GOODWILL VALUATIONS ON INCORPORATION

Stephen Burwood CTA MIoDNicholas Stobbs LLB MSc

Tuesday 4 September 2012

A VISUAL PRESENTATION BY VEQUITY INTELLIGENCE LLP

DELIVERED BY

STEPHEN BURWOOD CTA MIoD

NICHOLAS STOBBS LLB MSc

© Vequity Intelligence LLP 2012.

While every care has been taken to ensure the accuracy of these notes, no responsibility for loss occasioned by any person who acts or refrains from action as a result of any in-formation or opinions contained in them can be accepted by Vequity Intelligence, Stephen Burwood or Nicholas Stobbs. This visual presentation is intended to be a general guide

and professional advice should always be obtained in relation to any specific case.

These notes may not be reproduced without the permission of Vequity Intelligence LLP.

VEQUITY INTELLIGENCE LLP

WHO...?

VEQUITY INTELLIGENCE LLP

We provide specialist advice on share, goodwill and business valuations, including the preparation

of independent valuation reports. We work with a diverse range of professional firms to bring

external valuation expertise to their clients.

VEQUITY INTELLIGENCE LLP

Our approachThe Vequity Intelligence approach is a unique blend oftraditional methodologies, innovative financial modelling,high quality data analysis and commercial judgement.

Each valuation is bespoke. We conduct in depthresearch for each assignment, this includes:

- Insight from Industry and sector experts- UK and EU case law precedent- Economic data and industry benchmarks- Live market statistics inc. M&A & IPO deals- Geo-political and public affairs information

Our strategyOur strategies are designed to deliver first class valuation advice for every assignment.

We deliver share, goodwill and business valuations via three strategies:

Direct engagement - with the client.

Whitepaper valuation - delivered to the client via an intermediary, usually a professional firm e.g. an accountant.

Fee share arrangement - on a referral basis allowing Vequity Intelligence to deliver directly to the client.

Our services are retained on a regular basis by professional advisers where specialist share, goodwill and businessvaluation advice is required for their clients.

INTRODUCING

STEPHEN BURWOOD CTA MIoD

NICHOLAS STOBBS LLB MSc

Stephen Burwood CTA MIoDPartner

Nicholas Stobbs LLB MScPartner

- Recognised expert in transactional tax and author of several tax publications.

- Previously the editor and then consultant editor of Tax Advisor, the journal of the Chartered Institute of Taxation.

- 30 years experience specialising in direct taxation and valuations.

- Valuation engagement experience includes share schemes, complex management buy-outs and IPOs.

- Background in law, economics and finance

- Sophisticated grasp of the most technical aspects of financial modelling and traditional valuation methodologies.

- Developed his own set of sophisticated valuation models specific to certain sectors

- Experience in analysing economic data, live marker statistics, market information and UK & EU case law.

Introducing: Stephen Burwood & Nicholas Stobbs

What you’ll learn:

1. Why incorporation is an exciting prospect for your client

2. The meaning of goodwill

3. HMRC current approach to goodwill

4. HMRC position regarding goodwill on incorporation

5. The current issues surrounding goodwill on incorporation as identified by HMRC

6. Measures available to reduce to risk of HMRC challenging a valuation

READY ?

Chapter 1

Let’s start by outlining why incorporation is an

exciting prospect for your clients

1. Tax carrot: profits can be retained at relatively low tax rates.

2. Opportunity: further tax savings.

3. Credibility: limited status

4. Protection: personal liability

Why incorporation is an attractive propositionChapter 1 1 / 1

Chapter 2

The meaning of goodwill

- Asset: TCGA92/S21 (1)

- Legal authority: IRC v Muller & Co Margarine Limited [1901] AC217 Lord Macnaghten: ‘It is a thing very easy to describe, very difficult to define’...‘benefit and advantage of the good name, reputation and connection of a business. It is the attractive force which brings in custom’

‘distinguishes an old-established business from a new business at its first start’

‘composed of a variety of elements...differs in its composition in different trades and in different businesses in the same trade’ Lord Lindley: ‘includes whatever adds value to a business by reason of situation, name and reputation, connection, introduction to old customers and agreed absence from competition’

- Accounting: FRS10 definition: goodwill is the difference between the value of a business as a whole and the aggregate of the fair values of its separable net assets.

- Legislation: Schedule 29 Finance Act 2002 ‘Gains and losses of a company from intangible assets’ Goodwill has the meaning it has for accounting purposes.

The meaning of goodwill: definitionsChapter 2 1 / 2

When does goodwill begin ?

