| Gordon Brown | ||||||
April’s budget proposals from UK finance minister Gordon Brown contained a few little noticed but significant measures that might benefit UK companies, notably the proposal to make purchases of intangible assets, including goodwill, tax deductible bringing the UK into line with the US.
Currently the amortization of these items is not tax deductible. This penalizes firms with large amounts on the balance sheet for goodwill and intangible asset amortization, as they have to declare the deduction from reported income without benefiting from a corresponding deduction from taxable income. The effect is that a company gets tax relief on goodwill purchases year on year, although it is subject to a tax hit when the goodwill is sold and its amortization reversed.
However, there is a crucial difference between what will happen in the UK compared to other countries that allow tax deduction of goodwill, including the US. The tax treatment of goodwill will follow the accounting treatment, and the accounting standards in the UK give companies a lot of scope to define their own policies for the recognition and amortization of goodwill and intangible assets.
Chris Atwood of Ernst&Young’s corporate finance tax group says: “This tax change makes acquisitions more attractive and could influence company strategy. Indeed, it could encourage companies to focus on their core activities and sell parts of the business that don’t fit. What the change will really do is to widen the market for purchasers.”
Predictably, the Inland Revenue disagrees saying the change merely removes a distortion. Currently it is more tax advantageous for businesses to grow organically than by acquisition. “We do not want the tax system to affect and distort investment decisions,” says a spokesperson. “All we are doing is taking away a negative subsidy. It has not been our intention to give some artificial stimulus.”
But as Robert Turnbull, a partner at KPMG in M&A tax, notes, this is no easy matter. “It is almost impossible to conceive of removing one distortion without creating another,” he says.
John Kellas of KPMG agrees: “Tax relief or the lack of tax relief makes a material difference to businesses so that when a new tax relief reduces the cost of the acquisition process, not only are businesses more likely to make acquisitions than previously, but also they will be happier to pay more for the advice connected with that acquisition.”
Certainly advisers are likely to promote the fact that their services are now tax-deductible. But they will also need to focus on how to strike the most tax-efficient acquisition deal for their client.
Goodwill is defined as an asset, so the tax relief will only apply when a company purchases another’s assets, not its shares. “Asset-driven deals are rarer than share deals,” says Turnbull, “not least because they provide many complicated issues to deal with. It sounds as if those in the industry will have to work harder for their higher fees.
There is one particular part of the economy for which the tax change will be extremely significant: private equity. As Ernst&Young’s Atwood points out: “It is good to get tax relief on costs, but then they need to be written off in the P&L account, rather than being added to the cost of investment. This means that it hits the earnings per share figure,” he continues. “But for private-equity companies there is no downside, because the earnings per share figure does not matter unless you are a quoted company. For them there is only the upside of better cashflow.”
