Edited version of your written advice

Authorisation Number: 1013094405005

Date of advice: 5 October 2016

Ruling

Subject: Pre-CGT asset

Question 1

Is the goodwill of the Business operated by Company X a pre-CGT asset as that term is defined in section 149-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

If the answer to question 1 is yes, will the goodwill cease to be a pre-CGT asset due to the Proposed Share Transfer pursuant to section 149-30 of the ITAA 1997?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

Year ending 30 June 2020

The scheme commences on:

1 July 2016

Relevant facts and circumstances

The Business was established before 1985 by A and B.

The Business was transferred to Company X (the taxpayer) which was incorporated before
20 September 1985. The shareholders of Company X are A, B and Company Y (which was also incorporated before 20 September 1985).

The shareholders of Company Y are A, B and B as trustee for C and D.

The shares in Company X and Company Y carry discretionary rights to receive distributions of income and capital. Directors can declare and pay dividends in relation to any class of shares.

Since before 20 September 1985 the Business has grown and continued to expand. To date the following events occurred:

1. The Business was relocated to larger premises before 20 September 1985.

2. The Business has opened up several branches, including interstate locations.

3. Increased customer and employee bases were achieved.

4. After 20 September 1985 the Business changed its trading name, but its main Business and structure remained the same.

5. Company X became the exclusive Australian distributer for a range of goods within its industry.

6. After 20 September 1985 Company X constructed an assembly factory to keep up with demand for their goods.

In 20XX a valuation was conducted on the Business by a registered valuer. The valuation provided the following information:

• The net value of Company X (being the amount by which the sum of the market value of the assets of Company X exceeds the sum of its liabilities).

• The market value of all of the property, excluding trading stock and goodwill (if any) which exists in the business operated by Company X.

• The market value of the goodwill (if any) which exists in the Business.

• The market value of the fully paid ordinary share in Company X held by Company Y.

In relation to dividend payments made by Company X from before 20 September 1985 to date:

• all dividends have been paid to Company Y to the exclusion of the other shareholders (being A and B); and

• but for one exception, all dividends received by Company Y have, in turn, been paid to A and B in their own right. That one exception relates to a dividend payment paid to B in their capacity as trustee for C and D.

Proposed Share Transfer

Company Y is considering a proposal to transfer its ordinary share in Company X to either another proprietary company of which A and B are the sole shareholders (NewCo), or to A and B in their own right (Proposed Share Transfer).

Market value consideration will be paid by NewCo or A and B (as applicable) for the transfer of the ordinary share.

Assumption

NewCo will not be a company whose constitution prevents it from making any distributions, whether in money, property or otherwise, to its members.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 3-1

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

Income Tax Assessment Act 1997 subsection 104-10(5)

Income Tax Assessment Act 1997 subsection 109-5(2)

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

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1997 section 149-10

Income Tax Assessment Act 1997 paragraph 149-10(a)

Income Tax Assessment Act 1997 paragraph 149-10(b)

Income Tax Assessment Act 1997 paragraph 149-10(c)

Income Tax Assessment Act 1997 section 149-15

Income Tax Assessment Act 1997 subsection 149-15(1)

Income Tax Assessment Act 1997 subsection 149-15(2)

Income Tax Assessment Act 1997 subsection 149-15(3)

Income Tax Assessment Act 1997 subsection 149-15(4)

Income Tax Assessment Act 1997 subsection 149-15(5)

Income Tax Assessment Act 1997 section 149-30

Income Tax Assessment Act 1997 subsection 149-30(1)

Income Tax Assessment Act 1997 subsection 149-30(2)

Reasons for decision

Question 1

Summary

The goodwill generated by the Business is a pre-CGT asset as the goodwill is considered to have been acquired before 20 September 1985; Division 149 of the Income Tax Assessment Act 1997 does not apply to stop the goodwill being a pre-CGT asset; and the Business operated by Company X has not changed.

Detailed reasoning

Goodwill, or an interest in it, is a CGT asset (paragraph 108-5(2)(b)).

CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1)).

Subsection 104-10(5) provides that a capital gain or capital loss you make from a CGT event A1 is disregarded if you acquired the asset before 20 September 1985.

Division 149 provides that the pre-CGT status of assets (including goodwill) owned by a company or trust can be lost if there is a change in the majority underlying interests in the assets.

