The German Federal Court of Justice (BGH) confirmed that the goodwill of a freelance practice must generally be included in business valuations for gain equalization. The ruling requires the modified capitalized earnings method, deduction of an individual entrepreneur’s salary, and consideration of deferred income taxes to arrive at a realistic practice value.
Background and relevance
The valuation of a freelance practice is insufficiently codified by the standard setters. Neither IDW S1 nor IFRS consider freelance practices to be relevant valuation subjects. Nevertheless, the valuation of a medical practice, an architectural practice or a law or tax firm by an appraiser or tax consultant is regularly required, especially in the case of acquisitions or family law disputes.
Guidelines of the BGH on the valuation of freelance practices
In its ruling of 9 February 2011 (BGH, Case No. XII ZR 40/09), the German Federal Court of Justice established key principles for valuing freelance practices in gain equalization proceedings.
According to this ruling, the goodwill of a freelance practice is to be included as an intangible asset in the equalization of accrued gains and thus in the valuation. Goodwill is valued according to the three following principles:
1) Modified capitalized earnings value method
When measuring such goodwill, an entrepreneur's salary based on the individual circumstances of the owner must be deducted as part of the modified capitalized earnings value method. This method ensures that goodwill is valued realistically and fairly.
2) Consideration of goodwill in the equalization of accrued gains
The consideration of goodwill in the equalization of accrued gains does not violate the prohibition of double utilization. Goodwill relates to the intangible asset existing on the valuation date to the exclusion of the owner's actual work performance, while the maintenance claim is based on the owner's work performance and other property income.
3) Measurement as at the reporting date and deferred income taxes
The valuation of an owner practice as at the reporting date in the equalization of gains presupposes that the practice can be sold. Deferred income taxes must already be deducted in the valuation of these final assets as at the reporting date, irrespective of whether a sale is actually intended.
Wrap it up!
The BGH has established clear guidelines for the valuation of the goodwill of freelance practices, which are particularly relevant in gain equalization proceedings. The application of the modified discounted earnings method and the consideration of deferred income taxes are decisive factors in this process. smartZebra's tools and expertise can help to carry out these complex valuation processes efficiently and accurately.
Reference
- Federal Court of Justice (BGH), Judgment of 9 February 2011 – Case No. XII ZR 40/09: https://dejure.org/dienste/vernetzung/rechtsprechung?Gericht=BGH&Datum=2011-02-09&Aktenzeichen=XII%20ZR%2040%2F09.
- smartZebra Information Hub, Goodwill Impairment Test: A Guide to Initial and Subsequent Accounting: https://www.smart-zebra.com/post/goodwill-impairment-test-a-guide-to-initial-and-subsequent-accounting.
- smartZebra Information Hub, BGH Ruling on Debt Liabilities in the Capitalized Earnings Method: https://www.smart-zebra.com/post/bgh-ruling-on-debt-liabilities-in-the-capitalized-earnings-method.
