One of the things which makes working with our tax rules a fascinating occupation is the way sometimes quite vague and nebulous concepts can be immensely important for determining a person’s tax liability. Almost the archetypal example of this principle is the tax treatment of goodwill.
Goodwill is referred to in a number of different places in our tax legislation, but there’s very little, if anything, in the way of a definition of what the term actually means (except in one specific context, which is for the purpose of taking away a tax relief – of which more below).
What is goodwill?
There are various definitions of this nebulous concept out there, but perhaps the most straightforward is the accountant’s definition of the term as the value of a business over and above the value of its separately identifiable net assets. So if, for example, an accountancy practice changes hands for £250,000, and one looks at the value of the actual assets that formed part of the sale, you might find that there’s very little tangible to put your finger on, other than a few computers and items of office furniture. The reason a person is willing to pay a quarter of a million pounds for that business is because it has ‘goodwill’. This is derived not just from the good reputation the practice might have with its clients and others, but also the mere fact that it is a going concern; with the result that a lot of start-up expenditure of the sort that you would have to incur to set up a practice from nothing has already been incurred, giving the existing going concern a positive value for that reason alone.
Rollover relief and entrepreneurs’ relief
One specific example of the use of the term goodwill in tax legislation is in the area of rollover relief, as it applies to individuals and partnerships of individuals. Goodwill is one of those assets which is eligible for rollover (that is, deferral of capital gains tax) if you sell a trading asset and, within a period of one year before or three years after (normally) you spend a similar amount on acquiring new trading assets. The other principal categories of asset that you tend to find in practice are land and buildings used for the trade; and fixed plant and machinery.
Because, almost by definition, a sale of goodwill is likely to happen in the context of a sale of the business as a whole, you will also probably be eligible for entrepreneurs’ relief, giving a 10% capital gains tax rate, if or to the extent that you don’t roll over the gain.
Stamp duty land tax
Given the apparent tendency of stamp duty land tax (SDLT) to rise inexorably, goodwill is taking on a new importance from the point of view of SDLT too. Consider the scenario where a business is being purchased – that is the various assets of a business, including goodwill, plant, and property are being acquired, rather than the situation where, say, the shares in a company are being acquired. It’s always necessary to consider, in this scenario, how much of the total price for the business applies to each of the different elements. From the narrow point of view of SDLT, you are looking at the specific question of how much of your proceeds relate to the real property you’re acquiring as part of the business purchase; and how much you are paying for everything else.
Assets such as plant and stock tend to have a fairly uncontroversial valuation, and so the area where there is a lot of scope, potentially, for disagreement is that of how much you are paying for goodwill and how much for the property. As SDLT can apply at some fairly high rates now to the property element, it’s obviously to the purchaser’s advantage to maximise the amount that is apportioned to goodwill.
This is incidentally quite a topical subject of dispute at the moment between the professions and HMRC, in the area of ‘trade related properties’; HMRC have taken it into their heads to interpret accounting standards in such a way as to make it virtually impossible, in practice, to apportion any significant element of your purchase price to goodwill when you are buying a property like a pub, a restaurant, or a care home. This is too complex a dispute to discuss in full here, but it is obviously highly relevant not just to your SDLT liability but, also, where the purchaser is a company, to how much you are allowed to write off as ‘amortisation’ (of which more below). Suffice it to say, then, that the professions (including, in particular, the chartered surveying profession) are wholly convinced that HMRC’s reasoning is wrong here, and any disputes on the subject should not simply be conceded by the taxpayer. A test case is expected. Note that land and buildings transaction tax replaced SDLT in Scotland from 1 April 2015.
You may be blinking in disbelief at the idea of there being any interface between goodwill and VAT! Normally, of course, where there is a transaction in goodwill, it will be part of the transfer of a business as a going concern (TOGC). Transfers of going concerns are explicitly excluded from VAT, and for this reason the possibility of VAT applying to a sale of goodwill tends not even to be considered.
However, sales of goodwill aren’t always in the context of a transfer of a going concern. Sometimes, for tax planning or asset protection reasons, goodwill is dealt with by way of a transaction separate from a disposal of the business as a whole. Or, sometimes, the conditions for TOGC treatment aren’t met: perhaps, for example, because the assets are being onward sold to a third party straight away. In these instances, the possibility that VAT might apply is a very real one.
There is one situation where you would have thought that VAT would rear its ugly head but doesn’t; and this is where a business which owns goodwill de-registers from VAT, because it no longer expects to have taxable turnover over the threshold. HMRC appear to accept, here, that there is no ‘claw back’ VAT charge on the goodwill value, unlike certain other assets such as buildings or stock which are held at the time of de-registration.
The most problematical area of tax planning involving goodwill is where there is a limited company involved. Until recently, a company which bought goodwill could claim corporation tax relief for writing this off over a period of years, otherwise known as ‘amortising’ the goodwill. This has recently been done away with, and in another recent change an individual selling goodwill to his own connected company doesn’t qualify any more for entrepreneurs’ relief. Why have these changes been made?
The reason was because tax advisers were beginning to get a little bit too cocky about the ability to engineer ‘negative tax rates’. If you consider the situation where an individual incorporates his business, and sells the goodwill element to his company for its value, the tax which is payable as a result of this sale to the company is unlikely to be more than 10%, because of capital gains tax ‘entrepreneurs’ relief’. However, the company, by writing the goodwill off year on year, is able to secure relief at 20%, ultimately, for the same figure. So, by doing a transaction effectively with ‘yourself’, you ended up with an effective ‘negative tax rate’ of the difference between the 20% corporation tax relief and the 10% personal capital gains tax: that is a negative tax rate of 10%.
So this wheeze was stopped a year or so ago, and it is for these purposes that the taxman has taken the trouble of trying to define a bit more closely what he means by ‘goodwill’. This means not just the vague good name of the business, but also specific assets, such as the benefit of trading contracts, relating to the benefit of dealing with specific customers.
Interestingly, the negative tax rate idea still works in respect of all other intangible assets, such as, for example, computer software, trademarks, and other non-customer related intangible value. But recent changes to taxation, which post-date the abolition of negative tax rates on goodwill, suggest that, even following these swingeing changes, the practice of incorporating your business, with a value on goodwill, may still have a future. Even without entrepreneurs’ relief, the rate of tax you pay on a sale of your goodwill to the company is no more than 20%, and this is subject to annual exemptions and other CGT reliefs such as losses. If you consider that the alternative to paying 20%, and taking money out of your company at this rate, might be paying income tax on dividends at a rate of 32.5% or even 38.1%, this is beginning to look much more attractive!
- When buying a business in the form of an asset purchase, consider how much you can apportion to goodwill rather than to real property; the apportionment has a direct effect on how much SDLT you will pay.
- Consider incorporating a business which has a high intangible value due to assets other than goodwill, because ‘negative tax rates’ can be achieved in this scenario.
This article was first printed in Business Tax Insider in October 2016.