Edited version of your written advice

Authorisation Number: 1013128368964

Date of advice: 30 November 2016

Ruling

Subject: Dissolution of Partnership, Transfer of Partnership Business and Goodwill

Question 1

Upon the dissolution of the partnership and the independent and immediate continuance of the activities by separate companies, was the goodwill of the partnership business destroyed, thus resulting in a capital gains tax (CGT) C1 event happening under section 104-20 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Upon the dissolution of the partnership and the independent and immediate continuance of the activities by separate companies, did CGT event A1 happen in relation to the goodwill of the partnership business under Division 104 of the ITAA 1997?

Answer

Yes

Question 3

In the event that CGT Event A1 happened in relation to the goodwill of the partnership business under Division 104 of the ITAA 1997, does the partner, satisfy the basic conditions for relief under section 152-10 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

30 June 20YY

The scheme commences on:

20XX

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.

1. A partnership with several partners traded with separate distinct business units within the partnership.

2. The partners have affiliates and connected entities which did not conduct any active business of their own.

3. The separate business activities within the partnership were controlled by separate partners, where each partner had complete, unfettered control over the management, operational activities, employment of staff and financial decisions within the business unit.

4. The finances of each business unit were managed and reported separately. Monthly management accounts were prepared independently. The only merged financial reporting was the year-end financial statements which consolidated the business units for year-end reporting purposes only.

5. The partnership business employed employees in each of the business unit and shared administrative staff.

6. The partnership was dissolved and at the same time that the partnership dissolved, the business units were transferred to companies as a satisfaction of the partnership asset entitlements of each partner. What was transferred was a business going concern and not a collection of business assets.

7. The new companies were individually held by separate partners. The new companies took ownership of the respective client and master files specific to the respective business previously operated by the partnership.

8. The following occurred as a result of the transfer of the partnership businesses:

● the employees have changed their employer to reflect the new companies respectively. The employment duties, responsibilities, clients, email address etc did not change following the cessation of the partnership.

● the administrative staff are divided between the new companies. The services of the bookkeeper are divided between the new companies.

● both businesses continue to operate with the same phone number to eliminate any potential client conflict or confusion that may occur with a change of phone number and still share a joint website.

● the physical assets of each business (i.e. property, plant and equipment) remained with the business that used those assets.

● outstanding debts owing to the partnership have not been transferred to companies but will continue to be operated and/ administrated jointly.

● although the new companies now operate using independent ledgers (for accounting, financial reporting, invoicing, payroll etc), these use the same operating systems (and licenses) and mirror each other. They are operated by the same (joint) bookkeeper in order to create efficiencies.

● the new companies operate under the same roof.

● the new lease is in the joint names of the new companies to secure a more favourable lease. The businesses will divide the rent based on floor space used by each respective company and pay rent independently. Other occupancy expenses, utilities and rates are divided in accordance with usage or floor space.

1. Things that have changed with the dissolution of the partnership are:

● each company operates under separate Australian Business Numbers (ABN)

● each company has taken ownership of the respective client and matter files specific to the respective business unit previously operating under the partnership.

● each company operates out of a separate bank account.

● each company is responsible for their own insurance- property public liability, workers' compensation etc

● other expenses, such as employee amenities, supplies etc are ordered and paid for independently although the same suppliers may at times used.

● each company operates under its own payroll tax registration and lodges separate BAS.

● the ultimate individuals continue to independently control the business in the new companies respectively and have no influence over management, operational, employment or financial decisions made by the other business;

● the new companies now prepare financial statements separately as they are two separate legal entities, however from an internal perspective, the financial reporting and management of each business has not changed from when they operated under the partnership.

1. The entitlement received by each partner was effectively equal to the business unit transferred out of the partnership.

2. No monetary or other compensation was paid between partners. The transfer of the partnership business was carried out simultaneously with the dissolution of the partnership. No period of time had lapsed between the partnership's dissolution and the transfer of the partnership business units to the new companies respectively.

Assumption

The market valuation of the goodwill of the partnership businesses is less than $X as at 30 June 20XX.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 104-20(1),

Income Tax Assessment Act 1997 subsection 104-10(2),

Income Tax Assessment Act 1997 section 152-10,

Income Tax Assessment Act 1997 section 152-35 and

Income Tax Assessment Act 1997 section 152-40.

