Edited version of your written advice

Authorisation Number: 1051406911687

Date of advice: 10 August 2018

Ruling

Subject: Pre-CGT goodwill

Question

Will a capital gain made on the disposal of the Company’s business goodwill be disregarded pursuant to paragraph 104-10(5)(a) of the Income Assessment Act 1997 (ITAA 1997), by reason of that goodwill having been acquired before 20 September 1985?

Answer

Yes.

This ruling applies for the following periods:

Income Year ended 30 June 20XX

Income Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The Company was incorporated before 20 September 1985.

The Company commenced its Business before 20 September 1985 when it began manufacturing and distributing their Product.

The Company also conducted a secondary business prior to 20 September 1985, which was operated as a separate and distinct business, however this secondary business was subsequently sold as a going concern (with its own goodwill attached) after 20 September 1985.

Since 20 September 1985, the Business has expanded its product range, primarily through research and development, however the bulk of its additional products are largely based on the same processes and materials that it used to manufacture its original Product. The Company also began to import a limited number of products from overseas to supplement and complement its product range. In 20XX, the Company commenced importing certain products that were manufactured in an overseas country by a company that was partly owned by Company. From this time on, the Business ceased manufacturing this particular product in Australia.

Since inception, the Company has used the same logo for the sale of its products and has sold almost all of its products, whether imported or not, using that overall branding. Although some specific product lines carry their own trademarks as well, all of these product lines are sold through the Company’s branded distribution network and all invoicing and communications through the Company’s brand.

Since its inception, the Business has marketed its products to a wide range of commercial customers in Australia (with a number of its key customers prior to 20 September 1985 currently still key customers).

When the Business commenced trading before 20 September 1985, the supply of products to customers in the local area was by use of a truck owned by the Company. Transport contractors were also engaged to undertake deliveries in other areas.

With improved product lines, increase in types of products and increased quantities of orders, distribution of the products was wholly outsourced to transport and shipping contractors. This distribution model was adopted prior to 20 September 1985 and has remained largely unchanged, with the exception of adopting technological advances, to date.

From before 20 September 1985 to the late 1990s, the Business was operated from the Company’s head office where it manufactured, stored and distributed its products.

In 19XX, the Company relocated its Business to a new, larger facility in the same city which provided increased warehousing to meet the increasing demand for the Company’s products. The other business premises was not retained by the Company after that time.

The Company has always been a wholly owned family business. The Business' operations have always been carried out by a combination of family members and key, long term members of staff.

Post-20 September 1985, the Company has also acquired the assets of several of its competitors (Competitor A and Competitor B).

Following its acquisition, Competitor A’s assets were promptly incorporated into the Company’s Business.

This acquisition lead to the following:

a) Competitor A’s plant was closed and the staff were made redundant;

b) the servicing of the customer base of Competitor A was taken over by the Business’ sales force and distribution network;

c) most of Competitor A’s brands were stopped and replaced with the Company’s existing brands;

d) the Company did not move any of Competitor A’s product manufacturing to its premises.

Any of Competitor A’s products sold by the Business were sourced from overseas. By 20XX, the original Competitor A’s branded products constituted only a small percentage of the Business’ sales. Whilst strategic acquisitions were undertaken which supplemented the Business products, all products were complementary and auxiliary to the range; no new product lines were acquired. Other products which did not align with the Business’ product lines were disposed of immediately to an unrelated, third party.

The Company acquired another competitor, Competitor B, which had specialised in distributing identical products to the Company although Competitor B was, however, a much smaller supplier in the market place.

The majority of Competitor B’s branded products were stopped and replaced with the Company’s products. Only one product line resulting from the acquisition of Competitor B was adopted and continues to be supplied by the Business to date, which represents a small percentage of the Business’ sales.

The Company intends to sell its Business, including the goodwill and customer relationships.

No sale agreement has yet been drafted, however the proposed sale will include the sale of trading stock, fixed assets, goodwill and trademarks. These assets will enable the purchaser to carry on the business after the sale without interruption.

Prior to 20 September 1985, the Company was owned legally and beneficially by two family companies. 100% ownership of the two family companies was held by a discretionary trust.

The Commissioner has previously determined pursuant to subsection 149-30(2) of the ITAA 1997 that for the purpose of section 149-30 of the ITAA 1997, the Commissioner thinks it is reasonable to assume that the majority underlying interests in the pre-CGT assets of the Company were at all times had by ultimate owners who had majority underlying interests in the pre-CGT assets immediately before 20 September 1985.

