Ok - So these days it seems beneficial in the main to incorporate a Ltd Company from a previous sole trader business.
One of the benefits might be that you can charge goodwill to the new incorporated Ltd company.......but there is a rule somewhere (I may be wrong but I seem to recall this) that an individual cannot 'create' goodwill in a sole director company or 'for himself'. Does anyone know what the in's and out's are before I go trawling through the HMRC website - apologies for the laziness! It makes some sense I suppose when you consider that an artist may have a business where he is well thought of in his field and so the business is only really worth something with his name on it or his involvement in it.....so the goodwill is hardly transferable to someone else.
The question is, other than the value of assets creating a 'directors loan', could a sole trader 'artist' include a value for goodwill based on the business he has built up and the profits made over the previous periods and expected profits in future periods??
I know this isn't an every day bookkeeping issue, but it is a little interesting and something that may be valuable to others who are asked about incorporating v sole trader status which I'm sure happens all the time???
p.s. I realise as I am about to click on 'Submit Post' that I haven't searched for similar posts in the past!
There is nothing to stop someone creating goodwill as you say by incorporating their business into a limited company but what it has to be is goodwill separate from the person.
In your case of an artist there isnt any separate goodwill without the artist so if he tried to sell his business to someone else there wouldnt be any worth as the value is basically linked to him.
If you have a business that has value over and above the sole trader then there is justification of creating goodwill based as you say on things such as the historic profits of the business. eg if a window cleaner was selling a business and had built up a portfolio of clients then there will a value in his clients list over and above the ladders and other assets he has in the business. As to create such a list would incur a cost to someone else.
For any goodwill to exist you need to really ask if someone else was to buy the business would they pay a premium over and above the assets being sold.
If there is goodwill in the business incorporated you can get tax relief by writing it off over a period of time, say 5 years, provided the original business that was incorporated wasnt set up before 31 March 2002. If it was then you dont get any tax relief on the goodwill incorporated.
It might also be worth mentioning the other side of this is that it may cause a cgt liability for the sole trader which should get mitigated (hopefully to zero) by entrepreneurs relief and the annual exemption. If there isn't enough money in the pot to pay the original sole trader then it gets credited to the directors loan account.
I don't think it is a requirement to send your calculations into hmrc for the goodwill but of course they could challenge it at a later date so it is probably good practice to do so.
Remember that the recognition of goodwill derives from a sale from the individual to the new company.
That will give rise to a CGT liability of the taxpayer, however such can be deferred using incorporation relief.
For IR to be applicable the sale must incorporate all assets and the entity must be sold as a going concern.
The sale must be completely (or almost completely) in exchange for shares in the new entity rather than cash.
However, remember that there is a CGT allowance to be utilised.
Where incorporation relief has been claimed then when later the shares are sold entrepeneur relief rate applies.
A business can be sold for whatever someone is willing to pay for it and the difference between the fair value of the identifiable assets and liabilities as at the date of the exchange transaction is goodwill.
But... This is not an arms length transaction. It is someone selling something to themselves for whatever they want and looking to get £10,600 tax free and eventually pay 10% on the remainder via entrepeneurs relief.
HMRC will basically regard goodwill as being zero in the example given.
kind regards,
Shaun.
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Shaun
Responses are not meant as a substitute for professional advice. Answers are intended as outline only the advice of a qualified professional with access to all relevant information should be sought before acting on any response given.
Mark and Rob said everything before I posted so ignore my reply which just repeats what they say but not so well,
kind regards,
Shaun.
__________________
Shaun
Responses are not meant as a substitute for professional advice. Answers are intended as outline only the advice of a qualified professional with access to all relevant information should be sought before acting on any response given.
Thanks all.....thought as much! Not really a big problem for now as no real plans to pay dividends higher than threshold....although an extra cushion would be nice. Incidentally, at what point is CGT due?
CGT is due 31 January after the tax year it happens, same as tax due.
So if happened now would be due 31 January 2015.
From a tax planning viewpoint though you want to make it as early in a tax year as possbile to defer the liablity as long as possible. So if had the choice of doing it round about end of march would defer to at least until 6 april to give an additional years before it it is due.
