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Ruling

Subject: Income Tax - Capital Gains Tax - majority underlying ownership of a pre-CGT asset

Question 1

Is the goodwill attached to the business conducted by the Trustee for a unit trust (UT) a pre-capital gains tax (pre-CGT) asset of the UT in terms of Division 149 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

If Division 149 of the ITAA 1997 would otherwise convert the pre-CGT status of the goodwill to a post-CGT asset, will the Commissioner exercise his discretion under subsection 149-30(2) of the ITAA 1997 to treat the goodwill as a pre-CGT asset?

Answer

Yes.

This ruling applies for the following period

1 July 19XX to 30 June 2012

The scheme commenced on

1 July 19XX

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

A company acting as trustee for the UT

· established a business before 20 September1985 for CGT purposes;

· conducted the business from the same premises for the ownership period; and

· received gross sale proceeds relating to goodwill, depreciable plant, leasehold improvements, trading stock etc

A unit trust owned 70% of the units in The UT. The unit trusts existed pre-CGT.

The company was incorporated as trustee for the UT. Copies of the company's change of name certificate of registration and summary of member's register have been provided. The certificate provides evidence of the company's change of name and commencement date.

The company has always acted as trustee for the UT.

The company has not issued any further shares since prior to 1985.

At all times, (the majority of) the company's issued shares were held directly or indirectly by members of the one family. Details of the company's shareholding have been provided.

Copies of a sample of directors meetings have been provided in evidence of the family's involvement with the business which has been sold.

The owners of the original units comprised numerous discretionary trusts (and a company owned by one of those trusts) controlled by the one family.

The UT's sale of its business was reported in the local media with the report stating that the family had conducted a similar business at a different location over many years.

The unit trust deeds have been submitted as verification of the existence of the unit trusts since pre-CGT.

The trustees are to pay, apply or set aside any net income or capital gain made by the trusts in proportion to the number of units for which they are registered holders.

Where any unit holder proposed to transfer any units in the trusts they are to first offer them to a registered holder or alternatively a person selected by the trustee as a desirable person. They can only seek alternatives where neither of these are willing to pay a fair value. The restriction does not apply if the transferee is to be a family member or for the benefit of family members.

The family and trustees of the Family Trusts which had (in)direct interests in the UTs cannot supply records of distributions of income and capital from the relevant discretionary trusts which had interests in the UT for the 1985 income year (i.e. immediately before the introduction of CGT).

Relevant legislative provisions

Income Tax Assessment Act 1997 section 100-60

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 109-10

Income Tax Assessment Act 1997 section 149-10

Income Tax Assessment Act 1997 section 149-15

Income Tax Assessment Act 1997 section 149-25

Income Tax Assessment Act 1997 subsection 149-30(1)

Income Tax Assessment Act 1997 subsection 149-30(2)

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Summary

For the goodwill of a business to be treated as a pre-CGT asset of a business it is necessary to consider the way in which the discretionary powers of a trustee are exercised. There are insufficient records of the distribution of income/capital to the ultimate owners of the business sold by the UT to determine that the goodwill is a pre-CGT asset.

Detailed reasoning

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.

'Goodwill' has the meaning it bears under the general law for the purpose of CGT assets as outlined in section 108-5 of the ITAA 1997. Goodwill 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.

Subsection 995-1(1) of the ITAA 1997 provides that you acquire the goodwill in the circumstances and at the time worked out under Division 109 of the ITAA 1997.

Section 109-10 of the ITAA 1997 sets out specific rules for the circumstances in which, and the time at which, you acquire a CGT asset otherwise than as a result of a CGT event happening. Item 1 of section 109-10 of the ITAA 1997 states that if you create a CGT asset and you own it when the CGT asset is created, you acquire the CGT asset at the time the work that resulted in its creation started. If a taxpayer commences business and starts to create the goodwill, the goodwill of the business is acquired when the taxpayer starts work which results in the creation of the goodwill.

The UT's business is the work that has resulted in the creation of goodwill. As such, pursuant to item 1 of section 109-10, the UT is taken to have acquired the goodwill of the business from the commencement of the business.

The goodwill of a business that commenced before 20 September 1985 remains a pre-CGT asset (subject to Division 149 about when an asset stops being a pre-CGT asset) provided the same business continues to be carried on. This principle holds even though the sources of the goodwill of a business may vary during the life of the business; or there are fluctuations in goodwill during the life of the business. As such, any accretion to its goodwill since 20 September 1985 is not a post-CGT asset, provided the same business is being carried on.

The provisions of Subdivision 149-B of the ITAA 1997 determine when a CGT asset of an entity stops being a pre-CGT asset (unless the entity is a public entity listed in section 149-50 of the ITAA 1997). This happens at the earliest time when the 'majority underlying interests' in the asset were not held by 'ultimate owners' who held majority underlying interests in the asset immediately before 20 September 1985.

An ultimate owner indirectly has a beneficial interest in a CGT asset of another entity (that is not an ultimate owner) if he, she or it would receive for his, her or its own benefit any of the capital of the other entity if:

· the other entity were to distribute any of its capital; and

· the capital were then successively distributed by each entity interposed between the other entity and the ultimate owner.

Under section 149-30 of the ITAA 1997, an asset stops being a pre-CGT asset at the earliest time when the majority underlying interests in the asset were not held by the ultimate owners who held majority underlying interests in the asset immediately before 20 September 1985.

Majority underlying interests is defined in subsection 149-15(1) of the ITAA 1997 as more than 50% of:

a) the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset and

b) the beneficial interests that ultimate owners have (whether directly or indirectly) in any income that may be derived from the asset.

