Private ruling: Capital gains and consolidation - goodwill - sale of a business
Published: June 2013
Ruling period: Year ended 30 June 2010 | Year ended 30 June 2011 | Year ended 30 June 2012
Date scheme commenced: Year ended 30 June 2010

Ruling: Q1: Will the pre rules, as set out in Part 1 of Schedule 3 of the Tax Laws Amendment (2012 Measures No. 2) Act 2012 apply to the underlying assets of Company B on joining the Company A consolidated group? | A1: Yes. | Q2: If the answer to question 1 is YES, is the Y customer service agreement of Company B an asset that is treated as forming part of goodwill under subsection 701-63(3) of the pre rules? | A2: Yes. | Q3: To the extent that the answer to question 2 is YES, when Company A (as head company of the consolidated group) disposes of all of the rights and obligations associated with the sale of the Y customer service business, will Company A be entitled to include the goodwill deemed under subsection 701-63(3) of the pre rules in the cost base of the goodwill of that business for the purposes of working out the capital gain or loss pursuant to subsection 104-10(4) of the ITAA 1997? | A3: Yes.

Relevant facts and circumstances: Company A is the head company of a consolidated group. Company A acquired all the shares in Company B and joined the consolidated group before 12 May 2010. The assets of Company A include the Y customer service agreement. During the year ended 30 June 20XX, Company B entered into a Service Business Sale Contract with Company Z, an unrelated third party, to sell the Y customer service business. In addition to the assignment of the Y customer service agreement, the sale of the Y customer service business consisted of the transfer of all computer software utilised in the business, service agreements, plant and equipment, registered business names and domain names. Following the sale of the Y customer service business, no business activities are being undertaken by Company B.

Relevant legislative provisions: Income Tax Assessment Act 1997 (Tax Laws Amendment (2010 Measures No 1) Act 2010) | Income Tax Assessment Act 1997 , section 104-10 | Income Tax Assessment Act 1997 , subsection 104-10(4) | Income Tax Assessment Act 1997 , section 108-5 | Income Tax Assessment Act 1997 , subsection 108-5(2) | Income Tax Assessment Act 1997 , paragraph 108-5(2)(b) | Income Tax Assessment Act 1997 , paragraph 110-25(2)(a) | Income Tax Assessment Act 1997 , paragraph 110-25(2)(b) | Income Tax Assessment Act 1997 , section 701-10 | Income Tax Assessment Act 1997 subsection 701-55(5) of Tax Laws Amendment (2012 Measures No 2) Act 2012 (The Pre rules Part 1 in Schedule 3) | Income Tax Assessment Act 1997 section 701-63 of Tax Laws Amendment (2012 Measures No 2) Act 2012 (The Pre rules Part 1 in Schedule 3) | Income Tax Assessment Act 1997 subsection 701-63(2) of Tax Laws Amendment (2012 Measures No 2) Act 2012 (The Pre rules Part 1 in Schedule 3) | Income Tax Assessment Act 1997 paragraph 701-63(3)(c) of Tax Laws Amendment (2012 Measures No 2) Act 2012 (The Pre rules Part 1 in Schedule 3) | Income Tax Assessment Act 1997 subsection 701-63(4) of Tax Laws Amendment (2012 Measures No 2) Act 2012 (The Pre rules Part 1 in Schedule 3) | Income Tax Assessment Act 1997 , subsection 701-63(5) | Income Tax Assessment Act 1997 subsection 701-63(6) of Tax Laws Amendment (2012 Measures No 2) Act 2012 (The Pre rules Part 1 in Schedule 3) | Income Tax Assessment Act 1997 , section 705-35 | Income Tax Assessment Act 1997 subitem 50(1) of Tax Laws Amendment (2012 Measures No 2) Act 2012 (Application Part 4 in Schedule 3) | Income Tax Assessment Act 1997 subitem 50(2) of Tax Laws Amendment (2012 Measures No 2) Act 2012 (Application Part 4 in Schedule 3) | Income Tax Assessment Act 1997 subitem 50(3) of Tax Laws Amendment (2012 Measures No 2) Act 2012 (Application Part 4 in Schedule 3) | Income Tax Assessment Act 1997 , subsection 995-1(1)

