Edited version of private advice

Authorisation Number: 1051852106472

Date of advice: 28 June 2021

Ruling

Subject: Pre-CGT goodwill

Question

Is the goodwill of Company A taken to have been acquired before 20 September 1985?

Answer

Yes

This ruling applies for the following periods:

Income Year ended 30 June 20xx

The scheme commenced on:

1 July 20xx

Relevant facts and circumstances

Company B was incorporated before 20 September 1985 with the Individual and their Spouse each owning 50% of the ordinary shares on issue.

Company B carried on a business from incorporation until before 20 September 1985.

Before 20 September 1985, the Individual wanted to diversify the Company B business and became aware of a new business opportunity (the New Business).

The Individual decided to start the business venture and began to research the industry, its requirements, and possible locations. As part of this research, the Individual and a member of their family travelled interstate on several occasions to look at business equipment.

Before 20 September 1985, the Individual committed to purchase plant and equipment for the New Business.

Before 20 September 1985, family members of the Individual acquired a Property which was subsequently leased to Company B for use in the New Business.

Before 20 September 1985, the Individual commenced discussions with a potential Client of the New Business.

Before 20 September 1985, Company B documented a proposal to the Client for the supply of Product from the New Business which was accepted.

Before 20 September 1985, Company B's plant and equipment was delivered to the production location.

Before 20 September 1985, a contract between the Client and Company B was executed for the supply of the Product.

Before 20 September 1985, the production of the Product began.

Before and after 20 September 1985, the New Business has experienced significant growth in terms of revenue, client base, assets and other business attributes.

Company B also acquired a related business (the Related Business) after September 1985 which continued to trade under its former business name after its acquisition.

Sometime after 20 September 1985, as part of a restructure, two companies, Company A and Company C were incorporated with Company B owning 100% of the shares in these entities. This restructure involved the transfer of the business assets of the New Business to Company A and the Related Business to Company C. These transferred assets were subject to CGT rollover relief under the Subdivision 126-B of the ITAA 1997 (as it applied at that time).

Company A is proposing to sell the assets (including goodwill) of its New Business to an unrelated, third party.

Relevant legislative provisions

Section 104-10 of the ITAA 1997

Section 108-5 of the ITAA 1997

Section 109-10 of the ITAA 1997

Section 149-15 of the ITAA 1997

Section 149-30 of the ITAA 1997

Reasons for decision

Summary

The goodwill of Company A is taken to have been acquired before 20 September 1985.

Detailed Reasoning

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

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

Paragraph 104-10(5)(a) of the ITAA 1997 provides that a capital gain or capital loss you make from CGT event A1 is disregarded if you acquired the asset before 20 September 1985.

In the current circumstances, Company A is proposing to sell the assets (including goodwill) of its New Business to an unrelated, third party. It is therefore necessary to consider when the goodwill associated with the New Business was acquired.

Taxation Ruling TR 1999/16 Income Tax: capital gains: goodwill of a business (TR 1999/16) deals with CGT issues relating to the 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; (1998) 39 ATR 129 (the Murry case).

Meaning of goodwill

According to Taxation Ruling TR 1996/16 (TR 1999/16) goodwill has the legal definition which was established by the High Court in the Murry case. In this regard, paragraph 12 of TR 1999/16 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.

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

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

In the current circumstances, Company A acquired the assets of the New Business (including its goodwill) from Company B after 20 September 1985. Therefore, pursuant to subsection 109-5(2) of the ITAA 1997, as the goodwill was acquired from CGT event A1 happening (i.e. from the disposal of a CGT asset) it is taken to have been acquired either when the disposal contract was entered into or, if none, when the disposing entity stopped being the asset's owner. Accordingly, on face value, the acquisition date of the goodwill of the New Business transferred to Company A would be after 20 September 1985.

However, in the current circumstances, the transferred assets were subject to a CGT rollover relief under Subdivision 126-B of the ITAA 1997 as it applied at that time. It is relevant to note that, as stated in subsection 126-60(3) of the ITAA 1997, and reflected in item 8 of the table in section 109-55 of the ITAA 1997, if the originating company (Company B) acquired the roll-over asset before 20 September 1985, the recipient company, in this case Company A is also taken to have acquired it before that day (subject to Division 149 of the ITAA 1997). As a consequence, it is necessary to considered when Company B acquired the goodwill associated with the New Business.

With this in mind, 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. If a taxpayer commences business and starts to create the goodwill, the goodwill of the business is acquired when the taxpayer starts work that results in the creation of the goodwill.

When did the New Business commence?

The actual date of commencement of a business activity is a question of fact (Goodman Fielder Wattie Ltd v. FC of T 91 ATC 4438; (1991) 22 ATR 26) (Goodman Fielder Wattie).

For a business activity to have commenced a person must have:

•         purpose, intention and decision to commence the business activity

•         acquired a minimum level of business assets to allow that business activity to be carried on, and

•         actually commenced business operations (Calkin v. CIR 1 NZLR 440).

In the current circumstances, based on the information provided, it is considered that the New Business did commence prior to 20 September 1985.

Because the New Business commenced prior to 20 September 1985, pursuant to item 1 of section 109-10 of the ITAA 1997, Company B is taken to have acquired the goodwill of the New Business from when it started its business and consequently on face value, this goodwill will be taken to be acquired before 20 September 1985.

Same business test for CGT goodwill purposes

Paragraph 17 of TR 1999/16 highlights that the whole of the goodwill of a business that commenced before 20 September 1985 remains the same single pre-CGT asset (subject to the operation of Division 149 of the ITAA 1997, discussed below) 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.