Assumptions

There will be no changes to the majority underlying interests as defined in section 149-15 of the ITAA 1997 of the goodwill of the Business operated by the Company until when the proposed sale of the Business will occur.

There will be no material changes to way the Business is carried on from the date this ruling is issued until when the proposed sale of the business will occur.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-10

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

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

Income Tax Assessment Act 1997 Section 108-5

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

Income Tax Assessment Act 1997 Division 109

Income Tax Assessment Act 1997 Section 109-10

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1997 Section 149-15

Income Tax Assessment Act 1997 Section 149-30

Income Tax Assessment Act 1997 Subsection 149-30(1)

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

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Summary

A capital gain made on the disposal of the goodwill of the Business will be disregarded pursuant to paragraph 104-10(5)(a) of the ITAA 1997 as the goodwill was acquired before 20 September 1985.

Detailed reasoning

CGT event A1 happens if you dispose of a CGT asset pursuant to subsection 104-10(1) of the ITAA 1997.

However, pursuant to paragraph 104-10(5)(a) of the ITAA 1997, any capital gain or capital loss you make on disposal of an asset acquired prior to 20 September 1985 (pre-CGT) is disregarded.

Goodwill

Goodwill, or an interest in it, is a CGT asset under paragraph 108-5(2)(b) of the ITAA 1997.

Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business (TR 1999/16) provides guidance as to the taxation treatment of goodwill of a business. TR 1999/16 reflects the decision of the High Court of Australia in FC of T v. Murry 98 ATC 4585; (1988) 39 ATR 129. (Murry's Case).

Paragraphs 9 to 15 of TR 1999/16 provide the legal meaning of goodwill. Goodwill for the purposes of the definition of CGT asset in section 108-5 of the ITAA 1997 has the meaning it bears under the general law. It is the legal definition of goodwill as explained by the High Court in the Murry case, rather than its accounting and business definitions, which applies.

The legal meaning of goodwill according to the majority justices of the High Court in the Murry case has three different aspects namely property, sources and value.

Paragraph 12 of TR 1999/16 further states:

….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.

The goodwill of the Business will be a CGT asset pursuant to section 108-5 of the ITAA 1997.

This goodwill will include customer relations as, in accordance with paragraph 101 of TR 1999/16, they can’t be brought to account or realised separately from the Business itself.

When is the goodwill of a business acquired for CGT purposes?

Subsection 995-1(1) of the ITAA 1997 provides that you acquire a CGT asset in the circumstances and at the time worked out under Division 109 of the ITAA 1997.

Section 109-10 of the ITAA 1997 sets out specific rules for the circumstances in which, and the time at which, you acquire a CGT asset otherwise than as a result of a CGT event happening.

Item 1 of section 109-10 of the ITAA 1997 provides that if you create a CGT asset and you own it when the CGT asset is created, you acquire the CGT asset at the time the work that resulted in its creation started.

In respect of the acquisition of goodwill, this is further explained by paragraph 52 of TR 1999/16, which states:

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

The Company is taken to have acquired the goodwill associated with the Business when the business commenced, which was prior to 20 September 1985.

Goodwill remains a single CGT asset if the same business continues

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.

Paragraph 17 of TR 1999/16 outlines a ‘same business test’ to determine whether goodwill will continue to be one asset throughout the life of the business where it was acquired prior to 20 September 1985. 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.

It is relevant to note in the current circumstances that, 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 (paragraph 73 of TR 1999/16). In this case, since before September 1985, the Company carried on two separate and distinct businesses, being the Business and the secondary business until the secondary business was sold as a going concern with its own pre-CGT goodwill attached.

Paragraph 77 of TR 1999/16 considers the implications of such a disposal on the nature of the remaining business (in this case, the Business) and in this regard highlights that 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 and that the unsold portion of the vendor's business is regarded as the same business as that previously conducted by the vendor.

On this basis, consideration of the same business test referred to in paragraph 17 of TR 1999/16 will apply to the Business in isolation, not to any other activities or businesses that may also be carried on by the Company.

However, as noted in paragraph 17 of TR 1999/16, it is necessary to briefly consider the application of Division 149 of the ITAA 1997 before considering the same business test.

Division 149 of the ITAA 1997 – majority underlying interest in a CGT asset

Division 149 of the ITAA 1997 determines when an asset acquired before 20 September 1985 stops being a pre-CGT asset.

