Edited version of your written advice

Authorisation Number: 1051465886067

Date of advice: 14 December 2018

Ruling

Subject: Income tax - Capital gains tax - Exemptions - Pre-CGT assets - Income tax - Capital gains tax - CGT events - CGT events K1 to K12 - other CGT events

Question 1

Will the capital gain on the disposal of shares in ABC Pty Ltd by the A & B Partnership that arises under CGT event A1 be disregarded under paragraph 104-10(5)(a) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Is the goodwill of XYZ Pty Ltd property that was acquired before 20 September 1985 (i.e. pre-CGT) for the purpose of subsection 104-230(2) of ITAA 1997?

Answer

Yes.

Question 3

Will CGT event K6 under section 104-230 of the ITAA 1997 apply to the disposal of shares in ABC Pty Ltd by the A & B Partnership?

Answer

No.

This ruling applies for the following period

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

1. The relevant business is owned and operated by XYZ Pty Ltd.

2. XYZ Pty Ltd has continuously owned and operated the Australian business since well before September 1985.

3. 100% of the shares in XYZ Pty Ltd are owned by ABC Pty Ltd. ABC Pty Ltd has owned XYZ Pty Ltd continuously since well before September 1985.

Proposed restructure

4. The A & B Partnership presently own 100% of the shares in ABC Pty Ltd.

5. ABC Pty Ltd in turn owns 100% of various subsidiaries including XYZ Pty Ltd.

6. A restructure is being contemplated which involves A & B Partnership transferring ownership of 100% of the shares in ABC Pty Ltd to a newly incorporated company (“NewCo”).

Pre-CGT

7. The shares in ABC Pty Ltd currently held by the A & B Partnership were acquired by the partnership as a result of the demerger of ABC Pty Ltd by A Pty Ltd.

8. The A & B Partnership has continued to own 100% of the shares in ABC Pty Ltd since the demerger, other than for a minority employee shareholding between 20XX and 20XX.

Goodwill of XYZ Pty Ltd

9. The Australian business is operated by XYZ Pty Ltd. The business began in 19XX and has evolved into a fully integrated business.

10. Many of the customers the business has today have been customers since early 19XXs.

11. A compatible business was acquired in 20XX. Prior to the acquisition, XYZ Pty Ltd had used this business as a partner to enable the provision of services to its customers.

Following the acquisition of this business by XYZ Pty Ltd, the brand of the acquired business was immediately discontinued.

Assumption

15. An assumption is made that for the purposes of determining whether CGT event K6 applies, that there is no material change in the financials of ABC Pty Ltd and its relevant subsidiaries from 30 June 20XX to the date of the transaction when it is implemented.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 160ZZN

Income Tax Assessment Act 1936 Section 160ZZNA

Income Tax Assessment Act 1936 Section 160ZZO

Income Tax Assessment Act 1997 Paragraph 104-10(5)(a)

Income Tax Assessment Act 1997 Section 104-230

Income Tax Assessment Act 1997 Subsection 104-230(1)

Income Tax Assessment Act 1997 Subsection 104-230(2)

Income Tax Assessment Act 1997 Paragraph 104-230(2)(a)

Income Tax Assessment Act 1997 Paragraph 104-230(2)(b)

Income Tax Assessment Act 1997 Section 125-80

Income Tax Assessment Act 1997 Subsection 125-80(5)

Reasons for Decision

These reasons for decision accompany the Notice of private ruling for A & B Partnership.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

All legislative references are to the ITAA 1997 unless otherwise specified.

Question 1

Will the capital gain on the disposal of shares in ABC Pty Ltd by the A & B Partnership that arises under CGT event A1 be disregarded under paragraph 104-10(5)(a) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

16. Yes. The ABC Pty Ltd shares held by the A & B Partnership are pre-CGT such that any capital gain that arises upon their disposal under CGT event A1 will be disregarded pursuant to paragraph 104-10(5)(a).

Detailed reasoning

17. Subsection 104-10(1) provides that CGT event A1 happens if you dispose of a CGT asset. A share in ABC Pty Ltd is a CGT asset. The A & B Partnership will dispose of a CGT asset (i.e. shares in ABC Pty Ltd) when they are transferred to NewCo under the planned restructure.

18. Under paragraph 104-10(5)(a), a capital gain or loss made by the A & B Partnership is disregarded if the asset was acquired by the partnership before 20 September 1985.

