Private ruling: Goodwill of the business – whether pre-CGT asset
Date of advice: 27 February 2018
Published: June 2018
Date scheme commenced: 1 July 20xx

Ruling: Q1: Is the capital gain made on disposal of the business’s goodwill, including its customer relationships, disregarded pursuant to paragraph 104-10(5)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) by reason of that goodwill having been acquired before 20 September 1985? | A1: Yes. The period for which the ruling applies: 1 July 20xx to 30 June 20xx

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. X Pty Ltd is a family owned company incorporated before 20 September 1985 conducting its business in a particular geographical area in Australia (the Business). For several generations, the control and management of X Pty Ltd that conducted the Business had been in the hands of the same family (Family) and several key members of the staff. The Business consisted of producing and supplying a particular product (the Product) that was invented by a member of the Family that led the company for many years until the offspring took over. The Product received instant popularity among the targeted customers because of its usefulness in their particular trade. To keep up with the changing technology and consequent changes in the trade practices, X Pty Ltd focused on research and development activities. As a result, the Product evolved over time. It received number of awards at the national level that acknowledged the quality of the Product. By building up its reputation as a quality producer and reliable service provider, X Pty Ltd created a strong and loyal customer base for the Business which remained constant until the Business was sold post-CGT. Although X Pty Ltd exported the Product to several overseas markets, its main customer base remained constant within the particular geographical areas in Australia. It also had its management, research and development, production, distribution all conducted within a particular geographical locations within Australia to serve the same customer base. Although X Pty Ltd added a few products to its Business other than the Product, these products remained a minor percentage of its total sale and were phased out completely prior to the sale of the Business. Parallel to manufacturing the Product, X Pty Ltd started importing several items that were complementary to the Product and that were supplied to the same customer base. The decision to import those items instead of manufacturing them in Australia was part of X Pty Ltd’s business strategy to be cost effective. The branding and brand name under which the Product was sold remained constant prior to September 1985 to the date the Business was sold post CGT. While the imported items were sold under the name of the respective manufacturers, they were supplied under the banner of X Pty Ltd which provided the Business customers X Pty Ltd’s quality assurance. The distribution method that the Business employed prior to 20 September 1985 was maintained until the Business was sold post CGT. While X Pty Ltd acquired assets of couple of businesses after 20 September 1985, they were promptly absorbed into the Business. The majority underlying interest in X Pty Ltd remained with the Family at all time from its incorporation until the sale of the Business. When the Business was sold, it was sold in its entirety with all its assets, goodwill, trademark, licences and so on without any encumbrances whereby the buyer was able to continue the same business.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 104-5 | Income Tax Assessment Act 1997 section 108-5 | Income Tax Assessment Act 1997 section 149-10 | Income Tax Assessment Act 1997 section 149-15

