Edited version of your private ruling

Authorisation Number: 1051639379151

Date of advice: 14 December 2020

Ruling

Subject: Goodwill - pre-CGT asset

Question 1

Is the goodwill attached to the business carried on by the Trust, a pre-CGT asset of the Trust?

Answer

Yes

Question 2

If the answer to question 1 is 'yes', is the Commissioner satisfied, or thinks it is reasonable to assume, that the goodwill of the business is a pre-CGT asset of the Trust pursuant to subsection 149-30(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period(s)

1 July 20XX to 30 June 20XX

The scheme commences on

Pre 19 September 19XX

Relevant facts and circumstances

An entity (the Trust) commenced carrying on a business before 19 September 1985.

Person X is the sole shareholder of Company Trustee.

The Trust made a Family Trust Election (FTE) in 199X in accordance with Schedule 2F of the Income Tax Assessment Act 1936 (ITAA 1936), which has not been varied or revoked. The specified individual for the FTE is Person X.

Starting before 19 September 1985 to the date of the Private Ruling Application (the Relevant Period), the beneficiaries of the Trust have always been Person X and other members of Person X's immediate family and entities owned or controlled by Person X.

No amendments have ever been made to the Trust Deed during the Relevant Period to alter the identity or rights of the beneficiaries of the Trust; or vary the beneficiaries or the Trustee's discretionary power to distribute income and capital.

The Business

Before 19 September 1985, Person X decided to start carrying on his own business which consisted of:

•         a wholesale business, and

•         a logistics, distribution and merchandising services providing delivery of products to wholesale customers.

Since commencement and throughout the Relevant Period, the management, control and the ultimate ownership of the business has, at all times, remained with Person X and family through the Trust.

Person X has also at all time remained the governing mind of the Trustee of the Trust and of the business and has been critical to its success.

The long-term staff of the business have included Person X's immediate family members and otherwise unrelated parties, with three key personnel having been employed within the business for over 20 years. Further increases in staff throughout have occurred due to the organic growth of the business.

The trading name of the business at all times has been XYZ.

XYZ was established as a specialised producer of a number of products.

Since commencement the business has grown and naturally adapted through improved technology, sophistication of processes and efficiencies, occurring as a natural product of organic growth with the nature and character of the business remaining unchanged.

Over time, XYZ has sourced and sold products from other producers which is directly attributable to the ultimate organic growth of the business.

Throughout the Relevant Period, the nature of the assets of XYZ have remained essentially the same in respect to inventory line, plant and equipment, customer contracts and all relevant tangible and intangible assets necessary for the operation of XYZ.

XYZ has maintained a relatively unchanged long-term customer base, supplying their products to large wholesale retail stores.

The business premises of XYZ have, at all times, included the first business premises. XYZ continues to produce and sells its products from this location since the business was established.

Since the commencement of XYZ, the Trust also provides distribution, logistics and merchandising services for the effective delivery of products to large wholesale retail stores through the Trust. The expansion of the business resulted in the distribution, logistics and merchandising services being moved to a second business premises that was acquired.

This service existed as an extension of XYZ, supporting XYZ and all of its customers as well as wholesalers, providing end-to-end management of product delivery to customers.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 section 109-10

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1997 section 149-10

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 Subdivision 149-B

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

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

Income Tax Assessment Act 1936 Division 20

Income Tax Assessment Act 1936 section 160ZZS

Income Tax Assessment Act 1936 Schedule 2F

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.

Question 1

Is the goodwill attached to the business carried on by the Trust, a pre-CGT asset of the Trust?

Summary

The goodwill of the business is considered to be a pre-CGT asset of the Trust, as the business being carried on by the Trust is the same business that was carried on prior to 20 September 1985.

Detailed reasoning

The meaning of 'goodwill'

Whilst there is no statutory definition of 'goodwill' in the Income Tax Assessment Acts, goodwill is specifically included in the definition of a 'CGT asset' at paragraph 108-5(2)(b). Therefore, the meaning of goodwill is to be determined from general law.

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). It is the legal definition of goodwill, rather than its accounting and business definition, which applies according to the High Court in 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.