Providing they dont use the annual exemption and conform to ER rules then you can get a nice lump sum on the directors loan to draw down tax free.
Though if as you say they are going to be a basic rate taxpayer going forward there probably isnt any point doing it.
Well, I doubt that there will be any goodwill allowable in this instance (see my first reply).
but from a theoretical perspective there are many incorporations where provided that the entirety of the Goodwill in the business was created after 05.04.2002 (i.e. the business being incorporated did not exist before that date) then the goodwill can be amortised and is allowable for tax purposes.
In all other instances (where the business being incorporated existed on or before 05.04.2002) then it must be amortised but is not allowable for tax purposes.
Whenever goodwill is to be allowable for tax (rather than treated as per depreciation) then you risk HMRC overriding the assumption that any goodwill actually exists in which case the excess paid for a business over the fair value of the assets is simply a loan from the shareholder to the business.
For any hope of the goodwill being accepted by HMRC (without guarantee of acceptance) you would need an external valuation of the business as at the acquisition / incorporation date from a chartered / chartered Certified accountant or specialist valuation company to give any estimate of goodwill credence in the eye's of HMRC.
I don't think that Mark would have trouble convincing HMRC of the legitimacy of a valuation but I think that many others here, myself included, would not have similar rates of success without verifiable third party valuations from professional valuation companies.
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Shaun
Responses are not meant as a substitute for professional advice. Answers are intended as outline only the advice of a qualified professional with access to all relevant information should be sought before acting on any response given.
From whom does one obtain an official valuation? I need to have a chat with someone, about a job I am doing. The business has low value P&M assets, and my goodwill calculation has, so far, been based on the first year profit share generated by the website which was started in the partnership but is now used in the Ltd Co. Just want some advice really on whether I am under or over estimating.
I agree with the point that Goodwill should not really be allowable in this instance, but had it done I would be quite happy with the valuation and basis for it.
My main query that remains is the point at which CGT is payable. With entrepreneurs relief etc, the client (if I remember correctly) would be liable to pay £1k on goodwill of £25k. Now that is not a bad rate for almost free money!.....but as mentioned, if the intention (or ability!!) was to pay at or below the taxable threshold in terms of dividends, then there is no real benefit in the short term.....and if the £1k was payable in the first year, then it would be £1k that needn't be paid!
If however the CGT is due when the shares are sold on however (at a later date), then it might be a consideration.
when I've done this in the past I have tended to go on a weighted average of profits over three years, weighting the most recent year 3, previous year 2 and earlier year 1. I don't think there is a requirement to send in your valuation to HMRC but the benefit of doing so is that if it is agreed there and then which is likely if they are reasonably happy with your computations then there will be no comebacks years later.
Valuation of a business also depends on the industry.
Just find out what is typical for the industry concerned.
As Rob has said, I have done it on a weighted average of profits over the previous 3 years, or sometimes the following years projected turnover. I've never sent the valuation to HMRC, but always made a point of making sure the person does declare it for CGT and claiming Entrepreneurs Relief. As long as it is reasonable, and typical of the industry there should not be a problem.
The partnership was only existence for 12 months before incorporation, so not a lot to go on. I have contacted a valuer for a price. Given him some general figures, and he is going to tell me whether the tax saved will be worth his bill. I dont feel comfortable making the decision.
On a side note, do I need a related party note in the first year of the Ltd Co? Would this be needed in the event of no goodwill?
When making a valuation do not just go on past results. Think about information that is available when valuation is too be made.
As an example, I saw a valuation done to justify a '1982' value for CGT purposes. As you my well remember, the UK was in the midst of a bad recession in 1982 and the client had a number of low profit years.
The consultant making the valuation based his value on a year just before the recession hit where profits where high. His rationale was that the UK was coming out of recession and the company was expected to trade at the profit level the company had managed before the recession. The consultant then substantiated this valuation by providing details, to HMRC, of that businesses earnings after 1982 which proved his case. HMRC agreed the valuation.
So if you have a business transferring from a sole trader to a limited company because it has won a big contract there is nothing stopping the valuation including the effects of this contract. Just make sure you prepare a report to HMRC justifying the valuation.
Thanks for all your comments. As an update... I found a valuer and put him in touch with the client. We got a very good result in the goodwill valuation!
