Edited version of private advice

Authorisation Number: 1051661663946

Date of advice: 17 April 2020

Ruling

Subject: CGT and goodwill of the business

Question 1

Will CGT event A1 happen to the goodwill of Company pursuant to subsection 104-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997) under the 'Proposed Transaction' described in this Ruling?

Answer

No, CGT event A1 will not happen to the goodwill of Company under the 'Proposed Transaction', subject to the application of Subdivision 815-B of the ITAA 1997.

Question 2

If the answer to Question 1 is "no", will CGT event C1 happen to the goodwill of Company pursuant to subsection 104-20(1) of the ITAA 1997 under the 'Proposed Transaction' described in this Ruling?

Answer

No, CGT event C1 will not happen to the goodwill of Company under the 'Proposed Transaction', subject to the application of Subdivision 815-B of the ITAA 1997.

Question 3

If the answers to Questions 1 and 2 are "no", will CGT event C2 happen to the goodwill of Company pursuant to subsection 104-25(1) of the ITAA 1997 under the 'Proposed Transaction' described in this Ruling?

Answer

No, CGT event C2 will not happen to the goodwill of Company under the 'Proposed Transaction', subject to the application of Subdivision 815-B of the ITAA 1997.

This ruling applies for the following periods

Income years ending 31 December 2019 and 31 December 2020

The scheme commences on:

XX June 20XX

Relevant facts and circumstances

Company is the head entity of an Australian income tax consolidated group (the Australian Group) and a wholly owned subsidiary of Foreign Co.

The Australian Group carries on a business involving the manufacture and supply of Products. Key assets of the business carried on by the Australian Group include:

·        Cash and cash equivalent

·        Trade and other receivables

·        Inventory

·        Property, plant and equipment

·        Intangible assets including brands (registered trademarks), customer contracts and goodwill.

The Australian Group conducts business which has goodwill. The sources of goodwill of the business include, among other things, rights to use certain Trademarks that are owned by the Australian Group. The Trademarks relate to brands under which the Australian Group conducts the production, marketing and distribution of Products.

Members of the Australian Group entered into agreements with foreign related entities. Under certain agreements, the Australian Group agreed to assign Trademarks that it owns to the foreign entity for market value (the Proposed Transaction).

Related agreements were entered into between members of the Australian Group and foreign related entities to ensure that the Australian Group continue to carry on all of its existing functions and activities after the assignment of Trademarks, and that the Australian Group will continue to have the necessary rights to use the Trademarks to carry on its business. It will continue to manufacture and distribute Products to all of its existing customers under existing arrangements.

Other than the assignment of Trademarks, there are no other assets assigned by members of the Australian Group. There is no intention of the parties for there to be a disposal of any other assets or the business of the Australian Group under the agreements.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-20

Income Tax Assessment Act 1997 Section 104-25

Reasons for decision

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

Question 1

Summary

CGT event A1 will not happen to the goodwill of Company under the 'Proposed Transaction' described in this Ruling (subject to the application of Subdivision 815-B of the ITAA 1997).

Detailed reasoning

CGT event A1 happens if a taxpayer disposes of a CGT asset: subsection 104-10(1). The disposal of a CGT asset takes place if a change of ownership occurs from one entity to another entity, whether because of some act or event or by operation of law: subsection 104-10(2).

Taxation Ruling TR 1999/16 Income tax: capital gains tax: goodwill of a business sets out the ATO's views on goodwill of a business and the application of the capital gains tax (CGT) provisions to goodwill.

At paragraphs 9 - 10, the Ruling sets out what is 'goodwill' for CGT purposes:

9. 'Goodwill' for the purposes of the definition of 'CGT asset' in section 108-5 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.

10. 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.

Furthermore, at paragraphs 12 -14 of the Ruling:

12. As explained more fully at paragraph 85 of this Ruling, 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. [Emphasis added]

13. What goodwill means depends on the character and nature of the business to which it is attached. Goodwill differs in its composition in different trades or industries and in different businesses in the same trade or industry. One or more sources of goodwill may preponderate in one business and another source or sources may be prominent in another business.

