CGT – Entrepreneurs’ relief and compensation
In 2002 M who was suffering from ill health sold his interest in a thriving accountancy practice to the other two partners, C and P. Entrepreneurs’ relief was available on the gain attributable to the goodwill at the time of disposal.
In 2011, M discovered that C and P had deliberately used incorrect figures to calculate the value of the goodwill. C and P had disappeared. The then partners in the practice (who had not been involved in the 2002 sale) agreed to compensate M without the need for litigation. M and those partners settled the figure that should have been used to calculate the consideration under the original contract. This agreement was reached in 2014 with payment to be made in instalments.
M’s concern was how would this payment be taxed when it was received and, in particular, whether entrepreneurs’ relief would be available.
The amount received was most likely to be taxed as a sum received in settlement of potential claim for breach of contract. It should be possible to use Extra-Statutory Concession (ESC) D33 to claim entrepreneurs’ relief on the additional sum received. Paragraph 9 of ESC D33 reads as follows:
Where the right of action arises by reason of the total or partial loss or destruction of or damage to a form of property which is an asset for capital gains tax purposes, or because the claimant suffered some loss or disadvantage in connection with such a form of property, any gain or loss on the disposal of the right of action may by concession be computed as if the compensation derived from that asset, and not from the right of action. As a result a proportion of the cost of the asset, determined in accordance with normal part-disposal rules, and indexation allowance, may be deducted in computing the gain.’
Applying ESC D33, the receipt was analogous to a deferred (not an uncertain or contingent) payment under original contract. This characterisation would be necessary to relate the payment back to a time when M qualified for entrepreneurs’ relief. Section 28(1) TCGA 1992 could help:
28 Time of disposal and acquisition where asset disposed of under contract
(1) … where an asset is disposed of and acquired under a contract the time at which the disposal and acquisition is made is the time the contract is made (and not, if different, the time at which the asset is conveyed or transferred)’.
HMRC should be approached on this basis. If this approach was successful the 2002 gain could be recomputed and entrepreneurs’ relief claimed.
At the time of publication this case study was technically accurate however, as tax law and practice change rapidly, you should take specific advice before taking any action.