FA 2015 removes entrepreneur’s relief for transfers of goodwill and limits corporation tax deductions for acquisition of goodwill in transactions between companies and related parties. The changes were stated to be made to remove unfair tax advantages on incorporation; however, the changes affect rather more than just incorporations. In particular, family businesses will find that their options for structuring ongoing businesses on the retirement of one generation are limited. Some joint ventures and acquisitions will also need to take care to ensure that they can continue to benefit from corporation tax reliefs on certain acquisitions.
Finance Act 2015 brought into law two measures relating to transfers of goodwill from individuals to related companies: removing entrepreneur’s relief (ER); and reducing or removing debits under the corporate intangibles rules.
Both measures took effect from the date of the Autumn Statement, 3 December 2014, and were described as correcting ‘unintended’ tax benefits and making the tax system ‘fairer’. ‘Unintended’ is perhaps an unfortunate description, given that the ‘benefits’ in question had been in place and clearly known about by government for years (since 2008 in the case of ER; for over a decade in the case of amortisation). The recent financial cost of ER and amortisation relief on goodwill to the Treasury might have been more than estimated, but that’s not quite the same thing. ‘Fairer’ is also something of a misnomer, as the effects of the changes go well beyond that suggested by the HMRC press releases and explanatory notes.
The changes, of course, will affect principally businesses with significant goodwill. Other assets transferred will still attract ER and other intangible assets will continue to be capable of being amortised for tax purposes.
Pete Miller’s article set out the changes to the legislation. This article looks at some of the consequences arising from the changes that should be considered in certain situations.
Both measures relate to the acquisition of goodwill (and quasi-goodwill in the case of the amortisation measures) by a company from an individual who is a related party of the company. A ‘related party’ is defined by the corporate intangibles rules (applied by s 169LA(2) for ER), and the amortisation changes are also within the corporate intangibles rules.
CTA 2009 s 835 defines a ‘related party’ as (inter alia) an individual who:
A ‘participator’ in a close company includes (inter alia) someone who possesses or is entitled to acquire share capital of voting rights, etc. There is no minimum shareholding required to be a participator (CTA 2010 s 454). However, the ‘loan creditor’ definition of ‘participator’ in s 454 does not apply in determining who is a ‘related party’ within the corporate intangibles rules (CTA 2009 s 841(2)).
An ‘associate’ includes, inter alia, a linear relative (spouse/civil partner, parent or remoter ancestor, child or sibling) (CTA 2010 s 448).
At the time of the acquisition
The goodwill changes in FA 2015 relate to acquisition from an individual who is a related party at the time of the transaction.
The question of whether an individual is a related party at the time of an acquisition was considered in HSP Financial Planning [2011] UKFTT 106 (TC), where the tribunal found that ‘[o]n the sale agreement being made the partners became entitled to the shares and thereby became participators. What mattered was the entitlement to have the shares allotted and issued not when the allotment or issue occurred.’ This followed from the definition of participator which, at CTA 2010 s 454(3), states that:
‘a person is treated as entitled to do anything which the person:
As a result, the order in which events occur is not particularly relevant. An individual is not precluded from being a related party of a company simply because the goodwill transfer occurs before the issue of shares, for example, where they are entitled to the issue of those shares as a result of the transfer.
These are the main circumstances in which someone will be a related party of a company. There are some other circumstances as well (trusts, etc.), but these are not as likely to arise as those described above; they should not be overlooked where they do arise, however.
This measure (in FA 2015 s 42) is intended to ‘remove a tax incentive to incorporate an existing business’ (per the explanatory note), but the changes are not limited to transfers on incorporation. There is, for example, no requirement that there be continuing economic ownership of the business being transferred.
The measures apply to deny ER on goodwill sold by an individual to a close company where the vendor is a participator in the company (TCGA 1992 s 169LA(1), inserted by FA 2015 s 42). Technically, the vendor has to be a ‘related party’; in practice, with regard to a close company, that means that they will be a participator in the company.
The tax impact summary published by HMRC states that: ‘Individuals (including partners) who transfer their businesses to a company which they control in order to claim ER on the gains accruing will be most affected’. These will certainly be affected, but nothing in the legislation restricts the effects to transfers to close companies controlled by the transferor. All that is required is that the transferor be a participator in the close company, which simply requires a shareholding of any size, or an associate of a participator (which requires no shareholding by the vendor).
It is only ER which is removed for the individual; incorporation relief continues to be available where all of the assets of the business are transferred. Alternatively, holdover relief may be available. However, both of these require an ongoing shareholding in the company. They are not available to disposals on retirement, for example, where the vendor takes cash or debt on disposal of the business.
Impact on succession planning
As a result, the measures will limit some succession planning options. If an individual decides to retire and (in order to fund retirement) sells their business to a close family member, such as an adult child, they will have no ER if that child buys the business through a close company, even if market value is paid for the business. The vendor will be an associate of a participator in a close company, being the parent of the owner of the company.
