Edited version of private ruling

Authorisation Number: 1011790998778

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Ruling

Subject: Goodwill

Question 1

Is the intangible asset comprising A Company (A Co)s Goodwill an asset acquired by: A Co before 20 September 1985 for the purposes of Part 3-1 of the ITAA 1997?

Answer

Yes

This ruling applies for the following period<s>:

1 July 2010 to 30 June 2011

! July 2011 to 30 June 2012

The scheme commences on:

1 July 2010

Relevant facts and circumstances

X Co commenced business manufacturing appliances some time ago.

Production, sales and installation of appliances continued to increase.

Shortly after X Co had designed, and was manufacturing, selling and installing a large range of appliances which forms the basis of the range of appliances currently manufactured by them.

Production and sale of other appliances commenced after1985. X Co had previously sold appliances.

A Co derives a nominal amount of rental income

The first product that X Co manufactured was certain appliances.

X Co manufactured appliances for a short period

Other appliances were added to X Co's product portfolio but this has ceased.

Other appliances were added to X Co's product portfolio prior to 1985. Importation of other appliances has now ceased.

Other appliances were designed by X Co with production and sales commencing after1985.

A Co also acquired another appliance range.

A Co have now recommenced manufacturing another appliance.

A Co commenced wholesaling appliances.

The above described appliances form the basis of the product range currently manufactured and sold by A Co.

X Co changed its name to A Co in a certain year.

Relevant legislative provisions

Income Tax Assessment Act 1997

Subsection 180-5(2)

Section 149-10

Section 149-15

Summary

The intangible asset comprising A Co's goodwill is an asset acquired by A Co before 20 September 1985 for the purpose of Part 3-1 of the ITAA and thus will constitute a pre-CGT asset.

Detailed reasoning

Establishment of goodwill

Goodwill according to Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business (TR 1999/16) has the legal definition which was established by the High court in FC of T v. Murry 98 ATC 4585; (1998) 39 ATR 129. Paragraph 12 of TR 1999/16 states in part that:

… 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.

Based on the definition provided in TR 1999/16, X Co established goodwill when it was incorporated as a business in 1976 when it designed, manufactured, sold and installed appliances.

Subsection 108-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides guidance in relation to a CGT asset. It states that CGT assets include the following:

(a) part of, or an interest in, an asset referred to in subsection (1);

(b) goodwill or an interest in it;

(c) an interest in an asset of a partnership;

(d) an interest in a partnership that is not covered by paragraph (c).

A Co's Goodwill will constitute a CGT asset according to subsection 108-5(2) of the ITAA.

There is no doubt that an element of the value of A Co's business lies in Goodwill. However, what is under consideration for this Ruling is whether the Goodwill remains a single CGT asset.

Goodwill remains a single CGT asset if the same business continues

Paragraph 17 of TR 1999/16 provides guidance in deciding whether goodwill remains a single CGT asset if the same business is continued. It states 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. This is so even though:

(a) the sources of the goodwill of a business may vary during the life of the business; or

(b) there are fluctuations in goodwill during the life of the business.

Section 149-10 of the ITAA 1997 states the following in part:

A *CGT asset that an entity owns is a pre-CGT asset if, and only if:

(a) the entity last acquired the asset before 20 September 1985;

Based on the goodwill of A Co being established prior to 20 September 1985, the goodwill of A Co will remain the same single pre-CGT asset even though the goodwill of the business may have changed or fluctuated throughout the life of the business provided we are satisfied that the same business continued throughout the relevant period.

Can a Business 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?

A business may change to such an extent that it is no longer the same business which would mean the goodwill of the old business would cease when goodwill of new business is established. Paragraph 21 of TR 1999/16 states that:

The business does not need to be identical from its acquisition to its disposal. If the essential nature or character of the business is not changed, the business remains the same business for the CGT goodwill provisions. 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. 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 of itself cause it to be a new business provided the business retains its essential nature or character.

Discussing when for example when the essential nature or character of the business would remain the same. Paragraph 22 of TR 1999/16, states in part that it would remain the same:

… if all that happens is that portions of the operations of a business are discarded in an ordinary commercial way but the business retains its essential nature or character.

A business will also not essentially change its nature or character according to paragraph 23 of TR 1999/16, which states:

If the types of customers a business attracts change as the business evolves over the years, this does not necessarily mean the business is no longer the same business as was originally carried on.

When deciding whether a business has the same essential nature or character, a similar kind of business being carried on would be insufficient. The same business would not be carried on according to TR 1999/16 paragraph 24 in part 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.

Paragraph 91 of TR 1999/16 also provides important factors to consider when establishing the essential nature of character of the business; it states in part that consideration should be given to the following:

· 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

· The way in which a business is structured, carried on, managed and controlled.

Thus in considering whether A Co's goodwill would cease due to changes in the business, consideration must be given to the essential nature or character of the business.

A X Co has been in the business of designing, manufacturing, selling and installing appliances since it commenced. The following information details the various operations and activities of A Co and illustrates how the business has maintained its essential nature or character.

Product Range

Product range has remained the same since incorporation and has formed the basis of the business.

Suppliers

Since incorporation A Co has not had any major overhaul of suppliers.

Customers

A Co has continued to earn its income from wholesale or trade customers since it began. It has expanded its customer base across Australia and internationally, which has not changed the essential nature or character of the business which is to design, manufacture, sell and install appliances.

Acquisitions

X Co has been involved in acquisition of another company which primarily was to acquire its appliance assets to complement its product portfolio.

Based on the information provided it can be established the essential nature or character of A Co/X Co's business has remained the same since incorporation. Since A Co/X Co was established it has been involved in the designing, manufacturing, selling and installing of appliances.

Goodwill, as a whole, is either a pre-CGT asset or a post-CGT asset

According to TR 1999/16, goodwill is established as a whole either as a pre-CGT asset or a post-CGT asset. Paragraph 25 states in part:

The goodwill of a particular business cannot be characterised as partly pre-CGT goodwill and partly post-CGT goodwill. Goodwill is a composite asset.

A distinction should be made between goodwill and an in interest in goodwill. An interest in goodwill is not a composite asset.

Further clarification is provided in Paragraph 26 of TR 1999/16, which states in part:

An interest in goodwill, unlike goodwill itself, is not a composite asset. For example, a partner who owns a pre-CGT interest in a pre-CGT business might later acquire a post-CGT interest in the business. On acquiring the post-CGT interest in the business (with an associated post-CGT interest in the pre-CGT goodwill of the business), that interest in the business is not subsumed into the partner's pre-CGT interest in the business (and the associated pre-CGT interest in goodwill).

The goodwill which was established by X Co will be regarded as a pre-CGT due to the business being incorporated and operational prior to 20 September 1985. Even though the goodwill of the business may have increased since incorporation, the goodwill of X Co/A Co will be remain a single pre-CGT asset.