Private ruling: Capital gains tax
Date of advice: 19 March 2018
Published: June 2018
Ruling period: 1 July 2017 to 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Will the purchase price received by the taxpayer, which is not apportioned to plant and equipment, stock, debtors or WIP, be treated as capital proceeds in respect of the disposal of the goodwill of the business under Part 3-1 of the Income Tax Assessment Act 1997 and be taxed as a capital gain to the extent the capital proceeds exceed the relevant cost base? | A1: Yes | Q2: Is the market value of the business for the purposes of the $6,000,000 Maximum Net Asset Value Test $!@ in section 152-15 of the ITAA 1997 (pursuant to the independent valuation of the vendor)? | A2: No

Relevant facts and circumstances: ● The Company is the trustee for the Trust ● The directors of the Company are: ● ABC, and ● JKL ● The Trust comprises 2 units: ● 1 B class unit, and ● 1 C class unit ● The B class unit has a fixed entitlement to X% of the Trust income and capital and the C class unit has a fixed entitlement to Y% of the Trust income and capital ● The Trust operates a Business ● The Business provides administrative and support services while the X and Y operate their respective businesses as sole traders ● The Business provides: ● Access to rooms ● Administrative staff and assistants ● Stationary and consumables, and ● Billing and fee collection services ● The Purchaser has approached the Trust to acquire the Business as it will complement their existing portfolio and fits their broader acquisition strategy ● The Purchaser will: ● Acquire all assets of the Trust (including goodwill, stock, plant and equipment etc) ● Offer employment to all employees of the Trust, and ● Offer new contracts to all professionals who currently have service agreements with the Service Business. ● Key transactional documents are: ● Business Purchase Agreement (BPA), and ● Facilities and Administrative Services Agreement ● The BPA includes the goodwill of the Business, it does not include the goodwill of ABC and JKL ● The Purchaser is willing to pay a premium for the Business for various commercial reasons, including: ● The strategic value of the business to their mid to long term business plan ● The size and advanced nature of the Business, and ● The potential growth in net profit which they project can be achieved once the business is assimilated into the Purchaser’s group ● Under the BPA, the Purchaser has offered a purchase price of $!@#%, subject to some minor adjustments ● The Trust believes the offered purchase price is significantly above market value ● The Trust has obtained an independent valuation from 123 Accounting, who undertake valuations ● 123 Accounting based their valuation on the 20XX full year accounts as prepared by the Business’ accountants ● 123 Accounting originally valued the Business at $!@#. The valuation incorrectly included the value of the personal goodwill of ABC and JKL ● The valuation was updated to exclude the value of the personal goodwill of ABC and JKL (the proprietors’ practices). The updated valuation of the Business is $!@

Relevant legislative provisions: Part 3-1 of the Income Tax Assessment Act 1997 | Section 102-5 of the Income Tax Assessment Act 1997 | Section 152-15 of the Income Tax Assessment Act 1997 | Section 104-10 of the Income Tax Assessment Act 1997 | Section 108-5 of the Income Tax Assessment Act 1997 | Subdivision 152-A of the Income Tax Assessment Act 1997 Section 152-10 of the Income Tax Assessment Act 1997 | Section 152-15 of the Income Tax Assessment Act 1997 | Section 152-20 of the Income Tax Assessment Act 1997 | Section 960-400 of the Income Tax Assessment Act 1997 | Subdivision 960-S of the Income Tax Assessment Act 1997

