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You are here: BAILII >> Databases >> First-tier Tribunal (Tax) >> Wildin v Revenue & Customs [2014] UKFTT 459 (TC) (14 May 2014) URL: http://www.bailii.org/uk/cases/UKFTT/TC/2014/TC03586.html Cite as: [2014] UKFTT 459 (TC) |
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[2014] UKFTT 459 (TC)
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TC03586
Appeal number: TC/2010/06391
FIRST-TIER TRIBUNAL
TAX CHAMBER
CGT – valuation of goodwill in accounting practice –March 1982 deemed disposal valuation - calculation by reference to “client book” or “whole practice” taking account of net assets – market valuation – valuation on sale in 2003 – consistency of approach – valuation method to be used - multiple to be applied – held – “client book” accepted as most appropriate valuation method for accountancy firms – multiples for 1982 and 2003 adjusted- appeal allowed in part.
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Appellant |
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- and - |
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THE COMMISSIONERS FOR HER MAJESTY’S |
Respondents |
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REVENUE & CUSTOMS |
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TRIBUNAL: |
JUDGE RACHEL SHORT |
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MR JULIAN STAFFORD |
Sitting in public at 45 Bedford Square, London WC1 on 17 - 20 February 2014
Mr Wildin
representing himself as the Appellant
Ms Hui-Ling McCarthy instructed by the General Counsel and Solicitor to HM Revenue and Customs for the Respondents
© CROWN COPYRIGHT 2014
DECISION
This is an appeal
against a capital gains tax charge of £83,701.60 on the disposal by Mr Wildin
of his share of the goodwill in his accountancy practice in April 2003.
Background Facts
1.
Mr Wildin
acquired his practice,
Wildin
& Co, in July 1981 as the
result of his resignation as a partner in the accounting practice of Kingscott
Dix and Co. At that time £100,000 of clients were transferred to him, being the
clients of the existing Lydney office of Kingscott Dix. Mr
Wildin
commenced
trading as a sole practitioner with his new firm on 1 July 1981.
2.
Mr Wildin
’s new firm attracted a standard mixture of clients, doing
approximately 58% general accounting work, 30% audit and 12% other types of
accounting work and grew on the basis of Mr
Wildin
’s contacts in the local
area. Clients were billed at the end of their accounting year, which for most
of Mr
Wildin
’s clients was April – June, which were the busy months of the
year. The firm had no particular “niche” clients; its client base was and
remained typical for a small local accountancy practice. At the time of the
transfer of the clients of the Lydney office to Mr
Wildin
, all existing billable
work in progress was billed to the end of June 1981.
3.
Wildin
& Co moved to a new building in the centre of Lydney in
November 1981 which gave an additional impetus to the growth in the business.
Mr
Wildin
estimated that this gave rise to fee increases of approximately 70%.
Wildin
& Co’s fees earned for the year ended June 1982 amounted to £98,498. Mr
Wildin
’s drawings for 1982 were £14,000. As at 30 June 1982 fee notes for
£105,000 had been raised.
4.
Mr Wildin
increased the size and profitability of
Wildin
& Co over
the years and by 2003 the firm had one other partner and approximately 30 staff
members with 1,500 clients. Mr
Wildin
worked long hours, starting at 5am and
finishing at 5pm seven days a week. Mr
Wildin
transferred his share of the
business to
Wildin
& Co (Accountants and Financial Advisers) Limited on 1
April 2003. At that time the goodwill in the practice was valued at £1,650,000
of which Mr
Wildin
’s share was 84.85% following a transfer of 15.15% to his
business partner Mr Lewis shortly before the disposal to the company.
5.
Mr Wildin
’s self assessment return for the 2002 – 2003 tax year stated
that the capital gains arising as the result of his disposal of the goodwill in
Wildin
& Co amounted to £21,505. HMRC made an amendment to this self
assessment on the basis that the correct capital gains tax charge on Mr
Wildin
’s disposal was £230,759. A closure notice was issued by HMRC on 22
April 2010 which Mr
Wildin
appealed against on 26 April 2010. HMRC undertook a
statutory review which confirmed their original decision and notified Mr
Wildin
on 9 July 2010 and Mr
Wildin
appealed to this Tribunal on 3 August 2010.
The issues in dispute
6.
The dispute between the parties centres on the correct method for
valuing the goodwill in Wildin
and Co to establish its base cost under the
deemed disposal rules in March 1982 and its value on actual disposal in April
2003.
7.
The initial matter under appeal concerned only the 1982 valuation of the
goodwill in Wildin
& Co, but as a result of Mr
Wildin
’s request to amend
his grounds of appeal and pursuant to Directions issued on 12 December 2011, Mr
Wildin
also disputed the 2003 valuation of the goodwill in
Wildin
& Co and
HMRC withdrew their earlier agreement to the 2003 valuation of £1.4 million.
8.
It was not disputed that the goodwill of Mr Wildin
’s practice was an
asset for capital gains tax purposes, that the deemed disposal rules applied to
establish its base cost in March 1982 or that it was disposed of by Mr
Wildin
in April 2003 and that the burden of proof lies with Mr
Wildin
to demonstrate
that the assessment made by HMRC is not correct.
9.
