Edited version of private advice

Authorisation Number: 1051968647857

Date of advice: 7 April 2022

Ruling

Subject: Pre-CGT asset

Question 1

Is the goodwill of the Business an asset acquired by the Company ATF the Unit Trust before 20 September 1985 in accordance with item 1 of the table in section 109-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

If the goodwill of the Business is considered to have been acquired by the Unit Trust before 20 September 1985, will former section 160ZZS of the Income Tax Assessment Act 1936 (ITAA 1936) or 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 gain which arises to the Unit Trust on the disposal of the goodwill on sale of the Business be disregarded pursuant to paragraph 104-10(5)(a) of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

Income year ending 30 June 2023

Income year ending 30 June 2024

Income year ending 30 June 2025

Income year ending 30 June 2026

Income year ending 30 June 2027

Relevant facts and circumstances

Pre-20 September 1985

The Company is the trustee for the Unit Trust. Shares in the Company are held directly and indirectly by members of family A and family B (the Family Group). The majority of the directors of the Company are members of the Family Group.

The Unit Trust was established prior to 20 September 1985. Since shortly after the Unit Trust's establishment (and prior to 20 September 1985), and until 1997, units in the Unit Trust were held equally by Family Trust A, (controlled by Mr A, until his death) and Family Trust B (controlled by Mr B).

Since its establishment the Unit Trust has carried on the business of selling goods and offering services (the Business).

Since the acquisition of units by their family trusts in the Unit Trust, Mr A and Mr B had been intimately involved in the operations of the Business.

The beneficiaries of Family Trust A and Family Trust B include the following classes of beneficiary:

•                    Mr A, Mr B and the direct family members of Mr A or Mr B such as brothers, sisters, grandparents, children, grandchildren, spouses etc;

•                    companies beneficially owned by Mr A, Mr B or their family members; and

•                    Trustees of any trust under which Mr A, Mr B or their family members has an interest.

Mr A and each of his children were equally entitled to the trust fund on vesting of Family Trust A.

Mr B was entitled to the trust fund on vesting of Family Trust B.

The nature of the Business immediately before 20 September 1985 (the Test Time) included the expansion of products sold, specific store requirements, departmentation of goods and the targeting of a particular customer demographic.

Post 20-September 1985

Following the death of Mr A in 199X, the Business was jointly managed and controlled by Mr B and one of Mr A's children.

In 199X, family trust elections were made by the trustees of each of the Family Trusts.

In 20XX the trustee for Family Trust A irrevocably exercised its power of appointment to make each of the Family A Stakeholder Trusts, each created for the benefit of a child of Mr A, equally entitled to the trust fund on vesting. The Family A Stakeholder Trusts have not been made presently entitled to any income of Family Trust A.

In 20XX the trustee for Family Trust B irrevocably exercised its power of appointment to make each of the Family B Stakeholder Trusts, each created for the benefit of a child of Mr B, equally entitled to the trust fund on vesting. These Family B Stakeholder Trusts have not been made presently entitled to any income of the Family Trust B.

In 199X, the Unit Trust issued units to Trust C, held by Trust C until 20XX. The number of units issued to Trust C were minor compared to Family Trusts A and B. The unit holders in Trust C included Mr A, Mr B and particular employees of the Business who were not members of the Family Group. Each unit held by the employees in Trust C merely entitled the holder to $1 upon redemption.

From 20XX to 20XX, Trust C received distributions from the Unit Trust. It share of the distribution across those years was less than 1% of the total distribution made by the Unit Trust for the year. The total distribution that the Business employees received from the Unit Trust (i.e. indirectly as beneficiaries of Trust C) was less than 1% of the Unit Trust's total net income.

From 19XX to 20XX the trustees of the Unit Trust, Family Trust A and Family Trust B has exercised their power to make variations and amendments to their respective trust deeds. None of the variations and amendments made to the relevant trust deeds resulted in a change in the way the discretionary powers of the trustees of those trusts are exercised.

In 20XX the families of Mr A and Mr B entered into a Family Agreement to strengthen the application of the '50:50 Principle' to successive generations in accordance with the Family Charter taking into account the group's ongoing expansion. The agreement did not change the underlying beneficial ownership of any of the entities, including the Unit Trust.

The Family Charter and a Stakeholder's Agreement outlines and guides how the Business and other ventures are governed for the benefit of current and future generations of the Family Group. There are rules restricting the disposal of interests in entities associated with members of the Family Group to non-family members.

Whilst the Business has expanded over time and embraced new technologies, it continues to sell goods and offer services that are similar when compared to those goods and services provided at the Test Time.

Assumption

For the purposes of question 3 of this ruling:

(a)  there will be no material changes to the nature or character of the Business from the date this ruling is issued until the Business is sold; and

(b)  there will be no changes to the majority underlying interests in the goodwill of the Business until the Business is sold.