14. 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. [Emphasis added]

The High Court in Murry stated (at paragraph 4):

Goodwill is inseparable from the conduct of a business. It may derive from identifiable assets of a business, but it is an indivisible item of property, and it is an asset that is legally distinct from the sources - including other assets of the business - that have created the goodwill. Because that is so, goodwill does not inhere in the identifiable assets of a business, and the sale of an asset which is a source of goodwill, separate from the business itself, does not involve any disposition of the goodwill of the business (emphasis added).

The High Court also stated (at paragraphs 30-32):

Care must be taken to distinguish the sources of the goodwill of a business from the goodwill itself. Goodwill is an item of property and an asset in its own right. For legal and accounting purposes, it must be separated from those assets and revenue expenditures of a business that can be individually identified and quantified in the accounts of a business. Goodwill, as property, is "inherently inseverable from the business to which it relates". That which can be assigned and transferred from the business may, while it is connected to the business, be a source of the goodwill of the business but cannot logically constitute any part of the goodwill of the business...

It follows that the sale of an asset of a business does not involve any sale of goodwill unless the sale of the asset is accompanied by or carries with it the right to conduct the business... [emphasis added]

When an asset of the business is sold and the business is not, the sale may reduce the value of the goodwill of the business. Nevertheless, the sale does not involve the disposition of the goodwill of the business or any part of it.

The legal meaning of 'goodwill' as explained in Murry is confirmed and clarified by the High Court in Commissioner of State Revenue v Placer Dome Inc [2018] HCA 59; 2018 ATC 20-677. At paragraph 91, the High Court stated:

Goodwill for legal purposes does not extend to every positive advantage, and whatever adds value, including privileges or advantages that differentiate an established business from a business just starting out. Goodwill for legal purposes does extend to those sources which generate or add value (or earnings) to the business by attracting custom, whether that be from the use of identifiable assets, locations, people, efficiencies, systems, processes, or techniques of the business, or from some other identifiable source. And those sources of goodwill for legal purposes have a unified purpose and result - to generate or add value (or earnings) to the business by attracting custom.

Applying the principles in Murry and TR 1999/16 in the circumstances of the Proposed Transaction, the disposal of the Trademarks under the Proposed Transaction without a disposal of the business of the Company does not involve a disposal of goodwill of Company.

Whether there has been a disposal of one of several businesses, or part of a business which itself could constitute a business

While there has not been a disposal of the business of Company under the Proposed Transaction, it is necessary to consider whether the Proposed Transaction in the circumstances constitutes a disposal part of the business of the Company and therefore results in disposal of goodwill.

TR 1999/16 states at paragraphs 73-75:

73. 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...

74. If a business owner is carrying on one business and disposes of some part of the business, it is a question of fact whether the owner has disposed of a discrete business that a purchaser could conduct or has merely disposed of a business asset or a collection of business assets. This question is determined having regard to all of the circumstances (and not solely from the purchaser's perspective) including whether sufficient relevant assets are sold to enable the purchaser to carry on the business the vendor had carried on, whether the assets sold are accompanied or carry with them the legal right, privilege or entitlement to conduct the business and whether what is sold is sold as a self contained business. If a business owner disposes of part of their business, an important consideration is whether the effect of the transaction is to put the purchaser in possession of a going concern the activities of which the purchaser could carry on without interruption: see Full Supreme Court of Tasmania decision in Zeekap (No 56) Pty Ltd v C of SD (Tas) 99 ATC 4745 at 4747-8; (1999) 42 ATR 295 at 297-8.

75. Many factors are relevant to this question though few are conclusive in themselves. If a purchaser assumes the conduct of a vendor's business and continues to carry it on, this points to a business having been transferred rather than a transfer of a business asset or a collection of business assets. The converse is not, however, necessarily true because a transfer of a business may be complete even though the purchaser does not choose to avail themself of all the rights they acquire. For example, a purchaser might decide to subsume the discrete business within their larger existing business. Alternatively, a purchaser might decide not to run the business at all, having acquired it to eliminate a competitor. An express assignment of goodwill is strong evidence of a transfer of the business to which it is attached but the absence of an express assignment of goodwill does not conclusively mean that there has been no disposal of a business. The absence of an assignment of business premises, trading stock or outstanding contracts is likewise not conclusive. Nor is it a conclusive factor whether the vendor continues to carry on business at other locations. However, a disposal of business activities conducted at one geographical location separate from those conducted at other locations is a relevant factor in determining whether what was sold was a discrete business in its own right.

