Fair’s fair in goodwill valuation of care homes

HMRC can challenge deductions claimed by companies (and indeed sole traders and partnerships) either because of a statutory restriction (such as disallowance of business entertaining) or on the grounds that the taxable profit has not been computed in accordance with generally accepted accounting practice (GAAP). The latter challenges are rarer and could be construed as HMRC impugning the professional judgment of those who prepared the accounts. This is one such case – moreover one in which HMRC was successful.

Nellsar Limited is an operator of residential care homes. Between 2004 and 2007 it purchased five residential care and nursing homes, which are the subject of the appeal. 

Experts assemble

This first tier tribunal (FTT) case involved the complex interaction between UK GAAP, property valuation and tax legislation. Several expert witnesses were called, including chartered accountants and members of the Royal Institute of Chartered Surveyors (RICS). The tax implications of the decisions were two-fold:

• corporation tax (CT) relief – amortisation of goodwill and corresponding CT debits
• SDLT – just and reasonable apportionment of total consideration between properties and other assets, most materially goodwill.

Accounting treatment

Turning first to the provisions of UK GAAP and the financial reporting standards (FRS), FRS 6 Acquisitions and Mergers prescribes that the identifiable assets and liabilities of companies acquired should be included in the balance sheet at their fair value at the date of acquisition. Goodwill as part of a trade and assets purchase is calculated as the difference between the total consideration and the fair value of the identifiable net assets (those assets capable of being disposed of separately, without disposing of the business as a whole). 

FRS 10 Goodwill and Intangible Assets requires that purchased goodwill should be capitalised as an asset and amortised through the profit and loss (P&L) statement. A CT debit is available for amortisation based on the value of goodwill and calculated in accordance with Part 8 Corporation Tax Act 2009. The value attributed to goodwill was therefore integral to the correct calculation of CT liabilities.

Five purchases

On each of the five purchases, goodwill was calculated as the total purchase price less the values of various assets. These included – but were not limited to – fixtures and fittings, stock and other assets, but in each case it was the value of the property, a significant element of the overall figure in each transaction, that was under dispute.

The concept of fair value (FV) is explored in detail in FRS 7 Fair Values in Acquisition Accounting. Essentially, FV should be market value if there is an active market. An active market exists where homogenous transactions occur with sufficient regularity that a FV can be ascertained. In lay terms this means that a high volume of similar assets in a similar condition are regularly bought and sold. If no such market is available, assets should be valued at depreciated replacement cost (DRC), the cost of reinstating the asset adjusted for its age and condition.

It is important to note that it is the preserve of the Lands Chamber of the upper tribunal, not the FTT, to agree the final valuations. The issue to be decided in this hearing was simply whether FV or DRC was appropriate for the properties, not what those values were.

Identifiable asset

Nellsar argued that the “identifiable asset” under consideration in each case was the care home as a standalone property without the associated business – staff, residents, contracts and so on. Because properties used as care homes are usually sold as part of an ongoing business, the taxpayer argued that there is no active market for such properties as standalone assets. On that basis DRC was an appropriate valuation method for the properties.

Valuation reports were provided for each transaction which contained detailed determinations, in line with the RICS guidance, of the fair value of the property as a fully equipped operational care home, as well as an alternative reinstatement value. In every instance, Nellsar selected the reinstatement value, applied appropriate adjustments for the age and condition of the building and included the resultant DRC in the goodwill calculation. 

This resulted in higher goodwill values and higher CT debits for amortisation than if market value had been used. HMRC sought to reduce the value of goodwill capitalised and make corresponding increases to corporation tax on the grounds that the accounts were not UK GAAP compliant and did not give a “true and fair view”. In HMRC’s view, as each home was fitted out, open and operating as a business, this should be reflected in their valuation. There was a very active market in sales of operating care/nursing homes, enabling a valuer to arrive easily at a market value for these homes.

Adjusted operational entity valuation

The FTT heard evidence from experts and referred to the RICS guidance, lengthy extracts of which are included as an appendix to the tribunal summary. It concluded that Nellsar should have adopted an adjusted operational entity valuation to determine open market fair values for the properties in accordance with RICS guidance. The tribunal agreed with HMRC that the tax liabilities should be recomputed on the basis of UK GAAP-compliant accounts.

Any increase in FV of the land and buildings would also result in increased SDLT as the apportionment of the total consideration on a trade and assets purpose should be done on a “just and reasonable basis”. The values of land and buildings were material to this apportionment. HMRC argued, and the FTT agreed, that market values where available should form the basis for apportionment.