Private ruling: Capital Gains Tax: goodwill of ceased business
Date of advice: 10 April 2017
Published: September 2017
Ruling period: Year ended 30 June 2016
Date scheme commenced: During the 2016 income year

Ruling: Q1: Did Shop A (located in City A) constitute a discrete business such that its cessation triggered a CGT event C1 regarding the goodwill of that business pursuant to section 104-20 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: If Shop A did not constitute a discrete business separate from Shop B (located in City B) such that the goodwill related to both businesses, can the goodwill be proportionally allocated between the businesses? | A2: Not applicable

Relevant facts and circumstances: The Taxpayer operated a number of retail enterprises comprising distinct segments with each enterprise specialising in different products. The Taxpayer acquired Shop A and Shop A2 (which sold different products to Shop A) during the 2011 income year. This acquisition included the goodwill, plant and equipment and consumable stock in trade for both shops to continue each business. The following year, a separate division of Shop A was commenced in City B by the Taxpayer. This business (Shop B) used the name and concept of Shop A; however the Shop B operation also included another enterprise within the leasehold business premises. The property within which Shop A operated from was listed for sale during the 2016 income year at which time the Taxpayer also advertised for the sale of their businesses, with the businesses available separately or as one. The freehold from which Shop A operated was subsequently sold with a 60 day settlement period. The Taxpayer resolved to close Shop A and Shop A2 at the date of settlement as a result of there being no interest from any potential buyers of the businesses. The Taxpayer also decided that Shop B would continue operating as a discrete business. Both Shop A and Shop A2 ceased trading and closed at the date of settlement for the freehold on which Shop A operated. Shop B continued trading as a discrete business after this time. Prior to the ceasing of Shop A and Shop A2, the Taxpayer operated a number of business segments which all used the same ABN and GST registration for ease of accounting. The businesses were not large enough to warrant the use of separate branches within this ABN. All businesses used the same accounting system but reported as different divisions. The financial statements for each business of the Taxpayer were prepared separately. There were business segments that were clearly separate and distinct from one another and there were separate management teams in place for all businesses, business plans and strategies were formulated separately, and they catered to different demographics. Both Shop A and Shop B were operated independently and separately to one another. Each store had a local manager that handled day-to-day affairs without consultation with each other. Although the same accounting system was used as by other businesses managed by the Taxpayer, the day-to-day transactions at each location were processed by local staff. Although both stores used the same website and the social media page, all other advertising was handled separately between Shop A and Shop B. While the same brand operated in Shop A and Shop B and the majority of items sold (approximately 90%) were the same or similar, the individual store managers sourced their own products albeit via the same wholesale supplier. Both shops used the same price when selling the same items. However, Shop A was able to sell higher premium products due to its customer demographics. Shop B was not affected by Shop A ceasing business. As Shop B was operating independently with its own management, staff and business strategy, it was able to continue business with no operational concerns from the closure of Shop A. The concept in setting up Shop B involved the operation of another enterprise as part of the activities there that did not exist in Shop A.

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 102-25(1) | Income Tax Assessment Act 1997 section 104-20 | Income Tax Assessment Act 1997 subsection 104-20(1) | Income Tax Assessment Act 1997 paragraph 104-20(2)(b) | Income Tax Assessment Act 1997 subsection 104-20(3) | Income Tax Assessment Act 1997 section 104-25 | Income Tax Assessment Act 1997 section 108-5 | Income Tax Assessment Act 1997 subsection 108-5(1) | Income Tax Assessment Act 1997 subsection 108-5(2) | Income Tax Assessment Act 1997 section 116-30

Reasons for decision: Summary: Shop A constituted a discrete business separate from Shop B. CGT event C1 happened in relation to the goodwill of Shop A pursuant to section 104-20 of the ITAA 1997. The Taxpayer made a capital loss pursuant to subsection 104-20(3) of the ITAA 1997 equal to the amount of the reduced cost base of its goodwill. | Detailed Reasoning - Discrete business: Shop A is considered to have constituted a discrete business from Shop B on the basis of the following factors: ● the Taxpayer reported each business internally as different divisions; ● the Taxpayer prepared separate financial statements for each business; ● the businesses were operated independently; ● each business had a separate geographical location and clientele demographic; ● each business had different business strategies; ● there was separate advertising for each business; ● there were separate management and staff for each business; ● Shop A sold distinct premium range products which were not sold in Shop B; ● unlike Shop B, Shop A did not contain another enterprise; ● in the event that the business of Shop A was sold, the hypothetical purchaser could have conducted the business independently; and ● Shop B has continued to trade since the closure of Shop A. As it specialised in different products, Shop A2 also constituted a discrete business from Shop A. If a business owner is carrying on more than one business, each business has its own separate goodwill. | Detailed Reasoning - Goodwill is a CGT asset: Subsection 108-5(1) of the 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. To avoid doubt, subsection 108-5(2) of the ITAA 1997 confirms that 'goodwill' is a CGT asset. | Detailed Reasoning - CGT event C1 happens to goodwill when business ceases: Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business explains how the CGT provisions apply to a business when the business ceases. Paragraph 135 of TR 1999/16 states that if a business permanently ceases both CGT event C1 (about loss or destruction of a CGT asset) in section 104-20 of the ITAA 1997 and CGT event C2 (about cancellation, surrender and similar endings of intangible CGT assets) in section 104-25 of the ITAA 1997 can apply to the goodwill of the business. Subsection 102-25(1) of the ITAA 1997 requires in these circumstances the CGT event that is the most specific to the situation is the one to use. Paragraphs 68 and 136 of TR 1999/16 determine that the most specific CGT event which happens to the goodwill of a business when the business permanently ceases is CGT event C1. Section 104-20 provides: | Detailed Reasoning - 104-20(1): CGT event C1 happens if a *CGT asset you own is lost or destroyed. Note: This event can apply to part of a CGT asset: see section 108-5 (definition of CGT asset ). | Detailed Reasoning - 104-20(2): The time of the event is: (a) when you first receive compensation for the loss or destruction; or (b) if you receive no compensation - when the loss is discovered or the destruction occurred. | Detailed Reasoning - 104-20(3): You make a capital gain 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 *reduced cost base. | Detailed Reasoning - 104-20(4): A * capital gain or *capital loss you make is disregarded if you *acquired the asset before 20 September 1985. Whether the decision to permanently cease conducting a business is voluntary or involuntary, there is as a result a 'loss' or a 'destruction' of the goodwill of the business in the ordinary meaning of these words. Goodwill has no existence except in relation to a business. So, if there is no business being conducted, goodwill is lost or destroyed (paragraph 136 of TR 1999/16). It follows then that the cessation of Shop A triggered a CGT event C1 regarding the goodwill of the business pursuant to subsection 104-20(1) of the ITAA 1997. Paragraph 137 of TR 1999/16 confirms that the market value substitution rule contained in section 116-30 of the ITAA 1997 does not apply to deem the receipt of market value capital proceeds if a CGT asset is lost or destroyed. No amount of capital proceeds, therefore, is attributed to the loss or destruction of goodwill resulting from the permanent cessation of a business. In these circumstances the Taxpayer makes a capital loss equal to the amount, if any, of its reduced cost base of the goodwill. As no compensation was received by the Taxpayer for the loss or destruction of the goodwill the time of the event pursuant to paragraph 104-20(2)(b) of the ITAA 1997 was when the business ceased. | Detailed Reasoning - Question 2: A ruling is unable to be provided in view of the answer to question 1.