Relevant legislative provisions

Income Tax Assessment Act 1936 former section 160ZZS

Income Tax Assessment Act 1936 former subsection 160ZZS(1)

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 paragraph 104-10(5)(a)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 paragraph 108-5(2)(b)

Income Tax Assessment Act 1997 section 109-10

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1997 section 149-10

Income Tax Assessment Act 1997 paragraph 149-10(1)(c)

Income Tax Assessment Act 1997 subsection 149-15(1)

Income Tax Assessment Act 1997 subsection 149-15(2)

Income Tax Assessment Act 1997 subsection 149-15(3)

Income Tax Assessment Act 1997 subsection 149-15(4)

Income Tax Assessment Act 1997 subsection 149-15(5)

Income Tax Assessment Act 1997 Subdivision 149-B

Income Tax Assessment Act 1997 section 149-30

Income Tax Assessment Act 1997 subsection 149-30(1)

Income Tax Assessment Act 1997 subsection 149-30(2)

Taxation Administration Act 1953 section 357-85 of Schedule 1

Reasons for decision

Question1

Summary

The goodwill of the Business was acquired before 20 September 1985 pursuant to section 109-10 of the ITAA 1997[1].

Detailed reasoning

Goodwill, or an interest in goodwill, is a CGT asset (paragraph 108-5(2)(b)). Section 109-10 sets out specific circumstances and rules in relation to when a CGT asset is acquired without a CGT event:

109-10 When you acquire a CGT asset without a CGT event

This table sets out some 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.

The meaning of goodwill

Taxation Ruling TR 1999/16[2] (TR 1999/16) deals with CGT issues relating to the goodwill of a business. For the purposes of the definition of 'CGT asset' in section 108-5, goodwill has the meaning it bears under general law (as explained in FC of T v Murry 98 ATC 4585; (1998) 39 ATR 129 (the Murry case)). 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.

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.[3] 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.[4] 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.[5]

When was the goodwill acquired?

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.[6]

According to the High 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. This generally arises when the taxpayer commences or purchases a business.

If a taxpayer commences business and starts to create goodwill, the goodwill of the business is acquired when the taxpayer starts work that results in the creation of the goodwill.[7] 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.[8]

For the purposes of Part 3-1, the goodwill of a business that commenced before 20 September 1985 remains a pre-CGT asset (subject to the operation of Division 149) provided the same business continues to be carried on.

A business or the sources of its goodwill may change to such an extent that it is no longer the same business, resulting in the goodwill of the old business ceasing when the goodwill of the new business is established. Paragraph 21 of TR 1999/16 provides guidance on the growth of a business:

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.

In accordance with 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.

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 91 of TR 1999/16 provides various factors to consider in determining whether the same business is being carried on. These 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.

In applying the above factors to the Unit Trust's circumstances, it is considered that the business being carried on now is essentially the same as the business being carried on by the Unit Trust prior to the Test Time for the following reasons:

•                    The goods sold and services offered by the Business and the store requirements, including format, departments and sub-departments are the same, and the essential nature and character of the Business has remained the same.

•                    The core activities of the Business have remained unchanged, none of which constitute, or are treated by the business owners as constituting separate or distinct activities, enterprises, divisions or undertakings.

•                    The increase in size of the marketing department and the utilisation of improved technology to create an online presence has not resulted in the cessation of the original Business.

•                    The expansion of the Business and its growth in terms of revenue and customers, employee numbers, resources and other business attributes can be attributed to the organic growth of the Business and relates predominantly to the same core business operations.

•                    The management of the Business has continued to be centralised with Mr B and Mr A (and then his child) jointly managing and controlling the Business for the purpose of benefiting the Family Group.

Therefore, pursuant to section 109-10 the goodwill of the Business was acquired by the Unit Trust when the Business was created (before 20 September 1985).

Question2

Summary

Pursuant to subsection 149-30(2), it is reasonable for the Commissioner to assume that at all times after 20 September 1985 and until the date of this ruling, the majority underlying interests in the goodwill were held by the ultimate owners who had majority underlying interests in the goodwill immediately before that day, and subsection 149-30(1) applies as if that were in fact the case (such that the goodwill continues to be a pre-CGT asset).

As a consequence, former subsection 160ZZS(1) of the ITAA 1936 would not apply to deem the goodwill of the Business to have been acquired after 20 September 1985 (and before the 1999 income year).

