taxation law

Capital Gains Tax Editor: Grant Cathro

. with is goodwill, some other asset or both. Where T h e H i g h C o u r t On G o o d w i l l t h e transaction involves a dealing with both

C tC th goodwill and other assets which contribute to its

Arthur Robinson & ^edderwich C r e a t Ì O n > a P r 0 P e r a l l ° c a t i o n of value to the respective assets may assume critical importance. A

The decision of the High Court in Commissioner f a i l u r e t 0 i d e n t i i V e a c h r e l e v a n t a s s e t a n d a l l o c a t e

of Taxation ν Murry (1998) 39 ATR 129 goes a consideration to it may enable the Commissioner to

considerable way towards clarifying the nature of a r ê u e t h a t a n a m o u n t d e s c n b e d a s consideration, goodwill and its treatment in the context of the r e l a t e s t 0 m o r e t h a n o n e C G T e v e n t > s o t h a t li c a n

capital gains provisions. At the same time the be apportioned under s 116-40. decision has raised concerns about the breadth of I n o t h e r instances the goodwill of a business may the concessionary treatment afforded to goodwill by b e a P<>st-CGT asset; however, the person dealing Div MZ-C of the Income Tax Assessment Act \991 w i t h {t m a y b e a b l e t 0 t a k e a d v a n t a g e of the (the 1997 Act). It has also called into question the goodwill concession in Div 118-C or may be able to date of acquisition of goodwill where there have t a k e advantage of the small business rollover been changes in the nature or composition of a provisions in Div 17A of the Income Tax business Assessment Act 1936. In those instances it becomes

While the majority of the court made a number important to identify how much consideration is of observations in relation to the valuation of assets, received for the goodwill and how much is received significant questions remain about the proper for other assets, method of allocating value between goodwill and γ ^

6 n a j

u r e 0 f g o o d w i l l

the other assets of the business which contribute to its creation. The decision of the majority in Murry's case

confirms that: T h e i m p o r t a n c e of defining g o o d w i l l ·

A distinction is to be made between the

goodwill of the business and the other assets of It will often be important to define whether a

m e business which may provide the sources

given transition involves a dealing with goodwill f rom

which it is generated; and if it does what other assets are employed in the . Goodwill is an asset of a business independent business which must be considered separately from

0 f

t n e other assets of the business that provide

goodwill. m e

setting for its creation; In many instances a business which commenced

# Goodwill is inseparable from the business to

prior to the introduction of capital gains tax may which it relates and is only capable of being have pre-CGT goodwill. Yet other assets employed transferred in conjunction with the business, in the business such as a licence or trade mark, may The sale of an asset of the business does not have been acquired after the capital gains provisions involve any sale of goodwill unless the sale of the were introduced. In these circumstances it is

a s s e t is accompanied by or carries with it the right

important to determine whether or not what is dealt to conduct the business.

March 1999 ~~ 5 7

Capital Gains Tax

W h a t is g o o d w i l l ? be more trouble to go elsewhere. These categories serve as a reminder that the goodwill

According to the court, goodwill is property and ¡s a c o m p o s i t e thing referable in part to its an asset in its own right for Pt 3 purposes. l o c a l i t y i n p a r t t 0 t h e w a y i n w h i c h i t i s

Goodwill is conducted and the personality of those who "the legal right or privilege to conduct a business c o n d u c t i t a n d i n p a r t t 0 t h e i i k e l i h o o d 0 f in substantially the same manner and by competition, many customers being no doubt substantially the same means which in the past actamd by mixed motives in conferring their have attracted custom to the business" ((1998) custom " 39 ATR 129 at 137 and 143). T h e f a c t t h a t different t h i n g s contribute to the

It is the product "of combining and using the c r e a t i o n o f g o o d w i l l h a d i e d to the suggestion that tangible, intangible and human assets of a business t h e r e m i g h t b e d i f f e r e n t ^ p 6 5 o f goodwill, site for such purposes and in such ways that custom is g o ^ n i , p e r s o n a i g o o dwill, name goodwill and drawn to it" ((1998) 39 ATR 129 at 137). monopoly goodwill (see for example the comments

While recognising the accounting concept of o f H i | 1 j i n FCT v Krakos ¡nvestments Pty Ltd goodwill, the court would seem to reject the "added

( χ 9 % ) % A T C 4 0 6 3 ) a n d i n d e e d t 0 t h e s u g g e s t i o n

value" concept m favour of an approach to goodwill t h a t i t m a y p e r h a p s b e p o s s i b l e t 0 d e a

