Private ruling: CGT Asset - Goodwill
Published: January 2014
Ruling period: 1 July 2012 to 30 June 2015

Ruling: Q1: Is the goodwill attached to the business a pre-CGT asset of Company A? No. The goodwill attached to the business has ceased to be a pre-CGT asset. Would the goodwill attached to the business continue to be a pre-CGT asset of Company A if the company terminated its licensing agreement with Company x as trustee for the Trust B? No. The goodwill will not continue to be a pre-CGT asset.

Relevant facts and circumstances: Company A acquired a car dealership business from an unrelated party prior to 20 September 1985. Since that time company A has conducted the business under the same name and sold and serviced the same brand of new and used motor vehicles. The business premises have been situated in the same suburb, but the location changed on one occasion as the business expanded. In 20xx company A entered into a licensing agreement with a related entity - trust B. Under the terms of the agreement trust B was given the right to use the trading name and the benefit of the existing goodwill to operate the existing business of selling and servicing new and used motor vehicles. The terms of the agreement allowed trust B to carry on the business for its own benefit and to do all things necessary to carry on the business including: · Entering into a sub-lease to enable it to carry on the business from the same premises · Entering into agreements with the motor vehicle manufacturer to acquire and sell a particular brand of vehicle · Sell the vehicles and related products and provide servicing of new and used vehicles · Purchase all necessary goods and services relevant to the operation of the business · Employ necessary staff to enable the business to be carried on · Undertake any other things necessary to operate the business The licensing agreement allowed trust B to retain all profits from the business operations. In return company B was entitled to receive a licensing fee based on a percentage of the profits generated by trust B. Trust B has now carried on the business for several years. However under the terms of the licensing agreement the contract can be terminated by either party giving 6 months' notice of its intention to do so or because of some other 'termination event' specified in the agreement. Once the agreement is terminated trust B would cease to carry on the business and its dealership agreement with the motor vehicle manufacturer would also terminate. Company A would then commence to carry on the business, subject to the approval of the motor vehicle manufacturer.

Relevant legislative provisions: Income Tax Assessment Act 1997 Part 3-1. | Section 100-20 | Section 100-25 | Section 102-20 | Section 104-10 | Section 104-20 | Section 104-25 | Section 108-5 | Section 109-5 | Section 110-25 | Section 116-25

Reasons for decision: Summary: The meaning of 'goodwill' Goodwill is an asset for CGT purposes as there is a specific reference to it in the definition of a CGT asset at paragraph 108-5(2)(b) of the Income Tax Assessment Act 1997 ('ITAA 1997'). The Commissioner's views on the meaning of goodwill are set out in Taxation Ruling TR 1999/16, which reflects the decision of the High Court in Federal Commissioner of Taxation v Murry 89 ATC 4585 ('Murry'). TR 1999/16 defines the goodwill of a business as follows: 'Goodwill is not a series of CGT assets that inhere in other identifiable assets of a business. Goodwill, being a composite thing, attaches to the whole business. It does not attach separately to each identifiable asset of the business.' Paragraph 25 of the ruling states that the whole of goodwill of a business is either pre-CGT goodwill or post-CGT goodwill. The goodwill of a particular business cannot be characterised as partly pre-CGT goodwill and partly post-CGT goodwill. Paragraph 25 also notes that an interest in goodwill, unlike goodwill itself, is not a composite asset. The consequence of the goodwill of a business being one CGT asset is that the whole of the goodwill of a business that commenced before 20 September 1985 remains the same single pre-CGT asset, provided the same business continues to be carried on. Paragraph 17 of TR 1999/16 states that this is so even though: (a) the sources of the goodwill of a business may vary during the life of a business; or (b) there are fluctuations in goodwill during the life of the business According to the decision in Murry , as long as the business remains the same business, the goodwill acquired or created by a taxpayer is the same asset as that which is disposed of when the goodwill of the business is sold or otherwise transferred. Goodwill inseparable from a business Paragraph 12 of TR 1999/16 states that "Goodwill….