Before we start please feel free to talk us at the Accountancy Coop before making any decisions regarding incorporation.
Entrepreneurs’ relief is no longer available on the incorporation of many businesses, but HMRC’s attitude to trade-related properties leaves the door ajar for some…
In recent years, a large number of businesses (particularly professional practices) have incorporated, giving them the opportunity to retain profits at corporation tax rates rather than paying up to 60% income tax on funds that have been retained in the business. But, the Autumn Statement included new rules to remove the ‘unfair tax advantage’ enjoyed by entrepreneurs when they incorporate.
How it was…
A sole trader or a partnership could formerly sell the business to a company and claim entrepreneurs’ relief (ER) on the disposal of goodwill and other chargeable assets. Subject to the payment of 10% capital gains tax (CGT), the resulting loan account could then be drawn down over a number of years without any further personal tax liabilities. As a result, the company would acquire goodwill and, to the extent this goodwill was created or acquired by the individual or partnership on or after 1 April 2002, it could, and can continue to, claim corporation tax relief for the goodwill, usually as it is amortised in the accounts.
The Government has apparently decided that the combination of ER for the founder and tax relief for the successor company smacks of tax avoidance. With effect from 3 December 2014, if you sell goodwill to a close company with which you are related, you cannot claim ER and will have to pay CGT at normal rates on it. Furthermore, the company will not be able to claim corporation tax relief on such goodwill acquired on or after that date.
But what is goodwill? Essentially, it is an accounting concept and may generally be defined as the excess of the value of an entire business as a going concern over the fair value of its net assets. So whilst it may no longer be permissible for professional practices (or any other business where the assets go home at night) to incorporate and claim ER, what about businesses with valuable net assets?
Until now, the received wisdom when considering apportionment of the price paid on a business purchase was to value tangible assets such as real estate at the lower end of the range of supportable valuations and hence increase the value of goodwill (thereby saving stamp duty land tax and increasing the subsequent corporation tax relief for goodwill amortisation). Following the Autumn Statement, proper consideration should now be given to property valuations, to recognise the contribution that each asset makes to the value of the business.
HMRC’s own view of goodwill in connection with trade-related properties changed in 2002 (funnily enough, when corporation tax relief for purchased goodwill was introduced). Its 2013 guidance notes on apportioning the price paid for a business transferred as a going concern concludes that some types of goodwill “are not really goodwill at all”, as they inherently form part of the value of the trade-related property and should be reflected in the property valuation.
The hotel, pub, restaurant, care home or petrol filling station from which a successful business trades must therefore have some inherent ‘goodwill’ of its own and the trading potential that each asset has must be recognised. Indeed, this is reflected in the guidance notes issued by the Royal Institute of Chartered Surveyors, whose methodology can result in values for buildings that leave little or nothing left to attribute to business goodwill.
It follows that, in many circumstances, it could still be attractive to incorporate a business by selling all the trade-related properties to the company at the Red Book existing-use value and claiming ER. Just remember to sell the actual goodwill for £1 (and claim hold-over relief).