Incorporation of Your Accounting Practice - Planning for Stamp Duty on Goodwill and Valuation Rules
Where an accountant transfers his or her accountancy business to a company in which he has a controlling interest, it often happens that the company buys the goodwill and other assets of the business. Although the ‘incorporation’ of a business gives rise to multiple tax issues, in practice most attention is given to minimising stamp duty and the extraction of future earnings by side-stepping CGT ‘incorporation’ relief.
These key issues are addressed below.
Minimising Stamp Duty
The transfer of tangible and intangible assets to a company on incorporation can give rise to stamp duty at 6%. This liability can be avoided in respect of tangible assets to the extent that these pass by delivery, or where it is possible to "rest on contract". However, without planning, the transfer of intangible assets will trigger stamp duty at 6% even where no formal contract or agreement is executed.
Fortunately, there are a number of ways to transfer intangible assets such as including goodwill, book debts, cash on deposit and the benefits of contracts without triggering a charge to stamp duty.
Ensuring Capital Gains Tax Treatment
The disposal of a business to a company is a disposal for capital gains tax purposes although CGT ‘incorporation’ relief may provide full or partial deferral of tax arising provided certain conditions are met.
That said, many accountants opt to side-step CGT ‘incorporation’ relief and instead trigger an upfront charge to tax at 25% which is calculated by reference to the value of the business transferring. This is because a significant tax saving can be achieved by extracting future earnings by way of repayment of a director’s loan. In some cases the upfront CGT cost can be avoided if the accountant qualifies for retirement relief and/or if he or she has unused CGT losses.
Because of this the Revenue Commissioners carefully review valuations especially where the consideration for the transfer is used to inflate a director’ loan account. An independent valuation is crucial in order to defend the transaction from being regarded as having taken place at a valuation which is excessive. Furthermore, the valuation method used must be acceptable to Revenue and it is important that no weight is put to personal skills and attributes of the sole trader or partner as they are not capable of being transferred to the company.
Implications of Excessive Valuation
Should Revenue successfully find that the valuation is excessive the excess – in most cases reflected in the director’s loan account – will give rise to an income tax exposure for the accountant. In this regard, the timing of the transfer is relevant as the company may not be entitled to a corporation tax deduction for any excess brought within the charge to income tax resulting in a double taxation of earnings.
If the valuation is subject to challenge, but it is clear that there was no intention to transfer the goodwill at excess value, and reasonable efforts were made to carry out the transaction at market value - by using a professional valuation - then it is possible that any ‘excess’ could be ‘unwound’ subject to agreement with Revenue. But this will not apply if there is attempted avoidance or if the overvaluation was intentional or if no professional valuation was obtained.
Where it is agreed that an inadvertent distribution may be unwound, the individual must repay the excess value to the company. Where the original sale proceeds were credited to a loan account, that credit should be reduced, with effect from the date of the original transaction. If the individual has drawn from the loan account on the strength of the original credit, rewriting the loan account to reflect the unwinding of the distribution may result in the loan account becoming overdrawn resulting in benefit-in-kind issues for the shareholder and possible payments of income tax by the company under close company rules.
Estate Planning
The period of ownership of the business will be taken into account for retirement relief purposes in the event of a future disposal of shares in the business. However, an important point for accountants considering passing on their businesses is that this prior period is not taken into account for business property relief.
Conclusion
When incorporating an accounting practice it is essential that the transfer is correctly structured to maximise entitlement to tax stamp duty and CGT reliefs and to limit potential exposure to income tax in the event that the transfer is successfully challenged by Revenue. It is also critical to obtain a clear contemporaneous evidence of market value from a third party adviser prior to the transfer taking place.
Should you have any questions on the above, you can contact me at 01-544 4434 or by email (derek@andrewstax.ie)