19. In general, you acquire a CGT asset when you become its owner (section 109-5). The time at which you acquire a CGT asset could also depend on whether you acquired the asset as a result of a CGT event happening or without a CGT event happening (sections 109-5 and 109-10). There are also specific acquisition rules under Subdivision 109-B which could impact the time of acquisition.

20. The shares in ABC Pty Ltd currently held by the A & B Partnership were acquired as a result of the demerger of ABC Pty Ltd by A Pty Ltd.

21. The shares in ABC Pty Ltd held by the A & B Partnership are deemed to have been acquired before 20 September 1985, as a result of the combined application of subsections 125-80(5) and 125-70(1).

22. The A & B Partnership has continued to own 100% of the shares in ABC Pty Ltd since the demerger, other than for a minority employee shareholding between 20XX and 20XX.

Conclusion

23. Therefore, any capital gains on the future disposal of shares in ABC Pty Ltd by the A & B Partnership that arises under CGT event A1 will be disregarded under paragraph 104-10(5)(a).

Question 2

Is the goodwill of XYZ Pty Ltd property that was acquired before 20 September 1985 (i.e. pre-CGT) for the purpose of subsection 104-230(2) of ITAA 1997?

Summary

24. Yes. The business of XYZ Pty Ltd has retained its essential nature and character since 20 September 1985. Therefore, the goodwill of XYZ Pty Ltd is a pre-CGT asset that was acquired before 20 September 1985.

Detailed reasoning

CGT event K6

25. The planned disposal of the shares in ABC Pty Ltd by the A & B Partnership to NewCo will involve the disposal of pre-CGT shares. CGT event K6 under section 104-230 could potentially arise if the conditions under subsection 104-230(1) are met.

26. Subsection 104-230(2) contains two requirements, at least one of which must be satisfied before CGT event K6 can happen pursuant to paragraph 104-230(1)(d).

27. Subsection 104-230(2) requires that, just before the other event happened (which refers to the event in paragraph 104-230(1)(b)):

a. the market value of property of the company (that is not trading stock) that was acquired on or after 20 September 1985, or

b. the market value of interests the company owned through interposed companies in property (except trading stock) that was acquired on or after 20 September 1985

must be at least 75% of the net value of the company or trust.

28. In your case, the ‘company’ that is referred to in subsection 104-230(2) is ABC Pty Ltd.

Goodwill is property

29. The term ‘property’ is not defined for the purposes of CGT event K6, although trading stock is specifically excluded. Property in section 104-230 therefore takes its ordinary legal meaning (see ICI Australia Ltd v. Commissioner of Taxation; Hepples v. Commissioner of Taxation; R v. Toohey; Ex parte Meneling Station Pty Ltd; Naval, Military and Airforce Club of South Australia Inc v. Commissioner of Taxation).

30. In paragraph 15 of Taxation Ruling TR 1999/16: income tax: capital gains: goodwill of a business (TR 1999/16), the Commissioner recognises that goodwill is a species of intangible property. Goodwill is therefore property for the purpose of subsection 104-230(2).

Goodwill of LA

31. The goodwill of XYZ Pty Ltd is relevant to the second test under paragraph 104-230(2)(b), as property that is owned by lower tier companies in which the company referred to in paragraph 104-230(2)(a) has a direct or indirect interest (i.e. the goodwill of XYZ Pty Ltd is property that is owned by ABC Pty Ltd through its ownership of the shares in XYZ Pty Ltd).

32. The goodwill of XYZ Pty Ltd is not relevant to the first test under paragraph 104-230(2)(a) because the goodwill of XYZ Pty Ltd is taken into account in the market value of the equity interests in XYZ Pty Ltd owned by ABC Pty Ltd (rather than as a separate item of property owned by ABC Pty Ltd).

33. However, paragraph 104-230(2)(b) only takes into account the market value of property that was acquired on or after 20 September 1985 (i.e. post-CGT). To the extent that goodwill of a company was acquired before 20 September 1985 (i.e. pre-CGT), the market value of such goodwill will not be included under paragraph 104-230(2)(b).

34. The Commissioner is therefore required to consider whether the goodwill of XYZ Pty Ltd is pre-CGT or post-CGT for the purposes of the second test under paragraph 104-230(2)(b).

Meaning of Goodwill

35. TR 1999/16 considers the general meaning of goodwill as used in the context of the CGT provisions. The ruling reflects the decision of the High Court of Australia (HCA) in FC of T v. Murry 98 ATC 4585; (1998) 39 ATR 129 (Murry).

