Private ruling: Sale of business
Published: October 2011
Ruling period: Year ended 30 June 2011
Date scheme commenced: 1 July 2010

Ruling: Q1: Will the proposed payment to you be included in your assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Will the proposed payment to you be subject to the capital gains tax (CGT) provisions of the ITAA 1997? | A2: Yes.

Relevant facts and circumstances: You are a company. You acquired the business of an individual after 19 September 1985. This individual became your sole employee following the acquisition. An offer has been made to purchase your business. This offer has been accepted. The only significant asset of the business is goodwill. The purchaser proposes to make a payment to you for the sale. The contract includes the provision of services by you and the individual to the purchaser. Excluded from the sale are the title to, the lease of, or other arrangements under which the business occupies its existing premises, arrangements with suppliers of services used by the business at the existing premises, arrangements with any employees, and debts owed by the existing business. You will render services from the new premises of the purchaser for several years. You must not during the restraint period render services or conduct business at any place within a set radius of the existing business premises or the new premises of the purchaser. Neither you nor the individual will be partners or employees of the purchaser. The purchaser will supply services to you and the individual at the new premises. The purchaser will receive a percentage of all fees received for the services provided by you and the individual.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 100-35 | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Subsection 104-35(1) | Income Tax Assessment Act 1997 Section 108-5 | Income Tax Assessment Act 1997 Section 118-20 | Income Tax Assessment Act 1997 Division 152

