CASE 51/94
Members:P Gerber DP
Tribunal:
Administrative Appeals Tribunal
Dr P Gerber (Deputy President)
These applications are for the review of the respondent's decisions to disallow the objections of the applicants (hereafter the first applicant is referred to as T, and the second applicant as ST) against amended assessments in respect of the 1987 year of income which issued on 19 October 1988 and 20 October 1988 respectively. In light of the fact that the main issues for consideration relate to the assessability of T's and ST's shares of an amount received by three partners (of which T and ST were two), these applications were heard together.
2. At the hearing of these applications, the applicants were represented by Mr M Flynn of counsel, who was instructed by Mr P Hockridge of William Buck Chartered Accountants, and the respondent was represented by Mr GT Pagone of counsel, who was instructed by the Australian Government Solicitor.
3. The background to these applications may be briefly set out.
4. By a contract dated 13 June 1986, which settled on 19 September 1986 (the possession date), T, ST and C purchased from Mr & Mrs S a freehold property ``together with any improvements and the Goodwill of the Business known as the X Motel'' and ``all floor coverings, blinds, curtains, drapes, electric light fittings, T.V. antenna and furniture and equipment as set out in the inventory attached [ to the contract]''. General conditions 2, 3, 5, 7, 8 and 11 provided:
``2. The Vendors shall sign all documents (to be prepared by the purchasers) and do all
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things necessary for the purchasers to apply for and obtain the transfer to them of-
- (a) any business name relating to the business;
- (b) all licences, quotas, franchises and other like rights relating to the business including any specified herein and including the [name] Motel Chain Registration:
- (c) subject to the approval of Telecom the telephones for the business;
- (d) all permits and registrations necessary to enable the purchasers to carry on the business lawfully including any specified herein;
and shall hand those documents to the purchasers on the possession date.
3. The Vendors shall do all things and execute all documents which the Purchasers may reasonably require for assuring to the Purchasers quiet possession and enjoyment of the business and any other assets hereby sold. The Vendors shall not do or permit any act matter or thing inconsistent with the passing of the goodwill to the Purchasers or whereby the Purchasers may be interfered with or injured in any way whatever in the business.
...
5. The Vendors shall not after the possession date without the purchasers' written consent for a period of two years within 10 kilometres of the premises carry on or be engaged in a business of the type hereby sold in any capacity whatsoever.
...
7. The Vendors warrant that the premises described herein may be lawfully used for the conduct of a motel and are at the date hereof not subject to any notice, order or proposal. The Vendors shall comply prior to the possession date at their expense with any notice, order or proposal issued, delivered or served prior to the settlement date including any requirements or suggestions whatsoever of the [name] Motel Chain in respect of the business conducted at the premises.
8. Until the possession date the business, chattels and other assets hereby sold shall be at the risk of the Vendors who shall maintain the goodwill of the business and carry it on in a proper and businesslike manner. The chattels sold shall be delivered to the Purchasers on the possession date in the same state of repair as at the date hereof fair wear and tear excepted and where applicable in proper working order unless otherwise specified herein.
...
11. The Vendor (sic) warrants to the Purchaser (sic) and the Purchaser (sic) shall ensure that the premises and the business as at the possession date will comply with the minimum standard requirements of the [ name] Motel Chain.''
5. Special conditions 1, 2 and 6 of that contract provided:
``1. This contract is conditional upon the Purchasers obtaining satisfactory Lessees for the X Motel on or before the 12th day of September 1986 failing which this contract shall be voidable at the option of the Purchasers and the said deposit refunded to the Purchasers.
2. For the purposes of the Income Tax Assessment Act the value of all improvements and chattels on the said land included in the purchase price shall be the Written Down Value thereof as shown in the income Tax Return of the Vendors or of any partnership of which they are members for the year ended 30th June, 1985.
...
6. It is agreed between the Vendors and the Purchasers that the purchase price of $335,000.00 herein shall be apportioned between the Freehold, Furniture & Equipment, and Goodwill as follows:-
Freehold & Dwellings $196,092.00
Furniture & Equipment $ 13,908.00
Goodwill of the Business $125,000.00''
6. On 11 September 1986, T, ST and C, entered into a ``Contract for Sale of a Business'' with A Pty Ltd (``A''), an entity controlled by Mr and Mrs H, pursuant to which they purported to sell to A the business known as the X Motel (including goodwill), stock and furniture and equipment for the price of $145,000 plus stock at valuation (to a maximum of $5,000). Settlement of that contract was also effected on 19 September 1986. Pursuant to paragraph 11 of the particulars of sale, the price of $145,000 was apportioned as follows:
General conditions 2, 3 and 6 of that contract were in terms identical to general conditions 2, 3 and 7 respectively of the contract of 13 June 1986. General condition 7 of the contract of 11 September 1936 was also in terms of very similar effect to general condition 8 of the contract of 13 June 1986.
Special conditions 10, 11, 12, 17 and 18 of the contract of 11 September 1986 provided:
``10. This contract is subject to and conditional upon the parties having agreed upon the terms of the lease referred to in the particulars of sale herein and the parties shall execute the lease as soon as practicable after agreement has been reached on the said terms.
11. This contract is subject to and conditional upon the simultaneous settlement of the contract between [the Ss] as vendors and the vendors [T, ST and C] as purchasers of the freehold and dwelling, furniture and equipment and goodwill of the property and business known as the `X Motel' which contract is dated 13th day of June 1986.
