Edited version of your written advice

Authorisation Number: 1012766453252

Ruling

Subject: Income Tax - Capital Gains Tax - Other

Question 1

Does the pre-Capital Gains Tax (CGT) goodwill asset of the primary production business, which was subsequently expanded over time, retain its pre-CGT status such that any capital gain made, on the disposal of the goodwill asset is disregarded under paragraph 104-10(5)(a) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2015

Year ended 30 June 2016

Year ended 30 June 2017

Year ended 30 June 2018

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

ABC Pty Limited (ABC) is the head company of a tax consolidated group which includes subsidiary companies DEF Pty Limited (DEF) and XYZ Pty Limited. DEF owns XYZ Pty Limited and operates a primary production business on an amalgamation of rural properties, collectively known as 'XYZ'.

Prior to 20 September 1985

ABC acquired all of the shares in a company and changed its name to DEF in 19XX. DEF's first primary production business commenced in 19XX in a property that is geographically distant to the XYZ operation, is separately managed, and operates as a separate business.

In 198X DEF acquired XYZ Pty Ltd, a long-standing pastoral company that owned the property known as XYZ and engaged in the primary-production activities of cropping, livestock grazing, and hay /silage production.

In 198Y DEF acquired a property adjacent to XYZ, including water licences (general security/bore) and irrigation infrastructure with a view to expanding the cropping activities at the two properties.

As at 198Y, DEF engaged in three main businesses: primary production; commercial property management and leasing; and investment and manufacture and supply of prefabricated buildings.

As at 198Y, XYZ Pty Ltd held the title to the XYZ property and made the property available to DEF to conduct a primary production business thereon. DEF held the title to the adjacent property and operated the activities at XYZ and the adjacent property as a single primary production business. The XYZ and the adjacent property include the majority of the important infrastructure to operate the XYZ primary production business. The infrastructure included access to river systems, irrigated fields/levy banks, buildings, housing (rural), grain storage and handling facilities, and roads/airstrip.

As at 198Y, the XYZ primary production business comprised the activities of irrigated/dryland cropping, stud and commercial livestock farming, and hay and silage production. DEF's primary production customers were stud-buyers, grain merchants / traders, commercial livestock producers and meat companies.

After 20 September 1985

• In 198Z new livestock herds were established at XYZ properties with new blood stock from overseas breeds.

• In 198V two stations were purchased adjacent to original XYZ properties. In acquiring the new properties, DEF also acquired additional water licences. This allowed DEF to substantially expand the primary production activities at the amalgamated XYZ properties.

• In 198W DEF expanded irrigation on its primary production business. This allowed a diversification of crops/ grazing activities and increased productivity of the land.

• In 198W and 198T two more properties were acquired.

• In 1990s various new crops were introduced and rotated depending on climatic and market conditions and customer demand.

• In 199X and 199Y three more properties acquired along with accompanying water licences.

• In 199Z and 200X three more properties acquired along with accompanying water licences.

• Water licenses were continued to be purchased to supplement and support the land acquisitions made by DEF.

• Another station acquired along with accompanying water licences.

The properties acquired after 20 September 1985 were adjacent to their existing operations. Each new adjoining property acquired was amalgamated into the existing XYZ primary production infrastructure and activities and was managed by the same staff as managed the existing XYZ properties and is subject to one integrated management and control.

DEF is the registered proprietor of the business name 'XYZ'. DEF has at all times operated the XYZ primary production business under the business name 'XYZ'. The various activities and assets of the XYZ primary production business have at all times been treated in the company accounts as one enterprise. The ownership and management of the XYZ primary production business has remained with the same family since original acquisition in 198X.

The primary production activities at XYZ today are irrigated / dryland cropping, grain production, legume production, cotton production, livestock grazing, and hay and silage production. Current customers of the XYZ primary production business are grain merchants/traders, cotton merchants/traders, commercial livestock producers and meat companies.

DEF is negotiating with a purchaser for the sale of the XYZ primary production business, including the land, equipment, improvements, water facilities, employees, contractor arrangements, water licences, business names and goodwill.

