Goodwill is produced by, and only by, people and not by things they use in business, but confusion reigns.

The purpose of this article is to expose the pretence of clothing real property, land, with the value of goodwill, which is a species of personal property.

Goodwill comes from the commercial and personal relations between an individual who conducts a business and the clients or customers of that business. It is the reputation and connection formed with customers, and represents the value of an attraction to customers of a name and reputation. It is represented by the right granted to trade as the successor on sale of business. The grant will be at a price, in money or another form, where goodwill has a financial value.

Goodwill goes with people as part of their business, whether mobile or static. It is well established that goodwill may be dealt with as an entity separate from the particular premises in which the business has been carried on, even though, for example, by the terms of a lease it must be sold necessarily with the premises, and a widow might sell for her own benefit the goodwill of a business that was carried on at premises belonging to her husband’s estate. It has been decided that goodwill related to a business could be separated from the lease, and be subject to separate ownership, even if, as in many cases, the actual income and land are both in the same ownership. That income is generated and goes as directed by those behind it and not the land.

Confusion comes from a distinction between what the courts describe as personal goodwill, which is said to be merely the advantage of the recommendation of the owner of a business and use of the name of that owner, and local goodwill, which is said to attach and to be taken into account in calculating the value of premises. The courts would divide the value attributable to goodwill into three parts: the first consisting of customers who, on a change in the proprietorship of a business, remain attached to the premises ('cat goodwill'); the second, of customers who would follow the previous occupier ('dog goodwill'); and the third, of customers who would desert both the premises and the occupier ('rat goodwill'). Then again, Maugham LJ burrowed deep to discover 'rabbit goodwill', arising from customers who come simply from propinquity or nearness to the premises.

On examination it becomes clear that those light-hearted metaphors from the menagerie fail to distinguish local circumstances of any situation from what an entrepreneur would make out of them. Goodwill is a result of personal endeavours to exploit those circumstances. Application of the expression 'local goodwill' to what are just the local circumstances is a misnomer, a distortion of words and a confusion of ideas. The term 'local value', rather than 'local goodwill', describes facets and features that exist already, to be distinguished from the outcome, goodwill, of people exploiting them.

Circumstances, things inanimate, even animals do not make goodwill. Goodwill and land are like oil on water or particles in a colloid – they meet but never merge. Covenants in restraint of trade reveal the truth. Restrictive covenants lie in the lap of human relationships. They are enforceable only by, and in relation to goodwill attaching to, a person, but land is not of course alive to make or defend the characteristics of goodwill. People can exploit local value to generate goodwill, but goodwill emanates inextricably, rather than existing independently, from them.

In its attempt to tax goodwill, HM Revenue & Customs has called in aid the RICS Appraisal and Valuation Standards, and in particular UK practice statement 3, but those standards and statements are not tax law. While it is indeed right to require a valuation to market value, and while the RICS guidance note 1 is correct to direct that the market value should be arrived at on the basis of a fully equipped operational entity having regard to trading potential, that does not allow HMRC to add the goodwill of a business to its site value. Trading potential might rely on planning permission, geographical location, the state and condition of land and buildings, local population, access to communications and so on, and in any particular case that the property is a registered care home, a licensed restaurant, a cinema, garden centre or other, but when assessing values the characteristics of the entrepreneur should be distinguished from those of the land. The business acumen of a person, from whom goodwill is borne, is not to be confused with local circumstances.

As to stamp duty land tax (SDLT), it is exigible under section 43(1) of the Finance Act 2003, and fixes on a chargeable interest. That includes an estate, interest, right or power in or over land and the benefit of an obligation, restriction or condition affecting the value of the estate. At law and in fact goodwill is not an estate, interest, right or power in or over land, and it is not an obligation, restriction or condition affecting the value of the estate.

Value associated with the site according to relevant permissions and restrictions is one thing, but what is freely transferable, an income stream, from one location to another is quite another. On applying SDLT, any request by HMRC to examine accounts of the business for previous years would be inappropriate inasmuch as they describe the goodwill value of profit and loss. So long as any apportionment is genuine, there is no need to disclose to HMRC accounts of the business for previous years, because the value of transferable business is not stampable. SDLT is not a business tax. The land alone, but not the whole transaction, is taxable.

It is common ground with HMRC that the main issue to resolve is the appropriate property valuation, that this is required to be done on a just and reasonable basis, and that regard must be had to the market value of the premises as in fact they are at the date of acquisition. But, merging goodwill and land values is not just, reasonable or even lawful. There is no statutory authority that allows the shares valuation division to merge the value of goodwill of a business into the value of land where a business is conducted. There can be no tax without statute.

In a bizarre and contrary twist, HMRC has written to accountants that the land concerned in matters submitted for adjudication has been revalued so as to absorb most of what had been apportioned to goodwill. However, so long as a bona fide apportionment of the sale price is expressed, usually in the agreement for sale, there is no justification for the peremptory attempt to merge any value apportioned there for goodwill in the land value; they are separate and distinct from each other in accounting, commercial, legal and tax terms. HMRC has confused the complex issues by making an unauthorised classification. Free separable goodwill is not a statutory concept, and the chimera of immovable goodwill is simply an unfounded misconception. Any claim to tax on the myth of immovable goodwill is not justified by statutory authority, the cornerstone of all tax.

Various requirements in the panoply of tax legislation emphasise the principle of distinguishing in a transaction one item from another. For example, if an item of property is sold together with other property, the net proceeds are treated by section 562(3) of the Capital Allowances Act 2001 as, on a just and reasonable apportionment, is attributable to that item, and see other references in the taxation articles. The act acknowledges the very opposite of merger: the values of items are to be apportioned because they are separate from, and not absorbed within, each other.

On another tack, goodwill was exempted by section 116 of the Finance Act 2002 from liability to stamp duty, of which SDLT, according to its name, is generic to the species. Even if HMRC could have sustained the pretence that land value included what it calls 'immovable goodwill', the element of goodwill was eliminated expressly by that exemption, and subsequent SDLT legislation did not bring goodwill alone or combined with land back into charge. It seems that HMRC is trying to sneak in through the back door what was shown out via the front door.

Any claim to SDLT on goodwill should be appealed on the grounds of fundamental error. There is no statutory authority for taxing goodwill, and any SDLT paid on it should be recovered. Recovery should be sought of tax taken as well before as after exemption to the extent that such imposition was based on the false premise of immovable goodwill. Solicitors may wish to advise accordingly. It is commonsense, logic and the law.

Charles Smith has been a solicitor since 1966 and is the author of Sweet & Maxwell’s Company Precedents