- HMRC regard goodwill as beginning when trading commences.

- Deemed to grow with the business, on a consistent basis over the years.

Who owns the goodwill created ?

- Inseparable from the business in which it is generated and has its existence (CG68030).

- When a business is disposed as a going concern any goodwill attributed to the business will be transferred to the new proprietor.

- Any goodwill attributable to the personal skills of the proprietor, for example the personal skills of a chef or a hairdresser, will not be transferred to the new proprietor.

The meaning of goodwillChapter 2 2 / 2

Chapter 3

HMRC approach to goodwill

HMRC approach to goodwill has evolved over time and taken three guises:

First: - Animals: The Cat, Dog, Rat & Rabbit

Second

- Personal, Inherent and Free goodwill

Third - current approach

- Personal goodwill v Trading goodwill and Trade Related Property Goodwill

The evolution of goodwill under HMRCChapter 3 1 / 4

The catLocation notperson

The dogPerson not

location

The ratCasual neither personnor location

The rabbitClose and no other reason

First approach: animalsChapter 3 2 / 4

Personal goodwill:

- Arguable whether the goodwill in a sole trader’s business is personal to them or can really be disposed of to a company. - Personal goodwill is associated not with the business itself but with the proprietor of the business, by reference to their skills and personal attributes.- In HMRC view (CG68022) personal goodwill is “not capable of sale”.

Inherent goodwill:

- This attaches, not to the skills of the sole trader, but rather to the location of the business.- Only transferred on incorporation if the business premises, to which it refers, were transferred to the company or if any lease or licence to occupy the premises was transferred to the company.

Free goodwill:

- It is neither a function of the location nor of the sole trader’s personal attributes. - It is instead a measure of the business value over and above its net assets. - Subdivided into adherent free goodwill and separable free goodwill

Second approach: personal, inherent and freeChapter 3 3 / 4

Personal vs. Trading

- In certain types of business the nature of the goodwill is such that it does not attach to the business itself, but to the person of the owner/director. In these circumstances it is difficult for the goodwill to be transferred or sold if the business is disposed of.

- Circumstances where there is absolutely no business goodwill and where all value resides in the person or the owner are likely to be rare, and to exist only in very small business with few staff were the personality and skill of the owner might be crucial and cannot be subsumed into the new ownership.

Trade related property

- The identification and valuation of goodwill in trade related properties is split between HMRC SAV division, the Valuation Office Agency (VOA) and RICS.

- The current approach is based around apportioning the price paid for a business transferred as a going concern.

Third approach: personal vs. trading & trade related propertyChapter 3 4 / 4

Chapter 4

HMRC current position relating to

goodwill on incorporation

- The incorporation of a business of a sole trader or a partnership is a common occurrence.

- If on the incorporation of a business the transferor has control of the company, the disposal of goodwill will be a transfer between connected persons within TCGA92/S286(6).

- Where the transfer is between connected persons, any goodwill transferred to the company will be deemed to have been disposed of for a consideration equal to its market value in accordance with TCGA92/S17 and TCGA92/S18.

HMRC current position regarding goodwill on incorporationChapter 4 1 / 1

Chapter 5

Who deals with goodwill valuations within HMRC ?

- HMRC Shares and Assets Valuation (SAV) deal with all cases involving the valuation of goodwill and other intangible assets.

- SAV also deal with cases involving the valuation of goodwill and other intangible assets where the business concerned is located or registered outside the UK.

- Individuals and trustees can have the value of unquoted shares and goodwill checked by SAV if they wish.

Post Transaction Valuation Checks

- after disposals relevant to Capital Gains Tax - before the date you have to complete your Self Assessment tax return

Where appropriate, SAV will check the details on your CG34 and let you know if it: - accepts the value you have provided - requires further information from you - suggests an alternative value to negotiate with you

Who deals with goodwill valuations within HMRC ?Chapter 5 1 / 1

Chapter 6

Current issues surrounding

goodwill valuations on incorporation

Issue 1 Personal goodwill vs. trading goodwill

Issue 2 Trade related property goodwill

Issue 3 Over valuation of goodwill

Summary of the current issuesChapter 6 1 / 4

- Main issue is identifying between personal goodwill vs. trading goodwill

- Personal not ‘capable of being sold’

- Trading goodwill has value - issue goes straight to arriving at the correct value

Personal goodwill

- Key factors: Skills & access

- Test: The ability to step into their shoes and act as their successor e.g. famous photographer = No - Approach: Common sense and genuine commercial view

- Questions: Why acquire goodwill when there is already access to that revenue stream? Is there any advantage gained from acquiring this goodwill?

