1 Did the Company acquire its business goodwill before 20 September 1985 for the purposes of section 109-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?
1 Yes. Question 2 Pursuant to subsection 149-30(2) of the ITAA 1997, is the Commissioner satisfied, or does the Commissioner think it reasonable to assume that, at all times on or after 20 September 1985 to the date of this ruling application, a majority of the underlying interests in the Company were held by ultimate owners who had majority underlying interests in the Company immediately before that day, such that subsections (1) and (1A) apply as if that were in fact the case? Answer 2 Yes. This ruling applies for the following periods: Year ending 30 June 20XX Year ending 30 June 20XX The scheme commenced on: 1 July 20XX
The Company The Company was registered on DDMMYYYY. When the Company was registered the initial shareholders were the Individual and their then spouse (Former Spouse), each holding 1 ordinary share. Between DDMMYYYY and DDMMYYYY, the shareholders of the Company were the Individual and Former Spouse. A copy of an ASIC historical extract for the Company was supplied. On DDMMYYYY the Individual and the Former Spouse went through a property settlement as a result of their divorce. As part of the property settlement the Former Spouse's 1 ordinary share in the Company was transferred to the Individual on DDMMYYYY. A copy of the property settlement was supplied. The Company Since incorporation, the Company has at all times conducted the business of the design and manufacture of XXX products. Over time its activities have changed, but the products produced have continued to be XXX products. The Company position at 19 September 1985 As at 19 September 1985: • the Company's business name was Company;\ • the Company operated a business of design and manufacture of XXX products.
The Company had approximately XX 'floor' staff with approximately X working in the office. Floor staff consisted of tradespeople. The Company did not have a website. Design work for XXX products was done on computer aided design (CAD). The Company did have a sales and marketing function, primarily CAD 3-dimension modelling of designs. There was a key supplier amongst other local XXX distributors. The customers of the business were predominantly larger business. The sales made by the company were mainly direct rather than through distributors. The company operated from premises in a suburb in Australia. The design and manufacture of the product was done in-house. The major assets of the business are the equipment used in manufacture and the skills of the workforce. The Company's activities and circumstances post-20 September 1985 The Company registered a different business name in around YYYY or YYYY and that continues to be the trading name. Some customers still deal with the business using the original business name, but this is uncommon.
The Company had been manufacturing a particular XXX product in-house for its own use prior to 20 September 1985. In or around YYYY the Company began to design that same product for others. Initially the engineering sign-off for the product was done externally but this was brought in house in around the year YYYY. The Company mostly stopped supplying the other XXX products in around YYYY as a result of payment issues and the work becoming unprofitable. The Company's current activities are focussed on the design, manufacture and supply of XXX products. The Company currently has approximately XX 'floor' staff and an additional XX office staff. The floor staff still consist of tradespeople. The design of equipment and products is carried out in-house and manufacture of equipment now occurs approximately XX% in-house and approximately XX% being manufactured by unrelated parties overseas. Design work for XXX products continues to be done on CAD. The Company continues to have a sales and marketing function. The key supplier to the business has changed because the original supplier is no longer in business.
The customers of the business still consist of larger and smaller builders, but now also include mining companies. Approximately XX% of the sales are now through distributors. The company moved its operations from one site in a suburb of Australia to another site in the same suburb in Australia. The Company has not bought or sold any businesses or parts of businesses. The major assets of the business are the equipment used in manufacture and the skills of the workforce. The same XXXing tools and machines are still used. The table below summarises the business of the Company as on 19 September 1985 and its current business: Table 1: Summary of the Company as of 19 September 1985 as compared to their current operations. Activities Business conducted on 19 September 1985 Current business conducted Business activities The business predominantly consisted of designing and manufacturing XXX products. The business still predominantly consists of designing and manufacturing XXX products - focusing on a different product. Business name Trading as the Company. Trades under a slightly different name. Employees Approximately XX 'floor' staff and X office staff
Approximately XX 'floor' staff and XX office staff Turnover Turnover in the year ended 30 June 1985 was approximately $X The business had a turnover of approximately $X in the income year ended 30 June 20XX. Management The key management person was the Individual. The key management person remains the Individual. Location of Business The business was conducted from premises in a suburb in Australia. The business is still conducted from premises in the same suburb in Australia. Key suppliers The key supplier to the business was a XXX supplier and distributor. The key supplier is, a different XXX supplier and distributor. Key customers The key customers of the business were large and small builders who were sold to directly. The key customers of the business are still large and small builders, but also includes mining businesses and sales through distributors Major assets used The major assets of the business are the equipment used in manufacture and the skills of the workforce. The major assets of the business are the equipment used in manufacture and the skills of the workforce. Proposed sale of the Individual's shares
The Individual is negotiating the sale of their shares in the Company for approximately $X. It is likely that exchange of contracts will occur in the financial year ending 30 June 20XX.
