Edited version of your written advice

Authorisation Number: 1051228950773

Date of advice: 25 May 2017

Ruling

Subject: Capital gains tax - pre-CGT goodwill

Question 1

Is the intangible asset comprising the goodwill of the business an asset considered to have been acquired before 20 September 1985 for the purposes of section 109-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Would any capital gain made on the disposal of that goodwill asset be disregarded pursuant to paragraph 104-10(5)(a) of the ITAA 1997?

Answer

Yes.

Question 3

If the goodwill of the business is considered to have been acquired before 20 September 1985, has section 160ZZS of the Income Tax Assessment Act 1936 (ITAA 1936) or section 149-30 of the ITAA 1997 applied to deem the goodwill to be acquired after 19 September 1985?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 20KK

The scheme commences on:

1 July 20JJ

Relevant facts and circumstances

The following documents have been provided and should be read in conjunction with the information as set out below:

● Trust Deed for the First Trust dated November 19AA

● Deed of Amendment dated December 19DD

● Notice of Nomination of Beneficiary dated December 19FF

● Deed of Amendment dated December 19FF

● Deed of Amendment dated August 19GG

● Minutes of the meeting of directors of the Trustee Company dated June 20II

● Notice of Nomination of Beneficiary dated June 20LL

● Minutes of the meeting of directors of the Trustee Company dated June 20LL

● Consent of Appointor dated June 20LL

● Trust Deed for the Second Trust dated June 20II.

The business

The business commenced in 19AA as a distributor. The business was conducted by the First Trust. The goods were purchased from an overseas supplier and holder of worldwide distribution rights.

From 19AA the business was based on indenting product (by taking Australian Dealer orders) direct from the oversea factory to the Australian dealers and revenue was earned on percentage of sales (commission). The dealer network was relatively small at that stage.

Not long after the death of Person A in 19BB, Person B recognised that a change in direction was required to support the expected growing demand and to service the existing customers and dealers with improved availability and importantly provide spare parts, customer support and marketing.

This strategy was negotiated with Overseas Company management and it was agreed to start a dedicated wholesaling operation in Australia. Person B also successfully negotiated to change the Trustee Company name.

The implementation of the strategy was well underway by January 19CC. Initially the wholesale operation ran out of a particular store, and not long after that a warehouse was leased, sales and warehouse staff were employed.

From March to May 19CC three significant events occurred:

1. In March 19CC, the oversea business was restructured with a management buyout. They formed Overseas Company which forged expansion in the relationship with its Australian distributor, expanding the business and holding stock rather than operating on an indent basis.

2. Around May 19CC, Trustee Company signed a lease for premises including approximately XXXX square feet of storage.

3. In May 19CC, Trustee Company changed its name and would thereafter be known by that name in Australia until the sale of the business in 20JJ.

The business has always been managed and controlled by members of the Person B's family.

The activities undertaken by the business have essentially not changed since inception. The growth over the years was a result of growth in scale of operations. To efficiently fulfil the orders of a growing distribution network required systems, inventory and personnel. Staff numbers increased over time.

Growth in revenue and scale of the business was reflected in the number of retailers (or dealers) that had signed dealer agreements with the business, the majority of which are in Australia and a small number in the South Pacific. The business never sold direct to end customers - their model relied on the dealer network to make retail sales. By July 20JJ the dealer network, being account customers of the business, had grown significantly.

The location of the business has always been in the same area. The first premise was used until around 19EE after which larger premises were located. These premises were leased by the business. An additional adjoining warehouse unit was added around 19HH.

From the late 20XX's the business also entered into leases of additional warehouse facilities in the same area.

Goodwill asset of the business

The goodwill of the business was internally generated through the management of the business. The business promoted the brand in Australia and developed the distribution network through internal growth over almost 30 years.

On the sale of the business, all business assets were specifically assigned values under the business sale agreement. The goodwill component was determined by negotiation between the parties.

The purchaser, is a wholly owned subsidiary of Overseas Company, and operates at arm's length from the business. The price agreed was reflective of the strong brand promotion and the strong dealership network created by the business.

The First Trust

The First Trust was settled by Trust Deed in November 19AA the settlor, and Trustee Company as Trustee.

Schedule 2 of the Trust Deed allowed further nomination of eligible beneficiaries by the settlor before the vesting date by notification to the trustee. Eligible beneficiaries are included on Schedule 2.

In November 19BB, the appointor of the Trust, Person A died.

