Edited version of private advice

Authorisation Number: 1051597848535

Date of advice: 29 October 2019

Ruling

Subject: Capital gains tax - goodwill

Question

For the purposes of determining the application of section 104-230 of the Income Tax Assessment Act 1997 to the disposal of shares by the Applicant, will the interest in the goodwill of the business be taken to have been acquired before 20 September 1985?

Answer

Yes.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commenced in:

Pre-September 19XX

Relevant facts and circumstances

You own 100% of the shares in the Company. The Company in turn owns 100% of the units in the Trust.

The Trust was established pre-CGT.

The Trust was originally owned by unitholders.

You acquired a percentage% of the units in the Trust at the same time as another unitholder acquired a percentage of units. After this time, there were several equal unitholders in the Trust.

Later there was a reorganisation of affairs, whereby the Company was interposed between the Trust and its then unitholders.

Rollover relief was elected under section 160ZZPA(1) of the Income Tax Assessment Act 1936 (ITAA 1936) and notice provided to the Commissioner.

Due to rollover relief:

·         each shareholder in the Company was deemed to have acquired their shares prior to 20 September 1985 (pre-CGT) and

·         the Company was deemed to acquire the units in the Trust pre-CGT.

You acquired the remaining shares in the Company in later years.

You acquired majority ownership post CGT.

Division 149 of the ITAA 1997 would have applied when you acquired majority ownership.

You are selling the shares in the Company of which a percentage of shares acquired pre-CGT and CGT Event K6 will apply to the sale per section 104-230 of the Income Tax Assessment Act 1997 (ITAA 1997).

Business of the Trust

The Trust has operated its business under the trading name since it began operations.

This entity is in the business of service delivery and product supply. No other business has been carried on at any time.

The service delivery unit of the business

The service division provides services directly to the clients. The clients are referred to this entity for service. Often the clients already know what they need and just require the product to be supplied. Others need assistance to determine what product is suitable.

The service unit manufactures custom devices for individual clients and supplies off the shelf products. This has been consistent since establishing the entity.

The distribution unit of the business

Rather than clients being referred to the service unit, the entity distributes the products to other service providers, who then sell directly to customers. While the public can buy directly from this entity via their website, the sales that occur are very minor.

There are several divisions within the distribution unit supplying an assortment of products and services.

Post-CGT, this entity's business was predominantly service delivery with a less substantial distribution unit. Presently, this entity's business is predominantly distribution with less service delivery.

The service delivery unit of the business has not diminished and the income generated has been relatively constant.

The scale of the distribution unit of the business has substantially grown since pre-CGT.

You have provided a table indicating the sales of each unit of the business.

You (as controller) have been central to the entity's business pre-CGT. When you acquired a certain percentage ownership of the Trust pre-CGT, you felt that the business was not reaching its profit-making potential. You had a strong knowledge of distribution and your aim at the time of acquisition pre-CGT was to grow this unit of the business.

The growth of the distribution unit was completed by:

·         utilising client referral base

·         employment of more sales representatives, and

·         attending overseas conferences to negotiate distributions rights.

The following aspects of the business are relevant

The customer base is the same as it was pre-CGT.

Some of the suppliers of products are still the same suppliers that were contracted with pre-CGT. New suppliers have been contracted with as opportunities arose and have added to the product range.

Technology has allowed products to be manufactured with more advanced materials, but with the same purpose/characteristics.

The Trust has banked with the same bank since pre-CGT and treats all accounts as an integrated business.

Some of the key employees have been with the entity since pre-CGT.

Approximately 40% of the key staff have been employed for at least 15 years.

As the business has expanded, so have the personnel.

Key similarities in the business between 20 September 1985 and present

The business was and is still is service delivery and product supply.

The products consist of both manufactured and third-party products. This has remained consistent.

The business/trading name has always been this entity's name.

You bought into the business pre-CGT and have been central to the management and growth of the business since acquiring it.

The platform for gaining customers has not changed.

The customer base is the same as it was pre-CGT.

Many key aspects of the business are the same including some key employees and banking arrangements.

Key differences in the business between 20 September 1985 and present

The distribution unit of the business has grown substantially more than the service unit of the business.

Products have changed over time with technology and materials and products from new suppliers are distributed. However the concepts are the same.

The business was based initially in a capital city and has now become a national business.

For completeness

Post-CGT, the entity has acquired five other businesses.

These were acquisitions of the trading structure.

All entities except one carry on service delivery and were customers of this entity. The entities remain customers of this entity and products are supplied on a market value basis.

One entity involved the distribution of products. The business in this entity ceased trading and the customers of that entity are now serviced by this entity.