12. Neither of the vendors shall after the possession date without the purchasers' written consent for the period of time and within the radial distance from the premises as specified in paragraph 17 of the particulars of sale [three years and 10 kilometres] carry on or be engaged in a business of the type hereby sold in any capacity whatsoever.
...''
Special condition 17 of that contract was in identical terms to general condition 11 of the contract of 13 June 1986.
``18. This contract is conditional upon the freehold owners and the mortgagee consenting in writing by the date of possession and settlement to a mortgage of the lease in respect of the premises dated the 18th day of September 1986 and made between T, C and ST of the one part and A of the other part to the ANZ Bank and the freehold owner and mortgagee signing the usual form of consent required by the ANZ Bank in respect of the mortgage of the lease.''
7. On 18 September 1986, in accordance with special condition 10 of the contract of 11 September 1986, T, ST and C entered into a lease with A under which they leased the X Motel to A for a period of five years (with an option for two additional five year terms), commencing on 19 September 1986 at an annual rental of $30,000, indexed annually based on CPI increases with a minimum and maximum annual increase of 6% and 10% respectively.
8. Included in both T's and ST's income tax returns for the 1987 year of income was the following document:
``T
-
ST
--
C
-
JOINT VENTURE
-------------
FOR THE YEAR ENDED 30 JUNE 1987
-------------------------------
- 1. On 19 September 1986 the abovementioned purchased a freehold property plus a business known as the X Motel [address], for a purchase price of $335,000.
- The price was made up as follows:
Freehold & dwelling 213,092 Furniture & equipment 21,908 Goodwill 100,000 -------- $335,000 ======== - 2. On 19 September 1986 the taxpayers disposed of the business for a price of $145,000 which was made up as follows:
Goodwill 131,092 Furniture & equipment 13,908 -------- $145,000 ======== Profit on sale of Goodwill 31,092 Loss on sale of Furniture etc 8,000 ------- $23,092 ======= - This profit has been included in the profit and loss statement attached.
- ...
PROFIT & LOSS STATEMENT FOR
---------------------------
YEAR ENDED 30 JUNE 1987
-----------------------
Profit on sale of leasehold business 23,092
Rental income 19.9.86 -- 30.6.87 23,342
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9. In the notice of assessment in respect of the 1987 income year which issued to T on 19 April 1988, the only adjustment made to taxable income as returned by T was an increase of $1,000 said to be correction of ``an error in transferring information from an attachment to'' T's return. T's taxable income was assessed to be $20,849. In the notice of assessment in respect of that year which issued to ST on 19 February 1988, ST's taxable income was assessed as returned - $19,474.
10. In the adjustment sheet attached to a notice of amended assessment in respect of the 1987 income year which issued to T on 19 October 1988, T's taxable income for that year was said to have been amended from $20,849 to $45,849 as a result of the addition of a ``Capital Gain on Sale of Leasehold fully assessable - $25,000''. However, as Mr Flynn pointed out, the abovementiond notice of amended assessment stated that T's amended taxable income was (still) $20,849. Mr Flynn, quite rightly in my view, informed the Tribunal at the commencement of the hearing that that error was a simple typographical one since the tax assessed to T as a result of that amended assessment was in fact based on an amended taxable income of $45,849 as intended, and that nothing was to be made of that error. The amended assessment also included ``additional tax for incorrect return'' of $1,142.55.
11. In the notice of amended assessment in respect of the 1987 income year which issued to ST on 20 October 1988, ST's taxable income for that year was amended from $19,474 to $44,474, also as a result of the addition of a ``Capital Gain on Sale of Leasehold fully assessable - $25,000''. The amended assessment also included ``additional tax for incorrect return'' of $1,122.73.
12. On 16 December 1988 T and ST lodged objections in the same terms against those respective amended assessments on the grounds inter alia:
``...
3. The taxpayer is a partner holding a one- fourth share in a partnership (the other partners being [T or ST depending upon whose objection it is] as to one-fourth share and C as to one half share) which on 19 September, 1986 acquired land and improvements at [address], together with the Goodwill of the Business of the X Motel conducted at the same address for a purchase price as set out in clause 6 of the Special Conditions in the contract of sale thus:
Freehold & Dwellings 213,092.00 Furniture & Equipment 21,908.00 Goodwill of the Business 100,000.00 ---------- TOTAL PURCHASE PRICE $335,000.00 ===========4. A condition of the said Contract of Sale was that the partnership would obtain satisfactory lessees for the X Motel.
5. On 19 September, 1986, the partnership sold the Business of the X Motel (including the business name and plant and equipment) to A for a total price of one hundred and forty-five thousand dollars ($145,000) made up as follows, as per the Contract of Sale:-
Goodwill 131,092 Furniture and equipment 13,908 -------- $145,000 ========6. Accordingly, the partnership made a net capital gain of $23,092 (being the excess of $145,000 over $121,908) and this amount was properly returned as income in the 1987 Partnership return. The taxpayer's share was one fourth thereof, namely $5,773.
7. On the same day, the partnership entered a lease agreement with the purchaser of the business. This lease agreement was a normal, commercial, arm's length agreement for a period of five years with two further option periods of 5 years. No consideration was given or received in connection with the granting of this lease.
