Private ruling: Income tax - Capital gains tax - CGT assets - CGT events C1 to C3 - end of a CGT asset
Published: October 2014
Ruling period: Year ending 30 June 2015 | Year ending 30 June 2016 | Year ending 30 June 2017
Date scheme commenced: Not yet commenced.

Ruling: Q1: Will Capital Gains Tax (CGT) event C1 or C2 happen (either immediately or at a later time or times) when the Company ceases to carry on or winds down its business, where a related entity commences to carry out such activities? | A1: No. | Q2: In the event CGT event C1 happens, does the market value substitution rule apply to deem the Company to receive proceeds equal to the market value of the goodwill of some or all of its business and if so, when? | A2: Not necessary to consider.

Relevant facts and circumstances: The Company carries on a business. It is owned equally by two shareholders. As the scale of developments undertaken by the Company and other entities has increased, the shareholders of the Company have become more concerned about the increased risk they face as officers and directors of the Company and other entities, and the fact that an asset which could be available to creditors is their shares in the Company. The shareholders therefore propose that: • The Company will cease to enter into new contracts; • A new entity will commence a business of the same type as the Company; • The new entity is owned equally by the trustees of two discretionary trusts, controlled respectively by the two shareholders of the Company; and • The entity will not purchase goodwill or other assets from the Company. An important consequence of the above will be that the value of the shares in the Company will decline and may be extinguished. If so, in the event of any action taken against the directors, the shares that they will own in the Company will be of limited value. The new entity is a Unit Trust. The new entity will trade under a derivative of the name the Company trades under, although this is yet to be decided. The new entity will operate from the same business premises as the Company currently operates from. The fixed assets will continue to be held by the Company. The shares in the Company will remain in the name of the current shareholders. The Company will continue to be registered in accordance with the Corporations Act. The Company does not currently register their business name, but trades as such due to the name of the Company. The Unit Trust will operate under the licenses held by the shareholders of the Company. The Unit Trust has obtained relevant registrations, including a TFN and ABN, to commence business/trading. The Unit Trust will employ the same people as the Company. It may also employ additional staff to those employed by the Company. The Unit Trust will likely use the assets maintained in the Company, and where it does happen to use those assets, it will pay for such use. The Unit Trust may also accumulate assets in its own name over time. The Company shareholders will receive a salary from the Unit Trust, although the amount of the salary may differ to that which is currently received by them from the Company. The value of goodwill in the Company has not been determined.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 102-25(1) | Section 104-20 | Section 104-25 | Section 108-5

Reasons for decision: Summary: Capital Gains Tax (CGT) event C1 or C2 will not happen (either immediately or at a later time or times) when the Company ceases to carry on or winds down its business, where a related entity commences to carry out such activities. | Detailed Reasoning - Detailed reasoning: Section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997) confirms that 'goodwill or an interest in it' is a CGT asset. Subsection 104-20(1) of the ITAA 1997 states that 'CGT event C1 happens if a CGT asset you own is lost or destroyed.' Subsection 104-20(2) of the ITAA 1997 states that 'CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset: (a) being redeemed or cancelled; or (b) being released, discharged or satisfied; or (c) expiring; or (d) being abandoned, surrendered or forfeited; or …' | Detailed Reasoning - The meaning of goodwill: With reference to FC of T v. Murry 98 ATC 4585; (1998) 39 ATR 129 ( Murry case), paragraph 85 of Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business (TR 1999/16) discusses the meaning of goodwill. It provides that goodwill is 'a quality or attribute derived from the other assets of the business. Its existence depends on proof the business generates and is likely to generate earnings from the use of the identifiable assets, locations, people, efficiencies, systems, processes and techniques of the business. It includes whatever adds value to a business.' It 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 …It may be site, personality, service, price or habit that obtains custom. It states that goodwill is more accurately referred to 'as having sources than it is to refer to it as being composed of elements'. It states that goodwill is 'legally distinct from the sources that have created the goodwill' and that those sources 'may change and the part that various sources play in maintaining the goodwill may vary during the life of the business. But, 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'. | Detailed Reasoning - Same business: Paragraph 18 of TR 1999/16 states that 'A business or the sources of its goodwill may change so much it can no longer be said to be the same business as that previously conducted...If this happens the goodwill of the original business ceases to exist and a new CGT asset - being the goodwill of the new business - is acquired.' Paragraph 19 provides that 'CGT event C1 in section 104-20…happens in the situation in paragraph 18 and the business owner can make a capital loss on the loss or destruction of the goodwill of the old business.' Paragraph 20 states, in part, that '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.' In paragraphs 91 - 95, TR 1999/16 applies its own version of the 'same business' test. In this context, at paragraph 93 it provides that 'For the CGT goodwill provisions, the same business is carried on and no new goodwill asset is created if the business retains its same essential nature and character.' | Detailed Reasoning - Application to your circumstances: The Company carries on a business. The company is owned equally by two shareholders. It is proposed that the Unit Trust will carry on the same business activities as the Company. The Unit Trust is owned equally by the trustees of the two discretionary trusts, controlled respectively by the two shareholders of the Company. Both the Company and the Unit Trust will be operating from the same premises, will use the licences held by the shareholders, will likely utilise the same assets and will employ the same people. The Unit Trust will trade under a derivative of the name the Company uses; however it has not yet decided on the name. You state that the Company will cease to enter into new contracts and that the existing contracts will remain in the Company as it winds down over time. The Unit Trust will enter into new contracts and will continue to do so indefinitely. The Unit Trust will operate alongside the Company during this time. If a business permanently ceases both CGT event C1 in section 104-20 of the ITAA 1997 and CGT event C2 in section 104-25 of the ITAA 1997 can apply to the goodwill of the business. Subsection 102-25(1) of the ITAA 1997 requires in these circumstances the CGT event that is most specific to the situation is the one to use. Paragraph 68 of TR 1999/16 provides that 'The most specific CGT event when a business permanently ceases is CGT event C1 (about loss or destruction of a CGT asset) in section 104-20. The market value substitution rule does not apply: section 116-25).' With reference to the 'same business' discussion in TR 1999/16, it is evident that the Commissioner is referring to arrangements in which the entity in question continues a business operation in its original structure, but changes the nature of its activities to such an extent that the goodwill from the previous operations is destroyed. In your case, you have chosen to create a new structure, being the Unit Trust, through which the business will eventually exclusively operate. However, in the meantime the business will operate through both the Company and the Unit Trust. We consider that the actual activities to be undertaken by the Unit Trust represent no significant change from the activities being undertaken by the Company. The restructure will result in some changes to the way the business will operate. However, with regard to goodwill any internally generated goodwill will add to the composite goodwill of the business. Based on the information that you have provided, we believe that the business carried on by the Company will not permanently cease, either immediately or at a later time or times. Overall, the business to be carried on by the Unit Trust will be the same business being carried on by the Company, albeit under a different structure. The business itself retains its same essential nature and character. In this instance the business has not permanently ceased and neither GCT event C1 nor CGT event C2 will apply to the goodwill of the business. | Detailed Reasoning - Issue 1 Question 2: Not necessary to consider.