Edited version of your written advice

Authorisation Number: 1012985086884

Date of advice: 21 March 20XX

Ruling

Subject: Capital gains tax - status of goodwill

Question 1

Will the goodwill of the business operated by the Company be considered to be an asset acquired before 20 September 1985 for the purposes of section 109-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes. The goodwill of the business conducted by the Company is considered to have been acquired before 20 September 1985.

Question 2

Does Division 149 of the ITAA 1997 apply to deem the goodwill of the Company to be a post-CGT asset?

Answer

No. As there has not been a change in majority underlying interests in the Company, the goodwill of the company is taken to be a pre-CGT asset.

This ruling applies for the following period:

1 July 2015 to 30 June 20XX

Relevant facts and circumstances

Background

X owns 100% of the shares in the Company.

The Company was incorporated some 40 years ago and operates a business which commenced prior to 20 September 1985. A significant asset of the business is pre-CGT goodwill.

X intends to transfer their shares in the year ended 30 June 20, and needs certainty that his shares are taken to have been acquired prior to 20 September 1985.

Alternatively, the Company may transfer its business assets. If this is to occur, the Company would like confirmation that its goodwill is taken to have been acquired prior to 20 September 1985.

Facts

Below is a summary of the relevant dates setting out the timeline of events in relation to the share ownership of the Company.

Further explanation of events:

Pre 20 September 1985 event:

The Company was formed to act as trustee for the X Family Trust with less than five shares on issue. In turn, this trust commenced running the business operations.

Post 20 September 1985 events:

Trust to Company rollover. The business assets were rolled over from the Company (in its capacity as trustee of the X Family Trust) to the Company holding the assets in its own capacity. This occurred under the company to trust rollover that existed at the time. The rollover involved issuing shares to the X Family Trust as consideration for the transfer of the business assets. The initial shares on issue in the Company had a declaration of trust placed over them so that they were held on trust for the X Family Trust. All shares were held on trust for the X Family Trust on completion of the rollover.

X and X divorced and entered into a property settlement. Under the terms of the Family Court orders all of the shares which were held by the X Family Trust were transferred to X. Due to the Corporations Act requirements of the time, the Company had to have at least two shareholders. This meant that despite all the shares being beneficially owned by X, one of the shares was held in trust by X's parent.

On the death of X's parent, the share held beneficially for X was formally transferred to X. This change also involved the Company converting to a single shareholder and director by amending its constitution on that same date. The changes to the Corporations Act allowing a company to operate with one shareholder and director were legislated in 1995. This meant that X could be the legal owner of all the shares.

X has continued to hold all the shares in the Company since that time until the present day.

Relevant legislative provisions

Income Tax Assessment Act 1997

Part 3-1

Section 100-25

Section 104-10

Section 108-5

Section 109-5

Division 149

Section 149-10

Section 149-15

Section 149-25

Section 149-30

Income Tax Assessment Act 1936

Section 160ZZM

Section 160ZZMA

Section 160ZZN

Reasons for decision

Question 1

The meaning of 'goodwill'.

Goodwill is an asset for CGT purposes as there is a specific reference to it in the definition of CGT asset at paragraph 108-5(2) (b) of the Income Tax Assessment Act 1997 ('ITAA 1997').

Generally, goodwill can be said to be an intangible feature of a business that will often represent the business's reputation or following with customers or the capacity of a business to attract custom.

The Commissioner's views on the meaning of goodwill are set out in Taxation Ruling TR 1999/16, which reflects the decision of the High Court in Federal Commissioner of Taxation v Murry 89 ATC 4585 ('Murry').

Paragraph 12 of TR 1999/16 defines the goodwill of a business:

'…goodwill 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. The attraction of custom is central to the legal concept of goodwill. Goodwill is a quality or attribute that derives among other things from using or applying other assets of the business. It may be site, personality, service, price or habit that obtains custom. It is more accurate to refer to goodwill as having sources than it is to refer to it as being composed of elements. Goodwill is a composite thing. It is one whole. It is an indivisible item of property that is legally distinct from the sources from which it emanates. It is something that attaches to a business and is inseparable from the conduct of the business. It cannot be dealt with separately from the business with which it is associated.'

Paragraph 25 of the ruling states that the whole of the goodwill of a business is either pre-CGT goodwill or post-CGT goodwill. The goodwill of a particular business cannot be characterised as partly pre-CGT goodwill and partly post-CGT goodwill. Paragraph 26 notes that an interest in goodwill, unlike goodwill itself, is not a composite asset.

The consequence of the goodwill of a business being one CGT asset is that the whole of the goodwill of a business that commenced before 20 September 1985 remains the same single pre-CGT asset, provided the same business continues to be carried on. Paragraph 17 of TR 1999/16 states that this is so even though:

(a) the sources of the goodwill of a business may vary during the life of a business; or

(b) there are fluctuations in goodwill during the life of the business.

According to the decision in Murry, 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.

When is goodwill acquired?