8. Accordingly, whereas Sub-Section 160ZS(1) of the Act may deem the grant of a lease by the partnership to constitute the disposal of an asset, the effect of the Sub-
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section is rendered void as no premium was paid or payable for the grant of a lease. No amount was received as consideration for the grant of the lease or rights to the business.[there was no paragraph 9]
10. The lease between the partnership and the lessee was for the mount of $30,000 per Annum with provision for annual increases in line with CPI. The fact that a normal commercial rent was payable by the lessee overrides the allegation contained in the Adjustment Sheet that the amount of $100,000 represented the sale of a leasehold. No sensible, commercially-orientated lessee would pay $100,000 merely to secure a five year lease where the annual rental was $30,000 in the first year. What the lessee was in fact acquiring was the goodwill of an ongoing business as a going concern.
11. In the alternative and without limiting the generality of the foregoing, if the amount of $100,000 were properly held to represent the profit on sale of the leasehold (which is not admitted and which is clearly contrary to the documentary evidence), and is held not to represent goodwill of the business disposed of, then the amount of $100,000 paid in the contract of purchase must likewise not be held to represent goodwill, but must comprise amounts of expenditure by the taxpayer in respect of the acquisition of the rights to grant a lease. Therefore, the cost base to the partnership in respect of the leasehold amounts to $100,000 and reduces the profit on disposal of leasehold by the same amount.
The taxpayer claims his one fourth share of these amounts.
12. In the alternative and without limiting the generality of the foregoing, if the amount of $100,000 were properly held to represent the profit on sale of the leasehold, which is not admitted, and if the amount of $100,000 claimed in paragraph 11 as being the cost base of the grant of the leasehold is held not to be properly categorised as the cost base of the grant of the leasehold, then it is claimed that the amount of $100,000 is properly claimable as a loss on disposal of the goodwill of the business known as the X Motel (thus effectively reducing the profit on disposal of the business of $23,092 to a loss of $76,908). A loss is claimed to have been incurred because the amount of $100,000 was paid to acquire the goodwill of the business, and the goodwill would in the circumstances outlined have been disposed of for nil consideration, although this is not admitted. Accordingly, a capital loss of $100,000 has been sustained in the terms of Section 160Z of the Act, and in accordance with the terms of Section 160ZC, the capital loss serves to reduce the alleged capital gain of $123,092 to a net capital gain of $23,092. The taxpayer claims his one fourth share of these amounts.
13. The taxpayer is not assessable to tax under the provisions of Section 25(1), 26AAA, 92, Part IVA, or any other Section of the Income Tax Assessment Act.
14. Furthermore, the taxpayer requests the remission of the amount of $1,142.55 being additional tax in respect of allegedly incorrect return. The taxpayer's 1987 return of income provided a true and full disclosure of all matters necessary to make an assessment. Accordingly, the levying of the amount of additional tax is ultra vires the Commissioner. The Commissioner is not authorised to impose additional tax pursuant to Section 223(1) or 223 (2) of the Act, and the taxpayer is not liable to pay additional tax pursuant to Section 223, the Commissioner should exercise the discretion conferred on him by Section 227(3) and remit all or some part of the additional tax imposed.
15. Also, even if the amount of $100,000 was properly assessable to the partners, which is not admitted, the Commissioner had all necessary information to be able to make an assessment, and by no stretch of the imagination could it be argued that full disclosure was not made.''
13. On 22 December 1989, the respondent issued a ``Notice of Decision on Objection'' to both T and ST in identical terms except for the reference to the date of the relevant amended assessments (19 October 1988 for T and 20 October 1988 for ST). The respondent's notice stated:
``The objection dated 17 (sic) December 1988 against the assessment which issued on 19 October 1988 in respect of the year ended
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30 June 1987 has been considered but has been disallowed for the following reasons:Sub-section 160ZS(1) of Part IIIA (the Capital Gains Tax provisions) of the Income Tax Assessment Act deems that the amount received as Goodwill to be a lease premium.
...''
14. Being dissatisfied with those decisions, the applicants applied to this Tribunal.
15. As part of the applicants' case, T gave oral evidence. The respondent called a Mr N Diamantopoulos. The Tribunal had before it the following exhibits:
- (i) the T documents in relation to T's application - exhibit A;
- (ii) the T documents in relation to ST's application - exhibit B;
- (iii) two photographs of the motel in question - exhibit C;
- (iv) a list and street directory positions of the motels in the town in which the motel in question is situated - exhibit 1;
- (v) a copy of the income tax return of the Ss for the 1986 income year - exhibit 2; and
- (vi) a copy of a paper by Mr PC Cosgrave entitled, ``Leasehold motels, the Victorian disease'' - exhibit 3.
16. At the commencement of the hearing, Mr Flynn applied to amend the grounds of the applicants' objections by inserting the following after paragraph 6 in both objections:
``6A In the alternative to paragraph 5, the partnership made a profit of $6,092 (being the excess of $145,000 over $138,908) and this amount was assessable pursuant to section 26AAA of the Act. The taxpayer's share of the profit was one fourth of this amount, namely $1,523, for the year ended 30 June 1987. Pursuant to paragraph 160L(5)(b) of the Act the application of Part IIIA to the disposal of the business and the granting of the lease is therefore excluded.''
In the circumstances, including having regard to the fact that Mr Pagone advised me that the respondent did not oppose the amendment application and was not prejudiced by the amendment, I allowed the amendment sought to be made.
