Edited version of private advice

Authorisation Number: 1051733780403

Date of advice: 9 September 2020

Ruling

Subject: Allocation of capital proceeds from a sale of business assets

Question

Is the Trust able to apportion the total capital proceeds from the sale of goodwill and Plant & Equipment differently to the allocation specified in the Agreement, under subsection 116-40(1) of the Income Tax Assessment Act 1997[1]?

Answer

No. Because the Agreement specifies the capital proceeds relating to both the disposal of goodwill and to the disposal of the Plant & Equipment, and the Commissioner's view is that the parties were dealing at arm's length, section 116-40 does not operate to modify the allocation of total proceeds between goodwill and the Plant & Equipment.

For the sake of completeness, the Commissioner further notes that:

(a)       even if the proceeds were modified under subsection 116-40(1) to decrease the capital proceeds allocated to the Plant & Equipment (and as above, they are not), each item of Plant & Equipment is a depreciating asset for the purpose of Division 40, and thus the capital gain or loss realised on disposal of each item is disregarded under section 118-24; and

(b)       Item 6 of the table in subsection 40-300(2) also does not operate such that the termination value of each item of Plant & Equipment is its market value, because:

(i)         the parties were dealing at arm's length; and

(ii)        apart from Item 6, the proceeds allocated to each item of Plant & Equipment under section 40-305 would be more than the market value of each item.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

The scheme commenced on 5 December 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 trustee for the Trust, entered into an Agreement with a third-party purchaser to sell the Trust's business.

2.         According to the Agreement, the assets forming part of the business sale include amongst other things, goodwill, plant and equipment, motor vehicles, intellectual property, business records, work in progress, etc.

3.         Per the Agreement, the total sale consideration for the business was allocated as follows:

·         goodwill - $XXX

·         Plant & Equipment - $YYY

4.         The Trust and the third-party purchaser were acting independently, and both had legal representation advising throughout the negotiation process.

5.         Prior to the sale of the business, the decline in value of each item of Plant & Equipment was determined, and depreciating claimed as a deduction, by the Trust in accordance with Division 40.

6.         The Trustee's representative is of the view that the allocation of the sale proceeds between goodwill and Plant & Equipment and motor vehicles (hereafter together referred to as Plant & Equipment) in the Agreement does not reflect the total market value of each class of assets.

7.         The Trustee representative advised that they would not have signed the Agreement, had they been aware that the sale proceeds were allocated as set out under the Agreement, because the full replacement value of the Plant & Equipment sold was substantially less than what was allocated under the Agreement.

8.         The Trustee's representative only became aware of the discrepancy between the amount allocated to Plant & Equipment in the Agreement and the replacement value of the Plant & Equipment when the Trust's tax advisors were calculating the capital gains and assessable income arising from the sale of the business to be included in its income tax return.

9.         The Trustee's representative is now aware that the greater proportion of the sale price being allocated to the Plant & Equipment will result in a greater tax liability for beneficiaries of the Trust.

10.      After signing the Agreement, the trustee's representative was advised by another adviser, that the consideration allocated to the Plant & Equipment should be a fair and reasonable amount. The Trustee's representative was further advised that they should agree with the purchaser on a fair and reasonable consideration to be allocated to the Plant & Equipment.

Assumption(s)

The market value of each item of Plant & Equipment equals the full replacement value of each item, and the total market value of the Plant & Equipment equals the sum of the individual full replacement value of all the item of Plant & Equipment.

The proceeds allocated to each item of Plant & Equipment will be proportionate to the item's market value.

Relevant legislative provisions

Income Tax Assessment Act 1997, Section 40-30

Income Tax Assessment Act 1997, Subsection 40-300(2)

Income Tax Assessment Act 1997, section 40-305

Income Tax Assessment Act 1997, Subsection 116-40(1)

Reasons for decision

1.         Subsection 116-40(1) provides that where a taxpayer receives a payment from a transaction that relates to more than one CGT event, the capital proceeds apportioned to each event are so much of the payment as is reasonably attributable to that event.

