Edited version of your private ruling

Authorisation Number: 1012610117610

Ruling

Subject: Goodwill

Question 1

Is the intangible asset comprising the goodwill of the Company A Business taken to be property acquired by Company A Pty Ltd (Company A) before 20 September 1985 for the purposes of Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)

Answer

Yes.

Question 2

Is the goodwill of the Company A Business property acquired before 20 September 1985 for the purposes of applying section 104-230 of the ITAA 1997 to Investment Co, as trustee for the Family Trust, as a shareholder in Company A?

Answer

Yes.

This ruling applies for the following period:

1 July 2014 to 30 June 2015

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Company A Group and the Company A Tax Consolidated Group

As at the date of this ruling the Company A Group of companies comprises a number of entities.

The business commenced and conducted by Company A through the Company A Group prior to 20 September 1985 to the date of this ruling is referred to as the Company A Business.

As and from the financial year commencing 1 July 20XX, Company A elected to form the Company A Tax Consolidated group. The Company A Tax Consolidated Group comprises Y entities

The Company A Business

Overview

The Company A Business undertakes the manufacture, marketing and distribution of a wide range of products. The key product lines have remained staple offerings from the early days of the Company A Business to the present day.

The Company A Business has offices and distribution centres throughout Australia and exports to other countries throughout the world. The Company A Group's longest standing brand is a proud Australian product.

The head office of the Company A Business is still located at the site originally purchased in State A some time before 20 September 1985 after the Company A Business expanded from its original premises close by. While becoming more automated, the product manufacturing process has not changed and continues today.

History and evolution of the Company A Group

The Company A Group has evolved over time in line with the changing needs of the Company A Business. Increasingly over time some of the activities of the Company A Business have been concentrated into specialist subsidiaries owned by Company A. Following is an overview of the development of each of the main entities in the Company A Group.

Company A, Company B and Company C

The Company A Business was founded in the early 1900's.

Company A was incorporated a short time later as the vehicle through which the Company A Business was to be (and to this day, still is) conducted. Upon its incorporation, Company A assumed all the business activities of product manufacturing, marketing and distribution.

From its incorporation Company A undertook all the activities of the Company A Business. Those activities included (in addition to the core manufacturing activity) ownership of plant and equipment, trademarks, marketing, distribution and sales.

Over time, Company A has developed a number of wholly owned subsidiaries commencing with proprietary companies in other States, which were incorporated by Company A to conduct distribution activities in those States. The roles of these and other subsidiaries changed over time as both manufacturing and distribution were organised on a national basis and concentrated at the headquarters of the Company A Business in State A.

Prior to 20 September 1985, in its capacity as trustee for the Family Trust acquired all the shares in Company A. Accordingly, the Family Trust has from that time to the present owned the Company A Business conducted by Company A. For practical purposes, the founders' descendants and their respective families are the main beneficiaries of the Family Trust. The descendants were from an early age actively involved in the family business.

Company A has at all material times been the head company of the Company A Group, and has always been the main entity responsible for determining the structure of the group from time to time as it has evolved. It has also been responsible for setting the financial and operating policies of the group.

Originally, the Company A Business sourced a primary input for the production of its products from external suppliers. After 20 September 1985, to deal with changes in the market, Company A incorporated Company B. Company B is responsible for the production of the primary input. The primary input is then sold to Company C (see below) for use within the Company A Business.

Company B owns the land and buildings where the equipment is constructed and other premises where the primary input is stored.

Post 20 September 1985 a subsidiary company which was originally incorporated to carry out distribution in another State, ceased to carry out that role (and other roles it had assumed in the meantime) and changed its name to Company C. Company A then allocated the manufacturing and distribution activities of the Company A Group which was being undertaken by Company A, to Company C. Company C now uses manufacturing equipment and intellectual property owned by Company A under licence. This reorganisation/change is significant and relevant in the context of the applicant's private ruling application and so it has been described in more detail below under the heading 'Internal reorganisation of the Company A Business within the Company A Group'.

At present, besides determining as it has always done, the strategy of the Company A Group as well as its financial and operating policies, Company A remains the owner of:

• land on which the headquarters and main manufacturing facilities are constructed (but not the operations which are undertaken by Company B)

• the manufacturing plant and equipment and

• the intellectual property rights and brands (in particular, a substantial number of registered trade marks (all of which are used by Company C under license in the Company A Business)).

Overseas subsidiaries

Company A owns interests in various overseas entities which, amongst other things, assist with the distribution and manufacture of products overseas.

