Edited version of private ruling

Authorisation Number: 1011682148595

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Ruling

Subject: Assessability of payment

Question 1

Will the payment received by you be income derived or assessable income under section 6-5 or any other provision of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Did capital gains tax (CGT) event D1 under section 104-35 of the ITAA 1997 happen in relation to the receipt of the payment?

Answer

Yes.

Question 3

If CGT event D1 happened in relation to the receipt of the payment, will the small business concessions under Division 152 of the ITAA 1997 apply?

Answer

No.

Question 4

Is the payment received by you in the nature of a payment for personal goodwill to which the CGT provisions apply?

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 are carrying on business as a practitioner.

You were approached by representatives from another entity. After negotiations, you entered into an agreement to commence working at premises owned by the entity.

The agreement was a verbal agreement which stipulated that you should work at the premises as a full time practitioner for a period of time. The agreement also provided for a payment which was described as 'goodwill'.

As a result of signing the agreement and abandoning your previous practice, a considerable number of your previous clients followed you to your new location and became clients of the entity.

It was agreed between the parties that there would be no further lump sum payments paid to you under this arrangement.

The agreement did not provide for a refund of the payment for any reason.

You have continued the same type of practice since joining the entity.

You are an independent contractor at the entity.

You have worked intermittently with the entity for several years and you have recently commenced full-time work at the entity.

The entity has not acquired any assets from your previous practice apart from goodwill. Nothing else passed on to the entity in consequence of the agreement.

You are an Australian resident for tax purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-35

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

Income Tax Assessment Act 1997 Section 118-20

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

Question 1

Goodwill

Goodwill is a CGT asset as defined in subsection 108-5(2) of the ITAA 1997. Taxation Ruling TR 1999/16 explains the legal definition of goodwill as discussed by the High Court in FC of T v. Murry 98 ATC 4585; (1998) 39 ATR 129:

12. … 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. 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 a business. It cannot be dealt with separately from the business with which it is associated.

Taxation Ruling TR 1999/16 also discusses the transferability of so-called 'personal goodwill':

127. What judicial decisions have referred to as 'personal goodwill' is the source of goodwill comprised of the particular personal skills and abilities, reputation, character and personality possessed by persons working in a business. These personal attributes are so intimately identified with, and inseparably attached to, the particular persons that if those persons withdraw from the business the value of its goodwill diminishes. They are inherently unique to the individual and they are not things that are capable of transfer or assignment.

128. Although the personal skills and attributes of a business owner or employees that have contributed to goodwill are not transferable, the fact remains a purchaser might be prepared to pay money for the goodwill built up from those attributes and other sources. Other sources of goodwill of a business, including the habit and inertia of customers, will continue to draw custom to the business: Murry case at paragraph [37] (98 ATC at 4593; 39 ATR at 141) and paragraph [52] (98 ATC at 4596; 39 ATR at 145). The goodwill of the business is transferable.

Any goodwill in your case would have resulted from your personal skills and attributes, and therefore as discussed in paragraph 128 of TR 1999/16, this goodwill is not transferable. It would continue to attach to you during the period you are practising at the entity.

Accordingly, the payment is not considered to be for the disposal of goodwill.

Ordinary income

Section 6-5 of the ITAA 1997 provides that if you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year. In subsection 6-5(1) of the ITAA 1997, income according to ordinary concepts is called ordinary income.

The word income is not defined in the ITAA 1997. Judicial consideration of this term indicates that, generally, a receipt will constitute income according to ordinary concepts if it is a receipt arising out of a taxpayer's employment or business activities. This will be so even if the receipt is not directly related to any service provided by the recipient to the donor - FC of T v. Dixon (1952) 86 CLR 540; 5 AITR 443; 10 ATD 82. Whether or not a particular receipt is income depends upon its quality in the hands of the recipient - Scott v. FC of T (1966) 117 CLR 514; (1966) 10 AITR 290.

Taxation Ruling TR 92/3 provides guidance in determining whether profits or gains from isolated transactions are income and therefore assessable under section 6-5 of the ITAA 1997. The term 'isolated transactions' refers to:

(a) those transactions outside the ordinary course of business of a taxpayer carrying on a business and

(b) those transactions entered into by non-business taxpayers.

The ruling sets out the Commissioners view as to the application of the decision of the Full Court of the High Court of Australia in FC of T v. The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693 (Myer).

The relevant feature of Myer as it pertains to this case is:

The amount in issue was a profit from a transaction which, although not within the ordinary course of the taxpayer's business, was entered into with the purpose of making a profit and in the course of the taxpayer's business.

The transaction in your case consisted of an agreement whereby you would work at the entity as a full-time practitioner for several years, and also provided for a payment which was described as 'goodwill'.

As discussed above, we do not consider that the payment is for the disposal of goodwill. Also, the receipt of the amount is clearly not in respect of the ordinary course of your business as a practitioner. However, as the payment was made as part of the agreement referred to above, and was made shortly after you commenced working full-time at the entity as an independent contractor, we consider that the payment is incidental to the practitioner business which you are carrying on albeit that the transaction is unusual or extraordinary. The payment would be in the nature of an inducement to enter into the agreement.

The profit or gain from the isolated transaction is therefore assessable under section 6-5 of the ITAA 1997 as ordinary income.

Question 2

Under section 104-35 of the ITAA 1997, CGT event D1 happens if you create a contractual right or other legal or equitable rights in another entity. CGT event D1 happened in your case when you entered into the agreement with the entity.

As it has been determined above that the payment received by you is assessable as ordinary income under section 6-5 of the ITAA 1997, the anti-overlap provisions in section 118-20 of the ITAA 1997 would operate to reduce the capital gain arising as a result of CGT event D1 by the amount of the income assessed to you under section 6-5 of the ITAA 1997. Subsections 118-20(1) and (1A) of the ITAA 1997 in particular will apply.

The combined effect of sections 6-5 and 118-20 of the ITAA 1997 is that the payment would be assessed as ordinary income and the capital gain as a result of the CGT event would be reduced to nil.

Question 3

As discussed above, any capital gain as a result of CGT event D1 happening will be reduced to nil by the combined effect of sections 6-5 and 118-20 of the ITAA 1997, and the small business concessions in Division 152 of the ITAA 1997 will have no application.

Question 4

CGT event A1 under section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, happens when goodwill is disposed of.

We have determined above that the payment is not considered to be for the disposal of goodwill. CGT event A1 will therefore not happen in this case and the CGT provisions will not apply in relation to any disposal of goodwill.