Edited version of private advice

Authorisation Number: 1051535930903

Date of advice: 10 July 2019

Ruling

Subject: Capital gains tax and goodwill

Question 1

Will the goodwill of taxpayer's business be considered to be an asset acquired before 20 September 1985 for the purposes of section 109-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

If the goodwill of the taxpayer is considered to have been acquired before 20 September 1985, does section 149-30 of the ITAA 1997 apply to deem the goodwill to be acquired after 20 September 1985?

Answer

No

Question 3

Will any capital gains which arise on the sale of the goodwill of taxpayer's business be disregarded pursuant to paragraph 104-10(5)(a) of the ITAA 1997?

Answer

Yes

This ruling applies for the following period:

1 July 2019 to 30 June 2021

Relevant facts and circumstances

1.            In 198X, the taxpayer acquired a rail and road freight business. The business specialised in the transportation of food and consumer products and provided warehousing services.

2.            The taxpayer continued to haul freight and undertake distribution activities for a number of established clients and on-forward freight using vans, with a supplementary intermodal service (i.e. using containers) upon request by customers.

3.            From inception, the business also provided road freight and sea freight options to service its customers, which ran predominantly as a backup service to the rail operations between Melbourne and Perth in the event of track wash out, or other disruptions on the rail network. The road freight service was also provided in respect of east coast runs from Melbourne to Brisbane and Melbourne to Sydney in accordance with customer needs.

4.            In addition to the above, a refrigerated rail freight service (and to a lesser extent refrigerated road freight service) was also provided to existing customers in accordance with their respective needs. At this time the refrigerated service was provided via the application of dry ice into containers.

5.            Also from inception the business provided its customers with a warehouse and distribution service solution as an integral part of its logistics operation. Its customer base over the years has included a large number of food and drink manufacturers as well as large retail businesses. The size of this component of the total business' logistics operation over the years has tended to fluctuate in line with customer's needs and changes to their operations. Due to ongoing improved transit times over longer distances over the past several years, presently more product tends to be delivered directly to stores rather than warehoused and then distributed.

6.            To improve the efficiency of its operations and the level of service afforded to its customers, the taxpayer undertook construction of purpose-built freight terminals for exclusive use by the business.

7.            As a flow-on effect from the growth in its rail freight operations, the business' end-to-end transportation service model also led to significant growth in all other areas of freight, including road freight and refrigerated rail freight.

8.            Despite the growth that the business has experienced, it continues to service a considerable proportion of the major customer group that it had prior to 20 September 1985.

9.            Rail freight technology has remained similar during the past 30 years, although there have been innovations such as the introduction of refrigerated containers (used in both road and rail transport) and upgraded bogies to allow for higher speeds and increased load carrying capacities.

10.          Road freight equipment, however, has undertaken significant changes since 1985, with the business continually upgrading its fleet (in line with competitors) to ensure that it has the most appropriate and technologically advanced equipment with which to service its customers. Much of the advancement has been driven by increasing carrying capacity.

11.          Although there has been a significant growth in the taxpayer's business over the past 30 years, no new business has been acquired by the taxpayer continued to operate the business in the same manner and servicing the same customer.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 100-25

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 109-5

Income Tax Assessment Act 1997 Division 149

Reasons for decision

Question 1

Will the goodwill of the taxpayer's business be considered to be an asset acquired before 20 September 1985 for the purposes of section 109-5 of the ITAA 1997?

The meaning of 'goodwill'

12.          Whilst there is no statutory definition of 'goodwill' in the Income Tax Assessment Acts, goodwill is specifically included in the definition of a 'CGT asset' at paragraph 108-5(2)(b). Therefore, the meaning of goodwill is to be determined from general law.

13.          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.

14.          The Commissioner's views on the meaning of goodwill are set out in Taxation Ruling TR 1999/16, which reflects the decision of the High Court in Federal Commissioner of Taxation v Murry 89 ATC 4585 (Murry). It is the legal definition of goodwill, rather than its accounting and business definition, which applies according to the High Court in Murry.

15.          Paragraph 12 of TR 1999/16 defines the goodwill of a business:

'...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 the 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 the business. It cannot be dealt with separately from the business with which it is associated.'

16.          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 partly pre-CGT goodwill and partly post-CGT goodwill. If, for instance, a taxpayer disposes of a business acquired before 20 September 1985 (a 'pre-CGT business'), the whole of the goodwill of the business is taken to have been acquired before that date. Goodwill is not a series of CGT assets that inhere in other identifiable assets of a business. Goodwill, being a composite thing, attaches to the whole business. It does not attach separately to each identifiable asset of the business. Nor is there an element of goodwill in each identifiable asset of a business.