, w i t h t h e s e

which sees the attraction of custom to the business d i f f e r

e n t elements of goodwill separately. The as central to the concept of goodwill. Consequently,

d e c i s i o n i n Murry ~

s c a s e e s t a blishes quite clearly

the court indicated that an earlier definition of t h a

t this is not the case. The goodwill of a business goodwill given by McHugh J in Federal ¡s> ¡t w o u l d s e e m a s i n g l e a s s e t c a p a b l e o f b e i n g Commissioner of Taxation ν Hepples (1992)

d e a l t w k h o n l y w h e r e t h e r e ¡s a d e a l i n g w i t h t h e

22 ATR 465 at 498 which was "influenced by the b u s i n e S s . Of course, in certain circumstances, it is accounting and commercial view of goodwill, p o s s i b l e t h a t a t a x p a y e r m a y h a v e m o r e than one should not be regarded as an accurate statement of b u s i n e s s e a c h o f w h i c h h a s i t s 0 W n goodwill, the legal definition of goodwill" ((1998) 39 ATR 129 at 136-137, paras 20 and 21). T h e ^ ^ rf g Q o d w ¡ | ,

T h e r e l a t i o n s h i p b e t w e e n g o o d w i l l a n d A c c o r d i n g to the court "... goodwill is a quality o t h e r a s s e t s of a b u s i n e s s o r attribute that derives, inter alia, from using or

The ability to attract custom would appear to be 3PP1^11S t h e o t h e r a s s e t s o f t h e b u s i n e s s " ( a t 137> the cornerstone of goodwill. As earlier cases have s u c h a s t r a d e m a r k s ' a P a r t i c u l a r s i t e o r s e l h n S recognised, the features of a business which attract S o o d s a t c o m P e t i t i v e P r i c e s - " ^ s e f a c t o r s d o n o t ' custom vary from business to business. These however, form part of the goodwill. In some cases different features were defined in zoologically terms t h e f a c t o r s w h i c h c o m b i n e t 0 P r o v i d e t h e s o u r c e s o f

in FCT ν Williamson (1943) 67 CLR 561 at 564 8 o o d w i U a r e t h e m s e l v e s a s s e t s · F o r c a P l t a l ê a i n s

where referring to the English case of Whiteman PurPoses> t h e y a r e t 0 b e t r e a t e d a s s e P a r a t e a s s e t s

Smith Motor Co Limited ν Chaplain it was said that: ( s e e Μυ

"? a t λ 3 9 a n d 1 4 0 )

· "The cat prefers the old home to the person who

N o t a "

t h e s o u r c e s o f S

o o d w i 1 1 a r e ' h o w e v e r

' keeps it, and stays in the old home although the P

r o P

e r t y

o r a s s e t s f o r a c c o u n t i n S P t o s e s . Other

person who has kept the home leaves, and so it s o u r c e s o f

S o o d w i

" r e f e r r e d t 0

^ t h e

™^ ™ represents the customer who goes to the old shop

Murr y'

s c a s e i n c l u d e manufacturing and

whoever keeps it, and provides the local distribution techniques, the efficient use of assets of goodwill. The faithful dog is attached to the

a b u s i n e s s '

s u P

e r i o r m a n a 8

e m e n t practices, good

person rather than to the place; it will follow the i n d u s t r i a l r e l a t i o n s

' m o n e

y s

P e n t o n a d v e r t i s i n

g a n d

outgoing owner if he does not go too far. The rat P r o m o t i o n a n d s o m e o f t h e

expenditures incurred on

has no attachments, and is purely casual. The labour relations and customer services,

rabbit is attracted by mere propinquity. It comes G i v e n t h e b r o a d d e f i n i t i o n o f a s s e t s i n s 1 0 8

' 5 >

because it happens to live close by and it would s o m e o f t h e s o u r c e s o f