Disposal of a CGT asset

Before 20 September 1985, A and B transferred the Business to Company X. As no formal contract was executed by the parties to effect the transfer of the Business from A and B to Company X, Company X was deemed to have acquired the Business at the time at which A and B ceased to own that asset (subsection 109-5(2)).

Accordingly, Company X is deemed to have acquired any goodwill (attributed to the time A and B operated the Business) before 20 September 1985.

Is the goodwill of the Business a pre-CGT asset?

According to Taxation Ruling TR 1996/16 (TR 1999/16) goodwill has the legal definition which was established by the High Court in Federal Commissioner of Taxation v. Murry 98 ATC 4585. Paragraph 12 of TR 1999/16 states:

….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 a 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 a business. It cannot be dealt with separately from the business with which it is associated.

Based on the above definition, Company X established goodwill when it commenced business operations prior to 1985 with its Core Business Operations.

For the purposes of Part 3-1 of the ITAA 1997, goodwill acquired before 20 September 1985 remains a single pre-CGT asset (subject to the operation of Division 149, discussed below) if the same business continues to be carried on, "even though the sources of the goodwill of a business may vary during the life of the business; or there are fluctuations in goodwill during the life of the business" (paragraph 17 of TR 1999/16). Furthermore, goodwill is one CGT asset that is separate and distinct from other assets such as plant, licenses and rights (paragraph 27 of TR 1999/16).

A business or the sources of its goodwill may change to such an extent that it is no longer the same business, resulting in the goodwill of the old business ceasing when the goodwill of the new business is established. Paragraph 21 of TR 1999/16 provides guidance on the growth of a business:

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 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 of itself cause it to be a new business provided the business retains its essential nature or character.

Further to the above, paragraph 23 of TR 1999/16 provides that where the types of customers a business attracts change as the business evolves over the years, this will not necessarily mean that the business is no longer the same business that was originally carried on.

Paragraph 24 of TR 1999/16 emphasises that the same essential nature or character of the business is to be carried on and states:

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.

Paragraph 91 of TR 1999/16 provides various factors to consider in determining whether the same business is being carried on. These include:

• the nature and 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.

In applying the above factors to Company X's circumstances it is noted that:

• the Business has operated since before 20 September 1985.

• Since before 20 September 1985 Company X continues to conduct the Core Business Operations from their head office.

• Company X has continued to grow and expand the Business.

• Company X changed its business name (and company name) but the internal structure of the Business did not change.

• Company X's Core Business Operations as a wholesale distributor has expanded.

• To keep up with the continued demand an assembly factory was constructed in 20XX.

• The Business has expanded and grown to include multiple sites across Australia, resulting in an increased customer base and the number of employees.

Whilst the Business has evolved over time since its incorporation, because:

• the essential nature and character of the business, being the Core Business Operations, has remained the same since incorporation;

• the management and control of the Business has remained with A and B; and

• the expansion of the Business and the growth in the customer base can be attributed to the organic growth of the Business and relates solely to the Core Business Operations,

the Business being carried on now is essentially the same as the Business carried on prior to
20 September 1985, the goodwill of the Business is the same asset and retains its status as a pre-CGT asset (subject to the operation of Division 149).

Has there been a change in majority underlying interest of the goodwill?

Section 149-10 states that a CGT asset that an entity owns is only a pre-CGT asset if:

(a)  the entity last acquired the asset before 20 September 1985; and

(c)  the asset has not stopped being a pre-CGT asset of the entity because of this Division.

In relation to paragraph 149-10(a), Company X acquired the goodwill of the Business before
20 September 1985.

In relation to paragraph 149-10(b), Company X was not immediately before the start of the
1998-99 income year taken under either of the stated relevant provisions to have acquired the goodwill of the Business on or after 20 September 1985.

In relation to paragraph 149-10(c), Division 149 stops an asset of a non-public entity being a pre-CGT asset when the "majority underlying interests in the asset were not had by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985" (subsection 149-30(1)).

Immediately before 20 September 1985, the ultimate owners of the Business goodwill pursuant to subsection 149-15(3) were A, B and (as the beneficial holders of shares in Company Y) C and D.

