Edited version of private ruling

Authorisation Number: 1011665940728

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Ruling

Subject: Income Tax - Capital Gains Tax

Questions

1. Is the acquisition of post-capital gains tax goodwill by a pre-capital gains tax business an asset acquired prior to 20 September 1985 under Part 3-1 of the Income Tax Assessment Act 1997?

Answer: Yes

2. Is any gain derived from the disposal of goodwill of that business entitled to be disregarded under subsection 104-10(5) of the Income Tax Assessment Act 1997 upon disposal of the business?

Answer: Yes

This ruling applies for the following period:

Year ending 30 June 2011

The scheme commences on:

1 July 1972

Relevant facts and circumstances

In early 1973 the business commenced.

The business built up over the years and the building from which the business was operated was extended.

In order to expand the business, to cater for increasing demand, and to protect the goodwill of the business from competition, the taxpayer opened a further business in the same suburb.

The operator of both businesses was the same person. The owner of both businesses was A Pty Ltd as trustee for the A Family Trust. The operator is a director of A Pty Ltd.

In 1999 the original business was closed. The buildings and facilities were no longer appropriate. Staff were transferred to the remaining business. Customers were catered for at the remaining premises.

The remaining business was expanded upon leasing the premises next door.

The businesses had the same bank account, the same bookkeeper and management during the years of operation.

The trading names for both businesses were marginally different.

The customers could identify with the businesses by their common management.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1997 Part 3-1

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

Income Tax Assessment Act 1997 Section 109 - 10

Reasons for decision

Question 1

Summary

Where post-capital gains tax goodwill is subsumed with the pre-capital gains tax goodwill the goodwill is considered to have been acquired prior to 20 September 1985.

Detailed reasoning

The ATO view on goodwill for the purposes of capital gains tax (CGT) is explained in Taxation Ruling TR 1999/16. That Ruling reflects the decision of the High Court of Australia in Federal Commissioner of Taxation v. Murry (1998) 193 CLR 605; 98 ATC 4585; (1998) 39 ATR 129 (Murry's case).

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.

Goodwill 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.

In this case the applicants are in business. Any goodwill relating to the business is an asset of that business. When the entire business is disposed of the goodwill would be transferred with that disposal.

Goodwill is a composite thing. It is an indivisible item of property that is legally distinct from the sources from which it emanates. The whole of the goodwill of a business is either pre-CGT goodwill or post-CGT goodwill. 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 of the Income Tax Assessment Act 1997 (ITAA 1997) about when an asset stops being a pre-CGT asset] provided the same business continues to be carried on.

In Murry's case the High Court of Australia expressed the view that goodwill has three aspects - property, sources and value which combine to give the legal concept of goodwill. What unites the aspects is the conduct of a business to which goodwill is attached.

A 'business' is considered to be a course of conduct carried on for the purpose of profit and also involves notions of continuity and repetition of actions. A business uses assets, knowledge, skills, human resources and other things as required to continue activities for commercial purposes.

Section 109 -10 of the ITAA 1997 states that where you create a capital gains tax asset such as goodwill and you own it when it is created, you acquire the asset when the work that resulted in the creation of the asset started.

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.

On the facts of the case it is clear that the location and size of the business has fluctuated since 20 September 1985. What needs to be determined is whether the essential nature of the business has changed since that date. This is a question of fact taking into consideration the factors outlined above.

The following features of the business show that while the business has been undertaken in various locations since 20 September 1985 the essential character of the business has remained the same:

· you remained in the same business and this did not change with the addition of extra premises. Further premises were opened in response to an expanding demand.

· the second business was subject to the same integrated management and control as the existing business. The owners and the bookkeeper maintained control and records over both centres.

· a single bank account was kept for both businesses.

· although the trading name of the business was marginally different to the original trading name the customers could identify with the businesses because of the common operator and management.

· the customer base of the business remained the same and at all times business locations were contained within the one suburb. When the original premises were closed customers were catered for at the remaining business.

· on closure of the original premises staff were retained and transferred to the remaining business premises.

The first business opened in 1973 and has continued until this time (albeit in varying locations) operating in the same suburb, with the same management and ownership. It is therefore considered that the goodwill which commenced to be generated at the opening of the first business is a pre-CGT asset.

An accretion of internally generated goodwill adds to the goodwill of the business. Goodwill of a business may be enlarged by various means (including operating a business of the same nature at multiple premises) but the enlargement is not an 'improvement' or an 'acquisition' of post-CGT goodwill.

The post-CGT goodwill is subsumed with the pre-CGT goodwill therefore the goodwill is considered to have been acquired prior to 20 September 1985 under Part 3 - 1 of the ITAA 1997.

Question 2

Summary

The goodwill of the business is considered to have been acquired before 20 September 1985 therefore the capital gain or capital loss is disregarded upon disposal of that goodwill.

Detailed reasoning

The disposal of a capital gains tax (CGT) asset will cause CGT event A1 to happen. Paragraph 104-10(5)(a) of the ITAA 1997 provides that a capital gain on the disposal of an asset acquired before 20 September 1985 is disregarded. Section 100-25 of the ITAA 1997 includes property and goodwill as CGT assets.

Where goodwill was acquired before 20 September 1985 any capital gain or capital loss on its disposal is disregarded in accordance with paragraph 104-10(5)(a) of the ITAA 1997.