Detailed reasoning

Former section 160ZZS of the ITAA 1936

Before being re-written into Subdivision 149-B, former section 160ZZS of the ITAA 1936, which applied before the commencement of the 1999 income year, contained rules which governed when an asset acquired before 20 September 1985 stopped being a 'pre-CGT asset', as follows:

For the purposes of the application of this Part in relation to a taxpayer, an asset acquired by the taxpayer on or before 19 September 1985 shall be deemed to have been acquired by the taxpayer after that date unless the Commissioner is satisfied, or considers it reasonable to assume, that, at all times after that date when the asset was held by the taxpayer, majority underlying interests in the asset were held by natural persons who, immediately before 20 September 1985, held majority underlying interests in the asset.

Division 149

Division 149 contains rules, applicable to the 1999 and later income years, which govern when an asset acquired before 20 September 1985 stops being a 'pre-CGT asset'. Section 149-10 provides:

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 year, taken under:

(i) former subsection 160ZZS(1) of the Income Tax Assessment Act 1936; or

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

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.

In relation to paragraph 149-10(1)(c), and pursuant to subsection 149-30(1), an asset of a non-public entity stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not had by the ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985. Where a change in the ultimate owners who had the majority underlying interests occurs, the CGT asset is deemed to be acquired after 19 September 1985.

'Majority underlying interests' in a CGT asset is defined in subsection 149-15(1) to consist of more than 50% of:

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

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

An 'underlying interest' in a CGT asset is defined in subsection 149-15(2) as 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.

An 'ultimate owner' is defined in subsection 149-15(3) to include an individual or a company whose constitution prevents it from making any distribution, whether in money, property or otherwise, to its members.

Subsection 149-15(4) states:

An ultimate owner indirectly 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.

Subsection 149-15(5) states:

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.

The expression 'beneficial interest' as used in the definition of 'majority underlying interests' (as well as the definition of 'underlying interest') is not defined. Under ordinary legal concepts, where there is a discretionary trust deed, 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 the 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's discretion is exercised, it would not be possible for a discretionary trust to satisfy the continuing majority underlying interests test set out in subsection 149-30(1).

Under subsection 149-30(2), if the Commissioner is satisfied, or thinks it reasonable to assume, that the majority underlying interests in the asset have not changed up to a particular time, then subsection 149-30(1) applies as if that were in fact the case (and the asset continues to be a pre-CGT asset).

Taxation Ruling IT 2340[9] (IT 2340) reflects on an approach of looking through interposed entities to determine which natural persons hold the beneficial interests for the purposes of former section 160ZZS of the ITAA 1936.

Among other issues, the ruling deals with questions regarding the application of former section 160ZZS of the ITAA 1936 'to assets held by trustees of family trusts where the trustees are vested with discretionary powers as to distributions from the trusts'.

Under this approach the Commissioner can 'look through' an entity to determine the natural persons who hold beneficial interests in assets, as stated in paragraph 2 of IT 2340:

The terms "underlying interest" and "majority underlying interests", on the basis of which the provision operates, have the same meanings as they have in Subdivision G of Division 3 of Part III of the Act - which deals with the income tax treatment of interest in relation to "negatively geared" investments in rental property. In both cases (and like other provisions of the Act concerned with the measurement of ownership interests) underlying interests in relation to the assets concerned mean beneficial interests held by natural persons. The clear policy of the law thus permits and requires that, for the purposes of the relevant provisions, chains of companies, partnerships and trusts are to be "looked through" in order to determine whether there has been a change in the effective interests of natural persons in the assets.

IT 2340 correctly reflects the position that former section 160ZZS of the ITAA 1936, by its terms, necessarily supplants normal legal concepts of interests in assets. For the purposes of former section 160ZZS of the ITAA 1936, a beneficiary of a discretionary trust is treated as having a beneficial interest in the trust's assets.

IT 2340, at paragraph 5, states 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 at paragraphs 6 and 7:

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. That is consistent with the role of the section to close potential avenues for avoidance of tax in cases where there is a substantial change in underlying ownership of assets and the legislative guidance contained in Subdivision G of Division 3 of Part III of the Act. On that basis, trust assets acquired by the trustee before 20 September 1985 would remain outside the scope of the capital gains and losses provisions of the Act....

Section 357-85 of Schedule 1 of the Taxation Administration Act 1953 (TAA) provides that if the Commissioner has made a ruling about a relevant provision and that provision is re-enacted or remade, the ruling is taken to be about the re-enacted or remade provision, insofar as the new law expresses the same ideas as the old law. Section 357-85 of Schedule 1 to the TAA applies to all rulings, including public rulings (paragraphs 49 to 50 of Taxation Ruling TR 2006/10[10]). As former section 160ZZS of the ITAA 1936 expresses the same ideas as Division 149, IT 2340 equally applies to Division 149.

Application to the current circumstances

In the current circumstances, the goodwill of the Business acquired by the Unit Trust before the Test Time will a remain pre-CGT asset if the Commissioner thinks it is reasonable to assume that the majority underlying interests in that CGT asset has been had at all times by the same ultimate owners who had the majority underlying interests in the asset at the Test Time.