Property holding entities

Company A also owns all the units in several property holding unit trusts. These trusts own various parcels of land adjacent to the main business site (acquired post 20 September 1985). A related wholly-owned subsidiary owns in its own right an equitable interest in property leased to another operating entity whose business is conducted in another corporate group that is also controlled by the founders' family.

Other parcels of real property are held by related entities

Internal reorganisation of the Company A Business within the Company A Group

Significantly, the business activities within the Company A Group of entities were reorganised post 20 September 1985 as follows:

• both before and after the reorganisation Company A remained the entity which

• ultimately conducted the Company A Business and

• determined the strategy of the Company A Group, its structure and its financial and operating policies

• a subsidiary changed its name to Company C (whilst remaining a wholly-owned subsidiary of Company A)

• manufacturing, supply and sales arrangements and employees of Company A were assumed by Company C

• Company A granted a licence to Company C to use its intellectual property to manufacture, package and sell the relevant products anywhere in the world

• the licence agreement entered into between Company A and Company C (License Agreement) provides for an exclusive licence for a specified term after which time the licensee must no longer use the intellectual property

• the Licence Agreement provides for the payment of a royalty from Company C to Company A for the licence of the intellectual property and specifies that ownership of the intellectual property will at all times remain with Company A

• the Licence Agreement provides that the goodwill arising out of or in relation to the business conducted by Company A or the intellectual property vests with Company A. Further, it provides that any modifications, improvements or additions to the products or intellectual property also vest with Company A

• the licensing of intellectual property from Company A to Company C, was primarily driven by the following commercial factors

• a desire to quarantine risk from operations in a subsidiary trading vehicle

• concerns around putting the Company A Business at a commercial disadvantage in respect of its key customers and competitors and

• to clarify the internal roles of the members within the Company A Group so as to increase focus and efficiency

• the real estate, manufacturing, plant and equipment and intellectual property rights and brands continued to be owned by Company A and were licensed to Company C

The internal reorganisation has not made a material difference to the business relationships between the Company A Business and its customers, or its suppliers.

Product Branding

The Company A Business has over time, through the implementation of its branding strategy and with the assistance of technological advancements, developed from a business with a focus on the manufacture, distribution and sale of its key products to a more sophisticated business with a focus on the production of a broader range of products by:

• developing extensions of its brand Brand X in other applications to complimentary products and

• developing new ranges of products which are marketed under other brands, namely Brand Y, Brand Z, Brand S and Brand T.

The recognition of Brand X has allowed the Company A Business to use the brand as a platform to launch other categories of products:

• complimentary to the main products initially comprised the Company A Business product range; and

• that recognise the significant social change in relation to consumer preferences.

Company A invests yearly in order to maintain and increase as best as possible, customer awareness of its brand names and each product brands market share.

Major Brands

Brand X

The first use of the name Brand X by the Company A Business was some time before 20 September 1985.

Brand X has a central feature for the packaging of its branded products

Early on, the Brand X branded range of products consisted of only a few products. Since then, the product range has expanded to take into consideration changing consumer needs and the market. The product range has continued to expand.

Sales and distribution of Brand X branded products

In the early years of the Company A Business, sales and distribution channels were confined to its home State, State A. Distribution to interstate centres began shortly thereafter as did export of Brand X branded products.

The Company A Business subsequently expanded such that sales of its products were made on a national basis .

Since before 20 September 1985 the Company A Business has expanded its presence in Australia and overseas. Brand X branded products are exported to overseas markets.

Development of the Brand S and Brand T branded products

The Company A Business also manufactures, markets and sells products under the Brand T brand. The Brand T was first used after 20 September 1985. The Brand T range of products originated as an extension of main Brand X product production of the Company A Business and has constantly been extended since its launch.

The Brand T brand and its products were established to diversify the Company A Business products. The Brand S brand, which consists of similar products, was subsequently acquired by the Company A Business.

Given the expertise of the Company A Business in producing and distributing its main products the development of the Brand T brand represented a natural extension to the Brand X brand and product lines prior to 20 September 1985.

Brand T branded products are sold across Australia and overseas utilising similar sales and distribution networks as Brand X branded products.

The first export of Brand T branded products was post 20 September 1985. Since then the export market for Brand T branded products has continued to expand.

Brand Y branded product development

The Company A Business also manufactures, markets and sells products under the Brand Y brand on licence from a related party entity (outside the Company A Group). The Brand Y brand was developed in the period before 20 September 1985 and has, since that time, been used by the Company A Business under licence.

The Brand Y range of products was developed in response to a strategy to produce a product that was able to straddle the markets between various consumer groups.