Reasons for decision

Unless otherwise stated, all legislative references are to the Income Tax Assessment Act 1997.

Issue 1

Question 1

Summary

CGT Event C1 did not occur to the goodwill of the partnership businesses when the partnership dissolved and separate companies carrying on independent activities.

Detailed reasoning

In this case, the partnership was dissolved and the businesses were transferred out simultaneously. The partnership businesses never ceased and continued trading. The goodwill attached to the partnership businesses was transferred to the separate companies carrying on independent activities.

Goodwill, a form of property is capable of transfer. The conditions for transferring it, as established by the High Court in FC of T v. Murry 98 ATC 4585; (1998) 39 ATR 129 (Murry's case) include:

● transferring the “business” containing the goodwill, including the right or privilege to use the components of the business to earn profits and

● transferring all those matters and things essential to the existence of the goodwill including those things likely to continue to generate earnings for the business such as identifiable assets, locations, people, efficiencies, systems, processes and techniques of the business.

Taxation Ruling TR 1999/16 Income Tax: capital gains: goodwill of a business provides guidance on the sale of businesses and goodwill attached:

73. If a business owner is carrying on more than one business,

each business has its own separate goodwill and each business may be

disposed of along with the goodwill attaching to it. Section 118-250

applies (subject to the business exemption threshold being met) to any

capital gain attributable to the goodwill.

75…..If a purchaser assumes the conduct of a

vendor's business and continues to carry it on, this points to a business

having been transferred rather than a transfer of a business asset or a

collection of business assets…..An express assignment of goodwill is

strong evidence of a transfer of the business to which it is attached but

the absence of an express assignment of goodwill does not

conclusively mean that there has been no disposal of a business…..

77. If the part of the business sold constitutes a discrete business

and it is sold as a business, the sale includes a disposal of goodwill.

There must be a sale of sufficient assets including goodwill to enable a

purchaser to carry on the business the vendor did previously without

interruption.

Had the partnership dissolved, the partnership businesses would have ceased. A new business would have commenced under the companies independently by the founders in a different location from scratch, there then will be an argument that CGT event C2 occurred to the goodwill of the partnership businesses.

This is not the case here, there are discrete businesses being operated by the partnership prior to its dissolution. When the businesses were transferred from the partnership, each company took ownership of the respective client and matter files specific to the respective businesses previously operated by the partnership. The transfer of the business units to the companies were classified as a transfer of going business concern and not a collection of business assets. Hence, the transfer of each discrete business would include the disposal of goodwill of each business and the goodwill of the partnership businesses were not destroyed when the partnership dissolved. The businesses conducted under the partnership did not cease, it was simply transferred to two companies which continued the business.

The partnership businesses never ceased. They were transferred to the respective companies. Although the partnership was dissolved, the partnership businesses continued to operate and serve the customers. The accounts receivable of the partnership at dissolution was not transferred to the companies. On-going contracts with customers were honoured and staff was paid. The companies still refer to the same trading name and brand of the services they provided under the partnership. As a result of this, the business continued to be carried on respectively under the new companies.

The ATO view expressed in Taxation Ruling TR 1999/16 and TR 1999/16A Income tax: capital gains: goodwill of a business (TR 1999/16) resulting from the High Court decision of Murry's case has been applied in arriving at the conclusions in relation to the income tax outcomes for the partners' interest in the goodwill of the partnership and its subsequent transfer in the present case.

The following extracts from, TR 1999/16 has been applied in determining the answer to this question:

Paragraph 89:….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'.

Paragraph 91: It is a question of fact and degree whether the same business is being carried on. Factors to consider include the 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 - and the way in which the business is structured, carried on, managed and controlled.

Paragraph 92: …The word 'business' in its context in subsection 165-210(1) means only one 'overall business' and is a reference to all of the activities carried on or undertaken by the company irrespective of whether those activities constitute or are treated by the company as constituting separate or distinct activities, enterprises, divisions or undertakings (paragraphs 21, 22 and 25 of TR 95/31) whereas the word 'business' is used in a different context in the CGT goodwill provisions. Those provisions can extend to a situation in which a business owner carries on a series of separate businesses, each business having its own goodwill….