Assumptions:

The goodwill of XYZ primary production business will not stop being a pre-CGT asset because of the application of Division 149 of the ITAA 1997.

Relevant provisions:

Income Tax Assessment Act 1997 Section 104-10.

Income Tax Assessment Act 1997 Subsection 104-10(5).

Income Tax Assessment Act 1997 Paragraph 108-5(2)(b).

Part IVA of the Income Tax Assessment Act 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 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 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.

Reasons for decision

Goodwill, or an interest in it, is a Capital Gains Tax (CGT) asset as per paragraph 108-5(2)(b) of the Income Tax Assessment Act 1997 (ITAA 1997). CGT event A1 happens if you dispose of a CGT asset pursuant to subsection 104-10(1) of the ITAA 1997. However, pursuant to paragraph 104-10(5)(a) of the ITAA 1997, any capital gain or loss you make on disposal of an asset acquired prior to 20 September 1985 (pre-CGT) may be disregarded for income tax purposes.

Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business (TR 1999/16) provides guidance as to the taxation treatment of goodwill of a business. TR 1999/16 reflects the decision of the High Court of Australia in FC of T v. Murry 98 ATC 4585; (1988) 39 ATR 129. (Murry's Case).

Paragraphs 9-15 of TR 1999/16 provides the legal meaning of goodwill. Specifically at paragraph 12 it states:

….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.

In this case, DEF carries on the XYZ primary production business. The goodwill relating to DEF's XYZ primary production business is a CGT asset of the company. When the XYZ primary production business is disposed of, goodwill would be transferred with that disposal.

Paragraphs 50-52 of TR 1999/16 outline when goodwill is acquired. It states:

50. If goodwill is acquired on the acquisition of a business under a contract, the purchaser acquires it on the date the contract is entered into (subsection 109-5(2), event A1, case 1).

51. If goodwill is acquired other than under a contract, it is acquired when the vendor of the goodwill stops being its owner (subsection 109-5(2), event A1, case 1).

52. If a taxpayer commences business and starts to create goodwill, the goodwill of the business is acquired when the taxpayer starts work that results in the creation of the goodwill (subsection 109-10, item 1). When a taxpayer starts the work resulting in the creation of goodwill of a business is a question of fact dependent on the circumstances of each particular case.

In the present case, DEF acquired XYZ Pty Ltd and commenced the XYZ primary production business on dd/mm/yyyy. Accordingly, the goodwill of the XYZ primary production business was originally acquired pre-CGT.

Goodwill of a business can only be wholly pre-CGT or post-CGT (post 20 September 1985), as per paragraph 25 of TR 1999/16 which states:

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

Additionally, paragraph 89 of TR 1999/16 states:

89. The goodwill of a business that commenced before 20 September 1985 remains a pre-CGT asset provided the same business continues to be carried on. As the majority justices of the High Court said in the Murry case (98 ATC at 4594; 39 ATR at 143), 'as long as the business remains the "same business" (cf Avondale Motors (Parts) Pty Ltd v. FC of T (1971) 124 CLR 97), the goodwill acquired or created by a taxpayer is the same asset as that which is disposed of when the goodwill of the business is sold or otherwise transferred'. For a business that commenced before 20 September 1985, any accretion to its goodwill since 20 September 1985 is not a post-CGT asset.

Therefore, where an existing business has been expanded, any goodwill built up in conducting the expanded business is merely an expansion of the existing goodwill providing the business remains the same business. If a pre-CGT business is expanded, goodwill generated in conducting the expanded business is merely an accretion to the pre-CGT goodwill provided the same business continues to be carried on.

The question of whether an increase in business activities or operations constitutes an expansion of an existing business, or a new and separate business or businesses, is a question of fact dependent on the circumstances of each case. Paragraph 62 of TR 1999/16 list the factors that need to be considered including.

the nature of the new business operation or activity, the types of customers that the business operation or activity attracts and the extent to which the business operation or activity:

(a)   is subject to the same integrated management and control as the existing business;

(b)   is treated for banking and accounting purposes as an extension of the existing business or as a separate business;

(c)   uses one or more different trading names; and

(d)   is related to or dependent on the existing business in a practical, economic or commercial sense.

