Edited version of your written advice

Authorisation Number: 1012835592613

Date of advice: 30 July 2015

Ruling

Subject: Business reorganisation - capital gains tax

Question 1

Will the Commissioner confirm that no CGT event will occur in relation to the goodwill of the Company A tax consolidated group (Company A TCG) as a result of the implementation of the proposed business reorganisation in Australia as described herein?

Answer

Yes.

Question 2

Will the Commissioner confirm that no capital gain arises under CGT event D1 in relation to the extension of the Master Licence Agreement (MLA)?

Answer

Yes.

The scheme commences on:

Implementation Date

Relevant facts and circumstances

1. Company A is an Australian incorporated and tax resident company listed on the Australian Securities Exchange.

2. Company A is the head entity of the Company A income tax consolidated group (Company A TCG) as well as the ultimate holding company of the Company A worldwide group of companies (Company A).

3. Several years ago Company A established an offshore service provider and formed Company B to improve the competitive position of the global business. Company B provided services for the Product X business of the Company A TCG and the offshore members of Company A.

4. During this time an initiative was launched to consolidate the Product X related intellectual property (IP) of the Company A TCG and the IP of the offshore members of Company A. Members of the Company A TCG executed of a Master Licence Agreement (MLA) to licence IP owned by the Company A TCG to Company B. The offshore members of the Company A worldwide group of companies entered into similar agreements with Company B in respect of IP of those entities. For the use of the IP, Company B pays the IP owners a royalty.

5. Company A is proposing to re-organise their business structure in Australia and this will be a recalibration of the Company A TCG operating platform. The restructure will redeploy functions, assets and risks for all products to Company B.

6. The restructure will result in the transfer or ending of certain CGT assets. The Company A TCG is proposing to transfer trading stock and contractual rights from Company A to Company B on the proposed Implementation Date.

7. The proposed capital proceeds will be the market value.

8. The IP for all products will be licenced to Company B by varying the MLA to include all products. Company B will not pay an amount of consideration for the extension of the MLA, no capital proceeds will be received by the Company A TCG. An ongoing royalty for the use of the IP will be payable by Company B to the Company A TCG in respect of the extended rights that will be provided once the MLA is extended to apply to all products.

9. The Applicant advised that post restructure, the Company A TCG will retain the following assets:

(a) Manufacturing premises

(b) Plant and equipment

(c) Manufacturing licences and permits

(d) Australian customer contracts

(e) Customer relationships

(f) Cash, debtors and receivables

(g) Ownership IP (licenced to Company B under the MLA), and

(h) Goodwill.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 104

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 subsection 104-10(2)

Income Tax Assessment Act 1997 section 104-20

Income Tax Assessment Act 1997 subsection 104-20(1)

Income Tax Assessment Act 1997 section 104-35

Income Tax Assessment Act 1997 subsection 104-35(1)

Income Tax Assessment Act 1997 subsection 104-35(2)

Income Tax Assessment Act 1997 subsection 104-35(3)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 paragraph 108-5(2)(b)

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 paragraph 116-30(3)(b)

Reasons for decision

All legislative references in this Ruling are to the ITAA 1997 unless otherwise stated.

Question 1

Summary

The Commissioner confirms that no CGT event will occur in relation to the goodwill of the Company A TCG as a result of the business re-organisation in Australia.

Detailed reasoning

Paragraph 108-5(2)(b) expressly includes goodwill or an interest in it as a CGT asset.

The CGT events in relation to goodwill that are relevant to consider under the Scheme are:

• CGT event A1 in relation to a potential disposal of goodwill; or

• CGT event C1 in relation to a potential loss or destruction of goodwill.

Whether CGT event A1 applies on the basis that there has been a disposal of goodwill?

CGT event A1 happens if a taxpayer disposes of a CGT asset: subsection 104-10(1). The disposal of a CGT asset takes place if a change of ownership occurs from one entity to another entity, whether because of some act or event or by operation of law: subsection 104-10(2).

Taxation Ruling TR 1999/16 Income tax: capital gains tax: goodwill of a business sets out the Tax Office views on capital gains and goodwill of a business.

'Goodwill' for the purposes of the definition of 'CGT asset' in section 108-5 has the meaning it bears under the general law. It is the legal definition of goodwill as explained by the High Court in FC of T v Murry (1998) 193 CLR 605, rather than its accounting and business definitions, which applies. The High Court stated that the goodwill of a business is the product of combining and using the tangible, intangible and human assets of a business for such purposes and in such ways that custom is drawn to it [at paragraph 24]. The attraction of custom is central to the legal concept of goodwill.

The High Court in Murry stated [at paragraph 4]:

Goodwill is inseparable from the conduct of a business. It may derive from identifiable assets of a business, but it is an indivisible item of property, and it is an asset that is legally distinct from the sources - including other assets of the business - that have created the goodwill. Because that is so, goodwill does not inhere in the identifiable assets of a business, and the sale of an asset which is a source of goodwill, separate from the business itself, does not involve any disposition of the goodwill of the business (emphasis added).

