Spotlight on goodwill and entrepreneurs’ relief
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.