8 o o d w i

" w h i c h a r e n o t

58 AUSTRALIAN TAX REVIEW - VOLUME 28

Capital Gains Tax

property and would not be regarded as an asset for tied up with the site from which it was conducted accounting purposes, may nonetheless be an asset that a sale or mortgage of the premises, carried with for Pt 3 purposes. Were all of these non-proprietary it by implication a sale or mortgage of a business items to be treated as assets for Pt 3 purposes conducted on the site. separate from goodwill, most of the value of a Notwithstanding the fact that the sale of a single business may well be referable to assets other than asset such as a trade mark or a licence will not goodwill. One issue which is not considered in involve a transfer of goodwill, there will often be Murry's case is the extent to which the non- circumstances in which the sale of one of the assets proprietary rights involved with a business must be significantly reduces the value of goodwill. If, for treated as separate assets. Where a contract for the example, the owner of the Coca-Cola business were sale of a business apportions the sale price between to sell the trade mark "Coca-Cola", without selling tangible assets, licences and goodwill, but does not the secret formula by which it is made or other apportion any part of the consideration to any rights rights to conduct the business, the sale of the trade held by the business which are not proprietary in mark would not involve a sale of goodwill, yet nature, it is necessary to ask whether any non- arguably, that sale would diminish the value of the proprietary rights are to be treated as separate assets goodwill considerably. A purchaser of the trade to which consideration should be apportioned. mark would hope to be able to use the mark to Given that these non proprietary rights are generally attract much of the custom of the vendor's business not capable of transfer, are not afforded protection to the purchaser's business. As the majority of the by the law in their own right, but are generally court stated: protected indirectly as a consequence of the "... the potential use of an asset which is protection afforded to goodwill, it would seem that transferred out of the business may give it a when dealing with a business as whole, these items value which approximates to the value of the should not be treated as separate assets. goodwill which the business derived from the

It is interesting to note that the majority held that use of the assets. Nevertheless, potential use is a licence, other than an exclusive licence to conduct merely an attribute of an asset, while goodwill is business in a particular area, is unlikely to be a property which is inseverable from a business, source of goodwill. In Murry's case, the licence in They are not to be equated for legal purposes, question was a taxi licence which merely provided a notwithstanding that in some cases the value of right to enter the market, but given the number of the goodwill of a business may be reliable licences, provided no exclusivity. evidence as to the value of the asset or the

T h e sale of i n d i v i d u a l a s s e t s E ^ p ^ s a g e indicates, there is clearly the

As goodwill is "the legal right or privilege to potential for there to be some overlap between the conduct a business in substantially the same manner v a I u e of goodwill and the value of individual assets, and by substantially the means which in the past if those individual assets are valued on the basis of have attracted custom to the business...", it follows w h a t someone would pay for them if they were sold that a sale of an individual asset does not involve a o n t n e n " o w n · sale of goodwill, unless the asset is accompanied by T h e v a l u a t i o n o f g o o d w i l l or carries with it the right to conduct the business.

In some instances, the goodwill of a business How then is value to be apportioned between may be so dependent upon a particular asset that a goodwill and the other assets of a business which transfer or mortgage of that asset may be found to contribute to its creation? Much, it would seem, will carry with it a transfer or mortgage of the goodwill depend upon the bargain struck between the parties, of the business. In a modern context, circumstances If the parties have allocated the consideration across where this will occur are likely to be rare. In earlier all relevant assets, are dealing at arm's length and times when people were less mobile, the goodwill have not colluded in relation to the allocation of of a public house or hotel was considered to be so consideration, the Commissioner may have very

March 1999 59~

Capital Gains Tax

limited ability to argue for an apportionment which concessionary treatment provided in Div 118C may is different from that provided. (For further be limited. discussion, see 26 ATR 90.) One cannot help wondering whether the court

If the parties do not allocate the consideration has fully considered the implications of the across all relevant assets, s 116-40 will permit the alternative approaches which might be taken to the consideration to be apportioned on a reasonable valuation of goodwill. The question of valuation of basis. A number of observations made by the goodwill was not an issue which was directly in majority of the High Court in Murry's case are issue in Murry's case, and is unlikely to be an issue relevant in determining what is a reasonable value on which the court had the benefit of detailed to be placed on goodwill. submissions from counsel for either of the parties.