Additionally, at paragraph 64 of TR 1999/16 it states:

64. If a pre-CGT business is combined with another business acquired post-CGT and they are conducted as one business without the pre-CGT business losing its essential nature or character, the goodwill of the post-CGT business is subsumed into the goodwill of the pre-CGT business and all of the goodwill of the business is taken to have been acquired before 20 September 1985. The goodwill of each of the businesses coalesce without any disposal of the goodwill of the post-CGT business. The pre-CGT business must not lose its essential nature or character in the sense that it must remain the same business and not be overwhelmed by the post-CGT business in such a way that it has become a different business. The purchase of the post-CGT business must involve merely organic growth of the pre-CGT business or an expansion or accretion to it in reasonable proportions or it gives rise to a new, different business and its goodwill is a new asset.

Paragraph 91 of TR 1999/16 states that it is a question of fact and degree whether the same business is being carried on. It also lists the following factors for consideration:

• 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, and

• the way in which the business is structured, carried on, managed and controlled.

The applicant has submitted their analysis of the XYZ primary production business's goodwill in regard to the above factors outlined in TR 1999/16:

• DEF commenced its primary production business called 'XYZ' pre-CGT.

• DEF acquired numerous smaller adjoining primary production properties post-CGT. All of them were purchased and amalgamated into the existing XYZ primary production infrastructure and activities. None retained their previous identity.

• Over 40% of the current amalgamated land known as XYZ comprises the original pre-CGT properties XYZ and adjacent property. Accordingly, each of the subsequent smaller adjoining acquisitions has been made to support the infrastructure and primary production business commenced on XYZ and adjoining property.

• In many cases the smaller adjoining properties were acquired by DEF at the invitation of the previous owners. As XYZ was the biggest and most profitable primary production business in the area, DEF was the most appropriate purchaser for the properties. Generally, the properties were attractive to DEF because they were adjacent to their existing operations and could provide expansion opportunities including increased access to water and land.

• A major reason for acquiring adjoining land was to acquire additional water licences to support the growth of the cropping infrastructure, reducing the risk of adverse weather conditions and increasing water reliability to the primary production business.

• Another important reason for acquiring the adjoining land was to allow DEF greater freedom to spray its crops. By acquiring the adjoining land DEF reduced the risk of harm to neighbouring landholders as the cropping expanded. Over time the Government introduced heightened spraying regulations in relation to spray-drift on neighbouring properties. Accordingly, the company carried out acquisitions of neighbouring properties to mitigate this risk.

• Each new adjoining property was managed by the same staff as managed the existing XYZ properties.

• DEF's acquisition of new properties adjoining the original pre-CGT farms and integrating them into the existing XYZ primary production business has meant they have are subject to one integrated management and control. The same business model was adopted across all the properties. All the properties are run as one large rural primary production business.

From the information provided it is clear that the XYZ business has expanded its operations post CGT. What needs to be determined is whether the essential nature of the business has changed since that date. This is a question of fact taking into consideration the factors outlined above.

The applicant contends that the XYZ primary production business has expanded since 1985. However, the following factors support a conclusion that the expansion was within the guidelines contained in TR 1999/16 as being "organic growth, expansion or diversification" and the essential character of the business has remained the same:

• XYZ's primary production business has at all times involved irrigation, cropping and livestock grazing.

• While the amount and type of crops grown and the breed of livestock raised changes regularly, the focus of operations has been to maximise the profitability of the primary production business by improving the land and water access and increasing the flexibility and diversity of the primary production activities.

• While cropping has become the dominant activity, livestock grazing continue to be a part of primary production activity at XYZ. The essential nature of the business has always been primary production with fluctuating activities depending on market conditions.