Just prior to 20 September 1985

As confirmed at question 1 of this ruling, the goodwill of the Business was acquired by the Unit Trust before the Test Time.

As the unit holders in the Unit Trust at the Test Time (i.e. Family Trust A and Family Trust B) were discretionary trusts, it would not be possible under ordinary legal concepts for those trusts to satisfy the continuing majority underlying interests test set out in subsection 149-30(1). However, adopting the 'look through' approach outlined in IT 2340, the natural persons who held beneficial interests in the goodwill at that time - taking into account the way in which the Company (as trustee of Unit Trust) exercised its discretionary powers and the way in which the trustees for Family Trust A and Family Trust B administered those trusts for the exclusive benefit of members of the Family Group - were limited to members of the Family Group. It is therefore reasonable to assume that the majority underlying interests in the goodwill as at the Test Time were had by members of the Family Group.

From 20 September 1985

As the unit holders of the Unit Trust since the Test Time has been comprised of Family Trust A, the Family Trust B and, for a period beginning in 19XX and ending in 20XX, Trust C, it is not possible under ordinary legal concepts for those trusts to satisfy the continuing majority underlying interests test set out in subsection 149-30(1) for any period since the Test Time.

However, pursuant to subsection 149-30(2) and by virtue of adopting the 'look through' approach outlined in IT 2340, it is reasonable for the Commissioner to assume that the majority underlying interests in the goodwill of the Business have continued to be had as at the date of this ruling, and at all times since the Test Time, by members of the Family Group.

The reasonableness of that assumption is supported by the following factors:

•                    The Business has continued to be controlled by Mr B and Mr A (until his death). Since Mr A's death, Mr B, together with Mr A's son, have jointly managed and controlled the Business.

•                    But for the minority unitholding of Trust C for the 19XX to 20XX years, the unitholders have been the family trusts which have been administered for the benefit of the Family Group (or members thereof) at all times. This is evident by the following.

o        The terms of the trust deeds.

o        On vesting of Family Trust A and Family Trust B the trust fund vests for the benefit of a relevant family member (via their own family trust).

o        FTEs were made in respect of each Family Trust.

•                    The Family Agreement strengthens the application of the 50:50 Principle for successive generations in accordance with the Family Charter, taking into account the Family Group's ongoing expansion.

•                    The Family Charter ensures that interests in the entities associated with the Family Group remain within the family.

•                    None of the variations and amendments made to the trust deeds for the Unit Trust, Family Trust A and Family Trust B since the Test Time have resulted in a change in the way the discretionary powers of the trustees of those trusts are exercised.

•                    Total distributions made to Trust C (and by Trust C to the employees of the Unit Trust) was less than 1% of the Unit Trust's net income for the year.

•                    Consistent with the Family Charter and all available records regarding the respective distribution histories of Family Trust A and Family Trust B, distributions have always been for the benefit of members of Family Group.

It is noted that the families of Mr A and M B meet the definition of a 'particular family', as referred to in paragraph 6 of IT 2340, and the trustee of Family Trust A and the trustee of Family Trust B has not exercised discretionary powers to appoint beneficiaries not of the same family as the existing beneficiaries.

Under these circumstances, and consistent with paragraph 7 of IT 2340, subsection 149-30(1) applies as if majority underlying interests in the goodwill of the Business have been had by ultimate owners (the members of the Family Group) who had such interests at the Test Time, and the goodwill of the Business continues to be a pre-CGT asset of the Unit Trust.

Question3

Summary

Any capital gain which arises on the disposal of the goodwill on sale of the Business will be disregarded pursuant to paragraph 104-10(5)(a).

Detailed reasoning

CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1)).

Paragraph 104-10(5)(a) 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.

As confirmed in response to questions 1 and 2 of this ruling, the goodwill of the Business was acquired prior to 20 September 1985 and Division 149 does not apply to stop the goodwill from being a pre-CGT asset. Subject to the assumption made for the purposes of this question, paragraph 104-10(5)(a) will therefore apply to disregard a capital gain made on any disposal of the Unit Trust's goodwill.

[1]All legislative references are to the ITAA 1997 unless otherwise specified.

[2]Income tax: capital gains: goodwill of a business.

[3] Paragraph 25 of TR 1999/16.

[4] Paragraph 96 of TR 1999/16.

[5] Paragraph 14 of TR 1999/16.

[6] Paragraph 17 of TR 1999/16.

[7] Item 1 in the table in section 109-10.

[8] Paragraph 52 of TR 1999/16.

[9] Income tax : capital gains : deemed acquisition of assets by a taxpayer after 19 September 1985 where a change occurs in the underlying ownership of assets acquired by the taxpayer on or before that date.

[10] Public Rulings.