Private ruling: Pre-CGT status of goodwill
Date of advice: 5 December 2018
Published: March 2019
Ruling period: Year ending 20 June 2019
Date scheme commenced: 1 July 2018

Ruling: Q1: Is the current goodwill of Company A considered to be acquired before 20 September 1985 such that any capital gain or loss made on a disposal of the goodwill is disregarded pursuant to paragraph 104-10(5)(a) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: If there is a change in the majority underlying ownership in the pre-CGT goodwill of Company A, pursuant to section 149-30 of the ITAA 1997 as a result of the sale of the pre-CGT shares owned by Company B, will it be disregarded for the purposes of calculating a Capital Gains Tax (CGT) event K6 capital gain under section 104-230 when the shares of the remaining pre-CGT shareholders of Company B are sold? | A2: Yes

Relevant facts and circumstances: Company A is a family owned company. It has a number of key divisions. The business of Company A was established a considerable time before 1985 and is in its fourth generation of family management The current ownership of Company A is spread among the third and fourth generation via direct shareholding and indirect ownership through family trusts and a company, Company B. Company A has provided a number of services since the start of its business. Some parts of the business have increased slightly since 1985 however the core business activities have remained the same. More than 50% of the shares in Company A were acquired pre 19 September 1985, and are held by Company B and family trusts. The shareholders of Company A are considering the transition of ownership of the business to the new generation by the sale of the shares owned by Company B.

Relevant legislative provisions: 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 104-10(5) | Income Tax Assessment Act 1997 section 104-230 | Income Tax Assessment Act 1997 section 149-30

