Edited version of private ruling

Authorisation Number: 1011510526869

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Ruling

Subject: Goodwill

Issue 1

Question

Will the capital gains tax (CGT) provisions apply in relation to any goodwill existing at the time of the disposal of your business assets to your sole shareholder and practitioner?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Issue 2

Question

Will the Fringe Benefits Tax Assessment Act 1986 (FBTAA) apply in relation to goodwill existing at the time of the disposal of your business assets to your sole shareholder and practitioner?

Answer

No

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You have been operating as a medical practice.

You have a sole shareholder, who is also the sole practitioner and director (the individual).

The individual wishes to commence trading as a sole trader using your current business premises, and to cease trading through you.

There will be a new lease in relation to the business premises.

All income generated by the business is as a personal services business.

The individual has no contract of employment which restricts the individual from commencing a business.

All stationery, referral pads, medical registrations and insurances are in the name of the individual, however are paid for by the company.

You are proposing to sell off all of your fixed assets at market value to the individual, and there will be no invoice raised or amount paid in relation to any goodwill at the time of the disposal.

You do not have any value for goodwill.

Your motivation to cease trading is to avoid the unnecessary compliance costs of a company in your industry which do not result in significant benefits.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Subsection 108-5(2)

Income Tax Assessment Act 1997 Subsection 116-30(1)

Fringe Benefits Tax Assessment Act 1986 Subsection 136(1)

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Capital gains tax

You make a capital gain or capital loss if a CGT event happens. Most CGT events involve a CGT asset.

The CGT provisions will apply in your case if a CGT event happens to any goodwill attaching to your business. Goodwill is a CGT asset under paragraph 108-5(2)(b) of the Income Tax Assessment Act 1997 (ITAA 1997).

A private ruling can make no finding of fact on the existence or otherwise of whether goodwill is attached to a business.

In your case, if there is any goodwill attaching to your business, we would consider that any goodwill existing at the time of the transfer of your business assets to the individual, would also be transferred to the individual at this time. This is because your business is effectively being carried on by the individual in that the individual is the sole practitioner, and all stationery, referral pads, medical registrations and insurances are in the individual's name. Any part of the goodwill of the business that emanates from the individual's personality, reputation, skills or attributes would therefore be transferable.

When the business assets are transferred, the business will effectively continue to be carried on by the individual from the same premises. Any patients of your practice would continue to be patients of the individual's practice. Any goodwill attaching to your business would therefore continue to be attached to the business carried on by the individual.

This would mean that CGT event A1 under section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen in relation to any goodwill attaching to the business when the business assets are transferred from you to the individual, and the CGT provisions will apply.

You will make a capital gain from the disposal of any goodwill if the capital proceeds from the disposal are more than the cost base of the goodwill. You will make a capital loss if those capital proceeds are less than the reduced cost base of the goodwill.

Any capital gain attributable to goodwill may qualify for the small business CGT concessions in Division 152 of the ITAA 1997.

Cost base of goodwill

Paragraphs 53 to 58 and 124 to 126 of Taxation Ruling TR 1999/16 discuss the cost base of goodwill. Paragraph 57 of TR 1999/6 states that the cost base of goodwill includes capital expenditure to the extent it is incurred to increase the value of the goodwill and is reflected in the state or nature of the goodwill when a CGT event happens. It also includes capital expenditure to the extent it is incurred to establish, preserve or defend the taxpayer's title to, or right over, the goodwill.

Capital proceeds

Paragraph 47 of TR 1999/16 states that our preferred approach to valuing goodwill on the sale of a profitable business or a business expected to be profitable is the difference between:

the present value of the predicted earnings of the business and

the sum of the market values of off balance sheet assets and all identifiable net assets - in terms of accounting standards - other than goodwill of the business disposed of (subject to the restrictive covenant exception referred to in subparagraph 43(c) of the Ruling).

You state that you are proposing to sell off all of your fixed assets at market value to the individual, and there will be no invoice raised or amount paid in relation to any goodwill at the time of the disposal of your business.

If the sum of the market values of your off balance sheet assets and all identifiable net assets in terms of accounting standards equal the capital proceeds received by you from the disposal of those assets to the individual, any goodwill transferred will have a nil value, that is, no capital proceeds will be received by you for the disposal of the goodwill.

If this is the case, the market value substitution rule in subsection 116-30(1) of the ITAA 1997 will apply. This rule states that if you received no capital proceeds from a CGT event, you are taken to have received the market value of the CGT asset that is the subject of the event. The market value is worked out as at the time of the event.

You would need to determine the market value of any goodwill transferred to the individual as at the time of the CGT event to determine the amount of capital proceeds received for the disposal of the goodwill.

Fringe benefits tax

To be subject to FBT, a benefit must be a 'fringe benefit' as defined in subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA). That definition requires, among other things, that the benefit is provided to an employee (or to an associate of the employee) 'in respect of the employment of the employee'. This effectively means a benefit is provided to somebody because they are an employee.

Fringe benefits tax - a guide for employers (NAT 1054) suggests as a guide to whether a benefit is provided in respect of employment, 'ask yourself whether you would have provided the benefit if the person had not been an employee.'

