The Autumn Statement, delivered by the Chancellor in early December, included a surprising announcement of an immediate change to the taxation of goodwill for business incorporations. This article looks at how this could affect future incorporations of health and care businesses.
In the 'old' days
In the past, care home businesses were frequently operated via a partnership structure. In recent years, however, many such businesses have chosen to incorporate and now run their business through a company. Such decisions were largely driven by commercial and legal reasons but tax, as always, plays a big part.
One of the main tax benefits of an unincorporated care business selling its trade and assets, (including goodwill), to a company owned by the same individuals was that the sale proceeds could be left as a loan, which was then repaid out of the profits generated by the company post sale.
Providing certain criteria were met, Entrepreneurs' Relief could be claimed on the disposal, resulting in tax at a rate of 10%. The company would then be subject to corporation tax at a rate of 20% on profits, the balance of which could then be used to repay the directors loan account with no additional personal tax liability.
This was a very tax efficient way to extract cash from the company, which would otherwise be subject to income tax if it were drawn as salary or dividends (with national insurance also possibly applicable to salary payments). This route was also favourable in comparison to income tax on the same profits of up to 45% plus national insurance for the individual, had the care business remained unincorporated.
In addition to the above, new businesses, broadly those established after 1 April 2002, the amortisation (depreciation) of any goodwill transferred to the new company reduced the company's corporation tax bill.
It's all history
In an unexpected move, the Chancellor changed the landscape for business incorporations as part of the Autumn Statement, such that the taxation of goodwill was changed effective from 3 December 2014, the date of the announcement.
Firstly, goodwill acquired by a close company (broadly one controlled by five or fewer people) related to the seller no longer qualifies for Entrepreneurs' Relief. This change increases the tax payable by a care business on a future incorporation from the Entrepreneurs' Relief rate of 10% to the main rate of 28% (or possibly 18% to a limited degree).
With the tax rate on the sale increased to 28%, this makes the sale of goodwill in exchange for the loan account a less attractive proposition, particularly as the tax is payable up front and there are usually no actual sale proceeds from which to pay the tax. Whether a sale of the goodwill in this way is still a viable option will depend on whether the larger liability can be funded and if that liability will be outweighed by the annual savings in the longer term. Furthermore, there may be a more efficient method of extracting profits from the company, depending on each individual's personal circumstances.
Secondly, corporation tax relief on the amortisation of goodwill was also withdrawn where the company acquires the goodwill from a related party, regardless of when the business commenced trading, resulting in the same tax treatment now for all related party goodwill disposals.
Is this the end of incorporations?
There is no question that these two measures have reduced the tax benefits associated with goodwill unless there is a sale to an unconnected third party and change of ownership, as opposed to merely a change of trading entity. However, this is by no means an end to incorporation.
There are other reliefs available such that the tax liability on incorporation could be avoided, but these will generally not result in the creation of a loan account. However, with corporation tax rates reducing over the past few years (and down to 20% for all companies from April 2015) and with no income tax or national insurance due on dividends paid out up to the basic rate band (currently £31,865) the on-going savings are likely to make incorporation a good idea for care businesses.
In addition, other chargeable assets transferred into the business as part of the incorporation, such as property, are still eligible for the 10% tax rate. Stamp Duty Land Tax may also be mitigated by partnerships on incorporation if the property is transferred in to the new company and not retained personally.
In conclusion, tax on incorporations can still be minimised if structured correctly and may continue to offer on-going benefits to the owners. Health and care businesses still operating as a partnership should, therefore, not write off incorporation as a future option to run the business, just yet.
Tax Planning generally
With the significant difference in personal and corporate tax rates it is vital to carry out tax planning. Will an election bring a different party to power? Who knows, but if there is there could well be an increase in the highest rate of income tax from the current level of 45%. Planning is now more important than ever.
Originally published on 17 February 2015. Featured in Healthcare Business February 2015
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