Despite holding 1 ordinary share in Company X, Company Y does not satisfy the definition of "ultimate owner" in subsection 149-15(3), as its constitution permits the company to make income and capital distributions to its shareholders.

As there has been no change in the shareholding of Company X since immediately before
20 September 1985, any majority underlying interests in the goodwill of the Business have been had at all times by the same ultimate owners who had such interests immediately before
20 September 1985, and Division 149 will not affect the pre-CGT status of the goodwill.

Question 2

Summary

No, the goodwill will not cease to be a pre-CGT asset due to the Proposed Share Transfer as 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 that the majority underlying interests in the asset were had by the ultimate owners who had majority underlying interests in the asset immediately before that day.

Detailed reasoning

Goodwill of the Business is a pre-CGT asset for the purposes of section 149-10. However, the goodwill can stop being a pre-CGT asset if the majority underlying interests in the goodwill are not held by the same ultimate owners who held the majority underlying interests in the goodwill immediately before 20 September 1985 (subsection 149-30(1)). Where a change in the ultimate owners who had the majority underlying interests occurs, the CGT asset is deemed to be acquired after 19 September 1985.

Section 149-15 states:

149-15(1)

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.

149-15(2)

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.

149-15(3)

An ultimate owner is:

(a) an individual; or

(b) a company whose constitution prevents it from making any distribution, whether in money, property or otherwise, to its members;

…

149-15(4)

An *ultimate owner indirectly has a beneficial interest in a *CGT asset of another entity (that is not an ultimate owner) if he, she or it would receive for his, her or its own benefit any of the capital of the other entity if:

(a)  the other entity were to distribute any of its capital; and

(b)  the capital were then successively distributed by each entity interposed between the other entity and the ultimate owner.

149-15(5)

An ultimate owner indirectly has a beneficial interest in ordinary income that may be derived from a CGT asset of another entity (that is not an ultimate owner) if he, she or it would receive for his, her or its own benefit any of a dividend or income if:

(a) the other entity were to pay that dividend, or otherwise distribute that income; and

(b) the dividend or income were then successively paid or distributed by each entity interposed between the other entity and the ultimate owner (subsection 149-15(5)).

Subsection 149-30(2) allows the Commissioner, if satisfied, or thinks it reasonable to assume, that at all times on and after 20 September 1985 and before a particular time that the majority underlying interests in the asset were had by the ultimate owners who had majority underlying interests in the asset immediately before that day.

In other words, the Commissioner has to be satisfied that the majority underlying interests in the asset has not changed. Otherwise, the asset is deemed to have been acquired at the time that the change in the majority underlying interest in the asset happened.

Immediately prior to 20 September 1985 the shareholding of Company X was and still is:

• A;

• B; and

• Company Y.

The shareholding of Company Y immediately prior to 20 September 1985 was and still is:

• A;

• B; and

• B as trustee for C and D

Based on the above interests, A and B collectively were the ultimate owners of Company X who had a majority underlying interest in the goodwill of the Business immediately before
20 September 1985.

Under the Proposed Share Transfer, Company Y is proposing to transfer its ordinary share in Company X to NewCo (another proprietary company in which A and B will be the sole shareholders) or to A and B in their own right.

Therefore the new shareholding structure of Company X could be:

• A;

• B; and

• 1 ordinary share to NewCo with A and B as shareholders; or

• 1 ordinary share held by A and B in their own right.

Under the new shareholding structure the ultimate owners of Company X for the purpose of subsection 149-15(3), irrespective of the choice made under the Proposed Share Transfer, would have changed from A, B and B as trustee for C and D to A and B.

As A and B will be the sole ultimate owners of Company X if the Proposed Share Transfer was to take effect, majority underlying interests in the goodwill of the Business would be had by the same ultimate owners who had such interests immediately before 20 September 1985.

Further, in terms of subsection 149-30(2), the Commissioner, under the prevailing circumstances, is satisfied, or thinks it reasonable to assume, that majority underlying interests in the goodwill of the Business have been, and subsequent to the Proposed Share Transfer will continue to be, had by the same ultimate owners (being A and B) who had such interests in that asset immediately before 20 September 1985.

The goodwill of the Business will therefore not cease to be a pre-CGT asset as a result of the operation of section 149-30 if the Proposed Share Transfer takes effect.

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