In accordance with the definition provided in subsection 149-15(3) of the ITAA 1997 the ultimate owner in this case is an individual(s).

The expression 'beneficial interests' used in the definition of majority underlying interests is not defined. In general law, a beneficiary of a discretionary trust does not have any legal or equitable interest in the assets of that trust.

Taxation Ruling No IT 2340 (IT 2340) Income Tax: Capital Gains: Deemed acquisition of assets by a taxpayer after 19 September 1985 where a change occurs in the underlying ownership of assets acquired by the taxpayer on or before that date discusses the terms underlying interest and majority underlying interest, and former section 160ZZS of the Income Tax Assessment Act 1936 (ITAA 1936). Paragraph 2 of IT 2340 advocates a 'look through' approach in relation to chains of companies, partnerships and trusts in order to determine whether there has been a change in the effective interests of natural persons in the assets.

Where assets are held by the trustee of a discretionary trust, the assets are not beneficially owned by any persons. This creates difficulties when assessing whether the majority underlying beneficial interest in an asset is maintained. In this regard, paragraph 6 of IT 2340 requires the taxpayer to show that the trustee has administered the trust for the benefit of members of a particular family at all times during the relevant years of income.

Furthermore, in accordance with paragraph 8 of IT 2340, the trustee must not have exercised discretionary powers to appoint beneficiaries or amend the trust deed that would result in a practical change of 50% or more underlying interests in the trust assets.

It needs to be determined, whether majority underlying beneficial interest in the business has been maintained in relation to the discretionary trusts.

Where the terms of the trust deed and the pattern of distributions indicate that the trustee of the discretionary trust has administered the trust for the benefit of members of the family at all times during the relevant years of income, changes to the composition of the family ownership, though a series of discretionary trusts, is not considered to result in a failure of the family distribution criteria. The trust continues to be administered for the members of the family.

Paragraph 5 of IT 2340 indicates that 'in considering the question of whether majority underlying interest have been maintained in the assets of the trust it will be relevant to take into account the way in the which the discretionary powers of the trustee are in fact exercised.'

Where there is a lack of evidence of the pattern of distributions of income and capital from the discretionary trusts it is not possible for a 'look through' approach to be applied. Therefore in terms of Division 149 of the ITAA 1997 the business sold by the UT is not considered to be a pre-CGT asset.

Question 2

Summary

The Commissioner will exercise his discretion in terms of subsection 149-30(2) of the ITAA 1997 to treat the goodwill of the business sold by the UT as a pre-CGT asset.

Detailed reasoning

Under subsection 149-30(1) of the ITAA 1997, an asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not had by the ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985. This requires a measurement of the underlying interests.

Alternatively, if the Commissioner is satisfied or thinks it reasonable to assume that, at all times on and after 20 September 1985 and before a particular day, majority underlying interests in the asset were had by ultimate owners who had majority underlying interests in the asset immediately before that day, subsection 149-30(2) of the ITAA 1997 would apply. The Commissioner has discretion to overlook a lack of evidence of continuity of majority underlying interests and allow the pre-CGT status of the asset to continue as if the majority underlying interests had remained unchanged.

The expression 'beneficial interests' as used in the definition of majority underlying interests is not defined however section 149-30 of the ITAA 1997 does contemplate the tracing-through of companies and trusts (including discretionary trusts).

The terms majority underlying interests, underlying interest and ultimate owner are defined in subsections 149-15(1), (2) and (3) of the ITAA 1997. Subsections 149-15(4) and (5) define when an ultimate owner indirectly has a beneficial interest in a CGT asset of another entity or in ordinary income that may be derived from a CGT asset of another entity.

Company shareholders do not have any legal or equitable interest in the assets of that company as discussed in Archibald Howie Pty Ltd v. Commr of Stamp Duties (NSW) (1948) 77 CLR 143. Thus a shareholder does not have any beneficial interest in the assets owned by the company. For a discretionary trust, the beneficiary has no interest in trust income (Gartside & Anor v. IR Commrs [1968] 1 All ER 121; Re Weir's Settlement MacPherson & Anor v. IR Commrs [1970] 1 All ER 297) until the exercise of the trustee's discretion. In this case the UT has units owned by companies, other unit trusts and discretionary trusts which all result in ultimate ownership by various members of the one family.

IT 2340 states that the application of the trustee's powers determines the application of Division 149 of the ITAA 1997. Because there is no evidence of the trustee's distribution of income or capital (where available) in favour of the family members as outlined in the trust deeds, other facts must be considered before the Commissioner can reasonably assume that the assets of the business were acquired before 20 September 1985 and at all times there has been a majority underlying ownership.

Before 20 September 1985 the unit trust was set up and a company was registered to act as the trustee of the UT. The company owners and beneficiaries of the trusts were largely made up of members of the one family (as detailed in the facts and supported by documentary evidence). The company has not issued any shares since prior to 1985.

Minutes of company director's meetings held before 20 September 1985 have been submitted.

It was indicated that the business had been family run at the current location since before 20 September 1985.

Therefore the Commissioner will to exercise his discretion under subsection 149-30(2) of the ITAA 1997. It is 'reasonable to assume' that the business which has recently sold by the UT had been owned and operated by same ultimate owners at the time of the sale as those who had majority underlying interests in the units in the UT at 19 September 1985. The property remains a pre-CGT asset of the trust for the purposes of Division 149 of the ITAA 1997.

The business retained its pre-CGT status therefore the UT is taken to have acquired the goodwill of the business before 20 September 1985. Any capital gain made on the disposal of the goodwill of the business will be disregarded under paragraph 104-10(5)(a) of the ITAA 1997.

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