Edited version of your written advice

Authorisation Number: 1012883052555

Date of advice: 24 September 2015

Ruling

Subject: Capital Gains Tax and Goodwill

Question 1

Will the goodwill of Freight Trust's business be considered to be an asset acquired before 20 September 1985 for the purposes of section 109-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes. The goodwill of the business was acquired for the purposes of section 109-5 of the ITAA 1997 when the trustee of the Freight Trust entered into the contract to acquire the business.

Question 2

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

Answer

No. As there has not been a change in majority underlying interests, the goodwill of the business is considered to have been acquired before 20 September 1985.

Question 3

Will any capital gains which arise on the sale of the goodwill of Freight Trust's business be disregarded pursuant to paragraph 104-10(5)(a) of the ITAA 1997?

Answer

Yes. As the goodwill of the business was acquired before 20 September 1985, any capital gain or loss which arises on disposal of this asset will be disregarded pursuant to paragraph 104-10(5)(a) of the ITAA 1997.

This ruling applies for the following periods:

1 July 2015 to 30 June 2019

Relevant facts and circumstances

In 19XX a rail and road freight business was acquired by the Freight Trust. The business specialised in the transportation of food and consumer products and provided warehousing services.

The Freight Trust continued to haul freight and undertake distribution activities for a number of established clients and on-forward freight using louvre vans, with a supplementary intermodal service (i.e. using containers) upon request by certain customers.

From inception, the Freight Trust also provided road freight and sea freight options to service its customers, which ran predominantly as a backup service to the rail operations between certain states of Australia in the event of track "wash outs", or other disruptions on the rail network. The road freight service was also provided in respect of east coast runs from specific state to interstate city and city to city in accordance with customer needs.

In addition to the above, a refrigerated rail freight service (and to a lesser extent refrigerated road freight service) was also provided to existing customers in accordance with their respective needs. At this time the refrigerated service was provided via the application of dry ice into containers.

Initially, rail freight services were provided under arrangements with various State rail authorities. In 19YY X Rail was established by the Federal and two state governments to take over the running of all interstate services. Rather than rely on X Rail, Freight Trust began to acquire its own rolling stock, in particular louvre vans to maximise the volume and weight of freight.

Subsequently the Freight Trust was accredited as a private rail operator and was able to conduct its rail freight business independently of X Rail. In addition to rolling stock, the Freight Trust also acquired its own locomotives.

Also from inception the Freight Trust provided its customers with a warehouse and distribution service solution as an integral part of its logistics operation. Its customer base over the years has included a large number of food and drink manufacturers as well as large retail businesses. The size of this component of the total Freight Trust's logistics operation over the years has tended to fluctuate in line with customer's needs and changes to their operations. Due to ongoing improved transit times over longer distances over the past several years, presently more product tends to be delivered directly to stores rather than warehoused and then distributed.

To improve the efficiency of its operations and the level of service afforded to its customers, Freight Trust engaged a related party entity to establish purpose-built freight terminals for exclusive use by Freight Trust.

As a flow-on effect from the growth in its rail freight operations, Freight Trust's end-to-end transportation service model also led to significant growth in all other areas of freight, including road freight and refrigerated rail freight.

Despite the growth Freight Trust has experienced, it continues to service a considerable proportion of the major customer group that it had prior to September 1985.

Rail freight technology has remained similar during the past X years, although there have been innovations such as the introduction of refrigerated containers (used in both road and rail transport) and upgraded bogies to allow for higher speeds and increased load carrying capacities.

Road freight equipment, however, has undertaken significant changes since 198X, with the Freight Trust continually upgrading its fleet (in line with competitors) to ensure that it has the most appropriate and technologically advanced equipment with which to service its customers. Much of the advancement has been driven by increasing carrying capacity.

Although there has been a significant growth in Freight Trust's business over the past X years, no new business has been acquired by Freight Trust.

Relevant legislative provisions

Income Tax Assessment Act 1997

Part 3-1

Section 100-25

Section 104-10

Section 108-5

Section 109-5

Division 149

Income Tax Assessment Act 1936

Section 160ZZS

Reasons for decision

Question 1

The meaning of 'goodwill' and its acquisition time.

Goodwill is an asset for CGT purposes as there is a specific reference to it in the definition of CGT asset at paragraph 108-5(2)(b) of the Income Tax Assessment Act 1997 ('ITAA 1997').

Generally, goodwill can be said to be an intangible feature of a business that will often represent the business's reputation or following with customers or the capacity of a business to attract custom.

The Commissioner's views on the meaning of goodwill are set out in Taxation Ruling TR 1999/16, which reflects the decision of the High Court in Federal Commissioner of Taxation v Murry 89 ATC 4585 ('Murry').

Paragraph 12 of TR 1999/16 defines the goodwill of a business:

'…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 the 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 the business. It cannot be dealt with separately from the business with which it is associated.'

