UT: Income tax charge on incorporation

In HMRC v Mr Neil and Mrs Sharon Pickles [2022] UKUT00253, the Upper Tribunal (UT) found a distribution arose when an asset was transferred in excess of its market value on incorporation. The value of the distribution was the benefit received by the taxpayer over and above the market value of the asset transferred.

• The taxpayers incorporated their farming partnership into a company.
• Goodwill on sale was valued at £1.2m by a third party and credited to the Directors’ Loan account (DLA) in the new company. £771k of this loan was drawn down by the taxpayers.
• No capital gain was declared by either partner and as a result, HMRC investigated the taxpayers' affairs.
• HMRC subsequently revalued the goodwill at £450k and then raised an assessment on the directors for the balance between the sale price and HMRC's revised valuation.
• HMRC asserted that the difference between the actual value of the business, £450k, and what was credited to the directors' loan account, £1.2m, amounted to a Distribution for Income Tax of £750k.
• The taxpayers appealed to the First Tier Tribunal (FTT) who allowed the appeal, finding:
  • The market value of the goodwill transferred was £270k.
  • The amount of the distribution was £501k, the amount drawn down from the loan account of £771k less the market value of the goodwill, £270k, not the full amount credited to the DLA.
  • The remaining debt owed to the directors was not a distribution.

HMRC appealed to the UT and the taxpayers cross-appealed.

The UT found that:

• The amount of the distribution was the difference between the value of the asset transferred and the amount of the benefit received by the taxpayer.
• The FTT was wrong to view the benefit as received at the time it was paid. The correct interpretation was that the benefit was received, and valued, at the time the taxpayers had a contractually enforceable right to receive it: the date of disposal.
• The market value of the benefit received by the taxpayers was £1.2m as:
  • There was a third-party valuation which considered the value of the goodwill was £1.2m.
  • There was no evidence that either party considered and intended the value to be anything other than £1.2m.
  • There is no general principle that a debt needed to be valued on the basis of what could be immediately obtained.
  • There was no basis to discount the value of the debt on the basis that the company could only repay the debt if it had available funds.
  • The value of the goodwill should not be valued with the benefit of hindsight.
• The distribution was £930k, the value of the benefit the taxpayers received of £1.2m less the market value of the asset transferred, £270k.

HMRC’s appeal was allowed.

Comment

In similar cases HMRC has struggled to determine quite how the benefit of an overpayment of goodwill has been taxed: after all, a benefit provided in cash could either be taxed as a distribution or under PAYE.  

Useful guides on this topic

Tax and overvalued goodwill on incorporation
In Neil Pickles and Sharon Pickles v HMRC [2020] TC07681, goodwill was overvalued on the incorporation of a farm and then credited to the directors’ loan account without declaring Capital Gains Tax (CGT). Was this a distribution? The First Tier Tribunal (FTT) struggled with the issues.

Goodwill & incorporation: Tax issues
What are the tax issues in respect of intangible property (IP) assets, such as goodwill, on incorporation? What tax reliefs apply if you buy and sell goodwill and IP? What are the valuation and clearance procedures?

Valuation: Goodwill
What valuation methods are suitable for valuing a business? What are the issues with goodwill and other intangibles? What does HMRC suggest? What do the courts think?

Directors’ loan accounts: Toolkit
HM Revenue & Customs (HMRC) have a director's loan accounts toolkit for advisers. This is our enhanced (freeview) version with planning points. 

Directors’ loan accounts: Toolkit (subscribers)
HM Revenue & Customs (HMRC) have a director's loan accounts toolkit for advisers. This is our enhanced version with planning points. 

Dividend tax index
How do you tax a distribution or dividend received from a company? What are the rules for non-residents? What are the company law requirements for a valid dividend?

External links

HMRC v Mr Neil and Mrs Sharon Pickles [2022] UKUT00253