Income Tax Assessment Act 1997 subsection 104-10 Income Tax Assessment Act 1997 subsection 104-10(1) Income Tax Assessment Act 1997 paragraph 104-10(5)(a) Income Tax Assessment Act 1997 section 108-5 Income Tax Assessment Act 1997 paragraph 108-5(2)(b) Income Tax Assessment Act 1997 Division 109 Income Tax Assessment Act 1997 section 109-5 Income Tax Assessment Act 1997 section 109-10 Income Tax Assessment Act 1997 Division 149 Income Tax Assessment Act 1997 section 149-10 Income Tax Assessment Act 1997 subsection 149-15(1) Income Tax Assessment Act 1997 subsection 149-15(2) Income Tax Assessment Act 1997 subsection 149-15(4) Income Tax Assessment Act 1997 subsection 149-15(5) Income Tax Assessment Act 1997 Subdivision 149-B Income Tax Assessment Act 1997 section 149-30 Income Tax Assessme
All references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated. Issue Question 1 Summary The Company's business goodwill is considered to be an asset acquired before 20 September 1985 for the purposes of section 109-10. Detailed reasoning Goodwill, or an interest in it, is a CGT asset (paragraph 108-5(2)(b)). CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1)). Any capital gain or capital loss you make on disposal of an asset acquired prior to 20 September 1985 (pre-CGT) is disregarded (paragraph 104-10(5)(a)). Division 109 sets out the ways in which you can acquire a CGT asset and the time of acquisition. Under the general rule in section 109-5, you acquire a CGT asset when you become its owner. The table in section 109-10 provides specific rules for the circumstances in which, and the time at which, you acquire a CGT without a CGT event happening. Item 1 of the table states that where you create the CGT asset you acquire the asset when the work that resulted in the creation started. The meaning of goodwill Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business
(TR 1999/16) considers the general meaning of goodwill as used in the context of the CGT provisions. TR 1999/16 reflects the decision of the High Court of Australia in FC of T v. Murry 98 ATC 4585; (1988) 39 ATR 129 ( Murry ). Relevantly, paragraph 9 of TR 1999/16 explains that goodwill has the meaning it bears under the general law, rather than its accounting and business definitions. It is the legal definition of goodwill as explained by the High Court in Murry which is applicable. In paragraph 15 of TR 1999/16, the Commissioner recognises that goodwill is a species of intangible property. Paragraph 12 of TR 1999/16 explains goodwill in the following terms:
....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. The passage above reiterates the comments by the High Court in Murry at [22], that goodwill has 3 different aspects, namely property, sources and value, which combine to give definition to the legal concept of goodwill. Further, what unites these aspects is the conduct of a business. Murry
at [23] also described goodwill as 'the legal right or privilege to conduct a business in substantially the same manner and by substantially the same means that have attracted custom to it .' Goodwill remains a single CGT asset if the same business continues As noted above, goodwill is a composite thing and therefore a single item of property and CGT asset. One consequence of this is that the whole goodwill of a business that commenced before 20 September 1985 remains the same single pre-CGT asset (subject to Division 149), provided the same business continues to be carried on. This is so even though the sources of the goodwill of a business may vary during the life of the business (paragraph 17 of TR 1999/16). However, it is possible for a business or the sources of its goodwill to change to such an extent that it is no longer the same business as that previously conducted (paragraph 18 of TR 1999/16). Goodwill remains the same if essential nature or character maintained Whether the same business is carried on is a question of fact and degree that ultimately depends on the circumstances of each case. In this regard, paragraph 21 of TR 1999/16 provides 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 a 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: • 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.
In determining whether the same business is being carried on, paragraph 91 of TR 1999/16 sets out a number of factors to consider, including 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 a business is structured, carried on, managed and controlled. Therefore, if the essential nature or character of the business is not changed, the business remains the same business for CGT purposes. Goodwill should be assessed on a continual basis, rather than just comparing the taxpayer's business at 2 points in time. If the original business changes to an extent that it is no longer the same business, the old business ceases and a new business commences. 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 18 of TR 1999/16).