Paragraph 25 of the ruling states that the whole of the goodwill of a business is either pre-CGT goodwill or post-CGT goodwill. The goodwill of a particular business cannot be characterised as partly pre-CGT goodwill and partly post-CGT goodwill. Paragraph 26 notes that an interest in goodwill, unlike goodwill itself, is not a composite asset.

The consequence of the goodwill of a business being one CGT asset is 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. Paragraph 17 of TR 1999/16 states that this is so even though:

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

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

According to the decision in Murry, as long as the business remains the same business, 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.

The Freight Trust acquired its business prior to 20 September 1985. Accordingly, the goodwill of the business was also acquired at this time and is therefore a pre-CGT asset (as per subsection 109-5(2) of the ITAA 1997).

Question 2

Division 149 - majority underlying interests

A CGT asset is defined in section 108-5(1) of the ITAA 1997 as any kind of property or a legal or equitable right that is not property. A CGT asset is a pre-CGT asset if it was last acquired before 20 September 1985 and no income tax provision has operated to treat it as having been acquired after that date.

Division 149 of the ITAA 1997 contains provisions which govern when an asset held by an entity stops being a pre-CGT asset and is treated as having been acquired after that date.

Section 149-10 of the ITAA 1997 defines a pre-CGT asset in relation to Division 149 of the ITAA 1997 as follows:

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; and

(b) the entity was not, immediately before the start of the 1998-99 income years, taken under:

i. Former subsection 160ZZS(1) of the Income Tax Assessment Act 1936; or

ii. Subdivision C of Division 20 of former Part IIIA of that Act;

to have acquired the asset on or after 20 September 1985; and

(a) the asset has not stopped being a pre-CGT asset of the entity because of this Division

A CGT asset acquired before 20 September 1985 remains a pre-CGT asset if the majority underlying interests in the asset have not changed since before 20 September 1985. Where a change in the majority underlying interests occurs after 19 September 1985 the CGT asset is deemed to be acquired on the date the change occurred, either under Division 20 of the ITAA 1936 (pre-1998-99 income years) or Division 149 of the ITAA 1997.

Under section 149-30 of the ITAA 1997 an asset stops being a pre-CGT asset at the earliest time when the majority underlying interests in the asset were not held by the ultimate owners who held the majority underlying interests in the asset immediately before 20 September 1985.

In other words, the Commissioner has to be satisfied that the majority underlying interests in the assets have not changed. Otherwise the asset is deemed to have been acquired at the time that the change in majority underlying interests in that asset happened.

As the business of the trust commenced prior to 20 September 1985, the asset, which is the goodwill of the business, would be taken to have been acquired at the time the business commenced. Section 109-10 of the ITAA 1997 sets out the rules for when you acquire a CGT asset without a CGT event happening. In this case, there has been no CGT event in relation to the goodwill, so the goodwill of the trust is considered to be a pre-CGT asset as it is deemed to have been acquired when the business commenced.

"Majority underlying interests" is defined in subsection 149-15(1) of the ITAA 1997 as more than 50% of:

• the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset; and

• the beneficial interests that ultimate owners have (whether directly or indirectly) in any ordinary income that may be derived from the asset.

Subsection 149-15(2) of the ITAA 1997 defines "underlying interest" in a CGT asset as the beneficial interest that an ultimate owner has (whether directly or indirectly) in the asset or in any ordinary income that may be derived from the asset.

An ultimate owner is defined to mean an individual or any entity listed in subsection 149-15(3) of the ITAA 1997.

Subdivision 149-B of the ITAA 1997 sets out a factual test to determine when an asset of a non-public entity stops being a pre-CGT asset. Under the factual test, the asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not held by the ultimate owners who held the interests immediately before 20 September 1985.

In this case the ultimate owners must be individuals, as per paragraph 149-15(3)(a) of the ITAA 1997, because none of the other paragraphs of this provision would be applicable.

The entity carrying on the business is the Trustee for the Freight Trust, which is a unit trust. The units in the unit trust are held by two discretionary trusts:

• The X Family Trust (X units)

• The Y Family Trust (Y units)

There are a total of Z units on issue in Freight Trust. The units were acquired by the X and Y discretionary trusts prior to 20 September 1985.

Both discretionary trusts have made Family Trust Elections with the same person as the specified individual in each case.

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 has not changed and is now reflected in the legislation as 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.

It is evident from the Trust Deeds that the Trustees have continued to administer the Trusts for the benefit of the members of the same family since before 20 September 1985. We therefore consider that the majority underlying ownership interests have been maintained in the goodwill asset since before 20 September 1985.

Question 3

CGT event A1

CGT event A1 happens when you dispose of a CGT asset. Under paragraph 104-10(5)(a) of the ITAA 1997 a capital gain or loss is disregarded if the asset was acquired before 20 September 1985.

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. If the same business has been carried on the capital gain or loss made on the disposal of the goodwill will be disregarded.

