Edited version of private advice

Authorisation Number: 1052117499206

Date of advice: 10 May 2023

Ruling

Subject: Goodwill - pre CGT

Question 1

Is the Goodwill of the business carried on by Company A taken to be a pre-CGT asset?

Answer

Yes.

Question 2

If yes, are a proportionate number of shares (proportionate by respective asset values), issued by Company A in 20XX, in exchange for the business assets of the Family Trust under a CGT rollover pursuant to Division 122-A of the Income Tax Assessment Act 1997 as amended taken to be pre-CGT shares to the extent they were issued for pre-CGT goodwill?

Answer.

Yes

This ruling applies for the following periods:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1.            Person A and Person B started farming pre 1985. The land is in a well-known wine growing area.

2.            They originally grew XX acres of tobacco and established a vineyard of XX acres that included planting XX acres of 2 types of vines.

3.            Half an acre of this vineyard was set aside for their personal use.

4.            The Family Trust (the Trust) was established in 19XX and took over the tobacco and grape growing activities from Person A and Person B. The land was acquired by the Trust in the same year.

5.            In 19XX, the vineyard increased in size to XX acres of vines.

6.            The Trust from 19XX continued to keep the half acre of vineyard that Person A and Person B had set aside for personal use for the benefit and use of its beneficiaries.

7.            In 19XX, the Trust first produced wine with the intention of making commercial wines in the future. The wine was distributed to their family, relatives and friends for no consideration.

8.            Phylloxera impacted the vineyard from the early 19XXs.

9.            The Trust picked XXX tonnes of grapes in 19XX.

10.          In 19XX, the Trust entered a XX year contract with a wine maker to sell grapes that were produced from the vineyard, excluding the area set aside for personal use.

11.          There were a number of these agreements, one for each variety of grapes grown and they were amended or replaced as demand changed for greater volume.

12.          The Trust planted an additional XX acres of vines from the mid-19XXs every year until 19XX.

13.          Over the next X years the old rootstock vines were replanted with disease resistant rootstock.

14.          The vines planted suited making Italian wines.

15.          Towards the mid-19XXs the business began researching and experimenting with two relatively unknown (in Australia) Northern Italian red grape varieties.

16.          In the early 19XX's in Australia there were very few producers of these varieties, let alone nurseries stocking them, and not all areas had suitable growing conditions. The business saw an opportunity to develop and produce wines not (widely) grown by other producers in Australia, that were of Northern Italian heritage, and also suited to the cooler growing conditions where they were located.

17.          In 19XX the Trust took cuttings to a University for these to be green cultured and propagated to get enough stock for grafting a full vineyard.

18.          In 19XX, XX vines were planted which in 19XX gave the Trust enough buds to graft X acres. The produce was primarily used by the business, for the development of the Trust's own wines. The majority of the grapes were retained by the Trust for their own wine development, and a small amount of these grapes were sold to another wine producer, who were also looking at new varieties.

19.          One grape variety that was not sold to a wine maker, was the XX variety. This was retained by the Trust solely for development of the Trust's own variety.

20.          Another variety of Northern Italian wine that was grown and produced by the business in the early 19XX's was XX, which is a grape that is also grown in and originates from Northern Italy from the Alto Adige region. At that time, it was ultimately felt that the Australian market was not ready or suitable for this variety.

21.          The area set aside for the business to use was used to gain experience and knowledge to later produce their own wines commercially. Initially, wines produced from this area were mainly used for experimentation which included obtaining feedback from family & friends, as well as for local events purposes. No consideration was provided for these wines.

22.          At least one tonne of grapes was used for wine production from the early 19XXs which produced approximately XXX litres of wine per tonne of grapes. This was used by the Trust for research and development, a practice that has continued to the present day.

23.          Handwritten notes were taken of what worked well, what was not successful, feedback received, what adjustments were required etc. to develop better wines. The area of grapes was for wine making by the business and experimenting with the production of different varieties, with a view to making the Trust's own brands of wines.

24.          In the early to mid-XX's, the Trust used another person's wine making equipment to make their wines. At this time, the systems, processes and techniques involved with winemaking were being commenced by the Trust.

25.          By 19XX, there were less than XX acres of tobacco being grown due to the Governments quota and grapes picked had grown to XXX tonnes.

