Sale of goodwill: Income or capital?

Mark McLaughlin highlights a case on the tax treatment for a professional consultant who sold his business. 

It is common in many occupations and professions (e.g. law, medicine) for individuals to be engaged as self-employed consultants. Some consultants will build up their own practices before eventually selling them.

From a tax perspective, the question arises how the practice disposal proceeds should be treated. For example, is it an income or capital receipt? If capital, could anti-avoidance provisions apply to treat the capital receipt as income (and, therefore, potentially taxable at higher rates)? These issues were considered in Villar v Revenue and Customs [2019] UKFTT 0117 (TC).

In that case, the taxpayer (a renowned orthopaedic surgeon) entered into an agreement with a company for the sale and purchase of the taxpayer’s business in March 2010. The taxpayer received £1 million upon completion. When submitting his self-assessment return for 2009/10, the taxpayer returned the £1 million payment as a capital receipt. Following an enquiry into the tax return, HM Revenue and Customs (HMRC) assessed the £1 million payment as income. The taxpayer appealed.

HMRC argued: (1) that the payment was in fact revenue in nature, being effectively an advance for services provided and so subject to income tax; (2) alternatively, that even if the receipt was capital in law, it should be treated as income under anti-avoidance provisions (in ITA 2007, Pt 13, Ch 4) concerning ‘sales of occupation income’. 

The First-tier Tribunal noted that the taxpayer’s particular method of carrying on the business resulted in a book of customers which provided repeat business, and his name was capable of attracting customers, notwithstanding that not all medical services were provided by the taxpayer himself. By far the greater part of the value of the business was attributed to goodwill. The fact that much of the goodwill was connected with the taxpayer’s name, and the taxpayer continued to be known by that name, did not prevent him from having parted with the goodwill. 

On HMRC’s argument (1), the tribunal concluded that the £1 million consideration received was a capital payment.

On HMRC’s argument (2) concerning the anti-avoidance rule, the first question was whether the arrangements the taxpayer entered into with the purchaser were ‘made to exploit the earning capacity of an individual in an occupation’, meaning the earning capacity of the taxpayer as an orthopaedic surgeon (ITA 2007, s 773(2)). The tribunal found it difficult to conclude that this pre-condition was met.

However, if it was met, the next question would be whether ‘one of the main objects of the…arrangements [was] the avoidance or reduction of liability to income tax’. The tribunal was not persuaded by HMRC's arguments on this point. The taxpayer's appeal was allowed. 

HMRC’s principal argument in Villar was that the taxpayer had no business to sell, on the basis that the goodwill was personal to him. HMRC’s guidance (in its Capital Gains manual at CG68010) indicates that any goodwill attributable to an individual’s personal skills is not capable of transfer to another person. Consultants who are selling their businesses should consider such possible challenges by HMRC.