Reasons for decision: Summary: The current goodwill of Company A is considered to be acquired before 20 September 1985 such that any capital gain or loss made on a disposal of the goodwill is disregarded pursuant to paragraph 104-10(5)(a) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Goodwill, or an interest in it, is a CGT asset, pursuant to paragraph 108-5(2)(b) of the ITAA 1997. When goodwill is disposed of, CGT event A1 occurs pursuant to subsection 104-10(1) of the ITAA 1997. However, if the taxpayer acquired the goodwill before 20 September 1985, a capital gain or loss arising from the disposal of the goodwill will be disregarded, pursuant to subsection 104-10(5) of the ITAA 1997. The ATO view on goodwill for the purposes of CGT is explained in Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business (TR 1999/16), which discusses the implications of the decision of the High Court of Australia in FC of T v. Murry 98 ATC 4585; (1998) 39 ATR 129, (FC of T v Murry). Goodwill in TR 1999/16 is described as follows: ● 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. ● The meaning of goodwill has three different aspects namely property, sources and value. ● 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. A business owner cannot dispose of goodwill separately from the business to which it attaches. ● Goodwill is a composite thing. It is an indivisible item of property that is legally distinct from the sources from which it emanates. The whole of the goodwill of a business is either pre-CGT goodwill or post-CGT goodwill. 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 of ITAA 1997- about when an asset stops being a pre-CGT asset) provided the same business continues to be carried on. What goodwill means, depends on the character and nature of the business to which is attached. Goodwill differs in its composition in different trades or industries and in different businesses in the same trade or industry. A. When was the goodwill acquired? 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 result 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. The business of Company A was established sometime before 1985 with a number of core service offerings. The core service offerings remain the same, with some supplementary services added through the years as the commercial environment and government regulations changed. Therefore the goodwill of Company A was acquired before 19 September 1985. B. Is the same business being carried on? A business may change to such an extent that it becomes a new business with new goodwill. In FC of T v 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. Paragraphs 21 - 24 of TR 1999/16 state that if the essential nature or character of the business is not changed, the business remains the same business for 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 it retains its essential nature or character. Organic growth, expansion or diversification of a business by, for example: ● adopting new, compatible operations; or ● servicing different clients; or ● offering improved products or services does not of itself cause it to be new business provided the business retains its essential nature or character. 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 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. Paragraphs 60 – 62 of TR 1999/16 discuss internally generated goodwill and state the following: 60. If a new business operation or activity introduced by a taxpayer is an expansion of an existing business (whether it commenced before or after 20 September 1985), any goodwill built up in conducting the expanded business is merely an expansion of the existing goodwill of the business. If a business which commenced before 20 September 1985 (a “pre-CGT business”) is expanded, goodwill generated in conducting the expanded business is merely an accretion to the pre-GGT goodwill. 61. 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. 62. Whether an increase in business operations or in 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. The question of whether a business has changed 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 is one of fact and degree. The following factors have to be considered as set out in paragraph 91: ● 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; and ● the way in which the business is structured, carried on, managed and controlled. The nature and character of Company A’s business remains essentially unchanged since September 1985. Expansion has been organic and new service offerings were introduced to complement its core business offerings. The general category of the clients of Company A remains unchanged and long term relationships with clients are maintained. The workforce of Company A has not changed dramatically, with some employees including drivers and the safety officers having worked for Company A since before 1985. The income generated from new service offerings introduced by Company A since 1985 are supplemental and not its main source of income. Company A has not acquired any other businesses and it continues to operate only in one state. Company A is a family business and in its third generation of family management. There is no evidence of substantial change in the way in which the business is carried on, managed and controlled. The changes in structure and assets were not sufficient to alter the nature of the business. All of the above lead to the conclusion that the same business is carried on. C. The nature and character of the business Paragraph 93 of TR 1999/16 states that for the CGT goodwill provisions, the same business is carried on and no new goodwill asset is created if the business retains its same essential nature or character. It offers the following example: A business of a printer may have changed over time due to the purchase of new equipment and the adoption of improved technologies. The printer may now attract a different type of client such as large corporate clients (due to the capacity to produce high quality public relations material, annual reports, etc.). Formerly, the printer may only have provided services to small local businesses (e.g. business cards, calendars, invoice books and stationery.) No new business has been commenced. It is not a different business and the goodwill remains the same CGT asset. The printer is still conducting a printing business of the same essential nature or character, albeit one serving different clients. Businesses may naturally evolve by serving different clients or clients in different markets and offering improved products or services). 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. In the case of Company A the facts support a conclusion that the nature and character of the business has remained the same. Any expansion of the business has been organic. The core business and client categories of Company A have remained the same as before 19 September 1985. | Detailed Reasoning - Conclusion: The current goodwill of Company A is considered to be acquired before 20 September 1985 such that any capital gain or loss made on a disposal of the goodwill is disregarded pursuant of paragraph 104-10(5)(a) of the ITAA 1997. | Summary: If there is a change in the majority underlying ownership in the pre-CGT goodwill of Company A, pursuant to section 149-30 of the ITAA 1997 as a result of the sale of the pre-CGT shares owned by Company B, it will be disregarded for the purposes of calculating a CGT event K6 capital gain under section 104-230 when the shares of the remaining pre-CGT shareholders of Company A are sold. | Detailed Reasoning - Detailed reasoning: Section 104-230 of ITAA 1997 states the following: (1) CGT event K6 happens if: (a) you own shares in a company or an interest in a trust you acquired before 20 September 1985; and (b) CGT event A1, C2, E1, E2, E3, E5, E6, E7, E8, J1 or K3 happens in relation to the shares or interest; and (c) there is no roll-over for the other CGT event; and (d) the applicable requirement in subsection (2) is satisfied. (2) Just before the other event happened: (a) the market value of property of the company or trust (that is not its trading stock) that was acq uired on or after 20 September 1985; or (b) the market value of interests the company or trust owned through interposed companies or trusts in property (except trading stock) that was acquired on or after 20 September 1985; must be at least 75% of the net value of the company or trust. (5) The time of CGT event K6 is when the other event happens. (6) You make a capital gain equal to that part of the capital proceeds from the share or interest that is reasonably attributable to the amount by which the market value of the property referred to in subsection (2) is more than the sum of the cost bases of that property. Taxation Ruling TR 2004/18 Income tax: 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 (TR 2004/18) states at paragraph 14 that the item of property is acquired at the time the ITAA 1936 or ITAA 1997 treats the CGT asset as having been acquired. However paragraph 15 states the following: An exception applies where the CGT asset is treated as having been acquired post-CGT because of the operation of Division 149 of the ITAA 1997. In this case, the item of property continues to be treated as having been acquired pre-CGT for the purposes of CGT event K6. Therefore, for the purposes of calculating a CGT K6 event capital gain after the sale by Company B of the shares that it owned in Company A, any change in majority underlying ownership that resulted from the application of Division 149 of the ITAA 1997 at the time of the disposal by Company B, will be ignored.