Private ruling: G oodwill, CGT event C1, section 6-5 ordinary income and Part IVA
Date of advice: 13 December 2019
Published: March 2020
Ruling period: Years ending 30 June 2018, 2019, 2020

Ruling: Q1: Will section 104-20 of the Income Tax Assessment Act 1997 (' ITAA 1997 ') apply in respect of goodwill associated with the business conducted by Company A if Proposal 1 is carried out? | A1: Yes. | Q2: Will the payment from Company C to Company A under Proposal 2 be treated as ordinary income of Company A under section 6-5 of the ITAA 1997 or statutory income under section 6-10 of the ITAA 1997? | A2: Yes. | Q3: Is Proposal 2 a scheme to which section 177D in Part IVA of the Income Tax Assessment Act 1936 (' ITAA 1936 ') applies? | A3: No. | Q4: If section 104-20 of the ITAA 1997 applies to goodwill associated with the business conducted by Company A under Proposal 1, will this result in a capital gain for Company A? | A4: No.

Relevant facts and circumstances: Overview 35. A group of companies (' The Group ') that is comprised of two separate but related corporate groups, ' the first group ' and ' the second group ', provides skilled labour to various industries for various projects. The first group and the second group are related in that they are ultimately owned by the same persons. 36. The first group comprises Company A as well as other companies. The second group comprises Company B and Company C as well as other companies. The first group Company A 37. When Company A was established it provided all labour hire across certain states in Australia until recently, at which point Company A began to only have a presence in State A. 38. When Company A successfully obtains a project, specific labour-hire workers are obtained from a database that is shared between The Group. 39. Currently, Company A has a mix of permanent and casual employees. All or most of Company A's employees are drawn from the database that is shared between the two groups. The second group 40. After sustained growth in the first group, the second group was established to conduct new business activities. Company B 41. For the past 12 months, Company B was conducting a labour hire business in the same vein as Company A, with several distinctions. 42. Company A and Company B use the same trademark and are thereby recognised as a part of the same group. 43. Currently, Company B has a mix of permanent and casual employees. All or most of Company B's employees are drawn from the database that is shared between the two groups. Company C 44. For approximately 10 years prior to incorporation, Company C's business operated as a division of Company A. Company C provides labour services for certain projects and events again different to all of the above mentioned projects. The Group - general overview Goodwill 45. The reputation of The Group has been established and developed over a period of approximately 25 years. Customers are attracted to The Group's branding as it represents the whole of The Group and signifies The Group's reputation and history. 46. The entities in both the first group and the second group use the same logo to attract custom and it is used royalty free by those members. 47. In particular, in tendering for an engagement, Company A uses The Group's relevant trademark and associated intellectual property. The recognised trademark, and the reputation it carries, attracts custom to Company A. Company A has accordingly benefited from the use of that branding. PROPOSAL 1 48. Broadly, it is proposed that the labour hire function currently undertaken by Company A will be replicated by Company B (within the second group). 49. Specifically: a) Company A will gradually stop providing contract and labour hire services. b) These services will be taken up by Company B, which will provide relevant labour hire services under contracts for new projects. In this regard, Company B will be the entity to which existing and future customers of Company A will contract in respect of their engagements with The Group. c) Furthermore, Company B will be the relevant entity that will hold employment contracts with workers and Company A will cease its employment contracts with workers. d) Company B will not be involved in, or be assigned, projects for which Company A is currently engaged. It will not carry on the business in partnership with Company A and instead will have an independent view to profit. PROPOSAL 2 50. If Proposal 1 is viable, Company A and Company C propose to enter into the following arrangement. Step 1 51. Company A will not be dissolved and it will instead take on the role of engaging workers and assigning those workers to work on projects on behalf of Company C. 52. Specifically: a) Individuals required by Company C to work on its projects will enter into employment contracts with Company A, not Company C. As the workers would be employed by Company A, they will receive their salary, along with the minimum employer superannuation contributions, from Company A. b) These workers will then be assigned by Company A to work on Company C's projects. c) In return, Company C will pay Company A a fee for that assignment. This fee is equal to the cost incurred by Company A for engaging those workers (which includes the amount of the workers' salary and superannuation entitlements, as well as payroll tax and workers compensation on-costs, plus long service leave fund and redundancy fund contributions where applicable). 