Tax treatment of goodwill on incorporation
In an unexpected move, the Chancellor changed the landscape for business incorporations with an announcement that the taxation of goodwill will change with effect from 3 December 2014.
Firstly, it was announced that goodwill acquired by a close company related to the vendor will not qualify for capital gains tax entrepreneurs’ relief. This increases the tax payable on such a sale from the entrepreneurs’ relief rate of 10% to the main rate of 28% (or possibly 18% to a limited degree).
One of the tax benefits of an unincorporated business selling its trade and assets, together with goodwill, to a company owned by the vendor was that the sale proceeds could have been placed on loan account to be repaid to the vendor using the profits generated by the company post sale.
Where tax is payable at 10% on the sale, this is a very tax efficient way to extract cash from the company, which would otherwise be subject to income tax if it were drawn as salary or dividends (with national insurance also possibly applicable to salary payments).
With the tax rate on the sale increased to 28%, this makes the sale of goodwill in exchange for the loan account a less attractive proposition, particularly as the tax is payable up front and there are usually no actual sale proceeds from which to pay the tax.
Whether a sale of the goodwill in this way is still a viable option will depend on whether the larger liability can be funded, and whether or not it will be outweighed by the annual savings in the longer term.
The capital gains tax liability on incorporation can be avoided by claiming capital gains tax incorporation relief, whereby all assets of the business, including goodwill, are sold in exchange for shares in the company, and the gain arising is rolled over into the shares. In this situation there is no loan account to draw out in lieu of remuneration, so post-incorporation cash extracted from the company will need to be in the form of salary or dividends with its consequential income tax and, where applicable, national insurance liabilities.
There can still be annual tax savings with this route, and personal tax liabilities are timed with cash withdrawn from the business, but the savings are more modest than where a loan account is available. Alternatively, gift relief can be used in a tax efficient way on an incorporation situation, when it is appropriate to the circumstances, although again this will generally not result in the creation of a loan account.
The second measure announced was the withdrawal of corporation tax relief on the amortisation of goodwill and “customer related intangible assets” where the company acquires the goodwill from a related party.
Since the relief for intangible assets was introduced, relief has been denied where the acquisition is from a related party and the underlying asset existed before 1 April 2002, so only “new” businesses could benefit from the relief. This new measure extends this restriction to all goodwill acquired from a related party.
Effectively, from 3 December 2014, these two measures significantly reduce the tax benefits associated with goodwill unless there is a change of ownership, as opposed to just a change of trading entity. This is by no means an end to incorporation, but it does place more focus on the commercial reasons behind the decision and will change the financial modelling substantially.
This release has been prepared as a guide to topics of current financial business interests. Hazlewoods strongly recommend you take professional advice before making decisions on matters discussed here. No responsibility for any loss to any person acting as a result of the material can be accepted by Hazlewoods.
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