Brand Z branded product development

Post 20 September 1985 the Company A Business launched a further range of products under the Brand Z brand.

This range of products was developed as part of a multi-level product strategy to enable the Company A Business to compete at different price points within the relevant market and to target a greater market span of consumers.

Trademarks

Company A has filed for a large number of trademarks since its inception. The first trademark registration incorporating the name Brand X was some time ago. Most of the trade marks registered by Company A over time have continued to be maintained by Company A as registered trademarks until the present day.

In addition to the trademarks owned by Company A, Company A has at all material times since before 20 September 1985, had the right to use in its commercial operations the Brand Y trademarks, although the trademarks themselves are owned by another entity.

Manufacturing Operations

The Company A Business commenced manufacturing operations from one location in State A. These operations were then moved to the present location

The only major change in production relates to the streamlining of production with the establishment of the Company A Business' own production facility (as discussed above and further elaborated on below).

Employees

The Company A Business is a family run business. The manufacturing operations and head office continue to be located at the current site purchased after expanding from its original site. The family members continue to be involved in the Company A Business today.

The increase in the number of employees has been consistent with the expansion of the Company A Business. There have been no significant recruitment or redundancy events during the period. The number of employees as at 1985 has steadily increased to present day levels to accommodate the steady expansion of the Company A Business.

Suppliers

There have been no major changes in suppliers to the Company A Business for the period after 20 September 1985 other than the change in supply arrangements (this change involving the incorporation of Company B, discussed in detail immediately below, was made in response to market occurrences).

Incorporation of Company B

Company B was incorporated after 20 September 1985.

This enabled the Company A Business to continue to manufacture its original products.

Customers

Geographic

The Company A Business commenced as a locally based manufacturer. Initially, it distributed solely to locally based customers. Early on, the Company A Business commenced selling its products in other States and soon Brand X branded products were sold throughout Australia.

The Company A Business has, at all material times before and after 20 September 1985, sold its products to commercial outlets. It has never been a retailer of its products. Brand X branded products and other branded products owned by the Company A Business (e.g. Brand T) are offered for sale widely in Australia.

As discussed above, the Company A Business began exporting its products soon after commencing business operations. Brand X branded products are exported to many overseas markets.

Demographic

The Company A Business has also developed additional brands to penetrate varying demographics within the market. For instance, the Brand Y brand was intended to straddle the markets between various consumer groups

Further, the Brand T and Brand S range of products were introduced to target changing consumer preferences.

Financing Arrangements

The Company A Business had external debt until recently - it repaid this debt using cash from business operations. The Company A Business obtained external finance for the acquisition of specific capital assets such as manufacturing plant and equipment.

Management

There have been no significant changes in the management of the Company A Business.

Business Premises

The Company A Business commenced at one place before moving to the present location.

No other change to the Company A Business premises has occurred.

Accounting reporting

The Company A Business has maintained a consistent consolidated accounting reporting framework for the Company A Group since 20 September 1985. Specifically, since before that date, the Company A Group has consistently reported for all entities within the group on a group consolidated basis and the accounting reports have always been maintained from the original head office.

The Company A Business - Business snapshot over time

The applicant has provided a series of documents titled 'Business snapshot over time' for each of the following periods:

• Before 20 September 1985

• 1986-1990

• 1991-1995

• 1996- 2000

• 2001- 2005

• 2006- 2010

• 2011- 2013

Each snapshot provides, for the period of time covered by the respective snapshot, key data for each of the following topics:

• Company A Business

• Establishment and marketing

• Sales and distribution channels

• Customer base

• Key brands and product range

• New Trademark registrations

The snapshots, together with the additional information provided by the applicants in the private ruling application have been provided by the applicant in order to demonstrate both changes and continuities in the Company A Business goodwill since the inception of the Company A Business to the present day. The Commissioner accepts that the snapshots and the additional information that has not been referred to above (in particular, the tables summarising various data and showing relevant trends) forms part of the relevant facts and circumstances of this notice of decision.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 section 104-230

Income Tax Assessment Act 1997 subsection 104-230(1)

Income Tax Assessment Act 1997 subsection 104-230(2)

Reasons for decision

Question 1

Taxation Ruling TR 1996/16 Income tax: capital gains: goodwill of a business (TR 1999/16) details the ATO view on whether the goodwill of a business acquired prior to 20 September 1985 remains a pre-CGT asset for the purposes of part 3-1 of the ITAA 1997. In this case, the Commissioner considers that an analysis of the goodwill of the Company A Business pursuant to TR 1999/16 must address the goodwill of the entire Company A Group, not just the Company A tax consolidated group '..as goodwill cannot be dealt with separately from the business with which it is associated' (see paragraph 12 of TR 1999/16).

