Edited version of private advice

Authorisation Number: 1052294672561

Date of advice: 26 August 2024

Ruling

Subject: CGT - goodwill

Question

Will the capital gain on the sale of goodwill in X be disregarded pursuant to subsection 104-10(5) of the Income Tax Assessment Act 1997 (ITAA97)?

Answer

Yes.

This ruling applies for the following periods:

Financial year ending 30 June 2025

Financial year ending 30 June 2026

Financial year ending 30 June 2027

The scheme commenced on:

1 July 2024

Relevant facts and circumstances

Background to X's commencement as a business

X was incorporated as Y in 19XX.

Subsequently in 19XX Y's name changed to X.

X was managed full-time by T.

Ownership and management of X

X has always been managed and controlled by the XYZ family, which includes T.

X's product offering

X carries on a manufacturing business of z and has done so since 19XX. Consistent with this is X's income 19XX income tax return and X's website.

X's core product offering is, and always has been, the manufacture of z.

For the financial year ending 30 June 2023, 97% of all sales derived from sales of z.

Growth of X and accounting goodwill

Between 19XX and 20XX, X experienced significant organic growth. This growth was facilitated by X focussing on its core product offerings, and through its ongoing business relationships with key suppliers. X accumulated significant profits which were retained within X to fund its growth organically.

In 20XX X purchased the business assets and stock of R.

Any internally generated goodwill is not recognised in X's financial statements. However, as a result of the R purchase, X did recognise a small amount of purchased goodwill on its balance sheet in relation to this specific acquisition.

Location of operations and management

X initially commenced its business activities in the outer suburbs of State A. Since incorporation, X's operations have predominantly been based in the outer suburbs of State A. Its corporate office, warehouse and manufacturing facilities are currently located in a suburb of State A.

X primarily manufactures its products at its warehouse in State A.

Customer base

X has maintained a stable customer base, targeted towards distributors, wholesalers and manufacturers.

Since 19XX X has marketed itself using the same brand name, logo and core colour scheme. X primarily markets its products through its long-term relationships with key customers.

X has supplied its products to the same businesses since 19XX.

X sells its products to distributors, wholesalers and manufacturers in Australia and New Zealand (NZ). X initially distributed its products within Australia but expanded to supply customer(s) in NZ.

X currently has a single customer in NZ, which acquires products from across X's product range, based on demands of its customers. The total sales to the NZ customer for the year ended 30 June 2023 represent less than 1% of X's total sales.

Supplier base and manufacturing operations

X primarily manufactures through a specific process.

There have been no significant changes to its manufacturing process since 19XX, however plant and equipment has been upgraded in line with technological improvements.

In or around 20XX, X began selling a product which it acquires from an overseas manufacturer, to on-sell in its business as a complementary offering to its range. The cost of these products in comparison to X's raw materials and finished goods is relatively minor.

Relevant legislative provisions

104-10(5) of the ITAA97

108-5(2)(b) of the ITAA97

104-10(1) of the ITAA97

Division 149 of the ITAA97

Reasons for decision

Goodwill, or an interest in it, is a CGT asset under paragraph 108-5(2)(b) of the ITAA97.

CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1)).

Paragraph 104-10(5)(a) provides that a capital gain or capital loss you make from CGT event A1 is disregarded if you acquired the asset before 20 September 1985 (pre-CGT asset).

The meaning of goodwill

The Commissioner's views on the meaning of goodwill are set out in Taxation Ruling TR 1999/16 (TR 1999/16) Income tax: capital gains: goodwill of a business, which reflects the decision of the High Court in Federal Commissioner of Taxation v Murry [1998] HCA 42; 98 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 explains what goodwill of a business is legally:

"...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."

Accordingly the goodwill of a business is either created or purchased. For tax purposes, depending when either of these things happen, will determine if the goodwill is referred to as either pre-CGT goodwill or post-CGT goodwill.

TR 1999/16 takes the view that goodwill is a single asset for CGT purposes. Paragraph 14 states:

".. 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."