The table below sets out the basis on which Mr Wildin
and HMRC have
calculated the capital gains tax on Mr
Wildin
by reference to both the value of
the goodwill in
Wildin
& Co in March 1982 and on disposal in April 2003.
1982 valuation |
Mr |
HMRC |
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Comments |
1982 GRF |
£147,697 |
£108,774 minus net assets |
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1982 multiple |
3.5 |
1 |
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1982 CGT base cost (total) |
£516,940 |
£75,000 |
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1982 CGT base cost |
£438,624 |
£63,638. |
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Mr |
2003 valuation |
Mr |
HMRC |
|
|
2003 GRF |
£1,056,540 |
£833,000 |
|
Weighted average fees per Appellant |
2003 multiple |
1.5 |
0.88 |
|
HMRC’s “whole practice” valuation |
2003 CGT disposal value |
£1.585m |
£740,000 |
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Reflects alteration in position post December 2011 directions. |
Tax Payable |
Mr |
HMRC |
|
|
|
£8,602 on gain of £21,505 |
£83,701 on gain of £230,759 |
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Including other available reliefs. |
The Law
10. The relevant legislation relating to the capital gains tax treatment of goodwill is set out in the Taxation of Chargeable Gains Act 1992 (“TCGA”):
11. S 38 TCGA applies to determine the acquisition and disposal costs of capital assets:
“(1) Except as otherwise expressly provided, the sums allowable as a deduction from the consideration in the computation of the gain accruing to a person on the disposal of an asset shall be restricted to-
(a) the amount or value of the consideration, in money or money’s worth, given by him or on his behalf wholly and exclusively for the acquisition of the asset, together with the incidental costs to him of the acquisition or, if the asset was not acquired by him, any expenditure wholly and exclusively incurred by him in providing the asset,
(b) the amount of any expenditure wholly and exclusively incurred on the asset by him or on his behalf for the purpose of enhancing the value of the asset, being expenditure reflected in the state or nature of the asset at the time of the disposal, and any expenditure wholly and exclusively incurred by him in establishing, preserving or defending his title to, or right over, the asset.
I the incidental costs to him of making the disposal.”
12. S 35(2) TCGA sets out how the base cost of assets held at March 1982 and disposed of after April 1988 is calculated:
“(2) in computing for the purpose of this Act the gain or loss accruing on the disposal it shall be assumed that the asset was on 31st March 1982 sold by the person making the disposal, and immediately reacquired by that person, at its market value on that date”
13. S 272 TCGA provides the meaning of market value for capital gains tax purposes:
(1) “In this Act “market value” in relation to any assets means the price which those assets might reasonably be expected to fetch on a sale in the open market”
This is further clarified by s 273 in respect of unquoted securities:
(1) “The provisions of subsection (3) below shall have effect in any case where in relation to an asset to which this section applies, there falls to be determined by virtue of s 272(1) the price which the asset might reasonably be expected to fetch on a sale in the open market………..
(3) For the purposes of a determination falling within subsection (1) above, it shall be assumed that, in the open market which is postulated for the purposes of that determination, there is available to any prospective purchaser of the asset in question all the information which a prudent prospective purchaser of an asset might reasonably require if he were proposing to purchase it from a willing vendor by private treaty and at arm’s length”
The Evidence
14.
The Tribunal was given witness statements from Mr Wildin
and Mr Smith
for the taxpayer and Mr Roland and Mrs Hennessey for HMRC, all of whom also
gave oral evidence and were cross examined.
15. All parties referred extensively to statements made by Jeremy Kitchin in his website publication “Accountancy Practice Mergers and Acquisitions” (APMA) including that “goodwill represents the difference between the overall business valuation, (arrived at on an on going basis) and the aggregate book value of the individual net assets carried in the balance sheet”.
16.
HMRC and Mr Wildin
provided different interpretations of a number of statements
made by Mr Kitchin on this website.
17. HMRC produced a formula, on the basis of this statement which they said represented the way of establishing the value of goodwill in an accountancy practice, which had to be derived from the “whole practice value” This was set out in two ways depending on the multiple of fees that was known. M1 was the multiple to be used to calculate goodwill and M2 was the multiple to be used to calculate total practice value:
M1 x [Gross Recurring Fees] = Total Practice Value – net assets.
Total Practice Value = [Gross Recurring Fees] x M1 + net assets.
M2 Goodwill = [Gross Recurring Fees] x M2 – net assets
18.
In contrast, Mr Wildin
suggested that goodwill in an accountancy
practice was established simply by applying a multiple to the value of the
firm’s “gross recurring fees”, with no adjustment or reference to the net
assets of the firm. This is effectively the “M1” multiple.
Mr Smith – Expert Witness.
19.
Mr Smith is a senior consultant at Foulger Underwood Associates Limited,
specialist brokers in professional service firms. He stated that his experience
included 50 professional practice sales at Foulger Underwood and 3 partnership
goodwill disputes. Mr Smith confirmed that he had been instructed to look only at
the goodwill valuation of Wildin
& Co.
20. As a preliminary matter in response to questions from Ms McCarthy, Mr Smith agreed to strike out two comments in his witness statement relating to the valuation of goodwill in 1982 and the multiples which were relevant to accountancy practices in 1982. Mr Smith accepted that he had no records going back to 1982.
