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13 December 2000
Goodwill disposal
The practice in which my chartered surveyor client is a partner has recently acquired a smaller practice. The payment for the goodwill of this smaller practice is deferred so that there will be payments after one year and two years based on one-half of fees billed.
My client is currently entitled to one-fifth of the profits and the goodwill of the firm; but when he was first appointed an equity partner, his profit share and entitlement to goodwill was only one-tenth. The history of the base cost of his goodwill is as follows:
£
The practice in which my chartered surveyor client is a partner has recently acquired a smaller practice. The payment for the goodwill of this smaller practice is deferred so that there will be payments after one year and two years based on one-half of fees billed.
My client is currently entitled to one-fifth of the profits and the goodwill of the firm; but when he was first appointed an equity partner, his profit share and entitlement to goodwill was only one-tenth. The history of the base cost of his goodwill is as follows:
£
Goodwill disposal
The practice in which my chartered surveyor client is a partner has recently acquired a smaller practice. The payment for the goodwill of this smaller practice is deferred so that there will be payments after one year and two years based on one-half of fees billed.
My client is currently entitled to one-fifth of the profits and the goodwill of the firm; but when he was first appointed an equity partner, his profit share and entitlement to goodwill was only one-tenth. The history of the base cost of his goodwill is as follows:
£
1984 Purchased one-tenth 100,000
1988 One-tenth of goodwill of a practice
acquisition (paid by the practice) 5,000
1992 Purchased further one-tenth 100,000
2000 Estimated cost of one-fifth of recent
practice acquisition (payable by
the practice) 50,000
£255,000
He is now reducing his involvement in the firm. In the process, he is reducing his share of the profits and entitlement to goodwill to one-eighth in return for the receipt of £120,000. The client will need to report the capital gain incurred on his tax return without knowing the final amount to be paid for goodwill for the latest acquisition. Do we estimate the amount to be paid? If our estimate is low, will he be charged interest by the Revenue?
In calculating the overall gain utilising the part disposal formula, do we utilise the total base cost on a 'pooling' basis or take the early acquisitions on a first in first out basis? Does the change in the client's profit share from one-tenth to one-fifth affect the calculation in any way?
(Query T15,727) – Mr Badwill.
Although the Inland Revenue Capital Gains Tax Manual covers the subject of goodwill quite extensively from CG 2770 et seq, with several examples from 27780 to 27786, it is singularly unhelpful when applied to the facts in the particular case.
Various fundamental points need to be considered:
* the application of indexation and taper relief;
* whether rollover relief could be claimed relating to the payments not yet made on the new practice acquisition;
* the necessity for both the partnership and the individual to declare 'provisional figures' in self assessment returns, with explanations in 'the white space'.
It should be recognised that 'provisional figures' remain open until quantified, and some agreement with the Revenue will be necessary to the effect that 'estimated' rather than 'provisional' figures are used. Otherwise the returns are certain to be selected for Inland Revenue enquiry.
Provided full disclosure of all facts is made then there will be no future tax penalties, but interest on any underpayment (or overpayment) of tax will be imposed.
The key questions concerning the goodwill are:
(a) Should goodwill be treated on a first in first out basis?
(b) Should it be treated on a last in first out basis?
(c) Are the various purchases pooled?
Based on present law and practice the best solution might be to submit a draft computation to the Revenue showing the best position for the client. If this is done in good faith, the only downside could be interest. For example:
Sale of 7.5 per cent goodwill 120,000
Purchase 1984 (10 per cent) (100,000)
7.5 per cent 75,000
Indexation say 1.00 75,000
150,000
Purchase 1988 (10 per cent) (5,000)
7.5 per cent 3,750
Indexation say 0.70 2,625
6375
Purchase 2000 10 per cent (50,000)
7.5 per cent 37,500
No indexation. 193,875
Capital gains tax loss 73,875
The client might prefer to adopt the 'pooling' method or 'last in first out', depending on future expectations of sale of his remaining share. - Taperworm.
The starting point is that goodwill is a 'fungible asset'. It is treated as a security for capital gains tax purposes because, under section 104(3), Taxation of Chargeable Gains Act 1992 it falls within the definition of 'other assets where they are of a nature to be dealt in without identifying the particular assets disposed of or acquired. On this basis, the transactions with goodwill in this case in 1984 and 1992 are treated in exactly the same way as if one were dealing with acquisitions of shares in a single company. There is one pool of 20 per cent of the goodwill in the practice, purchased for £200,000. The client is now disposing of 7.5 per cent of his goodwill in the practice, to reduce the percentage share down to 12.5 per cent. It does not matter that the profit share also changes at the same time.