17. As a result of T's evidence more facts emerged.
18. The X motel was a fairly old motel, probably being built approximately 25 years ago. It consisted of nine rooms plus a residence and was of brick veneer construction with a flat iron roof. The photographs - exhibit C - which were apparently taken two years prior to the hearing confirm that description. The vendors, Mr and Mrs S, also ran the motel prior to its sale to the partners. The motel was situated in a residential area of a country town, approximately one kilometre from the main retail area of that town.
19. The advertised purchase price for the motel at the time T and his two partners became interested in purchasing it was $340,000. As a result of negotiations, they ``negotiated back to 335 on the basis of two conditions'' which T and his two partners insisted upon being included in the contract of sale. Those two conditions were expressed by T as being ``conditional upon finance [being obtained by the partners] through [name] Building Society'' and ``the sale of the goodwill within a 60 day period.'' In cross-examination T agreed that, by his reference to making the contract conditional on the sale of goodwill, he meant that the partners obtained the ``right'' set out in special condition 1 of the contract of sale of 13 June 1986 (see paragraph 4 above) which is set out in paragraph 5 above. The apportionment of the purchase price which appears in special condition 6 of that contract was said by T to have been agreed on the recommendation of the agent through whom the purchase negotiations took place, but T could not recall whether that apportionment occurred before or after the overall figure of $335,000 was agreed to. T also agreed that he did not obtain a valuation of the goodwill of the motel business prior to the purchase.
20. The orginal 60 day period expired with T and his partners being ``unable to sell the leasehold or the goodwill to a satisfactory lessee''. However, T and his partners agreed to an extension of that period by a further 30 days to 12 September 1986, the typed date which appears in the Tribunal's copy of the contract of 13 June 1986. After approximately two or three weeks into that further 30 day period, there was an introduction of a prospective buyer, and successful negotiations commenced between the partners (through an agent) and A, the other party to the ``Contract for Sale of a Business'' dated 11 September 1986 (see paragraph 6
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above) and the lease of the X motel dated 18 September 1986 (see paragraph 7 above). The partners ``original asking price'' for the motel business was $160,000, but as the contract of 11 September 1986 shows, the concluded price was $145,000 (plus an amount for stock). It was said by T that the apportionment of that amount which appears in paragraph 11 of the particulars of sale (see paragraph 6 above), was arrived at through negotiations (through the agent) between T and his two partners on the one hand and the purchaser A on the other.21. The lessee, A, complied with the terms of the lease until approximately January 1989 when they (the Hs who personally managed the motel on behalf of A) communicated to T and his partners that the motel business was not doing as well as they had hoped, and that, as a result, they were in some financial difficulty. As a result of that communication, T and his partners agreed to reduce the rent payable under the lease. However, some time later A ceased paying the rental and the ANZ bank, as mortgagee of the leasehold, attempted to sell the motel business by auction to recover amounts owing to it by the lessee and the Hs. As T described it, the auction was a ``non- event'' as no-one was present to bid. After subsequent negotiations, T and his partners re- purchased the business fixtures and fittings and allowed the bank to surrender the lease (no money passing hands in relation to the surrender). As T put it, ``we really had no choice because we had a motel that wasn't being run as a motel and unfortunately the agents weren't able to introduce a tenant of any description''.
22. For the next 11 months, from June 1991 to May 1992, the partners employed Mrs H to manage the motel for them. T's evidence was that at the commencement of that period he met with Mrs H to discuss ways to improve the running of the business, including improvement of her presentation, that of the office, and increased client service. According to T, these suggestions arose out of observations he had made whilst attending at the motel during the period when Mr and Mrs H ran the business for A. In June 1991, or shortly thereafter, the partners allowed the [name] Motel Chain Registration to lapse in an endeavour to reduce costs, notwithstanding that at the time of purchasing the motel business, the partners accepted the vendors' advice that it was an advantage in the motel being a member of the [ name] Motel Chain. T's evidence was that in that 11 months' period the partners lost ``in excess of $20,000... probably closer to $30,000'' running that business.
23. The partners subsequently converted the motel ``into bed-sitting apartments on a residential basis'', but that also was not very successful. However, a secondary college located some ``10 or 15 miles out of'' the town in which the (once) motel is situated has been leasing the property for use as a boarding house over the two years immediately preceding the hearing.
24. T agreed in cross-examination that when the partners visited the motel prior to negotiations which led to their purchase they considered it ``a concern'' that the motel was located in a residential area and not where he expected a country motel to be - on the main road, but that their view changed as a result of being told by Mr and Mrs S that the motel was ``quite well located'' and it was an advantage for the motel to be off the highway away from the traffic because often ``sales reps'' preferred that situation. T went on to agree that that acceptance of the Ss' explanation of the merits of the location was a consideration in the determination of the amount that they were prepared to pay for the property.
25. As mentioned in paragraph 15 above, the respondent called a Mr N Diamantopoulos. He has been a registered valuer since 1989, and at the time of the hearing was manager of a division of a well-known real estate agency. In the period between July 1989 and June 1991 he was solely involved in the valuation of ``hotel specialised properties incorporating hotel/pubs, accommodation hotels, motels, nightclubs, restaurants, properties whereby they are generally sold on a going concern basis''. During that period he undertook some 15 to 20 valuations of such properties, including some eight valuations of country motels.
