Edited version of your written advice

Authorisation Number: 1012702253421

Ruling

This is an edited version of a revised private ruling. It replaces the edited version of the private ruling with the authorisation number X.

Subject: CGT & goodwill

Question 1

Is the intangible asset comprising the goodwill of Retail Co an asset considered to have been acquired before 20 September 1985 for the purposes of section 109-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Would any capital gain made on the disposal of that goodwill asset be disregarded pursuant to paragraph 104-10(5)(a) of the ITAA 1997?

Answer

Yes

Question 3

If the goodwill of Retail Co is considered to have been acquired before 20 September 1985, has section 160ZZS of the Income Tax Assessment Act 1936 (ITAA 1936) or section 149-30 of the ITAA 1997 applied to deem the goodwill to be acquired after 20 September 1985?

Answer

No

This ruling applies for the following periods:

1July 2011 to 30 June 2015

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The goodwill asset of Retail Co

Retail Co was acquired by Investor Co in March 1981. At that time Retail Co-operated a retail business (the Retail Co Business).

The core components of the Retail Co Business are:

(a) direct sales to the public via retail stores and a number of other authorised stockists; and

(b) indirect sales to the public via phone, fax, internet and mail order retail services through the Retail Co Catalogue.

The main products sold by the Retail Co Business since 1981 to date have been electronic components. Since 1984 the Retail Co Business has produced a Catalogue that outlines the products sold by the Retail Co Business. The Catalogue shows that the products sold by the Retail Co Business have remained the same, allowing for technological change and an expanding range of products of a similar nature.

Each of the stores operates under the same trading name and retails the same products, as set out in the Catalogue. There is uniform pricing across all stores.

Since 1981 to date, the Retail Co Business has acquired 100% of its product range from Company A. Company A is a wholly owned subsidiary of Retail Co.

From 1981 to 2001 Retail Co-operated as an intermediary for Company A, supplying wholesale products to other electronics retailers. However in 2001 Company A became solely responsible for these activities.

Since 1981 Retail Co has taken advantage of growth opportunities, acquiring additional stores and by continuous evolution and progressive expansion of the product range of the Retail Co Business in line with technological changes.

Retail Co has not made any store acquisitions from 1985 involving any form of goodwill acquisition in the sense of a separately recognised amount of consideration payable for goodwill.

Any goodwill that has been acquired in the legal sense has been subsumed into the Retail Co Business goodwill.

In 1981 the Retail Co Business originally operated from one store and over time the business has expanded to comprise a significant number of stores.

The current arrangements for operating the Retail Co Business include:

• all retail stores are owned by Retail Co and use the same business systems as well as the same wholesaler supplier, being Company A;

• all stores are accounted for and report as a single business and use the one:

*Australian Business Number (ABN)

*Goods and Services Tax Registration

*bank account

*bank system for EFTPOS transactions

• stock is moved between stores on an as needs basis without cash flow taking place

• the workers' compensation costs are paid as a single cost by Company A

• the payroll is administered by Company A

The product range has grown significantly and a large number of the original products sold are still being sold by the business.

Authorised stockists are used by the Retail Co Business in locations where the population demographic is insufficient to justify a stand-alone retail store. Stockists enter into an agreement with Retail Co's wholly owned subsidiary Company A.

All products lines sold by the Retail Co Business are listed in the Catalogue. This is a document produced by the business each year since 1984. Not only does the Catalogue list the products sold by the Retail Co Business, it also sets out store and stockist locations as well as website details.

The Retail Co Business also started trading in Country A, via Retail (Country A) Co. This company is a wholly owned subsidiary of Retail Co. This company used the Retail Co Business goodwill and trading name, as well as trademarks and systems under licence from Retail Co and as such none of these assets were disposed of by Retail Co to Retail (Country A) Co during the time it was operating on behalf of Retail Co.

To simplify administration and compliance of returning the Country A trading income to the Australian resident shareholders the Country A operations were restructured in 2013 so that the Country A operations would be undertaken by Retail Co rather than Retail (Country A) Co. This had meant that stores in Country A commenced to operate in the same business model as the Australian stores.

Mr Black has had the central management and control of the Retail Co Business. He became managing director in 1981.The management structure gradually developed over time into a management committee, and has changed over time to cope with the increase in Retail Co Business operations through additional retail locations and the resulting increase in sales volume.