Paragraph 93: 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. To illustrate this same business test with an 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, 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.

Paragraph 138: A closure of a business for a finite period of time (e.g., an owner closes their shop due to ill health or to take holidays but with the intention of resuming business activities) does not constitute a cessation of business giving rise to a disposal of goodwill.

Paragraph 139: A closure of a shop and a move to new premises do not of themselves constitute a cessation of business. If a business owner moves the location of the shop and continues carrying on the same activities, serving at least some of its customers from the former trading location, the business has not ceased.

Paragraph 140: If, however, a business is moved so that its customer base completely changes and the former business is not known to any of its new customers, the former business ceases. If the business owner had previously purchased the business and its goodwill, a capital loss may arise on the loss or destruction of the goodwill of the business.

Paragraph 141: If a taxpayer undertakes several business activities, the taxpayer may in fact be carrying on several businesses. If one of the activities is permanently discontinued, and the activity constitutes a discrete business in its own right, a loss or destruction of the goodwill occurs in relation to the cessation of that business.

Based on the above observations of goodwill attaching to a particular business, given the circumstances in the present case, the goodwill of the business units were distinct and independent of each other and continued to exist by and large subsequent in the same form and substance upon the dissolution of the partnership and the transfer of these businesses into the new companies.

Accordingly, there would be no destruction of goodwill giving rise to CGT event C1.

Question 2

Summary

A CGT Event A1 occurred to the goodwill of the partnership businesses when the partnership dissolved and the partnership businesses were transferred to the separate newly incorporated companies.

Detailed reasoning

In general partners in a partnership have a fractional interest in each and every asset of the partnership. The ITAA 1997 recognises that the proprietary interest that each partner has in the assets of the partnership is a CGT asset (paragraph 108-5(2)(b)), including the interest in goodwill of the partnership. Therefore, for CGT purposes, the fractional interest that each partner has in the assets of the partnership is a CGT asset.

Upon dissolution of the partnership, each partner will therefore be entitled to their fractional interest in all of the assets of the partnership.

To the extent that the businesses units did not cease upon the dissolution of the partnership, upon the transfer of each partner's fractional interest in the assets of the partnership which would include the goodwill in each of the businesses to the new companies, it is a reasonable to conclude that the goodwill attributable to each of these businesses did not come to an end but was transferred to the new companies respectively.

The relevant CGT event in relation to the transfer of the goodwill of each of the businesses into the new companies in this instance would be, CGT event A1. Given there was no consideration given by the new companies for the transfer of the businesses, the market value substitution rule would result in each of the partners being deemed to have received capital proceeds equal to their shares each of the market value of the goodwill of each of the businesses that were transferred to the new companies. Given that there is no cost base attributable to each partner's fractional interest in the goodwill of each of the businesses, the partners would have a capital gain equal to the same amount.

To this end paragraph 148 of TR 1999/16 states that:

A disposal of a partner's entire interest in a partnership in which the partners conduct a business is a change of ownership of the partner's interest in the partners' business. The entire interest of the partner in the partnership carries with it all the rights and benefits attaching to that interest including the partner's interest in the assets and other things used in the business. Any capital gain made on disposing of the partner's interest in goodwill is a capital gain attributable to the goodwill of the business and qualifies for the concession in section 118-250.

In the present case the entire interest of each partner in the respective businesses is transferred to the new companies respectively. Accordingly, there is a change of ownership of each partners' interest in each of the businesses and accordingly results in CGT event A1 applying to the change of ownership which includes the goodwill attaching to each of the businesses.

Question 3

Summary

On the basis of the assumption that the goodwill of the partnership businesses is less than $X, where CGT Event A1 happens in relation to the goodwill of the partnership businesses under Division 104, the partners of the partnership will satisfy the basic conditions for relief under section 152-10.

Detailed reasoning

Section 152-10 is the provision that lists the basic conditions for relief.