The High Court also stated [at paragraphs 30-32]:

Care must be taken to distinguish the sources of the goodwill of a business from the goodwill itself. Goodwill is an item of property and an asset in its own right. For legal and accounting purposes, it must be separated from those assets and revenue expenditures of a business that can be individually identified and quantified in the accounts of a business. Goodwill, as property, is "inherently inseverable from the business to which it relates". That which can be assigned and transferred from the business may, while it is connected to the business, be a source of the goodwill of the business but cannot logically constitute any part of the goodwill of the business…

It follows that the sale of an asset of a business does not involve any sale of goodwill unless the sale of the asset is accompanied by or carries with it the right to conduct the business…

When an asset of the business is sold and the business is not, the sale may reduce the value of the goodwill of the business. Nevertheless, the sale does not involve the disposition of the goodwill of the business or any part of it.

Under the Scheme, the assets dealt with by the Company A TCG as part of the business re-organisation in Australia comprise of separately identified assets, including the trading stock and contract assets being transferred to Company B:

The assets comprise only of discrete, separately identified assets of the Company A TCG. Applying the principles in Murry, the disposal of the assets will not involve any disposal of goodwill of the Company A TCG. The goodwill of the Company A TCG is a separate asset of the Company A TCG's business, and does not inhere in the other assets of its business, including in the assets that will be transferred on the Implementation Date. The goodwill of the Company A TCG is inseverable from the business of the group and will remain with that business when discrete assets of the business are transferred or otherwise dealt with under the Scheme.

Whether there has been a disposal of one of several businesses, or part of a business which itself could constitute a business

As the assets do not comprise the entire business of the Company A TCG it is also relevant to consider whether a discrete business of the Company A TCG, which itself could constitute a business with goodwill (divisible from the broader goodwill), will be transferred as part of the business re-organisation in Australia.

It is stated in TR 1999/16:

73. If a business owner is carrying on more than one business, each business has its own separate goodwill and each business may be disposed of along with the goodwill attaching to it…

74. If a business owner is carrying on one business and disposes of some part of the business, it is a question of fact whether the owner has disposed of a discrete business that a purchaser could conduct or has merely disposed of a business asset or a collection of business assets. This question is determined having regard to all of the circumstances (and not solely from the purchaser's perspective) including whether sufficient relevant assets are sold to enable the purchaser to carry on the business the vendor had carried on, whether the assets sold are accompanied or carry with them the legal right, privilege or entitlement to conduct the business and whether what is sold is sold as a self contained business. If a business owner disposes of part of their business, an important consideration is whether the effect of the transaction is to put the purchaser in possession of a going concern the activities of which the purchaser could carry on without interruption: see Full Supreme Court of Tasmania decision in Zeekap (No 56) Pty Ltd v C of SD (Tas) 99 ATC 4745 at 4747-8; (1999) 42 ATR 295 at 297-8.

The disposal of the assets does not involve any disposal of any "sub-business" of the Company A TCG, or any disposal of a discrete business that any transferee (i.e. Company B or any other foreign Company A entity) could conduct. The CGT assets that will be disposed of following the business re-organisation in Australia are not sufficient to enable Company B or any other foreign Company A entity to carry on the business that the Company A TCG carried on, and are not sufficient to be considered an entire, self-contained business. The business re-organisation in Australia will not put any transferee in possession of a going concern the activities of which could be carried on without interruption. Instead, there has been a disposal of a collection of discrete business assets.

Accordingly, the business re-organisation in Australia does not involve the disposal of one of several businesses, or of part of a business which itself could constitute a business with goodwill (divisible from the broader goodwill).

Conclusion

The disposal of the assets, as discrete assets of the business will not attract any disposal of goodwill. Furthermore, the disposal of the assets will not constitute the disposal of a business which could otherwise include a disposal of goodwill.

Accordingly, the business re-organisation in Australia will not result in CGT event A1 happening in relation to the goodwill of the Company A TCG.

Does CGT event C1 happen as a result of the business re-organisation in Australia?

CGT event C1 happens if a CGT asset you own is lost or destroyed: subsection 104-20(1).

A business may change to such an extent that it is no longer the same business so that the goodwill of the old business ceases and goodwill of a new business is acquired. In such case, CGT event C1 will happen.

It is stated in TR 1999/16:

18. A business or the sources of its goodwill may change so much it can no longer be said to be the same business as that previously conducted. In other words the old business ceases and a new business commences. If this happens the goodwill of the original business ceases to exist and a new CGT asset - being the goodwill of the new business - is acquired.

19. CGT event C1 in section 104-20 (about a loss or destruction of a CGT asset) happens in the situation in paragraph 18...

