Edited version of your written advice

Authorisation Number: 1051294972145

Date of advice: 18 January 2018

Ruling

Subject: Business reorganisation – CGT and Part IVA

Question 1

Will the Commissioner confirm that no CGT event will occur in relation to the goodwill of AusCo tax consolidated group (AusCo TCG) as a result of the commencement 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 for AusCo Ltd in relation to the extension of The X Agreement?

Answer

Yes.

Question 3

Will the Commissioner exercise his power and make a determination pursuant to paragraphs 177F(1)(a) and (d) of the Income Tax Assessment Act 1936 to cancel the whole or part of any tax benefits of a kind referred respectively under paragraphs 177C(1)(a) and (bb) obtained, or that would but for paragraphs 177F(1(a) and (d) be obtained, by AusCo Ltd in connection with the Scheme?

Answer

No.

The scheme commences on:

Implementation Date

Relevant facts and circumstances

1. AusCo Ltd (AusCo) is an Australian resident head entity of an income tax consolidated group (AusCo TCG) and is also the ultimate holding company of a global group of companies (AusCo group).

2. The AusCo group started an initiative some time ago to improve its global operations and management. Among others, the initiative involved the establishment of an offshore related entity, ForeignCo Ltd (ForeignCo).

3. Currently, the AusCo TCG manufactures numerous products in Australia for sale and distribution domestically and overseas. These products are manufactured in Australia by a member of the AusCo TCG, SubCo Ltd (SubCo).

4. As part of adopting the initiative in Australia there is a need to undertake the following transactions.

5. Several discrete assets will be transferred by AusCo to ForeignCo for consideration.

6. There will be an extension to the X Agreement to enable it to extend to additional products for no consideration.

7. A new manufacturing and distribution model will be introduced where AusCo or SubCo will be compensated for undertaking certain manufacturing and distribution functions on behalf of ForeignCo.

8. This will involve entering into the relevant legal framework such as manufacturing and distribution agreements that affect the export of certain products on or before the proposed commencement date.

9. Post commencement ForeignCo will have ownership of certain finished products and will sell these to related foreign entities for on sale to their respective domestic market and AusCo will continue to sell to the Australian market.

10. There will be changes to the AusCo group’s supply chain; movement of staff to ForeignCo and expected substantial commercial benefits.

11. As a result there will also be increases in foreign income tax offsets (FITO) allowable, a reduction in Earnings Before Interest and Tax (EBIT) for AusCo, and reduction in the assessable income and the Australian income tax payable, by the Ausco group.

12. Under the new model ForeignCo will undertake all export sales outside the Australian market by supplying the products to related non-Australian group entities who will then sell and distribute product within their respective domestic markets.

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)

Income Tax Assessment Act 1936 section 177C

Income Tax Assessment Act 1936 section 177CB

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 section 177F

Income Tax Assessment Act 1936 Part X

Reasons for decision

All legislative references in the Reasons for decision are to the Income Tax Assessment Act 1936 unless otherwise stated.

Question 1

Summary

The Commissioner confirms that no CGT event will happen in relation to the goodwill of the AusCo TCG as a result of the implementation of the initiative in Australia.

Detailed reasoning

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

2. Section 104-5 contains a summary of CGT events that can happen to CGT assets. The following CGT events can happen in relation to goodwill:

● 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?

3. 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).

4. 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.

5. ‘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.

6. 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).

7. 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.

8. Under the Scheme, the assets dealt with by the AusCo TCG as part of the business re-organisation in Australia comprise of separately identified assets being transferred to ForeignCo:

9. The assets comprise only of discrete, separately identified assets of the AusCo TCG. Applying the principles in Murry, the disposal of the assets will not involve any disposal of goodwill of the AusCo TCG. The goodwill of the AusCo TCG is a separate asset of the AusCo TCG’s business, and does not inhere in the other assets of its business, including in the assets that will be transferred on the commencement date. The goodwill of the AusCo 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

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

11. 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.

12. The disposal of the assets does not involve any disposal of any “sub-business” of the AusCo TCG, or any disposal of a discrete business that any transferee (i.e. ForeignCo) could conduct. The CGT assets that will be disposed of following the implementation of the initiative in Australia are not sufficient to enable the ForeignCo to carry on the business that the AusCo TCG carried on, and are not sufficient to be considered an entire, self-contained business. The implementation of the initiative 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.

