Treatment of goodwill when changing from self-employed to ltd company status

E

elacsaplau

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Hi All

A friend of mine has a profitable sole trader business. He is considering establishing a limited company and wonders about how the goodwill of the sole trader business will be treated from a tax perspective in the company, both in the short and longer term.

Of course, probably a question for his tax advisor but any initial comments / points to consider would be much appreciated.
 
He will have to value all the assets to be transferred.

The Goodwill (the basis of calculation will need to be robust) can be transferred in return for a directors loan but goodwill is a chargeable asset and subject to CGT. Retirement may apply if over 55.

There is a conversion to ltd co relief from CGT, he should ask his accountant.
 
Joe_90 said:
There is a conversion to ltd co relief from CGT, he should ask his accountant.
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+1.

In years gone by, if the person were cash-rich they could forego this relief - but this loophole was tightened up about 5 years ago, IIRC.
 
Clearly when CGT was 20% then most paid CGT on the transfer.

With rates at 33% it's not as attractive to pay it up front so the relief may be of use.
 
If the goodwill is transferred into the company and CGT is paid (or relieved by Retirement Relief if appropriate), can the company claim capital allowances on that goodwill? Might be another aspect to consider in making a decision like this.
 
Thanks everyone for the advice - very much appreciated.

Can anybody elaborate on Joe's point in relation to transferring the goodwill (chargeable to CGT) in return for a director's loan, ideally with a simple example please?

For reference, he is under 55. My specific question is, let's say for simplicity, the goodwill is valued at €1m with a consequent CGT charge of €330k - what benefit does he get from the director's loan (i.e. does it negate the CGT charge, or better?)
 
Your friend (Mr X) sets up a company in which he is shareholder/director. Company purchases goodwill from your Mr X's sole trader business (at a fair market value). Mr X pays CGT of 330k on sale of goodwill.

But company does not have money to pay Mr X up front so purchase is done by way of a loan of €1m from Mr X and recognised as a loan in the accounts. When the company earns money it can repay the loan to Mr X (no tax on these payments).

By using a directors loan, you can turn the goodwill created in the sole trader business into cash (albeit paying cgt at 33% on the amount).

I think the company may be able to claim capital allowances on the goodwill at the rate at which the are written off in the accounts - this is worth 125k to the company (tax on €1m at 12.5%) - I'm not sure what the restrictions are in the legislation in this regard - someone else might comment and it would be worth taking advice on.
 
Zacchaos;1401190 I think the company may be able to claim capital allowances on the goodwill at the rate at which the are written off in the accounts - this is worth 125k to the company (tax on €1m at 12.5%) - I'm not sure what the restrictions are in the legislation in this regard - someone else might comment and it would be worth taking advice on.[/QUOTE said:
Where are you getting capital allowances on Goodwill from. I've never seen it?
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Joe_90 said:
Where are you getting capital allowances on Goodwill from. I've never seen it?
Click to expand...

You can claim wear & tear allowances on goodwill directly attributable to one of the inspecified intangible assets listed in S.291A(1), i.e. patents, trademarks etc... but that's nothing to do with common or garden trading goodwill of a sole trade.
 
Joe's advice above re: robustness of goodwill valuation will be quite important.

Revenue will quite rightly see goodwill valuations on incorporations as a high risk, due to the fact that they are in effect an artificial transaction (the same individual retains ownership) and as the example above illustrates they can generate an ability to draw substantial amounts of cash from a company tax-free. So prepare to have to justify your valuation at some point.

Interestingly, there would be certain circumstances where the goodwill attached primarily to an individual, who in effect "is" the business - and simply saying the business has transferred to the company doesn't actually mean that the value of the goodwill has transferred.

If that person incorporated in the morning and tried to sell the shares immediately to a third party, they'd pay very little for them without also securing the expertise of the individual for a number of years, because they know that the relationships that generate the goodwill are between that individual and the customers, and not "the company" and the customers. If they buy the shares and the individual walks away, the new owner has nothing that is actually capable of retaining the customers.

Edit:
Lets say I'm Mandelbrot T/A Mandelbrot Cabinet Makers - I'm a sole trader, and it's just me and a skivvy. I'm a fantastic cabinet maker and demand for my services is huge.

I incorporate my business so that I am now Mandelbrot Cabinet Makers Limited - but the customers still come because it is Mandelbrot they want to make a cabinet for them.

If Shoddy Carpentry Limited approach me and buy the shares in Mandelbrot Cabinet Makers Ltd from me tomorrow, there's no way in hell they'll pay me anything for the name or the company, unless I sign a contract committing my services to their company for a few years, so that they can, over a period of time, leverage the goodwill that attaches to me, Mandelbrot.
 
Honestly Mandelbrot - I'll leave you alone after this but I don't understand something again!

How precisely does the level of goodwill impact on one's "ability to draw substantial amounts of cash from a company tax-free?"