Given that the legal concept of goodwill differs In practice, the value of many intangible assets from the accounting concept, the court did not used in a business, such as trade marks or licences, accept that the value of goodwill could necessarily will be seen by accountants to increase as the be determined by looking at the value of goodwill business develops and its capacity to attract custom for accounting purposes. As the legal concept of increases. For example, where a purchaser buys a goodwill is based on custom, goodwill can exist for regional television station, it is likely that an legal purposes, even although a business may be accountant would value any identifiable tangible or loss making, and an accountant would conclude that intangible assets, including the television licence, the business has no goodwill. (which unlike a taxi licence, provides a form of

Yet, the majority of the court clearly felt that monopoly) having regard to the earnings of the provided the identifiable assets are valued with business. Consequently, where the particular station precision,"the value of goodwill for legal and has become well patronised, the value of the licence accounting purposes will often, perhaps usually, be is likely to be seen to be higher than it would have identical" (at 144). In so doing, the court appears to been when the licence was first issued. Yet the recognise that where the goodwill of a business is licence itself and the permission which it provides largely derived from using specific identifiable to carry on the business has not changed. assets, such an approach may apportion very little Experience suggests that people will pay far less for value to goodwill. As the court stated: a new licence than they would pay to acquire an

"Where the goodwill of a business largely existing television station, even after the new derives from using an identifiable asset or assets, licences have been issued. In many cases, the only the goodwill of the business, as such, when difference between the new licence and the existing correctly identified, may be of small value. This licence is the fact that the existing television station is because the earning power of the business will has developed patronage on its frequency because be largely commensurate with the earning power of the programming style, format and advertising of of the asset or assets. If the goodwill of a the existing television station. One wonders whether business largely depends on a trademark, for it is really correct to suggest that these benefits example, and the mark is fully valued, the real developed by using the licence and other assets of value of goodwill can only reflect a value that is the business increase the value of the licence, or similar to the difference between the business as whether in the context of a sale of the entire a going concern and the true value of the net business, the benefits should be reflected in the assets of the business including the trademark. A value of goodwill. purchaser of the business will not pay twice for The suggestion that, in the context of the sale of the same source of earning power. The purchaser the business, assets which provide the sources of will not pay a sum that represents the earning goodwill should be valued having regard to the power of the trademark and also the sum that price which a purchaser would pay for them on a represents the earning power of the business." stand alone basis, is at odds with other comments Such an approach is likely to mean that in many made by the court in relation to the sale of a single

businesses, the value of pre-CGT goodwill or the asset. The majority said that "when an asset of the value of goodwill which is entitled to the business is sold, and the business is not, the sale

60 AUSTRALIAN TAX REVIEW - VOLUME 28

Capital Gains Tax

may reduce the value of the goodwill of the on its business, whether connected with the business" {Murry at 140). Thus, where an exclusive premises in which the business was previously licence is sold on its own and a purchaser pays a carried on, or with the name of the late firm, or price which takes account of the fact that some of with any other matter carrying with it the benefit the patronage of the existing business is likely to of the business" {Cruttwell ν Lye (1810) 17 Ves flow with the licence, it would seem that the court Jun 335 at 346; 34 ER 129 at 134) accepts that the sale of the licence will erode the and that goodwill: value of the goodwill. As the majority stated: "is the benefit and advantage of the good name,

"the potential use of an asset which is transferred reputation and connection of a business. It is the out of the business may give it a value which attractive force which brings in custom. It is the approximates to the value of the goodwill which one thing which distinguishes an old-established the business derived from the use of the asset." business from a new business at its first start." This would suggest that where the licence is sold (Per Lord Macnaghten, Inland Revenue

as part of the sale of a business, it may be Commissioners ν Muller & Co 's Margarine Ltd appropriate to value the licence on some other basis, [1901] AC 217 at 223-224.) which places a greater value on goodwill. It is It may well be appropriate in the context of a possible that the distinction drawn between adherent sale of a business to value assets which are the goodwill and inherent goodwill in the United sources of goodwill, having regard to the price Kingdom case of Whiteman Smith Motor Co ν which someone would have paid for them, sterilised Chaplain [1934] 2 KB 35 at 41, 48-49 may be of of the benefits which accrue to those assets from some assistance in determining how the value of a their use in the business. Such an approach would business should be apportioned between goodwill see the value which accrued from those benefits and the other identifiable tangible and intangible which are inherent characteristics of an asset assets of the business. Inherent goodwill is the (inherent goodwill) accruing to the asset, but would benefit which arises because of some particular see the value accruing from the use of the assets in characteristic of another asset. Adherent goodwill is the business (adherent goodwill) accruing to the element of goodwill which arises because of the goodwill. conduct of a business using the asset. In Box ν FCT An approach which values all of the identifiable (1952) 86 CLR 387 at 398, the High Court referred tangible and intangible assets which are property to the difference between the two in the following based on what someone would pay for them on a terms: stand alone basis, is likely to create difficulties

