1 At the time that Entity B exited the Entity A income tax consolidated group (TCG), was the goodwill of the Entity B business an asset held by Entity A, as the head company of the TCG, for the purposes of step 1 in the table in subsection 711-20(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?
Yes. Question 2 For the purposes of step 1 in the table in subsection 711-20(1) of the ITAA 1997 for Entity B when it exited the TCG, was the 'terminating value' of the goodwill asset of the Entity B business under subsection 711-25(1) of the ITAA 1997 equal to the cost that was set for the goodwill asset under subsection 705-35(1) of the ITAA 1997 at the time that Entity B joined the TCG? Answer Yes. Question 3 For the purposes of step 1 in the table in subsection 711-20(1) of the ITAA 1997 for Entity B when it exited the TCG, was an amount required to be added under subsection 711-25(2) of the ITAA 1997 in respect of any asset consisting of goodwill that Entity A held at the leaving time because of its control and ownership of Entity B? Answer No. This ruling applies for the following period : Year ending 30 June 20XX The scheme commenced on: During the year ending 30 June 20XX
1. Entity A is an Australian resident company and the head company of the TCG. The TCG operates through several distinct business divisions. 2. The TCG previously acquired 100% of the issued share capital in Entity B from an unrelated Australian resident company, which included the acquisition of the Entity B business as a going concern (the Acquisition). 3. Upon Entity B's entry into the TCG, Entity A undertook an allocable cost amount (ACA) process. The goodwill of the Entity B business had its tax cost set in accordance with subsection 701-10(4) of the ITAA 1997. As part of this entry ACA process, Entity A did not separately recognise or set a tax cost for any synergistic goodwill under subsection 705-35(3) of the ITAA 1997.
4. Following the Acquisition, Entity B continued to operate its business on a standalone basis from the other business divisions within the TCG. In this regard: Entity B continued to produce standalone financial reports; the products and services offered by Entity B were not offered by any other business division within the TCG; Entity B's staff generally operated independently from staff in Entity A's other businesses; and the key assets and resources of Entity B's business were not used by any other business divisions within the TCG. 5. During the time that Entity B was owned by the TCG, Entity B's actions were directed towards building on its existing core product offering and customer base. Further, Entity B continued to generally operate in the same manner, with the same key assets and resources, as it did prior to the Acquisition. 6. Following the Acquisition, the TCG did not incur any other expenditure in relation to the goodwill of the Entity B business.
7. During the year ending 30 June 20XX, the TCG disposed of 100% of the issued share capital in Entity B to an unrelated Australian resident company, Entity C (the Sale). The Sale included the disposal of the Entity B business as a going concern. 8. As a result of the Sale, Entity B ceased being a subsidiary member of the TCG during the year ending 30 June 20XX.
Income Tax Assessment Act 1997 section 108-5 Income Tax Assessment Act 1997 Subdivision 110-A Income Tax Assessment Act 1997 Subdivision 110-B Income Tax Assessment Act 1997 Part 3-90 Income Tax Assessment Act 1997 subsection 701-1(1) Income Tax Assessment Act 1997 section 701-10 Income Tax Assessment Act 1997 section 701-55 Income Tax Assessment Act 1997 section 701-60 Income Tax Assessment Act 1997 section 705-30 Income Tax Assessment Act 1997 section 705-35 Income Tax Assessment Act 1997 Division 711 Income Tax Assessment Act 1997 section 711-20 Income Tax Assessment Act 1997 section 711-25 Income Tax Assessment Act 1997 section 711-30
All legislative references in these reasons for decision are to the ITAA 1997. Question 1 Summary Throughout the time that Entity B was a member of the TCG, Entity B's business remained a discrete business and the essential nature or character of the business did not change. Accordingly, at the time that Entity B exited the TCG, the goodwill of the Entity B business was a CGT asset of Entity B and the same goodwill CGT asset that existed at the time of the Acquisition. By virtue of the single entity rule ( SER ) in subsection 701-1(1), Entity A, as the head company of the TCG, was taken to hold the CGT asset comprising the goodwill of the Entity B business at the leaving time for the purposes of step 1 in the table in subsection 711-20(1). Detailed reasoning Step 1 of the exit ACA calculation 1. Part 3-90 allows certain groups of entities to be treated as single entities for income tax purposes. In particular, the SER in subsection 701-1(1) states:
If an entity is a *subsidiary member of a *consolidated group for any period, it and any other subsidiary member of the group are taken for the purposes covered by subsections (2) and (3) to be parts of the *head company of the group, rather than separate entities, during that period. 2. When an entity ceases to be a subsidiary member of a consolidated group, Division 711 provides that the tax cost setting amount for the group's membership interests in the leaving entity reflects the group's cost for the entity's net assets (section 711-1). In particular, Division 711 recognises the head company's costs for the group's membership interests in the leaving entity, just before the leaving time, as an amount equal to the cost of the leaving entity's assets at the leaving time, reduced by the amount of its liabilities (subsection 711-5(3)). 3. Under subsection 711-15(1), the first step in working out the tax cost setting amount for each membership interest in the leaving entity that members of the old group held is to work out the old group's ACA for the leaving entity in accordance with the table in subsection 711-20(1).