In accordance with subsection 149-30(1) of the ITAA 1997, an asset will stop being a pre-CGT asset at the earliest time when majority underlying interests in the asset are not had by the same ultimate owners who had majority underlying interests before 20 September 1985.

Alternatively, 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 day, majority underlying interests in the asset were had by ultimate owners who had majority underlying interests in the asset immediately before that day, subsection 149-30(2) of the ITAA 1997 would apply as if that were in fact the case, so that the assets would retain their pre-CGT asset status.

For the purpose of section 149-30 of the ITAA 1997, the Commissioner previously ruled that it was reasonable to assume that the majority underlying interests in the pre-CGT assets of the Company were at all times had by ultimate owners who had majority underlying interests in the pre-CGT assets immediately before 20 September 1985.

Accordingly, Division 149 of the ITAA 1997 will not apply to change the pre-CGT acquisition date of the goodwill of the Business.

Same business test for CGT goodwill purposes

Whether the same business is being carried on is a question of fact and degree that ultimately depends on the circumstances of each particular case. However, paragraph 21 of TR 1999/16 provides the following guidance on establishing whether the same business is carried on:

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.

Paragraph 23 of TR 1999/16 further states that 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.

Since September 1985, there have been various changes to the nature of the Business and therefore it is necessary to consider whether the ‘same business’ is being carried on such that the goodwill of the business retains its pre-CGT status.

Thus in considering whether the goodwill of the Business ceased due to changes in the business, consideration must be given to the essential nature or character of the business as well as some of the factors stated above.

The nature or character of the business

The Business has grown organically, expanded and evolved over time. However, the nature of the Business conducted by the Company has, from a broad perspective, remained consistent as it core activities have continued to focus on the manufacture and distribution of its products to commercial markets.

Since commencement of the Business, the range of products has continued to be developed through technological advances and research and development. Research and development has always been a point of focus of the Company, and as a consequence the quality and versatility of the products of the Business naturally evolved.

From about 1985, the range of the Business’ products continued to evolve with increasing demand. All products designed, produced and distributed by the Business, however have stemmed from the same processes and materials that it used to manufacture its original Product.

Since its inception, the Business has marketed its products to a wide range of commercial customers. Over the decades, the Business’ reputation for providing reliable products has steadily grown and been a significant driver of growing and retaining its loyal customer base. The nature of the customer base has substantially remained the same over the entire period of operation of the Business. These were customers pre September 1985 and have always been Australian domestic customers.

Location

From before 20 September 1985 to the late 1990s, the Business was operated from the Company’s head office where it has manufactured, stored and distributed its products.

In 19XX, the Company relocated its Business to a new, larger facility in the same city which provided increased warehousing to meet the increasing demand for the Company’s products. The other business premise was not retained by the Company after that time.

The Company also began to import a limited number of products from overseas to supplement and complement its product range. In 20XX, the Company commenced importing certain products that were manufactured in an overseas country by a company that was partly owned by the Company. From this time on, the Business ceased manufacturing this particular product in Australia.

Size

Since 1985, the Business has experienced significant growth in terms of products, revenue, client base and other business attributes.

Since before 1985, the products of the Business have continued to grow, due to the constant research and development conducted by the Company to continually improve its products.

The extent of changes in the assets and resources of the business

The Company has had some changes in the assets and resources of the business since September 1985, namely the acquisition of the business assets, including the goodwill, of Competitors A and B.

TR 1999/16 provides guidance on whether new goodwill is acquired on an expansion of an existing business or on commencement or acquisition of a new business. Paragraphs 63 and 64 of TR 1999/16 make the following statement in respect of purchased goodwill:

If a taxpayer who founded or purchased a business adds to that business an additional business purchased as a going concern, it is a question of fact dependent on the circumstances of each particular case whether the additional business is subsumed into and forms part of the existing business or whether the two businesses remain as separate businesses…

If a pre-CGT business is combined with another business acquired post-CGT and they are conducted as one business without the pre-CGT business losing its essential nature or character, the goodwill of the post-CGT business is subsumed into the goodwill of the pre-CGT business and all of the goodwill of the business is taken to have been acquired before 20 September 1985. The goodwill of each of the businesses coalesce without any disposal of the goodwill of the post-CGT business. The pre-CGT business must not lose its essential nature or character in the sense that it must remain the same business and not be overwhelmed by the post-CGT business in such a way that it has become a different business. The purchase of the post-CGT business must involve merely organic growth of the pre-CGT business or an expansion or accretion to it in reasonable proportions or it gives rise to a new, different business and its goodwill is a new asset.