The accounting, management and reporting for all stores is carried out within Retail Co. All stores use the same ABN and a single GST registration.

Since 1984 all employees of the Retail Co Business have been employed by Company A. Training of staff is undertaken at a national level through the head office.

The Retail Co Business has recently established websites in various foreign markets to test whether the Retail Co Business model is viable in those markets. However there are no immediate plans to establish retail stores in these markets - until the market is tested via the online sales.

Retail Co owns a number of intangible assets such as trading names and trademarks and also possesses a goodwill asset, based on the market values of all other assets of Retail Co.

Retail Co shareholding history

Retail Co is wholly owned by Investor Co and Company A is, in turn, wholly owned by Retail Co.

At present the shareholdings in Investor Co are as follows:

Mr Black owns 2 A Class shares;

White Pty Ltd as trustee for the Mr Black Family Trust No. 2 owns 3 A Class shares; and

Mr Black Nominees Pty Ltd as trustee for the Mr Black Family Trust owns 5 B Class shares, issued on 29 June 1983.

Mr Black acquired 4 A class shares on 3 March 1981.

On that day, Mr Grey acquired 1 A Class share as bare trustee for Mr Black, which he held until these shares were vested absolutely in Mr Black after 19 September 1985, but before 1998. As this share was held on a bare trust for Mr Black, this A Class share should be treated as always being held by Mr Black.

Mr Black transferred 3 A Class shares to White Pty Ltd as trustee for the Mr Black Family Trust No. 2 after 20 September 1985 but before 1998.

While at all times after 19 September 1985 Retail Co has been wholly owned by Investor Co, there has been a change in ownership of Investor Co since 1985.

The shareholdings of Investor Co are summarised in this table.

The A Class and B Class shares in Investor Co have the same rights and entitlements to dividends, although dividends may be declared in respect of one class to the exclusion of the other.

The B Class shares have a right to a return of capital and participation in the distribution of surplus assets on a winding up, while A Class shares have no such right.

Since 1 July 1986 approximately 63% of dividends declared by Investor Co have been paid to the A class shareholders and the remaining 37% have been paid to the B class shareholders. With respect to the dividends paid to the A class shareholders, these have been paid to Mr Black and the Mr Black Family Trust No. 2 in proportion to their shareholdings.

The dividends received by Mr Black Family Trust and Mr Black Family Trust No. 2 have been ultimately distributed to Mr Black and or other members of the Black family and or other related family entities as provided under the respective trust deeds.

Mr Black and his broader family members are the beneficiaries of both trusts. While there are some minor differences between the range of beneficiaries between the trusts, (for example, the Mr Black Family Trust No 2 includes stepchildren as beneficiaries, who are not included as beneficiaries of the Mr Black Family Trust) both trusts exist for the primary benefit of the Black family.

In these circumstances, all dividends have been received by Mr Black or other members of the Black family.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 109-5

Income Tax Assessment Act 1997 section 149-10

Income Tax Assessment Act 1997 section 149-15

Income Tax Assessment Act 1997 section 149-30

Reasons for decision

Question 1

Summary

The goodwill of Retail Co was acquired before 20 September 1985 and is still the same asset, albeit subjected to organic growth.

Detailed reasoning

Goodwill or an interest in goodwill is specifically listed as a CGT asset under paragraph 108-5(2)(b) of the ITAA 1997 for the purposes of the capital gains tax provisions of the tax law.

It is not disputed that when Investor Co acquired Retail Co, Retail Co possessed goodwill. The issue is whether that business is at present the same business as it was when Investor Co purchased Retail Co.

For a business, such as the Retail Co Business, which has commenced before 20 September 1985, it is a critical matter to determine the CGT status of the goodwill of the business, as this will have relevance when a CGT event may occur to that goodwill.

The main statement from the Commissioner on the subject of capital gains tax and goodwill assets is contained in taxation ruling, TR 1999/16 Income tax: capital gains; goodwill of a business.

Some relevant sections of this Ruling are set out below:

In paragraph 25 of TR 1999/16 the Commissioner takes the view that the whole of the goodwill of a business is taken to be acquired either before 20 September 1985 or after 19 September 1985. Goodwill cannot be regarded as partly pre CGT and partly post CGT.