26.          In 19XX, a portion of grapes were retained for the Trust's own wine production. The Trust produced between XXX-XXXX litres of wine per annum.

27.          All employees engaged in the business were employed by the Trust. All costs, work and activities have been put exclusively through the Trust, until 20XX.

28.          In 19XX, the Trust harvested the first grapes from the new rootstock.

29.          By the early 19XXs all the old vines had been replaced with new rootstock and around XXX tonnes of grapes were picked.

30.          In 19XX, the Trust had its first sale of commercial wine, which was sold in bulk and was unlabelled.

31.          Tobacco was last grown in 19XX.

32.          The contracts with the other wine producer finished in 19XX.

33.          From 19XX, the Trust made steps to move into wine making and dealt with various companies in selling grapes/juice/wines that was surplus to its needs.

34.          This change was gradual and from 19XX, grapes retained grew gradually (but not always in a linear fashion) from under 10% to almost 100% in 20XX, at an average rate of 4.5% per annum.

35.          In 19XX, the Trust produced around X litres of wine which was sold under its own label.

36.          In 19XX, the Trust engaged a distributor to sell the wine produced by the vineyard on the wholesale market.

37.          In 20XX, the business of the Trust was transferred to Company A and the Trust chose rollover relief under Division 122-A of the ITAA 1997 to disregard the capital gain made on this disposal.

38.          The land and buildings were retained by the Trust.

39.          The 20XX schedule of business assets transferred to Company A showed Assets of $X,XXX,XXX were transferred and Liabilities of $X,XXX,XXXX were assumed, leaving a net value of $XXX,XXX.

40.          XXX,XXX shares were issued in exchange for the business assets transferred.

41.          In 20XX, the issue of whether the business goodwill was pre-CGT was not given detailed consideration at that time, with no value attributed to goodwill.

42.          You have advised that you have not yet received a market valuation of goodwill from 20XX at the time of the rollover.

43.          Company A now keeps nearly 100% of the grapes produced by the vineyard and any surplus juice is sold into the wine market.

Information provided

44.          You have provided information in a number of documents in relation to your private ruling request, including:

•                     your private ruling application.

•                     supplementary information.

Assumption(s)

45.          No amount was paid for goodwill in 19XX when the business transferred from Person A and Person B to the Trust, and the consideration paid for the transfer of tangible assets was done at book value.

46.          The change from growing grapes and what was retained for wine making was gradual. Whilst the Trust did not have records to indicate the change, it might be expected that from 19XX, grapes retained then grew gradually (but not always in a linear fashion) from under 10% to almost 100% in 20XX, at an average rate of X% per annum.

Relevant legislative provisions

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

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

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

Income Tax Assessment Act 1997 Division 122-A

Reasons for decision

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

Question

Is the Goodwill of the business carried on by Company A taken to be a pre-CGT asset?

Summary

Yes, the goodwill of the business carried on by Company A is a pre-CGT asset.

Detailed reasoning

Goodwill

47.          Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business (TR 1999/16) explains what goodwill is for the purposes of the definition of a CGT asset. Relevantly, paragraph 17 of TR 1999/16 provides that the whole of the 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.

48.          Goodwill, or an interest in it, falls within the definition of a CGT asset.[1]

49.          When goodwill is disposed of CGT event A1 occurs.[2]

50.          However, if you acquired the goodwill before 20 September 1985, a capital gain or loss arising from the disposal of the goodwill will be disregarded.[3]

51.          TR 1999/16 reflects the decision of the High Court of Australia in FC of T v. Murry 98 ATC 4585; (1998) 39 ATR 129, (Murry Case). It is the legal definition of goodwill as the High Court in the Murry case, rather than its accounting and business definitions, which applies.[4]

52.          Goodwill in TR 1999/16 is described as follows.

53.          The meaning of goodwill has 3 different aspects namely property, sources and value,[5] which combine to give definition to the legal concept of goodwill. What unites these aspects is the conduct of a business. Goodwill is something which attaches to a business. It cannot be dealt with separately from the business with which it is associated. Goodwill is inseparable from the conduct of the business.[6]

54.          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.[7]

55.          What goodwill means depends on the character and nature of the business to which it is attached.[8]

56.          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. A business owner cannot dispose of goodwill separately from the business to which it attaches.

