UK: For What It´s Worth
Insights Into Goodwill In Partnerships - An Accountant´s Perspective

Mark McMullen explores some of the key issues that partnerships encounter when considering goodwill.

Goodwill is a nebulous asset and a complex area. Defined as the difference between the value of a business and the value of its separable net assets, it can lead to a host of issues.

There are three main ways that goodwill can arise: inherent in an established business, acquired on the purchase of a business or created on incorporation. Whichever type of goodwill has been created, similar issues are usually encountered.

Goodwill is an important consideration in professional firms, both within the partnership and in transactions with other firms. But defining its actual ‘value’ is often a point of debate. It depends on various factors including the earnings of the business, the hypothetical or prospective purchaser’s desired return on investment, and any premium he/she is prepared to pay for acquiring the firm and its earnings.

In a partnership transaction, where the purchase consideration is a profit share in the enlarged business, it is usually beneficial to allocate the consideration between payment for the business and compensation for future services.

Goodwill is not usually carried on the balance sheet of partnerships. And those partnerships that do include it usually do so at cost rather than at a revalued amount. International Financial Reporting Standard 3 requires that any goodwill arising be reviewed for impairment every year, whereas Financial Reporting Standard (FRS) 10 states that it be amortised over its estimated useful economic life, normally a maximum of 20 years. If there is impairment, the goodwill is written off to estimated, recoverable value.

The ‘write off ’ of goodwill, whether immediate or over time, can impact inequitably on partners where there are changes in profit-sharing ratios.

It is best practice for the partnership agreement to specify ownership of goodwill. In most cases, members of a partnership own it internally. But in some instances, partners outside the partnership can own it personally.

Within a partnership, partners usually own goodwill in their (capital) profit-sharing ratios. Incoming partners usually acquire a share of this on admission and can be asked to pay for the privilege. Partners typically realise their goodwill on retirement or on sale of the business.

Most partnerships will take steps to protect their goodwill, particularly in international situations. At a basic level, this will involve protecting the name through registration as a trade or service mark and preventing local partners from exploiting the goodwill for non-firm benefits. At a deeper level, this includes the setting and monitoring of common quality control standards.

On incorporation, the capital gain represented by the increase in the value of goodwill can usually, with care, be deferred and not give rise to an immediate charge.

Disposals of goodwill from changes in profit-sharing ratios are exempt from capital gains tax (CGT) under the Revenue’s statement of practice D12 – unless the goodwill has been revalued in the partnership accounts. In such circumstances, each change is subject to CGT. The combination of administrative complications and a tax burden make it relatively unusual to see revalued goodwill.

Retiring partners who receive a payment for their share of goodwill are subject to CGT on the disposal, currently at rates of between 10% and 40% depending on availability of business asset taper relief. This will change to a flat rate of 18% with effect from 6 April 2008, if the current proposals are enacted.

For long-established firms, the base cost of goodwill is dependent on its valuation as at 31 March 1982. It is important to maintain records to justify such a valuation.

Stamp duty, stamp duty land tax and VAT are not normally problematic for goodwill.

Goodwill is a complicated area and the above points are just some of the many factors to consider in partnerships. Clearly, the treatment of goodwill will vary depending on the nature of the business, how long it has been established and the individuals involved. However, in most situations, expert professional advice is essential to arriving at an amicable, and profitable, treatment.

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.