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.[1] If, for instance, a taxpayer disposes of a business acquired before 20 September 1985 (a 'pre-CGT business'), the whole of the goodwill of the business is taken to have been acquired before that date.[2] Goodwill is not a series of CGT assets that inhere in other identifiable assets of a business. Goodwill, being a composite thing, attaches to the whole business. It does not attach separately to each identifiable asset of the business. Nor is there an element of goodwill in each identifiable asset of a business.[3]

When was the goodwill acquired?

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 (subject to Division 149 - about when an asset stops being a pre-CGT asset), provided the same business continues to be carried on. 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.[4]

According to the Court in Murry, goodwill is identified as property and therefore an asset for CGT purposes, because it is a legal right or privilege to conduct a business in substantially the same manner and by the same means that have attracted custom to it. It follows that goodwill is acquired when a taxpayer acquires the legal right or privilege to conduct the business, generally this arises when the taxpayer commences or purchases a business.

In the case of a purchased business, goodwill is generally acquired at contract date or when the vendor stops being the owner of the goodwill for CGT purposes where the acquisition was not pursuant to a contract.

If a taxpayer commences business and starts to create goodwill, the goodwill of the business is acquired when the taxpayer starts work that result in the creation of the goodwill.[5] 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.[6]

In the present circumstances, the Trust commenced the business before 19 September 1985 and has continued to operate the business since that time.

The goodwill of the business is therefore, taken to have been acquired before 20 September 1985 and will remain a pre-CGT asset where the same business is continued to be carried on.

Same business being carried on

A business may change to such an extent that it becomes a new business with new goodwill. In 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.

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 its 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.[7]

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.[8]

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.[9]

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 existing goodwill 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.[10]

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.[11]

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. Factors to consider include:[12]

•         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.

Nature and character of the business

In relation to 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.

Many businesses naturally evolve by serving different clients or clients in different markets and offering improved products or services. However, 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.[13]

It would seem beyond doubt that 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.

Since commencement the Trust has continued to conduct the same business, which has grown naturally and adapted through improved technology, sophistication of processes and efficiencies, occurring as a natural product of organic growth with the nature of the business remaining unchanged. The goodwill of the business is therefore the same asset and is taken to be acquired before 20 September 1985.

Question 2

If the answer to question 1 is 'yes', is the Commissioner satisfied, or thinks it is reasonable to assume, that the goodwill of the business is a pre-CGT asset of the Trust pursuant to subsection 149-30(2)?

Summary

As the Trustee has continued to administer the Trust in accordance with the Trust Deed for the benefit of the members of the Trust since before 20 September 1985, it is reasonable for the Commissioner to assume that the majority underlying ownership interests have been maintained in the goodwill asset since before 20 September 1985.

Detailed reasoning

CGT asset acquired without a CGT event

Section 109-10 sets out the rules for when you acquire a CGT asset without a CGT event happening. Where a taxpayer commences business and starts to create the asset, e.g. goodwill, the goodwill of the business is acquired when the taxpayer starts the work that results in the creation of the goodwill.[14]

Whether 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. In the present case, as the business commenced in before 19 September 1985, the goodwill of the business would be taken to have been acquired at that time. Therefore, the goodwill of the Trust is considered to be a pre-CGT asset, as it is deemed to have been acquired when the business commenced.

Division 149 - majority underlying interests

Generally, any capital gain or capital loss made from the disposal of a pre-CGT asset is disregarded provided the asset has not stopped being a pre-CGT asset under Division 149 or the former Division 20 of the Income Tax Assessment Act 1936 (ITAA 1936) (pre-1998-99 income years).[15] On the facts of this case, the former Division 20 of the ITAA 1936 does not apply as the majority underlying interests in the asset continue to be maintained post 1998-99 income year.

Subdivision 149-B contains provisions which govern when an asset of non-public entity stops being a pre-CGT asset.

Subsection 149-30(1) provides that the asset stops being a pre-CGT asset at the earliest time when 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.

The test to determine when an asset of a non-public entity stops being a pre-CGT asset is a factual test. Under the test, the asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not maintained. Therefore, an entity must examine the underlying interests in its pre-CGT assets on an on-going basis to ensure that majority underlying interests in them have been maintained when there has been a change, direct or indirect, in its shareholdings, unitholdings or other membership interests.

'Majority underlying interests' in a CGT asset consist of more than 50% of:

(a)  the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset, and

(b)  the beneficial interests that ultimate owners have (whether directly or indirectly) in any ordinary income that may be derived from the asset.[16]

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.[17]

An 'ultimate owner' is defined in subsection 149-15(3) and includes:

•         an individual

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

•         the Commonwealth, a state or a territory

•         a municipal corporation

•         a local governing body, or

•         the government of a foreign country, or of part of a foreign country.