4. Step 1 in the table in subsection 711-20(1) (Step 1) ensures that the ACA includes the cost of the leaving entity's assets. Specifically, Step 1 provides: Start with the step 1 amount worked out under section 711-25, which is about the *terminating values of the leaving entity's assets just before the leaving time. 5. In accordance with subsection 711-25(1), the Step 1 amount is worked out by adding up the head company's 'terminating values' of all the assets that the head company holds at the leaving time because the leaving entity is taken by the SER in subsection 701-1(1) to be part of the head company. 6. Therefore, it is necessary to consider whether the goodwill of Entity B's business was an asset of Entity B at the time that it ceased to be a subsidiary member of the TCG. The legal meaning of 'goodwill' 7. The term 'CGT asset' is defined in subsection 108-5(1) to include any kind of property, or a legal or equitable right that is not property. Paragraph 108-5(2)(b) provides that goodwill, or an interest in it, is a CGT asset. 8. Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business
(TR 1999/16) sets out the Commissioner's views on the nature of goodwill and the application of the capital gains tax (CGT) provisions to goodwill. 9. TR 1999/16 (at [9]) provides that goodwill, for the purposes of the definition of 'CGT asset' in section 108-5, has the meaning it bears under the general law. In this regard, it is the legal definition of goodwill as explained by the High Court in Commissioner of Taxation v Murry (1998) 193 CLR 605 ( Murry ), rather than its accounting and business definitions, which applies (TR 1999/16, at [9]). 10. In TR 1999/16, the Commissioner goes onto explain the legal meaning of 'goodwill' for CGT purposes (based on the High Court's decision in Murry ), as follows:
12. ... 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 than it is to refer to it as being composed of elements. Goodwill is a composite thing. It is one whole. 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. ...
14. 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. Nor is there an element of goodwill in each identifiable asset of a business. 11. The general law meaning of goodwill, as explained by the High Court in Murry , was confirmed and clarified more recently by the High Court in Commissioner of State Revenue v Placer Dome Inc [2018] 265 CLR 585 ( Placer Dome ) (at [91]), as follows: Goodwill for legal purposes does not extend to every positive advantage, and whatever adds value , including privileges or advantages that differentiate an established business from a business just starting out. Goodwill for legal purposes does extend to those sources which generate or add value (or earnings) to the business by attracting custom
, whether that be from the use of identifiable assets, locations, people, efficiencies, systems, processes, or techniques of the business, or from some other identifiable source. And those sources of goodwill for legal purposes have a unified purpose and result - to generate or add value (or earnings) to the business by attracting custom. 12. In relation to purchased goodwill, TR 1999/16 provides that: 63. If a taxpayer who founded or purchased a business adds to that business an additional business purchased as a going concern, it is a question of fact dependent on the circumstances of each particular case whether the additional business is subsumed into and forms part of the existing business or whether the two businesses remain as separate businesses. If two post-CGT businesses are subsumed in this way, the goodwill of the businesses coalesce and the cost base of the goodwill of the business purchased as a going concern becomes part of the cost base of the goodwill of the entire business. 13. In relation to how goodwill is treated upon the disposal of a business, TR 1999/16 states that:
73. If a business owner is carrying on more than one business, each business has its own separate goodwill and each business may be disposed of along with the goodwill attaching to it. ... ... 77. If the part of the business sold constitutes a discrete business and it is sold as a business, the sale includes a disposal of goodwill. There must be a sale of sufficient assets including goodwill to enable a purchaser to carry on the business the vendor did previously without interruption. 14. On the disposal of a business, it is also necessary to consider if the business sold is the same business that was acquired, or if it has changed to such an extent that the goodwill of the original business no longer exists.
