Private ruling: Goodwill
Published: April 2014
Ruling period: Income year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Does the goodwill that was created in 20XX, still exist in the relevant year? | A1: Yes | Q2: Is the receipt of the payment attributable to the disposal of goodwill and consequently assessed under the capital gains tax provisions of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: No | Q3: Does the receipt of the payment comprise a derivation of ordinary income under section 6-5 of the ITAA 1997? | A3: Yes

Relevant facts and circumstances: You are a business that employs its sole director and shareholder as an employee. Your activities involved providing services from one location between 20XX and 20YY on an ongoing and all-year-round basis. From 20YY onwards, you ceased providing services from one location and begun providing services on a short-term basis at various locations around Australia, for intermittent periods of time. You were approached by a representative from a company. You are considering entering into an agreement to sell your business for an agreed purchase price which is described as payment for goodwill of the business and to commence providing services at the primary location of the purchaser. The payment would be a one off payment and it was agreed between the parties that there would be no further lump sum payments paid to you under this arrangement. The agreement does not provide for a refund of the payment for any reason. The company will not acquire any assets from you apart from goodwill. The key points set out in the sales and services contract are paraphrased below: • You agree to sell your business which includes the goodwill of the business to the purchaser • The purchase of the business is contingent on you entering into both the service contract and a performance guarantee • You must refund the lump sum payment if you do not meet the pre-conditions which include commencing business at the new premises under the services contract • You must render services from the new premises for a set period of years from the commence date. You agree that you will render services, only from the new premises during that period • A termination of the sale contract is an automatic termination of the services contract • The purchaser agrees to provide administrative services, clerical staff, facilities, plant and equipment as are necessary for you to conduct your business • You agree to pay a percentage of all fees charged out to clients, to the purchaser in return for the services specified by a particular clause of the agreement • You and the purchaser do not enter into either a partnership or an employment relationship. The purchaser does not provide services to any person or hold itself out as doing so.


Reasons for decision: Detailed Reasoning - The Nature of Goodwill: The leading authority on the definition of goodwill is the majority judgement of the High Court in FCT v Murry (1999) 39 ATR 129, Gaudron, McHugh , Gummow and Hayne JJ at paragraph 4: Section 160A defines ``asset'' to include ``goodwill'', but neither Pt IIIA nor the Act generally attempts to give any special meaning to the term. Goodwill is inseparable from the conduct of a business. It may derive from identifiable assets of a business, but it is an indivisible item of property, and it is an asset that is legally distinct from the sources - including other assets of the business - that have created the goodwill. Because that is so, goodwill does not inhere in the identifiable assets of a business, and the sale of an asset which is a source of goodwill, separate from the business itself, does not involve any disposition of the goodwill of the business. The commissioner's view on the definition of goodwill is found at paragraph 12 of Taxation Ruling TR 1999/16 adopting the principles of Murry : 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 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. Further at paragraph 21 it is explained that a business need not be identical from its commencement to its disposal for it to have the same goodwill: 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 it essential nature or character In applying the above principles to your factual scenario, you carry on a business of providing services through your employee (who is also your sole director and shareholder). Regardless of the location where you practice and who provides administrative services, the business will retain the same essential nature and character. Consequently the goodwill that was created in 20XX is the same goodwill that exists in the relevant year. | Detailed Reasoning - Transfer of Goodwill: You have been providing services at various locations around Australia, for intermittent periods of time. Consequently the nature of the goodwill that exists in the business you carry on is solely that which is described as personal goodwill, being that which is based off your reputation and skill. Considering that you have been providing services from either one fixed location in a different state from the proposed new premises or, from various other locations around Australia it is unlikely that you will be bringing clients with you from your previous business and the sole source of goodwill would best be described as your good reputation. Additionally, the company is not acquiring anything else that would draw custom to them such as taking over a lease or a trading name. Further, the purchaser is not able to direct you