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. 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. It is not sufficient, however, if just a similar kind of business is carried on. Factors to consider include the nature or character of the business, its location and size, its customer base, 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 owned as constituting separate or distinct activities, enterprises, divisions or undertakings and the way in which the business is structured, carried on, managed and controlled (see paragraphs 62 and 91 to 95 of TR 1999/16).

The 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.

However, as noted paragraph 24 of TR 1999/16, 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.

Has the same New Business continued to be carried on?

Before and after 20 September 1985, there have been various changes to the nature of the New Business conducted 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.

Based on the information provided, it is evident that the New Business has developed and expanded since 20 September 1985 as it has:

•         increased the range of its Products;

•         added various other services incidental to its business activities;

•         increased its customer base from its original location to interstate;

•         acquired a number of premises, primarily in its home state;

•         increased the number of staff it employs;

•         significantly increased its revenue and asset base;

•         acquired a Related Business which was subsequently transferred to a separate company; and

•         undertaken a fairly significant structural change in after 20 September 1985 when the assets of the New Business were transferred from Company B to Company A.

It is however considered that these changes represent organic growth and expansion of the New Business because none of the above activities change the essential nature or character of this business which continues to revolve around the production of its Product. Accordingly it is considered that the New Business carried on now is the same business as that carried on prior 20 September 1985. This is reflected in the fact that the New Business has:

•         maintained its focus on the sale of its Product

•         continued to service similar clients

•         continuously maintained its headquarters near its original location

•         held assets of a similar nature such as plant and equipment, motor vehicles, trade debtors and loans to related entities, and

•         been operated by and remains under the control of the Individual and their family.

It is also noted that ,based on the information provided, it is considered that the acquisition of the Related Business, prior to its transfer to Company C, did not change the nature of the New Business as the Related Business was treated as a separate and distinct activity that was not subsumed into the New Business.

Consequently the goodwill of the New Business is still taken to have been acquired before 20 September 1985.

Division 149 of the ITAA 1997: Change in majority underlying interests

Although the Goodwill of the New Business was acquired before 20 September 1985, in accordance with Division 149 of the ITAA 1997, the pre-CGT status of a CGT asset (including goodwill) owned by a company or trust can be lost if the 'majority underlying interests' in a CGT asset are not had by the same 'ultimate owners' who had the majority underlying interests in the CGT asset immediately before 20 September 1985 (subsection 149-30(1) of the ITAA 1997).

Majority underlying interests is defined in subsection 149-15(1) of the ITAA 1997 as more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in:

•         the asset, and

• any ordinary income that may be derived from the asset.

Subsection 149-15(2) of the ITAA 1997 provides that an 'underlying interest' means a beneficial interest that an ultimate owner may have in the asset or any ordinary income derived from the asset. An ultimate owner is defined to include an individual under subsection 149-15(3) of the ITAA 1997.

An ultimate owner indirectly has a beneficial interest in a CGT asset of another entity (that is not an ultimate owner) if they would receive for their own benefit any of the capital of the other entity if:

•         the other entity were to distribute any of its capital, and

• the capital were then successively distributed by each entity interposed between the other entity and the ultimate owner.

Section 149-15 of the ITAA 1997 provides:

(1) Majority underlying interestsin a *CGT asset consist of:

(a) more than 50% of the beneficial interests that *ultimate owners have (whether directly or *indirectly) in the asset; and

(b) more than 50% of the beneficial interests that *ultimate owners have (whether directly or *indirectly) in any *ordinary income that may be *derived from the asset.

(2) 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.

(3) An ultimate owner is:

(a) an individual; or

(b) a company whose *constitution prevents it from making any distribution, whether in money, property or otherwise, to its members; or

(c)...;

(4) An *ultimate ownerindirectly has a beneficial interest in a *CGT asset of another entity (that is not an *ultimate owner) if he, she or it would receive for his, her or its own benefit any of the capital of the other entity if:

(a) the other entity were to distribute any of its capital; and

(b) the capital were then successively distributed by each entity interposed between the other entity and the ultimate owner.

(5) An *ultimate owner indirectly has a beneficial interest in *ordinary income that may be *derived from a *CGT asset of another entity (that is not an *ultimate owner) if he, she or it would receive for his, her or its own benefit any of a *dividend or income if:

(a) the other entity were to pay that dividend, or otherwise distribute that income; and

(b) the dividend or income were then successively paid or distributed by each entity interposed between the other entity and the ultimate owner.

In the current circumstances, the goodwill of the New Business will remain a pre-CGT asset (acquired before 20 September 1985) if the majority underlying interests in the Goodwill are held by the same ultimate owners who had the majority underlying interests in the Goodwill immediately before 20 September 1985.

Just prior to 20 September 1985

Just prior to 20 September 1985, the ultimate owners of the Goodwill of the New Business were the Individual and their Spouse who each held 50% of the total ordinary shares on issue in Company B which directly owned the Goodwill of the New Business.

From 20 September 1985 to the disposal date

Since 20 September 1985, the most notable change that occurred to the direct ownership of the Goodwill of the New Business happened when, as a result of an internal restructure, Company B transferred the assets of the New Business (including the Goodwill) to Company A.

In this regard, it is noted that when Company A was incorporated, 100% of the shareholding in Company A was held by Company B (and continues to be held) and therefore this transfer did not result in a change in the ultimate ownership of the assets of the business, including the goodwill.

Therefore, because the majority underlying interests in the goodwill of the New Business continued to be held by the ultimate owners who had the majority underlying interests in the goodwill immediately before 20 September 1985, Subdivision 149-B of the ITAA 1997 will not cause the goodwill of the New Business to stop being a pre-CGT asset (acquired before 20 September 1985).