53. The above is proposed to take place within a period of between 12 to 34 months. Step 2 54. On the condition that Proposal 1 is carried out and is both commercially and practically viable, it is further intended that the role taken by Company A under this proposal will eventually be adopted by Company B (within the second group). This means that Company B will thereafter have 2 roles: a) It will provide labour hire services. b) It will engage workers and assign those workers to work on projects on behalf of Company C. In return, Company C will pay Company B a fee for the assignment equal to the cost incurred by Company B for engaging those workers (which includes the amount of the workers' salary and superannuation entitlements, as well as payroll tax and workers compensation on-costs, plus long service leave fund and redundancy fund contributions where applicable). 55. It is submitted by the applicant that the main reason for the arrangement under Proposal 2 is to avoid the unintended consequence that, upon a strict reading of the clauses in the Company A Enterprise Agreement and Company C Enterprise Agreement, some workers may be entitled to receive two minimum weekly superannuation payments. Furthermore, in light of the continued growth of the first group and the second group, the ultimate owners of The Group seek to undertake a corporate reorganisation to further address concerns regarding liabilities with unrelated assets. In particular, they seek to align the income streams of business activities with assets used to produce that income and the liabilities used to fund those assets. Assumption Company A will not receive any payment in respect of the cessation of its labour hire operations under Proposal 1.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 104-20 | Income Tax Assessment Act 1997 section 104-25 | Income Tax Assessment Act 1997 section 725-145 | Income Tax Assessment Act 1997 subsection 995-1(1) | Income Tax Assessment Act 1936 Part IVA Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business | Taxation Ruling TR 94/8 Income tax: whether business is carried on in partnership (including 'husband and wife' partnerships) | Practice Statement Law Administration PSLA 2005/24 | American Leaf Blending Co Sdn Bhd v Director General of Inland Revenue (Malaysia) (1978) STC 561 | Federal Commissioner of Taxation v Dixon (1952) 86 CLR 540 | MIM Holdings Ltd v Federal Commissioner of Taxation 97 ATC 4420 | Blank v Commissioner of Taxation [2016] HCA 42 | Detailed reasoning | Question 1 | Summary | Section 104-20 of the Income Tax Assessment Act 1997 will apply in respect of goodwill associated with the business conducted by Company A if Proposal 1 is carried out. | The law | Meaning of goodwill | 60. A CGT asset includes 'goodwill or an interest in it' (paragraph 108-5(2)(b)). 'Goodwill' for the purposes of the capital gains tax provisions bears meaning from the common law and is considered at length in Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business (' TR 1999/16 '). | 61. With reference to the High Court of Australia's decision in FC of T v Murry 1998 , paragraph 85 of TR 1999/16 defines goodwill to mean: | a quality or attribute derived from the other assets of the business. Its existence depends on proof the business generates and is likely to generate earning from the use of the identifiable assets, locations, people, efficiencies, systems, processes and techniques of the business. It includes whatever adds value to a business... | ...Goodwill is property, and an asset of a business, because it is the right or privilege of the owner of a business to use the other assets of the business, to make use of all that constitutes the attractive force which brings in custom and to conduct the business in substantially the same many and by substantially the same means which in the past have attracted custom to the business. | 62. Furthermore, goodwill is 'legally distinct from the sources that have created the goodwill' and 'attaches to a business and is inseparable from the conduct of a business' (paragraph 12 TR 1999/16). Accordingly, a business owner (e.g. a company) cannot dispose of goodwill separately from the business to which is attached. | 63. Accordingly, if a business owner disposes of part of their business (such as a particular business operation or activity) that is a discrete business in its own right; or an interest in their business (e.g. by admitting a partner), the goodwill may be transferred with that