Paragraph 17 of TR 1999/16 states:

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.

Paragraph 20 of TR 1996/16 states:

Whether the same business is being carried on is a question of fact and degree that ultimately depends on the circumstances of each particular case.

Paragraph 20 of TR 1996/16 states:

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 .

Therefore to determine whether a pre-CGT asset (in this case, the pre-CGT goodwill of the Company A Business) remains a pre-CGT asset is a question of fact and degree to be made by looking at the relevant business and examining its operations at all relevant times. Specifically, this question relates to whether the business as at the date of this ruling has retained its 'essential nature or character' (that is, is the same business) which was in place prior to 20 September 1985.

The Company A Business, as described and explained by the applicant, has been examined and as a result the Commissioner has determined that whilst it is evident that the Company A Business has clearly undergone growth, expansion of its customer base and product offering, the 'essential nature and character' of the business remains the same as it was prior to 20 September 1985. That is, fundamentally the Company A Business has been and currently still is a business that:

(a) is a producer of products that are produced/manufactured from its original premises,

(b) adopts a diverse brand mix for diversification, and

(c) sells and distributes its products through a variety of commercial outlets.

Crucially, the data provided in the Snapshots, detailing the operations of the Company A Business from prior to 20 September 1985 to 2013, substantiates and evidences a natural growth over time (particularly as expressed by sales and volumes) of the key products of the Company A Business. The Snapshots (along with all the other information provided by the applicant) do not show any divergence of the Company A Business into areas of operation/activities that are in obvious contrast to the business that has been undertaken by the Company A Business from its inception to the present day.

Similarly and importantly, in the course of analysing the Company A Business for the purposes of TR 1996/16, particular attention has been given to the establishment of Company B to meet the needs of the growing Company A Business, and the addition of the Brand S and Brand T brands and their associated products. The Commissioner considers that both of these actions are considered to fall within 'organic growth' and do not change the 'essential nature and character' of the business.

Accordingly, the goodwill of the Company A Business as the date of this notice of decision is still property that was acquired before 20 September 1985 (that is, is a pre-CGT asset) for the purposes of Part 3-1 of the ITAA 1997.

Question 2

Pursuant to subsection104-230(1) of the ITAA 1997, CGT event K6 happens if:

a) a taxpayer owns shares in a company acquired before 20 September 1985;

b) a relevant CGT event happens in relation to the shares;

c) there is no roll-over for the CGT event that occurs; and

d) the applicable requirement in subsection 104-230(2) of the ITAA 1997 is satisfied - the Commissioner addresses this requirement immediately below.

Subsection 104-230(2) of the ITAA 1997 provides that CGT event K6 will be triggered if either of the following tests is satisfied:

(1) the market value of the property of the company or trust that was acquired on or after 20 September 1985 (excluding trading stock) is at least 75% of the net value of the company or trust: ss 104-230(2)(a) of the ITAA 1997 (Part A calculation); or

(2) where the company or trust owns interests in interposed entities or trusts (ie 'lower tier entities'), the market value of the interests in the property acquired on or after 20 September 1985 (excluding trading stock) of those lower tier entities is at least 75% of the net value of the company or trust: ss 104-230(2)(b) of the ITAA 1997 (Part B calculation).

Taxation Ruling TR 2004/18 Income tax: capital gains: application of CGT event K6 (about pre-CGT shares and pre-CGT trust interest) in section 104-230 of the Income Tax Assessment Act 1997 (TR 2004/18) explains how the Commissioner considers section 104-230 of the ITAA 1997 operates and therefore how he determines whether CGT event K6 will apply.

Property

Paragraphs 52 and 53 of TR 2004/18 state:

The Macquarie Dictionary (3rd revised edn) defines 'property' to mean 'that which one owns; the possession or possessions of a particular owner'. The term 'property' in its context in section 104-230 is property owned by either the company referred to in paragraph 104-230(2)(a) or by lower tier companies.

It extends to any kind of property. It covers most CGT assets, including pre-CGT assets, but does not include a CGT asset that is not property. It can include such things as….goodwill….

Therefore goodwill is property for the purposes of subsections 104-230(1) and (2) of the ITAA 1997.

Effect of License Agreement on the ownership of the goodwill of the Company A Business

In the present circumstances, the Part-A calculation will only take into account the pre-CGT status of the shares in Company C (and other subsidiaries) in the Company A Group. The nature of the assets held by Company C (and other subsidiaries) is not relevant for the purposes of this calculation. However, under the Part-B calculation, the nature of the assets held by Company C (and other subsidiaries) is taken into consideration, including whether they are considered to be property acquired after 20 September 1985.

