Tax relief for goodwill
Written by Ray Coman
Following a consultation, the government has announced a tax relief for goodwill acquired on or after 1 April 2019. The tax relief will only apply where goodwill is acquired alongside intellectual property.
Background
An abolition of tax relief on the purchase of goodwill was announced in the Summer 2015 Budget, and applied to purchases on or after 8 July 2015.
The restriction on tax deduction for goodwill was intended to deter the transfer of a business as asset sale - rather than a share sale - purely for the purpose of tax avoidance. However, it was recognised as common practice for business transactions to be structured as sale of trade and assets for predominantly commercial reasons. By example, the purchase of shares often requires the acquirer to take warranties and indemnities against liabilities acquired with the business. Following a consultation, the deduction from corporation tax profits was reintroduced by the Finance Act 2019.
Goodwill
Goodwill is the premium that is paid for a business over the value of its assets. The net assets of the business is determined by reference to its balance sheet. In crude form, the carrying value of liabilities to tax, directors and trade creditor is deducted from current assets, such as equipment, stock, debtors and cash at bank in arriving at net assets. The consideration offered for the purchase of a business surplus to its net assets is referred to as goodwill. For the purposes of the FA19 regulation, HMRC refer to “relevant assets” a term which holds the same broad meaning as goodwill.
The process by which the value of an intangible asset erodes over time is known as amortisation. Amortisation is to intangible assets what depreciation is to tangible assets. Corporation tax relief on goodwill is a tax form of amortisation.
Conditions for the vendor
The goodwill has to be acquired:
- With a business
- Which has intellectual property (IP.)
- A related party incorporation is excluded from the relief. Therefore, a sole trader or partnership incorporating into a company cannot obtain tax relief for goodwill generated in the unincorporated business.
- No tax relief is given for goodwill held by the company prior to 1 April 2019. Anti-avoidance provisions apply to restrict the re-establishment (after 1 April 2019) of IP previously held.
Intellectual property
IP has a restricted meaning for the purpose of this form of tax relief. The intangible assets must be fixed, i.e. with a useful life that will continue in the hands of the new owner. The acquiring company must intend to use the IP.
Under FA2019, intellectual property includes patents, copyrights, design rights, or licenses over the rights.
Goodwill can be created by other means such as:
- Client relationships;
- Location;
- Know-how;
- Unregistered trademarks; and
- Trade secrets.
However, none of the above are considered as intellectual property by the tax system.
Practical considerations
Given that goodwill in the accounting sense is defined by the price paid for a business, it could be regarded as unfair that the FA2019 has imposed seemingly arbitrary definitions. In practice, however, a business typically has a value independent of its owner because of some form of IP. For instance, a vendor of a software or pharmaceutical would probably wish to obtain patent protection before taking the product to market.
A business with tax deductible “relevant assets” will be more valuable to a prospective UK purchaser. Therefore, practical tips to create goodwill in a business include as a first step:
- Publish the website and other business literature. A copyright is generated on creation of works. Registration of works provides extra protection.
- Register trademarks, such as business logo.
- Patent business ideas. Computer programs and other business process innovations obtain certain copyright protection regardless of patenting.
- Obtain design rights. This could include: textile, wallpaper, furniture and graphic design elements of a trademark.
As a secondary measure:
- Obtain an independent valuation for the above that can be relied upon in the event of an HMRC enquiry.
- Recognise the value on the balance sheet prior to sale.
- The amount paid for goodwill provides strong supporting evidence to any such valuation.
A license to the use a computer software is not regarded as IP, whereas a licence to distribute the software is tax deductible.
Conditions for the acquirer
The rules relating to the Finance Act 2019 concern corporation tax, and therefore the acquiring business must usually be a company. The acquired goodwill needs to be stated in the balance sheet.
The tax relief
A portion of the original cost is deducted each year from profits chargeable to corporation tax. The relief is at a fixed rate of 6.5% of per annum. The 6.5% is applied straight line (to original cost) rather than to the reducing balance of the goodwill value.
The rate is higher than the 4% write down that applied on goodwill purchased prior to 3 December 2014.
Restricted relief
The goodwill on which tax relief can be obtained is capped at the fair value of the IP, multiplied by six. The whole value of the goodwill is used if the value is less than six times the IP.
Comments
There is not the complication of amortisation in the scenario you have given.
Since1 April 2017, losses can be set against total profits of the company. Any surplus of losses are carried forward and then can only be set against gains on intangible assets in future periods. Application of the rules can get complex, and it would be preferably to address a specific scenario to avoid miscommunication.
Presumably in the case of no IP, when the goodwill is sold any profit is taxable with the trading profit and any loss is allowable as a trading loss?
Thanks again.
In that case there would be no corporation tax deduction for amortising goodwill. To get the tax relief goodwill has to be purchased with relevant assets. HMRC internal manual CIRD44060 defines relevant assets. Relevant assets are also defined in the report above.
Thanks