Edited version of private advice

Authorisation Number: 1051876620079

Date of advice: 5 August 2021

Ruling

Subject: Capital gains tax

Question 1

Has the business changed to such an extent that the original business can be said to have ceased, triggering CGT event C1 regarding the goodwill of the existing business pursuant to section 104-20 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

If the business is sold on the open market, will CGT event A1 regarding disposal of a CGT asset be triggered under section 104-10 of the ITAA 1997?

Answer

Yes.

Question 3

If the business is sold in an arms-length dealing to another entity within the beneficiaries of the Trust by 30 June 20XX, will a CGT event A1 regarding disposal of a CGT asset be triggered under section 104-10 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Trustee for a trust purchased a business.

Many attempts were made to sell the business over a number of years with no success.

Negotiations were underway for a new lease when COVID 19 severely impacted sales. The commercial lease expired before COVID 19. Negotiations took place to reduce the rent or downsize the size of the business premises.

It was decided to close the business and the commercial lease was not renewed.

A new lease was signed shortly after. It was at the same address with the same business name, but smaller premises.

The operations were restructured, but essentially remain the same.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-20

Income Tax Assessment Act 1997 paragraph 104-20(2)(b)

Income Tax Assessment Act 1997 subsection 104-20(3)

Income Tax Assessment Act 1997 section 108-5

Reasons for decision

Question 1

Subsection 108-5(1) of the ITAA 1997 provides that a capital gains tax (CGT) asset is:

(a) any kind of property; or

(b) a legal or equitable right that is not property.

To avoid doubt, subsection 108-5(2) of the ITAA 1997 confirms that 'goodwill' is a CGT asset.

Section 104-20 of the ITAA 1997 provides:

104-20(1) CGT event C1 happens if a *CGT asset you own is lost or destroyed.

104-20(2) The time of the event is:

(a)  when you first receive compensation for the loss or destruction; or

(b)  If you receive no compensation - when the loss is discovered or the destruction occurred.

Taxation Ruling TR 1999/16 explains how the CGT provisions apply to a business when the business ceases. In particular the following paragraphs are relevant:

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. 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 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.

22. Nor would it be a different business if all that happens is that portions of the operations of a business are discarded in an ordinary commercial way but the business retains its essential nature or character.

23. If the types of customers a business attracts change as the business evolves over the years, this does not necessarily mean the business is no longer the same business as was originally carried on.

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.

...

Does a CGT event happen to goodwill when a business ceases?

69. A temporary closure of a business or a move in location of a business does not constitute a permanent cessation of business and neither CGT event C1 nor CGT event C2 (about cancellation, surrender and similar endings of intangible assets) in section 104-25 happens to the goodwill.

Application to the facts

A C1 event does not happen to goodwill when part of a business ceases unless that part constitutes a business itself, or cessation of that part means that the business ceases and what remains is a new business.

The business lease expired. Negotiations for a new lease occurred for a number of months for either a reduction in rent or a reduction in the size of the business premises. It was decided by the trustee to close the business and a new lease was signed shortly afterwards. The business operations were restructured. The business continues to be essentially the same, with the same name, address and customer base as it had prior to the new lease being signed although the size of the premises reduced in area.

As TR 1999/16 states at paragraph 69 a temporary closure of a business or a move in location of a business does not constitute a permanent cessation of business resulting in a C1 event. The decision to lease smaller premises resulted in a temporary closure rather than the cessation of the business. A reduction in scale does not necessarily equate to a change in the identity of the business. The kind or essential character of the business has not changed.

In this case the business is not lost or destroyed, as its essential character remains, although on a smaller scale. There is no CGT C1 event.

Question 2

Where a CGT event A1 occurs, you make a capital gain if the capital proceeds from the disposal are more than the asset's cost base and you make a capital loss if those proceeds are less than the asset's reduced cost base s 104-10(4).

Therefore, if the business is sold on the open market, CGT event A1 will occur resulting in either a capital gain or loss.

Question 3

Where a CGT event A1 occurs, you make a capital gain if the capital proceeds from the disposal are more than the asset's cost base and you make a capital loss if those proceeds are less than the asset's reduced cost base s 104-10(4).

Therefore, if the business is sold to a beneficiary of the Trust, CGT event A1 will occur.

Subparagraph 116-30(2)(b)(i) would be relevant were the parties not dealing on an arms-length basis and would lead to the capital proceeds being modified by the market value substitution rule if they were more or less than the market value of the asset.