The 1982 Valuation
21. Mr Smith gave his view of the state of the accountancy market in 1982. At this period accounting firms were generally profitable, mainly because they operated in a less regulated market than subsequently. Mr Smith confirmed that in his experience most accounting firms were valued by reference to their client book; any other assets held by the firm were often of negligible value and were generally not transferred as part of the business. If they were transferred it would be as part of a separate purchase agreement. Mr Smith said that there were key differences in valuing professional services firms and unquoted corporate entities. In response to HMRC proposed method of valuation as set out by Mrs Hennessey he said categorically “I have been involved in accounting market transactions for more than twenty years and have never seen a valuation of goodwill done in the manner carried out by HMRC”. Mr Smith said that in the current market (2014) small professional service firms were being sold on multiples of “Gross Recurring Fees” (the client book) with multiples of 0.9 – 1.5, but in 1982 multiples of 2.0 – 3.0 were not unusual.
22. Mr Smith explained that the profit of a particular accounting firm was not a definitive measure of its value because the same turn over could produce different profits depending how a firm was managed, including how hard each partner worked and how efficiently they used their assets.
23. When questioned by Ms McCarthy Mr Smith agreed with the internal logic of HMRC’s M1 and M2 examples, but stressed that in his view the Jeremy Kitchin statements on the APMA website did not support HMRC’s approach. Mr Smith accepted that HMRC’s approach was an approach to valuing goodwill, but did not accept that it was one which was used in practice or necessarily one which gave the most accurate valuation.
24.
Mr Smith did disagree with Mr Wildin
’s inclusion of his additional work
in progress figures in coming to his goodwill valuation for 1982, which he
thought did amount to double-counting. He said that the correct approach was to
value work in progress by taking the difference between the opening value for
goodwill and its value at the end of the previous accounting period, which he
said gave a work in progress figure of £24,616 for 1982.
The 2003 Valuation
25.
As far as the 2003 valuation of Wildin
& Co was concerned, Mr Smith
had been provided with specific information from Mr
Wildin
from a questionnaire
which he had completed. Mr Smith confirmed that the information which he had
for client figures for 2003 was for audit only clients. Mr Smith said that on
the basis of this information it was clear that
Wildin
and Co had a normal
dispersion of client types, with no special features, no high value clients but
equally no negative issues.
26.
Mr Smith said that the so-called “consolidators” (listed companies which
were financed by external investors to acquire professional firms) were paying
a multiple of between 2.5 and 3.5 of turn-over for target accountancy practices
in 2003. He suggested that in order to establish Wildin
& Co’s goodwill
valuation in 2003 the best method would be to take the weighted average of fees
for the past three years and apply a multiple of between 1.00 and 2.00 to that
average.
27.
In Mr Smith’s view Wildin
& Co’s goodwill should be valued by
applying a multiple of 1.5 to the firm’s average turn-over, reflecting the “up-surging
market” in 2003, which would give a goodwill valuation of around £1,585,000 for
Wildin
& Co. Mr Smith cast doubt on the reliability of the publicly
available information about the pricing of accountancy firms in 2003 on which
HMRC relied.
Mr Roland – HMRC witness of fact.
28. Mr Roland is a team leader in HMRC’s “Charities, Assets and Residence, Shares and Assets Valuation” (SAV) group. He has 20 years experience in SAV and 15 years experience in the valuation of goodwill.
29. Mr Roland said that in his experience most accountancy practices were valued in the basis of goodwill by reference to gross recurring fees. Mr Roland referred to the ACCA Technical Factsheet 87 which states that accountancy practices are valued at multiples of between 75% and 150% of gross recurring fees.
30. He explained that he is the keeper of SAV database for HMRC, but that this is not a complete database; 50% of cases considered did not have complete records. The SAV database covers the period from 1980 to 2010 comprising 621 cases, of which complete records exist for 309. He said that approximately 10 valuations were done per year but that the database was “not as comprehensive as he would like”.
31.
Mr Roland explained that the SAV database provided evidence from the
records which were complete that for the 1982 – 2010 period the most common
multiple applied in valuing goodwill was 1 – 1.5, with the dispersion for 1982 itself
being very similar. The SAV database did provide evidence of some multiples of up
to 2 for 1982, but no higher. Mr Roland agreed with Mr Wildin
that the HMRC
database was giving a potentially misleading picture since in all but 16% of
cases the goodwill valuations had not been negotiated since there was no tax at
stake; therefore neither party had an interest in accurately valuing the
goodwill.
32. Mr Roland said that in the handful of accounting valuations he had seen, the valuation was usually based on gross recurring fees times a multiple (or by reference to turn-over) but that net asset value was not usually significant.
33. Mr Roland referred to HMRC guidance about how goodwill should be treated for tax purposes as set out in Mrs Hennessey’s witness statements, which is an extract from a book by Chris Glover which states that goodwill cannot be sold alone, but always attaches to a business.
Mrs Hennessey Evidence – Expert witness
34.
Mrs Hennessey is a partner in Lane, Clark and Peacock LLP. Her
experience includes valuing a wide range of businesses, and she explained that
she applied common principles in valuing Wildin
& Co. She believed that the
approach to valuation should be the same in all cases. Under questioning from
Mr
Wildin
, Mrs Hennessey accepted that her experience in valuing accountancy
practices was limited to 1-2 accounting practices, including her own. She has
also acted on deferred consideration disputes.