2.         In the absence of an agreed allocation, a party to a business sale is required to allocate the sale proceeds to the underlying assets (tangible and intangible) that form the assets of the business that were subject of the transaction.

3.         Taxation Ruling TR 1999/16[2], sets out the Commissioner view as to the allocation of capital proceeds to goodwill. Whilst specifically in relation to goodwill, the principles may in part be applied to other CGT assets.

4.         The Commissioner, at paragraph 43 sets out the requirements for the Commissioner to accept allocation to goodwill agreed between the parties. Those which are also relevant to other CGT assets are as follows:

Parties to an agreement for the sale of a business often allocate a discrete part of the sale proceeds to goodwill. We will accept the amount a vendor and purchaser attribute or allocate to goodwill as capital proceeds[3] for goodwill provided that all of the following requirements are met:

(a) The vendor owns the goodwill of the business, is entitled to dispose of it and has actually disposed of the goodwill in disposing of the business.

(b) The parties are dealing with each other at arm's length in transacting the sale and in allocating the capital proceeds...

5.         At paragraph 44 of TR 1999/16, the Commissioner further states that "(i)n determining whether the parties are dealing at arm's length in transacting the sale and in allocating the sale proceeds especially to goodwill, all relevant circumstances are taken into account". One of the factors considered in determining whether the parties are dealing at arm's length is "(i)f the amount allocated to goodwill is above or below the market value of the goodwill".

Dealing at arm's length

6.         In the caseThe Trustee for the Estate of the late AW Furse No 5 Will Trust v Federal Commissioner of Taxation [1990][4], consideration was given to subsection 102AG(3), which refers to parties "dealing with each other at arm's length''. Hill J stated (at p 4015):

What is required in determining whether the parties dealt with each other in respect of a particular dealing at arm's length is an assessment whether in respect of that dealing they dealt with each other as arm's length parties would normally do, so that the outcome of their dealing is a matter of real bargaining.

7.         Lee J observed in Granby Pty Ltd v Federal Commissioner of Taxation[5]:

If the parties to a transaction are at arm's length it will follow, usually, that the parties will have dealt with each other at arm's length. That is, the separate minds and wills of the parties will be applied to the bargaining process whatever the outcome of the bargain may be.

That is not to say, however, that parties at arm's length will be dealing with each other at arm's length in a transaction in which they collude to achieve a particular result, or in which one of the parties submits the exercise of its will to the dictation of the other, perhaps to promote the interests of the other. As in Minister of National Review v. Merritt 69 DTC 5159 at 5166 where the parties to the transaction were parties at arm's length, the terms of the loan transaction made between them had been dictated by the unilateral decision of one of them and no independent will in the formation of the transaction had been exercised by the other. It followed that it could not be said that the parties had dealt with each other at arm's length at the material time.

8.         The Commissioner's view is that the Trust and the Purchaser were dealing at arm's length in relation to the sale of the Trust's business for the following reasons:

(a)      the Trust and the Purchaser are not related parties

(b)       the parties in negotiating the sale of the business used external advisers in the course of negotiating the deal, and

(c)       you have advised that the trustee of the Trust (or their representative) would not have signed the Agreement had they realised the allocation to the Plant & Equipment exceeded their combined full replacement value, which implies that:

(i)        the parties to the Agreement were not colluding to obtain a particular outcome when the allocation was determined; and

(ii)       the Trustee's representative entered into the Agreement, despite the stated allocation of the sale consideration between goodwill and Plant & Equipment, because neither the Trustee's representative nor his advisers noticed that allocation or, alternatively, understood the taxation implications of that allocation.

9.         These factors outweigh the fact that the proceeds allocated to goodwill were less than market value, and those allocated to the Plant & Equipment were more than market value.