To this end it is necessary to examine all the facts and circumstances to determine whether the same single business has been continuously carried on since before 20 September 1985 or whether due to activities that have occurred since the commencement of the original business:

(a) a new business was commenced after 19 September 1985 and the former business no longer exists or

(b) new and separate businesses have been commenced such that more than one business is carried on and each have their own goodwill assets.

Old business has ceased

It is always a question of fact as to whether the same business is being carried on. A business does not have to be identical from the time of acquisition to the time of disposal to be regarded as the 'same' - paragraph 21 of TR 1999/16.

Per paragraph 95 of TR 1999/16, unless the facts indicate that a new business has commenced rather than an existing business continuing to be carried on, the goodwill of the business is not different from that existing when the business was originally acquired or commenced. A business owner may expand or contract activities or change the manner in which the business is carried on without ceasing the same business provided the business retains its essential nature or character.

Examples of organic growth, expansion or diversification of a business can include

• adopting new compatible operations

• servicing different clients

• offering improved products or services.

Per paragraph 24 of TR 1999/16 the business must be of the same essential nature or character to that carried on originally.

New business acquired

A business may increase its operations or scale of activity but it is also a question of fact whether such an expansion constitutes the expansion of an existing business or whether the expansion constitutes acquisition of a new business.

Applying the principles to Retail Co

Ever since the Retail Co Business commenced, Retail Co has used the same brand. Any store acquisitions or new store openings immediately traded under this brand name.

Factors that indicate that the Retail Co Business was and is single business include:

• all retail stores are owned by Retail Co and use the same business systems as well as the same wholesaler supplier, being Company A;

• all stores are accounted for and report as a single business and use the one:

• Australian Business Number (ABN)

• Goods and Services Tax Registration

• bank account

• bank system for EFTPOS transactions

• stock is moved between stores on an as needs basis without cash flow taking place

• the workers' compensation costs are paid as a single cost by Company A

• the payroll is administered by Company A

• the Country A operations, while initially conducted via a licence agreement with a wholly owned subsidiary are now directly under the control of Retail Co.

The facts presented indicate that the Retail Co Business is a single business operated from multiple locations (including the online sales operations) rather than multiple discrete businesses represented by each retail store. The single business has undergone a process of organic growth over the years. We also consider that this business commenced its operations before 20 September 1985.

Question 2

Summary

A capital gain made on the disposal of the goodwill of Retail Co would be disregarded.

Detailed reasoning

On the face of it a disposal of the goodwill of Retail Co would constitute a CGT event A1 under section 104-10 of the ITAA 1997. Under subsection 104-10(4) of the ITAA 1997 a capital gain would be made if the capital proceeds from such a disposal was more than the cost base of the goodwill. Conversely a capital loss would be made if the capital proceeds were less than the reduced cost base of the goodwill.

However under subsection 104-10(5)(a) of the ITAA 1997 such a capital gain or capital loss is disregarded if the asset was acquired before 20 September 1985.

As we consider above that Retail Co acquired the goodwill before 20 September 1985 it follows that any capital gain or capital loss made on the disposal of the goodwill can be disregarded, subject to satisfying the tests contained in Division 149 of the ITAA 1997.

Question 3

Summary

The majority underlying ownership interests in the goodwill of Retail Co have been maintained.

Detailed reasoning

Under subsection 149-30(1) of the ITAA 1997 an asset which is a pre-CGT asset (as defined by section 149-10 of the ITAA 1997) will stop being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not held by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985.

As set out in section 149-10 of the ITAA 1997, a pre-CGT asset is one that was acquired by an entity before 20 September 1985 and the entity has not been taken under provisions of the Income Tax Assessment Act 1936 to have acquired the asset on or after that date and nor had the asset stopped being a pre-CGT asset because of a previous operation of Division 149 of the ITAA 1997.

The meaning of the term 'majority underlying interests in a CGT asset is set out in section 149-15 of the ITAA 1997.

