Edited version of private advice

Authorisation Number: 1052175745787

Date of advice: 3 October 2023

Ruling

Subject: CGT - goodwill

Question 1

Will the goodwill of the Taxpayers' business be considered to be an asset acquired before 20 September 1985 for the purposes of section 109-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

If the goodwill of the Taxpayers' business is considered to have been acquired before 20 September 1985, does section 149-30 of the ITAA 1997 apply to deem the goodwill to be acquired after 20 September 1985?

Answer

No.

Question 3

Will CGT event K6 under section 104-230 of the ITAA 1997 apply on the disposal of the pre-CGT shares held by the Taxpayers in the Company?

Answer

No.

This ruling applies for the following period:

1 July XXXX to 30 June XXXX

The scheme commences on:

XX/XX/XXXX

Relevant facts and circumstances

1.            On XX/XX/XXXX, the Taxpayers registered a Company. All shares in the Company were issued to the Taxpayers. No new shares have been issued.

2.            The Company was incorporated to acquire a small business from a related entity that started the business pre 1985.

3.            Shortly after being incorporated, the Company purchased the wholesale business for $XX which was treated entirely as acquired goodwill.

4.            Following the purchase of the business, the Company continued the same business that was carried on by the related entity.

5.            While maintaining its core business, the Company began to expand its business through converting part of the main warehouse into a retail shop and acquisitions of competitor retail businesses. Currently, the Company is operating a number retail stores around the State. These businesses were integrated into Company's operation and established as branches of the main business.

6.            The retail component of the business was started when the Company saw on opportunity to provide a 'one stop shop' service to other businesses and the general public.

7.            The retail stores are selling both in-house products with a compliment of third party sourced products and brands.

8.            A large percentage of the Company's business is also generated through the 'business to business' (B2B) model and ecommerce channels.

9.            The Taxpayers are contemplating disposing of their shares in the Company. An independent valuation was obtained to determine the value of the shares and assets of the Company.

10.         In disposing their shares, the Taxpayers are not contemplating any arrangement to rollover the shares in the Company

Relevant legislative provisions

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

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

Income Tax Assessment Act 1936 former Subdivision C of Division 20 of Part IIIA

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

Income Tax Assessment Act 1997 subsection 104-10(2)

Income Tax Assessment Act 1997 subsection 104-10(3)

Income Tax Assessment Act 1997 paragraph 104-10(4)(a)

Income Tax Assessment Act 1997 section 104-230

Income Tax Assessment Act 1997 subsection 104-230(1)

Income Tax Assessment Act 1997 paragraph 104-230(1)(a)

Income Tax Assessment Act 1997 paragraph 104-230(1)(b)

Income Tax Assessment Act 1997 paragraph 104-230(1)(c)

Income Tax Assessment Act 1997 paragraph 104-230(1)(d)

Income Tax Assessment Act 1997 subsection 104-230(2)

Income Tax Assessment Act 1997 paragraph 104-230(2)(a)

Income Tax Assessment Act 1997 subsection 104-230(10)

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(b)(i)

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 Subdivision 149-B

Income Tax Assessment Act 1997 section 149-30

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise stated.

Question

Will the goodwill of the business carried on by the Company be considered to be an asset acquired before 20 September 1985 for the purposes of section 109-10?

Detailed reasoning

11.         Goodwill is specifically included in the definition of a 'CGT asset' in paragraph 108-5(2)(b). There is no statutory definition of 'goodwill' in the Income Tax Assessment Acts. Therefore, the meaning of goodwill is to be determined from general law.

12.         Generally, goodwill can be said to be an intangible feature of a business that will often represent the business's reputation or following with customers or the capacity of a business to attract custom.

13.         The Commissioner's views on the meaning of goodwill are set out in Taxation Ruling TR 1999/16, which reflects the decision of the High Court in Federal Commissioner of Taxation v Murry 89 ATC 4585 (Murry). It is the legal definition of goodwill, rather than its accounting and business definition, which applies according to the High Court in Murry.

14.         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.[1] 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.[2] 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.[3]

15.         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.[4]

16.         According to the 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, generally this arises when the taxpayer commences or purchases a business.

When was the goodwill acquired?

17.         In the case of a purchased business, goodwill is generally acquired at contract date or when the vendor stops being the owner of the goodwill for CGT purposes where the acquisition was not pursuant to a contract.

