The existence (and extent) of any goodwill have often been problematic questions for practitioners when valuing businesses over the years. A business usually comprises various assets, one of which might be goodwill. The accounts of some business proprietors may not recognise goodwill (e.g., because the proprietor has built up the business since commencement). However, if the accounts do not recognise goodwill, this does not necessarily mean that none exists.
The question of whether goodwill exists, and the nature of any goodwill, can be an important consideration, such as upon incorporation of the business (e.g., see Denning v Revenue and Customs [2022] EWCA Civ 909, discussed below).
Historically, it was once popular for individual business proprietors to incorporate their business, ‘sell’ goodwill to a newly-formed company owned by the business proprietors (with the proceeds being credited to their loan account with the company, and claim (what is now) business asset disposal relief (BADR) for capital gains tax (CGT) purposes on the disposal of goodwill. Unfortunately for business owners, claims for BADR on disposals of goodwill to a close company are no longer possible except in certain limited circumstances (TCGA 1992, s 169LA).
However, transferable goodwill may still be sold upon incorporation at market value, albeit that any chargeable gain will be subject to normal CGT rates (i.e., 10% and/or 20% for 2022/23). Alternatively, the goodwill might be the subject of a holdover relief claim (under TCGA 1992, s 165) on a transfer for no proceeds, or at undervalue.
The valuation of goodwill in businesses carried on from ‘trade-related property’ (e.g., pubs, hotels, petrol stations, cinemas, restaurants and care homes) has been a particularly difficult issue since a Practice Note on the subject was originally published by HMRC in January 2009 on the apportionment of the purchase price of a business sold as a going concern. The current version of the Practice Note is available from the Gov.uk website (tinyurl.com/HMRC-PN-Price-TOGC). Of course, the Practice Note is only a statement of HMRC’s views regarding goodwill and does not carry the force of law.
The Royal Institution of Chartered Surveyors (RICS) rejected the approach described in the Practice Note. Discussions between HMRC, the Valuation Office Agency (VOA) and the Chartered Institute of Taxation subsequently took place with input from RICS and other professional bodies.
A business can include various assets, such as land and buildings, fixtures and fittings, plus goodwill and other intangible assets such as registered trademarks. On the disposal of a business as a going concern, a just and reasonable apportionment of the consideration may be required for tax purposes. In recent years, HMRC has seemingly been particularly concerned about taxpayers excessively apportioning disposal proceeds to goodwill, not only for CGT purposes but (for companies) to obtain relief under the intangible fixed assets regime (CTA 2009, Pt 8), and (for disposals of business premises) to minimise the amount of stamp duty land tax (SDLT) payable.
The intangible nature of goodwill, and the lack of relevant statutory guidance on what constitutes a ‘just and reasonable’ apportionment of disposal proceeds has resulted in many disputes between taxpayers and HMRC in terms of identifying sums attributable to goodwill. HMRC (or rather, its valuation experts and/or the Valuation Office Agency) will generally seek to apportion the price paid between the underlying assets included in the sale on the basis of their relative values and the contribution they make to the price being apportioned.
HMRC accepts that if a business is sold as a going concern, the sale may include some element of goodwill. However, HMRC considers that the sale price will reflect the value of tangible assets and other assets such as goodwill, and that it is necessary to consider the contribution that each asset makes to the combined value.
HMRC’s approach involves treating the difference between the purchase price of the business and values of the property, fixtures and fittings etc. as being the value of the goodwill (and any other intangible business assets). Any goodwill etc. will reflect the capitalised value of the excess of the estimated recurring profits of the actual business owner over those of what HMRC refer to as a hypothetical ‘reasonably efficient operator’. HMRC states: “In some cases the value of the goodwill may be nominal but in some it may be substantial.”
The valuation of leasehold interests in two care homes was recently considered by the Court of Appeal in Denning v Revenue and Customs [2022] EWCA Civ 909. In that case, an individual (‘ZD’) owned two care homes as a sole proprietor. In March 2011, ZD entered into three agreements with two companies (‘MHL’ and ‘MPL’), which were wholly-owned subsidiaries of a parent company (‘JCHL’) of which ZD was the sole shareholder to transfer one care home to each company. The agreements also provided that the first taxpayer would grant leases over the properties from which the businesses were operated for a term of five years. The first taxpayer retained the freehold interest in both care homes. Deeds of assignment of the goodwill of the businesses from the first taxpayer to MPL and MHL for specified consideration.
The valuation of the leasehold interests (required for the purposes of TCGA 1992, s 272) in relation to CGT and SDLT was carried out in accordance with the guidance given by RICS (‘VPGA 4’ – See below). HMRC contended that the agreed capital values for the leasehold interests were their open market values, reflecting trading potential. The taxpayers argued that the transferable or business goodwill was an asset separate from the leasehold interest. The Upper Tribunal (UT) dismissed HMRC’s appeal. HMRC appealed.
The Court of Appeal found that trading potential referred to future profits, which was available to any reasonably efficient operator who acquired the property. On the basis that goodwill was what brought in custom, it would be reflected in the turnover and the profit of the actual business. The Court concluded that the UT made an error of law, which was to disaggregate property value on the one hand, and ‘transferable goodwill’ on the other. VPGA 4 was aimed at the valuation of property interests. That they were valued by reference to trading potential did not mean that two separate assets were being valued. HMRC’s appeal was allowed.
Reference was made by the Court of Appeal in Denning to the RICS Valuation – Global Standards (tinyurl.com/RICS-VPGA4), commonly referred to as the ‘Red Book’). The RICS Red Book includes section VPGA 4 (‘Valuation of individual trade related properties’).
This guidance points out that the essential characteristic of trade-related property is that it has been designed or adapted for a specific use, such that the value of the property interest is intrinsically linked to the returns that an owner can generate from that use. The value is therefore considered to reflect the trading potential of the property. It can be contrasted with generic property that can be occupied by a range of different business types, such as standard office, industrial or retail property.
VPGA 4 sets out the steps involved in the profits method of valuation. However, it should be borne in mind that the guidance is advisory and not mandatory.
The Court of Appeal’s decision in Denning (i.e., that transferable goodwill of a hypothetical business for valuation purposes is not an asset separate from the property interest but simply part of the inherent qualities of the property itself and its trading potential) will have unattractive CGT and SDLT (or devolved equivalent) consequences for taxpayers in many transactions involving trade-related property, subject to a taxpayer appeal to the Supreme Court.
For further guidance on goodwill and trade-related property, see Incorporating and Disincorporating a Business Chapter 9 and Tax Planning Chapter 4
Mark McLaughlin CTA (Fellow) ATT (Fellow) TEP is a co-author of Incorporating and Disincorporating a Business and General Editor and a co-author of Tax Planning (both Bloomsbury Professional).
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