Goodwill is a term we hear about often, but interestingly, is rarely mentioned in legislation. In fact, the term 'goodwill' is not defined for the purposes of the Capital Gains legislation in TCGA 1992.
Most definitions of goodwill are derived from case law. You could describe goodwill as the 'extra' value attributed to a business over and above a valuation of its tangible assets.
In the vast majority of cases when a business is sold, a significant proportion of the sale price will be for the intangible assets or goodwill of the company. This is essentially a way of putting a monetary value on the business's reputation and customer relationships. Valuing goodwill is complex and there are many different methods which are used and that vary from industry to industry.
HMRC’s internal manual states that:
'Most businesses can be expected to have goodwill even though its value is likely to fluctuate from time to time. The fact that goodwill may not be reflected in the balance sheet of a business does not mean that it does not exist. In the same way, the writing off of purchased goodwill in the accounts of a business does not mean that its value has decreased or that it has ceased to exist.'
As the value of goodwill is likely to be a significant component of a businesses' net worth, consideration of valuation methods will need to be carefully considered should the business owners seek advice on a sale.
Currently, the due date for paying any Capital Gains Tax (CGT) owed to HMRC is the 31 January, following the end of the tax year in which a Capital Gain was made. This deadline will change for UK residents from April 2020. Clients should be advised that this change will mean that any CGT due on the sale of a residential property will need to be reported earlier than is current the case. In addition, a payment on account of any CGT due (an advance payment towards their tax bill) will need to be made within 30 days of the completion of the transaction.
In practice, this change will apply to the sale of any residential property that does not qualify for Private Residence Relief (PRR). The PRR relief applies to qualifying residential properly used wholly as a main family residence. The new deadline will mainly apply to clients who are disposing of a second / holiday home, an investment rental property or a home that does not qualify or only partially qualifies for PRR.
There are also changes to the PRR rules which will see the final exempt period for CGT purposes being reduced from 18 months to 9 months from April 2020. This time period can be extended to 36 months under certain limited circumstances such as the owner having to move into care. This relief applies even if the homeowner was not living in the property when it was sold.
These CGT changes have already come into effect (from April 2019) for non-UK residents. If your client lives abroad and sells a UK residential property, they must inform HMRC within 30 days of the sale. The notification must be made whether or not there is any non-resident CGT to be paid. Any non-resident CGT that is due must be paid within 30 days of the sale.
As our readers are most likely aware there is usually no Capital Gains Tax (CGT) due on the transfer of assets between husbands and wives and civil partners. However, there is still a deemed disposal that has taken place for CGT purposes effectively at no gain or loss on the date of the transfer. When the asset ultimately comes to be sold, the gain or loss will be calculated using the date and cost when the asset was first owned by the transferring spouse or civil partner.
There are a few exceptions that couples should be aware when the CGT relief does not apply. This mainly relates to the use of goods which are sold on by the transferee’s business and for couples that were separated and not living together for the entire tax year when the assets were transferred. Spouses or civil partners that lived together at any point in the tax year when the assets were transferred can still benefit from these rules. If a transfer did not qualify then the asset must be retrospectively valued at the date of the transfer and the transferor is liable for any CGT that may be payable.
There are similar rules for assets that are gifted to charities. However, CGT may be due where an asset is sold to a charity for more than you paid for it and less than the market value. The gain in this case would be calculated based on what the charity paid you rather than the market value of the asset. We would recommend that evidence is held of any transfers in case of any future queries by HMRC.
The First-Tier Tribunal (FTT), in the case of Villar v Revenue and Customs examined whether the disposal of goodwill was capital or income in nature. The taxpayer in this case was a renowned orthopaedic surgeon specialising in hip arthroscopic procedures. The taxpayer sold his business in return for a payment of £1m, this payment was treated as capital in nature and a claim was made for Entrepreneur’s Relief. HMRC opened an enquiry into the relevant tax return and eventually issued a formal closure notice and assessed the £1m payment as income. This resulted in the appeal before the FTT.
The taxpayer’s position is that he received the £1m payment as consideration for the sale of a business as a going concern and therefore it should properly be assessed to Capital Gains Tax (CGT) whilst HMRC argued that the payment was in fact income in nature, being effectively an advance for services provided and so subject to Income Tax. HMRC also put forward a second argument to the FTT, that if the payment were in fact capital in nature, it remained clear that it should be treated as income based on the provisions of Part 13, Chapter 4, Income Tax Act 2007. Both parties agreed that the sale of a business is a capital transaction, the case revolved around this issue of whether or not the taxpayer’s arrangements amounted to the sale of a business.
The FTT, after examining all the facts, concluded that the £1m consideration received was a capital payment and rejected HMRC’s second argument that the relevant provisions of ITA 2007 applied finding that there was no evidence that the taxpayer had entered into the relevant arrangements in order to avoid or reduce the amount of Income Tax payable. The appeal was allowed in full. The case makes for interesting reading and provides some helpful guidance for those in similar situations although it must be remembered that no precedent is set by the FTT’s decision.
Entrepreneurs' Relief (ER) can be a valuable relief when selling your business, your shares in a trading company or your interest in a trading partnership. Where ER is available Capital Gains Tax (CGT) of 10% is payable in place of the standard rate. CGT on the disposal of chargeable assets is usually chargeable at 20%. There are a number of qualifying conditions that must be met in order to qualify for Entrepreneurs' Relief.
There is a lifetime limit that means that you can qualify for ER more than once, subject to an overriding total limit of £10m of qualifying capital gains. There are time limits that must be met to make a claim. To qualify for relief you should be either an officer or employee of the company and own at least 5% of the company and have at least 5% of the voting rights. There are also other qualifying conditions that must be met in order to qualify for the relief.
