Has anyone had any experience of incorporating a sole trader business and the calculation of goodwill?
I am intertested in what HMRC's take on an acceptable level of goodwill in a business such as this would be.
For instance, if the Limited Company 'inherits' the assets of the sole trader business, then the amount will clearly have an opposite entry to directors loan but what about intangible goodwill? This may have a huge bearing on whether or not to incorporate in some cases and so it would be interesting to know if anyone has agreed a figure with HMRC or had this questioned??
If there is is any inherent goodwill in the sole trader then the usual way to calculate would be to average the profits of the previous 3 years of the sole trader, take of a reasonable salary for a manager (as if someone else was taking over then they would want a salary), and deduct say 20% for CT.
Whatever profit you are left with, if a profit exists, then multiply by the P/E ratio of a similarly quoted business. The P/E rato would be discounted due to factors like lack of finance, lack of skills, size of business, etc. It would be normal to discount down to anything between 2 and 5 depending on starting point. When you are left with the adjusted P/E ratio multiply by the average 3 years profits and then round to a reasonable figure to calculate goodwill eg
I guess what I am trying to ask is if the HMRC have an accepted calculation method and p/e used? I understand the technique you illustrated, but wonder if you would confidently use a p/e of 3 for example....especially if the business was difficult to categorise.....or had diverse products/services.
Have you had any experience of this or, more importantly, had any queries with HMRC in relation to this?
I am inclined to go with, say, multiplying average profits less salary etc by three and stick to my guns!
I've used the method mentioned by Mark a few times, getting prior approval from HMRC, and never had a problem. I think I've used 3 times, 3.5 times and 4 times, and they've not questioned where I get my figures from.
I think it's more important to try and establish that there is genuine saleable goodwill, as the problem with an incorporation is that there isn't a third party.