20. Whether the same business is being carried on is a question of fact and degree that ultimately depends on the circumstances of each particular case…

21. The business does not need to be identical from its acquisition to its disposal. If the essential nature or character of the business is not changed, the business remains the same business for the CGT goodwill provisions. A business owner may expand or contract its activities, or change the way in which a business is carried on, without ceasing to carry on the same business, provided the business retains its essential nature or character…

24. It is not sufficient, however, if just a similar kind of business is carried on. It must be a business of the same essential nature or character that is carried on. The same business is not carried on if:

(a) through a planned or systematic process of change within a reasonable period of time, a business changes its essential nature or character; or

(b) there is a sudden and dramatic change in the business brought about by either the acquisition or the shedding of activities on a considerable scale.

It is further elaborated in TR 1999/16:

91. It is a question of fact and degree whether the same business is being carried on. Factors to consider include the nature or character of the business, its location and size, the extent of changes in the assets and resources of the business, the activities of the business - whether the activities constitute, or are treated by the business owner as constituting separate or distinct activities, enterprises, divisions or undertakings - and the way in which the business is structured, carried on, managed and controlled…

94. The High Court in the Murry case considered it ' arguable ' (emphasis added) that the goodwill of the business of an inner Sydney hotel is not the same asset as it was two decades ago because, due to a marketing change and a resulting change in the class of customer patronising the business, it is not the same business as it was then. The High Court said the sources of the goodwill of a business may change and the part that various sources play in maintaining the goodwill may vary over the life of the business to such an extent it can no longer be said that the same business is carried on (98 ATC at 4595; 39 ATR at 143). The question whether a change of business occurs remains one of fact and degree, however, and a change in the nature of the clients of a business does not of itself mean the business is a new business with new goodwill. Many businesses naturally evolve by serving different clients or clients in different markets and offering improved products or services.

It is noted that the High Court in Murry stated [at paragraph 45-46]:

The sources of the goodwill of a business may change and the part that various sources play in maintaining the goodwill may vary during the life of the business. But, as long as the business remains the "same business", the goodwill acquired or created by a taxpayer is the same asset as that which is disposed of when the goodwill of the business is sold or otherwise transferred.

In determining whether the "same business" is being carried on, the sources of the goodwill may have changed so much that, although the business is of the same kind as previously conducted, it cannot be said to be the same business.

The effect of the business re-organisation in Australia will be that Company A TCG will convert from a full-fledged manufacturer into a manufacturer with reduced function and risk for Company B.

Nonetheless, the Company A TCG will retain its essential character of manufacturing and supplying products and services in relation to the same markets. The Company A TCG will continue to conduct its same business and will still be manufacturing the same products following the business re-organisation in Australia. This will include continuing to maintain manufacturing sites, plants and require permits and licenses to conduct its operations. Further, there will be no change to activities in relation to the functional areas of human resources, projects and technology, strategy, and corporate affairs and responsibility upon the business re-organisation in Australia.

The sources of goodwill of the Company A TCG will not have changed so much that the business carried post-implementation would not be the same business. Finally, no sub-business of the Company A TCG will cease as a result of the business re-organisation in Australia and there will only be a transfer/ending of discrete, separately identified assets of the Company A TCG.

Conclusion

The business re-organisation in Australia will not result in the business of the Company A TCG changing its essential nature or character, or changing to such an extent that it is no longer the same business.

Accordingly the goodwill of the Company A TCG will not become 'lost or destroyed' for the purposes of section 104-20 and CGT event C1 will not apply.

The Commissioner concludes that neither CGT events A1, C1 (or any other CGT event) will apply in relation to the goodwill of the Company A TCG as a result of the business re-organisation in Australia.

Question 2

Summary

The Commissioner confirms that no capital gain arises under CGT event D1 in relation to the extension of the MLA.

Detailed reasoning

Section 104-35 - Creating contractual or other rights - CGT event D1

CGT event D1 happens when you create a contractual right or other legal or equitable right in another person or entity (subsection 104-35(1)). The time of the event is when the contract is entered into or when the right is created (subsection 104-35(2)).

A capital gain arises under CGT event D1 if the capital proceeds from creating the right are more than the incidental costs incurred that relate to the event (subsection 104-35(3)).

The capital proceeds from a CGT event include the amount of money and the market value of any property the taxpayer receives, or is entitled to receive, in respect of the event happening (section 116-20).

The market value substitution rule does not apply in relation to capital proceeds for CGT event D1 if no capital proceeds are received from that event happening (paragraph 116-30(3)(b)).

On our facts, there will be contractual variations under the MLA as a result of the MLA being extended to apply to all products.

However, no capital gain can arise under CGT event D1.

This is because the Company A TCG will not receive any capital proceeds upon the variation of the MLA and the market value substitution rule does not apply to CGT event D1 if no capital proceeds are received from that event happening.

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