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." This statement summarises a number of observations made by the High Court in FCT v Murry 98 ATC 4585: · Goodwill is inseparable from the conduct of a business (Para 4) · As Barwick CJ pointed out in Geraghty v Minter, "goodwill…attaches to a business. It cannot be dealt with separately from the business with which it is associated". (Para 22) · Goodwill is the legal right or privilege to conduct a business in substantially the same manner and by substantially the same means that have attracted custom to it. It is a right or privilege that is inseparable from the conduct of a business. (Para 23) · Goodwill…is inherently inseverable from the business to which it relates (Para 30) · …goodwill has no existence independently of the conduct of a business and that goodwill cannot be severed from the business which created it. (Para 36) · Once goodwill…is recognised as the legal right or privilege to conduct a business…it follows that a person acquires goodwill when he or she acquires that right or privilege. (Para 45) Is there a relationship of principal and agent between company A and trust B? For commercial law purposes an agent is a person who is authorised, either expressly or impliedly, by a principal to act for that principal so as to create or affect legal relationships between the principal and third parties.( International Harvester Company of Australia Proprietary Limited v. Carrigan's Hazeldene Pastoral Company (1958) 100 CLR 644. ) The relationship between company A and trust B is set out in the Licensing Agreement which was entered into in May 20xx. The relevant clauses state: 'The licensor [company A] hereby grants to the licensee [trust B], and the licensee hereby accepts the right to operate the business using the business names for the terms of this agreement and on the terms and conditions set out in this agreement. In consideration of the Licence granted to the licensee pursuant to the agreement, the licensee shall pay the license fee to the licensor on or before the agreement date.' The licence fee payable by trust is based on a percentage of sales which varies according to pre-tax profit. Under the license agreement company A retains ownership of all its assets including goodwill and business name. It is evident from the intention of the Licensing Agreement that trust B is to carry on the business in its own right and is entitled to all the profits from its business activities. There is no evidence to suggest that trust B is authorised to act in a legal capacity on behalf of company A. Therefore a relationship of principal and agent does not exist between company A and trust B and is unlike the relationship described in Lilyvale Hotel. The Lilyvale Hotel decision In Lilyvale Hotel Pty Ltd v. Federal Commissioner of Taxation 2009 ATC 20-094, the Full Federal Court held that the applicant continued to carry on the same business before and after the relevant test time. In that case the taxpayer operated a hotel business. Subsequently the taxpayer appointed another company as operator and manager of the hotel for a period of time. When the taxpayer was acquired by another entity the management agreement with the hotel operator was terminated and the taxpayer commenced to operate and manage the hotel again. At all material times the taxpayer's income was derived from the hotel business. The management agreement between the taxpayer and the managing entity (Enterprises Australia) gave it comprehensive control of the operation and management of the hotel and specified that the relationship between Enterprises Australia and the taxpayer under the agreement was not one of partnership or joint venture or any other relationship except principal and agent. In return for carrying out its management duties Enterprises Australia was paid a management fee and incentive fee based on a percentage of the total revenue and gross operating profit. The Full Federal Court confirmed that Enterprises Australia was the agent of Lilyvale under the proper construction of the management agreement. Consequently, there was no impediment to attributing the day to day activities of operating the hotel as those of the taxpayer. Has company A been carrying on the same business? Whether the same business is being carried on is a question of fact and degree that ultimately depends on the circumstances of each particular case. 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 purposes of the CGT goodwill provisions. It is not sufficient, however, if just a similar kind of business is carried on. Factors to consider include the nature and 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 and whether the activities constitute, or are treated by the business, as constituting separate or distinct activities, enterprises, divisions or undertakings and the way in which the business is structured, carried on, managed and controlled. According to paragraph 21 of TR 1999/16 a business does not need to be identical from its acquisition to its disposal. If the essential nature or character of the business has 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 the business is being 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 character or nature. It is accepted that at all times the business that has been carried on is the sale and service of motor vehicles. The organic growth and expansion of the business over time has not altered the underlying business activities. When the licensing agreement was entered into the same business activities were undertaken as compared with the activities undertaken prior to the licensing agreement. In particular: · the same products and services were supplied · the business traded under the same name · the business operated from the same premises · the same customers were supplied · the same suppliers of goods were used · the same plant and equipment was used · the same business systems and processes were used; and · the same employees were employed As stated in Murry , as