Reasons for decision: Detailed Reasoning - Capital Gains Tax (CGT): CGT provisions are found in Part 3-1 of the ITAA 1997. The CGT provisions are catch-all provisions. They apply to all gains that arise as a result of a CGT event happening (whether or not the gains are of a capital nature), subject to certain exemptions and exceptions, and to territorial and temporal limitations. The CGT rules affect a taxpayer's income tax liability because assessable income includes a net capital gain for the income year (section 102-5 of the ITAA 1997). A net capital gain is the total of a taxpayer's capital gains for an income year, reduced by certain capital losses made by the taxpayer. A capital loss cannot be deducted from a taxpayer's assessable income, but it can reduce a capital gain in the current income year or a later income year. To work out a capital gain, the cost base for the CGT asset is subtracted from the capital proceeds. If the capital proceeds exceed the cost base, the difference is a capital gain. If there is no capital gain, the capital proceeds are subtracted from the reduced cost base of the asset. If the reduced cost base exceeds the capital proceeds, the difference is a capital loss. If the capital proceeds are less than the cost base but more than the reduced cost base, there is neither a capital gain nor a capital loss. If a taxpayer's total capital gains for an income year are more than the sum of the taxpayer's total capital losses for the income year and unapplied net capital losses from previous years, the taxpayer has a net capital gain for the income year equal to the difference. Alternatively, if the taxpayer's total capital losses for the income year are more than the taxpayer's total capital gains for the income year, the taxpayer has a net capital loss for the income year equal to the difference. | Detailed Reasoning - CGT event: Section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997) states a CGT asset is any kind of property, or a legal or equitable right that is not property. CGT assets include: i. part of, or an interest in, property or a legal or equitable right that is not property ii. goodwill or an interest in it iii. an interest in a partnership asset, and iv. an interest in a partnership that is not an interest in a partnership asset. The Trust’s goodwill, stock, plant and equipment are assets of the trust. Section 104-10 of the ITAA 1997 states CGT event A1 happens if a taxpayer disposes of a CGT asset. The disposal of a CGT asset takes place if a change of ownership occurs from the taxpayer to another entity. The Purchaser is acquiring all assets of the Trust (including goodwill, stock, plant and equipment etc) and this triggers CGT event A1. | Detailed Reasoning - Small Business Concessions: Section 152-10 of the ITAA 1997 contains the basic conditions that a taxpayer must satisfy to be eligible for the small business capital gains tax (CGT) concessions. These conditions are: a) a CGT event happens in relation to a CGT asset of yours in an income year b) the event would (apart from this Division) have resulted in the gain c) at least one of the following applies: i. you are a small business entity for the income year ii. you satisfy the maximum net asset value test iii. you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership iv. the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year d) the CGT asset satisfies the active asset test | Detailed Reasoning - Maximum net asset value test: The maximum net asset test is stated in section 152-15 of the ITAA 1997: You satisfy the maximum net asset value test if, just before the CGT event, the sum of the following amounts does not exceed $6,000,000: a) the net value of the CGT assets of yours b) the net value of the CGT assets of any entities connected with you c) the net value of the CGT assets of any affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)) Section 152-20(1) of the ITAA 1997provides the meaning of net value of the CGT assets for the purposes of section 152-15 of the ITAA 1997: The net value of the CGT assets of an entity is the amount (whether positive, negative or nil) obtained by subtracting from the sum of the market values of those assets the sum of: a) the liabilities of the entity that are related to the assets; and b) the following provisions made by the entity: i. provisions for annual leave ii. provisions for long service leave iii. provisions for unearned income iv. provisions for tax liabilities | Detailed Reasoning - Market value: The current taxation law does not define 'market value' in any general provision. However, section 995-1 of the ITAA 1997 states that market value has a meaning affected by subdivision 960-S of the ITAA 1997. The general rule is that the expression 'market value' is used in the income tax laws with its ordinary meaning (section 960-400 of the ITAA 1997), but that does not fix its meaning to all contexts. As a result, market value usually takes the ordinary meanings given below, unless specifically defined or qualified by a particular provision. The most common definition for market value is derived from the High Court case of Spencer v The Commonwealth of Australia (1907) 5 CLR 418 (Spencer). It was held that a valuation of land should be based on the price that a willing purchaser at the date in question would have had to pay to a vendor 'not unwilling, but not anxious to sell'. In looking to apply the concept of a 'willing buyer and willing seller' to ascertain the market value of land, Griffith CJ commented at 432 in Spencer that: …the test of value of land is to be determined, not by inquiring about what price a man desiring to sell could have obtained for it on a given day, i.e. whether there was, in fact, on that day a willing buyer, but by inquiring: What would a man desiring to buy the land have had to pay for it on that day to a vendor willing to sell it for a fair price but not desirous to sell? The expression 'net value of CGT assets', as used in section 152-15 of the ITAA 1997, was examined in Syttadel Holdings Pty Ltd v FC of T 2011 ATC 10-199 (Syttadel Holdings) and Venturi v FC of T 2011 ATC 10-200 . In both cases, the Tribunal confirmed that the relevant enquiry was as to ‘market value’ according to its ordinary meaning, as noted in Spencer. In Syttadel’s case the most appropriate methodology for calculating market value was considered to be by an objective business valuation. A Decision Impact Statement (DIS) on Syttadel Holdings was released by the Commissioner in February 2012. In that statement, the ATO generally considers the sale price of an asset to be its market value. That DIS goes on to note however, that in each particular case, all the relevant facts and circumstances must be taken into account to determine the most appropriate methodology for calculating market value. In Excellar Pty Ltd v FCT [2015] AATA 282, the AAT held that the selling price of a particular parcel of land was the best evidence of its market value at the relevant date. More recently in the Federal Court, Wigney J in FCT v Miley 17 ATC 20-640 found at para 81 that: Where the asset in question has been the subject of a recent arm’s length sale, it is generally unnecessary to hypothesise. If the recent sale transaction can be said to be one between a willing but not anxious seller, and willing but not anxious buyer, the price that the buyer and seller actually agreed on may generally be taken to be the market price, or at least a reliable indicator, if not the best evidence, of the market price, | Detailed Reasoning - Conclusion: The disposal of the Trust’s assets is an A1 event and the CGT regime applies. The purchase price will be treated as the capital proceeds. In assessing your eligibility for small business CGT concessions under section 152-15 of the ITAA 1997, the market value of the Business for the purposes of the $6,000,000 Maximum Net Asset Value Test must be determined. We acknowledge the independent valuation you have provided and your view that the Purchaser is willing to pay a premium for the Business as they believe it has strategic value to their mid to long term business plan, the size and nature is appropriate to their business and has potential for growth in net profit which they project can be achieved once assimilated into their group. However, it is the view of the Commissioner that the purchase price of $!@#% is still the best evidence of market value.