In May 19CC, the Trustee changed its name.

In December 19DD, the Trustee amended the Trust Deed by replacing the Third Schedule of the original Trust Deed referring to “The Power of Trustee”. As the original appointor died, the Trustee declared their legal representative Person B to be the new appointor of the Trust. The new appointor gave consent to the proposed amendments.

In December 19FF, the settlor by notification to the Trustee nominated additional eligible beneficiaries.

In December 19FF, the Trustee pursuant to its amendment power under the Trust Deed, with consent of the new appointor, amended the Trust Deed to insert a definition of “Appointor”, a clause in relation to “Alternative Appointor” and a clarification of the application of a Clause involving amendments with consent of the appointor.

In December 19FF, the Trustee also changed the name of First Trust.

In December 19FF, the Trustee also amended the Second Schedule of the Trust Deed allowing the Trustee to nominate further eligible beneficiaries with the consent of the new appointor instead of the settlor. The settlor was a party to this amendment deed and consented to the amendment.

In August 19GG, the Trustee further amended the Trust Deed with consent of the new appointor to expand the Trustee's power to carry out various tasks.

In June 20II, the Trustee by formal notice to the appointor, appointed Company A as an additional eligible beneficiary of the Trust. The appointor consented to the appointment at the meeting of directors of Trustee.

In June 20LL, the Trustee by formal notice to the appointor, appointed Company B as an additional eligible beneficiary of the Trust. The appointor consented to the appointment at the meeting of directors of Trustee.

In August 20JJ, the Trustee changed its name.

Income and capital distributions have been made to eligible beneficiaries.

Related Entities

Company C was incorporated in August 19HH. The shareholders, who remain unchanged since inception are:

● Person B;

● Person C.

The Second Trust was settled by Trust Deed in June 20II by the settlor, and Company C as Trustee.

The Second Schedule of the Trust Deed of the Second Trust lists the eligible beneficiaries and includes several charities. There have been no amendments of this deed.

Income and capital distributions have been made to Person B.

Company A was incorporated in June 20II. The shareholders, who remain unchanged since inception, are:

● Company C ATF Second Trust;

● Person B;

● Person C.

Dividends have been paid to the Second Trust.

Company B was incorporated in June 20LL. The shareholders, who remain unchanged since inception, are:

● Company C ATF Second Trust;

● Person B;

● Person C;

● Person D.

No dividends have been paid.

Relevant legislative provisions

Income Tax Assessment Act 1997

Section 104-10

Subsection 104-10(4)

Paragraph 104-10(5)(a)

Section 108-5

Paragraph 108-5(2)(b)

Section 109-10

Division 149

Section 149-10

Section 149-15

Section 149-25

Section 149-30

Income Tax Assessment Act 1936

Section 160ZZS.

Reasons for decision

Question 1

Summary

The intangible asset comprising the goodwill of the business is an asset considered to have been acquired before 20 September 1985 for the purposes of section 109-10 of the Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

Goodwill or an interest in goodwill is specifically listed as a CGT asset under paragraph 108-5(2)(b) of the ITAA 1997 for the purposes of the capital gains tax provisions of the tax law.

Section 109-10 of the ITAA 1997 sets out some specific rules for the circumstances in which you acquire a CGT asset without a CGT event. Item 1 of the table in section 109-10 of the ITAA 1997 provides that if you construct or create a CGT asset, and you own it when the construction is finished or the asset is created, then you acquire the asset when construction, or work that resulted in the creation, started.

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.

For a business which has commenced before 20 September 1985, it is a critical matter to determine the CGT status of the goodwill of the business, as this will have relevance when a CGT event may occur to that goodwill.

The Commissioner views on the subject of capital gains tax and goodwill assets is contained in Taxation Ruling TR 1999/16 Income tax: capital gains; goodwill of a business (TR 1999/16), which reflects the decision of the High Court in Federal Commissioner of Taxation v Murry 89 ATC 4585 ('Murry').

Some relevant paragraphs of this Ruling are set out below:

Goodwill remains a single CGT asset if the same business continues

17. 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 - see paragraph 90) 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.

21. 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 that 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.

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

25. The whole of the goodwill of a business is either pre-CGT goodwill (subject to Division 149 - about when an asset stops being a pre-CGT asset - see paragraph 90) or post-CGT goodwill. The goodwill of a particular business cannot be characterised as partly pre-CGT goodwill and partly post-CGT goodwill. Goodwill is a composite asset.