36. Relevantly, paragraph 9 of TR 1999/16 explains that goodwill has the meaning it bears under the general law, rather than its accounting and business definitions. It is the legal definition of goodwill as explained by the HCA in Murry which is applicable. According to the HCA in Murry, goodwill has three different aspects namely property, sources and value.

37. As explained in paragraph 12 of TR 1999/16:

….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….

(emphasis added)

Goodwill remains a single CGT asset if the same business continues

38. Goodwill is a composite thing. As explained in paragraph 17 of TR 1999/16, one consequence of goodwill being a single asset is that the whole 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.

39. However, it is possible for a business to 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.

Changes to the business

40. Whether the same business is carried on is a question of fact and degree that ultimately depends on the circumstances of each particular case. As noted in paragraph 20 to 21 of TR 1999/16 the test is not the same test as the ‘same business test’ used to determine the availability of tax losses under subsection 165-210(1). Unlike the same business test used under subsection 165-210(1), the business does not need to be identical from its acquisition date. If the essential nature or character of the business is not changed, the business remains the same business for the CGT goodwill provisions.

41. In this regard, paragraph 21 of TR 1999/16 provides that:

A business owner may expand or contract, 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.

Whether new goodwill is acquired on the acquisition of a new business

42. Paragraph 63 and 64 of TR 1999/16 discuss purchased goodwill (as opposed to internally generated goodwill which is discussed in paragraphs 60 to 62 of TR 1999/16) and what happens to the goodwill of an existing business when it acquires an additional business purchased as a going concern.

43. Paragraphs 63 and 64 in TR 1999/16 provide as follows:

63. If a taxpayer who founded or purchased a business adds to that business an additional business purchased as a going concern, it is a question of fact dependent on the circumstances of each particular case whether the additional business is subsumed into and forms part of the existing business or whether the two businesses remain as separate businesses. If two post-CGT businesses are subsumed in this way, the goodwill of the businesses coalesce and the cost base of the goodwill of the business purchased as a going concern becomes part of the cost base of the goodwill of the entire business.

64. If a pre-CGT business is combined with another business acquired post-CGT and they are conducted as one business without the pre-CGT business losing its essential nature or character, the goodwill of the post-CGT business is subsumed into the goodwill of the pre-CGT business and all of the goodwill of the business is taken to have been acquired before 20 September 1985. The goodwill of each of the businesses coalesce without any disposal of the goodwill of the post-CGT business. The pre-CGT business must not lose its essential nature or character in the sense that it must remain the same business and not be overwhelmed by the post-CGT business in such a way that it has become a different business. The purchase of the post-CGT business must involve merely organic growth of the pre-CGT business or an expansion or accretion to it in reasonable proportions or it gives rise to a new, different business and its goodwill is a new asset.

(emphasis added)

Application of the facts

44. The facts indicate that by 20 September 1985, XYZ Pty Ltd was operating a range of integrated activities that made up its integrated business.

45. The Commissioner accepts that the essential character of the business of XYZ Pty Ltd has not changed since September 1985. This is the case despite the occurrence of the things listed below which should be seen as part of the organic expansion of the business:

a. improvements to technology employed in the business

b. the increased level of sophistication of how the business is operated

c. the increased integration of the business, and

d. the addition of products or services offered.

46. The Commissioner agrees that the acquisition of the compatible business by XYZ Pty Ltd in 20XX did not result in the acquisition of new goodwill or result in the commencement of a new business. Instead, the additional business was subsumed into and forms part of XYZ Pty Ltd’s existing integrated business without that business losing its essential nature or character. The result is that the goodwill of the acquired business is subsumed into the goodwill of XYZ Pty Ltd’s pre-CGT integrated business and all of the goodwill of XYZ Pty Ltd’s business is taken to have been acquired before 20 September 1985.

Conclusion

47. Therefore, the goodwill of XYZ Pty Ltd is a pre-CGT asset that was acquired before 20 September 1985.

Question 3

Will CGT event K6 under section 104-230 of the ITAA 1997 apply to the disposal of shares in ABC Pty Ltd by the A & B Partnership?

Summary

48. No. CGT event K6 will not apply on the disposal of shares in ABC Pty Ltd because the requirement in subsection 104-230(2), also known as the “75% test”, is not satisfied.