According to paragraph 24 of TR 1999/16, the same business would not be carried on if a business changes its essential nature or character through a planned or systematic process of change within a reasonable period of time, or if 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. Generally, where a new business operation or activity is introduced as an expansion of an existing business, any goodwill built up in conducting the expanded business is merely an expansion of the existing goodwill of the business. Therefore, if a business which commenced before 20 September 1985 is expanded, goodwill generated in conducting the expanded business is merely an accretion to the pre-CGT goodwill (paragraph 60 of TR 1999/16). However, where 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 (paragraph 61 of TR 1999/16). Paragraph 62 of TR 1999/16 provides further guidance by stating:
Whether an increase in business operations or in the scale of activities constitutes an expansion of an existing business, or a new and separate business in its own right, is a question of fact dependent on the circumstances of each particular 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: • is subject to the same integrated management and control as the existing business; • is treated for banking and accounting purposes as an extension of the existing business or as a separate business; • uses one or more different trading names; and • is related to or dependent on the existing business in a practical, economic or commercial sense. Application to the Company's circumstances
Under section 109-10 the Company is taken to have a acquired the goodwill when the business that created the goodwill began to operate on DDMMYYYY, which is before the introduction of Capital Gains Tax (CGT) on 20 September 1985 (pre-CGT). If the essential nature of the Company's business has not changed, then the Company's business remains the same business for CGT purposes and the goodwill of the Company will be the same that existed before 20 September 1985 and considered to have been acquired before 20 September 1985. It is a question of fact and degree whether the goodwill of the business is the same asset as it was when it was acquired. A comparison between the essential nature or character of the Company's business just prior to 20 September 1985 and on a continual basis since that time, indicates that the Company at all times conducted a XXX design and manufacture business. While initially the business focus was on the domestic design and manufacture of XXX products, the diversification overtime into new compatible operations was an organic expansion of the Company's business.
It is considered that the essential character of the Company's business, and therefore its goodwill, is the same as the one that existed just before 20 September 1985 on the following basis: • the activities of the Company which existed at that time are unchanged and the essential nature of the business activities have always consisted of designing and manufacturing XXX products • employee staff numbers and skills have remained consistent with floor staff predominantly trades people • key management has been the same throughout the period of operation, with the Individual continuously in control of the business • the location of the business has remained in the same suburb • key suppliers have remained XXX suppliers and distributors • key customers have been large and small business with expansion into mining businesses through distributors • the major assets of the business have continued to be the equipment used in manufacture and the skills of the workforce.
• there has been no sudden or dramatic change in the business brought about by either the acquisition or the shredding of activities on a considerable scale • In YYYY, when the Company began to diversify its designing and manufacturing to include other XXX products, it is considered an expansion of the existing business, rather than a new business, on the following basis: • the Company had been certifying and manufacturing those same products in-house for its own use prior to 20 September 1985 and the design and manufacture for others was a natural expansion • the same staff, skill set, and equipment have been utilised for the expansion • the customers continue to be large and small business, but now also include XXX businesses, with sales conducted through distributors • the progression to manufacture new products has been gradual over a 9 year period • the overall operation has continued to be managed by the Individual for the entire period
• the production of the new product by the business has been dependent on the existing business in a practical, economic and commercial sense, relying on the long-standing good reputation of the Company. Accordingly, the goodwill generated in conducting Company's business following specialisation into different XXX products, is merely an accretion to the pre-CGT goodwill. Conclusion The whole of the goodwill of the Company's business, commencing in YYYY, is a single pre-CGT asset as the same business continues to be carried on by the Company. Therefore, the goodwill of the Company's business is considered to be an asset acquired before 20 September 1985 for the purposes of section 109-10. Question 2 Summary The Commissioner accepts that it is reasonable to assume that the majority underlying interests in the business goodwill of the Company has been held by the same ultimate owners who held such interests immediately before 20 September 1985 for the purposes of Division 149. Detailed reasoning
Division 149 contains the provisions under which an asset acquired before 20 September 1985 is treated as having been acquired after that date, so that the asset stops being a pre-CGT asset. Subdivision 149-B provides for when the asset of an entity stops being a pre-CGT asset for entities that are not covered by section 149-50. Subdivision 149-B contains provisions which govern when an asset of non-public entity stops being a pre-CGT asset. A CGT asset is a pre-CGT asset if it was last acquired before 20 September 1985 and no income tax provision has operated to treat it as having been acquired after that date. Section 149-10 provides as follows: A CGT asset that an entity owns is a pre-CGT asset if, and only if: (a) the entity last acquired the asset before 20 September 1985; and (b) the entity was not, immediately before the start of the 1998-99 income year, taken under: (i) former subsection 160ZZS(1) of the Income Tax Assessment Act 1936; or (ii) Subdivision C of Division 20 of former Part IIIA of that Act; to have acquired the asset on or after 20 September 1985; and
(c) the asset has not stopped being a pre-CGT asset of the entity because of this Division. Section 149-30 provides that an asset of a non-public entity stops being a pre-CGT asset at the earliest time when the majority underlying interests in the asset were not held by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985. The test to determine when an asset of a non-public entity stops being a pre-CGT asset is a factual test. Under the test, the asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not maintained. Therefore, an entity must examine the underlying interests in its pre-CGT assets on an on-going basis to ensure that majority underlying interests in them have been maintained when there has been a change, direct or indirect, in its shareholdings, unit holdings or other membership interests. Subsection 149-15(3) defines an 'ultimate owner' to include an individual. It does not include companies that pay dividends to their members, or trusts.