long as the business remains the same business the goodwill acquired or created by a taxpayer is the same asset as that which is disposed of when the goodwill of the business is sold or otherwise transferred. The whole of the goodwill of a business that commenced before 20 September 1985 remains the same single pre-CGT asset, provided the same business continues to be carried on. Any goodwill generated in conducting an expanding business is merely an accretion to the pre-CGT goodwill. It is accepted that up to the time the Licensing Agreement was entered into, company A carried on the same business, namely the sale and service of motor vehicles. Accordingly, the goodwill associated with the business remained a pre-CGT asset up to this time. Effect of the licensing agreement As mentioned above, the Licensing Agreement gives trust A the right to carry on the business in consideration for a licence fee calculated as a percentage of the profits generated from the business. The business carried on by trust B is the same business as was previously carried on by company A prior to the parties entering into the licensing agreement i.e. the sale and servicing of motor vehicles. The business continued to be conducted from the same leased premises, using the same business name and licencee's marks. Although the licensing agreement gives trust B the right to use all the business assets including the benefit of the goodwill attached to the business, the Licensing Agreement makes it clear that the goodwill of the business does not pass to the licencee. Similarly the use of the business name "is not a proprietary right passing to the licencee and shall not be characterised as a disposition of personal property;" The licensing agreement allows trust B to carry on the business in its own right and for its own benefit (subject to the dealership agreement with the motor vehicle distributor). Paragraph 24 of TR 1999/16 states that the same business will not be carried on if there is a sudden and dramatic change brought about by the shedding of activities on a considerable scale. As a result of the Licensing Agreement, company A ceased to conduct the business - in other words its business activities ceased when trust B commenced carrying on the business. The passive receipt of licence fees cannot be taken to amount to the conduct of a business. Cessation of business The term 'business' is defined in TR 1999/16 in paragraph 7 as follows: It is a course of conduct carried on for the purpose of profit and also involves notions of continuity and repetition of actions. 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. A business is not a thing or a series of things. The course of conduct of the car dealership is carried on by trust B. This is the effect of the Licence Agreement. Trust B carries on the business for its own benefit and on its own account. On a proper construction of the Licence Agreement, the relationship between company A and trust B is not one of agency. Trust B runs the business independently, it enters into contracts in its own name and transacts in its own name. While they must put the licensor's name on various business documentation, this is not sufficient to establish agency. This is in distinction to the facts in Lilyvale. In Lilyvale the Full Federal Court held that the interposition of a manager did not fundamentally change the nature of the business being conducted by the taxpayer. In Lilyvale , the relationship was one of agency - this was critical to the finding in the case. That was because, whether the taxpayer ran the business themselves or engaged the services of a manager, they still derived the income from the activities of running a hotel. In Northern Engineering Pty. Ltd. v F.C. of T . 80 ATC 4025 the Full Federal Court found that the taxpayer company ceased to carry on its business of trading in vehicles and equipment when the taxpayer disposed of all its trading stock and assets, with the exception of a debt owing by its holding company. Brennan J said (at 4027): 'In my judgment the answer must be answered in the negative for the reason that no business was carried on after the appellant's trading credits were paid and its trading liabilities discharged. When a company's business is closing down there comes a time when the activity of a trading or profit-making nature comes to an end. The business of a company is not carried on merely by managing or disposing of the company's assets otherwise than in a business.' Furthermore, the question of whether a business is being carried on by an entity is determined by reference to the activities of that entity rather than by reference to the activities carried on by other entities, related or otherwise. Paragraph 57 of TR 1999/9 provides the following summary of relevant case law in this respect: In Case K20 ; 22 CTBR (NS) Case 40, the Board of Review said: 'It should also be mentioned that we can take no account of the fact, if it be a fact, that the overall business had remained the same in so far as it was being carried on within a "group" of companies.' The Board of Review in Case N109 ; 25 CTBR (NS) Case 63 expressed a similar view and followed the general principle that each company is a separate entity for taxation purposes (see also Phillimore J in Kodak Ltd v. Clark and Kitto J in Hobart Bridge Co Ltd (in liq) v. FC of T ). Accordingly, the business