Edited version of your written advice

Authorisation Number: 1012688407230

Ruling

Subject: CGT & goodwill

Question 1

Is the intangible asset comprising the goodwill of Company A an asset considered to have been acquired before 20 September 1985 for the purposes of section 109-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Would any capital gain made on the disposal of that goodwill asset be disregarded pursuant to paragraph 104-10(5)(a) of the ITAA 1997?

Answer

Yes

Question 3

If the goodwill of Company A is considered to have been acquired before 20 September 1985, has section 160ZZS of the Income Tax Assessment Act 1936 (ITAA 1936) or section 149-30 of the ITAA 1997 applied to deem the goodwill to be acquired after 20 September 1985?

Answer

No

This ruling applies for the following periods:

1 July 2011 to 30 June 2015

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The goodwill of Company A

Investor Co acquired Retail Co and its wholly owned subsidiary, Company A, in 198X. At that time Company A operated a wholesale electronics product business (Company A's Distribution Business).

Company A was formerly named XXX Pty Ltd and traded under that name. The change of name to Company A occurred in 200X and the company has traded under the name of Company A Distribution since then. For a period prior to this name change, the business traded under the name 'XYZ Wholesale'.

The products sold by Company A's Distribution Business since 198X have been electronic components, purchased both in Australia and overseas.

During the relevant years, Company A did import and wholesale non-core electronic component stock under a temporary arrangement with an associated entity. This non-core stock consisted mainly of camping and boating equipment. Sales of this non-core stock represented less than X% of total company sales for the 20XX year and less than Y% of total sales during the 20XY year. The importation and sale of the non-core electronic equipment ceased in the 20XY year.

Up until 200X the majority of Company A's Distribution Business involved supplying Retail Co and therefore the size of Company A's Distribution Business grew in a similar way to the growth of Retail Cc. Since 200X though there has also been organic growth in Company A's Distribution Business supplying to authorised stockists and other unrelated electronics retailers.

Since 198X to date supplies to Retail Co have at all times comprised at least 50% of all sales by Company A's Distribution Business and Retail Co has acquired 100% of its product range from Company A's Distribution Business.

As the sole supplier of Retail Co, the yearly product catalogue published by Retail Co since 198Y, provides an accurate record of the products sold by Company A's Distribution Business. Since 200X, Company A has also released a separate annual catalogue under the brand name 'Company A Distribution'.

Mr Black has had the central management and control of Company A's Distribution Business, becoming the managing director in 198X. The management structure gradually developed over time into a management committee, as is appropriate for a corporate group of this size. This management structure has changed over time to cope with the expansion of Company A's Distribution Business operations through the relocation to larger wholesale warehouse sites and increase in sales demand driven by growth in the sales of Retail Co.

Since 198Y all employees of both Retail Co and Company A's Distribution Business have been employed by Company A, with training being undertaken at a national level through head office.

The customers of the Company A's Distribution Business have always included Retail Co as the cornerstone buyer. At all times, at least 50% of sales have been to Retail Co. The remainder of sales have been to other electronics and technology based users and re-sellers.

The original model developed for Company A's Distribution Business was to leverage off the economies of scale and increase the volume of sales to ensure importing of stock was profitable.

Company A's Distribution Business has a reputation for being at the forefront of technology, by profiling and supplying new and different products.

Since 20XY Company A commenced supplying 'own brand' products as part of the product range. These products are in addition to the range of electronic products that Company A's Distribution Business sold prior to that time.

Company A'S Distribution Business had a product range of approximately 3,500 different products in 198X. The product range has grown to approximately 7,000 products as of present times. A substantial number of the original 3,500 products in the range have remained unchanged since the commencement of the business in 198X.

The expansion of the size of operations of Company A's Distribution Business is largely attributable to the growth of the business of Retail Co, as its main customer. Since 198X the wholesale activities and warehouse sites have gradually expanded to meet increased demand, from Retail Co and other retailers.

As part of business planning that took place in 200X and 200Y the management decided that Company A's Distribution Business would continue to focus on being the sole supplier of Retail Co as well as growing its supply activities to include other electronics retailers.

The key management decisions of Company A's Distribution Business and the Retail Co business have been made by Mr Black and a small management team. As the businesses have grown, the management team has also grown.

All assets held and activities (including employees) are carried on by a single company- Company A - which uses a single registration for GST purposes and has one ABN.

The shareholding of Company A

Company A is wholly owned by Retail Co and Retail Co is wholly owned by Investor Co.

At present the shareholdings in Investor Co are as follows:

Mr Black owns 2 A Class shares;

White Pty Ltd as trustee for the Mr Black Family Trust No. 2 owns 3 A Class shares; and

Mr Black Nominees Pty Ltd as trustee for the Mr Black Family Trust owns 5 B Class shares, issued in 198Z.

Mr Black acquired 4 A class shares in 198X. On that day, Mr Grey acquired 1 A Class share as bare trustee for Mr Black, which he held until these shares were vested absolutely in Mr Black after 19 September 1985, but before 1998. As this share was held on a bare trust for Mr Black, this A Class share should be treated as always being held by Mr Black.

