In a recent case, the company could not have ‘distributed’ the value of goodwill to the directors, because it had never owned it.
The case of Smith & Corbett v HMRC [2023] UKFTT 912 (TC) (reported in Tax Journal, 27 October 2023) concerned a company carrying on business as financial advisers which had transferred its business to an LLP. The company was owned by its directors who, it appears, were the only registered independent financial advisers (IFAs) working for it; and they (together with their wives) were the only members of the new LLP.
It wasn’t in dispute that there was a significant value in the client relationships that had been built up over the years. HMRC said that that value represented the goodwill of the business and belonged to the company. It argued, on the authority of a case from 1901, that goodwill was inseparable from the business to which it adds value and therefore can only ever belong to the entity carrying on the business to which it relates. The company’s transfer of that goodwill to the LLP without having been paid anything for it thus amounted to a ‘distribution’ made by the company on which the directors were liable to pay income tax.
The directors claimed, and the First-tier Tribunal (FTT) accepted, that the relationship between a client and an IFA was a personal one: ‘Individuals requiring independent financial advice, at least from small providers, will form a relationship [with] a particular regulated individual, agnostic to whom the IFA is employed by (if employed at all). This is so despite the contract for the provision of such advice being between the individual requiring advice and, where relevant, the IFA’s employer.’ Thus, the FTT accepted that it was normal (at least in small organisations) to consider that ‘client relationships from which such income is derived “belonged” to the IFA such that when moving between employers (or organisations) it was expected that the clients would follow the IFA.’
Having accepted that evidence, the decision of the FTT in favour of the taxpayers was all but inevitable. The company could not have ‘distributed’ the value of goodwill to the directors, because it had never owned it. Regarding HMRC’s argument as to the goodwill inevitably and necessarily being owned by the company, the FTT considered that ‘the position is more complex than HMRC contend. Plainly, goodwill is associated with the operation of a business but that is not the same as concluding that the goodwill so associated can only vest or be owned by the company.’
The principle of this case is not necessarily limited to IFAs, though it may be limited to small businesses. For example, clients of a small accountancy or legal practice might well regard themselves as clients of Mr, Mrs, Miss, Ms or Mx X rather than as having a relationship with the firm or company: but as the organisation grows and a larger team becomes involved in providing a wider range of services to the client, it becomes more difficult to say that the client ‘belongs’ to an individual rather than to the organisation.
Interestingly, that wasn’t the primary reason that the FTT found in favour of the taxpayers. The primary reason was a little odd (well, frankly, misconceived).
Although the goodwill in question was worth a substantial amount, the balance sheet of the company had never included any figure in respect of it. The FTT thought that HMRC’s assertion that the company owned the goodwill therefore amounted to an assertion ‘that the balance sheet valuation of the company was so materially inaccurate in each year that the accounts could not have represented a true and fair view.’ Since the FTT considered that ‘there was no basis on which to conclude that the accounts of both [the company and the LLP] are anything other than GAAP compliant and accordingly provide a true and fair view of each entity’, it followed that ‘on the basis of the accounts’ the goodwill was not an asset of the company.
The problem with that analysis is that the goodwill in question, being internally generated goodwill, would not have appeared on the balance sheet of the company even if the company had owned it. So, obviously, no conclusion could legitimately be drawn from its absence. The FTT’s principal reason for finding in favour of the taxpayers doesn’t hold water.
Fortunately, the second (that as a matter of fact the relationships were ‘owned’ throughout by the individuals) does.
In a recent case, the company could not have ‘distributed’ the value of goodwill to the directors, because it had never owned it.
The case of Smith & Corbett v HMRC [2023] UKFTT 912 (TC) (reported in Tax Journal, 27 October 2023) concerned a company carrying on business as financial advisers which had transferred its business to an LLP. The company was owned by its directors who, it appears, were the only registered independent financial advisers (IFAs) working for it; and they (together with their wives) were the only members of the new LLP.
It wasn’t in dispute that there was a significant value in the client relationships that had been built up over the years. HMRC said that that value represented the goodwill of the business and belonged to the company. It argued, on the authority of a case from 1901, that goodwill was inseparable from the business to which it adds value and therefore can only ever belong to the entity carrying on the business to which it relates. The company’s transfer of that goodwill to the LLP without having been paid anything for it thus amounted to a ‘distribution’ made by the company on which the directors were liable to pay income tax.
The directors claimed, and the First-tier Tribunal (FTT) accepted, that the relationship between a client and an IFA was a personal one: ‘Individuals requiring independent financial advice, at least from small providers, will form a relationship [with] a particular regulated individual, agnostic to whom the IFA is employed by (if employed at all). This is so despite the contract for the provision of such advice being between the individual requiring advice and, where relevant, the IFA’s employer.’ Thus, the FTT accepted that it was normal (at least in small organisations) to consider that ‘client relationships from which such income is derived “belonged” to the IFA such that when moving between employers (or organisations) it was expected that the clients would follow the IFA.’
Having accepted that evidence, the decision of the FTT in favour of the taxpayers was all but inevitable. The company could not have ‘distributed’ the value of goodwill to the directors, because it had never owned it. Regarding HMRC’s argument as to the goodwill inevitably and necessarily being owned by the company, the FTT considered that ‘the position is more complex than HMRC contend. Plainly, goodwill is associated with the operation of a business but that is not the same as concluding that the goodwill so associated can only vest or be owned by the company.’
The principle of this case is not necessarily limited to IFAs, though it may be limited to small businesses. For example, clients of a small accountancy or legal practice might well regard themselves as clients of Mr, Mrs, Miss, Ms or Mx X rather than as having a relationship with the firm or company: but as the organisation grows and a larger team becomes involved in providing a wider range of services to the client, it becomes more difficult to say that the client ‘belongs’ to an individual rather than to the organisation.
Interestingly, that wasn’t the primary reason that the FTT found in favour of the taxpayers. The primary reason was a little odd (well, frankly, misconceived).
Although the goodwill in question was worth a substantial amount, the balance sheet of the company had never included any figure in respect of it. The FTT thought that HMRC’s assertion that the company owned the goodwill therefore amounted to an assertion ‘that the balance sheet valuation of the company was so materially inaccurate in each year that the accounts could not have represented a true and fair view.’ Since the FTT considered that ‘there was no basis on which to conclude that the accounts of both [the company and the LLP] are anything other than GAAP compliant and accordingly provide a true and fair view of each entity’, it followed that ‘on the basis of the accounts’ the goodwill was not an asset of the company.
The problem with that analysis is that the goodwill in question, being internally generated goodwill, would not have appeared on the balance sheet of the company even if the company had owned it. So, obviously, no conclusion could legitimately be drawn from its absence. The FTT’s principal reason for finding in favour of the taxpayers doesn’t hold water.
Fortunately, the second (that as a matter of fact the relationships were ‘owned’ throughout by the individuals) does.