Paragraph 52 of TR 1999/16 provides that:

52. If a taxpayer commences business and starts to create goodwill, the goodwill of the business is acquired when the taxpayer starts work that results in the creation of the goodwill (subsection 109-10, item 1). When a taxpayer starts the work resulting in the creation of goodwill of a business is a question of fact dependent on the circumstances of each particular case.

Where a business expands as a result of the introduction of a new business operation or activity by a taxpayer, any goodwill that relates to the expanded business is merely an expansion of the business. If a business that commenced prior to 20 September 1985 is expanded, goodwill generated by the expanded business operations or activities will be an accretion to the pre-CGT goodwill (see paragraph 60 of TR 1999/16).

Is the same business being carried on?

A business may change to such an extent that it becomes a new business with new goodwill. In FC of T v Murry it is stated that, 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.

Paragraphs 21 - 24 of TR 1999/16 state that if the essential nature or character of the business has not changed, the business remains the same business for the purposes of the CGT goodwill provisions. The business may expand or contract 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. Organic growth, expansion or diversification of a business by, for example:

a) adopting new, compatible operations;

b) servicing different clients; or

c) offering improved products or services

does not constitute a new business as long as the essential character or nature of the business remains unchanged.

It is a question of fact and degree whether the goodwill of a business is the same asset as it was when it was acquired. For the CGT goodwill provisions, we consider that the same business is carried on and no new goodwill asset is created if the business retains its same essential nature or character.

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.

Paragraphs 60 - 62 discuss internally generated goodwill:

60. If a new business operation or activity introduced by a taxpayer is an expansion of an existing business (whether it commenced before or after 20 September 1985), any goodwill built up in conducting the expanded business is merely an expansion of the existing goodwill of the business. If a business which commenced before 20 September 1985 (a "pre-CGT business") is expanded, goodwill generated in conducting the expanded business is merely an accretion to the pre-GGT goodwill.

61. If an introduced business activity is a new business, the goodwill attaching to that business is a new asset separate from the goodwill of the existing business.

62. Whether an increase in business operations or in the scale of activity constitutes an expansion of an existing business, or a new and separate business, is a question of fact dependent on the circumstances of each case. Factors that need to be considered in determining whether the business operation or activity is part of the existing business or is a new business include the nature of the new business operation or activity, the types of customers that the business operation or activity attracts and the extent to which the business operation or activity:

(a)    is subject to the same integrated management and control as the existing business;

(b)    is treated for banking and accounting purposes as an extension of the existing business or as a separate business;

(c)    uses one or more different trading names; and

(d)    is related to or dependent on the existing business in a practical, economic or commercial sense.

The question of whether a business has changed 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 is one of fact and degree. The following factors have to be considered as set out in paragraph 91:

• 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; and

• the way in which the business is structured, carried on, managed and controlled.

The nature and character of the business

Paragraph 93 of TR 1999/16 states that for the CGT goodwill provisions, the same business is carried on and no new goodwill asset is created if the business retains its same essential nature or character and offers the following example:

A business of a printer may have changed over time due to the purchase of new equipment and the adoption of improved technologies. The printer may now attract a different type of client such as large corporate clients (due to the capacity to produce high quality public relations material, annual reports, etc). Formerly, the printer may only have provided services to small local businesses (e.g. business cards, calendars, invoice books and stationery.)

No new business has been commenced. It is not a different business and the goodwill remains the same CGT asset. The printer is still conducting a printing business of the same essential nature or character, albeit one serving different clients.

Businesses may naturally evolve by serving different clients or clients in different markets and offering improved products or services (paragraph 94).

Paragraph 95 states that, unless the facts are such that it can be established that a new business has commenced - rather than an existing business continued - the goodwill of the business is not different from that existing when the business was originally acquired or commenced.

Has the same business been carried on by the Company?

The Company business was established by X and X as a small workshop. It was initially directed towards a specific industry. By 19XX the business was focussed exclusively on developing its market for relevant products. The business began using the "XYZ" brand since establishment and continues to use the brand up to the present day.

The core product of the business is the manufacture of relevant products as well as associated options.

It is evident from the information presented that the Company's business has grown significantly in the past 30 years. However it has continued its core business of manufacturing relevant products. Although there has been some small scale diversification, this has been related to its core business.

Over the past 30 years there has not been a sudden or dramatic change in the business which was brought about by either the acquisition or shedding of activities on a considerable scale. It should also be noted that the Company did not acquire any new businesses during the period.

The expansion of the business and the growth in the customer base can be attributed to the organic growth of the business. At all times the management and control of the business has remained with members of X's family.

For the purposes of the CGT goodwill provisions, the same business is carried on and no new goodwill asset will be created if the business retains is same essential nature or character. A business may change the way it operates over time due to the purchase of new equipment and the adoption of improved technologies which, in turn, may attract new clients. This does not imply that a new business has commenced (paragraph 95 of TR 1999).

As the business being carried on now by the Company is essentially the same as the business carried on prior to 20 September 1985, the goodwill of the business is the same asset and is taken to be acquired before 20 September 1985.

