Private ruling: Pre CGT asset - goodwill
Date of advice: 17 July 2018
Published: September 2018
Ruling period: 1 July 20XX to 30 June 20XX
Date scheme commenced: The date of incorporation of Entity X

Ruling: Q1: Is the goodwill attached to the business carried on by the Taxpayer a pre-CGT asset of the Taxpayer? | A1: Yes

Relevant facts and circumstances: Entity X had previously applied for a private ruling (Authorisation number: Ref 0846) which applied for a number of periods. Entity X requests an extension of the period to which the original ruling applies for a further income year. The facts in the previous private ruling are correct and remain unchanged for the current private ruling application. Entity X commenced operation prior to 1985 as a family business. Entity X was incorporated prior to 1985. Entity X is wholly owned by a trustee for a unit trust whose ultimate beneficiaries are members of the family who started the business. Entity X is made up of two business divisions. Division A commenced operations prior to 1985 and is the fundamental business service of Entity X. Division B commenced after 20 September 1985 as an expansion of services provided by Division A to satisfy customer needs and embrace technological advances. The customer base of Entity X has remained consistent. Entity X increased in size and expanded operating from a single location to multiple locations within Australia. The founders of Entity X still remain as executive members of the company. There are other corporate entities (Y and Z) within the wider group of Entity X. Entity Y is a wholly owned subsidiary of Entity X. Entity Y commenced operations after 20 September 1985 and was incorporated separately to Entity X under different ABN. Entity Y operates to provide products of Entity X to certain industries. Entity X owns 100% of the shares of Entity Y. Entity Z is a wholly owned subsidiary of Entity X. Entity Z commenced operations after 20 September 1985 and was incorporated separately to Entity X under different ABN. Entity Z operates along with Entity X and provides similar products to the customer base of Entity X. Entity X owns 100% of the shares of Entity Z.

Relevant legislative provisions: Subsection 104-10(1) of the ITAA 1997, | Subsection 104-10(5) of the ITAA 1997, and | Paragraph 108-5(2)(b)of the ITAA 1997.

