Posted by James Pearson on 04 Dec 2014
Removal of a Beneficial Tax Treatment of Goodwill on Incorporation
The Chancellor is clearly not in a seasonal mood this December and has introduced changes that remove a beneficial tax treatment of goodwill on incorporation.
Despite the rhetoric of helping hard working taxpayers, the recent Autumn Statement removed a tax relief that allowed entrepreneurs who had successfully grown their business to benefit from a low rate of tax on the reorganisation of that business into a limited company.
As part of the normal growth of a business, there frequently comes a point when a sole trader or partnership chooses to incorporate the business into a limited company. This is done because a limited company structure offers significant benefits over self-employment for well-established trades, including legal protection, enhanced status and flexibility of taxation.
Prior to the Chancellor’s change, the sole trader or partnership could incorporate by selling their trade to a new company in exchange for cash and benefit from Entrepreneurs Relief, reducing the tax payable on the amount earned from the sale to 10%. For incorporations taking place from 3rd December 2014, Entrepreneurs Relief is not available on any part of the sale price that relates to goodwill.
Theoretically, goodwill is the market value of the reputation and client relationships a business has developed, but since this is virtually impossible to quantify, goodwill is more truthfully a name for the difference between what a third party would pay for a business and the market value of the most identifiable assets that the business owns.
Since unincorporated businesses tend to have fewer assets than limited companies, goodwill often makes up a significant part of their value and the Chancellor’s withdrawal of Entrepreneurs Relief for goodwill on incorporation means entrepreneurs are prevented from benefiting from the very relief that is designed to encourage their activities.
This change does not seem to be ideologically motivated or a logical extension of changes to the tax system (goodwill remains eligible for Entrepreneurs Relief in other situations), but is rather a targeted attempt to increase tax revenue by targeting business people as they take their businesses to the next level of growth. The draft legislation introduces complications and it is to be hoped that more thought is given to its impact before it becomes law.
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