Mr Black transferred 3 A Class shares to White Pty Ltd as trustee for the Mr Black Family Trust No. 2 after 20 September 1985 but before 1998.

While at all times since 19 September 1985 Retail Co has been wholly owned by Investor Co, there has been a change in ownership of Investor Co since 1985.

A Class and B Class shares in Investor Co have the same rights and entitlements to dividends, although dividends may be declared in respect of one class to the exclusion of the other.

B Class shares have a right to a return of capital and participation in the distribution of surplus assets on a winding up, while the A Class shares have no such right.

Since 1 July 198V approximately V% of dividends declared by Investor Co have been paid to the A class shareholders and the remaining W% have been paid to the B class shareholders. With respect to the dividends paid to the A class shareholders, these have been paid to Mr Black and the Mr Black Family Trust No. 2 in proportion to their shareholdings.

The dividends received by Mr Black Family Trust and Mr Black Family Trust No. 2 have been ultimately distributed to Mr Black and/or other members of the family and or other related family entities as provided under the respective trust deeds.

Mr Black and his broader family members are the beneficiaries of both trusts. While there are some minor differences between the range of beneficiaries between the trusts, (for example, the Mr Black Family Trust No 2 includes pchildren as beneficiaries, who are not included as beneficiaries of the Mr Black Family Trust) both trusts exist for the primary benefit of Mr Black's family.

In these circumstances, all dividends have been received by Mr Black or other members of the family.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 160ZZS

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 109-5

Income Tax Assessment Act 1997 section 149-15

Income Tax Assessment Act 1997 section 149-30

Reasons for decision

Question 1

Detailed reasoning

Goodwill or an interest in goodwill is specifically listed as a CGT asset under paragraph 108-5(2)(b) of the ITAA 1997 for the purposes of the capital gains tax provisions of the tax law.

It is not disputed that when Investor Co acquired Retail Co, and as a result, acquired Company A, Company A possessed goodwill. The issue is whether that business is at present the same business as it was when Investor Co purchased Retail Co (and acquired Company A).

For a business, such as Company A's Distribution Business, which has commenced before 20 September 1985, it is a critical matter to determine the CGT status of the goodwill of the business as this will have relevance when a CGT event may occur to that goodwill.

The main statement from the Commissioner on the subject of capital gains tax and goodwill assets is contained in taxation ruling, TR 1999/16 Income tax: capital gains; goodwill of a business.

Per paragraph 25 of TR 1999/16 the Commissioner takes the view that the whole of the goodwill of a business is taken to be acquired either before 20 September 1985 or after 19 September 1985. Goodwill cannot be regarded as partly pre CGT and partly post CGT.

To this end it is necessary to examine all the facts and circumstances to determine whether the same single business has been continuously carried on since before 20 September 1985 or whether due to activities that have occurred since the commencement of the original business:

a) a new business was commenced after 19 September 1985 and the former business no longer exists or

b) new and separate businesses have been commenced such that more than one business is carried on and each have their own goodwill assets.

Old business has ceased

It is always a question of fact as to whether the same business is being carried on. A business does not have to be identical from the time of acquisition to the time of disposal to be regarded as the 'same' - paragraph 21 of TR 1999/16.

Per paragraph 95 of TR 1999/16, unless the facts indicate that a new business has commenced rather than an existing business continuing to be carried on, the goodwill of the business is not different from that existing when the business was originally acquired or commenced. A business owner may expand or contract activities or change the manner in which the business is carried on without ceasing the same business provided the business retains its essential nature or character.

Examples of organic growth, expansion or diversification of a business can include

• adopting new compatible operations

• servicing different clients

• offering improved products or services.

Per paragraph 24 of TR 1999/16 the business must be of the same essential nature or character to that carried on originally.

New business acquired

A business may increase its operations or scale of activity but it is also a question of fact whether such an expansion constitutes the expansion of an existing business or whether the expansion constitutes acquisition of a new business.

Applying the principles to Company A

The facts presented indicate that Company A's Distribution Business is a single discrete business which has grown in size over the years. We consider that this business commenced its operations before 20 September 1985.

Question 2

Detailed reasoning

On the face of it a disposal of the goodwill of Company A's Distribution Business would constitute a CGT event A1 under section 104-10 of the ITAA 1997. Under subsection 104-10(4) of the ITAA 1997 a capital gain would be made if the capital proceeds from such a disposal was more than the cost base of the goodwill. Conversely a capital loss would be made if the capital proceeds were less than the reduced cost base of the goodwill.

However under subsection 104-10(5)(a) of the ITAA 1997 such a capital gain or capital loss is disregarded if the asset was acquired before 20 September 1985.

As we consider above that Company A acquired the goodwill of Company A's Distribution Business before 20 September 1985, it follows that any capital gain or capital loss made on the disposal of the goodwill can be disregarded, subject to satisfying the tests contained in Division 149 of the ITAA 1997.

Question 3

Detailed reasoning

Under subsection 149-30(1) of the ITAA 1997 an asset which is a pre-CGT asset (as defined by section 149-10 of the ITAA 1997) will stop being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not held by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985.