57.          Goodwill is a composite thing and attaches to the whole business. It is an indivisible item of property that is legally distinct from the sources from which it emanates.[9]

58.          The whole of the goodwill of a business is either pre-CGT goodwill or post-CGT goodwill. The goodwill of a business cannot be characterised as partly pre-CGT goodwill and partly post-CGT goodwill.[10]

59.          The goodwill of a business that commenced before 20 September 1985 remains a pre-CGT asset provided the same business continues to be carried on. As the majority of the High Court said in the Murry case, 'as long as the business remains the 'same business' (cf Avondale Motors (Parts) Pty Ltd v. FC of T (1971) 124 CLR 97), 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'.[11]

60.          Goodwill is considered to be acquired from the date that the taxpayer commences the work that generates the goodwill.[12]

61.          It is a question of fact and degree whether the same business is being carried on in each case.[13] 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.[14]

62.          If the essential nature or character of the business has not changed, it will be considered to be the same business for the goodwill CGT provision. 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.[15]

63.          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 in its own right, is a question of fact dependent on the circumstances of each particular 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 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 existing business

(b)          is treated for banking and accounting purposes as an extension of existing business or as a separate business

(c)   uses one or more different trading names, and

(d)  is related to or dependent on existing business in a practical, economic or commercial sense.[16]

64.          Where the same business is being carried on, the goodwill built up prior to 20 September 1985 extends to include any goodwill obtained through the introduction of new business operations.[17] 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.[18]

65.          What goodwill means, depends on the character and nature of the business to which is attached. Goodwill differs in its composition in different trades or industries and in different businesses in the same trade or industry.[19]

In your circumstances

66.          Person A and Person B started the business of growing grapes and tobacco in 19XX.

67.          No amount was paid for goodwill when the business transferred from the Person A and Person B to the Trust in 19XX. In 19XX, the vineyard increased in size to XX acres of vines.

68.          From 19XX, the business through the Trust continued to grow tobacco, grapes and experimenting with wine production.

69.          The Trust experimented and produced wine from 19XX which the Trust gave to family, friends and to community events.

70.          The Trust was in the business of developing, testing, improving and perfecting its own wines since 19XX. You have stated that throughout the early 1980s, between XXX-XXXX litres of wine was produced by the Trust per annum.

71.          In 19XX, the Trust took new variety cuttings to a University for these to be green cultured and propagated to get enough stock for grafting a full vineyard.

72.          In 19XX, XX vines of this cutting were planted which in 19XX gave the Trust enough buds to graft X acres. The produce was primarily used by the business, for the development of the Trust's own wines. The majority of the grapes were retained by the Trust for its own wine development, and a small amount of grapes were sold to another wine producer, who were also looking at new varieties.

73.          One grape variety was not sold to anyone. This was retained by the Trust solely for development of its own variety.

74.          The Trust grew the grape growing business by planting additional acres of vines each year during the 19XXs.

75.          You advised that in developing the wine intended for later commercial sale, handwritten notes were taken of what worked well, what was not successful, took on feedback from recipients of the wine and made adjustments to the wine produced where required, to develop better wines with a view to making the Trust's own brands of wines.

76.          You state that developing and refining wine growing skills was essential to becoming a successful winemaker as one must be able to 'manage the fruit'. Therefore, it can be said that the Trust's later commercial sale of wine in 19XX was an expansion of growing and harvesting grapes.

77.          You advised the Trust was undertaking activities to be a wine producer by:

(a)          replacing rootstock with disease-resistant rootstock in 19XX, commercial wine sales were made with root stock from prior to 19XX

(b)          commencing winemaking systems, processes and techniques from the early 19XXs

(c)           paying staff to pick the fruit and press out the grapes for winemaking in the 19XXs

(d)          purchasing bottles, corks and 20 litre-drums in the early 19XXs

78.          From the early 19XX's, the Trust moved from using another person's wine making equipment to purchasing and using its own equipment.

79.          In 19XX, the Trust applied the wine making knowledge to produce wine for commercial sale. Initially, the Trust sold the wine produced for commercial sale as 'cleanskins', with the first wine sold with its own label happening in 19XX.

