Private ruling: Capital gains tax implications on disposal of business
Published: June 2012
Ruling period: Year ended 30 June 2012 | Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015
Date scheme commenced: 1 July 2011

Ruling: Q1: Is the total amount you received on the disposal of your interest in the goodwill on the sale of an entire discrete business assessable under the capital gains tax (CGT) provisions in the 2011-12 financial year? | A1: Yes | Q2: Are you entitled to apply the 50% active asset reduction on any capital gain made on the disposal of the goodwill of the business? | A2: Yes | Q3: Are you entitled to apply the 50% CGT discount on any capital gain made on the disposal of the goodwill of the business? | A3: Yes | Q4: Is the total amount you received for the disposal of the tools as part of the sale of an entire discrete business assessable as ordinary income in the 2011-12 financial year? | A4: Yes | Q5: Is the interest component received on top of your monthly payments considered to be ordinary income and assessable in the financial year in which it is received? | A5: Yes

Relevant facts and circumstances: You run a business under a partnership structure In the 2011-12 financial year, you sold half your client list and some tools to another business. You state that the portion of the business was considered a discrete business in itself and the new owners run it that way. You continue to operate your business with your remaining clients. The sale price consisted of an amount for goodwill and an amount for tools. The buyers paid an amount upfront and will pay the remaining balance in monthly instalments over a period of years, including interest. The business activity began in the 2006-07 financial year (as a sole trader activity), the business was not purchased from another entity. The business has been operating as a partnership since the 2008-09 financial year. You state that you meet the small business entity test.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 108-5(1) | Income Tax Assessment Act 1997 Subsection 108-5(2) | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 152-10 | Income Tax Assessment Act 1997 Section 152-15 | Income Tax Assessment Act 1997 Subsection 152-10(1A) | Income Tax Assessment Act 1997 Section 152-35 | Income Tax Assessment Act 1997 Section 152-40 | Income Tax Assessment Act 1997 Subsection 152-40(1) | Income Tax Assessment Act 1997 Section 115-25 | Income Tax Assessment Act 1997 Section 110-25 | Income Tax Assessment Act 1997 Section 110-35 | Income Tax Assessment Act 1997 Section 109-10 | Income Tax Assessment Act 1997 Section 106-5 | Income Tax Assessment Act 1997 Section 102-5 | Income Tax Assessment Act 1997 Section 40-30

