
Fair’s fair in goodwill valuation of care homes
byThis tribunal case hinged on whether care homes should be valued at fair value or depreciated replacement cost for goodwill and amortisation.
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.
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Consulting Tax Editor for AccountingWEB.
I have spent the last 10 years teaching the accountants of the future, mainly ICAEW advanced level corporate reporting. I also cover tax news and write and edit tax updates for other publishers including PTP Limited.
Replies (9)
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Sounds like a slam dunk and one a first year trainee could have got right
I disagree. If anything it shows that no-one properly understands these things re goodwill etc. Another recent example of that (with the same taxpayer counsel) is here:
https://www.accountingweb.co.uk/any-answers/strange-goodwill-llp-tax-pla...
If you read this bit you're clearly wrong anyway "This first tier tribunal (FTT) case involved the complex interaction between UK GAAP, property valuation and tax legislation." Unless you're being sarcastic here of course.
I disagree with your disagreement. This case has nothing to do with goodwill, the valuation of the goodwill is not in question, both HMRC and the taxpayer agree it is the purchase price less the value of everything else.
I would agree this seems very straightforward, UK GAAP is clear enough that where a reasonably ascertainable market value for the property is available, this should be used as the valuation.
The taxpayer in fact had a qualified valuer provide exactly such a valuation then didn't use it relying instead on a very weak argument as to why they should be allowed to take a different value that, not coincidentally, gave them more tax relief.
They had both types of valuations available to them and chose the one specifically proscribed. A slam, as has already been said, dunk.
Unless you too are being sarcastic, there is no way a first year trainee would understand anything about what you're saying plus the tax aspects etc. per my above comment. Feel free to disagree with that (and make yourself look a fool) if you like.
Also, as far as I'm aware, there is no expert commentary anywhere that says this case was all bleedin' obvious or words to that effect (unlike certain other cases I could cite).
Agreed- struggle to see what reinstatement value has to do with anything here - with all our properties reinstatement is always higher than MV anyway, so strange it is considered lower. (does depend upon materials etc, e.g. most stone built properties have a higher reinstatement value than MV) IMHO the only reason for getting a reinstatement value is for insurance purposes.
Not that I am a valuer but to differentiate goodwill I would have thought the property should have been valued as a care home just built , with licensing /planning but no current occupants, ie on basis of its use class. Comparing that figure with its value as occupied on purchase would then have popped out the goodwill. (A bit like a rent review clause for say a pub that specifically ignores tenant generated goodwill /turnover etc when evaluating market rent)
Not entirely sure I was being sarcastic - there is no complex interaction between UK GAAP, property valuation and tax legislation. That's blowing smoke up the FTT...
As was stated in the article HMRC expect accounts to be prepared following UK GAAP, from which the tax comps/returns are prepared (that's covered in the Principles of Tax paper). The valuation point is moot - GAAP wasn't followed and as I said a first year ACA should have been aware this was wrong, definitely a second year and a qualified accountant would have no excuse (covered in Accounting and Financial Reporting papers).
It looks like you either don't understand the difference between a trainee ACA and a qualified ACA or you are rapidly backpedaling on your above comment.
Unless I'm riding a fixie, backpedalling isn't going to have much of an effect :) Perhaps you should consult the ACA syllabus and see what exams a 1st year ACA trainee has to study - I've helped by referring to a couple...
The problem seems to be that some advisers and some judges don't accept that the way that trade related properties are valued results in little or no goodwill. This is also the issue in Denning & others which is on its way to the SC.
In former times such goodwill was called inherent goodwill as it 'attached' to the building and was not the 'free' goodwill of the owner of he building. The result is the same: the difference between a care home's value as a going concern and its bricks and mortar valuation is not capable of separate sale.