Reasons for decision: Summary: All legislative references are to the ITAA 1997 unless otherwise specified . The capital gain made on disposal of the Business’s goodwill, including its customer relationships will be disregarded pursuant to paragraph 104-10(5)(a) of the ITAA 1997 by reason of that goodwill having been acquired before 20 September 1985. | Detailed Reasoning - Customer relationship is inseparable from goodwill: It is well established by case laws that customer relationship is part and parcel of goodwill of a business. Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business (TR 1999/16) explains the concept of goodwill relying on the decision by Gaudron, McHigh, Gummow and Hayne JJ in FC of T v. Murry 98 ATC 4585 ; (1998) 39 ATR 129. Paragraph 12 of TR 1999/6 states that: … 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. It may be site, personality, service, price or habit that obtains custom. It is more accurate to refer to goodwill as having sources than it is to refer to it as being composed of elements. Goodwill is a composite thing. It is one whole. It is an indivisible item of property that is legally distinct from the sources from which it emanates. 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. | Detailed Reasoning - Acquisition of goodwill: Paragraph 52 of TR 1999/16 states that: If a taxpayer commences business and starts to create goodwill, the goodwill of the business is acquired when the taxpayer starts work that results 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. | Detailed Reasoning - Goodwill as a CGT asset: A CGT asset is defined under subsection 108-5(1) as: (a) any kind of property; or (b) a legal or equitable right that is not property. The above is further elaborated under subsection 108-5(2) as: (a) part of, or an interest in, an asset referred to in subsection (1); (b) goodwill or an interest in it; (c) an interest in an asset of a partnership; (d) an interest in a partnership that is not covered by paragraph (c). | Detailed Reasoning - Goodwill, as a whole, is either a pre-CGT asset or a post-CGT asset: According to TR 1999/16, goodwill is established as a whole either as a pre-CGT asset or a post-CGT asset. Paragraph 25 states: The goodwill of a particular business cannot be characterised as partly pre-CGT goodwill and partly post-CGT goodwill. Goodwill is a composite asset. | Detailed Reasoning - Goodwill remains a single CGT asset if the same business continues: Paragraph 17 of TR 1999/16 states 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 the business; or (b) there are fluctuations in goodwill during the life of the business. | Detailed Reasoning - Division 149 – majority underlying interest in a CGT asset: Section 149-10 states in part as follows: 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) … Subsection 149-10(b) has been repealed by Tax Laws Amendment (Repeal of Inoperative Provisions) Act 2006 which now is dealt with by sections 149-30 and 149-35. According to section 149-30, the asset stops being a pre-CGT asset at the earliest time when the majority underlying interest is no longer held by the ultimate owners who held such interest in the asset immediately before 20 September 1985. Section 149-15 provides what constitutes a majority underlying interest in a CGT asset. It states as follows: 149-15(1) Majority underlying interests in a CGT asset consist of: (a) more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset; and (b) more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in any ordinary income that may be derived from the asset. 149- 15(2) 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. 149-15(3) An ultimate owner is: (a) an individual; or (b) a company whose constitution prevents it from making any distribution, whether in money, property or otherwise, to its members; or (c) the Commonwealth, a State or a Territory; or (d) a municipal corporation; or (e) a local governing body; or (f) the government of a foreign country, or of part of a foreign country. | Detailed Reasoning - Same business: A business may change to such an extent that it is no longer the same business which would mean the goodwill of the old business would cease when goodwill of new business is established. Paragraph 21 of TR 1999/16 states that: 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. Discussing when for example the essential nature or character of the business would remain the same, paragraph 22 of TR 1999/16 states that it would remain the same: … 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. A business will also not essentially change its nature or character according to paragraph 23 of TR 1999/16, which states: 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. When deciding whether a business has the same essential nature or character, a similar kind of business being carried on would be insufficient. The same business would not be carried on according to TR 1999/16 paragraph 24 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. Paragraph 91 of TR 1999/16 also provides important factors to consider when establishing the essential nature or character of the business. It states that consideration should be given, among others, to the following: ● 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 – whether the activities constitute, or are treated by the business owner as constituting separate or distinct activities, enterprises, divisions or undertakings ● the way in which a business is structured, carried on, managed and controlled. | Detailed Reasoning - Application to X Pty Ltd’s Business: The Product the Family member invented pre-CGT started the Business of X Pty Ltd which consisted of producing and supplying the Product to a specific customer base. In the course of Business, it earned the reputation of a quality producer and reliable service provider which created the goodwill of the Business among its customers. In addition, being a family-run Business, its constancy in mode of operation, management, decision-making added to that goodwill. All these had drawn the customer to the Business which was inseparable from the goodwill of the Business Since the Business was incorporated pre-CGT, the goodwill was also acquired pre-CGT. As a business strategy to be cost-effective, it imported products from overseas companies but they were complimentary to the Product and served the same customer base. Those products were sold under the name of the respective manufacturers alongside X Pty Ltd’s brand name and logo. While X Pty Ltd acquired assets of couple of competing businesses, they were quickly absorbed into the Business. Again, the management, mode of service delivery, location and decision-making of the Business had been constant from pre-CGT to the disposal of the Business post-CGT. Therefore, the essential nature and character of the Business was never lost and hence the same business continued from pre to post CGT. Again the majority underlying interest in X Pty Ltd held pre-CGT was maintained at all time by the Family until the disposal of the Business post-CGT. Therefore, the pre-CGT goodwill of the Business, including its customer relationship, is disregarded pursuant to paragraph 104-10(5)(a).