The licensing of Company C to use the goodwill of the Company A Business pursuant to the License Agreement is the potential event that could affect the pre-CGT status of the Company A Business goodwill owned by Company A. It is therefore relevant to determine whether the pre-CGT goodwill owned by Company A was transferred to Company C as part of the internal reorganisation of the Company A Business within the Company A Group and therefore whether the goodwill forms part of the post-CGT property of Company C for the purposes of the part B calculation.

Intra-group transfers - single entity rule

Ordinarily, transactions between members of consolidated groups for income tax purposes are disregarded under the single entity rule (SER). The effect of this would be that any intra-party transactions are taken not to have occurred for calculating the tax liability of the head company.

However, Taxation Determination 2007/D5 Income tax: consolidation: does the single entity rule in section 701-1 of the Income Tax Assessment Act 1997 apply in determining whether distributions by the liquidator of a head company represent 'income derived' by the head company for the purposes of section 47 of the Income Tax Assessment Act 1936? states that the SER does not apply to a consolidated group with respect to CGT event K6, and intra-party transactions are relevant for this CGT event (that is, if the goodwill was transferred to Company C by Company A then the intra-party transfer cannot be disregarded for the purposes of CGT event K6). With this in mind, the particulars of the License Agreement have been examined to determine if a transfer of goodwill has taken place.

The Licence Agreement between these two entities states that at all times during the License Agreement, goodwill will remain with the licensor, being Company A and it acknowledges that:

..the ownership of the Intellectual Property in respect of any modifications, improvements or additions to the Products or the Intellectual Property or any goodwill arising out of or in relation to the Business or the Intellectual Property, will vest with the Licensor.

When examining the substance of the License Agreement it is evident that the Licence Agreement extends only to the trading operations of the Company A Business. Specifically, the License Agreement states:

The Licensor, subject to compliance by the Licensee of its obligations under this Agreement, grants to the Licensee for the Term a license to use the Intellectual Property for the Permitted Use throughout the Territory…

…where the term Permitted Use is defined in the License Agreement as meaning only:

The use of Intellectual Property for the manufacture, packaging and distribution of the Products in the Territory.

Furthermore, the conduct and management of the Company A Business was not transferred under this License Agreement, with Company A continuing to determine the strategy of the business, and how its subsidiaries would perform the various functions of the business.

In Commissioner of Taxation of the Commonwealth of Australia v. Murry [1998] HCA 42; 193 CLR 605; 39 ATR 129: 98 ATC 4585 the High Court concluded that:

Goodwill is inseparable from the conduct of the business. It may derive from identifiable assets of a business, but it is an indivisible item of property, and is an asset legally distinct from its sources.

The Licence Agreement makes it clear that the core assets of the Company A Business forming sources of the goodwill of the business, being the intellectual property and physical assets, remain with Company A. The License Agreement states that '..the Intellectual Property is and will remain the exclusive property of the Licensor..' and only permits the licensee to use the Intellectual Property. Likewise, it states quite simply and directly 'The Licensor and the Licensee have agreed that the Licensee may conduct the Business for the Term'. The License Agreement, specifically through these clauses and considered in its entirety, in no way transfers any ownership in any asset whatsoever owned by Company A, to Company C. This supports the conclusion that no transfer of the goodwill occurred.

Further supporting this conclusion is the contention found in TR 1996/16 at paragraphs 12 and 25:

12. It (goodwill) cannot be dealt with separately from the business which it is associated.

25. The whole of the goodwill of a business is either pre-CGT goodwill (subject to Division 149 - about when an asset stops being a pre-CGT asset - see paragraph 90) or post-CGT goodwill. The goodwill of a particular business cannot be characterised as partly pre-CGT goodwill and partly post-CGT goodwill. Goodwill is a composite asset.

As such, it is the view of the Commissioner that goodwill cannot be separated into parts and at all times remains one whole indivisible asset. This asset remains with all the other assets and conduct of the Company A Business, which have not been affected/transferred to Company C by the License Agreement pursuant to the internal reorganisation that occurred - it is merely the right to use the goodwill for a specified period only, that has been provided (licensed) to Company C.

Accordingly, as the License Agreement did not amount to a transfer of goodwill from Company A to Company C, the goodwill is (remains) the pre-CGT property of Company A for the purposes of applying section 104-230 of the ITAA 1997 (CGT Event K6).