15. In relation to whether the same business is carried on at disposal, TR 1999/16 explains (at [21]) that the business does not need to be identical from its acquisition to its disposal. A business owner may expand or contract activities or change the way in which a business is carried on, without ceasing to carry on the same business. In this regard, organic growth, expansion or diversification of a business by, for example, adopting new compatible operations, servicing different clients or 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 (TR 1999/16, at [21]). 16. However, the same business is not carried on if, through a planned or systemic process of change within a reasonable period of time, a business changes its essential nature or character, or 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 (TR 1999/16, at [24]). 17. In relation to whether the same business is carried on, TR 1999/16 further states that:
91. It is a question of fact and degree whether the same business is being carried on. Factors to consider include the nature or 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 - whether the activities constitute or are treated by the business owner as constituting separate or distinct activities, enterprises, divisions or undertakings - and the way in which the business is structured, carried on, managed and controlled. ...
93. 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 or character. To illustrate this same business test with an example, a business of a printer may have changed over time due to the purchase of new equipment and the adoption of improved technologies. The printer may now attract a different type of client such as large corporate clients (due to the capacity to produce high quality public relations material, annual reports, etc). Formerly, the printer may only have provided services to small local businesses (e.g., business cards, calendars, invoice books, stationery). No new business has been commenced. It is not a different business and the goodwill remains the same CGT asset. The printer is still conducting a printing business of the same essential nature or character, albeit one serving different clients.
94. ... The question whether a change of business occurs remains one of fact and degree, however, and a change in the nature of the clients of a business does not of itself mean the business is a new business with new goodwill. Many businesses naturally evolve by serving different clients or clients in different markets and offering improved products or services. 95. Unless the facts are such that it can be established that a new business has commenced - rather than an existing business continued - the goodwill of the business is not different from that existing when the business was originally acquired or commenced. This is so in considering whether a pre-CGT business becomes a different post-CGT business or whether a post-CGT business becomes a different post-CGT business. 18. Further, the High Court in Murry stated (at [45] to [46]):
... The sources of the goodwill of a business 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. ... 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 be the same business. ... Application to the Entity B business
19. At the time of the Acquisition, Entity A acquired the Entity B business as a going concern and continued the business operations. Throughout the time that Entity B was a member of the TCG, Entity B continued to essentially operate as a standalone business, with its business operations being maintained in a sufficiently discrete manner from the TCG's other business divisions. Therefore, the Entity B business remained a discrete business while it was owned by the TCG, with its goodwill not being subsumed into the goodwill of Entity A's existing business. 20. Throughout the time that Entity B was owned by the TCG, Entity B's business remained essentially the same business, with the same essential nature or character, that existed at the time of the Acquisition. Therefore, in accordance with the principles in TR 1999/16, the goodwill of the Entity B business was the same goodwill that was attached to the business at the time of the Acquisition.
21. Consequently, at the time that Entity B exited the TCG, the goodwill of the Entity B business was a CGT asset of Entity B and the same goodwill CGT asset that existed at the time of the Acquisition. By virtue of the SER in subsection 701-1(1), Entity A, as the head company of the TCG, was taken to hold the CGT asset comprising the goodwill of the Entity B business at the leaving time for the purposes of Step 1. Question 2 Summary For the purposes of step 1 in the table in subsection 711-20(1) for Entity B when it exited the TCG, the 'terminating value' of the goodwill asset of the Entity B business under subsection 711-25(1) was equal to the cost that was set for the goodwill asset under subsection 705-35(1) at the time that Entity B joined the TCG. Detailed reasoning 1. The first step in calculating the ACA for the head company's membership interests in a leaving entity involves adding the 'terminating values' of assets that the leaving entity takes with it when it ceases to be a subsidiary member of the consolidated group.