Measurement of goodwill

43. Parties to an agreement for the sale of a business often allocate a discrete part of the sale proceeds to goodwill. We will accept the amount a vendor and purchaser attribute or allocate to goodwill as capital proceeds for goodwill provided that all of the following requirements are met:

(a) The vendor owns the goodwill of the business, is entitled to dispose of it and has actually disposed of the goodwill in disposing of the business.

(b) The parties are dealing with each other at arm's length in transacting the sale and in allocating the capital proceeds.

(c) The parties do not allocate goodwill an amount that should be properly attributed to an off balance sheet asset or 'identifiable asset' (in terms of accounting standards) distinct from goodwill…

(d) The amount of capital proceeds attributed to goodwill, when added to the proceeds attributed to all off balance sheet assets and identifiable assets of the business, equals the total proceeds received for the sale of the business.

When is goodwill acquired?

52. If a taxpayer commences business and starts to create goodwill, the goodwill of the business if acquired when the taxpayer starts work that results in the creation of the goodwill (subsection 109-10, item 1). When the 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.

Per paragraph 25 of TR 1999/16 the Commissioner takes the view that the whole of the goodwill of a business is taken to be acquired either before 20 September 1985 or after 19 September 1985. Goodwill cannot be regarded as partly pre CGT and partly post CGT.

To this end it is necessary to examine all the facts and circumstances to determine whether the same business has been continuously carried on since before 20 September 1985 or whether due to activities that have occurred since the commencement of the original business, a new business was commenced after 19 September 1985 and the former business no longer exists.

It is always a question of fact as to whether the same business is being carried on. A business does not have to be identical from the time of acquisition to the time of disposal to be regarded as the 'same' - paragraph 21 of TR 1999/16.

Per paragraph 95 of TR 1999/16, unless the facts indicate that a new business has commenced rather than an existing business continuing to be carried on, the goodwill of the business is not different from that existing when the business was originally acquired or commenced. A business owner may expand or contract activities or change the manner in which the business is carried on without ceasing the same business provided the business retains its essential nature or character.

Examples of organic growth, expansion or diversification of a business can include:

● adopting new compatible operations,

● servicing different clients,

● offering improved products or services.

Per paragraph 21 of TR 1999/16, 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 may increase its operations or scale of activity but it is also a question of fact whether such an expansion constitutes the expansion of an existing business or whether the expansion constitutes acquisition of a new business.

Application to your circumstances

The business commenced in 19AA as a distributor. It originally operated on a commission basis, importing goods direct from the overseas factory for Australian dealers. The dealer network at this stage was relatively small.

Shortly after the death of Person A in 19BB, Person B recognised that a change in direction was required to support growing demand, service existing customers and dealers with improved availability and provide spare parts, customer support and marketing. Person B successfully negotiated for the business to become a dedicated wholesaling operation and operate under the Trustee Company name.

The business grew rapidly at times during the period from the mid 19YY's to 20JJ. Initially the wholesale operation was conducted from a particular store, but not long after in May 19CC a warehouse was leased and sales and warehouse staff were employed. The business operated from this warehouse until 19EE when the business relocated to larger premises. An additional adjoining warehouse unit was added in 19HH and in 20XX the business leased additional warehouse facilities nearby.

The business grew internally from a small distribution network in 19CC (and earlier) to a comprehensive network in 20JJ. The growing distribution network required investment in systems, inventory and personnel. Staff numbers increased from 19DD to 20JJ.

Factors that indicate that the business was the same business for the CGT goodwill provisions include:

● It had operated from the same area since May 19CC;

● The business has operated under the same trust structure since inception;

● The management and control of the business has continually been undertaken by Person B, either alone or jointly with family members;

● The business name was used from May 19CC until the date of sale;

● The business has always been an importer and distributor of branded products via a distribution network;

● Its customers have all been retailers, located mostly in Australia; and

● It has used the same banking providers over the years.

The business began to generate goodwill from the time the business commenced in 19AA and continued to do so until it was sold in August 20JJ. The facts presented show that whilst the business has grown over time, this growth has been organic. The business has maintained its essential nature or character, that is, a distributor.

Therefore, we consider that the intangible asset comprising the goodwill of the business is an asset considered to have been acquired before 20 September 1985 for the purposes of section 109-10 of the ITAA 1997.