Reasons for decision: Summary: The disposal of your interest in the goodwill on the sale of an entire discrete business is assessable under the capital gains tax provisions in the 2011-12 financial year as you have disposed of a CGT asset (goodwill) in that financial year. You are entitled to reduce your capital gain on the disposal of goodwill by the 50% CGT discount as you have owned the asset (goodwill) for a period of at least 12 months prior to the disposal. You are entitled to reduce your capital gain on the disposal of goodwill by the 50% active asset reduction concession as you satisfy all the necessary conditions. Any gain made on the disposal of the tools as part of the sale of the business is treated as ordinary income (and any loss is treated as a deduction) as the tools are a depreciating asset used in the business. The interest component of the instalment payments to be received over the next three years is assessable as ordinary income in the financial year in which each interest payment is received. | Detailed Reasoning - Detailed reasoning:: Disposal of goodwill (non-depreciating asset) Subsection 108-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a capital gains tax (CGT) asset is: (a) any kind of property; or (b) a legal or equitable right that is not property. Subsection 108-5(2) of the ITAA 1997 defines a CGT asset to include 'goodwill'. Section 104-10 of the ITAA 1997 provides that CGT event A1 occurs when your ownership in a CGT asset (eg. goodwill of a business) is transferred to another entity. 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 (not when settlement or payment occurs). Taxation Ruling TR 1999/16 discusses capital gains and the goodwill of a business. Paragraph 143 of the ruling explains that if a business owner disposes of their entire business; a part of their business (that could be considered a discrete business in its own right); or an interest in their business, goodwill may be transferred with that disposal. Example 10 at paragraphs 187-191 of Taxation Ruling TR 1999/16 provides details of a situation in relation to the disposal of goodwill by partners. 187. Rita and Daryl carry on a lawn mowing business in partnership. The partnership mows lawns in two suburbs of Perth, Leederville and Subiaco. 188. Rita and Daryl decide to reduce their workload and sell for $40,000 their lawn mowing round in Subiaco, including cylinder and rotary lawn mowers and customer records of cutting schedules and other requirements. They enter into a sale contract in which they undertake not to solicit the business of their Subiaco customers. The Subiaco round is capable of being conducted by a purchaser as a discrete - though small - business in its own right. An amount of $25,000 is allocated in the sale contract as capital proceeds for goodwill. 189. Rita and Daryl continue to mow lawns in Leederville. 190. How should the amount of $12,500 Rita receives for her interest in the goodwill be treated for Part 3-1 purposes? 191. Daryl and Rita have disposed of their entire interests in a discrete business along with their interests in its goodwill. Rita makes a capital gain of $12,500 on the disposal of her interest in the goodwill of the Subiaco business. In your case, you have disposed of a CGT asset (goodwill) in the 2011-12 financial year, when change of ownership occurred. Accordingly, any capital gain made on disposal of the goodwill is taken to have occurred in the 2011-12 financial year. | Detailed Reasoning - Cost base for a CGT asset: You make a capital gain from the disposal of an asset if the amount of money you received on the disposal was more than the cost base of the asset. Section 110-25 of the ITAA 1997 provides that there are five elements of the cost base; · money paid, or market value of property given, to acquire the asset · incidental costs of acquiring the asset, or that relate to the CGT event that happens to the asset · certain non-capital costs of ownership · capital expenditure on improvements · capital expenditure in respect of title or right to the asset Section 110-35 of the ITAA 1997 provides that incidental costs include remuneration for the services of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal adviser. Small business CGT concession eligibility and the active asset test Section 152-10 of the ITAA 1997 contains the basic conditions you must satisfy to be eligible for the small business capital gains tax (CGT) concessions. These conditions are: · a CGT event happens in relation to a CGT asset in an income year. · the event would have resulted in the gain · at least one of the following applies: · you are a small business entity for the income year · you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997 · you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership or · the conditions in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year. · the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997. Section 152-40 of the ITAA 1997 provides the meaning of 'active asset'. A CGT asset will be an active asset at a time if, at that time, you own the asset and the asset was used or held ready for use by you, an affiliate of yours, or by another entity that is 'connected with' you, in the course of carrying on a business. However, an asset whose main use is to derive rent, can not be an active asset. Section 152-35 of the ITAA 1997 explains that an asset will be an active asset if you have owned the asset for more than 15 years and it was an active asset for a total of at least 7 ½ years from the time when you acquired the asset until the CGT event. Or, you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the time from when you acquired the asset until the CGT event. Subsection 152-40(1) of the ITAA 1997 provides that an asset is an active asset if the asset is an intangible asset you own and is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or an entity connected with you. Goodwill is an asset that is considered to be inherently connected with a business. As the CGT asset (goodwill) disposed of is considered to be an active asset, and you satisfy the remaining basic conditions for the small business concessions, you are entitled to the 50% active asset reduction on the capital gain made in relation to the disposal. 50% CGT discount A 50% discount may be applied to a discount capital gain realised by an individual. In order to be considered a discount capital gain, the asset that gave rise to the capital gain must have been owned for a period of at least 12 months prior to the CGT event (section 115-25 of the ITAA 1997). A capital gain attributable to goodwill may also qualify for the CGT discount. Where a taxpayer commences carrying on a business or internally generates goodwill, it must be considered when the CGT asset (goodwill) was acquired. Section 109-10 of the ITAA 1997 provides that you acquire a CGT asset that you construct or create, when the construction, or work that resulted in the creation, started. Therefore, as the partnership began in the 2008-09 financial year, this is the time that construction, or work that resulted in the creation of the CGT asset (goodwill), started. Accordingly, as the CGT asset has been held for a period of at least 12 months prior to its disposal, you are entitled to apply the 50% CGT discount to any capital gain made on disposal of the goodwill. | Detailed Reasoning - Calculating your capital gain: You make a capital gain from the disposal of an asset if the amount of money you received on the disposal was more than the cost base of the asset. Section 106-5 of the ITAA 1997 discusses capital gains in relation to partnerships. It provides that any capital gain from a CGT event happening to a partnership asset is made by the partners individually, with each partner's gain calculated by reference to the partnership agreement, or partnership law if there is no agreement. Each partner has a separate cost base for the partner's interest in the CGT asset of the partnership. Section 102-5 of the ITAA 1997 outlines a method statement for calculating a net capital gain. This amount is then included in the taxpayer's assessable income. A net capital gain is essentially the result of the following process: · the sum of the taxpayer's individual capital gains for the income year · less any capital losses made in the income year and previously unapplied net capital losses from earlier income years · adjusting for any concessions (such as the discount capital gain concession and the small business concessions). After applying any capital losses, individuals eligible for both the CGT discount and the small business 50% active asset reduction can reduce a capital gain by 75% (that is, by 50% then 50% of the remainder). | Detailed Reasoning - Example:: Ken is a small business operator who sells an active asset that he has owned for more than 12 months. He makes a capital gain of $20,000. Ken also has a separate capital loss of $4,000. Assuming he satisfies all the conditions for the CGT discount and the small business 50% active asset reduction, Ken calculates his net capital gain as follows: Capital gain Capital loss Take the loss away from the gain. $20,000 $4,000 $16,000 Apply 50% CGT discount. $8,000 $8,000 Apply 50% small business active asset reduction Reduced capital gain $4,000 $4,000 | Detailed Reasoning - Disposal of tools (depreciating assets): Section 40-30 of the ITAA 1997 defines a depreciating asset as an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used, but does not include intangible assets such as goodwill. If you use a depreciating asset for a taxable purpose (for example, in a business) any gain you make on the disposal of it is treated as ordinary income and any loss as a deduction. It is only when a depreciating asset has been used for a non-taxable purpose (for example, used privately) that you can make a capital gain or capital loss on it. Accordingly, the tools sold on disposal of the business are considered depreciating assets and therefore any gain (or loss) on the sale of the tools is assessed as ordinary income (or is a deduction). | Detailed Reasoning - Interest component: Section 6-5 of the ITAA 1997 provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income). Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business. Other characteristics of income that have evolved from case law include receipts that: · are earned · are expected · are relied upon, and · have an element of periodicity, recurrence or regularity. Interest is, generally speaking, income according to ordinary concepts. Interest received that is expected, relied upon and has an element of regularity display the characteristics of ordinary income. In addition, interest received in compensation for the loss of the use of the capital proceeds (to which you are entitled) during a period in which the proceeds would possibly earn income, is also considered ordinary income. Therefore, the interest component of the payment will be assessable as ordinary income under section 6-5 of the ITAA 1997 in the financial year in which it is received.

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