Reasons for decision: Summary: Goodwill, or an interest in it, is a CGT asset, pursuant to paragraph 108-5(2)(b) of the Income Tax Assessment Act 1997 (ITAA 1997). Subsection 104-10(1) of the ITAA 1997 provides the disposal of a CGT asset means CGT event A1 happens. Subsection 104-10(5) of the ITAA 1997 provides that a capital gain or capital loss you make from CGT event A1 is disregarded if you acquired the asset before 20 September 1985. Goodwill according to Taxation Ruling TR 1999/16 Income Tax: capital gains: goodwill of a business (TR 1999/16) has the legal definition which was established by the High Court in Federal Commissioner of Taxation v. Murry 98 ATC 4585; (1998) 39 ATR 129 (Murry’s Case). Paragraph 12 of TR 1999/16 states in part that: … 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 that it is to refer to it as being composed of elements. Goodwill is a composite thing. It is one whole. It is an individual 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. Paragraph 13 of TR 1999/16 in part states: What goodwill means depends on the character and nature of the business to which it is attached. Goodwill differs in its composition in different trades or industries and in different businesses in the same trade or industry. … Paragraph 17 of TR 1999/16 provides guidance on deciding whether goodwill remains a single CGT asset if the same business is continued. It states that: The whole of the goodwill of a business that commenced before 20 September 1985 remains the same pre-CGT asset (subject to Division 149 – about when an asset stops being a pre-CGT asset) provided the same business continues to be carried on. This is so even though: (a) the sources of goodwill of a business may vary during the life of the business, or (b) there are fluctuations in goodwill during the life of the business. Furthermore, paragraph 89 of TR 1999/16 states: The goodwill of a business that commenced before 20 September 1985 remains a pre-CGT asset provided the same business continues to be carried on. As the majority justices of the High Court said in the Murry Case, ‘as long as the business remains the “same business” (cf Avondale Motors (Parts) Pty Ltd v. FC of T (1971) 124 CLR 97), the good will 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’. For a business that commenced before 20 September 1985, any accretion of its goodwill since 20 September 1985 is not a post-CGT asset. The whole of the goodwill of a business is either pre-CGT goodwill or post-CGT goodwill (see paragraph 96 of TR 1999/16). The whole of the goodwill of a business that commenced before 20 September 1985 remains the same single pre-CGT asset (subject to Division 149 of ITAA 1997 - about when an asset stops being a pre-CGT asset) provided the same business continues to be carried on. Paragraph 52 of TR 1999/16 discusses about when goodwill is acquired: If a taxpayer commences business and starts to create goodwill, the goodwill of the business is acquired when the taxpayer starts work that result in the creation of the goodwill (subsection 109-10, item 1). When a taxpayer starts the work resulting in the creation of goodwill of a business is a question of fact dependent on the circumstances of each particular case. Where a business expands as a result of the introduction of a new business operation or activity by a taxpayer, any goodwill that relates to the expanded business is merely an expansion of the business. If a business that commenced prior to 20 September 1985 is expanded, goodwill generated by the expanded business operations or activities will be an accretion to the pre-CGT goodwill (see paragraph 60 of TR 1999/16). A business may change to such an extent that it becomes a new business with new goodwill. In Murry’s case it is stated that, in determining whether the same business is being carried on, the sources of the goodwill may have changed so much that, although the business is of the same kind as previously conducted, it cannot be said to the same business. Paragraph 21 of TR 1999/16 states that: 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 as business is 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 nature or character. When discussing the essential nature or character of the business would remain the same, paragraph 22 of TR 1999/16 states in part that it would remain the same: … if all that happens is that portions of the operations of a business are discarded in an ordinary commercial way but the business retains its essential nature or character. A business will also not essentially change its nature or character according to paragraph 23 of TR 1999/16, which states: If the types of customers a business attracts change as the business evolves over the years, this does not necessarily mean the business is no longer the same business as was originally carried on. When deciding whether a business has the same essential nature or character, a similar kind of business being carried on would be insufficient. The same business would not be carried on according to paragraph 24 of TR 1999/16 if: (a) through a planned or systematic process of change within a reasonable period of time, a business changes its essential nature or character; or (b) there is a sudden and dramatic change in the business brought about by either the acquisition or the shedding of activities on a considerable scale. Paragraphs 60 to 62 of TR 1999/16 discuss internally generated goodwill which states: 60. If a new business operation or activity introduced by a taxpayer is an expansion of an existing business (whether it commenced before or after 20 September 1985), any goodwill built up in conducting the expanded business is merely an expansion of the existing goodwill of the business. If a business which commenced before 20 September 1985 (a “pre-CGT business’) is expanded, goodwill generated in conducting the expanded business is merely an accretion to the pre-GGT goodwill. 61. If an introduced business activity is a new business, the goodwill attaching to that business is a new asset separate from the goodwill of the existing business. 62. Whether an increase in business operations or in the scale of activity constitutes an expansion of an existing business, or a new and separate business, is a question of fact dependent on the circumstances of each case. Factors that need to be considered in determining whether the business operation or activity is part of the existing business or is a new business include the nature of the new business operation or activity, the types of customers that the business operation or activity attracts and the extent to which the business operation or activity: (a) is subject to the same integrated management and control as the existing business; (b) is treated for banking and accounting purposes as an extension of the existing business or as a separate business; (c) uses one or more different trading names; and (d) is related to or dependent on the existing business in a practical, economic or commercial sense. Since Entity X’s incorporation, which took place prior to 1985, the business has expanded while maintaining the essential character of the business. The following factors demonstrate the consistency of Entity X’s business: ● Entity X was commenced prior to 1985 as a family business. ● After a few years from commencement, Entity X was incorporated prior to 1985. ● The business activities of Entity X expanded while maintaining its fundamental business service and their customer base. ● Entity X consists of two business divisions. Division A provides the fundament business services of Entity X and began operation when Entity X was incorporated. Division B commenced operations after 20 September 1985 as an expansion of business to satisfy customer needs and embrace technological advances. ● Technological advances occurred over time and currently in the industry of Entity X, services provided by Division B is the most cost-effective solution for certain products. However, services provided by Division A also remain relevant as there are certain products that cannot be serviced by methods utilised by Division B. In many cases, customers of Entity X require the services from both divisions. The following factors are also relevant: ● Entity X increased in size and expanded operating from a single location to multiple locations within Australia. ● The founders of Entity X still remain as executive members of the company. ● Entity X is wholly owned by a trustee for a unit trust whose ultimate beneficiaries are members of the family who started the business. ● There are other entities within the wider Group of Entity X. Based on the facts presented, any goodwill associated with Entity X would be viewed as a pre-CGT asset. Despite expansion of the size, location, product range, and technology, the character and nature of the business did not change. On the basis of the information provided in the application, it appears that Entity X is still operating in the business service line that they started with. As the shares acquired in Entity X was before 20 September 1985, any goodwill attached with the business with the disposal of Entity X shares will be viewed as a pre-CGT asset. Entity Y and Entity Z are both 100% owned subsidiary of Entity X. Entity X owns 100% shareholdings in Entity Y and Entity Z. Entity X acquired these shares after 20 September 1985. While these companies operate within the same wider group as Entity X, they were incorporated separately under different ABNs. Both Entity Y and Entity Z hold different goodwill on their own and they will not be included as a part of Entity X’s goodwill. Both companies may have created new goodwill after the date of their incorporation. Entity Y was incorporated in the 20XX income year and Entity Z was incorporated in the 20XX income year. These are both incorporated after 20 September 1985. Based on this information, any disposal of shares in Entity Y and Entity Z with any attached goodwill will be viewed as a post-CGT asset.