Edited version of your written advice

Authorisation Number: 1051226759903

Date of Advice: 19 May 2017

Ruling

Subject: Goodwill of the business - whether pre-CGT asset

Question 1

Is the goodwill of X Pty Ltd an asset that was acquired before 20 September 1985 for the purposes of Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following periods:

1 July 20xx to 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances:

Person A and Person B designed a system for a particular industrial application (system) in the late 19XX's and started their business in the mid-19XX's when they first secured their on-going contract. The business was incorporated as X Pty Ltd around the same time.

With continuous research and innovation, X Pty Ltd.'s products expanded in various fields and the customer base also expanded from the local to international market. Irrespective of such growth and expansion, X Pty Ltd only manufactured its system and related products for a particular industry. It has its own extensive manufacturing facilities. It owns its own research facilities and directly owns all its intellectual properties.

There has not been any significant acquisition or discontinuance of the business during the life of the business. Its sale figures have steadily grown from mid-19XX's. There has not been any sudden shift or major overhaul of suppliers at any point.

While the growth of the business demanded appointment of new staff, the main control and management of the business continued to be held by Person A and Person B as well as the key personnel who were involved from the beginning. The business product is also known by its brand name and the control and management of the business remained mainly in its head office where it first started its business. International customers are serviced by wholly owned subsidiaries in various parts of the world.

X Pty Ltd have organised exhibition of its products in various international forums from mid-19XX's and have received awards for that particular industry on a regular basis from the very beginning.

Person A and Person B have always been the provider of majority funding for the operation of X Pty Ltd's business. They have also held majority shares in X Pty Ltd from its incorporation in mid-19XX's until present.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 180-5

Income Tax Assessment Act 1997 section 149-10

Income Tax Assessment Act 1997 section 149-15

Income Tax (Transitional Provisions) Act 1997 section 130-20

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise stated.

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 FC of T v. Murry 98 ATC 4585; (1998) 39 ATR 129. 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. 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.

Paragraph 52 of TR 1999/16 states that:

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.

X Pty Ltd's expansion in product range, customer base, market and recognition through various awards exhibits that X Pty Ltd has created a substantive goodwill for its business. Since the work for the business started in the mid 1970's, the goodwill was acquired at the same time as per the above paragraph.

Goodwill as a CGT asset

A CGT asset is defined under subsection 108-5(1) as:

(a) any kind of property; or

(b) a legal or equitable right that is not property.

The above is further elaborated under subsection 108-5(2) as:

(a) part of, or an interest in, an asset referred to in subsection (1);

(b) goodwill or an interest in it;

(c) an interest in an asset of a partnership;

(d) an interest in a partnership that is not covered by paragraph (c).

X Pty Ltd's goodwill thus constitutes a CGT asset according to paragraph 108-5(2)(b).

Goodwill, as a whole, is either a pre-CGT asset or a post-CGT asset

According to TR 1999/16, goodwill is established as a whole either as a pre-CGT asset or a post-CGT asset. Paragraph 25 states:

The goodwill of a particular business cannot be characterised as partly pre-CGT goodwill and partly post-CGT goodwill. Goodwill is a composite asset.

Therefore, X Pty Ltd's goodwill will be either pre-CGT or post-CGT asset. It cannot be partly pre-CGT and partly post-CGT.

Goodwill remains a single CGT asset if the same business continues

Paragraph 17 of TR 1999/16 states that:

The whole of the goodwill of a business that commenced before 20 September 1985 remains the same single pre-CGT asset (subject to Division 149 - about when an asset stops being a 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.

Therefore, to determine whether X Pty Ltd's pre-CGT goodwill will remain pre-CGT, the same business needs to continue post-CGT. Moreover X Pty Ltd needs to satisfy Division 149. The following discusses these two aspects.

Division 149 - majority underlying interest in a CGT asset

Section 149-10 states in part 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) …

Subsection 149-10(b) has been repealed by Tax Laws Amendment (Repeal of Inoperative Provisions) Act 2006 which now is dealt with by sections 149-30 and 149-35. According to section 149-30, the asset stops being a pre-CGT asset at the earliest time when the majority underlying interest is no longer held by the ultimate owners who held such interest in the asset immediately before 20 September 1985.

Section 149-15 provides what constitutes a majority underlying interest in a CGT asset. It states as follows:

149-15(1) Majority underlying interests in a CGT asset consist of:

(a) more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset; and

149-15(3) An ultimate owner is:

(a) an individual; or

(b) a company whose constitution prevents it from making any distribution, whether in money, property or otherwise, to its members; or

(c) the Commonwealth, a State or a Territory; or

(d) a municipal corporation; or

(e) a local governing body; or

(f) the government of a foreign country, or of part of a foreign country.

More than 50% of beneficial interests in X Pty Ltd remain in the hands of Person A and Person B from mid-19XX's until present. Although the number of shares was increased, the same proportion of shareholding is maintained.

Same business

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 .

Discussing when for example the essential nature or character of the business would remain the same, paragraph 22 of TR 1999/16 states 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.

Paragraph 91 of TR 1999/16 also provides important factors to consider when establishing the essential nature or character of the business. It states that consideration should be given, among others, 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.

In the present case, the essential nature and character of X Pty Ltd's product continues to be the same from its formative period until present despite its development and expansion in market and customer base. The same system that Person A and Person B invented continues to be at the core of all its products. The brand-name by which X Pty Ltd's customers associate its products, continue to do so at present. There has not been any major overhaul of its suppliers as well as any major acquisition or discontinuance of its business. All its research, innovation, manufacturing and servicing works have always been done from X Pty Ltd's head office with wholly owned subsidiaries to service the international customers. All decision making of management functions have also always remained with Person A and Person B. While they have always been the majority shareholder, they have also always provided majority funding for the business.

Therefore, since the same business continues for X Pty Ltd from pre-CGT and since there has not been any changes in its shareholding from pre-CGT, the goodwill that X Pty Ltd acquired for its business pre-CGT continues its pre-CGT status for the purposes of Part 3-1.