35. Mrs Hennessey explained her approach to valuing goodwill, namely that goodwill is more than fees but includes other intangible assets (such as brand name, staff and contracts) and everything used for attracting clients. She accepted that it is possible in theory to sell blocks of fees, but did not accept that this was the correct starting point for the valuation of an accountancy practice. Mrs Hennessey’s interpretation of Jeremy Kitchin’s valuation guidance on the APMA website was that it is applying a multiple of fees to determine total practice value, from which net assets need to be deducted.
36.
For her 1982 valuation of Wildin
& Co, her approach had been to
apply a multiple of 1 to gross recurring fees as at June 1982, to come to a
value of the whole practice and then deduct net asset value to come to a value
of goodwill. In terms of HMRC’s formula described as M1 and M2, Mrs Hennessey
accepted that when attempting to use the M2 formula, there is no concrete
evidence to find M2.
37.
Mrs Hennessy explained the basis on which she had established Wildin
& Co’s goodwill value for 1982. She said that at that time the practice had
only been established for nine months and its actual revenues were uncertain.
While it had attracted new clients, in March 1982 no work would have actually
been started for many of those new clients. Moreover the new firm was
completely dependant on Mr
Wildin
and would be at significant risk if he left
soon after a purchase of the business. The practice had made a loss for the
year to June 1982 (or a very small profit if allowance was made for equipment
leasing costs). As at June 1982 Mr
Wildin
’s drawings were £14,091, the firm’s
net assets were £37,059 and the firm had fee income of £98,498 with debtors of
£51,565, with no real evidence of the growth potential in its client base.
38.
The valuation was required to be done on the basis of the information
available as at March 1982. The firm’s 1983 turn over and 1982 work in progress
were irrelevant and, contrary to Mr Wildin
’s contentions, it is not permissible
to look at future information. She looked at the June 1982 accounts figures
only. In coming to her work in progress she had assumed that work in progress
amounted to 3 weeks’ turn over being £5,000. She did not accept that much if
any value could be put on new clients at this stage; it was necessary to take
account of new clients and clients at risk of not being retained.
39.
Mrs Hennessey also referred to wider economic indicators of the state of
the economy in 1982 including 13% interest rates, 2.7 million unemployed and a generally
depressed market. On the basis of her valuation the price earnings ratio of
Wildin
& Co would be 10.8, which seemed very high compared to the FTSE
price earnings ratio for the same period for listed companies of only 9.7.
Therefore she considered that a valuation of even £75,000 was generous.
40.
For all of these reasons Mrs Hennessey had concluded that an open market
value of no more than £75,000 was a reasonable valuation for the goodwill in
Wildin
& Co, on the assumption that Mr
Wildin
stayed with the firm for at
least a year after it was purchased. (Derived from gross recurring fees of £108,000
plus £5,000 work in progress, minus net assets of £39,000).
The 2003 Valuation
41.
As far as the valuation in 2003 was concerned, Mrs Hennessey had looked
at market comparables and the publicly available pricing information from the
activities of the “consolidators” at this time and had concentrated on the
valuation of a practice called H&L Bloom based in Glasgow in particular,
because she considered this was a very similar firm to Wildin
& Co. From
Mrs Hennessey’s view of the market at this time a multiple of 2.5 was the maximum
which anyone would be prepared to pay for an accounting practice.
42. In deriving the value for the accounting practice in 2003 Mrs Hennessey’s approach entailed looking at the total price paid for whole practice, including net assets and then deducting net assets to give a value for goodwill. Mrs Hennessey accepted that the value of goodwill for the comparable market transactions which she looked at was not publicly available.
43.
Her 2003 valuation was based on Wildin
& Co’s turn-over for the year
to 30 June 2002 of £1,003,828, to which she applied a “whole practice” multiple
of 0.88 giving a figure rounded to £883,000 and then deducted net assets, which
she valued at £139,032, giving a 2003 goodwill valuation of £743,968 rounded
to £740,000.
The Appellant’s arguments
The 1982 Valuation
44.
Mr Wildin
’s starting point was that no expert evidence existed relating
to 1982 valuations for this or any other accountancy practice. He explained the
attempts which he had made to obtain third party evidence about valuations and
multiples going back twenty five years, including conversations with
practitioners who he knew were involved in the market at that time. Nevertheless,
Mr
Wildin
said that he had experience of valuing accounting practices,
including his own and provided evidence from conversations he had had with
other practitioners who had been in the market in 1982.
45.
The core of Mr Wildin
’s case is that, contrary to what is said by HMRC,
the correct basis for the valuation of the goodwill in an accountancy practice
such as
Wildin
& Co is by reference to gross recurring fees to which a
multiple is applied; buying an accounting practice is essentially buying a
block of fees and cannot be compared to a standard corporate acquisition.
46.
There is no basis on which net asset value should be included in the
calculation of how a professional services firm should be valued. Mr Wildin
was clear that it is possible to buy a “client book” (as made clear by adverts
for sales of accountancy practices in 1982 to which he referred us) and indeed
this is how accounting practices were then and are still sold.
47.