What then of the amounts paid in relation to the two acquisitions of the other practices, one on 1998 and one in 2000? I suggest that the answer is that these sums fall to be treated as enhancement expenditure within section 38(1)(b), Taxation of Chargeable Gains Act 1992. They were not acquisitions of further goodwill in the existing practice. They were sums paid to increase the value of that goodwill by the addition of further clients. So there is a pool of goodwill having a cost of £200,000 and enhancement expenditure on that pool of £55,000, giving a total cost of £255,000. The last item of enhancement expenditure must be shown on the self assessment return as being provisional and the self assessment system allows for subsequent corrections in the computation submitted. Mathematically, it will be found that the client is disposing of 37.5 per cent of his goodwill and that proportion of the total cost, including the enhancement expenditure, will be deductible from the proceeds. - Big Shot.
The practice in which my chartered surveyor client is a partner has recently acquired a smaller practice. The payment for the goodwill of this smaller practice is deferred so that there will be payments after one year and two years based on one-half of fees billed.
My client is currently entitled to one-fifth of the profits and the goodwill of the firm; but when he was first appointed an equity partner, his profit share and entitlement to goodwill was only one-tenth. The history of the base cost of his goodwill is as follows:
£
1984 Purchased one-tenth 100,000
1988 One-tenth of goodwill of a practice
acquisition (paid by the practice) 5,000
1992 Purchased further one-tenth 100,000
2000 Estimated cost of one-fifth of recent
practice acquisition (payable by
the practice) 50,000
£255,000
He is now reducing his involvement in the firm. In the process, he is reducing his share of the profits and entitlement to goodwill to one-eighth in return for the receipt of £120,000. The client will need to report the capital gain incurred on his tax return without knowing the final amount to be paid for goodwill for the latest acquisition. Do we estimate the amount to be paid? If our estimate is low, will he be charged interest by the Revenue?
In calculating the overall gain utilising the part disposal formula, do we utilise the total base cost on a 'pooling' basis or take the early acquisitions on a first in first out basis? Does the change in the client's profit share from one-tenth to one-fifth affect the calculation in any way?
(Query T15,727) – Mr Badwill.
Although the Inland Revenue Capital Gains Tax Manual covers the subject of goodwill quite extensively from CG 2770 et seq, with several examples from 27780 to 27786, it is singularly unhelpful when applied to the facts in the particular case.
Various fundamental points need to be considered:
* the application of indexation and taper relief;
* whether rollover relief could be claimed relating to the payments not yet made on the new practice acquisition;
* the necessity for both the partnership and the individual to declare 'provisional figures' in self assessment returns, with explanations in 'the white space'.
It should be recognised that 'provisional figures' remain open until quantified, and some agreement with the Revenue will be necessary to the effect that 'estimated' rather than 'provisional' figures are used. Otherwise the returns are certain to be selected for Inland Revenue enquiry.
Provided full disclosure of all facts is made then there will be no future tax penalties, but interest on any underpayment (or overpayment) of tax will be imposed.
The key questions concerning the goodwill are:
(a) Should goodwill be treated on a first in first out basis?
(b) Should it be treated on a last in first out basis?
(c) Are the various purchases pooled?
Based on present law and practice the best solution might be to submit a draft computation to the Revenue showing the best position for the client. If this is done in good faith, the only downside could be interest. For example:
Sale of 7.5 per cent goodwill 120,000
Purchase 1984 (10 per cent) (100,000)
7.5 per cent 75,000
Indexation say 1.00 75,000
150,000
Purchase 1988 (10 per cent) (5,000)
7.5 per cent 3,750
Indexation say 0.70 2,625
6375
Purchase 2000 10 per cent (50,000)
7.5 per cent 37,500
No indexation. 193,875
Capital gains tax loss 73,875
The client might prefer to adopt the 'pooling' method or 'last in first out', depending on future expectations of sale of his remaining share. - Taperworm.
The starting point is that goodwill is a 'fungible asset'. It is treated as a security for capital gains tax purposes because, under section 104(3), Taxation of Chargeable Gains Act 1992 it falls within the definition of 'other assets where they are of a nature to be dealt in without identifying the particular assets disposed of or acquired. On this basis, the transactions with goodwill in this case in 1984 and 1992 are treated in exactly the same way as if one were dealing with acquisitions of shares in a single company. There is one pool of 20 per cent of the goodwill in the practice, purchased for £200,000. The client is now disposing of 7.5 per cent of his goodwill in the practice, to reduce the percentage share down to 12.5 per cent. It does not matter that the profit share also changes at the same time.
What then of the amounts paid in relation to the two acquisitions of the other practices, one on 1998 and one in 2000? I suggest that the answer is that these sums fall to be treated as enhancement expenditure within section 38(1)(b), Taxation of Chargeable Gains Act 1992. They were not acquisitions of further goodwill in the existing practice. They were sums paid to increase the value of that goodwill by the addition of further clients. So there is a pool of goodwill having a cost of £200,000 and enhancement expenditure on that pool of £55,000, giving a total cost of £255,000. The last item of enhancement expenditure must be shown on the self assessment return as being provisional and the self assessment system allows for subsequent corrections in the computation submitted. Mathematically, it will be found that the client is disposing of 37.5 per cent of his goodwill and that proportion of the total cost, including the enhancement expenditure, will be deductible from the proceeds. - Big Shot.
