Edited version of your written advice

Authorisation Number: 1012936509336

Date of advice: 15 January 2016

Ruling

Subject: Pre-CGT Goodwill

Question:

Is any capital gain realised from the sale of the goodwill of the business disregarded under subsection 104-10(5) of the Income Tax Assessment Act 1997 (ITAA1997) because the business was acquired prior to 20 September 1985?

Answer:

Yes

This ruling applies for the following period:

Year ended 30 June 2015

The scheme commenced on:

1 July 2014

Relevant facts

The discretionary trust was established prior to 1985 for the benefit of a certain family.

Shortly after the establishment of the trust, it commenced a business providing services to the general public.

The business initially operated under one trading name. However due to the changing nature of the industry it changed its trading name.

The change of business name was to align with the public's perception of the industry it operated in.

The business moved or relocated a number of times within a small geographical area as a result of the growth of the business's client base, to improve access and parking for clients and to reduce lease expenditure.

The business provided the same services and kept the same client base when the business moved or re-located.

The day to day running and operation of the business was undertaken by members of the family that the trust operates for the benefit of.

The entity entered into a contract for the sale of its business assets, including the goodwill of the business.

A capital gain was realised from the sale.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 104-10 (1)

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

Income Tax Assessment Act 1997 Subsection 108-5(2)

Income Tax Assessment Act 1997 Section 149-10

Income Tax Assessment Act 1997 Section 149-15

Reasons for decision

Goodwill, or an interest in it, is a capital gains tax (CGT) asset under paragraph 108-5(2)(b) of the Income Tax Assessment Act 1997 (ITAA 1997)

Subsection 104-10(1) of the ITAA 1997 provides the disposal of a CGT asset means CGT event A1 happens.

Subsection 104-10(5) of the ITAA 1997 provides that a capital gain or capital loss you make from CGT event A1 is disregarded if you acquired the asset before 20 September 1985.

Establishment of goodwill

Goodwill according to Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business (TR 1999/16) has the legal definition which was established by the High Court in Federal Commissioner of Taxation v. Murry 98 ATC 4585; (1998) 39 ATR 129. Paragraph 12 of TR 1999/16 states in part that:

… 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.

Based on the definition provided in TR 1999/16, the entity established goodwill when it commenced business operations prior to 1985 providing services to the general public.

There is no doubt that an element of the value of the trust's business operation lies in goodwill. However, what is under consideration is whether the goodwill remains a single CGT asset.

Goodwill remains a single CGT asset if the same business continues

Paragraph 17 of TR 1999/16 provides guidance in deciding whether goodwill remains a single CGT asset if the same business is continued. It states 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. 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.

Section 149-10 of the ITAA 1997 states the following in part:

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;

Based on the goodwill of the trust's business operation being established prior to 20 September 1985, the goodwill of the trust will remain the same single pre-CGT asset even though the goodwill of the business may have changed or fluctuated throughout the life of the business provided it can be satisfied that the same business continued throughout the relevant period.

Majority underlying interest

Under section 149-15 of the ITAA 1997, the pre-CGT status of assets owned by a company or trust can be lost if there is a change in the majority underlying owners of the company or trust.

The trust has always been administered for the benefit of the same group of beneficiaries, being the members of the relevant family.

Can a Business change 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?

A business may change to such an extent that it is no longer the same business which would mean the goodwill of the old business would cease when goodwill of new business is established. Paragraph 21 of TR 1999/16 states that:

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 .

When discussing the essential nature or character of the business would remain the same paragraph 22 of TR 1999/16, states in part that it would remain the same:

… if all that happens is that portions of the operations of a business are discarded in an ordinary commercial way but the business retains its essential nature or character.

A business will also not essentially change its nature or character according to paragraph 23 of TR 1999/16, which states:

If the types of customers a business attracts, change as the business evolves over the years, this does not necessarily mean the business is no longer the same business as was originally carried on.

When deciding whether a business has the same essential nature or character, a similar kind of business being carried on would be insufficient. The same business would not be carried on according to TR 1999/16 paragraph 24 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.

Further paragraph 91 of TR 1999/16 also provides important factors to consider when establishing the essential nature or character of the business; it states in part that consideration should be given to the following:

• 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 - whether the activities constitute, or are treated by the business owner as constituting separate or distinct activities, enterprises, divisions or undertakings

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

Thus in considering whether the trust's business goodwill would cease due to changes in the business, consideration must be given to the essential nature or character of the business and each case is determined on its own facts.

Applying the above factors noted in TR 1999/16 to the trust's business operations

The trust has been in the business of providing its services since it commenced its business operation prior to 1985. Since commencement the trust's business operations have continued to be administered and operated by members of the relevant family.

The entity's business provides services mainly focusing on products within its professional expertise. While some of the products may have changed this is as a result of a natural evolution of the business focused on satisfying the needs of its customers and the changing nature of the industry over time.

Although the business operations began using a different trading name it is accepted that it would make normal commercial sense to use a trading name that reflects the public's perception of the industry the entity operates in. The fact that the business had a change of name does not in itself mean the essential nature or character of the business has changed.

While a change in business locations has occurred on number of occasions this is as a result of the business's growth and expansion to accommodate its clients and to reduce operating costs and it would also make normal commercial sense to do these things to operate the business in a more efficient and cost-effective manner.

Based on the information provided it can be established the essential nature or character of the trust's business operation has remained the same. Since the business operations were established it has been involved in providing services to the general public and was operated and administered by family members who have played an integral part in the management of the business. Further a natural expansion of the business has occurred until the business was sold.

Accordingly as the same business has been carried on since it commenced prior to 1985, the goodwill in relation to the trust's business operation which began with the establishment of the pre-CGT business, has grown with the business and represents a single pre-CGT asset. Any capital gain or loss on its disposal will be disregarded under subsection 104-10(5) of the ITAA 1997.