13. Accordingly, the commencement of the initiative 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

14. 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.

15. Accordingly, the implementation of the initiative in Australia will not result in CGT event A1 happening in relation to the goodwill of the AusCo TCG.

Does CGT event C1 happen as a result of the commencement of the initiative in Australia?

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

17. 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.

18. 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.

19. 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.

20. 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.

21. An effect of the commencement of the initiative in Australia will be that AusCo TCG will change its manufacturing risk profile and model.

22. However the AusCo TCG will retain its essential character of manufacturing and supplying products and services in relation to the same markets. The AusCo TCG will continue to conduct its same business and will still be manufacturing the same products. 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 functional areas of human resources, projects and technology, strategy, and corporate affairs and responsibility after implementation.

23. The sources of goodwill of the AusCo 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 AusCo TCG will cease as a result and there will only be a transfer/ending of discrete, separately identified assets of the AusCo TCG.

Conclusion

24. The commencement of the initiative in Australia will not result in the business of the AusCo TCG changing its essential nature or character, or changing to such an extent that it is no longer the same business.

25. Accordingly the goodwill of the AusCo TCG will not become ‘lost or destroyed’ for the purposes of section 104-20 and CGT event C1 will not apply.

26. The Commissioner confirms that no CGT event will happen in relation to the goodwill of the AusCo TCG as a result of the implementation of the initiative in Australia

Question 2

Summary

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

Detailed reasoning

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

1. 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)).

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)).

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).

4. 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)).

5. On our facts, there will be contractual variations under the X Agreement as a result of it being extended to apply to additional products.

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

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

Question 3

Summary

The Commissioner will not make a determination under paragraphs 177F(1)(a) and (d) to cancel the whole or part of any tax benefit of a kind referred respectively under paragraphs 177C(1)(a) and (bb) obtained, or that would but for paragraphs 177F(1)(a) and (d) be obtained, by AusCo as a result of the Scheme?

Detailed reasoning

1. Part IVA applies to a scheme, or any part of a scheme, entered into or carried out by a person for the dominant purpose of enabling a taxpayer to obtain a tax benefit in connection with the scheme. If Part IVA applies to a scheme, the Commissioner can make a determination under section 177F to cancel the tax benefit obtained under the scheme.

The Scheme

2. The relevant identified Scheme as described at paragraph 12 of the relevant facts and circumstances entails the new model whereby ForeignCo will undertake all export sales outside the Australian market by supplying the products to related non-Australian group entities who will then sell and distribute product within their respective domestic markets

3. The steps involved in the Scheme include entry into the relevant legal framework that affects the export of certain products.

The Tax Benefit

4. Broadly, subsection 177C(1) provides that a tax benefit exists for the purposes of Part IVA where it would, or might reasonably be expected that, an amount would be included in assessable income; a deduction would not be allowable; a capital loss would not be incurred; or a foreign tax credit would not be allowable; to the taxpayer in a year of income, if the scheme had not been entered into or carried out.

5. Subsection 177D(3) provides that Part IVA only applies to the Scheme if the relevant taxpayer has obtained or would obtain a tax benefit in connection with the scheme.

6. The relevant enquiry in determining the tax benefit would therefore be the difference between what would be, as head of the Ausco TCG, AusCo’s FITO and assessable income under the Scheme entered into or carried out and what would be, or might reasonably be expected to be, AusCo’s FITO and assessable income if the scheme had not been entered into or carried out.

7. Section 177CB refers to two bases upon which the existence of tax benefits can be established, the ‘would have’ and the ‘might reasonably be expected to have’ approaches.

8. The first approach, otherwise known as the annihilation or ‘would have’ approach, is that if the scheme had not been entered into or carried out what ‘would have’ been the tax outcome for AusCo, as head of the AusCo TCG.

9. Under this approach, the postulate would be not to proceed with the Scheme in regard to the export of the relevant products.

10. This approach identified tax benefits for AusCo (as head company of the AusCo TCG) in relation to the omitted amounts of assessable income and increased FITO allowable for the AusCo TCG.