• These primary production activities would be considered to be 'compatible operations' under TR 1999/16.

• The changes and growth in the activities at XYZ were gradual and progressive and not 'sudden or dramatic'. None of the original activities have been disposed of. Accordingly, they are more in the nature of organic growth / diversification than a change in the essential nature of the primary production business.

• DEF commenced acquiring adjoining properties and water licences pre-CGT. This demonstrates the business plan which continued over the next 15 years. Accordingly, the further acquisition of new adjoining properties and additional water licences to support the expansion and diversification of the primary production business activities can be considered as 'organic growth' as described in TR 1999/16.

• The various activities and assets of the XYZ primary production business have at all times been treated in the company accounts as one enterprise.

• The ownership and management of the XYZ primary production business has remained with the same family since the original acquisition in 198X.

• DEF has at all times operated the XYZ primary production business under the business name 'XYZ'.

Additionally, the applicant has provided the following contentions in respect to whether a new business has commenced (or been acquired) which may give rise to a separate goodwill asset. The specific factors outlined in paragraph 62 of TR 1999/16 are addressed below:

• XYZ's activities have always part of its primary production business. The scale and diversity of its cropping and grazing activities have expanded over the years. Such expansion has occurred as a function of the market and climatic conditions and the available resources (primarily land and water) from year to year.

• XYZ's customers are of the same type as they were in 1985. Although the mixture of produce has changed from time to time, DEF sells its crops and livestock produce to merchant / traders and meat companies who on-sell the produce to the wider market.

• The XYZ primary production business has at all times been subject to the same integrated management and control. Although different personnel necessarily have responsibility for the different activities, the senior management team is responsible for all activities and decision making and has remained constant since the acquisition of the XYZ business in 198X.

• DEF wholly owns XYZ Pty Limited and accordingly has since 198X had the right to use the name "XYZ" in its primary production business. DEF is also the registered proprietor of the business name 'XYZ'. As XYZ acquired more and more adjoining properties to expand its XYZ primary production business, the use of the name expanded and the reputation of the primary production business grew amongst primary producers and customers. The amalgamation of properties is known throughout the country region as XYZ and to customers as XYZ.

• The amalgamated properties are run as a single primary production business and have integrated irrigation and cropping infrastructure and management.

• The same staff manages all the properties and crops are amalgamated for sale to customers. In a practical and economic sense they are all operating as one property and a single primary production business.

On the basis of the information provide, it is considered DEF is still operating the same XYZ business as it has since its commencement. Although there has been an expansion of the business post CGT we consider that this expansion has not resulted in a change to the essential nature of the business. Paragraph 21 of TR 1999/16 provides that 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 does not of itself cause it to be a new business provided the business retains its essential nature or character.

It is considered that the following features of the XYZ primary production business indicate that the business has retained its essential nature:

• All adjacent properties acquired were amalgamated into the existing XYZ primary production infrastructure and activities. Each new adjoining property was managed by the same staff as managed the existing XYZ properties.

• DEF wholly owns XYZ Pty Limited and is the registered proprietor of the business name XYZ. DEF has at all times operated the XYZ primary production business under the business name XYZ. The various activities and assets of the XYZ primary production business have at all times been treated in the company accounts as one enterprise. The ownership and management of the XYZ primary production business has remained with the same family since original acquisition in 198X.

• XYZ's primary production business has expanded over the years. However, XYZ's key activities have always part of its primary production business including cropping and livestock grazing. XYZ's customers are of the same type as they were in 198Y such as merchant/traders and meat companies.

Conclusion

The goodwill of the XYZ primary production business was originally acquired by DEF pre-CGT. It remains a pre-CGT asset as the business remains the same business and has not changed its essential nature.

Based upon the assumption that the goodwill of the XYZ primary production business will not stop being a pre-CGT asset because of the application of Division 149 of the ITAA 1997, any capital gain or losses made on the disposal of the goodwill of the XYZ primary production business will be disregarded pursuant to paragraph 104-10(5)(a) of the ITAA 1997.