On 3 December 2014 the Chancellor unexpectedly announced changes to the taxation of goodwill on the incorporation of businesses. The changes were made immediately effective.
Changes to Capital Gains Tax
Goodwill acquired by a related close company (i.e. if you are incorporating your business) will no longer qualify for Entrepreneurs Relief (ER). The Capital Gains Tax (CGT) rate applicable to goodwill will be at the main rate of 20% (potentially part at 10%) instead of the ER rate of 10%.
Historically, it has been possible to pay 10% CGT on a ‘sale’ of goodwill to a company and credit your Director Loan account with the goodwill value. You are then able to draw down on the loan account without incurring further tax charges. Although the tax is payable up front, it is still a very efficient way to draw funds from the company, since traditional dividends or salary payments are likely to attract further income tax and national insurance (salary only) liabilities.
Since the CGT rate applicable to goodwill has been increased to 20%, it is now less tax efficient and attractive to structure a sale of goodwill in exchange for a Director Loan account balance. It must be considered whether the cash is available to make a CGT payment at 20% and if the initial tax payment will be outweighed by savings in future years.
It is still possible to incorporate your business without incurring a CGT liability, by claiming incorporation relief or gift relief, although this will not result in the creation of a Director Loan account balance.
Amortisation of goodwill
The second change introduced was the retraction of corporation tax relief on the ‘amortisation’ of goodwill acquired from a related party.
Previously, companies have been able to claim corporation tax relief for the amortisation of goodwill acquired from a related party, provided the underlying asset (i.e. the business goodwill) did not exist before 1 April 2002. The restriction has now been extended to remove the relief for all goodwill acquired from a related party.
Both these changes reduce the tax advantages linked with incorporation and the ‘sale’ of goodwill. However, there are still potential tax benefits to incorporating your business, such as remuneration planning taking advantage of the comparatively lower corporation tax rates.