Relevant legislative provisions

Section 160ZZPA(1) of the Income Tax Assessment Act 1936

Part 3-1 of the Income Tax assessment Act 1997

Division 149 of the Income Tax assessment Act 1997

Section 109-10 of the Income Tax assessment Act 1997

Section 104-230 of the Income Tax assessment Act 1997

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated.

Question

For the purposes of determining the application of section 104-230 of the Income Tax Assessment Act 1997 to the disposal of shares by the Applicant, will the interest in the goodwill of the business be taken to have been acquired before 20 September 1985?

Summary

For the purposes of determining the application of section 104-230 of the Income Tax Assessment Act 1997 (ITAA 1997) to the disposal of shares by the Applicant, the interest in the goodwill of the Trust will be taken to have been acquired before 20 September 1985.

Detailed reasoning

CGT event K6

Section 104-230 is an anti-avoidance provision designed to capture the accumulation of post-CGT acquired property in a company with pre-CGT shareholders. Its application 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 through interposed companies or trust, in property that was acquired on or after 20 September 1985.

Under section 104-230 the market value of such property or interest must be at least 75% of the net value of the company or trust in order that CGT event K6 happens.

Taxation ruling TR 2004/18 Income tax: capital gains: application of CGT event K6 (about pre-CGT shares and pre-CGT trust interests) in section 104-230 of the Income Tax Assessment Act 1997 (TR 2004/18) states that the term 'property' for the purposes of CGT event K6 has its ordinary meaning, and will include goodwill.

In your situation, you have an interest acquired pre-CGT in the Trust which has been conducting a business since it was established. You plan to sell your shares in the interposed entity. The property of the Trust includes goodwill.

Goodwill of the business

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). The legal definition as set out in the High Court decision in Federal Commissioner of Taxation v Murry 98 ATC 4585, has three aspects of property, source 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 Trust has been in the business of service delivery and product distribution pre-CGT when it commenced its business operations. Under item 1 of section 109-10, the goodwill attached to the business is also taken to have commenced at that time, being the time which work that resulted in the creation of the goodwill started.

Goodwill is a single asset for the purposes of Part 3-1 of the ITAA 1997. The whole of the goodwill of a business that commenced before 20 September 1985 remains the same single asset provided the same business continues to be carried on. TR 1999/16 at paragraph 17 states:

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.

TR 1999/16 also recognises at paragraph 18 that a business or the sources of its goodwill may change so much that it can no longer be said to be the same business.

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.

Paragraph 21 of TR 1999/16 provides that the business does not need to be identical from its acquisition to its disposal. If the essential nature or character of the business is not changed, the business remains the same business for the CGT goodwill provisions. A business owner may expand or contract activities, or change the way in which a business is carried on, without ceasing to carry on the same business provided the business retains its essential nature or character. Organic growth, expansion or diversification of a business does not of itself cause it to be a new business, providing the business retains its essential nature or character.

Paragraph 24 of TR 1999/16 provides the same business is not being 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.

Paragraphs 60 to 62 of TR 1999/16 discuss whether new goodwill is acquired when an existing business either expands, or commences a new business. Where a new business operation is merely the expansion of an existing business, any goodwill built up will be an expansion of the existing goodwill of the business. On the other hand, if the new business activity is a new business, the goodwill attaching to that business activity will be a new separate asset to the goodwill of the existing business.

The question is whether the goodwill of the business conducted by the Trust as it existed prior to 20 September 1985 is the same goodwill that continues to exist or whether 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, consideration must be given to the business activities conducted by the Trust just before 20 September 1985 and the business activities conducted between 20 September 1985 and the current time. In particular, regard is given to the growth of the business over this period and whether such growth may be considered an expansion of the existing goodwill of the business or as a result of the introduction of a new and separate business in its 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 exiting business in a practical, economic or commercial sense.

Application of each of these factors to the trust's business operations is considered below:

Management and control

Originally the Trust was owned by several unitholders when it was established.

Pre-CGT you acquired a certain percentage interest in the business and there were other co-owners.

Later, the reorganisation of affairs with the introduction of the Company as an interposed entity did not change the pre-CGT status of your interest in the business due to the operation of the rollover relief election under section 160ZZPA(1) of the Income Tax Assessment Act 1936. From this time, you held your interest as shares in the Company who in turn owned 100% of the units in the Trust.

You acquired the remaining shares and from that point have continued to own 100% of the shares in the Company.

Since your involvement, the business operations have predominantly been managed by you. The other unit holders/shareholders contributed to the business. Unitholders were involved in both the service delivery and the product distribution unit assisting you.

Additionally, some of the key employees have remained the same, having been employed since a time pre-CGT. Approximately 40 % of the key staff have been employed for at least 15 years.