26. Mr Diamantopoulos was asked to comment on a statement made in a paper by Mr PC Cosgrave entitled ``Leasehold motels, the Victorian disease'' - exhibit 3 - to the effect that in the case of ``purpose built motels and hotels, goodwill, or the ability to earn an income of reasonably definable amounts, is built into the property''. Mr Pagone asked: ``Does that mean that in the case where you are valuing a freehold with vacant possession, that
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the business is taken from a valuation point of view as being part of the value of the freehold?'', to which the witness replied: ``Yes, it is inherently included in the value of the property on a walk-in walk-out basis as a whole''.27. The only other evidence of any real significance given by Mr Diamantopoulos was that he had encountered the use of gross income per annum multiplied by a factor so as ascertain ``a very broad parameter'' in valuing leasehold business interests, but the factor he had ``come across'' was one (rather than 1¼ as T said he had used) and this was more often in the context of the valuation of hotels than in relation to motels.
28. The reasons for the respondent's objection decision in respect of each applicant as set out in the ``T'' documents are as follows:
``Subsection 160ZS(1) states:
`For the purposes of this Part, the grant of a lease of property shall not be taken to constitute the disposal of part of the property but shall be deemed to constitute the disposal by the lessor to the lessee of an asset (that is to say, the lease) created by the lessor for a consideration equal to the premium paid or payable for the grant of the lease.'
The applicant contends that the payment received was for goodwill. Court decisions have established that goodwill can be made up of local goodwill and personal goodwill.
`Local goodwill' refers to the extent to which the trade connection depends on the place in which the business is carried on. This includes the locality, the number and proximity of competitors, the character and standard of the buildings, the propensity of customers to resort to the same premises and, in the case of a motel, the nearness of facilities which may attract customers to stay there (e.g. centres of entertainment, recreation or sport, or retail outlets).
`Personal goodwill' relates to a person's good reputation, ability, and personality.
F.C. of T. v. Williamson (1943) 67 C.L.R. 561.The evidence shows that the applicant acquired the motel freehold and then leased out the business on the same day. Therefore, he and the other joint venturers did not act as proprietors of the motel and could not have held any personal goodwill in respect of the business.
It is a well established principle that the local goodwill of a business is attached to the premises on which the business is carried on. It cannot be disposed of or severed from the land and buildings. Refer
Tooth & Co. Ltd. v. Commissioner of Stamp Duties (N.S.W.) (1909) 9 SR (NSW) 652.For there to be a disposal of the local goodwill of a business the title to the land must pass to the purchaser of the business.
In the case of the applicant the title to the land owned by the joint venture, did not pass to the purchaser of the business - [A]. Therefore, no local goodwill was disposed of.
It is concluded that the sum of $141,092 was not goodwill but was consideration received on the granting of the lease and is therefore assessable under section 160ZS.''
29. Mr Pagone's submission in effect adopted the respondents ``reasons for decision'' and Income Tax Ruling IT 2535. That ruling relevantly states:
``Grant of a lease over a hotel
5. The agreement between the lessor and lessee may refer to an amount being received for the sale of goodwill, whereas the amount may be at law and in fact wholly or partly a lease premium, being the amount received as consideration for the grant of the lease.
6. It is considered that the main issue which determines whether the grant of a lease over a hotel is associated with the disposal of goodwill or a lease premium, is whether the goodwill is local or personal. Personal goodwill depends upon the personal reputation of the person who carries on the business and is independent of the premises upon which the business is carried on. Goodwill is local if it depends upon the particular place of business.
7. Whether the goodwill associated with a hotel business is local or personal will be a question of fact. This matter is discussed in the judgment of Rich J. in the High Court case of
F.C. of T. v. Williamson (1943) 67 C.L.R. 561 at pp. 563-564:
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`As an abstract proposition, there can be no doubt that a particular goodwill may be local or personal or partly one and partly the other. Its character depends on the nature of the business or the circumstances. It is local to the extent to which the trade connection depends on the place in which the business is carried on, for example, where there is only one hotel in a place the connection may be for all practical purposes entirely local. It is personal to the extent to which it is the personality, ability and good reputation of the trader that attract the trade and not the place where it is carried on. To the extent to which the goodwill is local it is attached to and cannot be severed from the land on which the business is carried on (
Tooth & Co. Ltd. v. Commissioner of Stamp Duties (1909) 9 S.R. (N.S.W.) 652; 26 W.N. 162). To the extent to which it is personal it is only accidentally associated with the land, and may be severed from it and dealt with separately (
Rosehill Racecourse Co. v. Commissioner of Stamp Duties (N.S.W.) (1905) 3 C.L.R. 393).'8. Where the goodwill is local, on the grant of a lease the ownership remains with the owner of the premises as it is not capable of being transferred without the premises. The lessee of the hotel has the use and enjoyment of both the premises and the goodwill for the term of the lease.
9. To determine if the goodwill of a hotel business is local or is separate from the hotel premises and capable of being separated from the premises by the lessor, the following points need to be taken into consideration:
- (a) the locality of the hotel and the number of other hotels in the surrounding area;
- (b) the method of calculating the payment received. If calculated by reference to the term of the lease, it may be a lease premium;
- (c) the value of the premises with the business and without the business. If the value without the business is less, it would suggest that the goodwill is local;
- (d) the arrangements (ongoing or otherwise) made at the time of entering into the lease to encourage the customers to give their custom to the lessee; and
- (e) the arrangement made in respect of the expiration of the lease. If goodwill has been acquired by the lessee, at the time of expiration the lessee should be able to benefit from that goodwill in other premises.