of a company is identified, for the purpose of applying the same business test, by reference to the business activities carried on by that company and not by reference to the business activities carried on by a commonly owned or controlled group of companies to which that company belongs. Thus, in determining whether company A is carrying on the business of a car dealership, only its activities are relevant. In contrast to the facts in Lilyvale , company A is deriving its income in a fundamentally different way to the way in which it derived the income prior to the Licence Agreement. It went from operating the business to allowing another to operate the business independently and for its own account. Trust A bears the economic risk of the operations. Company A is clearly not conducting the same business it conducted prior to the Licence Agreement. It is not relevant, to this point, that there is a common ownership between company A and trust B. Nor is it to the point that the income now derived by company A, the licence fee, expressed as a percentage of profits derived by trust B, ultimately stems from the car dealership activities. Company A does not conduct a car dealership business and the income it derives is not from these activities but from a contractual obligation to pay a licence fee. Moreover, a business of selling and servicing motor vehicles, like a business of dealing in motor parts and accessories, is not a business which can be conducted with mere passivity (see Avondale Motors (Parts) Pty Ltd v FC of T ). The dealership business is a business of a trading nature and, as such, ceases when activities of a trading or profit-making nature come to an end. The licensing of goodwill and trade names to another entity for use in its own business does not mean that the licensor is also carrying on that business. As explained in Zeekap (No 56) Pty Ltd v Commissioner of Stamp Duties (Tas) (1999) 42 ATR 295: A man who leases to another an asset for use in the other's business is not himself conducting that business any more than is the landlord who leases to a shopkeeper the house or land from which he conducts that enterprise. … Merely because some residual value may accrue to him if the second man's business ceases and the use and enjoyment of the property reverts to the owner, this does not alter the position.' Conclusion As a result of the licensing agreement entered into by company A its business activities ceased and that after several years of inactivity it is reasonable to conclude that any goodwill that formerly attached to that business has expired with the passage of time. Under the terms of the licence agreement either party may terminate the agreement if certain termination events occur. The Licensing Agreement sets out the consequences of the termination of the agreement: "In the event of termination for any reason all rights of the licensee granted under this agreement shall terminate and the licensee will forthwith cease to use the business names in any manner whatsoever." The termination of the licence agreement would effectively cancel trust B's right to carry on the business. During the period that the licensing agreement has been in place, trust B has carried on the business and it can be reasonably inferred that it created its own goodwill during that time. The goodwill created by trust B has supplanted the earlier goodwill attached to the business when it was carried on by company A. However if there were to be a termination of the agreement and trust B is deprived of its rights to carry on the business its goodwill must also be extinguished as the goodwill is inseparable from the conduct of the business. Whether the decision to permanently cease conducting a business is a voluntary one or an involuntary one, there is as a result a loss or destruction of the goodwill of the business. If company B were to resume carrying on the business the original goodwill is not resurrected. In Pink v JA Sharwood & Co Ltd (1913) 109 LT 594 Eve J said: …I do not believe that [the plaintiff] even thought that in refusing to sell the name, they were retaining, or that they ever intended to retain, the right to resume the use of it should the plaintiff be restored to health. But even if they had that intention, I do not think it is one to which any effect can be given. The goodwill of this business came to an end when the premises were, so to speak, gutted and handed over for the purpose of another business, and when this business was in fact abandoned. If, hereafter, the plaintiff should recover and resume business, he will resume with the benefit of his former reputation, but the goodwill which he will then assume will be a goodwill he will then start to create, and not the goodwill of the old business revived and resuscitated. Any goodwill attaching to the new business will be that created from the time company A resumes carrying on that business. Conclusion As the licensing agreement was entered into after 20 September 1985 the goodwill generated by trust B during the period it carries on its business is post-CGT goodwill. Under the terms of the licensing agreement a 'termination event' would result in the cessation of the business conducted by trust B. If company A were to resume carrying on the business the goodwill attaching to the business would be the goodwill created after it re-commenced the business.