Mr Wildin
gave his interpretation of third party commentators’ statements
about the valuation of accounting practices and the Jeremy Kitchin statements in
particular. He stressed that in his view it was not normal to deduct net assets
in valuing accountancy practices. Mr
Wildin
disagreed with the interpretation
of Jeremy Kitchin’s statements which suggested that the value of goodwill
differed depending whether the whole business was being bought compared with a
block of fees. Mr
Wildin
had entered into correspondence directly with Mr
Kitchin in which he had confirmed that taking a multiple of gross recurring
fees is the normal method of valuation of an accountancy practice.
48.
In Mr Wildin
’s view, the best starting point for estimating the 1982
value of his client book was the June 1983 accounts of
Wildin
& Co, because
these most accurately reflected work which was still to be billed at March 1982
and which would have made up the gross recurring fees for 1982, including for
example the work billed for a significant new client, Gullivers, for whom work
had only just commenced in March 1982.
49.
Mr Wildin
also explained that work in progress needed to be included as an
addition to 1982 figures. This was not double counting and reflected clients as
at March 1982 (amounting to £74,000).
50.
As regards the appropriate multiple which should be applied to this
gross recurring fee figure, Mr Wildin
’s view was that the multiple should be 3
(plus 0.5 for work in progress), on the basis of the booming market in 1982,
adverts from selling brokers in 1982 and his letters to Lloyds bank at that time.
Mr
Wildin
produced copies of a number of brokers’ adverts from the accountancy
press in March 1982 which referred to “clients looking for up to three times
gross recurring fees” and to letters which he had written to Lloyds bank
seeking a loan in October 1981 and October 1983 in which he valued the firm’s
clients at “the very least £500,000”. He also referred to the multiple which
had been applied by his old firm, Kingscott Dix, when they acquired a small block
of fees in 1979, which was a multiple of 3.
51.
In relation to the multiples suggested by HMRC relying on the SAV
database, Mr Wildin
pointed out that these were skewed because they covered a
large number of cases in which no tax was actually payable and therefore the
accuracy of the goodwill valuation was not important.
The 2003 Valuation.
52.
In Mr Wildin
’s view any valuation method which was used in 2003 should
be consistent with the method used in 1982. That method should be based on the
value of the current book of client fees which is the equivalent of the value
of the good will in the practice.
53.
In finding that valuation for 2003, HMRC should take the valuation of
the goodwill reflected by a proposed fee transfer agreement of 2003, in which
20% of Wildin
& Co’s fees were to be sold for £240,000, giving a total
valuation of £1.65 million although this fee transfer did not ultimately take
place. Mr
Wildin
cast doubt on whether the comparative deals relied on by Mrs
Hennessy, particularly the H&L Bloom disposal was sufficiently similar to
his firm to provide a proper market comparison;
Wildin
& Co was not sold
for cash or in a “consolidator” type deal.
54.
In Mr Wildin
’s view the correct multiple for 2003 was 1.5 on the basis
of his market knowledge and the fact that
Wildin
& Co was a firm with no
historic issues and which would have been attractive to a purchaser in the up-surging
market in 2003.
55.
In response to HMRC’s witness evidence Mr Wildin
cast doubt on Mrs
Hennessey’s expertise in valuing accountancy practices, as opposed to other
company valuations and also objected to HMRC withdrawing their previous agreement
that the correct 2003 goodwill valuation was £1.4 million for Mr
Wildin
’s
84.85% share of the goodwill.
HMRC’s arguments.
56.
For HMRC Ms McCarthy argued that goodwill should be valued by taking
Wildin
& Co’s gross recurring fees x a multiple minus net assets. This is
a “whole practice” valuation. The valuation must be done only by reference to
information available at the time and making realistic assumptions about the
approach of the seller and purchaser as made clear in IRC v Gray “one
assumes that the hypothetical vendor and purchaser did whatever reasonable
people buying and selling such property would be likely to have done in real
life” ([1994] STC 360)
57. In ascertaining the “whole practice” valuation, net assets have to be taken account of. If the practice multiple is known (the M2 formula), in order to ascertain goodwill, net assets have to be deducted. If the goodwill multiple is known (the M1formula), in order to ascertain the whole practice value net assets need to be added to M1. All of the secondary sources cited (including Jeremy Kitchin) are referring to multiples which are being applied to M2, not M1 and are attempting to derive the “whole practice” valuation, therefore the value of net assets needs to be deducted after this multiple has been applied. The value of net assets does have an impact on the value of a firm’s goodwill, according to HMRC “all other things being equal, a business with larger net assets will have a lower value of goodwill than a business with a smaller value for net assets”.
1982 Valuation
58.
In HMRC’s view, the correct multiple to be applied to the gross
recurring fees of the Wildin
practice in 1982 was a multiple of 1, taking
account of the nature of the practice and the state of the wider UK economy at that time, as explained by Mrs Hennessey. Moreover that multiple should be
applied to
Wildin
& Co’s June 1982 fees, that being the best available
evidence at the time. There was no basis on which it was possible to use later
information in coming to this valuation, particularly the 1983 figures as
suggested by Mr
Wildin
. HMRC said that in 1982, when
Wildin
& Co was a
relatively new firm, there was no evidence that fees would increase as
suggested by Mr
Wildin
as the fee levels in 1982 could have been a “bubble”
which was not sustained. That fee level was in part a result of the long hours
worked by Mr
Wildin
, which would not necessarily be replicated by a purchaser.