Before you scream, my understanding of the gist of the posts herein is that one can fund for the amount of goodwill via a director's loan and then subsequently withdraw the amount of director's loan, tax free.

My understanding is that this is (broadly or absolutely) true of all director's loans so I'm struggling to see how the level the company pays for goodwill assists in tax effective withdrawal of funds from a company (unless it has something to do with retirement relief in the future)?
 

Ok, I'm not screaming I promise!

Lets say you loan your company €1m to buy a building from a third party - no problem, the company owes you a million quid so obviously you can have it repaid to you tax free.

Now lets say you are selling the goodwill of your business into your company - it's not an actual loan of cash money from you to the company, and the value of what has been transferred is not easily ascertained - Revenue's own manual acknowledges valuation is often said to be more art than science.

Quite simply, the greater the goodwill valuation you use, the greater the amount the company owes you for it, and the greater the loan that the company recognises at day 1. That is how it assists tax-free withdrawal, as long as you are owed the loan you can draw cash by repayment of loan rather than by salary.

So the risk is that you'll decide that your business is worth €1m (or €10m or €100m!) when by any reasonable measure it's only worth a fraction of that - potentially you're going to spend years drawing hundreds of thousands out of the company by repayment of an inflated loan instead of having to draw a salary and paying tax, PRSI & USC on it.
 
mandelbrot said:
You can claim wear & tear allowances on goodwill directly attributable to one of the inspecified intangible assets listed in S.291A(1), i.e. patents, trademarks etc... but that's nothing to do with common or garden trading goodwill of a sole trade.
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From Revenue Briefing on s291A - Intangible Assets scheme...

[broken link removed]

Q 3. How is Goodwill treated under the scheme?

Goodwill is included in the scheme to the extent that it is
  • recognised as an intangible asset under generally accepted accounting practice and
  • directly attributable to any of the other specified intangible assets listed in section 291A(1).
Only goodwill that is externally acquired is recognised as an intangible asset under generally accepted accounting practice. Acquired goodwill is the amount by which the cost of an acquired business exceeds the fair value of the identifiable assets less liabilities of the business. Internally generated goodwill is not regarded as an intangible asset and is therefore not included in the scheme.

Say if Company pays sole trader €1m for the business where assets less liabilities = 500k - and Goodwill is 500k (valued by an independent source). Company has externally acquired goodwill and can claim capital allowances on 500k - would you not agree??
 

No I wouldn't!

See the word "and" between your 2 bullet points - only goodwill that is directly attributable to the assets specified in S291A(1) qualifies.

Have a read of the whole Tax Briefing, look at the list near the end, it clearly doesn't apply to a normal trade; in fact in order to calculate the allowances it requires the exploitation of the IP to be treated as a separate trade. Look at the amendment to paragraph h., which was necessary to make it clear that it doesn't apply to a pub trade. Why exclude pubs but otherwise have general application?!

S291A is part of Ireland's attempt to get pharma/software/medical etc companies to park their valuable IP here.

If you were right, there would have been an explosion of incorporations in recent years.
 
Mandelbrot,

I'm not sure that if I was right, it would have led to an explosion in incorporations in recent years - To go down this road would mean crystallising a capital gain and paying tax on it at 33% - which may be prohibitive in many cases, and the capital allowances on goodwill built up might be insignificant in comparison.

As correctly pointed earlier in the thread the crystallisation of goodwill (by means of a directors loan), is attractive if you wish to turn the value built up in a trade into cash, where it is otherwise unlikely and you can afford to pay the CGT. In many other cases, individuals who wish to incorporate go down the road of transferring the business in full in exchange for shares to avail of CGT exemption.

Apologies to the original poster Elacsaplau for taking the thread off in a different direction, but I was hoping to probe the area of capital allowances on goodwill in companies.

I do not dispute that S291A is part of Ireland's attempt to be more attractive to the SMART multinationals and to attract inward investment. However, the legislation applies to all within the Irish tax system.

S291A encompasses "brands and brand names" and goodwill generated from the brand is included, if quantified and recognised in the accounts.

As in your example above, if Mandelbrot Cabinet Makers was a sole trade and had built up a reputation as the best around due to your exquisite cabinet making skills and you then go to incorporate and keep the same name – is Mandelbrot Cabinet Makers a brand name for the purposes of the legislation? Where does the legislation start and stop with a “brand or brand name”. In some furniture circles people would be saying that I’d love a Mandelbrot cabinet in the same way that I’d love to have a Miele washing machine.

The restriction you referred to in the section means the capital allowances on the intangible assets may only be claimed against the trade they are identified with. If you the company trades on the reputation (goodwill) that Mandelbrot Cabinet Makers has built up, then it is exploiting that asset and can claim capital allowances against that trade??

I’m not saying that I’m right – I may have missed the blatantly obvious, but in reading the legislation and related info on this section I always thought that it might be open to a wider interpretation.
 
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