After 1985, the Company purchased the assets of one of its Australian competitors, Competitor A. Competitor A produced products and these products overlapped with the Business’ product range. The original Competitor A branded products currently constitute only small percentage of the Business’ sales.

The Company also acquired Competitor B which was a much small supplier that had specialised in distributing identical products to the Company.

Only one product line resulting from the acquisition of Competitor B was adopted and continues to be supplied by the Business to date that was supplementary to the Company’s other products. In 20XX, this product represented a small percentage of the Business’ sales.

The acquisition of the business of Competitor A and Competitor B by the Company included product lines which were identical and complementary to the products already being produced and distributed by the Business at the time of their respective acquisitions.

The business assets of Competitor A and Competitor B which were acquired by the Company were immediately subsumed into the existing Business and the same integrated management and control was applied to these as the existing business. Additionally, the acquired assets were treated for banking and accounting purposes as an extension of the existing business, and the same accounting methods, bank accounts, finance teams, back office mechanics were utilised as was operated for the Business.

Taking into account the discussion in paragraphs 63 and 64 of TR 1999/16, the acquisition of Competitors A and B is not consistent with the acquisition of a new business with its own goodwill. Instead, the businesses have been subsumed into the Company as their competitors plants were shutdown, the products were rebranded and taken on as its own, and the Company continued to operate as one business.

Additionally, the total sales from products originating from Competitors A and B are not significant compared to the overall products sold by the Company and consequently the acquisition of these competitors did not overwhelm the Business in such a way that it became a different business. The purchase of these competitors can be attributed to the organic growth of the Business.

The activities of the business

Since 1985, the core activities of the Business have remained unchanged, primarily focusing on the manufacturing and distribution of its products.

From an administrative perspective, there have also been no major changes to the structure of the Business; it has always been operated by the Company and the family.

The Business on its own has been treated as a separate business by the family. This is evident as it has been operated and carried on as a distinct business to that of the other businesses carried on by the Company.

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

The Company has always been a wholly owned family business. The Business' operations have always been carried out by a combination of family members and key, long term members of staff.

There have been no periods of discontinuance or temporary cessation of the Business since its inception. No part of the Business or any of its business assets have been disposed of since commencement of the business.

Additionally, the vision and ethos of the Business has always remained constant.

Conclusion

Based on the information provided, it is evident that the Business has developed and expanded since 1985 as it:

● provides a greater range of products sold as part of its business operations;

● increased its customer base;

● relocated its headquarters;

● commenced importing certain products from overseas at various times; and

● acquired the business assets of Competitors A and B.

It is however considered that these changes represent organic growth and expansion of the Business because the above factors do not change the essential nature or character of the business, being a manufacturer and distributor of its products to commercial customers in Australia.

It is not considered that through a planned or systematic process of change within a reasonable period of time, the Business has changed its essential nature or character. Neither has there been a sudden nor dramatic change in the business brought about by either the acquisition or the shedding of activities on a considerable scale.

The Business continues to carry on the same business as demonstrated by the following features:

● The Business has maintained its primary focus on manufacturing and distributing its products to commercial customers;

● The Company has continued to operate the same Business without any break in its operations since the commencement, and it currently continues to operate in the same manner, supplying markets the same products;

● The products of the Business have largely stemmed from the same processes and materials that it used to manufacture its original Product;

● It has continued to service clients in the same industries;

● Since its inception, the Business has maintained a core and identifiable end user customer base and has maintained business with a number of its biggest suppliers since before 1985;

● The business assets acquired from Competitors A and B were a result of the organic growth of the Business;

● The business headquarters have always been in the same city, with the relocation of the business to larger premises required due to the growth of the Business;

● The same logo and branding has remained the same; and

● The business structure, management and control have remained largely unchanged with the business continually being managed by the same family.

Accordingly, despite the developments and expansion of the Business over the years from 1985 to the present, the goodwill of the Business is taken to have been acquired before 20 September 1985, and therefore is a pre-CGT asset.

As a consequence, any capital gain made on the disposal of the goodwill of the Business will be disregarded pursuant to paragraph 104-10(5)(a) of the ITAA 1997 by reason of that goodwill having been acquired before 20 September 1985.