The applicable purpose test

11. In determining objectively whether the sole or dominant purpose in entering into the scheme is to obtain (or would but for section 177(F)) a tax benefit, regard must be had to the eight matters outlined in subsection 177D(2).

Manner, substance & timing of the Scheme and nature of connection of entities in the scheme

12. The first three matters in paragraphs 177D(2) (a), (b) and (c) direct us to examine how the scheme is to be carried out; to focus our attention on the commercial and economic substance of the scheme; and to consider whether timing aspects of the scheme achieve a beneficial tax outcome.

13. Paragraph 177D(2)(h) enquires into the nature of the connection of the relevant taxpayer or any other person in connection with the scheme, and along with the above three matters, consider how the scheme achieves its effect to determine whether the taxpayer had the requisite purpose.

14. The relevant Scheme involves a new model whereby ForeignCo will undertake all export sales outside the Australian market by supplying the products to related non-Australian group entities who will then sell and distribute product within their respective domestic markets. This forms part of the broader commencement of the initiative in other regions.

15. The Scheme requires that the parties enter into the relevant legal framework before the proposed commencement date.

16. The legal framework will facilitate transactional and operational efficiency and affects numerous aspects of the supply chain of the products produced.

17. The timing of the Scheme is consistent with the wider planned commencement of the initiative in Australia and is also aligned with a long period of transition into a more centralised operation for regional activities offshore.

18. Together, all these factors do not indicate any contrivance or artificiality in respect of the Scheme. There is no discrepancy when comparing the intended manner in which the Scheme is to be implemented and the desired practical outcome expected from the scheme.

Non-tax consequences as a result of the Scheme

19. The other three matters in paragraphs 177D(2)(e), (f) and (g) focus on the legal, financial and other non-tax consequences for AusCo and related entities as a result of the Scheme. These factors direct an inquiry into the practical non-tax outcomes to assess whether the sole or dominant purpose of AusCo in entering into the Scheme is to obtain a tax benefit.

20. The changes to the ownership of certain assets, some of the functions performed and certain risks borne by AusCo, SubsidiaryCo, ForeignCo and relevant foreign AusCo group entities, reflect the legal framework of the Scheme.

21. These changes are necessary features of the Scheme in order to achieve the expected economic and financial gains for the AusCo group, including AusCo TCG.

22. Specifically, there will be substantial non-tax commercial gains under the Scheme that are expected to arise from improvements in the operations which are also anticipated to benefit the AusCo group and AusCo TCG.

23. Together these anticipated non-tax consequences and the previous matters in subsection 177D(2) discussed earlier indicate that the Scheme is reasonably expected to result in practical changes in the overall financial, legal and economic position of AusCo group, which includes AusCo and the AusCo TCG.

Tax consequences as a result of the Scheme

24. The final matter to be discussed in subsection 177D(2) requires consideration of the tax consequences that would be achieved by the Scheme in evaluating whether AusCo has the sole or dominant purpose in entering into scheme of obtaining the tax benefits (paragraph 177D(2)(d)).

25. The estimated tax benefits for AusCo in entering into the Scheme is the amount not included in the assessable income and the increase in FITO allowable in each income year as a result of entering into or carrying out the Scheme.

26. There will also be a net tax result under the Scheme that would be obtained by AusCo, representing the overall reduction in its Australian income tax payable in contrast with its Australian income tax payable had an alternative scheme been entered into or carried out.

27. Finally, there will be financial benefits worldwide and in Australia from the initiative, including the new manufacturing and distribution models for the relevant income years.

28. The estimated financial benefits as a result of the Scheme are significant when compared with the estimated increase in FITO allowable and the reduction in assessable income and Australian income tax payable for the relevant income years under the scheme.

Conclusion

29. Having regard to the eight matters in subsection 177D(2), we conclude that AusCo does not have a sole or dominant purpose in entering into the Scheme of obtaining a tax benefit. Rather, the Scheme is proposed to be entered into as part of the global reorganisation taking place within the AusCo group and AusCo TCG in order to achieve practical outcomes from the Scheme which has a significant commercial basis.

30. Accordingly, the Commissioner will not exercise his power to make a determination pursuant to paragraphs 177F(1)(a) and (d).

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