Referring to some of the considerations referred to at paragraphs 74 to 75 of TR 1999/16 in determining whether there has been a disposal of a discrete business, it is considered that in the circumstances described in this Ruling, the Proposed Transaction does not involve a disposal of a self-contained business to the purchaser.

Question 2

Summary

Where the answer to Question 1 is 'no', CGT event C1 will not happen to the goodwill of Company under the 'Proposed Transaction' described in this Ruling (subject to the application of Subdivision 815-B of the ITAA 1997).

Detailed reasoning

CGT event C1happens if a CGT asset you own is lost or destroyed: subsection 104-20(1).

It is stated in TR 1999/16:

18. A business or the sources of its goodwill may change so much it can no longer be said to be the same business as that previously conducted. In other words the old business ceases and a new business commences. If this happens the goodwill of the original business ceases to exist and a new CGT asset - being the goodwill of the new business - is acquired.

19. CGT event C1 in section 104-20 (about a loss or destruction of a CGT asset) happens in the situation in paragraph 18...

20. 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...[emphasis added]

21. The business does not need to be identical from its acquisition to its disposal. If the essential nature or character of the business is not changed, the business remains the same business for the CGT goodwill provisions [Emphasis added]. A business owner may expand or contract its 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...

24. It is not sufficient, however, if just a similar kind of business is carried on. It must be a business of the same essential nature or character that is carried on. 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.

It is further elaborated in TR 1999/16:

91. It is a question of fact and degree whether the same business is being carried on. Factors to consider include the 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 - and the way in which the business is structured, carried on, managed and controlled...

94. The High Court in the Murry case considered it ' arguable ' (emphasis added) that the goodwill of the business of an inner Sydney hotel is not the same asset as it was two decades ago because, due to a marketing change and a resulting change in the class of customer patronising the business, it is not the same business as it was then. The High Court said the sources of the goodwill of a business may change and the part that various sources play in maintaining the goodwill may vary over the life of the business to such an extent it can no longer be said that the same business is carried on (98 ATC at 4595; 39 ATR at 143). The question whether a change of business occurs remains one of fact and degree, however, and a change in the nature of the clients of a business does not of itself mean the business is a new business with new goodwill. Many businesses naturally evolve by serving different clients or clients in different markets and offering improved products or services...

It is noted that the High Court in Murry stated [at paragraph 45-46]:

The sources of the goodwill of a business may change and the part that various sources play in maintaining the goodwill may vary during the life of the business. But, 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.

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.

In considering whether Company's business will retain its essential character, some of the factors that are relevant in determining this question of fact, as described in paragraph 91 of TR 1999/16, are considered with reference to the relevant facts and circumstances of this Ruling.

When considered in totality of all the relevant facts and circumstances, the business has not changed to such an extent that it can be said to be no longer the same business. The Proposed Transaction will not result in the business of the Company changing its essential nature or character, or changing to such an extent that it is no longer the same business. Accordingly the goodwill of Company will not become 'lost or destroyed' for the purposes of section 104-20 and CGT event C1 will not occur.

Question 3

Summary

Where the answers to Question 1 and 2 are 'no', CGT event C2 will not happen to the goodwill of Company under the 'Proposed Transaction' described in this Ruling (subject to the application of Subdivision 815-B of the ITAA 1997).

Detailed reasoning

Under subsection 104-25(1), CGT event C2happens if your ownership of an intangible CGT asset ends by the asset:

(a)             being redeemed or cancelled; or

(b)             being released, discharged or satisfied; or

(c)             expiring; or

(d)             being abandoned, surrendered or forfeited; or

(e)             if the asset is an option - being exercised; or

(f)              if the asset is a *convertible interest - being converted.

Paragraphs 135-136 of TR 1999/19 states that where a business permanently ceases, CGT event C2 may also occur to the goodwill asset where a business ceases to operate, however, CGT event C1 is the more specific event in the circumstances (pursuant to subsection 102-25(1)).

In the circumstances of the Proposed Transaction, it is considered that there is no ending of the goodwill asset of Company in a manner contemplated under subsection 104-25(1). Therefore CGT event C2 will not occur under the Proposed Transaction.