An important potential advantage of trading through a limited company (as opposed to a partnership or sole trader) is the availability of tax relief for the amortisation of goodwill under the intangible fixed asset legislation (CTA 2009, Part 8), where certain conditions are satisfied.
The intangible fixed asset rules were originally introduced in Finance Act 2002. Previously, intangible assets fell within the chargeable gains regime. The current provisions broadly take specified intangible assets of companies out of that regime and into the normal trading rules.
The most common form of intangible fixed asset for small and family companies is probably goodwill. For example, the incorporation of a partnership or sole trader provides an opportunity for the company to claim tax relief for the amortisation of goodwill purchased from the unincorporated business. A deduction for the expenditure is normally spread over a period of time, based on either generally accepted accounting principles, or by election on a fixed rate basis (CTA 2009, s 726). The ‘flip side’ is that receipts from the disposal of intangible fixed assets are treated as taxable.
There are rules to deny tax relief in respect of transactions between related parties (CTA 2009, s 882). In the context of business incorporations, the general rule is that if a sole trader or partnership established before 1 April 2002 (when the intangible fixed assets rules were introduced) incorporates the business and sells goodwill to the company, it is not possible for the company to claim tax relief for the cost.
However, there are certain exceptions to this general rule preventing the company from claiming a deduction under the intangible fixed assets provisions upon an acquisition from a related party. One such exception is where the unincorporated business (or any other person) created the asset after 31 March 2002 (CTA 2009, s 882(5)). This exception has become increasingly significant as time has progressed.
Another important exception from the related party prohibition of intangibles relief is where a related sole trader or partnership acquired the goodwill after 31 March 2002 from an unrelated third party (CTA 2009, s 882(1)(b)). A 'related party' includes a participator in a close company (s 835(5)(a)). For example, partners in small partnerships will be related if they were already shareholders when the goodwill was acquired, or became shareholders upon the goodwill transfer.
In HSP Financial Planning Ltd v Revenue & Customs  UKFTT 106 (TC), the company acquired goodwill from three partners under a Sale Agreement in January 2004, for consideration which included the allotment to each partner of 30% of the company's shares (the remaining 10% having been allotted to an employee of the partnership). HMRC disallowed a deduction for the amortisation of goodwill, on the ground that the goodwill did not fall within the intangible regime because the parties were related. The company appealed, contending that under the Sale Agreement the partners only became entitled to the shares once the goodwill had been transferred, and so were not related at the time of transfer.
The tribunal held that the Sale Agreement gave rise to mutual obligations, all of which arose when the Sale Agreement was concluded. It held that the words in FA 2002, Sch 29, para 118(1)(b) (now CTA 2009, s 882(1)(b)) "at the time of acquisition is not a related party" did not apply in this case. The individuals became related parties at the same moment in time as the acquisition. The exclusion of related parties was not limited to persons who immediately before the acquisitions were related parties. The company's appeal was dismissed.
Does size matter?
The definition of 'related party' in the intangibles rules includes a close company and its participators (or associates). In the context of a partnership incorporation, the fact that this related party test applies to a 'close company' implies that it only applies to small partnerships, who incorporate to become 'closely controlled' companies. However, HMRC does not appear to take this view. Its guidance on the incorporation of partnership business states: "When a partnership transfers the partnership business to a close company, at a time when one of the partners is also a participator or associate of a participator in that company, the transfer is likely to be between related parties" (CIRD45260). HMRC also states:
"Where a partnership of individuals transfers its business to a company, set up for this purpose, in exchange, wholly or partly, for shares issued by the company to the partners, the company is likely to be closely controlled, however numerous the partners. That is because:
• the interest of one participator in a company can be attributed to another where they are associates of one another,
• partners are associates of one another,
• so each partner’s holding can be attributed to five or fewer partners (indeed just to one) to make the company a close company.
Each partner is therefore a related party of the company" (CIRD45250). The tribunal's decision in HSP Financial Planning Ltd appears to reinforce HMRC's view that partnerships large and small are generally related parties under the intangibles rules.
Mark McLaughlin CTA (Fellow) ATT TEP