Edited version of your written advice

Authorisation Number: 1013003355254

Date of advice: 6 May 2016

Ruling

Subject: Pre-CGT business

Question 1

Will any capital gain or loss made from the sale of the goodwill of the business be disregarded pursuant to subsection 104-10(5) of the Income Tax Assessment Act 1997 ('ITAA 1997')?

Answer

Yes

Question 2

If the answer to question 1 is yes, will the goodwill of the business stop being a pre-CGT asset pursuant to section 149-30 of the ITAA 1997?

Answer

No

This ruling applies for the following periods:

1 January 2015 to 30 June 2016

The scheme commenced on:

Before 20 September 1985

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The Applicant is a company incorporated in the 19X0s. The Applicant commenced carrying on its business in the 19X0s.

The Proposed Transaction

The Applicant is proposing to sell its business assets and goodwill of the business. The Applicant will not sell the land on which the business is carried on; rather it will lease the land to the purchaser, so the business continues to be conducted from the same premises. The disposal is in connection with the retirement plan of Individual A, who is the Managing Director of the Applicant and over 55 years old.

The Business Operations & Structure

From the time of commencement, the business has always been providing the same services to commercial businesses. The business has always relied on a mix of employees and contractors for labour supply.

The business provides services to a range of customers, which are predominantly:

• schools

• governments

• commercial offices

• hospitals and aged care facilities

• retail shopping centres

The business contracts have always been short-term in nature and renewed or cancelled on a periodic basis.

The business has always been carried out from the same premises.

The business practices have changed and developed over the years as a result of development of technology. The size and scale of the business has remained steady since prior to September 1985.

Since pre-September 1985, Individual A has been the Managing Director of the Applicant. The business contracts have always been negotiated and secured by Individual A, who continues to utilise similar methods to contact prospective clients.

The shareholders of the Applicant are Individual A and Trust A, which have remained unchanged since prior to September 1985.

Trust A is a family discretionary trust. The only beneficiaries who were entitled to distributions of income or capital under the trust deed were members of Individual A's family or companies or trusts in which those family members had an interest. Trust A has never made any distributions.

Relevant legislative provisions

Income Tax Assessment Act 1997 paragraph 104-10(5)(a)

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

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1997 Subdivision 149-B

Income Tax Assessment Act 1997 subsection 149-15(1)

Income Tax Assessment Act 1997 subsection 149-15(2)

Income Tax Assessment Act 1997 subsection 149-15(3)

Income Tax Assessment Act 1997 section 149-30

Income Tax Assessment Act 1997 subsection 149-30(2)

Reasons for decision

Question 1

Summary

The essential nature and character of the business has remained the same since the business started operating in the 19X0s. Therefore, the goodwill attached to the Applicant's business constitutes a pre-CGT asset. As such, any capital gain realised on the sale of the goodwill of the Applicant's business will be disregarded under paragraph 104-10(5)(a) of the ITAA 1997.

Detailed reasoning

The meaning of 'goodwill'

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

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 states 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…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 Murry's case the High Court of Australia expressed the view that goodwill has three aspects - property, sources and value - which combine to give the legal concept of goodwill. What unites the aspects is the conduct of a business to which goodwill is attached.

Paragraph 25 of TR 1999/16 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 a partly pre-CGT goodwill and partly post-CGT goodwill.

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). 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 the business; or

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

The Applicant commenced carrying on its business in the 19X0s. Therefore, in order for the goodwill attached to the Applicant's business to be a pre-CGT asset, it must be determined whether the same business has continued to be carried on by the Applicant since prior to 20 September 1985.

Essential nature or character of the business

According to paragraph 21 of TR 1999/16, the business would remain the same business as long as the essential nature or character of the business has not changed. Paragraph 21 further provides that:

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.

Paragraph 91 of TR 1999/16 provides the following important factors to consider when determining whether the same business is being carried on:

• 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

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

The following features of the Applicant's business show that the essential nature or character of the business has remained the same since prior to 20 September 1985:

• although the development of technology has changed and developed some of the business practices, the size and scale of the business has remained steady over the years.

