Private ruling: Capital Gains Tax and event K6
Date of advice: 24 August 2015
Published: August 2015
Ruling period: 1 July 2015 to 30 June 2016 | 1 July 2016 to 30 June 2017 | 1 July 2017 to 30 June 2018

Ruling: Question and answer | Will CGT event K6 apply to the sale of shares in the company? | No.

Relevant facts and circumstances: Pre 20 September 1985 and prior to establishing the Company, director 1 was appointed to establish a new product. Subsequent to this appointment and pre 20 September 1985, director 1 incorporated the Company. Director 1 and Director 2 are shareholders of the Company. The issued shares in the Company are beneficially owned equally, and there have been no changes to the shareholding in the Company since its incorporation. The shares in the Company were issued prior to 20 September 1985. The core of the Company's business since inception has been the development and sale of a product to businesses. The Company developed and installed an in-house product. The design, technology, know-how and intellectual property, underlying this product, together with director 1's experience, underpins the Company's goodwill and forms the basis of the Company's ongoing business activities. The original product was further developed. Since inception, the Company has provided its customers with product solutions, using the same original concept and the functionality of the original product which was designed. This product has been the basis for the Company's reputation and the goodwill of its customers. In order to diversify the marketability of the core product and to expand the Company's business, the product has been adapted and improved over time to enable the business to continue to sell the same product successfully over a number of decades. The Company operates in the fast-changing technology sector and ongoing development of the product is necessary to have continued relevance in their key markets. The Company has been highly successful in accommodating the shifts over time. There are three main brands under which the Company has sold its core product from inception to date. Over the last several years, the majority of the Company's revenue has been derived from two of the products. The Company continues to service a number of clients in relation to the original product, the amount of revenue derived from this product is relatively minor in comparison to the total revenue received. Based on the most recent balance sheet of the Company, the value of the Company's goodwill is a large proportion of its value.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 104-230

Reasons for decision: Summary: Summary CGT event K6 will not apply to the sale of shares in the Company. Detailed reasoning In accordance with section 104-230 of the Income Tax Assessment Act 1997 (ITAA 1997), Capital Gains Tax (CGT) event K6 occurs if: • You own shares in a company you acquired before 20 September 1985 • CGT event A1, C2, E1, E2, E3, E5, E6, E7, E8, J1, or K3 happens in relation to the shares • There is no roll-over for the other CGT event, and • The market value of the property of the company that it acquired on or after 20 September 1985 is at least 75% of the net value of the company. Director 1 and director 2 acquired their shares in the Company prior to 20 September 1985; CGT event A1 will happen when the directors dispose of their shares in the Company; and there will be no roll-over in relation to the CGT event A1. Based on the most recent balance sheet of the Company, the value of the Company's goodwill is a large proportion of its value. 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 states that the term 'property' for the purposes of CGT event K6 has its ordinary meaning, and will include goodwill. Therefore it is necessary to determine when the goodwill of the Company is considered to be acquired. Taxation ruling TR 1999/16 Income tax: capital gains: goodwill of a business discusses, amongst other matters, when goodwill is considered to be acquired. Taxation Ruling TR 1999/16 states at paragraph 17: 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 the business; or (b) there are fluctuations in goodwill during the life of the business. TR 1999/16 also recognises that a business or the sources of its goodwill may change so much that it can no longer be said to be the same business. (paragraph 18). TR 1999/16 further states: 20. Whether the same business is being carried on is a question of fact and degree that ultimately depends on the circumstances of each particular case. The test to use for whether the same business is being carried on is not the same test as that described in paragraphs 9 and 10 of Taxation Ruling TR 95/31 for continuity of business in applying the tax loss provisions in subsection 165-210(1). 21. The business does not need to be identical from its acquisition to its disposal. If the essential nature or character of the business is not changed, the business remains the same business for the CGT goodwill provisions. A business owner 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 of itself cause it to be a new business provided the business retains its essential nature or character. 22. Nor would it be a different business if all that happens is that portions of the operations of a business are discarded in an ordinary commercial way but the business retains its essential nature or character. 23. If the types of customers a business attracts change as the business evolves over the years, this does not necessarily mean the business is no longer the same business as was originally carried on. 24. It is not sufficient, however, if just a similar kind of business is carried on. It must be a business of the same essential nature or character that is carried on. 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. Additionally, TR 1999/16 states that the goodwill is a composite asset. That is, the whole of the goodwill of a business will either be a pre-CGT goodwill or post-CGT goodwill. It cannot be split into a pre-CGT and a post-CGT portion. (TR 1999/16 paragraph 25) Paragraphs 60 to 62 of TR 1999/16 discuss whether new goodwill is acquired when an existing business either expands, or commences a new business. Where a new business operation is merely the expansion of an existing business, any goodwill built up will be an expansion of the existing goodwill of the business. On the other hand, if the new business activity is a new business, the goodwill attaching to that business activity will be a new separate asset to the goodwill of the existing business. Whether or not a there is an expansion of an existing business or the introduction of a new business activity will be a question of fact dependent on the circumstances of each particular case. Paragraph 62 of TR 1999/16 provides the following factors that should be taken into account in determining whether there is merely an expansion of an existing activity or there is a new business activity commenced: • nature of the new business operation or activity, • types of customers that the business operation or activity attracts • extent to which the business operation or activity: • is subject to the same integrated management and control as the existing business • is treated for banking and accounting purposes as an extension of the existing business or as a separate business • uses one or more different trading names • is related to or dependent on the exiting business in a practical, economic or commercial sense. Furthermore, paragraph 93 of TR 1999/16 gives the example of a business of a printer that may change over time due various factors and as a result it may now attract a different type of clientele. Paragraph 93 explains that it is not a different business and the goodwill remains the same CGT asset. Paragraph 94 of TR 1996/16 make the comment that a change in the nature of the clients of a business does not of itself mean the business is a new business with new goodwill. Paragraph 94 further comments that ' Many businesses naturally evolve by serving different clients or clients in different markets and offering improved products or services' . In the current case, there are three main arms of the business operations of the Company. The applicant has stated that the three products subject to the same integrated management and control and are not regarded as separate businesses from an accounting or economic view point. This is supported by the fact that the financial statements produced by the company do not separately identify income and expenses in relation to any of these three products. Given that one of the products has no 'stand-alone' functionality to another of the products, it is accepted that these two products could not be considered to be a separate business activity/operation. Therefore it is necessary to consider whether the two products are a separate business operation to the original product. The applicant argues that, since inception, the Company has undertaken a 'business of providing product solutions to its customers'. The two products are merely an extension of the original product to adapt it for use in businesses. The independent valuation obtained has been based on the fact that the two products Intellectual Property was based on the initial product developed. There is no question that the Company has grown since its inception and that it has expanded the products offered. However the Company commenced with the original product has now expanded to include to other products. It is considered that the facts of this case point to the Company having grown and evolved since inception, however it is considered to be still the same business. Accordingly it is accepted that the goodwill of the business will be a pre-CGT asset of the business. Therefore, CGT event K6 will not apply to the sale of the shares in the Company.

Does Part IVA apply to this ruling?: Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable. | We have not considered the application of Part IVA to the arrangement you asked us to rule on.