disposal (paragraphs 142-143 of TR 1999/16). | 64. A business owner can also transfer something less than a discrete business, when it involves a disposal of identifiable assets of the business without goodwill (paragraph 144 TR 1999/16). | Meaning of business | 65. TR 1999/16 discusses the meaning of a business for the purposes of section 118-250. The meaning of business takes its ordinary meaning as a course of conduct carried on for the purposes of profit and involves notions of continuity and repetition of action. It is an undertaking or going concern in which an entity or entities use assets, knowledge, skills, human resources and other things as required in continuing activities or transactions for commercial purposes. | 66. Furthermore, if a company, which is incorporated for the purpose of making profits for its shareholder, puts any of its assets to any gainful use, there is a prima facie inference that the company is carrying on a business (American Leaf Blending Co Sdn Bhd v Director General of Inland Revenue (Malaysia) (1978) STC 561). Each case is decided on its own facts (Departmental and Interpretation Practice Note No 39, para 7). | CGT event C1 and C2 | 67. CGT event C1 happens if a CGT asset is lost or destroyed (section 104-20). CGT event C2 happens when ownership of an intangible CGT asset ends by the asset being discharged or satisfied (section 104-25). | 68. Paragraphs 135 to 141 of TR 1999/16 elaborates on the application of these provisions to the cessation of a business and associated goodwill, stating that if a business permanently ceases, both CGT events C1 and C2 can apply to the goodwill of the business. Subsection 102-5(1) requires that the most specific event apply, and paragraph 136 of TR 1999/16 confirms that the most specific CGT event which happens when a business 'permanently ceases' is CGT event C1. This is so even when the decision to permanently cease conducting a business is a voluntary one. | Application to facts | Is there a separate business? | 69. Company A at present provides contract and labour hire services across Australia. | 70. Recently, Company B was established and also provides labour hire services in the same vein as Company A. | 71. The same commercial activities appear to continue to be conducted in Company B as a matter of substance. On one view, such a consideration would appear to support the contention that the business carried on by Company A and Company B are practically speaking one and the same, given that both entities have the same ultimate owner and are part of The Group. If so, it could be argued that a single business (and its associated goodwill) continues to exist under the proposal - there will be no cessation of that goodwill. | 72. However, in the present case two different legal entities are conducting separate commercial endeavours ('businesses') each. Each of Company A and Company B operate their activities through separate incorporated companies. Each has its own views to profit, in that each holds its respective contracts separately, and has its own set of financial statements. Each is a subsidiary company of a separate group. | 73. Accordingly, the Commissioner's view is that: | · Company A and Company B run separate businesses; and | · Each such business carries its own goodwill. | 74. For completeness, it is noted that Company A and Company B are not in partnership and do not operate a single business of labour hire as partners. | Is there a CGT C1 or C2 event? | 75. It is now proposed that the labour hire function currently undertaken by Company A be replicated by Company B. Company A will take on no new projects. Instead, Company B will tender and provide services for any new relevant projects requiring labour hire services. | 76. As noted above, TR 1999/16 makes a distinction between a business disposing, or ceasing, their business as compared with merely disposing of assets of their business (paragraph 144 of TR 1999/16). Therefore the question becomes whether Company A is: | a) disposing of, or ceasing, a business or discrete part of the business; or | b) disposing of identifiable assets. | 77. Company A will cease to engage in commercial building projects and will end its employment contracts with the employees. This supports the view that Company A is ceasing to conduct their labour hire business. That is, the facts do not reflect the disposal of identifiable assets but - in substance - the cessation by Company A of the labour hire business in its entirety. | 78. As mentioned above, as between the application of CGT event C1 and C2, subsection 102-5(1) requires that the most specific event apply. Paragraph 136 of TR 1999/16 confirms that the most specific CGT event which happens when a business 'permanently ceases' is CGT event C1. | 79. In this regard, section 104-20 provides that CGT event C1 happens ' if a CGT asset you own is lost or destroyed '. | 80. The Commissioner's view, as articulated in paragraph 136 of TR 1999/16 is that the permanent cessation of a business results in a 'loss' or 'destruction' of its associated goodwill. | 81. It follows that section 104-20 applies in respect of goodwill associated with the business conducted by Company A upon its cessation. | Question 2 | Summary | The payment from Company C to Company A under Proposal 2 will be treated as ordinary income of Company A under section 6-5 of the Income Tax Assessment Act 1997 . Detailed reasoning | The law | 82. Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states that your assessable income includes income according to ordinary concepts, which is called ordinary income. | 83. The legislation does not provide any specific guidance on what is meant by income according to ordinary concepts. The Explanatory Memorandum for the ITAA 1997 states that it has been left to the courts to develop principles for determining what is ordinary income. | 84. There is no complete set of rules for determining that question, nor any single test that meets every situation. Some of the characteristics that help determine whether an amount received is ordinary income include: periodicity, recurrence and regularity of the payments; expectation of payment; and whether the payments are associated with business activities or services rendered. Proceeds of an isolated transaction, even if received as a lump sum, may also be income. | Expectation of payment | 85. A frequent characteristic of income receipts is an expectation for a regular or periodical payment, even where they are not directly attributable to employment or services rendered. | 86. In Federal Commissioner of Taxation v Dixon (1952) 86 CLR 540; 10 ATD 82 the High Court held that weekly amounts paid to a soldier by his former employer, to make up the difference between his former pay and that of his defence force pay, were ordinary income. Dixon CJ and Williams J held (at CLR p 557) that the amounts were: | ... an expected periodical payment arising out of the circumstances which attended the war service undertaken by the taxpayer and because it formed part of the receipts upon which he depended for the regular expenditure of himself and his dependants and was paid to him for that purpose, it appears to us to have the character of income. | Reward for services | 87. In MIM Holdings Ltd v Federal Commissioner of Taxation 97 ATC 4420 at 4429 the Full Federal Court set out the relevant principles for determining whether payment are of an income character, citing Hayes and Reuter as authority that: | Amounts paid in consideration of the performance of services will almost always be income. | 88. In Blank v Commissioner of Taxation [2016] HCA 42 the court stated at paragraph 56: | Section 6-5(1) of the 1997 Act provides that a person's assessable income includes income according to ordinary concepts, which is called ordinary income. Some things are so obviously income that their nature is unchallengeable. One is the reward for services rendered in the form of remuneration or compensation. | Application to facts | 89. On the application of the principles developed in the above authorities, it is the Commissioner's view that the payment from Company C to Company A under Proposal 2 will be treated as ordinary income of Company A under section 6-5 of the ITAA 1997. The reasons for this view are contained in the following paragraphs. | 90. Company A will provide a service to Company C, being the assignment of workers to Company C as and when required by Company C for the projects in which it is involved. | 91. In return for such a service, Company A will receive a fee from Company C. That is, the fee represents consideration for the performance of services by Company A. Adopting the approach of the courts in the MIM Holdings case and the Blank case, this (at least, prima facie) imbues such payments with the character of income. | 92. It is proposed that Company A's business will eventually solely comprise the provision of these services. | 93. Company C will not itself engage workers, but the provision of labour under the contracts to which it is a party forms an essential part of its business. As such, there is an expectation of its continued reliance on Company A for the provision of workers; and, it follows, an expectation that Company A will be in regular and periodical receipt of fees from Company C for the services rendered in engaging and assigning workers (which again indicates that such payments are in the nature of ordinary income). | 94. For the above reasons, it is considered that the payment from Company C to Company A under Proposal 2 will be treated as ordinary income of Company A under section 6-5 of the ITAA 1997. | Question 3 | Summary | 95. Proposal 2 is a not scheme to which section 177D in Part IVA of the Income Tax Assessment Act 1936 applies. | Detailed reasoning | The law | 96. Section 177D of the ITAA 1936 provides: | This Part applies to a scheme if it would be concluded (having regard to the matters in subsection (2)) that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of: | (c) enabling a taxpayer (a relevant taxpayer) to obtain a tax benefit in connection with the scheme; or | (d) enabling the relevant taxpayer and another taxpayer (or other taxpayers) each to obtain a tax benefit in connection with the scheme; | whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers. | 97. Broadly, the three key requirements of subsection 177D(1) are: | · a 'scheme', which is given wide definition in subsection 177A(1); | · a 'tax benefit in connection with the scheme', as defined in section 177C together with section 177CB; and | · the requisite purpose, the subject matter of section 177D. | Scheme | 98. 