Detailed reasoning

49. Subsection 104-230(1) states that:

CGT event K6 happens if:

(a) you own shares in a company that you acquired before 20 September 1985; and

(b) CGT event A1, C2, E1, E2, E3, E5, E6, E7, E8, J1 or K3 happens in relation to the shares or interest; and

(c) there is no roll-over for the other CGT event; and

(d) the applicable requirement in subsection (2) is satisfied.

50. Subsection 104-230(2) states that:

Just before the other event happened:

(a) the market value of property of the company or trust (that is not its trading stock) that was acquired on or after 20 September 1985; or

(b) the market value of interests the company or trust owned through interposed companies or trusts in property (except trading stock) that was acquired on or after 20 September 1985;

must be at least 75% of the net value of the company or trust.

51. As stated in paragraph 16 of Taxation Ruling TR 2004/18: income tax: capital gains: application of CGT event K6 (about pre-CGT shares and pre-CGT trust interests) in section 104-230 of the Income Tax Assessment Act 1997 (TR 2004/18), the “75% test” (as the test under subsection 104-230(2) is referred to in TR 2004/18) is satisfied if one or both of the tests in paragraphs 104-230(2)(a) or (b) are met.

52. Subsection 104-230(5) states that the time of CGT event K6 is when the other event happens and is a reference to the relevant CGT event that happens in relation to the shares or interest under paragraph 104-230(1)(b).

53. In respect of the requirements in paragraphs 104-230(1)(a) to (c) it is noted that:

● the shares in ABC Pty Ltd are pre-CGT shares

● CGT event A1 will arise on the disposal of the ABC Pty Ltd shares by the A & B Partnership to NewCo, and

● there is no rollover relief in respect of the disposal of the ABC Pty Ltd shares to NewCo.

54. For the purposes of the tests under subsection 104-230(2), the calculations are in respect of the values ‘just before the other event happened’. In your case, the ‘other event’ refers to CGT event A1 that happens when the pre-CGT ABC Pty Ltd shares are disposed of by the partnership. Therefore, the applicable test time for subsection 104-230(2) is just before CGT event A1 happens to the shares in ABC Pty Ltd.

When CGT event A1 happens

55. Subsection 104-10(1) states that CGT event A1 happens if you dispose of a CGT asset.

56. Subsection 104-10(2) states that you dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law.

57. Subsection 104-10(3) states that the time of the event is when you enter into the contract for the disposal or if there is no contract, when the change of ownership occurs.

58. To the extent that the ABC Pty Ltd shares that are held by the A & B Partnership are disposed of to NewCo under a contract, the calculations under subsection 104-230(2) are based on the values at the date of contract.

59. To the extent that ABC Pty Ltd shares are not disposed of under a contract, the calculations under subsection 104-230(2) are based on the values at the time the ownership change occurs.

75% Test 1: paragraph 104-230(2)(a)

60. The 75% test is satisfied if, just before CGT event A1 occurs to the shares in ABC Pty Ltd, the market value of property of ABC Pty Ltd that was acquired on or after 20 September 1985 equals or exceeds 75% of the net value of ABC Pty Ltd.

61. As stated in paragraph 17 of TR 2004/18, property, for the purposes of paragraph 104-230(2)(a) can include post-CGT shares in, or loans to, lower tier companies.

62. The market value of post-CGT property of ABC Pty Ltd is below 75% of the net value of ABC Pty Ltd and paragraph 104-230(2)(a) is not satisfied.

75% Test 2: paragraph 104-230(2)(b)

63. The 75% test is satisfied if, just before CGT event A1 occurs to the shares in ABC Pty Ltd, the market value of property that ABC Pty Ltd owned through interposed companies that was acquired on or after 20 September 1985 equals or exceeds 75% of the net value of ABC Pty Ltd.

64. As explained in paragraph 18 of TR 2004/18, the property taken into account under paragraph 104-230(2)(b) is post-CGT property that is owned by lower tier companies in which the company referred to in paragraph 104-230(2)(a) has a direct or indirect interest. It does not matter whether the shares in the lower tier company giving rise to the interest were acquired pre-CGT or post-CGT.

65. The market value of interests ABC Pty Ltd owned through interposed companies in post-CGT property is below 75% of the net value of ABC Pty Ltd and paragraph 104-230(2)(b) is not satisfied.

66. Since neither paragraph 104-230(2)(a) or (b) applies, subsection 104-230(2) is not satisfied, resulting in CGT event K6 not applying as the condition in paragraph 104-230(1)(d) is not met.

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