On 30 September HMRC published a Practice Note looking at the apportionment to goodwill of the price paid for a business transferred as a going concern – particularly those that comprises premises that are integral to the trade, for example care homes, restaurants, and hotels. This has been subject of debate for several years, and was brought to practitioners’ attention when the case of Balloon Promotions Ltd v Wilson (SpC 524 STC (SCD) 167), which concerned the disposal of Pizza Express franchises, was considered by the Special Commissioners.
What is goodwill for tax purposes?
The Practice Note starts by looking at the types of transaction where an apportionment is required; at the statutory provisions which consider how an apportionment should be addressed; and, in particular, how goodwill is to be identified for tax purposes.
For capital gains tax, SDLT, and also capital allowances purposes, a just and reasonable approach is adopted to arrive at an apportionment of the consideration to identify the amount on which a particular tax charge arises. However, statute does not define a method for arriving at a just and reasonable apportionment.
Part 8 of the Corporation Tax Act 2009 considers the identification of goodwill for the purposes of the intangibles legislation, and provides that goodwill has the meaning it has for accounting purposes. FRS 10 provides that “purchased goodwill” should be taken to be the difference between the cost of an acquired entity and the aggregate of the fair values of the entity’s identifiable assets and liabilities”.
The Practice Note then quotes a number of sources to provide a definition of goodwill. Halsbury’s Laws of England defines goodwill as
the value of the attraction to customers which the name and reputation possesses.
The crux of the issue for HMRC is set out in the final paragraph of this section:
Traditionally goodwill has been subdivided into different types such as ‘inherent goodwill’, ‘adherent goodwill’ and ‘free goodwill’. These subdivisions are no longer considered helpful as they tend to cause confusion. ‘Inherent’ and ‘adherent’ goodwill are not really goodwill at all as they form part of the value of the property asset and are properly reflected within such.
Trade related properties
A trade related property is a property that has been designed or adapted for use in a particular trade and where the property value is closely linked to the returns the owner or occupier can generate from such use. This is the “trading potential” which is defined by the RICS as:
the future profit, in the context of a valuation of the property, that a reasonably efficient operator would expect to be able to realise from occupation of the property. This could be above or below the recent trading history of the property. It reflects a range of factors such as the location, design and character, level of adaptation and trading history of the property within the market conditions prevailing that are inherent to the property asset.
Valuing goodwill in trade related properties
It is generally accepted that the value of goodwill is the difference between the price paid and the value of the separable assets purchased. However, the difficult is in arriving at the value of property when it is trade related. The Practice Note outlines some of the difficulties that arise in connection with such valuations.
- The established approach to valuation of this type of property typically relies on ‘the profits method’. In applying this valuation method there can sometimes be confusion in distinguishing the income and trading potential that runs with the operational property from any additional income arising from the actual operator’s business.
- The value of such properties is often significantly reduced if the property ceases to be occupied for any length of time because customers go elsewhere and the purchaser has to rebuild the level of trade. The enhanced value that arises as a result of the property having been occupied by the vendor and any predecessors for the particular use (ie. the property’s trading history) is part of what was previously described as ‘adherent’ goodwill but is properly part of the property value and is reflected in the property’s ‘trading potential’,
- The property value is often significantly reduced if the property is stripped of chattels because the purchaser has to re-fit the premises before being ready to trade.
- It can sometimes be difficult to obtain new licences where these have been lost.
The Practice Note emphasises that the value of the tangible assets must reflect the facts at the valuation date. The valuation of the property should have regard to any established use or trading history up to the valuation date. A property that has been operational up to the valuation date is likely to have a higher value than one that has been empty for six months because there is an expectation of continuing trade.
The Practice Note then looks at two approaches to the valuation of an operational trade related property, the Profits Approach and the Investment Method. HMRC views the Investment Method as an approach where there are difficulties in applying the Profits Approach. The objective, however, is to value the tangible assets as an “operational entity” in accordance with the RICS guidance on Valuation of Individual Trade Related Properties.
Apportionment for CGT and SDLT
The apportionment of the price paid for a business as a going concern should be approached by first identifying the value of any goodwill, bearing in mind the comments in the Practice Note that have been summarised above.
This will, according to the Practice Note involve the following steps:
Step 1 Estimate the market value of all the tangible assets, together as an operational entity having regard to the guidance above.
Step 2 Identify the sum attributable to goodwill and any other intangible assets included in the sale by deducting the value of the property, licences and chattels (Step 1 value) from the sale price (or market value) of the business as a going concern.
Step 3 Identify the sum attributable to the chattels by estimating their ‘in-situ’ value (i.e. the value to an incoming purchaser.
Step 4 Identify the sum attributable to the property by deducting the value of the chattels (Step 3 value) from the Step 1 value.
Step 5 Stand back and consider whether the answer produced is reasonable in the particular circumstances of the case.
The Practice Note gives a number of examples showing the methodology HMRC favour in valuing goodwill in relation to trade related properties. The purpose of the Note, as illustrated by the examples, is to ensure that goodwill is restricted to the excess of the price paid for the going concern over the value of all the tangible assets as an operational entity.
This means that there is likely to be less value attributable to goodwill and more to the value of the property. This will have an impact for SDLT, and also for companies seeking to amortise goodwill under the intangible asset regime.
The Practice Note does not have the status of law, but practitioners will need to refer to the methodology and approach adopted by HMRC. Property valuers should be familiar with the concepts as they are drawn heavily from existing RICS guidance.