59.
HMRC pointed out that there was no third party evidence for a multiple
of 3 in 1982. The only evidence of this was either from brokers in the market
who had an incentive to inflate sales multiples and Mr Wildin
’s own
correspondence with his bank. A multiple of 3 was unjustifiably high, giving a
valuation of the practice of £516,940, equal to 37 times Mr
Wildin
’s drawings
of £14,000. This was not credible during a period of recession such as 1982. In
their view a more appropriate multiple is in the range of 1 – 1.25, as
suggested by Mrs Hennessey. A multiple of 1 was a ballpark figure for the early
1980s and there were no special features of
Wildin
& Co at this stage in
particular to support a premium above that multiple.
60. In HMRC’s view the best evidence for the correct multiple for 1982 can be derived from the SAV database referred to by Mr Roland and an article of August 1982 in the Accountants’ Magazine by R A Scott which supported a multiple of 1. Equally the APMA website referred to a thirty year period of valuations none of which supported a valuation based on a multiple higher than 1. HMRC had also entered into correspondence with Mr Kitchin in October 2007 in which he had confirmed his view that a valuation based on a multiple of 1 – 1.25 was a reasonable multiple for this period.
61.
The multiple should be applied to Wildin
and Co’s turn-over as recorded
in the year end accounts for June 1982, which was £108,774 and which was the
best contemporaneous evidence which could be used to ascertain the correct
level of turn over. HMRC said that they were no longer bound by their statement
to Mr
Wildin
in their letter of 5 January 2006 in which they had accepted a
gross recurring fee figure of £147,697 for 1982, since this agreement had been
withdrawn by their letter of 27 July 2007.
62.
The best 1982 valuation for the goodwill in Wildin
& Co was £75,000,
taking £108,000 as the firm’s gross recurring fees, adding work in progress,
applying a multiple of 1 and then deducting net assets of £37,000.
2003 Valuation
63.
HMRC explained their position about their withdrawal of their proposed
settlement of Mr Wildin
’s 2003 valuation figures and referred to their letter
of 27 July 2007. They viewed the offer which had previously been made to Mr
Wildin
as predicated on the basis that all other aspects of the dispute were
agreed. Since this was not the case, their letter of 27 July 2007 overrode any
previous agreements about the 2003 goodwill value, which had effectively been a
conditional offer whose conditions had not been met.
64.
HMRC stated that a similar approach to valuation should be taken in 2003
as for 1982 and that the valuation starting point was the “whole practice” to
which a multiple of 0.88 should be applied. That multiple was derived from the
evidence of valuations in the market provided by Mrs Hennessey and the
activities of the so called consolidators in particular. The H&L Bloom
consolidator sale was a close comparison for Mr Wildin
’s business and was
aligned with other third party evidence including the ACCA Technical Factsheet
87 referred to by Mr Roland and the APMA website.
Discussion
Findings of Fact
65. On the basis of the oral and written evidence provided to the Tribunal we make the following findings of fact;
66. It was common practice to value accountancy firms by reference to a multiple of fees or by reference to their “client book” both in 1982 and 2003, although other methods of valuing businesses prevailed elsewhere.
67.
Mr Wildin
’s accountancy practice was a standard small local practice
with no niche clients or other special features. The success of the firm was
dependent on Mr
Wildin
’s own local contacts and his work ethic.
68. While the accountancy market was relatively healthy in 1982, the UK economy was in recession.
Goodwill in accountancy practices.
69. There is no specific definition of goodwill in the capital gains tax legislation and case authorities make it clear that goodwill cannot be defined the same way for all types of businesses: it is not “one size fits all”, as was stated by McNaughten in the Muller decision (IRC v Muller & Co Margarine Ltd [1901] AC 217) “it differs in its composition in different trades and in different businesses in the same trade”, which is an approach reflected in 2006 in the Balloon decision which was cited to us (Balloon Promotions Limited v Wilson [2006] STC (SCD) 167). HMRC stressed that goodwill must be attached to a business and that is clearly a correct statement, and is derived from HMRC’s own guidance coming itself from the work by Chris Glover. However the Tribunal considers that this is more a statement of the legal and commercial aspects of goodwill and not necessarily an indication of how it should always be valued.
70.
The Tribunal has approached this question of valuation on the basis that
it is an art not a science; the Tribunal’s job is to ascertain the best method
for valuing goodwill for this taxpayer on these facts and on the basis that no
method will provide a perfect answer. The evidence from Mrs Hennessey, Mr
Roland and Mr Smith made clear to us that there were a number of different
methods for valuing goodwill and that the critical question was, of those
methods, which gives the most accurate valuation of a business like Mr
Wildin
’s.
71.
We took from the oral evidence provided to us from Mr Wildin
, Mr Smith
and Mrs Hennessey and the secondary sources to which they referred that while
there is a general commercial approach to valuing goodwill for standard
businesses, there is a different approach which is usually applied to professional
services firms. Our conclusions from this evidence, including in particular
the approach of Jeremy Kitchin in the APMA website referred to, is that in
practice goodwill is ascertained in a particular way for professional services
firms, reflecting the different value structure of these businesses. For these
businesses goodwill is not “everything else which is not net assets”, it is the
business. To quote from the Kitchin website “In the case of professional
partnerships in general, and accounting practices in particular, a different
valuation convention can generally be adopted. A methodology involving a
multiple of turn over is normally adopted which, in so far as it is not
expressed as a multiple of profit, appears initially to be quite distinct from
that used in commercial businesses….”