- Professions: Medical practitioner, Artists, Authors, Consultants, Solicitors, etc.

Personal goodwill vs. trading goodwillChapter 6 2 / 4

Dealt with by three professional bodies:

1. HMRC Shares and Assets Valuation division (SAV) 2. Valuation Office Agency (VOA) 3. Royal Institute Chartered Surveyors (RICS)

- No coherent agreement to approach to trade related property goodwill.

- Current HMRC view: The view now is that if a business is sold as a going concern then the sale must include some element of goodwill. The question to be answered is not whether goodwill exists but what is the value of that goodwill? That question has to be decided on the facts of each individual case. In some cases the value of the goodwill may be nominal but in some it may be substantial.

- HMRC have issued interim guidance relating to apportionment - we believe this will be their approach going forward

Trade related property goodwillChapter 6 3 / 4

Whilst is not very easy to challenge the existence of goodwill when a profitable business has been established HMRC may make a challenge on the basis that goodwill is overvalued when sold to a company.

If HMRC is successful, the excess (however this will be determined, as valuation is not an exact science) would be taxed, subject to wording of sale and purchase agreement., as either:

- A income distribution – it is taxed as if it is a dividend (s1000 CTA 2010)

- A loan, providing that the amount is repayable to the company. There will be a tax benefit charge if the amount exceeds £5,000, and a tax charge under s455 CTA 2010 if the loan is outstanding more than nine months following the end of the accounting period.

- Employment income – as earnings (s62 ITEPA 2003) or as a benefit (s203 ITEPA 2003) and subject to NICs. The company will obtain corresponding tax relief for the amount treated as employment income. In the majority of cases involving close companies any overvalued excess of goodwill will be taxable as a distribution because the seller has become a shareholder.

Overvaluing goodwillChapter 6 4 / 4

Chapter 7

What measures can be taken

to reduce the risk of a challenge by HMRC ?

As a specialist share, goodwill and business valuation firm we are in regular contact with HMRC SAV division. We’re hearing the following from HMRC in regard to the valuation of goodwill and measures we can take to reduce challenges:

- Be realistic

- Choose the correct valuation methodology based on the clients circumstances

- Use sound accounting principles

- Complete thorough research including economic data, live market statistics and industry benchmarks

- Produce a clear, concise and detailed valuation report that contains the information required by HMRC to review the valuation

- Use specific wording giving flexibility to the client in the event that we disagree with the valuation proposed.

Measures available to reduce the risk of a challenge by HMRCChapter 7 1 / 1

Chapter 8

Why use Vequity Intelligence ?

- Complex: Goodwill valuations on incorporation are a complex area and currently under the scrutiny of H M Revenue & Customs SAV division.

- Understanding: We understand the complexities involved and HMRCs current position regarding goodwill valuations on incorporation.

- Expertise: We have the expertise to identify the correct valuation approach in line with recommendations made by HMRC SAV division.

- Resources: We have the resources available to complete a comprehensive valuation report which details all the information identified by HMRC SAV division as necessary to agree a valuation.

- Experience: We have experience of dealing with H M Revenue & Customs SAV division and agreeing valuations

- Guarantee: We guarantee our valuations and will defend any challenge by HMRC at no additional cost.

Why use Vequity Intelligence ?Chapter 8 1 / 2

Our goodwill valuation service includes:

- Preparation of an independent goodwill valuation report

- Submission of the valuation report and supporting documents to H M Revenue & Customs SAV division

- Completion of a post transaction valuation check (PTVC)

- Full support in regards to any challenge of the valuation by HMRC until a valuation is agreed

- A guarantee on all valuations

Our pricing structure

We do not provide a structured pricing strategy as each client is unique and their demands differ.

As a guideline our fee for a completed goodwill valuation agreed by HMRC is a 1/4 of a % of turnover.

Our goodwill valuation serviceChapter 8 2 / 2

Get in touchWe welcome the opportunity to initially discuss any valuation requirements you may have, and how Vequity Intelligence LLP may be of assistance.

Please contact Nicholas Stobbs on +44 (0)20 7129 1158 or email nicholas.stobbs@vequityintelligence.co.uk

We look forward to speaking with you, in person, soon.

60 Lombard StreetLondonEC3V 9EATel: +44 (0)20 7129 1158Fax: +44 (0)20 7464 8656

1 City SquareLeedsLS1 2ESTel: +44 (0)113 366 3065Fax: +44 (0)113 366 3066

www.vequityintelligence.co.uk