80.          You have advised the Trust started from scratch and to progress from producing grapes to producing commercial wine usually takes 5 to 6 years before wine can be sold. You provided the following timeline:

(a)          clearing land and planting vines - 6 to 12 months

(b)          vines bear fruit - 3 to 4 years

(c)           sale of first vintage 2 years.

81.          You have also advised that producing wine for commercial success relies heavily on the winemaker's ability to 'manage the fruit' and that producing wine was a logical step in the progression of the business.

82.          Since the beginning of the business, there has been no alteration in trading name between 19XX and 20XX. The business has been subject to the same integrated management and control for banking and accounts purposes throughout its lifetime.

83.          The business had been experimenting with growing grapes for wine making and making wine with these grapes from the early 19XXs.

84.          This early grape growing and wine experimentation progressed to the commercial sale of wine in 19XX.

85.          The Trust has shown that it has been in the business of producing tobacco, grapes and wine production from 19XX.

86.          Therefore, any goodwill associated with the business would be a continuation of the goodwill from the business started in 19XX and as such will be classified as a pre-CGT asset.

Question 2

If yes, are a proportionate number of shares (proportionate by respective asset values), issued by Company A in 2012, in exchange for the business assets of the Family Trust under a CGT rollover pursuant to Division 122-A as amended taken to be pre-CGT shares to the extent they were issued for pre-CGT goodwill?

Summary

The number of shares issued for the transfer of the business from the Trust to the company, and the values ascertained for the transfer of the post-CGT assets and the pre-CGT goodwill, is to be used to apportion the shares into pre-CGT shares and post-CGT shares using the methodology set out in section 122-60.

Detailed reasoning

87.          If the assets transferred to the company are a mixture of post-CGT and pre-CGT assets, a calculation is first made to determine the number of the shares transferred that will be treated as pre-CGT shares.[20]

88.          The number of shares (which must be a whole number) deemed to be pre-CGT shares (when expressed as a percentage of all the shares) is the greatest possible that does not exceed the percentage calculated in accordance with the following formula:

89.          Those shares which are not deemed to be pre-CGT shares are taken to be post-CGT shares. The first element of the cost base/reduced cost base (as appropriate) of each post-CGT share is the sum of the market values of any precluded post-CGT assets and the cost bases/reduced cost bases (as appropriate) of the other post-CGT assets (less any liabilities the company undertakes to discharge in respect of all of those assets) divided by the number of post-CGT shares.[21]

90.          At the time the Trust claimed rollover under Division 122 in 20XX for the transfer of business and its assets to the Company no value was attributed to the goodwill of the business and the net asset value of the business assets was $XXX,XXX.

91.          As a result, XXX,XXX $1 shares were issued in Company A in exchange for the business assets of the Trust. All of the shares issued were considered to be post-CGT assets at the time rollover was claimed.

92.          You have not yet had the goodwill of the business valued.

93.          In question 1, we have ruled that the goodwill of the business is a pre-CGT asset. As a consequence of this finding, an apportionment of the value of all the pre-CGT asset and post-CGT assets transferred is required to determine how many of the shares are pre-CGT shares and post-CGT shares. This is determined using the formula set out above.

[1] Paragraph 108-5(2)(b)

[2] Subsection 104-10(1)

[3] Subsection 104-10(5)

[4] Paragraphs 4, 9 and 85(b) in TR 1999/16

[5] Paragraphs 10 and 85(c) in TR 1999/16

[6] Paragraph 85(c) in TR 1999/16

[7] Paragraph 12 in TR 1999/16

[8] Paragraphs 13 in TR 1999/16

[9] Paragraph 14 in TR 1999/16

[10] Paragraph 25 in TR 1999/16

[11] Paragraph 89 in TR 1999/16

[12] Paragraph 51 TR 1999/16.

[13] Paragraph 20 TR 1999/16 citing Paragraphs 9-10 TR 95/13

[14] Paragraph 91 in TR 1999/16

[15] Paragraph 21 TR 1999/16

[16] Paragraph 62 TR 1999/16

[17] Paragraph 60 TR 1999/16

[18] Paragraph 93 in TR 1999/16

[19] Paragraph 87 in TR 1999/16

[20] Subsection 122-60(1)

[21] Subsections 122-60(2) and (3)

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