2. Subsection 711-25(1) provides that the Step 1 amount is worked out by adding up the head company's 'terminating values' of all the assets that the head company holds at the leaving time because the leaving entity is taken by the SER in subsection 701-1(1) to be part of the head company. 3. In accordance with subsection 711-25(1), it is necessary to determine the 'terminating value' of the goodwill CGT asset of the Entity B business. 4. The head company's 'terminating value' for an asset is worked out in accordance with section 711-30, which provides: (1) The *head company's terminating value for an asset that it holds at the leaving time because the leaving entity is taken by subsection 701-1(1) to be a part of the head company is worked out as follows. (2) The amount is worked out by applying section 705-30 in a corresponding way to the way that section applies to work out the *terminating value for an asset that a joining entity holds at the joining time. ... 5. The goodwill of the Entity B business is a CGT asset that is not covered by any of subsections 705-30(1) to (3B). Consequently, subsection 705-30(4) applies. Subsection 705-30(4) states:
Other CGT assets (4) If an asset of the joining entity is a *CGT asset that is not covered by any of the above subsections, the joining entity's terminating value for the asset is equal to the asset's *cost base just before the joining time. 6. In accordance with Taxation Determination 2006/19 Income tax: consolidation: for the purposes of working out step 1 of a consolidated group's exit allocable cost amount in the leaving entity under section 711-25 of the Income Tax Assessment Act 1997, is the terminating value for a CGT asset determined under Division 110 for assets that have their tax cost set under subsection 701-10(4)? (TD 2006/19) at [15], by applying subsection 705-30(4) in a corresponding way, the terminating value for the CGT asset consisting of the Entity B business goodwill was equal to the asset's 'cost base' just before the leaving time. The meaning of the term 'cost base' in subsection 705-30(4) is the same as in Subdivision 110-A, and subsection 711-20(2) extends the reference to the term 'cost base' to include the 'reduced cost base' worked out under Subdivision 110-B (TD 2006/19, at [16]). 7. TD 2006/19 further explains that:
1. ... The terminating value of a CGT asset of a leaving entity is equal to the asset's cost base or reduced cost base just before the leaving time. 2. The CGT asset's cost base or reduced cost base is worked out under Subdivisions 110-A and 110-B of the ITAA 1997 respectively. The tax cost that was set for the CGT asset under subsection 701-10(4) of the ITAA 1997 when the subsidiary member joined the consolidated group, is what would be the asset's cost base under section 110-25 of the ITAA 1997 or the asset's reduced cost base under section 110-55 of the ITAA 1997 if a cost base or reduced cost base was worked out at that time. 3. The terminating value of a CGT asset of a leaving entity that had its tax cost set at the joining time under subsection 701-10(4) of the ITAA 1997 will therefore consist of the cost set at the joining time and reflect any adjustments that are made to the cost base or reduced cost base in accordance with Subdivision 110-A or Subdivision 110-B of the ITAA 1997 respectively, as well as other related provisions that make adjustments to the cost base or reduced cost base, until just before the asset leaves the consolidated group.
8. Section 701-10 applies in relation to each asset that would be an asset of a joining entity at the time it becomes a subsidiary member of a consolidated group, assuming that the SER did not apply (subsection 701-10(2)). Subsection 701-10(4) provides that each asset's 'tax cost is set' at the time the entity becomes a subsidiary member of the group at the asset's 'tax cost setting amount'. 9. Section 701-55 states the meaning of the expression an asset's 'tax cost is set' at a particular time at the asset's 'tax cost setting amount' (subsection 701-55(1)). Subsection 701-55(5) provides: (5) If Part 3-1 or 3-3 is to apply in relation to the asset, the expression means that the Part applies as if the asset's *cost base or *reduced cost base were increased or reduced so that the cost base or reduced cost base at the particular time equals the asset's *tax cost setting amount.
10. The asset's 'tax cost setting amount' is worked out using the table in section 701-60. In accordance with item 1 in the table in section 701-60, if the asset's tax cost is set by section 701-10, then the asset's tax cost setting amount is the amount worked out in accordance with Division 705. Subsection 705-35(1) sets out how to work out the tax cost setting amount for each 'reset cost base asset' of the joining entity. A goodwill asset of a joining entity is a reset cost base asset that has a tax cost set when the entity joins a consolidated group (Taxation Ruling TR 2005/17 Income tax: goodwill: identification and tax cost setting for the purposes of Part 3-90 of the Income Tax Assessment Act 1997 (TR 2005/17), at [22]). 11. When Entity B was acquired by the TCG, the goodwill asset of the Entity B business had its tax cost set in accordance with subsection 701-10(4). In accordance with item 1 in the table in section 701-60, the tax cost setting amount at the joining time was worked out in accordance with subsection 705-35(1). Therefore, as noted in subsection 701-55(5), this also set the CGT cost base or reduced cost base of the asset.