Special rules apply to work out majority underlying interests if an ultimate owner (new owner) has acquired an interest in an asset because it was transferred to the new owner by the former owner as result of marriage breakdown covered by Subdivision 126-A. Subsections 149-30(3) and 149-30(4) provides that the new owner is treated as having held the underlying interests of the former owner for the period the former owner held them. Taxation Determination TD 1999/49 Income tax: capital gains: is roll-over under sections 126-5 and 126-15 of the Income Tax Assessment Act 1997 dependent on there being a marriage breakdown between the spouses? confirms that that former section 160ZZM of the ITAA1936 (now rewritten as section 126-5 of the ITAA 1997) affords roll-over to asset transfers between spouses 'upon the breakdown of their marriage' Relevantly, 149-30(3) and 149-30(4) applies where a taxpayer disposes of an asset to his or her spouse pursuant to an order of a court under the Family Law Act 1975 or under a corresponding law of a foreign country
Taxation Determination TD 1999/47 Income tax: capital gains: is there roll-over under section 126-5 or 126-15 of the Income Tax Assessment Act 1997 if a CGT event happens because of a court order under the Family Law Act 1975 made by consent? explains that an order made by consent is a 'court order' in terms of paragraphs 126-5(1)(a) and 126-15(1)(a). Subsection 149-15(2) defines an 'underlying interest' in a CGT asset as a beneficial interest that an ultimate owner has (whether directly or indirectly) in the asset or in any ordinary income that may be derived from the asset. Subsection 149-15(1) defines majority underlying interests. It requires ultimate owners to hold more than 50% of the beneficial interests (either directly or indirectly through one or more interposed companies, trusts or partnerships) in the CGT asset and in any ordinary income that may be derived from the asset. Subsections 149-15(4) and (5) provide that an ultimate owner has an indirect beneficial interest in a CGT asset of another entity if they would receive for their own benefit any capital or ordinary income distributed by the entity through interposed entities.
Under subsection 149-30(2), if the Commissioner is satisfied, or thinks it reasonable to assume, that the majority underlying interests in the asset have not changed up to a particular time, then subsections 149-30(1) and (1A) apply and the asset continues to be a pre-CGT asset. Simply put, subsection 149-30(2) requires that the Commissioner has to be satisfied that the majority underlying interests in the assets have not changed, otherwise the asset is deemed to have been acquired at the time that the change in majority underlying interests in that asset happened. Application to the Company's circumstances For the goodwill to retain its pre-CGT status, the ultimate owners who held majority underlying interests in the goodwill immediately before 20 September 1985 must retain such interests after that date, otherwise Division 149 will operate to convert the asset into a post-CGT asset.
No new shareholders have gained any entitlements since 20 September 1985. By virtue of the special rule in subsections 149-30(3) and 149-30(4), that applies to the transfer of shares because of marriage breakdown, the Individual is treated as having held the underlying interests of their former spouse for the period they held them and therefore they have held 100% of the shares in the Company at all times. As such, no new person has gained the right (or potential right) to more than 50% of the ordinary income and capital that may be derived from the goodwill. This means that the asset will remain a pre-CGT asset. Conclusion The Commissioner accepts that in this case it is reasonable to assume that the majority underlying interests in the goodwill has been held by the same ultimate owners who held such interests immediately before 20 September 1985 for the purposes of Division 149. The goodwill is therefore not taken to have stopped being a pre-CGT asset of the Company for the purposes of section 149-10.