Therefore the goodwill of a particular business cannot be characterised as partly pre-CGT goodwill and partly post-CGT goodwill.

X has minimal goodwill recognised in its financial statements, as the majority of its goodwill is internally generated and the value of this goodwill has not been recognised in its financial statements. In accordance with Murry and TR 1999/16 the legal definition of goodwill is different to its accounting and business definition. Further, goodwill attaches to X's business as a whole.

When is 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. In accordance with Paragraph 17 of TR 1999/16 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."

Paragraph 52 of TR 1999/16 provides that:

"If a taxpayer commences business and starts to create goodwill, the goodwill of the business is acquired when the taxpayer starts work that results in the creation of the goodwill (subsection 109-10, item 1). 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."

Paragraph 89 of TR 1999/16 states:

"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 justices of the High Court said in the Murry case (98 ATC at 4594; 39 ATR at 143), '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'. For a business that commenced before 20 September 1985, any accretion to its goodwill since 20 September 1985 is not a post-CGT asset."

X was incorporated in 1983 and its business commenced in or around 1983. Therefore the business commenced before 20 September 1985 and prima facie the goodwill pertaining to the business as whole is a pre-CGT asset, and any accretion to goodwill since 20 September 1985 is not a post-CGT asset. If, however, X has not carried on the same business since 20 September 1985, then the goodwill attached to X's business may be in fact considered a post-CGT asset. Therefore it is necessary to determine whether X is carrying on the same business as it did in September 1985.

Is the same business being carried on?

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 (for example new equipment and improved technologies which attracts new customers, without ceasing to carry on the same business), provided the business retains its essential nature or character. This is a question of fact and degree. In this regard Paragraph TR 1999/16 states:

"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."

However, paragraphs 18 and 19 of TR 1999/16 states that a business can 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. Further, Paragraph 24 of TR 1999/16 states:

"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.

In relation to the nature and character of the business, it is noted in TR 1999/16 at paragraphs 94 and 95:

"...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.

95. 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."

And at paragraph 93:

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.

X has gradually expanded its business in size though organic growth from 1984 apart from the R acquisition and the diversification into the importation of a product produced overseas to complement its existing product mix. X throughout the years has accumulated retained earnings, and reinvested these amounts into the business to expand its size. From business commencement in 1983, X has maintained the same product mix, focused on the production of z, with a customer and supplier base consistent with that product mix.

Even though new plant and equipment and technologies have been introduced into X's production processes, the essential manufacturing activity to which it is involved has not changed. X's key input into its manufacturing process have not changed since commencement of the business.

Whilst plant and equipment has been upgraded in line with technological improvements, there have been no significant changes to its manufacturing process since 1984. The importation of a certain product from overseas is of small scale compared to X's local manufacturing operations.

X's client base also remains the same in nature, being distributors, wholesalers and manufacturers. Although X's customer base expanded to include NZ customer(s), that hasn't changed the nature of X's client base. This is because essentially X continues to supply products to the same customer type, albeit currently one of those customers is located in New Zealand.

It is also relevant that X's management has not changed since its establishment.

Further, X brand identity (in terms of its brand name, logo and core colour scheme) has remained the same since 1983.

R acquisition

TR 1999/16 states:

"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.

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.

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 an expansion 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."

In relation to the nature and character of the business, it is noted in TR 1999/16 at paragraphs 94 and 95:

"...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.

95. 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."

And at paragraph 93:

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.

It is noted the R acquisition was of a small scale compared to the rest of X's business. Further, R's business was also in the production of a product similar to z, consistent with X's business. R has been integrated into X's existing business and it cannot be said that there was a planned or systematic process of change or a sudden and dramatic change in the business when X acquired R.

Conclusion

The whole of the goodwill of X's business, commencing in 19XX, is a single pre-CGT asset as the same business continues to be carried on by X. As the goodwill of X is a pre-CGT asset, any capital gain on the sale of goodwill in X will be disregarded pursuant to subsection 104-10(5).

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