18.         If a taxpayer commences business and starts to create goodwill, the goodwill of the business is acquired when the taxpayer starts work that result in the creation of the goodwill.[5] 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.[6]

19.         In the present circumstances, the Company acquired the business from the related entity in 19XX and continued to operate the business since that time. The goodwill of the business is therefore, taken to have been acquired before 20 September 1985 and will remain a pre-CGT asset provided the same business is continued to be carried on.

Same business being carried on

20.         A business may change to such an extent that it becomes a new business with new goodwill. In Murry it is stated that, 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.

21.         If the essential nature or character of the business has not changed, the business remains the same business for CGT purposes. The business may expand or contract or change the way in which its 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.[7]

22.         It is a question of fact and degree whether the goodwill of a business is the same asset as it was when it was acquired. The factors to be considered are discussed at paragraph 91 of TR 1999/16. For the CGT goodwill provisions, we consider that the same business is carried on and no new goodwill asset is created if the business retains its same essential nature or character.[8]

23.         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.[9]

24.         Many businesses naturally evolve by serving different clients or clients in different markets and offering improved products or services. However, unless the facts are such that it can be established that a new business has commenced - rather than an existing business continued - the goodwill of the business is not different from that existing when the business was originally acquired or commenced.[10]

25.         Where a business expands as a result of the introduction of a new business operation or activity by a taxpayer, any goodwill that relates to the expanded business is merely an expansion of the existing goodwill of the business. If a business that commenced prior to 20 September 1985 is expanded, goodwill generated by the expanded business operations or activities will be an accretion to the pre-CGT goodwill.[11]

26.         If an introduced business activity is a new business, the goodwill attaching to that business is a new asset separate from the goodwill of the existing business.[12]

27.         Whether an increase in business operations or the scale of activity constitutes an expansion of an existing business, or a new and separate business, is a question of fact dependent on the circumstances of each case. Factors that need to be considered in determining whether the business operation or activity is part of the existing business or is a new business include the nature of the new business operation or activity, the types of customers that the business operation or activity attracts and the extent to which the business operation or activity:

(a)          is subject to the same integrated management and control as the existing business;

(b)          is treated for banking and accounting purposes as an extension of the existing business or as a separate business;

(c)           uses one or more different trading names; and

(d)          is related to or dependent on the existing business in a practical, economic or commercial sense.

Has the same business been carried on by the Company?

28.         After acquiring the business from a related entity pre 1985, the Company continued to carry on the wholesale business that was started by the related entity. After 1985, the Company diversified into other activities that were complimenting to the main business activity.

29.         The Company launched its retail trading operation around early 20XX. The first retail shop was located at the manufacturing warehouse, utilising the front area of the premises. Since the establishing the first retail shop, the business has grown to a number of retail stores, accounting for approximately 30% of sales revenue. The retail stores are selling both in-house produced items with a compliment of third party sourced products and brands.

30.         The facts outlined above do not demonstrate that a new business has commenced. The Company's business has grown significantly since it started pre 1985, with some relatively small scale diversification and retail presence. However, at its core the business still remains the same business that was carried on from when it was purchased from the related entity.

31.         As the business being carried on now is essentially the same as the business carried on prior to 20 September 1985, the goodwill of the business is the same asset that is taken to have been acquired before 20 September 1985 and is a pre-CGT asset.

Purchased goodwill

32.         In order to expand its operations, the Company acquired established competitor businesses. The acquired businesses were integrated into the Company's main business operation and established as branches of the main business, offering the same type of goods and services.

33.         If a taxpayer who founded or purchased a business adds to that business an additional business purchased as a going concern, it is a question of fact dependent on the circumstances of each particular case whether the additional business is subsumed into and forms part of the existing business or whether the two businesses remain as separate businesses.[13]

34.         Paragraph 64 of TR 1999/16 further states:

If a pre-CGT business is combined with another business acquired post-CGT and they are conducted as one business without the pre-CGT business losing its essential nature or character, the goodwill of the post-CGT business is subsumed into the goodwill of the pre-CGT business and all of the goodwill of the business is taken to have been acquired before 20 September 1985. The goodwill of each of the businesses coalesce without any disposal of the goodwill of the post-CGT business. The pre-CGT business must not lose its essential nature or character in the sense that it must remain the same business and not be overwhelmed by the post-CGT business in such a way that it has become a different business. The purchase of the post-CGT business must involve merely organic growth of the pre-CGT business or an expansion or accretion to it in reasonable proportions or it gives rise to a new, different business and its goodwill is a new asset.

