Edited version of your written advice

Authorisation Number: 1051458683892

Date of advice: 27 November 2018

Ruling

Subject: Pre-CGT assets

Question 1

In applying section 104-230 to the sale of shares in Current Holding Co to New Holding Co, will the goodwill of X Co immediately prior to the sale be taken to have been acquired prior to 20 September 1985 under Division 109 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

For the purposes of the capital gain calculation under section 104-230 of the ITAA 1997, will Current Holding Co’s shares in X Co be taken to have been acquired prior to 20 September 1985, notwithstanding the operation of Division 149 of the ITAA 1997?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2019.

The scheme commences on:

Year ended 30 June 2019.

Relevant facts and circumstances

Current Holding Co was established prior to 20 September 1985. It holds all the shares in X Co.

X Co was established prior to 20 September 1985. It had, and continues to have, several subsidiaries established prior to 20 September 1985. Together they conducted X business activities.

The relationship between X Co and its subsidiaries was as follows:

● When X Co was established, it provided X services.

● It continued to perform these business operations after the establishment of its subsidiary companies, as it held the core contracts with its customers; was the main employer within the group; had the financial position necessary to support undertaking the work; and held the plant and equipment necessary for those activities. However in the year ended 30 June 1985 one of its subsidiaries under agreement undertook its trading activities.

● X Co held an executive function and the role of management for the group, overseeing the conduct of the group as a whole. It also acquired and retained ownership of plant and equipment for the group and lent the equipment to the subsidiary companies when required.

● Together, the subsidiary entities also provided X services for the group.

● After 20 September 1985, more companies were established as subsidiaries to X Co as an asset protection measure taken by the owners of the group.

X Co is presently the head company of a consolidated group comprising eight active trading entities and nine dormant non-trading entities.

The practical relationship between the entities in the group is currently as follows:

● Executive function

X Co’s executive function provides strategic direction for all entities in the group, applying to all their operations and their management. Specifically, its role in the group is as follows:

It manages and controls the group as a whole, including its subsidiaries. This includes the making of broader strategic decisions for the group, as well as day-to-day management of all the entities in the group.

It employs individuals to manage the group.

● Plant and equipment

Over 80% of the plant and equipment in the group is acquired and held by X Co, but is made available for use by the other entities in the group, subject to a recovery charge.

● Administrative function

Administrative functions for all the entities in the group, such as finance, IT and other administrative support functions, are conducted by X Co.

● Loss-making entities

Profitable entities subsidise loss-making entities within the group.

● Profits:

Excess retained profits of each subsidiary member are transferred in full each year to X Co.

● Loans:

X Co provides working capital loans to subsidiary entities. Loans provided by financial institutions to subsidiary entities are supported by X Co and loan covenants imposed by the relevant financial institution are imposed on a group-wide basis.

Management and control

Mr X has had ultimate control of X Co and the group since their establishment, and they continue to have this control.

X has been and remains integral to the business.

The day-to-day management and control of the group were, and continue to be, directly undertaken by a sole managing director.

Activities

X Co considers, and has always considered, the business it conducts to include those specifically carried out by its subsidiaries. That is, X Co considers its business to be the business of the group, inclusive of all the services and activities in which the group as a whole is engaged.

The group both prior to and after 20 September 1985 was solely engaged in X activities. It also continues today to be engaged solely in the conduct of these activities.

The group’s customers

The group is focussed on capturing large service contracts with large organisations. It has been able to build long term relationships with its customers.

The majority of the group’s total revenue continues to be generated from its clients to which it had provided services prior to 20 September 1985.

The group’s sales income continues to be generated from the same industries it serviced prior to 20 September 1985.

Banking, finance and accounting

X Co’s core financial service provider has, from the period prior to 20 September 1985 to the date of the ruling application, been Bank X.

Bank X views the group as a whole, inclusive of X Co’s subsidiaries, for the purposes of addressing the satisfaction of its lending covenants and ongoing arrangements.

The subsidiaries transfer their retained profits on an annual basis to X Co. Loss-making entities and contracts within the group are funded by the group as a whole through profitable operations and subsidiaries.

Funds are lent to each subsidiary within the group as required, subject to the lending entity’s working capital needs, and a secured interest is registered over these funds. No interest is charged on these loans.

Intercompany charges are raised from X Co to its subsidiaries for the use of assets within the group, management oversight of the group and the administrative services provided to the group.

Use of trading names

The trading name is and has been used consistently by the business.

Plant and equipment

The group has always required plant and equipment, inventory, working capital and people as its key resources, necessary to enable it to perform its services to its clients. The plant and equipment used by the group has changed over the years as newer and more efficient equipment became available. As the group expanded in scale and diversified within its market and industry sectors, it continued to acquire plant and equipment to meet the expanding needs of its customer base.

Proposal

Mr X will sell his shares in Current Holding Co to New Holding Co.