Reasons for decision: Summary: The pre rules, as set out in Part 1 of Schedule 3 of the Tax Laws Amendment (2012 Measures No. 2) Act 2012 will apply to the underlying assets of Company B on joining the Company A consolidated group. | Detailed Reasoning - Detailed reasoning: The application rules in TLAA 2012 No.2 are relevant in ascertaining which rules apply to the head company of a consolidated group in respect of an entity that becomes a member of that group at a particular time. Subitem 50(1) provides that: The pre rules, interim rules or prospective rules apply to an assessment of the head company of a consolidated group or MEC group for an income year in respect of an entity (the joining entity ) that becomes a member of the group at a time (the joining time ), in accordance with subitems (2), (3), (4) and (5). Subitem 50(2) provides that: The pre rules apply, for the income year in respect of the joining entity, if: (a) the joining time is before 12 May 2010; or (b) the arrangement under which the entity joined the group commenced (see item 52) before 10 February 2010). Subitem 50(3) provides for an exception to the pre rules, allowing the interim rules to apply, for the income year in respect of the joining entity, if: both of these conditions are satisfied: (i) apart from this subitem, the pre rules would apply, for the income year in respect of the joining entity, in accordance with subitem (2); (ii) the head company's latest notice of assessment, for the income year, that relates to the application of the original 2010 law in respect of the joining entity, was served on the head company by the Commissioner on or after 12 May 2010 an on or before 30 March 2011; or (a) both of these conditions are satisfied: (i) the joining time is on or after 12 May 2010; (ii) the arrangement under which the joining entity joined the group commenced (see item 52) on or after 10 February 2010 and on or before 30 March 2011. Subitem 50(5) also provides for an exception from the pre rules applying. It states: Despite subitems (2) and (3), the original 2002 law applies, for the income year in respect of the joining entity, if the head company's latest notice of assessment, for the income year, that relates to the application of subsection 701-55(6) of the original 2002 law in respect of the joining entity, was served on the head company by the Commissioner before 12 May 2010. On the basis of the facts, the exceptions contained in subitems 50(3) and 50(5) do not apply to Company A. Therefore, in accordance with subitem 50(2)(a), the pre rules apply to Company A on the basis that Company B joined the Company A consolidated group before 12 May 2010. | Summary: The Y customer service agreement of Company B is an asset that is treated as forming part of goodwill under subsection 701-63(3) of the pre rules. | Detailed Reasoning - Detailed reasoning: The consolidation provisions in Part 3-90 apply to an entity that becomes a member of a consolidated group. Under the pre rules, certain assets are treated as forming part of goodwill. Subsection 701-63(3) of the pre rules provides that: An asset forming part of goodwill means any of the following: (a) an intangible asset, the value of which is attributable to expected future profits from *life insurance policies or *general insurance policies; (b) a customer relationship asset, know-how asset or other accounting intangible asset, that is not any of the following: (i) a *CGT asset; (ii) a *revenue asset; (iii) a *depreciating asset; (iv) *trading stock; (v) a thing that is or is part of a *Division 230 financial arrangement; (vi) goodwill; (vii) an excluded asset for the purposes of section 705-35; (c) a *non-deductible right to future income. Relevant to this ruling is whether the rights under the Y customer service agreement are non-deductible rights to future income that are subject to paragraph 701-63(3)(c). In accordance with subsection 701-63(4), a non-deductible right to future income is a *right to future income that is not an *unbilled income asset. Subsection 701-63(5) defines a right to future income as: …a valuable right (including a contingent right) to receive an amount for the performance of work or services or the provision of goods if: (a) the valuable right forms part of a contract or agreement; and (b) the *market value of the valuable right (taking into account all the obligations and conditions relating to the right) is greater than nil; and (c) the valuable right is neither a *Division 230 financial arrangement nor part of a Division 230 financial arrangement. Under subsection 701-63(6) an asset that is a *right to future income is an unbilled income asset if: (a) the asset: (i) is in respect of work (but not goods) that has been performed, or partially performed, by an entity for another entity; or (ii) is in respect of goods (other than *trading stock) or services that have been provided, by an entity to another entity; and (b) a recoverable debt has not yet arisen in respect of the work, goods or services. Whilst the Y customer service agreement can be viewed as a right to future income asset on the basis that it represents a valuable right held by Company B as a result of entering into a contract for the provision of work or services, it cannot be said to be an unbilled income asset as it is not in respect of services that have been provided but rather in respect of services that will be provided in the future. Therefore, the asset (represented by the rights under the Y customer service agreement) that is a right to future income is a non-deductible right to future income that forms part of the goodwill asset of Company B's Y customer service business. For the purposes of Part 3-90, the goodwill asset of Company B's Y customer service business is treated as a single asset. Relevantly, subsection 701-63(2) provides: For the purposes of this Part (other than this section): (a) treat goodwill of a business of the joining entity as a single asset; and (b) treat an asset of that business of the joining entity that