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31 August 2011

Taking advantage of Tax from goodwill?

You may be familiar with the attraction of incorporation involving selling a business to a new company at full market value to take advantage of entrepreneur’s relief (on gains of up to £5 million from 23 June 2010). The sale proceeds are credited to director’s loan account and can of course be drawn tax-free as and when company funds permit, in preference to taxable remuneration or dividends, or to top up income bearing in mind that dividends are effectively exempt within the basic rate. The new 50% top rate of income tax from 2010/11 enhances the strategy by encouraging the retention of company profits as far as possible given a small companies rate of 21% (20% from 1 April 2011).

Only ‘free’ goodwill can be transferred and so not only must any personal goodwill be excluded from the valuation, but also ‘adherent’ goodwill which attaches to a premises e.g. a pub or hotel and so if a property is not transferred (as may be advisable) this will also limit the value of any free goodwill. Valuation of goodwill is clearly a Specialist subject, but for further advice you should contact us on 0207 636 2430.

The temptation is naturally to place as high a value on the goodwill as possible but this can lead to complications. HM Revenue may be expected to pay close attention to goodwill valuations and it will not help negotiations with HM Revenue’s Valuation Agency if an over-optimistic or fanciful value has been placed upon the goodwill, which therefore cannot be supported. If it has to be conceded that the valuation was excessive, the excess could be treated as a distribution taxable, of course, as a dividend. This could be remedied by an adjuster clause in the sale agreement allowing the credit to DLA to be adjusted if a different value for goodwill is agreed with HM Revenue. However, provided there was no deliberate attempt to ‘over-egg’ the valuation the Inspector will often allow the distribution to be unravelled provided reasonable efforts were made to establish market value, for example, by obtaining a professional valuation.

Finally, it is sometimes assumed that goodwill acquired from a connected party cannot be amortised for corporation tax purposes. However, if the unincorporated business commenced on or after 1 April 2002 or was acquired from a third party on or after that date then amortisation will be an allowable expense for the company.

 

*Article for guidance only. Professional advice should be obtained to ensure that all circumstances are assessed in providing a complete answer.