As the individual in your case meets the definition of 'employee', we must consider whether a benefit is to be provided 'in respect of employment'. Paragraphs 5, 6 and 9 of Miscellaneous Taxation Ruling MT 2019 (Fringe benefits tax: shareholder employees of family private companies and directors of corporate trustees) state:

5. If a shareholder of a family private company does meet the definition of "employee", for example, because that person is, or has at some time been, a director of the company in receipt of directors' fees, the company will be liable for FBT on benefits provided to that shareholder (or an associate) in respect of his or her employment by the company. The term "employment" is defined as including, broadly, the activity (e.g., the holding of the office of director) that results, will result or has resulted in the person being treated as an employee within the meaning of the FBT legislation. Thus the benefit must be associated with some past, current or expected future employment activity which results in the person being treated as an employee.

6. By virtue of paragraph 148(1)(a) of the Fringe Benefits Tax Assessment Act, a benefit provided to a person by reason of both his or her employment activity and shareholding will be taken to be provided in respect of the person's employment. If, however, it can be established that a benefit is provided to a shareholder/employee solely by reason of that person's position as a shareholder of the company and not to any extent by reason of that person's employment by the company, the benefit will not be subject to FBT.

9. In relation to benefits that are not expressly linked to the carrying out of the employee's duties, it is necessary to examine all the facts and circumstances of the case to establish whether the benefit is fairly to be regarded as having been granted to the shareholder/employee in his or her capacity as an employee or as a shareholder. Factors such as the nature of the benefit, any cash remuneration paid, the nature and extent of any trading activities of the company, the extent of any services rendered by the shareholder/employee and the extent of his or her shareholding may be relevant in concluding whether a non-cash benefit was provided as remuneration for services or in the capacity of shareholder.

The meaning of the phrase 'in respect of employment' was considered by the Federal Court in J & G Knowles v. Federal Commissioner of Taxation [2000] 96 FCR 402; 2000 ATC 4151; 44 ATR 22 (Knowles) and Starrim Pty Ltd v. Federal Commissioner of Taxation [2000] FCA 952; 2000 ATC 4460; 44 ATR 487 (Starrim).

In Knowles the Court considered the judgements in Smith v. FCT (1987) 164 CLR 513; 19 ATR 274; 87 ATC 4883 and Federal Commissioner of Taxation v. Rowe (1995) 60 FCR 99; 31 ATR 392; 95 ATC 4691 before concluding that it is not sufficient for the purposes of the FBTAA to conclude that there is a causal connection between the benefit and the employment.

At paragraph 26 the Court said:

Whatever question is to be asked, it must be remembered that what must be established is whether there is a sufficient or material, rather than a, causal connection or relationship between the benefit and the employment.

At paragraphs 28 and 29 the Court said:

While the width of the definition of fringe benefit was designed to capture benefits that, in truth, were other than remuneration, the stated purpose suggests that asking whether the benefit is a product or incident of the employment will be helpful. If it is not then the benefit is likely to be extraneous to the employment and will not bear FBT, notwithstanding that the employment might have been a causal factor in the provision of the benefit. In particular, the fact that a benefit is provided to a director because it was authorised by that director will not, of itself, be sufficient to characterise the benefit as one which is in respect of the employment. Without more, it is not a product of incident of that office.

To put the matter another way, although the process of characterising the benefit provided in a particular case can involve questions of fact and degree, it is not sufficient for the purposes of the Act merely to enquire whether there is some causal connection between the benefit and the employment: see FC of T v Rowe 95 ATC 4691 at 4703 and 4710; (1995) 60 FCR 99 at 114 and 123; 31 ATR 392 at 404 and 412; 95 ATC 4691 at 4703 and 4710. Although Brennan, Deane and Gaudron JJ observed in Technical Products (at 47), that the requisite connection will not exist unless there is some discernible and rational link between the 2 subject matters which the statute requires to be linked, as was pointed out by Dawson J (at 51), the connection must be material.

In Starrim, Lindgren J. further considered the phrase in relation to a private company which provided benefits to a husband and wife who were its only shareholders and directors. In considering whether the benefits were provided in respect of their employment as directors, Lindgren J said at paragraph 52, in part: 

the decision of the full court in Knowles establishes that the required relationship between the provision of a benefit and the employment is not established merely by the existence of some or a causal relationship, and, in particular, that it is not established by nothing more that the fact that the employee has been able to cause the benefit to be provided to him by reason of his or her office as a director of the employer. There must be a sufficient or material relationship between the employment and the provision of the benefit.

Further in Starrim, Lindgren J at paragraph 60 submits the reference to Knowles in his observations in relation to the expression 'in respect of' as defined in the FBTAA:

The AAT was correct in stating that the phrase requires a `nexus, some discernible and rational link, between the benefit and employment'. That, however, does not take the matter far enough. For what is required is a sufficient link for the purposes of the particular legislation:... It cannot be said that any causal relationship between the benefit and the employment is a sufficient link so as to result in a taxable transaction. For example, a discretionary trust with a corporate trustee might be established to purchase a family home for the benefit of its directors and their family. It does not follow that the rent free occupation of that home on the authority of the directors is a benefit provided `in respect of' their employment for the purposes of the Act. While there is a causal relationship between the provision of the benefit and the employment it is not a sufficient or material relationship. The rent free occupancy arises because the trust was established for that purpose; a reason extraneous to the employment of the directors.

You have advised that the motivation to cease trading as a company is to avoid unnecessary compliance costs. To achieve this outcome, assets of the company will be sold to the individual at market value.

Any benefit obtained by the individual in respect of goodwill would not be considered to be provided in respect of the employment of the individual. It is not likely that a similar benefit would be provided to any employee who was not your sole shareholder. There is no evidence of a sufficient or material relationship between the individual's employment and the provision of a benefit.

Without a sufficient or material relationship between the benefit and the employment, the FBTAA will not operate to impose FBT as there can be no fringe benefit.