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Reader feedback: valuation of trade-related properties

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Ian Maston makes some interesting points in his article ‘Impact of incorporation on business property relief’ (see Tax Journal, 5 February 2016 - see link below). 50% relief on the premises and 100% on the rest of the business, for example free goodwill, is one thing. However, the position could actually become worse. 
A restaurant is known by real estate valuers as a ‘trade-related property’ (TRP). The argument runs that a TRP specifically adapted for use as a restaurant could not be used for any other trading activity; and that therefore it is appropriate to value the bricks and mortar by reference to the notional profitability of the business conducted within it, as seen through the eyes of a ‘reasonably efficient operator’, generally not the actual operator. Whereas ordinarily a profitable trading business might be expected to have valuable free goodwill, this would of course attract the business property relief (BPR) to which Ian refers, at 100%. However, if the profits of the restaurant are captured in the value of the premises, they cannot surely be used a second time in order to determine the value of any free goodwill in the business. Unsurprisingly, on that basis, in many recent business incorporation cases the specialist valuation department of HMRC – Shares and Assets Valuations (SAV) – has succeeded in maximising the real estate value, marginalising that of free goodwill, and consequently minimising the tax advantages that were supposedly available on incorporation.
Those tax advantages are of course now largely gone, but SAV has said that it will remain consistent in its approach and will therefore continue to value goodwill in TRPs as it has done historically. That will presumably apply for IHT as well. On that basis, the bulk, if not the entirety, of the value in a restaurant business, and other TRPs, will continue to lie in the real estate. 
One of Ian’s key points is that the amount of BPR hangs on how the premises are owned – relief could be 100%, but it might only be 50%. If the premises were transferred into the company, relief applies at 100% after two years, although there would be an SDLT cost on its transfer, on the very high values that follow from the TRP valuation methodology. If, however, the premises remain outside the company, only 50% relief will be available on them, and, by reason of its exclusion from the business value, negligible relief at 100% on free goodwill, a further unfortunate dimension to the scenario that Ian identifies. 
For example, A Ltd, a widget manufacturer, achieves profits of circa £200,000 per annum, trading from premises valued at £500,000 including various tangible assets. Capitalised on a multiple of five, A Ltd would be valued at £1,000,000. Following the convention that goodwill is what remains after all other assets have been deducted, it is therefore valued at £1,000,000 – £500,000 = £500,000. If A Ltd owns the premises, etc., business property relief is available on the entire value including goodwill, at 100%. If it was owned by the controlling shareholder, only 50% of its value would attract BPR (£250,000) and the same amount might attract IHT at 40% (£100,000). If not owned by the controlling shareholder, IHT might be £200,000.
B Ltd is a restaurant, also making profits – EBITDA – of £200,000. If, for the sake of argument it was also capitalised by five, its value would also be £1,000,000. However, as it is a TRP, the £1,000,000 represents in effect the value of the restaurant premises, and there is no separate free goodwill. If the restaurant is owned by B Ltd, relief at 100% would seem to apply. However, if owned by the controlling shareholder, the reduced 50% rate would mean that this time £500,000 would be liable to IHT, with a potential tax liability of £200,000. If not owned by the controlling shareholder, IHT might be £400,000.
Plan with care!