Private ruling: Income Tax: Capital gains Tax and Part IVA
Published: February 2015
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 any Capital Gains Tax (CGT) event apply, in particular but not limited to CGT event A1 when the Company ceases to carry on or winds down its business, where a related entity commences to carry out such activities? | A1: Yes, we consider that CGT event F1 will occur when the related entity commences to carry on business. | Q2: Will Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply if the Company ceases to carry on some or all of its business and a related entity commences to carry on such a business? | A2: Not ruled upon.

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 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 new entity will operate under the licenses held by the shareholders of the Company. The new entity has obtained relevant registrations, including a TFN and ABN, to commence business/trading. The new entity will employ the same people as the Company. It may also employ additional staff to those employed by the Company. The new entity 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 new entity may also accumulate assets in its own name over time. The Company shareholders will receive a salary from the new entity, 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 1936 Section 177A, | Income Tax Assessment Act 1936 Subsection 177A(5), | Income Tax Assessment Act 1936 Section 177D, | Income Tax Assessment Act 1936 Subsection 177D(2), | Income Tax Assessment Act 1997 Section 102-25, | Income Tax Assessment Act 1997 Subsection 102-25(3), | Income Tax Assessment Act 1997 Section 104-10, | Income Tax Assessment Act 1997 Section 104-15, | Income Tax Assessment Act 1997 Subsection 104-55(1), | Income Tax Assessment Act 1997 Subsection 104-60(2), | Income Tax Assessment Act 1997 Section 104-110, | Income Tax Assessment Act 1997 Subsection 104-110(1) and | Income Tax Assessment Act 1997 Section 110-10.

Reasons for decision: Summary: A CGT event F1 pursuant to section 104-110 of the Income Tax Assessment Act 1997 (ITAA 1997) will happen when a lease is granted to the new entity. | 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.' 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 new entity, through which the business will eventually exclusively operate. However, in the meantime the business will operate through both entities. In reference to our previous Private Ruling, we agree with our finding that CGT events C1 or C2 will not happen (either immediately or at a later time or times) when the Company ceased to carry out or winds down its business. We agree with the finding that the new entity will carry on the same business as the Company albeit under a different structure. As the business has not permanently ceased, neither CGT event CI or C2 will apply to the goodwill of the business Section 102-25 of the ITAA 1997 provides that a taxpayer must work out which CGT event applies most to their circumstances. Where more than one CGT event can apply the one to use is the event most specific to the circumstances. | Detailed Reasoning - CGT event A1: Section 104-10 of the ITAA 1997 contains the rules dealing with CGT event A1. CGT event A1 happens if a taxpayer disposes of a CGT asset. A disposal will occur if there is a change of ownership between entities, whether because of some act or event or by operation of law. In relation to the goodwill of the Company, it is the ATO view that goodwill attaches to the business and as discussed previously, in the absence of the disposal of the business, there is no disposal of goodwill. As paragraph 12 of Taxation Ruling TR 1999/16 states: It is an indivisible 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. You have stated that no disposal of assets from the Company has occurred. In accordance with the facts of this case, there has been no disposal of a CGT asset when the new entity was created. Until such time as a CGT asset of the Company is disposed of, CGT event A1 is not triggered. | Detailed Reasoning - CGT Event B1: Subsection 104-15 of the ITAA 1997 states that: 104-15(1) CGT event B1 happens if you enter into an agreement with another entity under which: (a) the right to the use and enjoyment of a *CGT asset you own passes to the other entity; and (b) title in the asset will or may pass to the other entity at or before the end of the agreement. The time of the event is when the other entity first obtains the use and enjoyment of the asset. You have stated that no such agreements have been entered into with the new entity or any other entity. Therefore, it is not considered that title in a CGT asset will, or even may, pass to another entity and CGT Event B1 is not triggered. If any such agreement is entered into in the future, consideration of CGT event B1 may be relevant. | Detailed Reasoning - CGT Event E1: Subsection 104-55(1) of the ITAA 1997 states CGT event E1 happens if you create a trust over a CGT asset by declaration or settlement. It is not considered that there has been any trust created over a CGT asset. The new entity was not created over any CGT asset. | Detailed Reasoning - CGT event E2: According to subsection 104-60(2) of the ITAA 1997, CGT event E2 happens when; 'you transfer a CGT asset to an existing trust' Based upon the facts of this case, no transfer of a CGT asset to an existing trust has occurred. Therefore, CGT Event E2 is not triggered. | Detailed Reasoning - CGT event F1: The granting of a lease is a CGT event F1. CGT event F1 will happen if a lessor grants a lease under subsection 104-110(1) of the ITAA 1997 as follows: (1) CGT event F1 happens if a lessor grants, renews or extends a lease. Note 1: Other CGT events can apply to leases. An assignment of a lease is an example of CGT event A1. Note 2: There are special rules that apply to some lease transactions: see Division 132. (2) The time of the event is: (a) for the grant of a lease: (i) when the contract for the lease is entered into; or (ii) if there is no contract at the start of the lease; or (b) for a renewal or extension at the start of the renewal or extension. (3) The lessor makes a capital gain if the capital proceeds from the grant renewal or extension are more than the expenditure it incurred on the grant, renewal or extension. It makes a capital loss if those capital proceeds are less. In this case, the Company intends to provide a lease agreement between the two entities so that the new entity may conduct their business using the Company's existing assets. Ownership of the assets will continue with the Company and the new entity will pay a commercial lease payment each month for the use of these assets. No lease agreement is currently in existence. However, as the question at issue is when the new entity commences business, this may not occur without the lease of the Company's assets. A CGT event F1 in section 104-110 of the ITTA 1997 will happen if a lease is granted to the new entity. The general rules for capital proceeds in regard to CGT event F1 are outlined in the table provided in subsection 116-20(2) of ITAA 1997. It states the capital proceeds are any premium paid or payable to you for the grant, renewal or extension of a lease. As stated in section 110-10 of the ITAA 1997 the normal cost base rules are not relevant for CGT event F1. However, you must refer to section 104-110 to determine how to calculate a capital gain or loss from CGT event F1. As you have stated that no premium will be paid for the granting of any lease or leases, this will result in no capital gain. There may be a capital loss if there is expenditure incurred on the grant of the lease or leases. However, even if there is no capital gain or capital loss, a CGT event still occurs pursuant to section 102-23 of the ITAA 1997. | Detailed Reasoning - CGT event D1: CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity. CGT event D1, together with CGT event H2 are events of last resort and only apply if no other applicable CGT event happens as per subsection 102-25(3) of the ITAA 1997. As CGT event F1 happens, CGT event D1 cannot apply. | Summary: Not necessary to consider.