The relevant asset is the goodwill of Retail Co, which is an asset that was held by Retail Co when that company was acquired by Investor Co, an event that occurred before 20 September 1985. As Retail Co is wholly owned by Investor Co it is necessary, for the purposes of the tests contained in section 149-30 of the ITAA 1997, to examine the shareholdings in that company to determine the majority underlying ownership interests in the goodwill of Retail Co. In the present case, the ultimate owners have to be individuals, per paragraph 149-15(3)(a) of the ITAA 1997 because none of the other paragraphs of this provision would be applicable. For the purposes of paragraph 149-15(1)(a) of the ITAA 1997 (interests in the asset) it is only the B Class shares that are relevant because it is only the B Class shares that can participate in the capital of Investor Co upon its winding up. It is only these shares that confer a beneficial interest in the asset itself.

The 5 B Class shares have been held by the same entity being the Mr Black Family Trust since before 20 September 1985 which continues to hold them today.

Under ordinary legal concepts when a trust is a discretionary trust, no beneficiary is entitled to income or capital of the trust until the trustee exercises its discretion to distribute income or to make an appointment of capital. As a beneficiary of a discretionary trust does not hold an interest in any asset of the trust or in the ordinary income derived from the asset until the trustee exercises its discretion, it would usually not be possible for a discretionary trust to satisfy the majority underlying ownership interest tests set out in subsection 149-30(1) of the ITAA 1997.

However the Commissioner has set out a pragmatic approach, as stated in Taxation Ruling IT 2340, of looking through interposed entities to determine which natural persons hold the beneficial interests for the purposes of section 160ZZS of the Income Tax Assessment Act 1936 (ITAA 1936) which preceded Division 149 of the ITAA 1997.

Taxation Ruling IT 2340 states at paragraph 5 that it will be relevant to take into account the way in which the discretionary powers of the trustee are exercised when considering the question whether majority underlying interests have been maintained in the assets of the trust. IT 2340 continues:

    6. Where a trustee continues to administer a trust for the benefit of members of a particular family, for example, it will not bring section 160ZZS into application merely because distributions to family members who are beneficiaries are made in such amounts and to such of those beneficiaries as the trustee determines in the exercise of his discretion.

  7. In such a case the Commissioner would, in terms of sub-section 160ZZS(1), find it reasonable to assume that for all practical purposes the majority underlying interests in the trust assets have not changed....

Taxation Ruling IT 2340 correctly reflects the position that section 160ZZS of the ITAA 1936, by its terms, necessarily supplants normal legal concepts of interests in assets. For the purposes of section 160ZZS, a beneficiary of a discretionary trust is treated as having a beneficial interest in the trust's assets. The position stated in paragraph 7 of IT 2340 above of the Commissioner making a reasonable assumption that majority underlying ownership interests have not changed is now reflected in the legislation because subsection 149-30(2) of the ITAA 1997 provides:

149-30(2) If the Commissioner is satisfied, or thinks it reasonable to assume, that at all times on and after 20 September 1985 and before a particular time, majority underlying interests in the asset were held by ultimate owners who had majority underlying interest in the assets immediately before that date, subsections (1) and (1A) apply as if that were in fact the case.

We therefore consider that majority underlying ownership interests have been maintained in the goodwill asset since before 20 September 1985.

For the purposes of paragraph 149-15(1)(b) of the ITAA 1997 (interests in the income derived from the asset) it is necessary to look to shareholdings of both the A and B class shares in Investor Co because both classes of shares can receive dividends, although at the discretion of the company.

There has been a change in the shareholding of the A and B Class shares in Investor Co which took place after 19 September 1985, compared to the position before 20 September 1985. The 5 A Class shares were held by Mr Black including 1 share that was held on a bare trust for Mr Black and the 5 B Class shares were held by the Mr Black Family Trust. In 1989 three of the A Class shares were transferred to the trustee of the Mr Black Family Trust No 2.

This transfer left the 7 remaining A Class and B Class shares (the majority of the shares) being held by the same entities that held them before 20 September 1985. Two A class shares were and are held by Mr Black (an individual and therefore an ultimate owner) and five B class shares were and are held by the Mr Black Family Trust.

As discussed above, the fact that all of the B Class shares were held by a discretionary trust does not disturb the notion that the same ultimate owners held the beneficial interests in the income from the asset.

The test of paragraph 149-15(1)(b) of the ITAA 1997 is therefore also met - meaning that as at the date of this ruling, the Commissioner considers that the goodwill of Retail Co is still regarded as having been acquired before 20 September 1985.