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Pickles - Credit available for drawing from directors' loan accounts not taxable as distributions

15 July 2020.

In Pickles v HMRC [2020] UKFTT 00195 (TC), the First-tier Tribunal (FTT) held that excessive consideration for goodwill left outstanding on directors' loan accounts was not taxable under section 1020, Corporation Tax Act 2010 (CTA), as distributions.


Mr and Mrs Pickles (the taxpayers) carried on a business in partnership known as Holmes Farm Produce, which processed and graded potatoes.  

By an agreement dated 27 March 2011, the business and all its assets were sold by the taxpayers to a related party, Holme Farm Produce Ltd (HFPL), with effect from 1 May 2011. 

It was not disputed that HFPL was a company established for the purpose of incorporating the partnership and neither was it disputed that the incorporation was driven by commercial considerations. 

The sum of £1,199,043 was attributed to goodwill on the sale of the business, and this was credited to the directors' loan accounts.   The taxpayers did not declare a capital gain on the sale of the goodwill in their tax returns for the year ended 5 April 2012.  

HMRC opened an enquiry, and issued closure notices under section 28A, Taxes Management Act 1970, based on a then agreed goodwill value of £450,000.  The balance of £749,043 was assessed to income tax as a distribution.  

HFPL entered in to administration in July 2014, and was dissolved in October 2015, with £427,180 outstanding on the directors' loan accounts (the balance of £771,863 having been repaid).  

The taxpayers appealed against the amendments made by the closure notices.

Relevant law

Sales to connected parties otherwise than by way of an arm's-length bargain are treated as being made for market value consideration (sections 17 and 18, Taxation of Chargeable Gains Act 1992 (TCGA)).  Section 272(1), TCGA, provides that 'market value' means the price which assets might reasonably be expected to fetch on a sale in the open market.

Section 1020,  CTA, when read together with section 1000(1)(G), CTA, provides that if, on a transfer of assets or liabilities by a company to its members, or to a company by its members, the amount or value of the benefit received by a member exceeds the amount or value of any new consideration given by the member, that amount is treated as a distribution.  

FTT decision

The appeal was allowed in part.

As a preliminary issue, the FTT had to determine whether the taxpayers' representative, who had submitted what was intended to be expert evidence, could be both advocate and expert. The FTT concluded that on the facts, the issue did not arise since the FTT did not consider that the expert report which the representative had submitted qualified as such, since it lacked both a statement of truth and a statement that he understood and had complied with his duty to the FTT, both of which are requirements of a valid expert's report.  

The appeal raised two substantive issues.

The valuation issue

The first related to the valuation of the goodwill component of the sale proceeds.  It was common ground that the sale was to a connected party and was therefore to be treated as having been made for market value consideration (sections 17 and 18, TCGA).  HMRC's expert had proposed a valuation which took account of the need for the seller to hire additional staff to replace the taxpayers.  In light of the turnover of the business and the fact that they paid their accountants a fee of only £7,413 for the relevant year (which, in the view of the FTT, would be insufficient to provide a 'finance director' role), the FTT agreed with HMRC that an arm's-length purchaser would have needed to hire a managing director and a finance director to fill the gaps in the management team left by the departure of the taxpayers, which lowered the value properly attributable to the goodwill from that previously agreed.   

The FTT also agreed that the valuation multiple adopted by HMRC's expert was not too low for a business whose success depended on the weather and commodity prices.  The FTT agreed with HMRC's expert, who had valued the goodwill at £270,200.

The distribution issue

The FTT then considered the distribution issue.  HMRC had argued that insofar as the taxpayers received consideration for goodwill in excess of its market value, a charge to income tax arose under section 1020, CTA.  It claimed that the entire amount credited to the directors' loan accounts (£1,199,043) was consideration for goodwill and the FTT agreed.  However, in the view of the FTT, it did not follow that simply because the sum payable for the goodwill was fixed at this sum, any difference between this sum and the goodwill's market value fell to be taxed under section 1020.  

The FTT considered that the distribution was the value of the benefit received that exceeded the value of the consideration given by the member on a transfer of assets.  The consideration given in the instant case was £270,200 (represented by the goodwill transferred by the taxpayers to the company).  By creating the loan account, a liability (and not an asset) had been created by the company and there was therefore no transfer of assets.  The difference of £501,663 between the value of the debt that had been paid (£771,863) and the value of the goodwill (£270,200) was a benefit received by the taxpayers and constituted a distribution and was, accordingly, taxable.  The appeal was therefore allowed in part. The FTT did not determine figures but the closure notice assessments were to be reduced so that the taxpayers paid income tax (less any dividend tax credit that might be due) on the sum of £501,663. 

Interestingly, the FTT was unable to reach a unanimous view.  The dissenting member agreed that the open market value of the goodwill was £270,200, and that the amount agreed to be paid as consideration by HFPL to the taxpayers for the goodwill was £1,199,043.  However, she was overruled in her view that there had been no attempt to allocate any payment to the directors to the debt due for the goodwill (in that the loan accounts had been used effectively as current accounts by the directors), and it was not possible to identify any individual payment as a distribution for the purposes of section 1000, CTA.  She considered that the amount of any distribution had to be set at the difference between the market value of the goodwill and the £1,199,043 agreed to be paid for it.  


The fact that the FTT was unable to agree on the outcome of this appeal is indicative of the complexity of the law in this area. Indeed, the FTT commented that, in relation to the distribution issue, there were no relevant authorities to assist it in determining this issue. It also noted that despite careful consideration, the panel had been unable to reach agreement on the correct interpretation of the relevant legislation. The FTT was of the view that this is an important point of wide significance upon which the Upper Tribunal should provide definitive guidance, and it therefore not only gave HMRC  permission to appeal on this point it positively encouraged it to do so. 

A copy of the decision can be viewed here.