72.
On that basis we considered the two formulae suggested by HMRC and their
assertion that it is necessary to derive goodwill from a “whole practice
valuation” – the so called M2 approach, taking fee income times a multiple then
deducting net assets and the so called M1 approach which starts from a multiple
of gross recurring fees and adds the value of net assets to find the value of
the whole practice. The question for the Tribunal is whether this “whole
practice” approach to goodwill valuation is a better approach than the approach
suggested by Mr Wildin
which equates goodwill with a straightforward multiple
of gross recurring fees.
73. Mr Smith said, when pushed by Ms McCarthy that HMRC’s “whole practice method” was “a method” but that is not to say that it is the best approximation of goodwill for this market. Mr Roland said that from his experience the normal practice was to value goodwill on the basis of gross recurring fees or turn-over. Mrs Hennessey agreed that in using the M2 method it was necessary to rely on an unknown element to determine the value of the goodwill itself.
74. The Tribunal has concluded that it cannot be correct that the value of a professional firm’s net assets should affect its overall goodwill value. The Tribunal disagrees with HMRC’s assertion that there is any necessary link between the net assets of a professional firm and the value of its goodwill. Indeed it is clear that deducting net assets to find the goodwill value can result in anomalies, particularly where freehold properties are involved or where practices have different approaches to profit retention. Taking “client book” as proxy for value of goodwill is a reasonable method of arriving at a goodwill valuation for capital gains tax purposes for professional firms. This is in our view supported by the Jeremy Kitchin APMA information and by Mr Roland’s evidence about what was commonly done in practice.
75.
For these reasons we have concluded that valuing goodwill on the basis
of a multiple of gross recurring fees is a more accurate method of valuing
professional firms including small accountancy practices like Wildin
& Co
and that this is the method which should be adopted for tax purposes for
Wildin
& Co’s goodwill valuation in 1982 and 2003.
1982 Valuation – the Multiple
76.
Having concluded that a multiple of gross recurring fees gives the most
accurate approach to the valuation of Wildin
& Co’s goodwill, the next
question is what multiple should be applied to the “client book”. The multiple
as applied here is an approximation of market value. In estimating open market
value the capital gains tax legislation and authorities direct us to make
certain assumptions and to assume reasonable people operating in a real market,
who would have done due diligence and understand the local market (and
Wildin
& Co’s place in it). On this basis, a willing buyer would have been aware
of both the positive and negative aspects of the
Wildin
practice, including its
reliance on Mr
Wildin
as the main source of new clients and the current state
of the accountancy market.
77.
We were provided with detailed evidence of the market at this time from
Mr Smith, Mr Wildin
and Mrs Hennessey, but on this point we agree with HMRC
that we were not given any independent third party evidence that a multiple of
3 was reasonable for Mr
Wildin
’s practice at this time. We were provided with some
evidence (including HMRC’s SAV database) for multiples up to 2 and that the
average multiple for 1982 was 1 – 1.5. Over and above this, we cannot see any
reason why
Wildin
& Co should attract a particular premium. The evidence,
including Mr
Wildin
’s own statements, suggested this was a fairly normal
accounting practice. If it did attract a premium, that was as a result of Mr
Wildin
himself and his personal contacts, which as Mrs Hennessey pointed out,
might not be an asset which the business retained for very long if it was sold.
78.
The Tribunal has taken the relatively limited evidence available from
1982 and placed reliance in particular on the information from the SAV
database, as the best available independent evidence, to determine a reasonable
range for the multiple to be applied to Wildin
& Co’s goodwill in 1982. We
have assumed that while Mr
Wildin
’s practice was successful, and so might have
commanded a multiple at the top of the SAV database range, there were
nevertheless some risks in his business, including the retention of some newly
acquired clients. For these reasons the Tribunal has concluded that a
reasonable multiple for Mr
Wildin
’s practice in 1982 is in the range of 1.5 –
1.75.
79.
Having established a range for the multiple to be applied, we need to
clarify the correct fee figure for applying that multiple for 1982. We take
HMRC’s point that the 1982 valuation has to be based on the best available contemporary
evidence. In deciding what this best available evidence is we have taken account
of (i) the fact that all pre-July 1981 work in progress was excluded prior to the
sale to Mr Wildin
(ii) that Mr
Wildin
’s clients were billed annually with a peak
from April to June (iii) that Mr
Wildin
took in new clients during quarter 3
and 4 of 1981 who had had work done but not billed until quarter 3 of 1982 (e.g.
their new client, Gullivers). Mrs Hennessey for HMRC did accept that one could
take account of new clients at this stage if there was some evidence that they
would remain with the firm.
80.
Therefore we agree with Mr Wildin
that the 1983 year end numbers give the
best available estimate of 1982 turn over and we do take notice that HMRC did
also at one point accept this as a reasonable starting point. However on this
basis we do not think that it is correct to include, as Mr
Wildin
attempted to
persuade us, any additional work in progress for 1982. (Represented by Mr
Wildin
’s 0.5 additional multiple). Our conclusion at this point on the
calculation of the base cost of
Wildin
& Co’s goodwill in March 1982 is that
it is in the range of £147,697 x 1.5 and £147,697 x 1.75.