'Scheme' is defined in subsection 177A(1) of the ITAA 1936 to mean any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and any scheme, plan, proposal, action, course of action or course of conduct. | 99. In the present case, the scheme comprises the steps in proposal 2 as outlined in the facts. Broadly: | · Company A will take on the role of engaging workers and assigning those workers to work on projects on behalf of Company C. This means that individuals required by Company C to work on its projects will enter into employment contracts with Company A. As the workers would be employed by Company A, they will receive their salary, along with the minimum employer superannuation contributions, from Company A. | · In return, Company C will pay Company A a fee for the assignment. This fee is equal to the cost incurred by Company A for engaging those workers. | · If Proposal 1 is carried out and is viable, it is further intended that the role taken by Company A under this proposal will eventually be adopted by Company B. | Tax benefit | 100. Sections 177C and 177CB of the ITAA 1936 explains what a tax benefit is for the purpose of Part IVA. | 101. Section 177C states: | Section 177C Tax benefits | (1) Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to: | (a) an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out; ... | and, for the purposes of this Part, the amount of the tax benefit shall be taken to be: | (c) in a case to which paragraph (a) applies - the amount referred to in that paragraph;... | 102. For schemes entered into on or after 16 November 2012, section 177CB also applies in determining the tax benefit. Section 177CB relevantly states: | Section 177CB The bases for identifying tax benefits | (1) This section applies to deciding, under section 177C, whether any of the following (tax effects) would have occurred, or might reasonably be expected to have occurred, if a scheme had not been entered into or carried out: | (a) an amount being included in the assessable income of the taxpayer; | (b) the whole or a part of a deduction not being allowable to the taxpayer... | (2) A decision that a tax effect would have occurred if the scheme had not been entered into or carried out must be based on a postulate that comprises only the events or circumstances that actually happened or existed (other than those that form part of the scheme). | (3) A decision that a tax effect might reasonably be expected to have occurred if the scheme had not been entered into or carried out must be based on a postulate that is a reasonable alternative to entering into or carrying out the scheme. | (4) In determining for the purposes of subsection (3) whether a postulate is such a reasonable alternative: | (a) have particular regard to: | (i) the substance of the scheme; and | (ii) any result or consequence for the taxpayer that is or would be achieved by the scheme (other than a result in relation to the operation of this Act); but | (b) disregard any result in relation to the operation of this Act that would be achieved by the postulate for any person (whether or not a party to the scheme). Application to facts | 103. The scheme comprises all the steps in Proposal 2. The defining aspect of the scheme in this case is the cessation of engagement of workers by Company C for its projects; and the 'outsourcing' of such engagement to the related entity, Company A; and as a possible further step, Company B. | Consequences for Company C | 104. The consequence of the scheme for Company C is that it will no longer have any obligations relevant to the engagement of these workers - e.g. payment of remuneration to the workers, superannuation contributions. | 105. At the same time, the fees it pays Company A for the assignment of workers to it will be deductible by Company C. | Consequences for Company A | 106. The consequence of the scheme for Company A is that it, instead of Company C, will assume the obligations relevant to the engagement of the workers, including remuneration and superannuation contributions. | 107. Company A will be entitled to deductions in respect of remuneration and superannuation paid by Company A in respect of the workers engaged. | 108. However it will, commensurately, have assessable income comprising the