These factors all indicate that the management and control of the business has remained consistent since you acquired your percentage interest pre-CGT and this continues to exit.

Nature of business operation or activity

The Trust has been in the business of service delivery and product distribution since it commenced its business operations. The activities of the business have always involved both service delivery and product distribution units. While, the product distribution unit started smaller it has grown disproportionately over time to become the larger portion of the business activities, although the service delivery unit still generates income. The decision to grow the product distribution unit of the business was made pre-CGT and reflects the expertise and interest within the management team.

Both pre and post the introduction of CGT the business has involved both service delivery and product distribution. The service delivery unit involves the provision of direct client service and sales including both manufactured products and third party products. The product distribution unit has consistently sold third party products to other service providers for use in their business.

It is accepted that the business has continued to undertake the same activities as those conducted prior to 20 September 1985 and any changes to the business and products have been part of the natural evolution and growth of the business.

The types of customers that the business operation or activity attracts

From the start of the business, the customer base has remained the same. Other service providers are a significant source of work and the primary clients of the entity.

The service delivery unit involves client service delivery and sales directly to the client including both manufactured products and third party products. The distribution unit has consistently sold third party products to other service providers for use in their business.

The platform for gaining customers has not changed and is the same for both business units. The marketing is to other service providers, whether they refer to the entity or purchase the products direct.

Due to advancements in technology with the introduction of websites and on-line shopping the general public are now able to acquire products directly from the online store. This is a new development since 20 September 1985 that has occurred incidentally and is only a minor part of the overall sales. This does not in itself affect the nature or character of the business.

Accordingly, the types of customers that the business attracts are the same as those that the business had attracted prior to 20 September 1985.

Banking and finance and accounting

The service delivery and product distribution activities have always been treated as the one business and this has continued through the pre-CGT and post CGT period.

The business has always operated under the one business name and this has remained consistent throughout.

There has always been only one set of financial settlements that are prepared with an integrated profit and loss statement.

The banking is integrated with no separation between the different units or pre and post CGT periods.

The entity has banked with the same banking institution since pre-CGT.

It is accepted that from a banking and finance perspective, the business has been treated as one business.

Use of trading names

Since the commencement of the business, the business/trading name has always been the same.

It is accepted that the trading name has been used consistently by the business.

Interdependence

Over time, the entity has acquired a number of entities containing service delivery businesses. These businesses were customers of the entity and continue to be customers after their acquisition.

The nature of the business activities has remained essentially the same throughout, Products have changed over time with technology and materials and products from new suppliers distributed. However the concept is the same.

The scale of the business activities has grown significantly, in particular the activities of the product distribution unit. This significant expansion has occurred gradually over the 37 year period the business has been operating and is consistent with the natural growth of a business.

The head office of the business has always been in a capital city.

Pre-CGT, the business was only conducted in this capital city, but as a result of business growth and expansion together with improvements in technology it has now expanded into a national business.

Advancements in technology with the introduction of a website and on-line store have led to the expansion of the product distribution arm of the business.

These factors indicate that the current operation is interdependent on the business that existed before 20 September 1985.

Outcome

After considering the indicators from TR 1999/16, together with the circumstances of the Trust, it is concluded that the essential nature or character of the business has not changed as a result of any activities or changes introduced since 20 September 1985. Growth and expansion has occurred, along with some changes in processes and technology, but these have happened naturally as a result of the business growth over a long period of time. Based on the information provided, the essential nature or character of the business operation has remained the same for the purposes of the CGT goodwill provisions.

Majority underlying interest

Ordinarily, 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 is a provision that affects the status of a pre-CGT asset. Under this Division, the pre-CGT status of assets owned by a company or trust can be lost if there is a change in the majority underlying owners of the company or trust.

You indicate there was a change in the majority underlying post-CGT and accept that Division 149 would operate to treat the pre-CGT asset of goodwill as being a post-CGT asset.

However, for the purposes of applying the 75% test in section 104-230, and the capital gain, TR 2004/18 provides that the provisions in Division 149 are ignored.

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.

Using this approach, even though your share of the CGT asset of goodwill owned through the interposed entities is by virtue of the application of Division 149 treated as having been acquired post-CGT, it is treated as having been acquired pre-CGT for the purpose of CGT event K6 in section 104-230 of the ITAA 1997. This is consistent with the view taken in TR 2004/18.

Conclusion

For the reasons indicated above, the goodwill of the business remains a pre-CGT asset as the same business continues to be carried on. This outcome is not affected by the operation of Division 149 as these provisions are ignored for the purposes of section 104-230. Therefore, as the goodwill is considered to be a pre-CGT asset it will not be included in the calculation of property acquired on or after 20 September 1985 for the purposes of CGT event K6.