10. Insofar as the grant of a lease over a hotel is not capable of involving an actual disposal of goodwill because it is not severable from the premises, it is considered that a payment received as consideration in respect of the lease (not including payments relating to the actual disposal of assets such as plant or trading stock) is a lease premium within the meaning of sec. 160ZS of the Act. This is so even where such a payment is described as being for the sale of goodwill.
11. Where, after examining all the facts of a particular case, it is clear that there is personal goodwill associated with the hotel and that goodwill is disposed of to the lessee of the premises, a payment received for the disposal is to be treated as consideration in respect of the disposal of goodwill and not as a lease premium. For capital gains tax purposes, where the lessor reacquires the goodwill from the lessee at the expiration of the lease there will be a new acquisition date and cost base.
Grant of a lease over other premises
12. Paragraphs 5 to 11 of this ruling deal specifically with payments received by a lessor on the grant of a lease over a hotel. The ruling has its basis in the close link that exists between a hotel business and the premises at which it is conducted. In other situations where a similar nexus exists between the business conducted and the premises leased, the ruling will also apply. Examples of situations where this could occur are a lease over a newsagency, service station, motel, restaurant or fast-food outlet.''
30. The first thing to note in relation to the respondent's ``reasons for decision'' and IT 2535, is that nowhere in s 160ZS of the Income Tax Assessment Act 1936 (``the Act'') is the concept of goodwill mentioned. As Mr Flynn rightly pointed out, the real question is what is meant by the expression ``premium paid or payable for the grant of the lease'' when used in
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sub-s 160ZS(1). The word ``premium'' is not defined in the Act for the purposes of s 160ZS. Both Mr Pagone and Mr Flynn referred me to authorities dealing with the general law meaning of ``premium'' in relation to leasehold interests.31. Mr Pagone referred me to
Frazier v Commr of Stamp Duties (NSW) 85 ATC 4735, in which Lee J of the Supreme Court of New South Wales, after referring to observations of Warrington LJ in
King v Earl Cadogan [1915] 3 KB 485 at 492, and of the Full Court of the Supreme Court of New South Wales in
Nixon v Doney (1961) 61 SR (NSW) 311 at 316, concluded that a ``premium'' was a sum ``paid as consideration for the grant of the lease''. He also referred me to
Strick (Inspector of Taxes) v Regent Oil Co Ltd [1966] AC 295, in which Lord Upjohn opined at p 341 that ``[t]here is no magic in the use of the word `premium'; it merely means a lump sum paid as a consideration for the acquisition of the lease.''
32. Mr Flynn, however, submitted that " [p]remium has a well accepted legal meaning -
Clarke v United Real Ltd [1988] STC 273 per Walton J at p. 291 (the capital value of the difference between the actual rent and the market rent)." However, when one looks at that decision, one finds that the reference given by Mr Flynn is not part of the judgment of Walton J sitting in the Chancery Division of the English High Court, but part of the decision of a single Special Commissioner from whose decision the appeal was brought before Walton J. The judgment of Walton J commences at p 295. At p 299, the judge, after referring to the dictum of Lord Goddard CJ in
R v Birmingham (West) Rent Tribunal [1951] 2 KB 54 at 57, in fact defines a premium ``as any sum paid by the tenant to the landlord in consideration of the grant of the lease''.
33. Having regard to the cases cited, I am satisfied that the general law meaning of ``premium'' in the context of leasehold interests is a sum paid as consideration for the grant of a lease. Further, I see no reason why that meaning is not applicable in the context of s 160ZS. Both that definition and sub-s 160ZS(1) refer to the consideration being ``for'' the grant of the lease. On the other hand, the definitions of ``premium'' in relation to leases which are contained in provisions of the Act such as s 26AB and s 83 speak of consideration payable ``for or in connexion with the grant... of a lease''. In
Berry v FC of T (1953) 10 ATD 262; (1953) 89 CLR 653, Kitto J said at ATD p 265; CLR p 659:
``The words `for or in connection with' imply that a consideration may satisfy the definition as being `in connection with' one of the subjects mentioned, although not `for' it. Now, while it is true that a payment cannot be described as a consideration `for' anything but that which is given in exchange for it, to speak of a consideration being `in connection with' an item of property parted with is to use language quite appropriate to the case of a payment received as consideration `for' something other than the property in question, so long as the receipt of the payment has a substantial relation, in a practical business sense, to that property. A consideration may be `in connection with' more things than that `for' which it is received.''
However, Parliament has not added the words ``or in connection with'' after ``for'' in sub-s 160ZS(1). In the circumstances, I am satisfied that whether the amount in question is a ``premium paid or payable for the grant of the lease'' is to be determined by considering for what was that amount given in exchange, that is, was the amount given in exchange for the grant of the lease or for something else?
34. It is in this context that it is appropriate to consider the respondent's ``reasons for decision'' and IT 2535. In essence, the respondents process of reasoning is to exclude the possibility that the amount in question is consideration for the disposal of goodwill, from which it is said to follow that if the receipt is not for goodwill, then it must be consideration for the grant of the lease and thus a lease premium ``caught'' by s 160ZS. However, as the following analysis will demonstrate, that process of reasoning is based upon errors of fact and law.
35. Firstly, the respondent negatives the possibility that the amount in question is consideration for the disposal of local goodwill from T and his partners to A. He does this by reasoning that:
``For there to be a disposal of the local goodwill of a business the title to the land must pass to the purchaser of the business.
In the case of the applicant the title to the land owned by the joint venture, did not pass
ATC 458
to the purchaser of the business - [A]. Therefore, no local goodwill was disposed of.''(see paragraph 28 above)
(The respondent is presumably referring to freehold title.)
