A recent case has highlighted the importance of allocating the purchase price on a business transfer between the different assets transferred.  

The case

The Mertrux case concerned the sale of a Mercedes dealership. Under Mertrux’s dealership agreement with Daimler-Chrysler (UK) Ltd, Mertrux was entitled to a territory release payment in the event that it was taken over by a new dealer or required to surrender its dealership to Daimler-Chrysler. The payment was to reflect the exclusive territorial sales rights that would be given up by Mertrux in those scenarios.

Mertrux transferred its dealership to a new dealer and received an overall payment of £1.7m. Daimler-Chrysler appointed the transferee an authorised dealer.

Mertrux took the view that the whole of the gain arising on the disposal was a gain on the sale of goodwill (the case related to a time before the new tax rules on intangibles). HMRC argued that 50% of the gain was referable to Mertrux agreeing to the early termination of its exclusivity rights.

This mattered because, if HMRC were correct, only 50% of the gain was eligible for capital gains tax rollover relief.

The Upper Tribunal, in its 14 August 2012 judgment, has allowed HMRC’s appeal (overturning the decision of the First-Tier Tribunal). The Upper Tribunal found that it was necessary to consider what Mertrux was doing for the payment received (not just what the buyer thought it was paying for).

The Tribunal placed emphasis on what the contracts provided, rather than simply what the tax computations said.

The implications

The allocation of purchase price to assets can materially alter the tax profile of the deal done, for both parties. In this case, as rollover relief could only apply to a gain on the disposal of goodwill and would not apply to the gain on a termination of the exclusivity right, the judgment means that (subject to any appeal) half of the overall gain comes into charge to tax rather than being rolled over into other assets.

It is important to get your tax advisers involved at an early stage of a business sale or acquisition. The legal documentation should reflect the agreed tax position between the parties in order to provide contemporaneous evidence.

Specifically, franchised businesses should think carefully about what the purchase price properly relates to in a case where the arrangements involve terminations of exclusivity rights.