dr Goodwill 10k

Cr DLA 10k

Goodwill goes in his tax return and is covered by 11k exemption - no tax

Goodwill is amortised in F/s  but added back in tax comp like entertaining

 

Lets say its the local Engineering Established post 01/4/02- a firm with 6 employees and Gwill = 111k

Dr Goodwill 111k

Cr DLA £111k

 

Goodwill goes in his personal tax return net of £11k allowance and he pays CGT on 100k at 28% as he is a high rate tax payer already  = £28k

Goodwill is amortised in the financial statements and its added back same as entertaining

Total cost £28k

 

Whereas before CGT was £10k and the £111k was tax deductable in the company saving £22k CT so overall you were £12k up!!

 

thats  a £40k swing.

 

But someone correct me if they think this is wrong!

 

Tom

www.ttca.co.uk

 

Ps I know someone who is now in tears as he was incorporating in the new year and the numbers were 5x bigger!

 

 

Thanks (1)
Replying to SouthCoastAcc:
avatar
By whiteways
10th Dec 2014 21:49

Capitalization or DLA?

There seems to be a difference of opinion still. Some say the value of the goodwill transferred must now be capitalized and rolled into the value of the shares. Others that it is transferred to the DLA.

Also, what if the new shareholder(s) are not identical to the owner(s) of the old business?    

Thanks (0)
Replying to SouthCoastAcc:
avatar
By Whinger
11th Dec 2014 12:17

double whammy?

Tom 7000 wrote:

As above

So, the value of Goodwill transferred by the Director from the previous S/T or Partnership no longer gets credited to his DLA but has to be capitalised instead?

I think the answer is No

I think it works like this....

lets say you incorporate the window cleaner

Dr Goodwill 10k

Cr DLA 10k

Goodwill goes in his tax return and is covered by 11k exemption - no tax

Goodwill is amortised in F/s  but added back in tax comp like entertaining

Lets say its the local Engineering Established post 01/4/02- a firm with 6 employees and Gwill = 111k

Dr Goodwill 111k

Cr DLA £111k

Goodwill goes in his personal tax return net of £11k allowance and he pays CGT on 100k at 28% as he is a high rate tax payer already  = £28k

Goodwill is amortised in the financial statements and its added back same as entertaining

Total cost £28k

Whereas before CGT was £10k and the £111k was tax deductable in the company saving £22k CT so overall you were £12k up!!

thats  a £40k swing.

But someone correct me if they think this is wrong!

Tom

www.ttca.co.uk

Ps I know someone who is now in tears as he was incorporating in the new year and the numbers were 5x bigger!

Thanks Tom.

So, for smaller businesses it could be a case of "let's not bother with the goodwill". But, could this be a move by HMRC to now insist on goodwill valuations, so they can charge CGT on the seller with no CT claim in the company? (I haven't looked at this in detail yet, but) On the face of it this looks like not only taking away a claim on the CT but increaing/adding a charge on CGT; a double whammy. 

Thanks (0)
Replying to Desert Orchid:
avatar
By Vaughan Blake1
11th Dec 2014 15:37

Unlikely to be a problem Whinger

Whinger wrote:

So, for smaller businesses it could be a case of "let's not bother with the goodwill". But, could this be a move by HMRC to now insist on goodwill valuations, so they can charge CGT on the seller with no CT claim in the company? (I haven't looked at this in detail yet, but) On the face of it this looks like not only taking away a claim on the CT but increaing/adding a charge on CGT; a double whammy. 

Given the time limit for a s165 holdover claim versus the time limit to enquire into a SATR, I don't think that they will bother.

Thanks (0)
avatar
By nick farrow
08th Dec 2014 15:21

credit balance on DLA

if sole trader has significant positive net assets (e.g. equipment, stock, debtors) which are being transferred to newco on incorporation this can still create a useful credit balance on the DLA

Thanks (0)
7om
By Tom 7000
08th Dec 2014 17:09

debtors on transfer

And will you pay the stamp duty on the debtors ?