If the child acquired the business from a third party, at the same price and in the same conditions, the vendor would get ER. Where the child chooses to buy the family business, the vendor gets no ER. The parent would be better off selling the business outside the family – or to a non-linear relative such as a cousin – as they would not be an associate. The measures – in this case – appear to create unfairness, rather than removing it.
Retiring partners
ER is preserved for retiring partners, where the continuing partnership decides to incorporate (s 169LA(1)). However, there is still an issue with family succession planning, as this option is not open to partners in family partnerships. In order to get relief, the retiring partner must not be an associate of the continuing partners, other than through being members in the partnership (s 169LA(3)(c)). As above, this limits the options of the ongoing partners or successors to the business, which would not apply in a non-family situation.
Later incorporation – anti-avoidance
In such family scenarios, there might be a temptation to acquire the business and, at some later date, incorporate. Care will be needed with this. It will need to be clear that such incorporation is a separate decision to the decision to acquire the business; otherwise, there is the potential for the anti-avoidance provisions in s 169LA(6) to apply to deny ER for the vendor on the goodwill transferred, if the later incorporation is considered to constitute ‘relevant avoidance arrangements’.
In addition to removing ER for the vendor, the purchasing company will almost certainly be unable to claim deductions for any amortisation of the acquired goodwill in the accounts.
FA 2015 s 26 amends CTA 2009 Part 8 in order to disallow ‘certain debits relating to goodwill etc. acquired from a related individual or firm’. The explanatory note states that it restricts relief in relation to transfers ‘on incorporation’ but, as with the changes to ER, the impact of the amendment to the legislation is not limited to incorporations.
The effect of the changes is to remove or limit amortisation deductions on the costs of acquisition of the intangible asset, and to limit debits on any subsequent disposal of the asset. There is some scope for continuing deductions where the relevant asset was originally acquired from a third party and is transferred to the company as part of the transfer of a business (CTA 2009 s 849B(4),(5) as inserted by FA 2015 s 26).
Affected intangible assets
The amortisation restriction applies to the acquisition from a related party of goodwill and a number of marketing related intangible assets, and to the acquisition of licences over such assets. This last element follows logically from the corporate intangibles rules, as a licence is a separate intangible asset for the purposes of those rules.
As these changes apply to more than goodwill, it should be noted that there is no requirement that the transfer be part of the transfer of a business. Some of the assets affected cannot be transferred separately from a business (goodwill and unregistered trademarks), but others can (customer information and customer relationships). Where the intangible asset is transferred on a standalone basis, even if the asset was originally acquired from a third party, no amortisation debits can be brought into account; and, on disposal of the asset, the debit is treated as a non-trading debit, which limits the ability of the company to utilise the debit (s 849B(4),(5) only apply where a business is also transferred; all other acquisitions fall into s 849B(6)).
Sale of company, ongoing involvement
The explanatory note indicates that this change is intended to deal with situations where there is continuing economic ownership of the intangibles assets. This takes too narrow a view of the changes. A person who is a participator in a close company is a related party of that company, but does not necessarily have any continuing economic ownership of the assets, as there is no requirement for a controlling shareholding in order to be a participator.
If a business is acquired by third parties into a close newco, with some shareholding provided to the former owner (e.g. as a form of earn-out, or to retain the owner in the business for a time), then this will be a related party transaction. The company will not be able to claim debits for amortisation of these types of intangible asset if they were generated by the former owner; the former owner will also not be able to claim ER on the sale of the goodwill to the close company.
Acquisition of information, joint ventures
Another scenario that also may not involve continuing economic ownership but would similarly deny corporate tax reliefs arises where a close company acquires a relevant asset (e.g. a customer relationship or licence of customer information) from a shareholder without acquiring any other business assets. Even if the intangible asset was originally acquired from a third party, if the company does not acquire the intangible as part of a business from that shareholder, the company is denied amortisation of that asset. Such a transaction has nothing to do with incorporation, and will not involve continuing economic ownership where the shareholder does not have control of the company.
For example, a joint venture company may enter into an agreement with one of the joint venture parties which licenses to the company the customer information of that party’s business. In such circumstances, the joint venture company will not be able to claim any amortisation of the costs of that licence.
Similarly, a licence of an unregistered trademark by an individual to a joint venture (or other such) company in which that individual has an interest could result in a restriction of corporate tax relief. It may be more appropriate to register trademarks where there is any plan to allow the trademark to be licensed to a close company.
It is not clear why the legislation changes go so much further than the incorporation scenarios which were outlined in the Autumn Statement. Even if it has taken some years for the government to decide to limit access to these reliefs on incorporation, it is perhaps not unreasonable to change things in order to ensure that incorporation does not give a further tax benefit, which is not available to those who choose not to incorporate. That does not, however, explain why the rules limit the options for succession planning within families, or remove amortisation for, for example, transfers of customer information or licences of trademarks within joint ventures, in situations where there is no effective continuing economic ownership of a business as such.