Under subsection 152-10(1), a capital gain (except a capital gain from CGT event K7) you make may be reduced or disregarded if the following basic conditions are satisfied for the gain:

(a) a CGT event happens in relation to a CGT asset of yours in an income year;

(b) the event would (apart from this Division) have resulted in the gain;

(c) at least one of the following applies:

(i) you are a *small business entity for the income year;

(ii) you satisfy the maximum net asset value test (see section 152-15);

(iii) you are a partner in a partnership that is a small business entity for the

income year and the CGT asset is an interest in an asset of the partnership;

(iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in

relation to the CGT asset in the income year;

(d) the CGT asset satisfies the active asset test (see section 152-35).

The analysis below makes references to the following ATO guides:

● Guide to capital gains tax concessions for small business

● Advanced guide to capital gains tax concessions for small business

a) Small Business Entity Test

A partner cannot be a small business entity. It is the partnership that must satisfy the small business entity test (that is, the $2 million aggregated turnover test) to qualify as a small business entity.

Partners may also be eligible for the concessions for a CGT asset the partner owns (that is not their interest in a partnership asset) when the following conditions are satisfied in the income year:

● they were a partner in a partnership in the income year in which the CGT event happens to the partner's CGT asset;

● that partnership uses the asset at a time in the income year, in carrying on the partnership business and is a small business entity for that income year;

● the only business the partner carries on is as a partner in a partnership.

If the aggregated turnover for a partnership for the previous two years had been more than $2m, the partnership would not qualify as a small business entity. This is the case for the partnership.

b) Maximum Net Asset Value Test

Section 152-15 is the provision that defines the parameters of the 'maximum net asset value test'. You satisfy the maximum net asset value test if, just before the *CGT event, the sum of the following amounts does not exceed $6,000,000:

(a) the *net value of the CGT assets of yours;

(b) the net value of the CGT assets of any entities *connected with you;

(c) the net value of the CGT assets of any *affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)).

In calculating the maximum net asset value, include the net value of assets of your affiliates, and entities connected with your affiliates, only if the assets are used, or held ready for use, in a business carried on by you or an entity connected with you.

Do not include an asset if it is used in the business of an entity that is connected with you only because of your affiliate.

If you are a partner in a partnership and the CGT event happens in relation to an asset of yours or a CGT asset of the partnership (for example, disposal of a partnership asset) the maximum net asset value test would also include:

● all the assets of the partnership if you are connected with it, and you would exclude the value of your interest in the partnership, or

● only your interest in the partnership if you are not connected with it, and you would not count the assets of the partnership as a whole.

In calculating whether you are connected to a partnership, you need to consider whether directly or indirectly (via other entities that you control) you have the right to receive 50% or more of the income and rights to the assets of the partnership.

The net value of CGT assets is the market value of these assets and not their book value. Internally generated goodwill may not have zero book value but a positive market value to be included in the Maximum Net Asset Value Test (MNAV).

When calculating net value, you should exclude the shares, units and other interests (apart from debt) that you hold in an entity connected with you or your affiliate. This is because the net value of the CGT assets of the connected entity is already included in the test. However, include any liabilities relating to these excluded interests in connected entities.

Although in the present case, no market valuations have been provided of the “goodwill” of the two partnership businesses transferred, we are able to rule on whether the partners have met the MNAV test on the basis of an assumption that the market value of the goodwill of the partnership businesses is less than $X and no other businesses were being operated in any of the affiliates or connected entities named in the private ruling before CGT event A1 in relation to the goodwill of the businesses operated under the partnership.

Other than the businesses in the partnership, there are no other active businesses in the connected entities and/or affiliates of the partner.

Based on the assumption in this ruling, the partner will satisfy the MNAV test.

(c) Active Asset Test

Under subsection 152-40(1), a CGT asset is an active asset at a time if, at that time:

(a) You own the asset and it is used , or held for ready for use, in the course of carrying on a business that is carried on (whether alone or in partnership) by you, or your affiliate, or another entity connected with you;

(b) If the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, or your affiliate, or another entity connected with you.

The CGT asset in the present case is the goodwill attaching to the businesses conducted in the partnership. These therefore by definition are active assets of the partnership as it was used by the partnership in carrying on the business of the partnership.

Therefore, the partner satisfies the basic conditions for small business CGT relief under section 152-10.