Similar reasoning is expressed in a slightly different way in paragraph 8 of IT 2535 which is set out in paragraph 29 above.
36. This reasoning is, however, based upon a misunderstanding of what Rich J said in
FC of T v Williamson (1943) 7 ATD 272, at 273; (1943) 67 CLR 561, at 563-4, and of the decision in
Tooth & Co Ltd v Commr of Stamp Duies (1909) 9 SR (NSW) 652. I am satisfied that there is nothing in Williamson to suggest that when Rich J said at pp 563-4 that ``[t]o the extent to which the goodwill is local it is attached to and cannot be severed from the land on which the business is carried on ([citing Tooth])'' (my emphasis), his Honour was referring to the ownership of the land. Indeed, when one examines the judgments of the majority (Pring and Sly JJ) in Tooth, it is evident that local goodwill is attached to the possession of the land on which the relevant business is carried on, and thus passes with a lease of those premises. For example, Pring J states at p 665:
``In my opinion the reasoning of Chanell J. in the West London Syndicate case applies to this case. He says in [1898] 1 Q.B. at p. 238:- `But in the case of a public-house there is nothing, I think, that could in any way be severed from the enjoyment of the land. It is attached to the possession of the land. It is not necessarily attached to the lease, there may be a lease, and there may be an underlease, and so on, but the only person who can get the benefit of the trade of the public-house, which is what the goodwill really means, is the person who is entitled to the possession of the premises,...'.''
and Sly J states at p 668:
``I am of opinion that the local goodwill attached to the premises necessarily passed by the transfer of the lease; such goodwill is not separable from the premises, and can only be regarded as situated where the premises are: see
Inland Revenue Commissioners v. Muller & Co.'s Margarine Ltd. ([1901] A.C. 217).''
37. Thus any local goodwill associated with the X motel business was able to be disposed of by T and his partners to A notwithstanding that ownership of the land (in the sense of freehold title) upon which that business was conducted remained with T and his partners.
38. Secondly, the respondent negatives the possibility that the amount in question is consideration for the disposal of personal goodwill from T and his partners to A. He does this by reasoning that (see paragraph 28 above):
```Personal goodwill' relates to a person's good reputation, ability, and personality.
F.C. of T. v. Williamson (1943) 67 C.L.R. 561.The evidence shows that the applicant acquired the motel freehold and then leased out the business on the same day. Therefore, he and the other joint venturers did not act as proprietors of the motel and could not have held any personal goodwill in respect of the business.''
39. This reasoning is also erroneous for reasons to which I will come later. But before that, and before considering the evidence in further detail, it is necessary to say something as to the nature of the goodwill of a business. In
Inland Revenue Commissioners v Muller & Co.'s Margarine Ltd [1901] AC 217, Lord Macnaghten said at p 223-4:
``What is goodwill? It is a thing very easy to describe, very difficult to define. It is the benefit and advantage of the good name, reputation, and connection of a business. It is the attractive force which brings in custom.... To analyze goodwill and split it up into its component parts, to pare it down as the Commissioners desire to do until nothing is left but a dry residuum ingrained in the actual place where the business is carried on while everything else is in the air, seems to me to be as useful for practical purposes as it would be to resolve the human body into the various substances of which it is said to be composed. The goodwill of a business is one whole, and in a case like this it must be dealt with as such.''
In that same case Lord Lindley said at p 235:
``Goodwill regarded as property has no meaning except in connection with some trade, business or calling. In that connection I understand the word to include whatever adds value to a business by reason of situation, name and reputation, connection, introduction to old customers, and agreed
ATC 459
absence from competition, or any of these things, and there may be others which do not occur to me.''
In Williamson, apart from the passage of Rich J set out in IT 2535 (see paragraph 29 above), his Honour also noted at ATD p 273; CLR p 564 that:
``the goodwill of a business is a composite thing referable in part to its locality, in part to the way in which it is conducted and the personality of those who conduct it and in part to the likelihood of competition, many customers being no doubt actuated by mixed motives in conferring their custom.''
In
Box v FC of T (1952) 10 ATD 71; (1952) 86 CLR 387, Dixon CJ, Williams, Fullagar and Kitto JJ stated at ATD p 75; CLR p 397:
``Goodwill includes whatever adds value to a business, and different businesses derive their value from different considerations. The goodwill of some businesses is derived almost entirely from the place where they are carried on, some goodwills are purely personal, and some goodwills derive their value partly from the locality where the business is carried on and partly from the reputation built up around the name of the individual or firm or company under which it has previously been carried on.''
Recently in
Hepples v FC of T 91 ATC 4808, McHugh J, after referring to the abovementioned statements in IRC v Muller and Box, said at p 4837:
``It will be seen from the statements in I.R.C. v. Muller that goodwill is the collective name for various intangible sources of the earnings of a business which are not able to be individually quantified and recorded in the accounts as assets of the business.''