When was the goodwill acquired?

Paragraph 52 of TR 1999/16 provides that

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.

Where a business expands as a result of the introduction of a new business operation or activity by a taxpayer, any goodwill that relates to the expanded business is merely an expansion of the business. If a business that commenced prior to 20 September 1985 is expanded, goodwill generated by the expanded business operations or activities will be an accretion to the pre-CGT goodwill (see paragraph 60 of TR 1999/16)

Is the same business being carried on?

A business may change to such an extent that it becomes a new business with new goodwill. In FC of T v Murry it is stated that, in determining whether the same business is being carried on, the sources of the goodwill may have changed so much that, although the business is of the same kind as previously conducted, it cannot be said to the same business.

Paragraphs 21 - 24 of TR 1999/16 state that if the essential nature or character of the business has not changed, the business remains the same business for the purposes of the CGT goodwill provisions. The business 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:

• adopting new, compatible operations;

• servicing different clients; or

• offering improved products or services

does not constitute a new business as long as the essential character or nature of the business remains unchanged.

It is a question of fact and degree whether the goodwill of a business is the same asset as it was when it was acquired. For the CGT goodwill provisions, we consider that the same business is carried on and no new goodwill asset is created if the business retains its same essential nature or character.

The same business is not carried on 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.

Paragraphs 60 - 62 discuss internally generated goodwill and states the following: 

60. If a new business operation or activity introduced by a taxpayer is an expansion of an existing business (whether it commenced before or after 20 September 1985), any goodwill built up in conducting the expanded business is merely an expansion of the existing goodwill of the business. If a business which commenced before 20 September 1985 (a "pre-CGT business') is expanded, goodwill generated in conducting the expanded business is merely an accretion to the pre-GGT goodwill.

61. In an introduced business activity is a new business, the goodwill attaching to that business is a new asset separate from the goodwill of the existing business.

62. Whether an increase in business operations or in the scale of activity constitutes an expansion of an existing business, or a new and separate business, is a question of fact dependent on the circumstances of each case. Factors that need to be considered in determining whether the business operation or activity is part of the existing business or is a new business include 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.

The question of whether a business has changed 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 is one of fact and degree. The following factors have to be considered as set out in paragraph 91:

• 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 nature and character of the business

Paragraph 93 of TR 1999/16 states that for the CGT goodwill provisions, the same business is carried on and no new goodwill asset is created if the business retains its same essential nature or character and offers the following example:

A business of a printer may have changed over time due to the purchase of new equipment and the adoption of improved technologies. The printer may now attract a different type of client such as large corporate clients (due to the capacity to produce high quality public relations material, annual reports, etc). Formerly, the printer may only have provided services to small local businesses (e.g. business cards, calendars, invoice books and stationery.)

No new business has been commenced. It is not a different business and the goodwill remains the same CGT asset. The printer is still conducting a printing business of the same essential nature or character, albeit one serving different clients.

Businesses may naturally evolve by serving different clients or clients in different markets and offering improved products or services (paragraph 94).

Paragraph 95 states that, unless the facts are such that it can be established that a new business has commenced - rather than an existing business continued - the goodwill of the business is not different from that existing when the business was originally acquired or commenced.

Has the same business been carried on?

It is evident from the information presented that Freight Trust's business has grown significantly in the past X years. However at its core the business still remains as a rail and road freight business even though the business has expanded and there has been some relatively small scale diversification. Although these ventures are somewhat specialised, they can still be described as road freight activities.

Although the expansion of the business has resulted in a broader customer base, Freight Trust still provides freight services for a number of large clients who were clients prior to 20 September 1985. However a broader customer base is not necessarily indicative that the nature of the business has changed (paragraph 23 of TR 1999/16).

In order to provide a more complete service for clients the business has adopted new technologies and efficiencies such as refrigerated container vans and other innovations which has enabled more efficient transport of goods.

In addition to the expansion of road and rail freight, there has also been a similar expansion in the provision of warehousing facilities for customers, which was an activity carried on prior to 20 September 1985.

Over the past X years there has not been a sudden or dramatic change in the business brought about by either the acquisition or the shedding of activities on a considerable scale. It should also be noted that Freight Trust did not acquire any new businesses during this period.

For the CGT goodwill provisions, the same business is carried on and no new goodwill asset will be created if the business retains its same essential nature or character. A business may change the way it operates over time due to the purchase of new equipment and the adoption of improved technologies which, in turn, may attract new clients. This does not imply that a new business has commenced (paragraph 95 of TR 1999/16).

The facts do not demonstrate that a new business has commenced.

As the business being carried on now by Freight Trust is essentially the same as the business carried on prior to 20 September 1985, the goodwill of the business is the same asset and is taken to be acquired before 20 September 1985.

Accordingly, any capital gain that arises on the disposal of this asset will be disregarded as the goodwill is a pre-CGT asset.