Entrepreneurs’ relief is generally available to reduce CGT payable on gains arising on the transfer of assets to a company on incorporation of a business. Where the seller has operated the original business for at least 12 months before the transfer, he can claim entrepreneurs’ relief on the gains made on the transfer of ‘relevant assets’ on incorporation. This reduces the tax rate payable on the net gains to 10%.
The transferred assets may well include goodwill, which can be made up of the value of the business reputation, customer relationships, and continuing contracts.
Some forms of goodwill cannot be detached from the individual business owner. For example the personal reputation of an individual can’t be transferred, so a value for any ‘personal goodwill’ should not form part of the assets sold to the company on incorporation.
Where the goodwill is transferrable it must be valued at its open-market value at the date of transfer, which is very tricky exercise.
In spite of such difficulties, accountants frequently assign high values to goodwill transferred on incorporation, even where the goodwill is the only significant asset of the business. This creates a large capital gain in the hands of the seller, as the goodwill will normally have no acquisition value.
The company may not pay the seller immediately for the assets it acquires. Any unpaid balance is left as outstanding on a director’s account within the company. Subsequently the director extracts the balance as tax-free and NI-free payments from the company.
Although there is no avoidance of tax in this arrangement as the seller has correctly paid CGT at 10% on the gains he made, the rules for entrepreneurs’ relief were altered for business disposals made on and after 3 December 2014. From that date entrepreneurs’ relief cannot apply to a gain arising from the transfer of goodwill to a close company, where that company is a ‘related party’ to the seller (ie the seller and the company are connected).
Entrepreneurs’ relief is still available on gains from the transfer of other relevant assets on incorporation, but goodwill is no longer considered to be a ‘relevant asset’.
There are other CGT reliefs that can be used the reduce CGT payable on incorporation: incorporation relief (TCGA 1992 s 162) or holdover relief (TCGA 1992 s 165), both of which are covered in Capital Gains Tax Reliefs for SMEs and Entrepreneurs 2014/15.
Rebecca Cave qualified as a Chartered Accountant with KPMG and achieved Chartered Tax Adviser status while working for Robson Rhodes. She is the co-author of the core tax annual: Capital Gains Tax, and of Capital Gains Tax Roll-over Hold-over and Deferrals Reliefs, both published by Bloomsbury Professional. She also edits Bloomsbury's Tax Rates and Tables.
Rebecca is a member of the ICAEW Tax Faculty's Small Business Tax technical tax committee, and serves the CIOT's Owner Managed Business Tax sub-committee. She is also immediate past chair of the CIOT Mid-Anglia branch.