Thanks (0)
avatar
By North East Accountant
09th Dec 2014 09:17

Shutting the door before the horse bolts
I might be being cynical here but I wonder if they are shutting the door before the horse bolts.

The door being Entrepreneurs Relief on incorporations and the horse being LLP's. There is currently a BIS consultation on Corporate Directors which may see Corporate Members of LLP's being outlawed.

If they do so any LLP's with Corporate Members will need to reconsider their structure and possible consider incorporating.

Oops, the door has been bolted already on a tax friendly way to do so!

Thanks (0)
avatar
By richboo
09th Dec 2014 10:07

Exemption for small and mirco businesses?

What do people make of this comment in HMRC's policy note in the 'other impacts' section?

"small and micro businesses which are carried on by individuals, alone or in partnership, can benefit from being transferred to a company under the same ownership. This measure does not obstruct such incorporations, for which tax relief remains available to the former proprietor".

Does this mean that there will be an exemption for the smallest businesses?

Thanks (0)
avatar
By BKD
09th Dec 2014 10:54

No exemption

I suspect that they're referring to s162 and s165 reliefs (or perhaps suggesting that very small businesses don't have transferable goodwill of any significance)

Thanks (0)
avatar
By nick farrow
09th Dec 2014 13:58

stamp duty on trade debtors?

surely not?

Thanks (0)
7om
By Tom 7000
09th Dec 2014 16:11

stamp duty

I thought the only way to legally pass trade debtors from one party to another was by an agreement signed by all 3 parties concerned. This agreement has to be documented and in writing and where its in writing has to be stamped. Therefore you pay stamp duty on the full trade Dr balance.

 

So I have never bothered with that. I just allow the s/e guy to collect the cash in and just move this to the co as a loan...saves the issue...

 

Besides they all pay electronically into the old bank account anyway!!

Thanks (0)
avatar
By BKD
09th Dec 2014 16:20

Bring yourself up to date, Tom!

Stamp Duty on trade debts vanished in 2003.

Thanks (0)
avatar
By BKD
11th Dec 2014 10:10

Capitalisation or DLA?

I don't understand the question. The proposed legislation simply removes certain goodwill from the scope of ER, and removes certain goodwill from the scope of amortisation relief. It does not in any shape or form alter the methods by which goodwill may be transferred to a company.

Re the question about non-identical ownership, go and read the definition of "related" party.

Thanks (0)
Replying to mail.taxperfect.co.uk:
avatar
By whiteways
11th Dec 2014 21:26

I don't understand your answer.

The OP stated. "However, using incorporation relief or holdover relief will roll the gain into the value of the new shares of the company, or into the base-cost of the assets held by the company. In either situation there will be no balance available for the seller to drawdown tax free from the company."

It seems to me the OP is implying that the seller would no longer have the benefit of a credit to his DLA in respect of the sale of the Goodwill to the new Company. Are you saying this is wrong?  

Thanks (0)
avatar
By BKD
11th Dec 2014 13:03

A double whammy, indeed

And given HMRC's past tendency to argue that goodwill in the case of a one-man band is not transferable let's see if they've changed their mind.

Thanks (1)
avatar
By Marky
11th Dec 2014 15:19

Has anyone had a look at the optimal profit levels when goodwill will be worth obtaining on incorporation for a single owner. Even with a deduction say of 25% for personal use.

I have a client who has just approached me to incorporate with annual net profits of £60,000. So if a business has a low level of tangible assets but a high level of contracts, repeat business,  high brand awareness, employees who generate the sales then this is the type of business that will suffer the most.

How would a value of say £50k  for goodwill be entered in the books. Does anyone know how we code this if not to DLA.

I think I need to go and do my sums!

Thanks (0)
avatar
By Vaughan Blake1
11th Dec 2014 15:46

Marky

They have only changed the rate of CGT on the sale of goodwill and stopped companies claiming a tax deduction for the write off.  The accounting entries are the same as you can still:

1) Sell the goodwill to the company, pay the tax and have a DLA.

