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We act for a dentist who bought a former colleague's practice on the latter's retirement. Under the terms of the agreement, the retiring dentist is entitled to 25 per cent of fees generated from the retiring dentist's practice provided that the appointment was made within three years of the date of retirement (31 July 2001). These are payable in three annual instalments on 31 December each year (starting 2002).
Is our client entitled to an income tax deduction in respect of these costs or are they capital?
We act for a dentist who bought a former colleague's practice on the latter's retirement. Under the terms of the agreement, the retiring dentist is entitled to 25 per cent of fees generated from the retiring dentist's practice provided that the appointment was made within three years of the date of retirement (31 July 2001). These are payable in three annual instalments on 31 December each year (starting 2002).
Is our client entitled to an income tax deduction in respect of these costs or are they capital?
Out of interest, what would be the correct way of dealing with the receipts of the retiring dentist? Our guess is that they are capital and ought to be brought in under Marren v Ingles [1980] STC 500 principles. Should this affect the treatment our client adopts?
(Query T15,951) – Beth.
Marren v Ingles [1980] STC 500 established that the right to further or delayed consideration for the disposal of a capital asset, dependent on future circumstances, is a capital asset and that the consideration eventually received is capital. This might be challenged if the pursuit of other ends were reflected in ambiguous wording in the agreement. So the agreement should first be examined. It could say one of three things:
(a) That the vendor shall participate in the profits of the first three years of new operation, with a share equal to '25 per cent of turnover …'
(b) That the vendor shall receive 'sums equal to' the said fraction of turnover for the said years.
(c) That the vendor shall receive the said fractions of turnover for the said years.
In (a) the purchaser is covered. He takes all turnover into the accounts, but the agreed share of profit does not cost him any tax, as it is extracted and paid to its contractual owner. But the vendor is open to a challenge by the Inspector because his entitlement is described as income in the agreement. It would be interesting to see if he could get out of that on the strength of the ostensibly sweeping definition in Marren v Ingles.
In (b) the vendor is safe. The calculation method does not matter. He is entitled merely to sums of money, and the case defines them as capital. But the purchaser is caught, by the same token. He must fund payments but pay tax on profit based on the full turnover.
Option (c) shows the most promise. The entitlement is not to 'sums equal to' some of the turnover, but to the slice of turnover itself. There is no reference to operational participation, and the vendor should be able to rely on Marren v Ingles. Correspondingly, the purchaser is entitled to only 75 per cent of the turnover, so that is all he need bring into his accounts. The rest was simply collected for and paid to the vendor.
In a nutshell, read the agreement cannily and see what you can make of it. – Man of Kent.
The answer to the question of whether a tax deduction will be given to 'Beth's' client for the payments and how they will be taxed on the retiring dentist will lie in the documentation for the sale.
One possibility is that the payments are in the form of consultancy so that the retiring dentist makes himself available to work in the practice. In such a situation, the payments will be deductible against the profits of the client and assessable on the retiring dentist as income on an accruals basis.
However, if the payments are for goodwill, no deduction is available for 'Beth's' client against income. The payments will be the cost of acquiring goodwill and deductible on a future disposal for capital gains tax.
If the payments are for goodwill, 'Beth' is correct in saying that Marren v Ingles would apply to the retiring dentist in calculating the capital gain on the sale. This has no effect on 'Beth's' client as the cost of acquisition will be the amount ultimately paid and the asset that he will be purchasing will be goodwill. The fact that part of the consideration may have to be taxed as the sale of a chose in action on the retiring dentist has no effect on the purchaser. – Chris.
Extract from reply by 'GJF':
A method adopted in certain circles is to re-label the goodwill consideration as 'consultancy/locum fees', with the somewhat rudimentary intention of turning capital into income for the vendor, and likewise creating a revenue deduction for the purchaser. However, where there is clearly no actual performance of consultancy/locum work, the parties leave themselves wide open to re-interpretation by the Inland Revenue, if the latter decides to review the case in-depth. For example, the Inspector might ask to see the vendor's time-sheets/billing-records for the consultancy period, and follow the audit-trail into the purchasers' sales figure in their practice accounts. This would enable any fictional elements to be discredited.
My view is that the consideration paid to the outgoing party should be described as 'commission', which is less vulnerable to Revenue attack, since no physical presence by the vendor is necessary in order for him to earn his commission! Also, with commission, there is no tenable link between hours worked and sums earned, unlike consultancy/locum fees which are invariably paid at an hourly rate.