40. On the whole of the evidence, I am satisfied that there was goodwill associated with the X motel business which was transferred to T and his partners by Mr and Mrs S pursuant to the contract of 13 June 1986. Although the evidence on a number of aspects was somewhat equivocal, I am satisfied, on balance, that that goodwill was in part referable to the motel's locality, the business' name, the way the Ss had conducted the business, their agreement not to compete with that business after the sale, and the advantage in reputation in the motel having [ name] Motel Chain registration. Further, I am satisfied that that goodwill was transferred by T and his partners to A pursuant to the contract of 11 September 1986. Although T and his partners had no personal reputation of having run a motel business, the reputation which subsisted as a result of the way the Ss had conducted the business, the name of the motel and the [name] Motel Chain registration all formed part of the goodwill transferred. So, for the respondent to say that T and his partners held no ``personal'' goodwill in respect of the business because they did not act as proprietors of the motel is, in effect, to answer the wrong question. As the following passage from Box at ATD p 76; CLR p 399 illustrates, the good reputation which stemmed from the abovementioned factors does not cling to those who established it as long as the transferee of the goodwill does nothing to affect adversely that reputation:
``The great bulk of the sales to these customers was made in their own homes so that the real value of the goodwill had nothing to do with any particular site but consisted in the formation of a personal connection with a large number of purchasers of bread who were quite unmindful where the bread was baked, whether at 86 Elphin Road or elsewhere, so long as bread of the same quality continued to be delivered to them by the Elphin Bakery at their homes.''
Thus, the part of goodwill referable to the business' reputation built up by the Ss was able to be transferred (as part of the goodwill as a whole) by T and his partners to A because they had done nothing to affect it adversely.
41. Returning to my finding that the goodwill of the business was transferred to A pursuant to the contract of 11 September 1986, inherent in that is rejection of the respondent's submission that there was not such a transfer, since all A received was the ``use'' of that goodwill, which reverted to T and his partners at the expiration of the lease of the motel premises. I an satisfied that the agreement of 11 September 1986 was an effective, arm's length and bona fide sale of the business (including all of the goodwill of that business), as was the agreement of 13 June 1986 an effective, arm's length and bona fide purchase of the business (including all of the goodwill of that business). Further, there is nothing in the evidence to suggest that the apportionment of the purchase price under
ATC 460
either contract was other than bona fide. Indeed, I am satisfied on balance, particularly having regard to the evidence as to the negotiations that took place, that that apportionment was bona fide. Further, there is nothing in the evidence to suggest that the rental payable under the lease was other than market value. I am satisfied, as the applicant submits, that $131,092 of the $145,000 was received by T and his partners in consideration for the sale of the goodwill of the motel business as stated in that contract. I am thus satisfied that the amount in issue was not a lease premium ``caught'' by s 160ZS.42. Although the ``local element'' of goodwill could not be transferred separately from the lease of the premises, it does not follow that the lease and the goodwill are not separate assets for the purposes of Part IIIA of the Act. Indeed, ``goodwill'' is specifically included as an ``asset'' in s 160A. Further, there is nothing to suggest that various elements which make up the goodwill of a business are separate assets for the purposes of Part IIIA. Indeed, having regard to the various statements in the cases referred to in paragraph 39 above, it would appear to me that ``goodwill'' (in its composite or collective form) is one asset for the purposes of Part IIIA.
43. As a result, I am satisfied that if any capital gain accrues to the partners in the circumstances, it is as a result of the disposal of the goodwill of the motel business for a consideration of $131,092, having acquired the goodwill from the Ss under the contract of 13 June 1986 for an arm's length consideration of $125,000. Further, the amount of any such capital gain would be reduced by the (then) one-fifth exemption provided for in s 160ZZR.
44. However, I am satisfied that no such capital gain accrues because the applicant is correct in concluding that the effect of s 160L(5)(b) in the circumstances is that Part IIIA does not apply in respect of the disposal of the goodwill, since as a result of that disposal the partnership made a profit of $6,092 which has been or will be included in the net income of the partnership by virtue of s 26AAA.
45. Mr Pagone submitted that s 26AAA could not apply because that section required an ``exact coincidence'' between the property acquired and the property sold. Such a ``coincidence'' was submitted not to exist because:
``What they transferred was the goodwill attaching to the new lease. That is a new thing altogether. It was created at the time that the new lease was entered into and hence what they disposed of is not what they acquired beforehand. What they acquired beforehand was the freehold interest.''
That is another way of expressing arguments with which I have already dealt. Rather than repeat myself, let me simply say that I have concluded that the goodwill of the motel business was purchased by the partners pursuant to the contract of 13 June 1986 and was sold by them to A pursuant to the contract of 11 September 1986. That goodwill is clearly property: see for example IRC v Muller at pp 223 and 235;
The Bacchus Marsh Concentrated Milk Co Ltd (In Liquidation) & Anor v Joseph Nathan & Co Ltd (1919) 26 CLR 410 at p 438. Therefore even if Mr Pagone's submission is correct that an ``exact coincidence'' between the property acquired and the property sold is required before s 26AAA can apply (on which I refrain from expressing a concluded view), I am nevertheless satisfied that the amount of the abovementioned profit is assessable income of the partnership pursuant to s 26AAA.
46. For the above reasons, the objection decisions under review are set aside and the matters remitted to the respondent to amend the applicants' assessments in respect of the 1987 year of income in accordance with these reasons for decision. Liberty to apply is granted in the event that there is some dispute as to those amendments.
THE TRIBUNAL DECIDED:
The Tribunal sets aside the objection decisions under review and remits the matters to the respondent to amend the applicants' assessments in respect of the 1987 year of income in accordance with the Tribunal's reasons for decision.
Liberty to apply is granted in the event that there is some dispute as to those amendments.
The Tribunal certifies that these proceedings have terminated in a manner favourable to the applicants.
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