In a recent change, the minimum period during which certain conditions must be met in order to qualify for ER increased from one to two years (from 6 April 2019). If you are looking to sell your business, you need to be mindful of meeting all the necessary conditions in order to qualify for ER.
There is also a sister relief called Investor’s relief which has a separate £10 million lifetime cap. This is useful for investors who do not meet the officer or employee requirement for ER.
There are special rules concerning the payment of Capital Gains Tax (CGT) on the sale of personal possessions also known as 'chattels'. Personal possessions are generally defined as possessions with a predictable useful life of 50 years or less and are exempt from CGT up to a value of £6,000.
Personal possessions include items like jewellery, paintings, antiques and coins and stamps. Marginal relief may be available where the proceeds of sale are between £6,000 and £15,000. The taxable gain is calculated as the lower of the actual gain or 5/3rds of the excess over £6,000. The disposal proceeds will normally be the amount of money you received when you disposed of the item.
There are different rules for sets of personal possessions. A set is two or more items together which are similar and complementary to each other, and worth more together than separately. Examples include matching ornaments or a set of chess pieces. Where a set is sold the £6,000 limit applies to the set collectively. Special rules apply to sets that have been broken up and sold separately.
You are only required to report Capital Gains as and when you have a liability to pay CGT. Of course, calculations should be prepared (and held on file) to establish whether there is a liability to CGT. If the proceeds exceed £15,000 then any chargeable gain should be calculated using the normal CGT rules.
Historically, the term bed and breakfasting (sale and repurchase) of shares referred to transactions whereby someone sold shares one day and bought them back the next morning. This used to have Capital Gains Tax (CGT) benefits by crystallising a gain or a loss but is no longer tax effective over such a short period. The rules changed in 1998 when new legislation introduced special share matching rules. Under these rules there are a number of limitations, including a 30-day waiting period before the shares can be repurchased again.
However, it is possible under certain circumstances to use a modified bed and breakfasting type of arrangement to sell an asset only to buy it back again a short time later. A gain could be created in order to use up the annual exempt amount or a non-resident may 'bed and breakfast' their chargeable assets to establish a higher base cost before they enter the UK tax regime.
Proper consideration should be taken before undertaking such transactions to ensure that all tax aspects have been observed. For example, in order for any bed and breakfast transaction to be effective, there must be a genuine transfer of beneficial ownership of the asset and the share matching rules must be met.
A charge to Capital Gains Tax (CGT) usually arises after an asset is sold. However, there are special rules concerning the sale of certain personal assets that are worth considering. That is because these assets or possessions with a predictable useful life of 50 years or less are normally exempt from CGT. A chattel is a legal term that defines an article of movable personal property. Chattels include items like household furniture, paintings, antiques, items of crockery and china, plate and silverware, motor cars, lorries, motorcycles and items of plant and machinery not permanently fixed to a building.
The gains on any chattels you sell are exempt if the proceeds do not exceed £6,000 per item. In addition, marginal relief may be available where the proceeds are between £6,000 and £15,000. The taxable gain is calculated as the lower of the actual gain or 5/3rds of the excess over £6,000. The disposal proceeds will normally be the amount of money you received when you disposed of the chattel.
There are also special rules for sets of chattels. A set is two or more chattels together which are similar and complementary to each other, and worth more together than separately. Examples include matching ornaments or a set of chess pieces. Where a set is sold, the £6,000 limit applies to the set and there are special rules to sets that have been broken up and sold separately.
Please call if you are concerned about the CGT consequences of an impending disposal.
Entrepreneurs' relief applies to the sale of a business, shares in a trading company or an individual’s interest in a trading partnership. Where this relief is available Capital Gains Tax (CGT) of 10% is payable in place of the standard rate. CGT on the disposal of chargeable assets is usually chargeable at 20%. There are a number of qualifying conditions that must be met in order to qualify for Entrepreneurs' relief.
There is a lifetime limit that means individuals can qualify for the relief more than once, subject to an overriding total limit of £10m of qualifying capital gains. The relief is available to individuals as well as some trustees of settlements. To qualify the individual should be either an officer or employee of the company and own at least 5% of the company and have at least 5% of the voting rights. There are also some other qualifying conditions that must be met in order to qualify for the relief.
The minimum period during which certain conditions must be met in order to qualify for Entrepreneurs' relief increased from one to two years from 6 April 2019. There are special provisions if the business ceased operating before 29 October 2018. This measure means that taxpayers looking to claim ER will be required to have a longer-term interest in their business. There had been suggestions that the relief could have been abolished in its entirety so for most entrepreneurs this is a manageable change.
Where a taxpayer owns a business as a sole trader or in partnership, a Capital Gain will be deemed to arise if the business is converted into a company by reference to the market value of the business assets including goodwill. This could give rise to a chargeable gain based broadly on the difference between the market value of the assets and their original cost.
However, in most cases the incorporation of the business will be done in such a way that satisfies the conditions necessary to secure incorporation relief. One such condition is that the entire business with the whole of its assets (or the whole of its assets other than cash), must be transferred as a going concern wholly or partly in exchange for shares in the new company.
It is important to note that where the necessary conditions are met, incorporation relief is given automatically and there is no need to make a claim. The relief works by reducing the base cost of the new assets by a proportion of the gain arising from the disposal of the old assets.
Although the relief is automatic, it is possible to make an election in writing for incorporation relief not to apply. An election must be made before the second anniversary of 31 January following the tax year in which the transfer took place e.g. an election in respect of a transfer made in the current 2019-20 tax year must be made by 31 January 2023. The election deadline is reduced by one year if the shares are disposed of in the year following that in which the business was incorporated.