Edited version of private advice

Authorisation Number: 1012635596822

Ruling

Subject: Market value of goodwill

Question 1

If the business activities of Company X cease and the same (or near same) business activities are carried out by Company A, will the Commissioner consider that, for the purpose of subsection 116-30(1) of the Income Tax Assessment Act 1997 (ITAA 1997), the market value of goodwill in Company X is nil in respect of any capital gains tax (CGT) event happening within the AXY group of companies?

Answer

Yes.

Question 2

If the business activities of Company Y cease and the same (or near same) business activities are carried out by Company A, will the Commissioner consider that, for the purpose of subsection 116-30(1) of the ITAA 1997, the market value of goodwill in Company Y is nil in respect of any CGT event happening within the AXY group of companies?

Answer

Yes.

This ruling applies for the following period

2014 income year

The scheme commences

During the 2014 income year

Relevant facts and circumstances

Company A has business operations in various states of Australia.

Company X and Company Y have operated as agencies or branches of Company A, so as to serve the local customers of the business of Company A in the relevant states.

No License was ever drafted between Company A and Company X/Company Y. All three companies are controlled by the same entity.

Invoicing for the sale of business has always been done on the Company A letterhead and the customer statements are sent under the name of Company A.

All the marketing activities of business were and are undertaken by Company A.

All contracts with vital stock suppliers of the business have always been and continue to be with Company A.

Company A, Company X and Company Y together have been referred to as AXY group.

The three companies form the one group for GST purposes, with Company A being the head entity.

Company X and Company Y do not have any trademark or other intellectual property in respect of their business.

All funding and working capital for the branches/divisions initially came from Company A and the working capital continues to be provided by Company A to Company X and Company Y.

All head office functions of the business are conducted solely by Company A.

It has been proposed that the current activities carried out by Company X and Company Y cease and the two companies wound up.

Company A would directly resume all interstate operations of the business.

The restructure will simplify the Group's corporate structure and reduce annual accounting and compliance costs.

A valuation of the Company X and Company Y was undertaken by DEF and the valuation report concluded that the value of Company X and Company Y under both the CMFE and DCF methodologies is less than the value of its net assets. It further states that Company X and Company Y have no goodwill and it does not contribute in any way to the AXY group business valuation.

A critique of the valuation report by the Australian Valuation Office (AVO) states that the conclusions in the report with regard to the allocation of AXY group goodwill to be acceptable.

Company A will not pay any consideration in relation to goodwill to Company X and Company Y for the cessation of their operations and the same (or near same) business activities being carried out by Company A.

Reasons for decision

Unless otherwise specified, all legislative references are to the ITAA 1997.

Question 1

Summary

The Commissioner accepts that the market value of goodwill in Company X is nil in respect of any CGT event happening to the goodwill of Company X for the purpose of subsection 116-30(1) upon the cessation of business activities by Company X.

Detailed reasoning

1. Background

Division 116 prescribes how to determine the capital proceeds from a CGT event which is required to work out capital gain or loss from the event.

2. Nature of CGT events happening to the goodwill of Company X

Though it is not considered necessary to determine the precise CGT event in this case as the focus of the ruling is on the market value of the goodwill of Company X, the following commentary is provided as a context to the application of market value substitution rule.

CGT event means any of the CGT events described in Division 104.

If a business owner (whether a sole trader or practitioner, a company, a trustee of a trust estate) disposes of their entire business, goodwill may be transferred with that business. CGT event A1 in section 104-10 (about disposals of CGT assets) happens to the goodwill of the business.

Under section 104-20 CGT event C1 happens if a CGT asset you own is lost or destroyed.

CGT event C2 happens if the ownership of an intangible CGT asset ends by the asset:

• being redeemed or cancelled; or

• being released, discharged or satisfied; or

• expiring; or

• being abandoned, surrendered or forfeited; or

• if the asset is an option--being exercised; or

• if the asset is a convertible interest--being converted.

The market value substitution rule applies to CGT events A1 and C2 but does not apply to CGT event C1 (section 116-25). Thus market value substitution rule will apply to Company X goodwill if the CGT event resulting from the cessation of business activities and its commencement under Company A is determined to be A1 or C2.

3. Meaning of goodwill

'Goodwill' for the purposes of the definition of 'CGT asset' in section 108-5 has the meaning it bears under the general law. It is the legal definition of goodwill as explained by the High Court in FC of T v. Murry 98 ATC 4585 (1998) 39 ATR 129 (Murry) case, rather than its accounting and business definitions, which applies.

4. Application of market value rules to the goodwill of Company X

Paragraph 116-30(1) states:

(1) 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.)

Example: You give a CGT asset to another entity. You are taken to have received the market value' of the CGT asset.

Company A will not pay any consideration in relation to goodwill to Company X in relation to Company X ceasing its operations and the same (or near same) business activities being carried out by Company A.

It follows that Company X will not receive any amount for the goodwill when its activities cease and are commenced under Company A.

The issue which then needs to be considered is the market value of the CGT asset i.e. goodwill of Company X in this case.

5. Meaning of market value

The term market value is defined in section 995-1 as having a meaning affected by Subdivision 960-S.

Section 960-400 states that the term market value is often used in the ITAA 1997 according to its ordinary meaning, however, in some cases that expression has a meaning affected by this Subdivision.

Special rules apply where the Goods and Services Tax affects the market value of an asset and in the case of market value of non-cash benefits. Neither of these special rules is relevant for the purposes of the market value of the goodwill under the Scheme so market value has its ordinary meaning. It is considered that the terms of Subdivision 960-S do not affect the ordinary meaning of market value of goodwill of Company X.

6. Market value of goodwill

Our preferred approach to valuing goodwill on the sale of a profitable business or a business expected to be profitable is the difference between:

(a) the present value of the predicted earnings of the business; and

(b) the sum of the market values of off balance sheet assets and all identifiable net assets - in terms of the accounting standards - other than goodwill of the business disposed of (subject to the restrictive covenant exceptions).

We recognise and accept, however, that other valuation methods may be adopted.

Further, the ATO market value guidelines state that the valuation of goodwill is generally based on the calculation of a residual value. In basic terms, this approach requires the valuation of the net identifiable assets of the business (market-adjusted) and the valuation (market value) of the equity of the business.

A residual value may be derived by subtracting the value of the net identifiable assets of the business from the value of equity of the business.

The valuation report by DEF concluded that the value of Company X under both the CMFE and DCF methodologies is less than the value of its net assets. It further states that Company X has no goodwill and it does not contribute in any way to the AXY group business valuation.

A critique of the valuation report by AVO states that the conclusions in the report with regard to the allocation of the AXY group goodwill to be acceptable.

Accordingly it is considered that for the for the purpose of subsection 116-30(1), the market value of goodwill in Company X is nil in respect of any CGT event happening to the goodwill of Company X if the business activities of Company X cease.

Question 2

Summary

The Commissioner accepts that the market value of goodwill in Company Y is nil in respect of any CGT event happening to the goodwill of Company Y for the purpose of subsection 116-30(1) upon the cessation of business activities by Company Y.

Detailed reasoning

The valuation report by DEF concluded that the value of Company Y under both the CMFE and DCF methodologies is less than the value of its net assets. It further states that Company Y has no goodwill and it does not contribute in any way to the AXY group business valuation.

A critique of the valuation report by AVO states that the conclusions in the report with regard to the allocation of CH Group goodwill to be acceptable.

Accordingly it is considered that for the for the purpose of subsection 116-30(1), the market value of goodwill in Company Y is nil in respect of any CGT event happening to the goodwill of Company X if the business activities of Company Y cease.