Accordingly, any capital gain or loss that arises on the disposal of this asset will be disregarded as the goodwill is a pre-CGT asset.

Question 2

Division 149 - change in majority underlying interests

An asset of a non-public entity stops being a pre-CGT asset when majority underlying interests in the asset were not held by the same ultimate owners who held majority underlying interests in the asset immediately before 20 September 1985 (subsection 149-30(1) of the ITAA 1997).

Majority underlying interests in a CGT asset Subsection 149-15(1) of the ITAA 1997 sets out the meaning of majority underlying interests in a CGT asset:

Majority underlying interests in a *CGT asset consist of:

(a) more than 50% of the beneficial interests that *ultimate owners have (whether directly or *indirectly) in the asset; and

(b) more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in any *ordinary income that may be *derived from the asset.

An underlying interest in a *CGT asset is a beneficial interest that an *ultimate owner has (whether directly or *indirectly) in the asset or in any *ordinary income that may be *derived from the asset.

Position immediately before 20 September 1985

Immediately prior to 20 September 1985 there were less than five shares on issue in the Company. One share was held by X, one share was held by X and one share was held jointly by X and X. These individuals were the 'ultimate owners' at that time.

Position post 20 September 1985

The shareholdings in the Company remained unchanged until a trust to company rollover occurred (section 160ZZN of the ITAA 1936). The X Family Trust received shares in the Company in return for the transfer of plant and goodwill to the Company. These shares were deemed to be pre-CGT shares under paragraph 160ZZN(7)(a) of the ITAA 1936.

The original shares were transferred to the trust on the same day. Accordingly, the X Family Trust now held 100% of the shares in the Company. Note: the original shares and the shares issued as a result of the rollover all carry the same voting rights and rights to income.

Also on the same day declarations of trust were made and less than five shares were transferred:

• X - to hold one ordinary $1 share upon trust.

• X - to hold one ordinary $1 share upon trust.

• X & X - to hold one ordinary $1 share upon trust (jointly).

These declarations of trust were made to comply with the requirements of the Corporations Act which, at that time, stipulated that a company must have a minimum of two shareholders and two directors (Companies Act 1981, subsection 219(1)).

The Declarations of Trust state that the individuals hold the shares "as Trustee for and on behalf of X Family Trust which has paid for the said shares."

Has the creation of the new shares and the transfer of the original shares to the X Family Trust resulted in a change in majority underlying interests?

The X Family Trust is a discretionary trust. The beneficiaries of the Trust are members of X's family and entities associated with them.

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 of the ITAA 1936, 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 as subsection 149-30(2) of the ITAA 1997 which 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.

Exercise of trustee's discretion

The distributions made by the Trustee suggest that the trust is being administered 'for the benefit of a particular family'. It would be reasonable to assume that X and X still remained the ultimate owners of the Company and the creation of the new shares as a result of the section 160ZZN roll over has not altered the majority underlying interests in the Company. There is nothing to suggest that the beneficial ownership of the shares was transferred to other individuals or entities.

The section 160ZZMA rollover

X and X were subsequently divorced. As a result of a court order (under The Family Law Act 1975) all shares in the Company, previously held by the X Family Trust, were transferred to X, who became the sole shareholder in the Company. The transfer of the shares was eligible for rollover relief under section 160ZZMA of the ITAA 1936 (Transfer of Assets from Company or Trust to Spouse upon Marriage Breakdown). Because of the 'two directors/two shareholders' rule in force at that time one share was subsequently transferred upon trust to X's parent.

On the basis that X and X continued to hold a 50% interest each in the Company until the section 160ZZM rollover, the transfer of X's interests to X does not constitute a change in majority underlying interests. Neither individual held beneficial interests of more than 50% in the Company.

CGT status of the Company shares

The Company was registered prior to 20 September 1985. The three original shares were held by Mr and Mrs X (1 share each and 1 share jointly). These shares were acquired before 20 September 1985.

A trust to company roll-over (section 160ZZN of the ITAA 1936) occurred which resulted in the issue of more than 200,000 new shares in the Company in return for the transfer of plant and goodwill to the Company. As the plant and goodwill were acquired before 20 September 1985, the shares were deemed by subsection 160ZZN(7) of the ITAA 1936 to be pre-CGT shares.

Subsequently there was a transfer (roll-over) of shares to X as a result of divorce proceedings. The transfer was pursuant to an order of a court under the Family Law Act 1975 (paragraph 160ZZM(1)(b)(i) of the ITAA 1936). Under subsection 160ZZMA(2)(a) of the ITAA 1936 the roll-over asset will be deemed to still be a pre-CGT asset if that asset was acquired before 20 September 1985. As the shares still maintained their pre-CGT status under the previous rollover, they will still be deemed to be acquired before 20 September 1985.

Conclusion

It is the Commissioner's view that as there has not been a change in the majority underlying interests in the Company, the goodwill of the Company is taken to be a pre-CGT asset.

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