Edited version of private advice

Authorisation Number: 1052087077732

Date of advice: 5 April 2023

Ruling

Subject: CGT - pre-CGT status of goodwill

Question 1

Is the sale of the goodwill of the Business owned by the Trust a disposal of a CGT asset under section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will the goodwill of the Business operated by the Trust be considered an asset acquired before 20 September 1985 for the purpose of section 109-50 of the ITAA 1997?

Answer

Yes

Question 3

Does Division 149 of the ITAA 1997 apply to deem the goodwill of the Business operated by the Trust to be a post-CGT asset?

Answer

No

Question 4

Does subsection 104-10(5) of the ITAA 1997 apply to disregard the capital gain on the sale of the goodwill of the Business operated by the Trust?

Answer

Yes

This ruling applies for the following period:

Financial year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The Trust was settled prior to 20 September 1985. The Trust is a discretionary family for the benefit of Family A.

The Trust carried on a service (the Business) since settlement until the 20XX-XX financial year when the business was sold to an unrelated third party.

Throughout its period of operation, the Business retained its business name, Family A members were the key personnel, it provided similar services in the same geographical area to similar types of customers.

The Trust amended its Trust deed approximately XX years ago. The amendment established the existing beneficiaries as default beneficiaries and added an additional member of Family A as a beneficiary.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

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

Income Tax Assessment Act 1997 paragraph 104-10(3)(a)

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

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

Income Tax Assessment Act 1997 section 109-50

Income Tax Assessment Act 1997 Division 149

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

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

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 1936 section 160ZZS

Income Tax Assessment Act 1936 subsection 160ZZS(1)

Reasons for decision

Legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated.

Question 1

Summary

The sale of the Business goodwill owned the Trust was a disposal of a CGT asset being a CGT event A1 under section 104-10.

Detailed reasoning

Goodwill, or an interest in it, is a capital gains tax (CGT) asset under paragraph 108-5(2)(b).

CGT event A1 happens if you dispose of a CGT asset where there is a change of ownership occurs from you to another entity (subsection 104-10(1)). The time of event is when you enter into the contract for the disposal (paragraph 104-10(3)(a)).

CGT event A1 happened when you disposed of the Business goodwill upon the Trust entering into the Business assets sale contract with the third-party purchaser.

Question 2

Summary

We are satisfied that the essential nature of the Business established by the Trust prior to 20 September 1985 has not changed. The goodwill of the Business operated by the Trust is considered to be a CGT asset acquired before 20 September 1985 for the purpose of section 109-50.

Detailed reasoning

According to Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business (TR 1999/16) the legal definition of goodwill which was established by the High Court in Federal Commissioner of Taxation v. Murry 98 ATC 4585; (1998) 39 ATR 129. Paragraph 12 of TR 1999/16 states in part that:

... 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.

Paragraph 52 of TR 1999/16 provides that:

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 (subsection 109-10, item 1). 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.

Paragraph 17 of TR 1999/16 provides guidance in deciding whether goodwill remains a single CGT asset if the same business is continued. It states that:

The whole of the goodwill of a business that commenced before 20 September 1985 remains the same single 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.

Paragraphs 21 of TR 1999/16 states that:

if the essential nature or character of the business has not changed, the business remains the same business for the purposes of the CGT goodwill provisions. The business 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 constitute a new business as long as the essential character or nature of the business remains unchanged.

However, paragraphs 18 and 19 of TR 1999/16 sets out that a business can change to such an extent that it is no longer the same business so that the goodwill of the old business ceases and goodwill of a new business is acquired. Further, paragraph 24 specifies that:

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.

Application to your circumstances

The goodwill of the Business was built up over the years, since the Business commenced prior to 20 September 1985. Since establishment, the Business has retained its business name, Family A members were the key personnel and it provided similar services in the same geographical area to similar types of customers.

We are satisfied that the essential nature of the Business established by the Trust prior to 20 September 1985 has not changed either through a planned or systematic process over a period of time, or in a sudden or dramatic way. Consequently, the goodwill of the Business operated by the Trust is considered to be a CGT asset acquired before 20 September 1985 for the purpose of section 109-50.

Question 3

Summary

Family A members have always been the beneficiaries of the Trust and they were not substituted for members of a new family as a result of the amendment to the Trust's deed. Consequently Division 149 does not apply to deem the goodwill of the Business operated by the Trust to be a post-CGT asset.

Detailed reasoning

Former section 160ZZS of the Income Tax Assessment Act 1936 (ITAA 1936) and Division 149 (about when an asset stops being a pre-CGT asset) need to be considered for the purpose of determining the CGT status of pre-CGT assets acquired before 20 September 1985. If a pre-CGT goodwill no longer has the same majority underlying ownership under these provisions, it is treated as being post-CGT asset.

An asset of a non-public entity stops being a pre-CGT asset when majority underlying interests in the asset are not held by the same ultimate owners who held majority underlying interests in the asset immediately before 20 September 1985 (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).

Subsections 149-15(1) and (2) sets out the meaning of majority underlying interests in a CGT asset:

149-15(1)

Majority underlying interests in 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.

149-15(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.

An 'ultimate owner' is defined in subsection 149-15(3) to include an individual.

Taxation ruling IT 2340 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 (IT 2340) provides relevant guidance on discretionary trusts retaining their pre-CGT status.

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.

8. On the other hand where, by the exercise of a trustee's discretionary powers to appoint beneficiaries or by amendment of the trust deed, there is in practical effect a change of 50% or more in the underlying interests in the trust assets - such as where the members of a new family are substituted as recipients of distributions from the trust in place of persons who were formerly the object of such distributions - the section would have its intended application as described.

Application to your circumstances

Family A members have always been the beneficiaries of the Trust. We accept that the amendment to the Trust did not result in members of a 'new family' being substituted for members of Family A. Members of Family A were the beneficiaries of the Trust both before and after the amendment. The trustee continued to administer the Trust for the benefit of members of the 'particular family' being family A. Consequently Division 149 does not apply to deem the goodwill of the Business operated by the Trust to be a post-CGT asset

Question 4

Summary

The capital gain the Trust made from the sale of the goodwill of the Business can be disregarded under paragraph 104-10(5)(a). We do not consider that either the essential nature of the Trust's business or the majority underlying interests in its goodwill to have changed since establishment prior to 20 September 1985.

Detailed reasoning

Under paragraph 104-10(5)(a), a capital gain you make from a CGT event A1 is disregarded if you acquired the asset before 20 September 1985.

As per question 1 of this ruling. The sale of the goodwill of the Business was a CGT event A1.

Per question 2, the essential nature of the Business established by the Trust prior to 20 September 1985 has not changed. The goodwill of the Business operated by the Trust is considered to be a CGT asset acquired before 20 September 1985.

Per question 3, as the majority underlying interest of the Trust has not changed, Division 149 does not apply to deem the goodwill of the Business to be a post-CGT asset.

Consequentially, the capital gain the Trust made from the sale of the goodwill of the Business can be disregarded under paragraph 104-10(5)(a).