2) Gift the goodwill, holdover the gain under S165 and not have a DLA.

3) Roll it into the share valuation under S162 and again not have a DLA.

BTW not sure how personal use fits in here.

Thanks (0)
avatar
By BKD
12th Dec 2014 09:42

You don't understand the answer, because ...

... you don't understand the point that the OP was making. The changes to the legislation don't affect in any way the availability of s162 and s165, both of which are optional. It may be the case that people will be more inclined to use those reliefs because of the higher CGT charges, but they do not, as you suggested in your earlier email, have to  capitalise the value of the goodwill.

Thanks (0)
Replying to jaffe123:
avatar
By whiteways
12th Dec 2014 14:49

Not what I read

Without getting into a debate concerning English usage, that is definitely not how I read the original post. Needs clarification in my view. 

Thanks (0)
avatar
By BKD
12th Dec 2014 15:48

Seems perfectly clear to me

But then I fully understand the meaning of the word "can" - (as in "may", not a container for cat food).

Thanks (0)
Replying to James Green:
avatar
By whiteways
14th Dec 2014 20:58

Not amused.

Your idiotic sarcasm not withstanding, you need to go back and read the paragraph I quoted, as there was no conditional adverb within it.

However, without clarification from the OP, it seems we will have to agree to differ.  

Thanks (0)
By miketombs
14th Dec 2014 18:44

Surely it's completely unworkable?

Goodwill needs to be written off for accounting purposes over max 5 years, and in fact 5 years profit is not an unreasonable total for goodwill.

If a business is generating £100K per annum and goodwill is valued at £500K then won't it work like this? (I'll simplify it by ignoring the £11K capital gain not taxed.)

The seller has a liability at 28% of £140K which he can defer if he rolls it into the shares issued, otherwise he pays it but leaves the £500K initially on a loan account.

Ignoring inflation etc, year 1 the company makes a profit of £100K LESS goodwill amortised of £100K = Zero. For tax purposes the amortisation is added back so if the company creates a deferred tax asset (hate those) profits are zero, otherwise there is a negative retained earnings figure of £20K. Same thing happens in years 2 to 5 so throughout the period, there is NO profit available for dividends. At the end of the 5 years, depending on the deferred tax treatment there are either no retained earnings or a negative £100K.

If the owner elects to take incorporation relief there is nothing on the loan account, so no source of cash at all. (Will he be entitled to welfare benefits because he has nothing else to live on.) If he doesn't take incorporation relief he pays the £140K and then draws down on the loan account. At least the company is presumably generating cash so the loan can be repaid.

This scheme is a massive disincentive to incorporate. It's a massive kick in the teeth to small businesses. Whenever a business is transferred into a limited company HMRC will be trying to get the highest goodwill value possible and the businesman gets screwed. If the previous system was considered abusive, then there may be some logic in either denying entrepreneurs relief or denying the deductability of the amortisation of goodwill, but doing both makes no sense at all.

And guess who it hits? The small business owners, not the big corporates, not the people with deep pockets, just the small sole traders and partnerships looking to build a better future for themselves and their kids.

 

Thanks (0)
By cfield
14th Dec 2014 20:00

Having their cake and eating it

The huge tax savings on incorporating always were too good to be true. I only wish I'd done a few more of these deals before the new rules came in.

I see they've rushed these new rules in overnight so we don't even have until 5 April 2015 to complete current valuations.

However, the net tax saving was never as great as people imagined, There was always an element of quid pro quo to it which the Government seems to have either overlooked or just plain ignored. We've now got a situation where they are both having their cake and eating it.

We're going from a net tax effect over the whole period of amortisation of +10% to -28% so it is a huge shift of the goalposts in favour of HMRC. Even before, the cash flow effect was often in their favour, as the taxpayers usually had to pay a huge CGT bill up-front and only got the 20% tax relief on the amortisation much later over a period of years.

Now, they expect to get 18% or 28% up-front and give nothing in return on the amortisation. Unless goodwill valuations are small enough to be covered wholly or mainly by the annual CGT exemptions, it will now be better to use section 165 Gift Relief instead.