Commissioner's discretion

Subsection 149-30(2) provides the Commissioner with a discretion to overlook the factual test in subsection 149-30(1) if he is satisfied, or thinks it reasonable to assume, that at all times after 20 September 1985 when the asset was held by the taxpayer, majority underlying interests in the asset was held by a natural person who, immediately before that date, held majority underlying interests in the asset.

Simply put, subsection 149-30(2) requires that the Commissioner has to be satisfied that the majority underlying interests in the assets have not changed, otherwise the asset is deemed to have been acquired at the time that the change in majority underlying interests in that asset happened.

In the present case, the pre-CGT goodwill was created in a business that is being carried on by a discretionary trust. Beneficiaries of a discretionary trust are generally not considered to have any interest, either individually or collectively, in the property or income of a trust estate.[18] Therefore, a discretionary trust cannot be an ultimate owner for the purpose of the majority underlying interest test. To determine the ultimate owners of a discretionary trust, it is necessary to trace through to an individual as the other ultimate owners listed in subsection 149-15(3) are not applicable.

The Commissioner has set out a pragmatic approach in Taxation Ruling IT 2340, of looking through interposed entities to determine which natural persons hold the beneficial interests for the purposes of the former section 160ZZS of the ITAA 1936 (the equivalent of Division 149). As a starting point, IT 2340 assumes that a beneficiary of a discretionary trust as having a beneficial interest in the trust's assets.

Paragraph 5 of IT 2340 states that in relation to what are generally referred to as discretionary trusts, i.e., family trusts 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 reflects the Commissioner's view that where a trustee of a family trust continues to administer the trust for the benefit of members of a particular family, Division 149will not apply merely because different distributions to family members who are beneficiaries are made in such amounts, and to such of those beneficiaries, as the trustee determines in accordance with the exercise of the trustee's discretion.[19] In such a case, the Commissioner would find it reasonable to assume that for all practical purposes the majority underlying interests in the trust assets have not changed.[20]

However, the Commissioner also takes the view that if by the exercise of a trustee's discretionary powers to appoint new beneficiaries, or by amendment of the trust deed, there is in practical effect a change in the 'majority underlying interests' in the trust assets, subsection 149-30(1) will apply.[21]

In the present case, the Trust to which Person X is the Guardian and Appointer, made a family trust election in 199X with Person X as the specified individual. Relevantly, the Specified Beneficiaries are the children of Person X and the Additional Beneficiaries includes Person X and other family members.

No amendments to the trust deed have occurred to include or exclude different classes of beneficiaries and appointments of trust income by the trustee have only been made to those beneficiaries who are members of Person X family group.

It is therefore evident from the Trust Deeds and the family trust election made under Schedule 2F to the ITAA 1936, that the Trustee has continued to administer the Trust for the benefit of the members of Person X family group since before 20 September 1985.

As there has been no change in the beneficiaries of the Trust, i.e. no beneficiaries outside Person X family group, there has been no change in majority underlying interest. Accordingly, the Commissioner finds it reasonable to assume that the majority underlying interests have been held at all times in the goodwill asset by the same ultimate owners who held such interests immediately before 20 September 1985.

[1] Paragraph 25 of TR 1999/16

[2] Paragraph 96 of TR 1999/16

[3] Paragraph 14 of TR 1999/16

[4] Paragraph 17 of TR 1999/16

[5] Item 1 in the table in section 109-10

[6] Paragraph 52 of TR 1999/16

[7] Paragraphs 21 - 24 of TR 1999/16

[8] Paragraph 93 of TR 1999/16

[9] Paragraph 24 of TR 1999/16

[10] Paragraph 60 of TR 1999/16

[11] Paragraph 61 of TR 1999/16

[12] Paragraph 91 of TR 1999/16

[13] Paragraph 94 - 95 of TR 1999/16

[14] Section 109-10, item 1

[15] Section 149-10

[16] Subsection 149-15(1)

[17] Subsection 149-15(2)

[18] Taxation Determination TD 2003/28

[19] IT 2340, paragraph 6

[20] IT 2340, paragraph 7

[21] IT 2340, paragraph 8

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