81. HMRC suggested that if the Tribunal concluded that the correct multiple was in a range which resulted in a range of valuations which did not include either the Taxpayer’s or HMRC’s suggested valuations, the Tribunal should take the mid-point of their suggested range as the most reasonable valuation to apply. On that basis we are applying a multiple of 1.625 for the purposes of the 1983 goodwill valuation.
2003 Valuation
82.
We have accepted that as a result of the Directions issued by this
Tribunal in December 2011 and HMRC’s statements before this Tribunal the 2003
valuation of the goodwill in Mr Wildin
’s practice is in dispute. We can see no
reason for adopting an approach to goodwill valuation in 2003 which is
different from the approach which we have set out above for the 1982 valuation.
This means that for 2003 we have concluded that the gross recurring fees of
Wildin
& Co should be the starting point for the 2003 valuation as for
1982, to which the relevant multiple should be applied. As a result of
accounting rule changes between 1982 and 2003, there is no longer any question
of whether work in progress needs to be added to these figures since accounting
rules require it to be included in
Wildin
& Co’s turn-over for tax purposes.
83.
In applying this approach to Wildin
& Co’s gross recurring fees in
2003 it is necessary to establish what the correct multiple is by this date. Mr
Wildin
relied on the valuation from a proposed sale of a block of fees to a
third party to suggest a multiple of 1.5 which HMRC considered to be high, but
HMRC had previously accepted £1.4 million (implying a multiple of 1.5) as a
reasonable 2003 valuation. Mr Smith referred to his firm’s experience of private
sales, the buoyancy in the market in 2003 and the impact of the “consolidators”
to suggest that a range of 1 – 2 was a reasonable multiple for this time.
84. HMRC’s alternative multiples came from Mrs Hennessey’s information from the “consolidators” (and the sale of the H&L Bloom practice in Glasgow in particular). Mr Smith suggested that this was a “partial” view of the market, with the consolidators not being representative of the prices which were being applied elsewhere. Relying on these figures HMRC suggested that a multiple of 0.88 should be applied to the “whole practice” in 2003. Mrs Hennessey accepted that she would apply a different multiple if considering client book only.
85.
We have concluded from the evidence provided to us in respect of 2003 that
it is not clear that Mrs Hennessey’s comparison with the consolidator market
price and the H&L Bloom sale is necessarily an accurate way of pricing
Wildin
& Co and that Mr Smith’s evidence concerning the wider accounting
market in 2003 is to be preferred. Taking Mr Smith’s suggestion of a range of 1
-2 as a multiple for this period, we have concluded that 1.5 is a reasonable
multiple to apply to the
Wildin
& Co practice. This is also in line with
the information from the SAV database and the figure previously accepted by
HMRC for the 2003 valuation.
86.
There is one further point to clarify in coming to the 2003 valuation
which is the correct turn-over for applying the multiple in 2003. Mrs
Hennessey’s starting point was Wildin
& Co’s turn over for the previous
year (£1,003,828). Mr Smith took a three-year average of
Wildin
& Co’s turn-over,
giving him £1,056,540.
87.
As between Mr Smith and Mrs Hennessey we have concluded that Mr Smith’s
approach of taking a three year average turn over provides the best approximation
for the 2003 fee valuation and we have therefore concluded that a multiple of 1.5
should be applied to this £1,056,540 valuation to give a valuation of Wildin
& Co’s goodwill at the time of disposal in April 2003.
Conclusion:
88.
For the reasons set out above the Tribunal has concluded that the base
cost for capital gains tax purposes of Mr Wildin
’s share in the goodwill of
Wildin
& Co at March 1982 should be calculated by applying a multiple of 1.625
to
Wildin
& Co’s gross recurring fees as at June 1983 of £147,697, giving a
base cost of £240,008.
89.
The disposal value of Mr Wildin
’s share of the goodwill of
Wildin
&
Co in 2003 should be valued on the same basis, applying a multiple of 1.5 to
the gross recurring fees of £1,056,540 in 2003 giving a disposal value of £1,584,810
and a resulting gain of £1,344,802 chargeable to capital gains tax, of which £1,141,064
represents Mr
Wildin
’s 84.85% share in the business, subject to any available
reliefs.
90.
Mr Wildin
’s original appeal to this Tribunal included an application to
strike out HMRC’s case under Rule 8 of the Tribunal Procedure (First-tier
Tribunal) (Tax Chamber) Rules 2009 (the Tribunal Rules). Mr
Wildin confirmed
to the Tribunal at the end of the hearing that he was withdrawing this strike
out application.
Costs
91. Both parties reserved the right to make applications for costs in the proceedings depending on the outcome of the case. This case was categorised as a standard case and therefore costs can only be awarded under Rule 10 of the Tribunal Rules if a party has acted unreasonably in bringing, defending or conducting the proceedings. In the light of this decision, the Tribunal does not consider that either party has grounds for making a claim for costs.
92. This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First– tier Tribunal) (Tax Chamber) Rules 2009. The application must be received by this Tribunal not later than 56 days after this decision is sent to that party. The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.
RACHEL SHORT