I wonder if HMRC will still be so keen to argue that one-man businesses don't have transferable goodwill. They'll probably change tack now and insist on high goodwill valuations!

To those who argue that the system was being abused, don't forget that you are legally obliged to base CGT on the market value of an asset if the disposal was between connected parties. Valuing goodwill on incorporations is not an abuse of the law. On the contrary, it is exactly what the law prescribes.

However, some firms were trying it on with huge goodwill valuations on owner-run businesses. You are supposed to reduce it significantly for personal goodwill, but a lot of the firms marketing incorporation schemes weren't really doing so, and few ever got challenged until fairly recently when HMRC started getting hotter on CG34 valuations.

There was also a lot of abuse of the Tax Credits system, in that new shareholders were being encouraged to refrain from taking dividends in order to keep their income below the Tax Credit threshold.

Once again, it seems a sledgehammer has been used to crack a nut.

Thanks (1)
avatar
By BKD
15th Dec 2014 09:19

Well

You may want to read again the first word of the paragraph that you quoted. If you want to read the quoted paragraph in isolation, in particular without reference to the immediately preceding paragraph, I can see why you might be confused. The "clarification" (not that any is needed) is in that preceding paragraph.

Thanks (0)
Replying to pdtaylor78:
avatar
By whiteways
15th Dec 2014 19:26

I did.

I DID read both paragraphs together. You seem to be ignoring the fact that the paragraph I quoted begins with "However..." Thus it seems that this para dictates the effect of applying s.162/165 mentioned in the previous para, i.e the cost of Goodwill rolls up into the capital value of the shares rather than being repayable as tax free cash via the DLA. Hence my original post.     

Thanks (0)
avatar
By BKD
15th Dec 2014 22:16

I think that it is you ...

... that is ignoring (or misunderstanding) the "However" (hence the suggestion in my last previous post). You are quite correct in saying that the two paragraphs are linked (by virtue of the "However").  Look back at the first of the two paragraphs, and you will see that the word "can" (as in "may") appears more than once. So, the first paragraph merely confirms that one may use s162 or s165 if s/he wants to. The second paragraph merely sets out the consequences should one choose to claim either of the reliefs.

As I said previously, the proposed changes may result in a greater take-up of the reliefs - but it is still a matter of choice. If you think that the OP is suggesting that there will no longer be that choice you simply haven't understood what is, frankly, plain English.

Thanks (0)
avatar
By Malcolm Veall
16th Dec 2014 00:54

Relax it is Christmas

Guys, (BKD & Whiteways) - don't get wound up - you are two knowledgeable accountants and your contributions are valued.  Why not kiss and make-up?

Of more importance to the wider world - Mike's "Surely it is unworkable" post. If Goodwill valuations rise, maybe from HMRC pressures, maybe from clients not worrying about CGT because they are now using s162/s165,  the insistence of current GAAP on a 5 year write-off will unduly depress distributable reserves, even if the clients can draw against their DLA.

I guess the problem is GAAP rather than George O's Autumn Statement.

Thanks (0)
avatar
By Vaughan Blake1
16th Dec 2014 09:21

Just to be clear...
If the goodwill is gifted into the company, how is this accounted for?
Will there be a revaluation account which the amortisation can be written off against?

Alternatively can we just ignore it in the accounts altogether?

If we use S162 does this automatically create a share premium account? And can the amortisation be written off against this.

Thanks (0)
avatar
By AndrewV12
12th Jan 2015 16:10

Why

Good article, good points well made above, i am just trying to fathom out why it was mentioned in the Budget. Whats it all leading to.

Thanks (0)
avatar
By nathluthra
22nd Mar 2015 13:35

Goodwill and incorporation

I am glad that the chancellor has announced that the tax relief of write off the goodwill and

stopping of the ER. One thing that there was detrimental cost being incurred by HMRC and the

Accountants in negotiating the value of the goodwill and in any case this provision was

being abused in case  many small businesses.

Thanks (0)