When was the goodwill acquired?

17.          The consequence of the goodwill of a business being one CGT asset is 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 a business; or

(b)           there are fluctuations in goodwill during the life of the business

18.          According to the Court in Murry, goodwill is identified as property and therefore an asset for CGT purposes, because it is a legal right or privilege to conduct a business in substantially the same manner and by the same means that have attracted custom to it. It follows that goodwill is acquired when a taxpayer acquires the legal right or privilege to conduct the business, generally this arises when the taxpayer commences or purchases a business.

19.          In the case of a purchased business, goodwill is generally acquired at contract date or when the vendor stops being the owner of the goodwill for CGT purposes where the acquisition was not pursuant to a contract.

20.          If a taxpayer commences business and starts to create goodwill, the goodwill of the business is acquired when the taxpayer starts work that result in the creation of the goodwill. 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.

21.          In the present circumstances, the taxpayer acquired the freight business in July 198x and continued to operate the business since that time. The goodwill of the business is therefore, taken to have been acquired before 20 September 1985 and will remain a pre-CGT asset where the same business is continued to be carried on.

Same business being carried on

22.          A business may change to such an extent that it becomes a new business with new goodwill. In Murry it is stated that, in determining whether the same business is being carried on, the sources of the goodwill may have changed so much that, although the business is of the same kind as previously conducted, it cannot be said to be the same business.

23.          If the essential nature or character of the business has not changed, the business remains the same business for the purposes of the CGT goodwill provisions. The business may expand or contract activities or change the way in which its 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 constitute a new business as long as the essential character or nature of the business remains unchanged.

24.          It is a question of fact and degree whether the goodwill of a business is the same asset as it was when it was acquired. For the CGT goodwill provisions, we consider that the same business is carried on and no new goodwill asset is created if the business retains its same essential nature or character.

25.          The same business is not carried on 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.

26.          Where a business expands as a result of the introduction of a new business operation or activity by a taxpayer, any goodwill that relates to the expanded business is merely an expansion of the existing goodwill of the business. If a business that commenced prior to 20 September 1985 is expanded, goodwill generated by the expanded business operations or activities will be an accretion to the pre-CGT goodwill.

27.          If an introduced business activity is a new business, the goodwill attaching to that business is a new asset separate from the goodwill of the existing business.

28.          Whether an increase in business operations or in the scale of activity constitutes an expansion of an existing business, or a new and separate business, is a question of fact dependent on the circumstances of each case. 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.

29.          The question of whether a business has changed to such an extent that it is no longer the same business so that the goodwill of the old business ceases and goodwill of a new business is acquired is one of fact and degree. Factors to consider include.

·           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, and

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

Nature and character of the business

30.          In relation to the 'nature and character of the business' paragraph 93 of TR 1999/16 states that 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 and offers the following 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 and 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.

31.          Many businesses naturally evolve by serving different clients or clients in different markets and offering improved products or services. However, unless the facts are such that it can be established that a new business has commenced - rather than an existing business continued - the goodwill of the business is not different from that existing when the business was originally acquired or commenced.

32.          It would seem beyond doubt that as long as the business remains the 'same business', 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.

Has the same business been carried on?

33.          The taxpayer's business has grown significantly in the past 3X years, with some relatively small scale diversification, such as the sugar haulage and sand transport ventures. At its core, the business still remains a rail and road freight business.

34.          Although the expansion of the business has resulted in a broader customer base, the taxpayer still provides freight services for a number of large clients that have been clients prior to 20 September 1985. However, a broader customer base is not necessarily indicative that the nature of the business has changed.

35.          In order to provide a more complete service for its clients the business has adopted new technologies and efficiencies such as refrigerated container vans and other innovations which has enabled more efficient transport of goods.

36.          In addition to the expansion of road and rail freight, there has also been a similar expansion in the provision of warehousing facilities for customers, which was an activity carried on prior to 20 September 1985.

37.          Over the past 3X years there has not been a sudden or dramatic change in the business brought about by either the acquisition or the shedding of activities on a considerable scale. It should also be noted that the taxpayer did not acquire any new businesses during this period.

38.          For the CGT goodwill provisions, the same business is carried on and no new goodwill asset will be created if the business retains its same essential nature or character. A business may change the way it operates over time due to the purchase of new equipment and the adoption of improved technologies which, in turn, may attract new clients. This does not imply that a new business has commenced.

39.          The facts do not demonstrate that a new business has commenced. As the business being carried on now by the taxpayer is essentially the same as the business carried on prior to 20 September 1985, the goodwill of the business is the same asset and is taken to be acquired before 20 September 1985.

