Since 6 April 2008, when Entrepreneur’s Relief (‘ER’) was introduced, it has been available to reduce capital gains tax ('CGT') payable on gains arising on the incorporation of a business.
Some businesses find they are carrying a significant value of goodwill, for example, reputation, customer relationships, value of continuing contracts, when they decide to incorporate. The goodwill is transferred to the company along with the other assets of the trade and relief could be claimed.
Whether the goodwill is of a nature that is capable of being transferred from the individual to the company is another very contentious matter.
The company that takes over the trade, which need not be a newly formed company, is unlikely to have the funds to pay the seller for the assets transferred and so it leaves the balance on an account within the company owing to the seller.
After deducting the very generous CGT annual exemption from the value of the goodwill, which normally has a zero base cost, the seller pays 10% CGT, claiming ER on the balance. Subsequently he gradually extracts funds equal to that balance as tax-free and NI-free payments from the company, as the CGT has already been paid.
Although the company will be a related party to the individual who sold the goodwill, it can claim tax relief for the cost of the goodwill under the corporate intangible assets regime. Only where the original business was founded before 1 April 2002, and hence the goodwill is deemed to be created before that date, will the company be barred from claiming tax relief on the value of the goodwill it acquires from the related party.
The Government has, however, decided that the combination of 10% tax for the business founder plus corporation tax relief for the successor company on a value which is difficult to prove with any accuracy is an abuse of the tax rules.
So with effect for business disposals on and after 3 December, ER can’t apply to a gain arising on the transfer of goodwill to a close company, where that company is a related party to the seller.
ER will continue to be available on incorporations it’s just that the value of goodwill is excluded from the assets that qualify for ER on the business disposal.
The company will also be denied tax relief on the value of goodwill acquired on and after 3 December where the seller of the goodwill is related to the company.
Where a business wants to incorporate, it can still use other capital gains tax reliefs to reduce or defer any capital gains arising.