Tribunal allows taxpayers' appeals against discovery assessments

In Smith v HMRC [2023] UKFTT 00912 (TC), the First-tier Tribunal (FTT) allowed the taxpayers' appeals against discovery assessments, finding that a transfer of goodwill did not amount to a distribution under section 1000, Corporation Tax Act 2010 (CTA), because the goodwill was owned personally by the taxpayers.

Background

Mr Smith and Mr Corbett (the Appellants) were independent financial advisors. Mr Smith commenced employment for Mr Corbett who, at that time, operated as a sole trader under the name Simpson Independent Financial Advisors (SIFA). It was expected that Mr Smith would cultivate and nurture professional relationships with the clients with whom he had historically worked and develop new relationships.

SIFA was incorporated in June 1999 and Mr Corbett was appointed as a director.

In 2002, Mr Smith’s employment arrangements were formalised with SIFA through a written contract, which reflected the oral arrangements that had previously existed. Mr Smith was appointed a director of SIFA in January 2006, and became a shareholder in October 2006, paying £15,000 for one third of the shares. The price paid for the shares represented approximately one third of the net book value of fixtures and fittings.

In 2012, the Appellants were advised that conversion from a limited company to a limited liability partnership would suit the business. The underlying rationale was said to be that the corporate structure did not permit fair remuneration for the shareholder/directors through dividends. Accordingly, in June 2012, Simpson Wealth Management LLP (SWM) and SIFA entered into a business transfer agreement under which the business of SIFA was transferred to SWM as a going concern, along with all assets used in the business including the goodwill. The consideration for the transfer was the fair value of the business, which was transferred as a credit to the capital account of SIFA in SWM. The relevant accounts for SIFA did not ascribe any value to the goodwill. 

On 1 October 2012, each of the Appellants introduced as capital to SWM what was recorded as "goodwill introduced". Mr Corbett contributed £1,179,000 and Mr Smith contributed £1,017,000, with the amounts credited to their individual SWM capital accounts. The contributions represented the market value of the personal relationships with individuals requiring independent financial advice and were made by the Appellants personally.

In December 2014, HMRC opened an enquiry into SWM's partnership return for the year ended 5 April 2013. Following that enquiry, HMRC issued the Appellants with discovery assessments to income tax, pursuant to section 29, Taxes Management Act 1970, on the basis that the amounts credited to their capital accounts constituted a distribution from SIFA, in accordance with section 1000, CTA.

The Appellants appealed the assessments. The sole issue for determination by the FTT was whether there was a distribution made by SIFA to the Appellants.

FTT decision

The appeals were allowed.

The Appellants' primary contention was that, as HMRC had not directly contested that the accounts for SIFA were GAAP compliant, there was no basis on which to conclude there had been a distribution. In any event, the Appellants argued that the goodwill contributed by them had never belonged to SIFA and could not have been contributed by it on their behalf. In that regard, and contrary to HMRC's argument that all goodwill associated with the provision of advice by SIFA must have belonged to SIFA because goodwill cannot inherently be held or exist separately from the business to which it relates, the Appellants contended that goodwill was personal to them as individuals and was never an asset of SIFA as they each had their own reputation and strong relationships with clients loyal to them personally.

The FTT accepted that the accounts of both SIFA and SWW were GAAP compliant and therefore provided a 'true and fair view' of each entity. Those accounts showed that, in the period prior to 1 October 2012, SIFA was not the owner of any asset associated with the personal relationships of the Appellants with individual clients. The FTT noted that to conclude, as HMRC suggested, that more than £2.2m of value had been omitted from the accounts over a number of years would require the FTT to find that the balance sheet valuation of the company was so materially inaccurate in each year that the accounts could not have represented a true and fair view. The FTT was unwilling to reach such a conclusion on the evidence. Rather, based on the accounts, the FTT determined that the goodwill could not have been an asset of SIFA and so could not have been distributed by SIFA.

That effectively disposed of the appeal. However, the FTT went on to consider the parties' arguments on the nature of goodwill. Dismissing HMRC's contention that goodwill could only ever belong to the entity that carried on the business to which the goodwill related, and in reliance on the Court of Appeal decision in Kirby v Thorn EMI plc [1987] BTC 462, the FTT observed that while goodwill was associated with the operation of a business, that was not the same as concluding that the goodwill could only vest or be owned by the company. Rather, the FTT determined that the Appellants' relationships with individual clients represented a valuable asset and, whilst in employment those relationships provided SIFA the opportunity to generate income, the relationships vested with each of the Appellants and could be taken from SIFA without restriction. The FTT therefore considered that the asset of the reputation and relationships of the Appellants with individuals belonged to them and not to SIFA.

Comment

While this decision ultimately rested on the supremacy of the GAAP-compliant accounts, the FTT's comments on the nature of goodwill are  of wider importance to taxpayers. In particular, the FTT's rejection of HMRC's assertion that goodwill cannot inherently be held or exist separately from the business to which it relates in preference of the analysis provided in Kirby, is likely to be of relevance to a range of businesses whose goodwill is based on an individual's reputation and their relationship with their clients.          

The decision can be viewed here.