Question 2

Summary

Subject to satisfying the tests contained in Division 149 of the ITAA 1997, any capital gain or loss made on the disposal of the goodwill asset will be disregarded in accordance with paragraph 104-10(5)(a) of the ITAA 1997.

Detailed reasoning

The disposal of the goodwill of the business constitutes CGT event A1 under section 104-10 of the ITAA 1997. Under subsection 104-10(4) of the ITAA 1997 a capital gain would be made if the capital proceeds from such a disposal was more than the cost base of the goodwill. Conversely a capital loss would be made if the capital proceeds were less than the reduced cost base of the goodwill.

However under paragraph 104-10(5)(a) of the ITAA 1997 such a capital gain or capital loss is disregarded if the asset was acquired before 20 September 1985.

As we consider above that the goodwill of the business was acquired before 20 September 1985 it follows that any capital gain or capital loss made on the disposal of the goodwill can be disregarded, subject to satisfying the tests contained in Division 149 of the ITAA 1997.

Question 3

Summary

The goodwill of the business is considered to have been acquired before 20 September 1985. Section 160ZZS of the Income Tax Assessment Act 1936 (ITAA 1936) or section 149-30 of the ITAA 1997 has not applied to deem the goodwill to be acquired after 19 September 1985.

Detailed reasoning

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 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

(c) 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 subsection 149-30(1) of the ITAA 1997 an asset which is a pre-CGT asset will stop being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not held by ultimate owners who had 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.

The meaning of the term 'majority underlying interests' is set out in section 149-15 of the ITAA 1997:

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

(b) more than 50% of the beneficial interests that ultimate owners have (whether directly or *indirectly) in any *ordinary income that may be *derived from the asset.

149-15(2) An underlying interest in a CGT asset is a 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.

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 part of a foreign country.

149-15(4) An *ultimate owner indirectly has a beneficial interest in a *CGT asset of another entity (that is not an ultimate owner) if he, she or it would receive for his or her benefit any of the capital of the other entity if;

(a) the other entity were to distribute any of its capital; and

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

149-15(5) An *ultimate owner indirectly has a beneficial interest in *ordinary income that may be *derived from a *CGT asset of another entity (that is not an ultimate owner) if he, she or it would receive for his, her or its own benefit any of a *dividend or income if:

(a) the other entity were to pay that dividend, or otherwise distribute that income; and

(b) the dividend or income were then successively paid or distributed by each entity interposed between the other entity and the ultimate owner.

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.

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 Income tax: Capital gains tax: deemed acquisition of assets by a taxpayer after 19 September 1985 where a change occurs in the underlying ownership of assets acquired by the taxpayer on or before that date (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.

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.... On that basis, trust assets acquired by the trustee before 20 September 1985 would remain outside the scope of the capital gains and losses provisions of the Act.

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.

Application to your circumstances

The entity that carried on the business was the Trustee for First Trust (First Trust). The First Trust is a discretionary trust and was settled by trust deed in November 19AA.

As the business of the First Trust commenced prior to 20 September 1985, the asset, which is the goodwill of the business, is taken to have been acquired at the time the business commenced.

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.

According to the trust deed of the First Trust the eligible beneficiaries are identified in Schedule 2. This schedule has been amended multiple times during the life of the trust to include new eligible beneficiaries due to births, deaths and marriages of members of Person B's family. The schedule was also amended to include two companies as eligible beneficiaries of the trust, being Company A and Company B.

Income and capital distributions of the First Trust have been made to eligible beneficiaries.

Company A was incorporated in June 20II. The shareholders, who have remained unchanged since inception, are:

● Company C ATF Second Trust;

● Person B;

● Person C.

Dividends have only been paid to the Second Trust.

Company B was incorporated in June 20LL. The shareholders, who have remained unchanged since inception, are:

● Company C ATF Second Trust;

● Person B;

● Person C;

● Person D.

Dividends have not been paid.

Company C was incorporated in August 19HH. The shareholders, who have remained unchanged since inception are:

● Person B;

● Person C.

The Second Trust was settled by trust deed in June 20II with Company C as Trustee.

The Second Schedule of the trust deed of the Second Trust lists the eligible beneficiaries. There have been no amendments of this deed. The Second Trust's eligible beneficiaries are essentially the same individuals as the First Trust; however charities are also included amongst the list of potential beneficiaries.

Income and capital distributions of the Second Trust have only been made to Person B.

It is evident from the trust deed and amendments to that deed that the Trustee of First Trust has continued to administer the First Trust for the benefit of the members of Person B's 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.