equivalent amount of fees paid from Company C. | Consequences for Company B | 109. In the event that Step 2 of Proposal 2 is implemented, the intra-group transactions between Company C and Company B would have the same consequences noted above. | 110. As above, the consequence of the scheme for Company B is that it, instead of Company C or Company A, will assume the obligations relevant to the engagement of the workers, including remuneration and superannuation contributions. | 111. Company B will be entitled to deductions in respect of remuneration and superannuation paid by Company B in respect of the workers engaged, but will commensurately also have assessable income comprising the equivalent amount of fees paid from Company C. | Summary of the tax effects | 112. From a broad perspective, the overall tax consequences of the scheme approximate Company C's current tax position in respect of its engagement of the workers. It will be entitled to deductions for the fees paid to Company A or Company B, the amount of which would be broadly equal to the available deductions if it were to engage the workers directly. From the perspective of Company A (and Company B under Step 2), the fees received by Company C will equal the cost they incur in engaging the workers, resulting in no net income or loss for them. | 113. That is, under the ' would have ' (or ' annihilation approach ') limb of subsection 177C(1), the scheme - taking into account the obligations of Company C, Company A and Company B under Proposal 2 and a consideration of the current obligations of these entities - would not confer a tax benefit to these entities. As no tax benefit is identifiable under the terms of Proposal 2, the requirement in section 177D is not met in this case; and consequently the provision does not apply. | Question 4 | Summary | If section 104-20 of the ITAA 1997 applies to goodwill associated with the business conducted by Company A under Proposal 1, no capital gain will result for Company A. | Detailed reasoning | The law | 56. Section 102-20 of the ITAA 1997 states you make a capital gain (or loss) if a CGT event happens. The gain or loss is made at the time of the event. | 57. You make a capital gain in relation to CGT event C1 if the capital proceeds from the loss or destruction are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's cost base (see subsection 104-20(3), ITAA 1997). | 58. The capital proceeds are the total of the money you have received , or are entitled to receive, in respect of the event happenings; and the market value of any other property you have received , or are entitled to receive, in respect of the event happening (worked out as at the time of the event) (section 116-20, ITAA 1997). | 59. Section 116-25 of the ITAA 1997 outlines 6 modifications to the above general rules that relate to capital proceeds. It states that 'only' modification rules 2, 3, 4 and 6 can apply to CGT event C1. These modifications are as follows: | a) Apportionment rule: modification 2 (section 116-40). | b) Non-receipt rule: modification 3 (section 116-45). | c) Repaid rule: modification 4 (section 116-50). | d) Misappropriation rule: modification 6 (section 116-60). | 60. Specifically, the 'market value substitution rule: modification 1' in section 116-30 cannot apply to a CGT event C1. This is acknowledged at paragraph 137 of TR 1999/16: | Section 116-30 does not apply to deem the receipt of market value capital proceeds if a CGT asset is lost or destroyed: see section 116-25, event C1. No amount of capital proceeds, therefore, is attributed to the loss or destruction of goodwill resulting from the permanent cessation of a business. | Capital losses and goodwill | 61. It is also noted that a capital loss as a result of CGT event C1 will be equal to the amount, if any, of the reduced cost base of the goodwill. In relation to internally generated goodwill, TR 1999/16 suggests that goodwill will not have a cost of acquisition as most costs associated with creating goodwill are expenses made in the ordinary course of conducting a business. | Application to facts | 62. CGT event C1 will happen to the goodwill of Company A as it will permanently cease its business of labour hire. | 63. The event will occur at the time its contracts are fulfilled. Company A will not receive any money or other property for the purposes of section 116-20 as a result of the cessation of the business and the consequent loss of goodwill. | 64. As the relevant CGT event is C1, the ' market value substitution rule: modification 1 ' in section 116-30 cannot apply to a CGT event C1. | 65. Given that the market value substitution rule will not apply in this case (and given that no other modification rule applies), Company A's ' capital proceeds ' for its loss of goodwill will be nil for the purposes of section 104-20 of the ITAA 1997. It follows that it will not derive a capital gain in respect of the loss of goodwill upon the implementation of Proposal 1.