is an *asset forming part of goodwill as being part of that single asset; and (c) as a result of paragraph (b), do not treat an asset of that business of the joining entity that is an asset forming part of goodwill as a separate asset. The Explanatory Memorandum to Tax Laws Amendment (2012 Measures No.2) Bill 2012 (the EM) at paragraph 3.53 clarifies that the assets which are treated as part of the goodwill of a business may include: · some assets which are already legal goodwill under general principles; and · some assets which are not legal goodwill. Section 701-10 requires a head company to set the tax costs of each asset that would be an asset of the entity at the time it becomes a subsidiary member of the consolidated group. For the purposes of this tax setting process, the assets that are treated as forming part of goodwill under subsection 701-63(3) of the pre rules will not be separately recognised. Instead, they will be treated as forming part of the goodwill asset of a business of the joining entity which will have its tax cost set at the joining time in accordance with section 701-10. Therefore, the goodwill asset of Company B's Y customer service business (which includes the non-deductible right to future income) will have its tax cost set at the joining time in accordance with section 701-10. | Summary: A consequence of deeming the goodwill of the business to include the non-deductible right to future income is that this asset will be reflected in the cost base/reduced cost base of the goodwill of that business for the purposes of working out the capital gain or loss pursuant to subsection 104-10(4) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Taxation Ruling TR 1999/16 explains how the CGT provisions apply to goodwill assets. One consequence of applying that ruling is that the tax costs allocated to a goodwill asset (through the asset tax cost setting process in Part 3-90) will be recognised when the goodwill asset is sold. In relation to TR 1999/16 the EM at paragraph 3.61 states: The Taxation Ruling also states that the goodwill of a business is a single CGT asset (paragraph 16). However, the Taxation Ruling also discusses the issue as to whether there is a disposal of goodwill on a disposal of one of several businesses or on the disposal of something less than a business (paragraphs 70 to 79). 'If a business owner is carrying on more than one business, each business has its own separate goodwill and each business may be disposed of along with the goodwill attaching to it.' (Paragraph 73 of Taxation Ruling TR 1999/16) 'If a business owner is carrying on one business and disposes of some part of that business, it is a question of fact as to whether the owner has disposed of a discrete business that a purchaser could conduct or has merely disposed of a business asset or a collection of business assets. …If a business owner disposes of part of their business, an important consideration is whether the effect of the transaction is to put the purchaser in possession of a going concern the activities of which the purchaser could carry on without interruption.' (Paragraph 74 of Taxation Ruling TR 1999/16) Relevant to Company A's disposal of the Y customer service business is paragraph 77 of TR 1999/16 which states: 'If the part of the business sold constitutes a discrete business and it is sold as a business, the sale includes a disposal of goodwill. There must be a sale of sufficient assets including goodwill to enable a purchaser to carry on the business the vendor did previously without interruption.' The disposal of a business or even part of a business may result in the transfer of goodwill. Paragraph 143 in the explanations section of TR 1999/16 states: 'If a business owner (whether a sole trader or practitioner, a company, a trustee of a trust estate) disposes of: (a) their entire business; (b) a part of their business (in the sense of a particular business operation or activity) that is a discrete business in its own right; or (c) an interest in their business (e.g., by admitting a partner) goodwill may be transferred with that disposal.' The Y customer service business is a discrete business that has been disposed of, which in essence was part of the Company A's wider business. The business disposed of was an entire, self-contained business that the purchaser can conduct without interruption. Consequently, goodwill that attaches to this business has also been disposed of as part of the sale of the business. That goodwill asset includes assets that have been treated as forming part of goodwill under subsection 701-63(3). | Detailed Reasoning - Capital gains tax and cost base of goodwill: Paragraph 108-5(2)(b) specifically lists goodwill or an interest in it as a CGT asset. As goodwill is a CGT asset, subsection 701-55(5) will apply to specify how the reset tax cost of goodwill is used in Part 3-1 or 3-3 (the CGT provisions). Subsection 701-55(5) provides: If Part 3-1 or 3-3 is to apply in relation to the asset, the expression means that the Part applies as if the asset's *cost base or *reduced cost base were increased or reduced so that the cost base or reduced cost base at the particular time equals the asset's *tax cost setting amount. The CGT provisions apply such that the asset's cost base or reduced cost base at the joining time is equal to the asset's tax cost setting amount. The tax cost setting amount of the goodwill asset will reflect the inclusion of the non-deductible right to future income because of the operation of section 701-63 of the pre rules. Therefore, for the purposes of calculating the capital gain on disposal of the assets of the business pursuant to subsection 104-10(4), the first element of the cost base of the goodwill asset of the Y customer service business will include the Y customer service agreement asset that is treated as an asset forming part of goodwill under subsection 701-63(3) of the pre rules.

Reasons for decision: All legislative references in this Ruling are to the ITAA 1997 unless otherwise stated.