Reasons for decision: Summary: Section 100-35 of the ITAA 1997 states that a capital gain arises where you receive (or are entitled to receive) capital amounts from a CGT event which exceeds the total costs associated with that event. The anti-overlap provisions in section 118-20 of the ITAA 1997 operate, however, to reduce a capital gain arising from a CGT event by an amount of income assessed under another provision such as section 6-5 of the ITAA 1997. Will you make a capital gain as a result of the payment made? Goodwill is listed as a CGT asset under section 108-5 of the ITAA 1997, and the sale of goodwill is a CGT event A1 under section 104-10 of the ITAA 1997. A right created under a restrictive covenant including an exclusive trade-tie agreement is also a CGT asset which is separate from the goodwill of a business. Such a right constitutes a CGT asset as defined in section 108-5 of the ITAA 1997, and is either a proprietary right (paragraph 108-5(1)(a) of the ITAA 1997) or a legal or equitable, non-proprietary right (paragraph 108-5(1)(b) of the ITAA 1997). The creation of such a right in favour of the purchaser is a CGT event D1 under subsection 104-35(1) of the ITAA 1997. The Commissioner's definition of a restrictive covenant in subparagraph 6(a) of Taxation Ruling TR 95/3 is 'an agreement between two or more parties to refrain from doing some act or thing'. An example of exclusive trade-tie in subparagraph 40(b) of TR 95/3 is an exclusive dealing contract to take supplies of a product exclusively from a particular supplier for a particular period. An exclusive trade-tie falls within the definition of a restrictive covenant. In your case, the contracts contain exclusive dealing and restraint clauses. These clauses satisfy the definition of a restrictive covenant and CGT event D1 will happen at the time the contracts are entered into. The Commissioner's view on the relationship between a restrictive covenant and goodwill in Taxation Ruling TR 1999/16 is: 105. The value of goodwill and the granting of a restrictive covenant on the sale of a business are inextricably linked. The absence of a covenant may be reflected in a lower price being paid for goodwill. The presence of a restrictive covenant tends to indicate the parties really do transfer some goodwill, though this is by no means conclusive. As the High Court majority justices said in the Murry case, the lack of competition from an enforceable restrictive covenant may enhance the goodwill of a business: 98 ATC at 4591; 39 ATR at 138. 106. If a vendor and a purchaser of a business, dealing at arm's length and having given proper thought to the appropriate value of a restrictive covenant, do not separately allocate any part of the capital proceeds to a restrictive covenant, we will treat the granting of the covenant as being ancillary to the disposal of the goodwill of the business. We will accept that no part of the capital proceeds is attributable to the restrictive covenant. We consider that as you were dealing at arm's length in transacting the sale and in allocating the capital proceeds, we will treat the granting of the covenant as being ancillary to the disposal of the goodwill of the business. We therefore accept that no part of the capital proceeds is attributable to the restrictive covenant and that the total of the capital proceeds is for the goodwill. CGT event A1 under section 104-10 of the ITAA 1997 will therefore happen when you sell the business, including the goodwill of the business. A capital gain may arise when CGT event A1 happens. As the goodwill was acquired by you after 19 September 1985 when you acquired the business of the individual, any capital gain which results from the sale will not be disregarded under paragraph 104-10(5)(a) of the ITAA 1997. | Detailed Reasoning - Will any capital gain be reduced by the anti-overlap provisions?: In order to determine this question, it needs to be determined whether the amount payable to you in relation to the sale of the business is included in your assessable income under any other provision of the ITAA 1997. The provision to be considered in your case is section 6-5 of the ITAA 1997. Section 6-5 of the ITAA 1997 provides that if you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year. In subsection 6-5(1) of the ITAA 1997, income according to ordinary concepts is called ordinary income. The payment to be made to you could constitute income as an inducement or reward as considered in FC of T v. Montgomery (1999) 164 CLR 435; (1999) 198 CLR 639; (1999) 42 ATR 475; 99 ATC 4749. In Montgomery's case, the firm was able to use its capital to obtain a good inducement offer to take premises. The use of its capital was considered to be in the course of carrying on its business, although in a transaction which was regarded as singular or extraordinary. In your case, the information supplied does not indicate that this occurred in your dealings with the purchaser. Nor is there any indication that the payment of the amount is a normal incident of the signing of an exclusive trade tie by you. It is therefore considered that the payment to you by the purchaser would not be assessable income on this basis. Taxation Ruling TR 92/3 discusses whether profits on isolated transactions are income. TR 92/3 provides the following guidelines which can be applied to your circumstances: · If a transaction or operation is outside the ordinary course of a taxpayer's business, the intention or purpose of profit-making must exist in relation to the transaction or operation in question (paragraph 10). · It is not necessary that the profit be obtained by a means specifically contemplated (either on its own or as one of several possible means) when the taxpayer enters into the transaction (paragraph 14). · The intention or purpose of the taxpayer (of making a profit or gain) is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case (paragraph 38). · It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose (paragraph 40). · The taxpayer must have the prerequisite purpose at the time of entering into the relevant transaction or operation (paragraph 41). · It is not our view, nor has it ever been, that all receipts or profits of a business are income. For example, when a taxpayer derives a profit from a transaction outside the ordinary course of carrying on its business and the taxpayer did not enter that transaction with the purpose of making a profit, the profit is not assessable income (paragraph 44). In your case, the transaction is clearly outside your ordinary course of carrying on a business. To determine your intention or purpose in entering into the transaction, it has to be discerned from an objective consideration of the facts and circumstances of your case. The main elements of your agreement with the purchaser is that in return for the payment and the services to be provided by the purchaser, you will sell the business including the goodwill, and provide exclusive services using the premises of the purchaser for a certain period of time. In your case, it can not be said that you are entering into this transaction with a significant intention or purpose of making a profit as required in paragraphs 40 and 44 of Taxation Ruling TR 92/3. The payment will therefore also not be assessable income on this basis. The payment will therefore not be included in your assessable income under section 6-5 of the ITAA 1997, and the anti-overlap provisions in section 118-20 of the ITAA 1997 will not apply to reduce any capital gain resulting from the sale. | Detailed Reasoning - Conclusion: The sale of your goodwill is a CGT event A1 under section 104-10 of the ITAA 1997 and the anti-overlap provisions in section 118-20 of the ITAA 1997 will not apply. Any capital gain resulting from the sale of the goodwill may qualify for the small business CGT concessions under Division 152 of the ITAA 1997 provided that any relevant conditions for the particular concessions applied are satisfied. Further information relating to the conditions to be satisfied can be obtained from our publication 'Advanced guide to capital gains tax concessions for small business' which is available from our website at www.ato.gov.au

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | Does Part IVA apply to this ruling?: Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable. | We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part. | If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply. | For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.