35.         The facts in the present case indicate that the Company continued to operate the same business and did not commence or acquire new businesses. The acquired businesses were integrated and consolidated into the Company's main pre 1985 business and were acquired as a consequence of the single business undergoing a process of organic growth over the years. The acquired goodwill had been subsumed the Company's pre-CGT goodwill as a result of integration into the Company's operation and therefore will be taken to have been acquired before 20 September 1985.

Question2

If the goodwill of the business carried on by the Company is considered to have been acquired before 20 September 1985, does section 149-30 apply to deem the goodwill to be acquired after 20 September 1985?

Summary

The majority underlying ownership interest in the Company's assets has been held by ultimate owners who in aggregate and immediately prior to 20 September 1985, held majority underlying interest in those assets. Accordingly, under Division 149, the goodwill has not stopped being a pre-CGT asset.

Detailed reasoning

36.         Division 149 contains provisions which govern when an asset held by an entity stops being a pre-CGT asset and is treated as having been acquired after 20 September 1985.

37.         Section 149-10 states:

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 (ITAA 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.

38.         Section 109-10 sets out the rules for when you acquire a CGT asset without a CGT event happening. As the Company commenced its business prior to 20 September 1985, the asset, which is the goodwill of the business, would be taken to have been acquired at the time the business commenced. Therefore, the goodwill is considered to be a pre-CGT asset, as it is deemed to have been acquired when the business commenced.

Section 160ZZS and Subdivision C of Division 20 of former Part IIIA of the 1936 Act

39.         As the Company is not a public entity, it is necessary to consider if former subsection 160ZZS(1) of the Income Tax Assessment Act 1936 (ITAA 1936) would apply. This subsection deals with changes in majority ownership of an asset, between 19 September 1985 and 30 June 1998 and states:

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 (emphasis added).

40.         The terms 'majority underlying interests' is defined in subsection 160ZZRR(1) of the ITAA 1936:

majority underlying interests, in relation to an asset, means more than one-half of:

(a)          the beneficial interests that natural persons hold (whether directly or indirectly) in the asset; and

(b)          the beneficial interests that natural persons hold (whether directly or indirectly) in any income that may be derived from the asset.

41.         The shares in the Company are beneficially owned by the Taxpayers and there have been no new shares issued. The Taxpayers are the natural persons who hold the beneficial interests in the assets of the Company. As there has not been any change in the ownership of the shares, it is considered that more than one half of both, the beneficial interests in the property of the Company and the beneficial interest in any income in the Company that may be derived by that person were held by the same natural persons (whether directly or through one or more interposed entities).

42.         Therefore, the Company is not immediately before the start of the 1998-99 income year, taken under former subsection 160ZZS(1) of the ITAA 1936 to have acquired the asset on or after 20 September 1985 for the purposes of subparagraph 149-10(b)(i). As the Company is not a public entity, it is not necessary to consider the application of Subdivision C of Division 20 of former part IIIA of the ITAA 1936.

Subdivision 149-B

43.         In relation to the income years after 1998-99, Subdivision of 149-B provides the test of when an asset of a non-public entity stops being a pre-CGT asset. Under section 149-30 an asset stops being a pre-CGT asset at the earliest time when the majority underlying interests in the asset were not held by the ultimate owners who held the majority underlying interests in the asset immediately before 20 September 1985.

44.         'Majority underlying interests' in a CGT asset 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.[14]

45.         Therefore, 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.[15]

46.         An 'ultimate owner' can be an individual, a company or any entity listed in subsection 149-15(3).

47.         Based on the facts presented, the Commissioner is satisfied that the majority underlying ownership interest in the Company's assets have been held by ultimate owners who in aggregate and immediately prior to 20 September 1985, held majority underlying interest in those assets. Accordingly, for the purpose of Division 149, the goodwill of the Taxpayers' business has not stopped being a pre-CGT asset.

Question3

Will CGT event K6 under section 104-230 apply on the disposal of the pre-CGT shares in the Company?

Summary

CGT event K6 will not apply on the sale of shares in the Company as the condition in paragraph 104-230(1)(d) is not satisfied.

Detailed reasoning

48.         Shares in a company are a CGT asset as defined in section 108-5.

49.         CGT event A1 happens if you dispose of a CGT asset.[16] You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law.[17] The time of the event is when you enter into a contract for the disposal, or, if there is no contract, the time of disposal is taken to be the time when the change in ownership occurs.[18]

50.         Generally, capital gains derived from the sale of assets that are acquired prior to 20 September 1985 (pre-CGT) are disregarded for CGT purposes.[19] However, special rules apply to pre-CGT shares in a company where 75% or more of the company's net value is made up of property acquired on or after 20 September 1985 (post-CGT property).[20] In these circumstances, a capital gain may arise at the time that a CGT event happens to the pre-CGT interests because of the special rules in respect to CGT event K6.