40.          Accordingly, any capital gain that arises on the disposal of this asset will be disregarded as the goodwill is a pre-CGT asset.

Question 2

If the goodwill of the taxpayer is considered to have been acquired before 20 September 1985, does section 149-30 of the ITAA 1997 apply to deem the goodwill to be acquired after 20 September 1985?

Division 149 - majority underlying interests

41.          Division 149 contains provisions which govern when an asset held by an entity stops being a pre-CGT asset and is treated as having been acquired after that date.

42.          Pursuant to section 149-10, 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 ITAA 1936, or

(ii)           Subdivision C of Division 20 of former Part IIIA of that Act;

(iii)          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.

43.          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 149 or the former Division 20 of the ITAA 1936 (pre-1998-99 income years).

44.          On the facts of this case, the former Division 20 of the ITAA 1936 does not apply as the majority underlying interests in the asset continue to be maintained post 1998-99 income year.

45.          Under section 149-30 an asset stops being a pre-CGT asset at the earliest time when the majority underlying interests in the asset were not held by the ultimate owners who held the majority underlying interests in the asset immediately before 20 September 1985.

46.          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.

47.          Section 109-10 sets out the rules for when you acquire a CGT asset without a CGT event happening. As the business of the taxpayer commenced prior to 20 September 1985, the asset, which is the goodwill of the business, would be taken to have been acquired at the time the business commenced. Therefore, the goodwill of the business is considered to be a pre-CGT asset, as it is deemed to have been acquired when the business commenced.

48.          'Majority underlying interests' in a CGT asset consist of more than 50% of:

·           the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset, and

·           the beneficial interests that ultimate owners have (whether directly or indirectly) in any ordinary income that may be derived from the asset.

49.          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.

50.          An 'ultimate owner' is ' an individual or any entity listed in subsection 149-15(3).

51.          Subdivision 149-B 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.

52.          In this case, the ultimate owners must be individuals because none of the other paragraphs in subsection 149-15(3) are applicable.

53.          The entity carrying on the business is a privately owned unit trust. The units in the unit trust are held by two discretionary trusts:

·           The X Family Trust (50 units)

·           The Y Family Trust (47 units)

54.          There are a total of 97 units on issue in the unit trust. The units were acquired by the X Family Trust and the Y Family Trust on 30 June 198x and October 198y respectively.

55.          Both discretionary trusts have made family trust elections with the same person as the specified individual. The commencement time for both family trust elections is 1 July 2003.

56.          There have not been any amendments to the classes of beneficiaries in neither the X Family Trust nor the Y Family Trust.

57.          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).

58.          However, the Commissioner has set out a pragmatic approach in Taxation Ruling IT 2340, of looking through interposed entities to determine which natural persons hold the beneficial interests for the purposes of the former section 160ZZS of the ITAA 1936.

59.          Taxation Ruling 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....

60.          Taxation Ruling 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 expressed in paragraph 7 of IT 2340 is now reflected in the legislation at subsection 149-30(2) which states:

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 had by ultimate owners who had majority underlying interests in the asset immediately before that day, subsections (1) and (1A) apply as if that were in fact the case.

61.          On the facts of this case, it is evident from the Trust Deeds that the Trustees of the X Family Trust and the Y Family Trust have continued to administer the trusts for the benefit members of the same family since before 20 September 1985. Therefore, it is considered that the majority underlying ownership interests have been maintained in the goodwill asset since before 20 September 1985.

Question 3

Will any capital gains which arise on the sale of the goodwill of the taxpayer's business be disregarded pursuant to paragraph 104-10(5)(a) of the ITAA 1997?

CGT event A1

62.          CGT event A1 happens when you dispose of a CGT asset. If the CGT asset was acquired before 20 September 1985, the capital gain or loss made as a result of its disposal is disregarded.

63.          Goodwill of a business is a single CGT asset for the purposes of Part 3-1. This means that in relation to a business that commenced before 20 September 1985, the whole of the goodwill attached to that business remains the same single pre-CGT asset provided the same business continues to be carried on. If the same business has been carried on the capital gain or loss made on the disposal of the goodwill will be disregarded.

64.          The business was acquired by the taxpayer on 1 July 198x. As has been established in the previous questions above, the taxpayer continued to hold majority ownership in the business since that time and the business being carried on now is substantially the same business that the taxpayer carried on before 20 September 1985. Therefore, it has been established that the goodwill of the business remained the same asset that was acquired before 20 September 1985.

65.          Accordingly, any capital gain that arises on the disposal of the goodwill of the business will be disregarded pursuant to paragraph 104-10(5)(a), as the goodwill was acquired for the purpose of section 109-10 before September 1985.