12. In accordance with TD 2006/19 (at [3]), the terminating value of the goodwill CGT asset of the Entity B business consists of the cost that was set for the asset under subsection 705-35(1) at the joining time and reflects any adjustments that were made to the cost base or reduced cost base of the asset until just before Entity B left the TCG. 13. Following the Acquisition, the TCG did not incur any other expenditure in relation to the goodwill of the Entity B business that would give rise to an adjustment to the goodwill CGT asset's cost base under Subdivision 110-A, or the asset's reduced cost base under Subdivision 110-B. 14. Therefore, for the purposes of Step 1 for Entity B when it exited the TCG, the terminating value of the goodwill CGT asset of the Entity B business under subsection 711-25(1) was equal to the tax cost that was set for the goodwill asset under subsection 705-35(1) at the time that Entity B joined the TCG. Question 3 Summary
For the purposes of step 1 in the table in subsection 711-20(1) for Entity B when it exited the TCG, an amount was not required to be added under subsection 711-25(2) in respect of any asset consisting of goodwill that Entity A held at the leaving time because of its control and ownership of Entity B. Detailed reasoning 1. In the context of a goodwill asset, subsection 711-25(2) provides: (2) If loss of control and ownership of the leaving entity by the *head company would decrease the *market value of the goodwill associated with assets or businesses of the old group (other than those of the leaving entity), the head company's *cost base of the asset consisting of goodwill that it holds at the leaving time because of its control and ownership of the leaving entity is added to the step 1 amount. 2. The note to subsection 711-25(2) states that, if the asset arose because the head company acquired control and ownership of a joining entity, subsection 705-35(3) would have applied in relation to the joining entity.
3. Subsection 705-35(3) addresses any synergistic goodwill that accretes to an acquiring group when an entity joins a consolidated group. Specifically, subsection 705-35(3) provides: (3) If, just after the joining time, the *head company has, because of its ownership and control of the joining entity, a goodwill asset associated with assets or businesses of the joined group: (a) for the head company core purposes, the asset's *tax cost is set at the joining time at its *tax cost setting amount; and (b) for the purpose of doing so: (i) the asset is taken to be an asset of the joining entity that becomes an asset of the head company because subsection 701-1(1) (the single entity rule) applies; and (ii) it is taken to have a *market value just before the joining time of an amount equal to its market value just after the joining time. 4. TR 2005/17 explains how goodwill is identified and its tax cost setting amount calculated and set under Part 3-90.
5. TR 2005/17 provides (at [18]) that, in addition to the cost of the goodwill of the leaving entity that is added to the ACA under subsection 711-25(1), subsection 711-25(2) adds an amount of the cost base of goodwill associated with businesses of the old group if it meets the following tests: (a) the loss of control and ownership of the leaving entity by the head company, if it did occur, would reduce the market value of the goodwill associated with the businesses and assets of the old group, that is, other than those of the leaving entity; (b) some or all of the goodwill asset associated with the businesses and assets that the old group holds at the leaving time exists because of its ownership and control of the leaving entity; and (c) a tax cost was set for this goodwill at the joining time that would be its cost base at that time.
6. Accordingly, subsection 711-25(2) will apply to synergistic goodwill that has been separately recognised and had its tax cost set under subsection 705-35(3) (TR 2005/17, at [60]). TR 2005/17 provides (at [60]) that the cost allocated to this subsection 711-25(2) goodwill under subsection 705-35(3), that becomes its cost base or reduced cost base because of subsection 701-55(5), is added to the ACA worked out at Step 1. 7. This is supported by Taxation Determination TD 2007/27 Income tax: consolidation: is the cost base of the goodwill referred to in subsection 711-25(2) of the Income Tax Assessment Act 1997 limited to the cost base of goodwill previously identified under subsection 705-35(3) of that Act? (TD 2007/27), which provides (at [1]) that subsection 711-25(2) only refers to goodwill that was separately identified and its cost base or reduced cost base worked out and set under subsection 705-35(3). In this regard, TD 2007/27 provides (at [20]) that, if no goodwill was recognised at the joining time under subsection 705-35(3), then at the leaving time no amount can be included in the cost base of the membership interests under subsection 711-25(2).
8. At the time that Entity B joined the TCG, Entity A did not separately recognise or set a tax cost for any synergistic goodwill under subsection 705-35(3). The only tax cost set for goodwill was in respect of the inherent goodwill of the Entity B business in accordance with subsection 701-10(4), which had its tax cost setting amount worked out in accordance with subsection 705-35(1). 9. Therefore, for the purposes of Step 1 for Entity B when it exited the TCG, an amount was not required to be added under subsection 711-25(2) in respect of any asset consisting of goodwill that Entity A held at the leaving time because of its control and ownership of Entity B.