51.         Under subsection 104-230(1), CGT event K6 happens when:

(a)          you own shares in a company or an interest in a trust you acquired before 20 September 1985,

(b)          CGT event A1, C2, E1, E2, E3, E5, E6, E7, E8, J1 or K3 (the other CGT event) happens in relation to the shares or interest in the trust,

(c)           there is no roll-over for the other CGT event, and

(d)          the '75% test' in subsection 104-230(2) is satisfied.

52.         As all the shares in the Company were issued to and there has been no change in the ownership of the shares since incorporation, the first condition in paragraph 104-230(1)(a) is satisfied.

53.         As CGT event A1 will happen when ownership of the shares in the Company is transferred from Taxpayers to the acquirer, the condition in paragraph 104-230(1)(b) is satisfied.

54.         Generally, a rollover would not extend to a disposal of shares that were acquired before 20 September 1985. However, exchange of pre-CGT shares may result in a capital gain under CGT event K6 to which subsection 104-230(10) would apply. In this case, as the Taxpayers are not contemplating any arrangement to rollover the shares, the condition in paragraph 104-230(1)(c) is satisfied.

55.         The final condition in paragraph 104-230(1)(d) requires the satisfaction of one of the requirements in subsection 104-230(2). As the Company does not hold any interest through another company or trust that it owns, the applicable requirement in this case is set out in paragraph 104-230(2)(a). To satisfy this requirement, just before CGT event A1 happened in relation to the disposal of the shares in the Company, the market value of the property of the Company (that is not its trading stock) that was acquired on or after 20 September 1985 must be at least 75% of the Company's net value.

56.         The term 'property' is not specifically defined for the purpose of CGT event K6, although trading stock is specifically excluded. Taxation Ruling TR 2004/18 - capital gains: application of CGT event K6 (about pre-CGT shares and pre-CGT trust interests) in section 104-230 of the Income Tax Assessment Act 1997 states:

51. Property in section 104-230 has its ordinary legal meaning.

....

53. It extends to any kind of property. It covers most CGT assets, including pre-CGT assets, but does not include a CGT asset that is not property. It can include....land and buildings, shares in a company, units in a trust, options debts owed to the company, interest in assets and goodwill.

54. On the other hand, the ordinary meaning of 'property' excludes personal rights such as a contractual right revocable at will by the other party: Austell Pty Ltd v. Commr of State Taxation (WA) and, possibly non-assignable rights under an employment contract: Hepples v. Commissioner of Taxation.

57.         Ordinarily, property encompasses tangible items and intangible rights that are capable of being transferred or assigned between parties in respect of which the law recognises legally enforceable rights of ownership. While tangible property is generally associated with items that have a physical presence such as land and buildings, intangible property on the other hand, such as a bundle of rights, is often difficult to identify but nevertheless property for CGT event K6 purposes.

58.         Based on information provided, the percentage of the total market value of the Company's properties that were acquired after 20 September 1985 is below the 75% test. Therefore, the requirement in paragraph 104-230(2)(a) is not satisfied, and as a consequence the condition in paragraph 104-230(1)(d) is not met. Accordingly, CGT event K6 will not apply when the Taxpayers dispose of their shares in the Company.

[1] Paragraph 25 of TR 1999/16.

[2] Paragraph 96 of TR 1999/16.

[3] Paragraph 14 of TR 1999/16.

[4] Paragraph 17 of TR 1999/16.

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

[6] Paragraph 52 of TR 1999/16.

[7] Paragraphs 21 - 24 of TR 1999/16.

[8] Paragraph 93 of TR 1999/16.

[9] Paragraph 24 of TR 1999/16.

[10] Paragraph 94 - 95 of TR 1999/16.

[11] Paragraph 60 of TR 1999/16.

[12] Paragraph 61 of TR 1999/16.

[13] Paragraph 63 of TR 1999/16.

[14] Subsection 149-15(1).

[15] Subsection 149-15(2).

[16] Subsection 104-10(1).

[17] Subsection 104-10(2).

[18] Subsection 104-10(3).

[19] see paragraph 104-10(4)(a).

[20] see section 104-230.