• the business has always been providing the same services to the same type of customers, i.e. commercial businesses, such as schools, governments, commercial offices etc.

• the business has always been carried on, managed and controlled by Individual A.

• the business still utilises the same strategies to contact prospective clients.

• the business contracts have always been short-term in nature, and negotiated and secured by the same person, Individual A.

• the business has always been conducted from the same premises.

After consideration of all the facts, the essential nature and character of the business appears to have remained the same over time. The changes made to the business since it began operating in the 19X0s are considered to be as a result of the organic growth and expansion of the business and do not alter the underlying business activities.

Therefore, the goodwill attached to the Applicant's business constitutes a pre-CGT asset. As such, any capital gain realised on the sale of the goodwill of the Applicant's business will be disregarded under paragraph 104-10(5)(a) of the ITAA 1997.

Question 2

Summary

It is reasonable to assume that for all practical purposes the majority underlying interests in the goodwill of the Applicant has not changed. The Commissioner will exercise his discretion under subsection 149-30(2) of the ITAA 1997 and thus, the goodwill of the business will remain a pre-CGT asset of the Applicant.

Detailed reasoning

The provisions of Subdivision 149-B of the ITAA 1997 determine when a CGT asset of an entity stops being a pre-CGT asset. 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 majority underlying interests in the asset immediately before 20 September 1985.

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

• any ordinary income that may be derived from the asset.

Subsection 149-15(2) of the ITAA 1997 provides that an 'underlying interest' means a beneficial interest that an ultimate owner may have in the asset or any ordinary income derived from the asset. An ultimate owner is defined to include an individual under subsection 149-15(3) of the ITAA 1997.

An ultimate owner indirectly has a beneficial interest in a CGT asset of another entity (that is not an ultimate owner) if they would receive for their own benefit any of the capital of the other entity if:

• the other entity were to distribute any of its capital; and

• the capital were then successively distributed by each entity interposed between the other entity and the ultimate owner.

Taxation Ruling No IT 2340 ('IT 2340') discusses the application of former section 160ZZS of the Income Tax Assessment Act 1936 ('ITAA 1936'), which is the predecessor provision to Division 149 of the ITAA 1997, in the context of discretionary trusts. Paragraph 2 of IT 2340 supports a 'look through' approach in relation to chains of companies, partnerships and trusts in order to determine whether there has been a change in the effective interests of natural persons in the assets.

Generally, a beneficiary of a discretionary trust does not have any legal or equitable interest in the assets or any income derived from the assets of the trust as their entitlement is subject to the trustee exercising their discretion. However, paragraph 6 of IT 2340 provides that:

Where a trustee continues to administer a trust for the benefit of members of a particular family…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.

Since prior to 20 September 1985, the Applicant has always had two shareholders, Individual A and Trust A. Therefore, it needs to be determined whether the majority underlying beneficial interest in the Applicant's business has been maintained in relation to Trust A.

Paragraph 5 of IT 2340 indicates that:

…in considering the question of whether majority underlying interests have been maintained in the assets of the trust it will be relevant to take into account the way in which the discretionary powers of the trustees are in fact exercised.

Trust A has not made any distributions of income and capital to its beneficiaries for the 1985 income year or any later income year.

Paragraph 7 of IT 2340 states that when the trust is continued to be administered for members of a particular family, the Commissioner would 'find it reasonable to assume that for all practical purposes the majority underlying interests in the trust assets have not changed.'

The Trust A is a family discretionary trust. The only beneficiaries who were entitled to distributions of income or capital under the trust deed were members of Individual A's family or companies or trusts in which those family members had an interest.

Thus, the ultimate beneficial owners of the business continue to be Individual A and members of Individual A's family. Therefore, Division 149 of the ITAA 1997 will not apply and the goodwill of the business will remain a pre-CGT asset of the Applicant.