10.      Accordingly, the Commissioner accepts the allocation of the total capital proceeds to the Plant & Equipment (and goodwill) as set out in the Agreement. That is, subsection 116-40(1) does not operate to allocate the total capital proceeds on a different basis to that set out in the Agreement.

11.      For the sake of completeness, the Commissioner sets out how the CGT provisions interact with the provisions as to Division 40 depreciating assets, and rules as to the termination value of depreciating assets set out in sections 40-300 and 40-305.

Treatment of depreciating assets

12.      Even if the Trust and the Purchaser were not dealing at arm's length in relation to the sale of the business, while both the goodwill and items of Plant & Equipment are CGT assets, the capital gain or loss you realise from a CGT event in relation to a depreciating asset is disregarded for CGT purposes under section 118-24 where its decline in value was worked out under Division 40.

13.      Given that the items of Plant & Equipment are depreciating assets as defined in section 40-30, a balancing adjustment event occurred for each depreciating asset you stopped holding as a consequence of the business sale.

14.      The calculation of the assessable gain or loss, i.e. the balancing adjustment arising under section 40-285 as a result of the balancing adjustment event that occurs under section 40-295 on the disposal of a depreciating asset, is worked out by comparing the asset's termination value and its adjustable value at the time of the balancing adjustment event.

15.      Section 40-300 provides the meaning of termination value of a depreciating asset. Generally, the termination value of the asset is the amount the taxpayer received or is entitled to receive for the balancing adjustment event (per section 40-305). There are specified termination values that may apply in preference to the general rule, as set out in the table in subsection 40-300(2).

16.      Item 6 of the table in subsection 40-300(2) applies where a taxpayer stops holding a depreciating asset under a non-arm's length dealing and the consideration (the termination value) the taxpayer receives is less than its market value. In such circumstances, the termination value of the depreciating asset is deemed to be its market value just before the taxpayer stopped holding it.

17.      On the same basis as above, the Commissioner is of the view that the parties to the Agreement were dealing at arm's length. Further, the total sale proceeds allocated under the Agreement to all items of Plant & Equipment is more than the total market value of the items of Plant & Equipment sold, and the sale proceeds will be allocated proportionate to the market value of each item. That is, the proceeds allocated to each item of Plant & Equipment is more than the market value of the item.

18.      Accordingly, Item 6 of the table in subsection 40-300(2) also does not operate such that the termination value of each item of Plant & Equipment disposed of as part of the sale of the business is its market value.

Conclusion

19.      Subsection 116-40(1) does not apply to modify the allocation of the capital proceeds under the Agreement between the goodwill and the Plant & Equipment because the parties were dealing at arm's length in relation to the sale of the Trust's business.

20.      Each item of Plant & Equipment is a depreciating asset for the purpose of Division 40 and you claimed deductions for the decline in value of those assets, and thus the capital gain or loss realised on disposal of each item is disregarded under section 118-24.

21.      Item 6 of the table in subsection 40-300(2) does not operate such that the termination value of each item of Plant & Equipment disposed of is its market value in your circumstances, because the parties were dealing at arm's length and, apart from any application of item 6, the proceeds allocated to each item of Plant & Equipment is more than the market value of each item of Plant & Equipment.

[1] All legislative references are to the Income Tax Assessment Act 1997, unless otherwise indicated.

[2] Taxation Ruling TR 1999/16: Income Tax: Capital gains: Goodwill of a business

[3] The Commissioner makes a similar statement in relation to the allocation of capital proceeds to CGT assets in paragraph 3 of TD 98/24 Income tax: capital gains: what are the CGT consequences of a CGT event happening to post-CGT real property if the property comprises separate CGT assets under Subdivision 108-D in Part 3-1 of the Income Tax Assessment Act 1997 (the 1997 Act) or if the property is sold with depreciable assets.

[4] FCA 676; 91 ATC 4007; 21 ATR 1123

[5] 95 ATC 4240 at p 4244

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