Disappearing Relief! Companies And Goodwill

There is no tax relief for companies on the cost of goodwill acquired after 7 July 2015. James Bailey looks at the background and implications.

There is a progression that will be familiar to those who know their tax history. It goes something like this: the Government introduces a tax relief to encourage people to transfer their businesses into limited companies; people transfer their businesses into limited companies and claim the relief; the Government worries that too much tax relief is being given; the Government announces that people are ’exploiting’ the relief (by claiming it, presumably!); the Government abolishes the relief.

Until December 2014, it was possible to transfer a trading business from a sole trader or partnership into a limited company owned by the sole trader or the partnership, and to claim some valuable tax reliefs. The vendor (the partnership or sole trader) could be paid for the goodwill of the business at its market value (usually based on a multiple of its annual profits) and could claim entrepreneurs’ relief on the resulting capital gain, leading to a capital gains tax rate of only 10%. 

The company could then write the goodwill off over a period of years, claiming tax relief on the amount written off each year. The vendor was usually not paid cash, but instead was given a loan account with the company, on which he could draw with no further tax to pay.

In December 2014, it was announced that the 2015 Finance Act would include legislation to deny both entrepreneurs’ relief to the vendor, and corporation tax relief to the buyer, in cases where the two were ’related’, for deals taking place after 2 December 2014.

This still left both reliefs (entrepreneurs’ relief for the seller, and corporation tax relief for the buyer) available in a case where the person selling the business and the company buying it were not connected. 

When a company buys a business from an individual or partnership, there is no choice but to buy its assets, including any goodwill. When the vendor is another company, there is quite often a negotiation as to whether the shares in the target company are to be sold, or whether it will sell its assets to the buyer.

There are many factors to consider in such a case, though as a very general rule the seller will want to sell the shares, and the buyer will want to buy the assets. The reasons for an asset purchase are not all tax related. If you buy the shares in a company, you also buy any skeletons lurking in its cupboards, which is why in general a share purchase involves more extensive ’due diligence’ on the part of the buyer, looking for those skeletons, and a system of ’warranties and indemnities’ whereby the vendor will compensate the buyer for any further skeletons that emerge for a period (usually four to six years) after the sale.

One of the attractions of buying the assets rather than the shares is (or was) the tax relief for goodwill, but it was only one of a number of factors that need considering. For goodwill acquired from 8 July 2015, the tax relief will no longer be available, but this is unlikely to make a big difference to the choice between assets and shares.

The big difference, of course, will be that there will be much less tax relief claimed. HMRC estimates a gain of £100 million in 2016/17 – the first full year affected by the new rules, rising to £320 million by 2020/21.

If your company is buying a business, the absence of relief for goodwill should be remembered – but it is unlikely to affect the way the deal is structured.