As set out in section 149-10 of the ITAA 1997, a pre-CGT asset is one that was acquired by an entity before 20 September 1985 and the entity has not been taken under provisions of the Income Tax Assessment Act 1936 to have acquired the asset on or after that date and nor had the asset stopped being a pre-CGT asset because of a previous operation of Division 149 of the ITAA 1997.

The meaning of the term 'majority underlying interests in a CGT asset is set out in section 149-15 of the ITAA 1997.

The relevant asset is the goodwill of Company A, which is an asset that was held by Company A when the parent company of Company A, Retail Co was acquired by Investor Co, an event that occurred before 20 September 1985. As Company A is wholly owned by Retail Co which in turn is wholly owned by Investor Co it is necessary, for the purposes of the tests contained in section 149-30 of the ITAA 1997, to examine the shareholdings of Investor Co to determine the majority underlying ownership interests in the goodwill of Company A.

In the present case, the ultimate owners have to be individuals, per paragraph 149-15(3)(a) of the ITAA 1997 because none of the other paragraphs of this provision would be applicable. For the purposes of paragraph 149-15(1)(a) of the ITAA 1997 (interests in the asset) it is only the B Class shares that are relevant because it is only the B Class shares that can participate in the capital of Investor Co upon its winding up. It is only these shares that confer a beneficial interest in the asset itself.

The 5 B Class shares have been held by the same entity being the Mr Black Family Trust since before 20 September 1985 which continues to hold them today.

Under ordinary legal concepts when a trust is a discretionary trust, no beneficiary is entitled to income or capital of the trust until the trustee exercises its discretion to distribute income or to make an appointment of capital. As a beneficiary of a discretionary trust does not hold an interest in any asset of the trust or in the ordinary income derived from the asset until the trustee exercises its discretion, it would usually not be possible for a discretionary trust to satisfy the majority underlying ownership interest tests set out in subsection 149-30(1) of the ITAA 1997.

However the Commissioner has set out a pragmatic approach, as stated in Taxation Ruling IT 2340, of looking through interposed entities to determine which natural persons hold the beneficial interests for the purposes of section 160ZZS of the Income Tax Assessment Act 1936 (ITAA 1936) which preceded Division 149 of the ITAA 1997.

Taxation Ruling IT 2340 states at paragraph 5 that it will be relevant to take into account the way in which the discretionary powers of the trustee are exercised when considering the question whether majority underlying interests have been maintained in the assets of the trust. IT 2340 continues:

6. Where a trustee continues to administer a trust for the benefit of members of a particular family, for example, it will not bring section 160ZZS into application merely because distributions to family members who are beneficiaries are made in such amounts and to such of those beneficiaries as the trustee determines in the exercise of his discretion.

7. In such a case the Commissioner would, in terms of sub-section 160ZZS(1), find it reasonable to assume that for all practical purposes the majority underlying interests in the trust assets have not changed.

Taxation Ruling IT 2340 correctly reflects the position that section 160ZZS of the ITAA 1936, by its terms, necessarily supplants normal legal concepts of interests in assets. For the purposes of section 160ZZS, a beneficiary of a discretionary trust is treated as having a beneficial interest in the trust's assets. The position stated in paragraph 7 of IT 2340 above of the Commissioner making a reasonable assumption that majority underlying ownership interests have not changed is now reflected in the legislation because subsection 149-30(2) of the ITAA 1997 provides:

149-30(2) If the Commissioner is satisfied, or thinks it reasonable to assume, that at all times on and after 20 September 1985 and before a particular time, majority underlying interests in the asset were held by ultimate owners who had majority underlying interest in the assets immediately before that date, subsections (1) and (1A) apply as if that were in fact the case.

We therefore consider that majority underlying ownership interests have been maintained in the goodwill asset since before 20 September 1985.

For the purposes of paragraph 149-15(1)(b) of the ITAA 1997 (interests in the income derived from the asset) it is necessary to look to shareholdings of both the A and B class shares in Investor Co because both classes of shares can receive dividends, although at the discretion of the company.

There has been a change in the shareholding of the A and B Class shares in Investor Co which took place after 19 September 1985, compared to the position before 20 September 1985. The 5 A Class shares were held by Mr Black including 1 share that was held on a bare trust for Mr Black and the 5 B Class shares were held by the Mr Black Family Trust. In 198X three of the A Class shares were transferred to the trustee of the Mr Black Family Trust No 2.

This transfer left the 7 remaining A Class and B Class shares (the majority of the shares) being held by the same entities that held them before 20 September 1985. Five were and are held by Mr Black (an individual and therefore an ultimate owner) and 2 were and are held by the Mr Black Family Trust.

As discussed above, the fact that some of the B Class shares were held by a discretionary trust does not disturb the notion that the same ultimate owners held the beneficial interests in the income from the asset.

The test of paragraph 149-15(1)(b) of the ITAA 1997 is therefore also met - meaning that as at the date of this ruling, the Commissioner considers that the goodwill of Company A is still regarded as having been acquired before 20 September 1985.

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