Relevant legislative provisions

Section 104-230 of the ITAA 1997

Division 109 of the ITAA 1997

Division 149 of the ITAA 1997

Reasons for decision

Question 1

Summary

In applying section 104-230 to the sale of shares in Current Holding Co to New Holding Co, the goodwill of X Co immediately prior to the sale will be taken to have been acquired prior to 20 September 1985 under Division 109 of the ITAA 1997.

Detailed reasoning

The application of section 104-230 depends on the determination and calculation of the market value of property of the company or trust, or the market value of interests the company or trust owned though interposed companies or trusts, in property that was acquired on or after 20 September 1985. Under subsection 104-230(2) the market value of such property or interests must be at least 75% of the net value of the company or trust in order that CGT event K6 happens.

The specific question for which the present ruling is sought is whether the interest in goodwill of the business of X Co was acquired prior to 20 September 1985.

The general meaning of ‘goodwill’ as used in the context of the CGT provisions is explained in Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business (TR 1999/16). It is derived from general law. Under the decision of the High Court in FCT v Murry 98 ATC 4585, it has 3 aspects: property, sources and value.

Paragraph 12 of TR 1999/16 provides as follows:

‘….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 business was established in 1961. The goodwill attached to it is also taken to have commenced at that time, being the time at which ‘work that resulted in the creation started’: item 1, section 109-10 of the ITAA 1997.

Goodwill is a single CGT asset for the purposes of Part 3-1 of the ITAA 1997: paragraph 16 of TR 1999/16. The whole of the goodwill of a business that commenced before 20 September 1985 remains the same single pre-CGT asset provided that the same business continues to be carried on. The goodwill of a business ceases if the business changes to the extent that it can no longer be regarded as the same business. In such a case, the old business (and its associated goodwill) ceases and a new business commences: paragraphs 17 and 18 of TR 1999/16.

The question is whether the goodwill of the business conducted by X Co as it existed prior to 20 September 1985 is the same goodwill that exists at the date of this ruling; or whether the business had at some point after 20 September 1985 changed to the extent that it became a different business (resulting in the cessation of the goodwill associated with the original business).

In reaching a view on this issue:

● Regard is first had to the business activities conducted by X Co just before 20 September 1985; and

● Consideration is given to the business activities conducted by X Co in the period between 20 September 1985 and the date of this ruling.

The approach taken above is aimed at ascertaining whether X Co has at all times from 20 September 1985 conducted the same business that existed just before that date, and consequently whether the same goodwill exists. In particular, consideration is given to the growth of the business over this period; and whether such growth may be regarded as an expansion of the existing goodwill of the business (and therefore an accretion to the pre-CGT goodwill) or as a result of the introduction of new and separate businesses in their own right.

In this regard, paragraph 62 of TR 1999/16 provides that:

Factors that need to be considered in determining whether the business operation or activity is part of the existing business or is a new business include the nature of the new business operation or activity, the types of customers that the business operation or activity attracts and the extent to which the business operation or activity:

(a) is subject to the same integrated management and control as the existing business;

(b) is treated for banking and accounting purposes as an extension of the existing business or as a separate business;

(c) uses one or more different trading names; and

(d) is related to or dependent on the existing business in a practical, economic or commercial sense.

Having regard to the abovementioned factors, it is the Commissioner’s view that the goodwill of X Co immediately prior to the sale is taken to have been acquired prior to 20 September 1985 under Division 109 of the ITAA 1997.

Each of these factors is considered in further detail below.

Management and control

It is accepted that the day-to-day management and control of X Co and its subsidiaries were, and continue to be, directly undertaken by a sole managing director.

X Co’s growth since its establishment involved the setting up and the acquisition of subsidiary companies. These companies currently form the consolidated group of which it is a head company.

It is noted that:

● The business conducted by X Co prior to 1985, being its sole commercial undertaking and the course of conduct in which it was engaged at the time, was the provision of X services.

● After its establishment and prior to 20 September 1985, it acquired 100% owned subsidiaries. Together, the subsidiary entities also provided X services.

● Gradually, the function of X Co changed. It took on an executive function for the group; managing, administering and providing strategic direction for the group as a whole. The devolution of its trading activities commenced prior to 20 September 1985.

● It continues to provide executive direction in respect of all the services and activities in which all the subsidiary entities in group are engaged; managing, administering and providing strategic direction for the group as a whole including (though its sole managing director) the day-to-day management of the entities in the group.

● The background to and reasons for the establishment of the subsidiary companies are to principally reduce its exposure to risk as the business expanded. It is accepted that the incorporation of subsidiaries, and the undertaking by the subsidiary companies of services which were being provided by the group, was a response to – and subsequently formed part of - this expansion.

This structure existed as at 20 September 1985 and continues to exist at the date of this ruling.

Nature of business operation or activity

The Commissioner is of the view that the nature of the business and the activities in which X Co is involved are fundamentally the same as those which were conducted prior to 20 September 1985.