as to how to provide services, nor do they have an entitlement to any of your profits outside of the arrangement for administrative services. The Commissioner's view on the transferability of personal goodwill is provided by paragraph 59 of Taxation Ruling 1999/16: If a sole practitioner disposes of their business, the part of the goodwill of the business that emanates from their personality, reputation, skills or attributes is not transferable. Similarly, if key employees of the sole practitioner are not employed by the purchaser on the disposal of the business, any part of the goodwill that emanates from their personality, reputation, skills or attributes is also not transferable. The proposed contracts are explicit in providing that you and the company are not entering into a contract for employment and that you and not the company are providing the services. Additionally, even if there was some other component of the goodwill that was transferrable the purported sale of goodwill would still be ineffective. Under the proposed contract you have a legal obligation to continue to carry on your business of providing services. Goodwill is inseparable from the conduct of the business (see Murry at [4],[20] and [36]), so it is impossible to effectively transfer goodwill where you continue to carry on that business. | Detailed Reasoning - Characterisation of the Receipt: The characterisation of the receipt in the hands of the recipient is necessary in order to provide an answer to the questions at issue. Such characterisation is decided in light of the facts, the true nature of the transaction and the arrangement. Such a characterisation is not restricted solely to the documents executed. All relevant circumstances should be taken into account. Hence in examining the character of the obligations and relationship established under the legal documents, the true nature of the obligations and relationship are not determined by the labels given to them. The purported purchase is contingent on you signing two separate agreements being the Contract and the Performance Guarantee. The two main legal obligations imposed on you for entering into these two agreements are that: 1. You provide services for a period of five years at the company's premises. 2. You agree to pay a percentage of the fees billed to clients in return for the provision of administrative services. As already explained we do not view the proposed contract of sale as an effective transfer of goodwill. Consequently, we consider the correct characterisation of the payments is an inducement payment for you to enter into the services contract whereby you commit to surrender half of your profits in return for the provision of administrative services and a location from which to run your business. | Detailed Reasoning - Assessable Income from an Isolated Transaction: The commissioner's view on whether profits on isolated transactions are assessable income under ordinary concepts is contained in Taxation Ruling TR 92/3. Profit from an isolated transaction is generally income when both: • the intention and purpose for the taxpayer in entering into the transaction was to make a profit or gain and the transaction was entered into; and • the profit was made in the course of carrying on a business or in carrying out a business operation or commercial transaction. In Montgomery v FCT [1999] HCA 34, the majority judgement of the High Court held that inducement payments paid to a firm of solicitors to take up a lease were assessable income and not of a capital nature, Gaudron, Gummow, Kirby and Hayne JJ at [118]: ….. The firm used or exploited its capital in the course of carrying on its business, albeit in a transaction properly regarded as singular or extraordinary. And the sums it received from the transactions were not as growth or increment of value in its profit-yielding structure - the receipts came in or were derived for the separate use, benefit and disposal of the firm and its members as they saw fit. It is considered that the principles in the above case apply to your factual circumstances as even though you have not entered into a lease for a fixed price the company is providing you a place to practice and administrative services in return for you assigning a percentage of the fees you charge. Both charging fees to patients and paying expenses such as lease and administrative fees are revenue, and not capital in nature. Even though this is an isolated commercial transaction there is a clear profit making intention or purpose, and the transaction is entered into in the course of carrying on your business and therefore the receipt of the payment will be assessable as ordinary income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Restrictive Covenant: While under the sales contract there is a covenant which restricts you to only run your business from the new premise for a period of X years. We consider that this is incidental to your activity of deriving income from provisions of personal professional services on the purchaser's premises and the lease structure payments required with the purchaser under the arrangement (i.e. instead of set period lease payments, X% of the fess banked from the rendering of services is charged). Accordingly, as there is no amount of the payment that is specifically allocated to the restrictive covenant, we will treat the granting of the covenant as merely being part of the contract entered into between the relevant parties for the provision of services.