Each of the current subsidiary entities is involved in, and carry out the primary activities of, the group which were conducted prior to 20 September 1985. That is, these activities continue to be undertaken as part of the group’s business from 20 September 1985, and they remain the primary activities in which the group is engaged.

The types of customers that the business operation or activity attracts

The types of customers that the business attracts are the same as those that the business had attracted prior to 20 September 1985. In particular it is noted that:

● The group has retained long-term clients with which it had established a business relationship prior to 20 September 1985.

● The majority of the group’s total revenue continues to be generated from its clients to which it had provided services prior to 20 September 1985.

● In the course of the business’s expansion, it has cultivated new clients, but it is accepted that they are the same types of customers as those that were acquired prior to 20 September 1985, being primarily participants in the steel, construction, coal, concrete, recycling and glass industries.

Banking, finance and accounting

While the business took the shape of a consolidated group after 1985, it is accepted that the group as a whole has been generally treated as an extension of X Co rather than as separate businesses comprising those of each individual subsidiary.

This view is based on the following considerations:

● The group’s main financial service provider has been Bank X from the period prior to 20 September 1985, and remains so at the date of the ruling application.

● Within the group, the subsidiaries transfer their retained profits on an annual basis to X Co. Loss-making entities and contracts within the group are funded by the group as a whole through profitable operations and subsidiaries.

● Funds are lent to each subsidiary within the group, subject to the lending entity’s working capital needs, and a secured interest is registered over these funds. No interest is charged on these loans.

Use of trading names

It is accepted that the trading name is and has been used consistently by all the entities in the group.

Interdependence between entities

The entities within the group are interdependent in the following respects:

● Management and administration: X Co’s executive function provides strategic direction for all entities in the group, applying to all their operations and their management. Administrative functions for all the entities in the group, such as finance, IT and other administrative support functions, are conducted by X Co.

● Use of plant and equipment: Over 80% of the plant and equipment in the group is held by X Co, but is made available for use by the other entities in the group. Entities within the group operate these assets as though they were branches of X Co, rather than separate business.

● Funding and loans: Profitable entities subsidise loss-making entities within the group. Further, working capital loans are provided to subsidiary entities by X Co.

Loans provided by financial institutions to subsidiary entities are supported by X Co on the basis that loan covenants with the relevant financial institution are imposed on a group-wide basis.

● Profits: Excess retained profits of each subsidiary member are transferred in full each year to X Co.

Other factors

It is acknowledged that:

● The business has grown geographically. It is however the Commissioner’s view that this is part of its natural expansion in responding to its customer demands and acquiring new clients.

● The plant and equipment used by the group entities has changed over the years. This is however a reflection of its expansion and the need to be more responsive to its clients specific needs as well as of changing technology, rather than being a reflection of the establishment of new, different businesses.

It is relevant that X Co has owned the majority of the plant and equipment of the group used in the conduct of its business by various entities within the broader group, and it continues to do so.

QUESTION 2

Summary

For the purposes of the capital gain calculation under section 104-230 of the ITAA 1997, Current Holding Co’s shares in X Co will be taken to have been acquired prior to 20 September 1985, notwithstanding the operation of Division 149 of the ITAA 1997.

Detailed reasoning

Paragraph 64 of TR 2004/18 provides:

64. For CGT event K6 purposes, the item of property is taken to have been acquired at the time the ITAA 1936 or ITAA 1997 treats the CGT asset as having been acquired. Thus, for example, if a CGT asset is taken to have been acquired before 20 September 1985 under a roll-over provision within Parts 3-1 and 3-3, the item of property will also be taken to have been acquired before that date for CGT event K6 purposes.

65. An exception applies where the CGT asset is treated as having been acquired post-CGT because of the operation of Division 149. In this case, the item of property continues to be treated as having been acquired pre-CGT for the purposes of CGT event K6.

The reason for this approach is explained further in the ruling:

66. Continuing to treat the item of property as acquired pre-CGT is consistent with the objective of CGT event K6. As an anti-avoidance or transitional provision, it is designed to capture the accumulation of post-CGT acquired property in a company with pre-CGT shareholders. CGT event K6 is not targeted at the accumulation of property which is only deemed post-CGT acquired because of the operation of another anti-avoidance or transitional provision in Division 149.

67. Extending the context of the deeming in Division 149 to the operation of CGT event K6 could lead to one deemed result from an anti-avoidance provision adversely interacting with another deemed result from another anti-avoidance provision.

Following this approach, it is the Commissioner’s view that Current Holding Co’s shares in X Co will attract the operation of Division 149.

However, while these assets are by virtue of the application Division 149 treated as having been acquired post-CGT, they are treated as having been acquired pre-CGT for the purpose of CGT event K6 in section 104-230 of the ITAA 1997. This approach is taken pursuant to the view taken in TR 2004/18.