"Some premises have a site goodwill because the where unregistered trade marks become registered, site has some particular advantage for carrying or technology which is originally unpublished and on a business, as where premises adapted for a kept secret, is later patented. As unregistered trade shop are situated in a position especially marks are not property, they can only be transferred favourable for the business in a busy shopping as a part of goodwill (see FC of T ν Just Jeans Pty area, or where a licence can be obtained for Ltd (1987) 87 ATC 4363). Likewise, know-how is carrying on a business such as that of a publican not property and cannot be transferred. It would on a suitable site on which it would otherwise be seem that the value accruing to a business from an unlawful to carry it on. Other premises may have unregistered mark or know-how is likely to form acquired a site goodwill, as in the case of a retail part of the value of goodwill. If that unregistered store, because a profitable business has been mark is subsequently registered, or the know-how carried on there for a number of years and people ultimately results in the grant of a patent, does the have become accustomed to resort to that site to value of goodwill suddenly decrease in value? do their business." Registration of a trade mark does not take away The majority of the High Court appears to have from the protection offered to the mark at common

accepted {Murry at 135-136) that goodwill is law, but merely provides the proprietor of the mark "every advantage - every positive advantage ... with an item of property and additional remedies that has been acquired by the old firm in carrying against anyone who infringes the mark. The

March 1999 o T

Capital Gains Tax

alternative approach suggested would ensure the disposed of when the goodwill of the business is value which accrues to the business from the mark's sold or otherwise transferred ..." {Murry at 143). use in the business forms part of the value of In making these comments, the court gave an goodwill, whereas the value which accrues from example which might be seen to suggest that in registration forms part of the value of the registered applying this test, the business at the later point in mark. time is to be compared with the business at the

In practical terms, an approach which placed a earlier point in time without regard to the manner in value on goodwill in excess of the residual value which, or time period over which, any change has remaining after all other identifiable tangible and occurred. The court also referred to the case of intangible assets had been valued on a stand alone Avondale Motors (Parts) Pty Ltd ν FCT{\91\) 124 basis, would give the goodwill concession in Div CLR 1997 as authority dealing with this "same 118C a scope of operation which reflects the business" test. In doing so it would seem that the original policy for its introduction. It would seem court did not intend to imply that the test to be that the intention of Parliament was that the applied in determining whether the business was the goodwill concession should apply to something same business was any different from the test created by the enterprise, either by the present or a applied in the context of the carry forward loss previous proprietor, and that the concession should provisions. Consequently, it would seem that the provide a benefit to taxpayers who, by their efforts, mere fact that the business conducted now is generated additional value in a business (see the markedly different from that conducted prior to the terms of the original para (d) of s 160ZZR(I) and introduction of capital gains tax would not be Senate Debates, 5 June 1986 at 3492). The decision determinative in deciding whether the goodwill of of the majority of the High Court, that goodwill is the business was still a pre-CGT asset. In an asset separate from the other assets which determining whether the goodwill was the same contribute to its creation, ensures that the asset it would be necessary to look at the way in concession is not given scope beyond that originally which this change had come about and determine intended by Parliament. The approach to valuation whether it had merely resulted from a process of of goodwill will however determine whether the gradual change and organic growth, or from a concession provides the result which it would seem sudden one-off change in activity. was originally intended. _,

Conclusion Effect of changes in a business ^

1 , . . . . .

L Λ u

The decision m Murry s case has removed much Comments made by the court in relation to of the uncertainty which previously existed in

changes in the composition of a business have dealing with goodwill in the capital gains context. It caused many taxpayers some concern. The court has made clear that goodwill is an asset independent indicated that goodwill was acquired when a person of the other assets of the business which provide the originally acquires the legal right or privilege to sources from which it is created. It has also made conduct a business in substantially the same manner clear that goodwill cannot be dealt with and by substantially the same means which in the independently of the business to which it relates, past have attracted customers to the business. The two most significant issues which now Ordinarily, this would be when they commence or remain are the determination of the proper method purchase the business. of valuing goodwill, and identifying which, if any,

There would seem little doubt, given the nature of the non-proprietary elements of a business which of goodwill, that goodwill can only remain the same might be regarded as assets within Pt 3 are to be asset if the business remains the same business. As treated as assets independently of the goodwill and the majority stated: valued independently.

"as long as the business remains the 'same There is much in Murry's case to suggest that the business', the goodwill acquired or created by a value of goodwill will often be determined by taxpayer is the same asset as that which is deducting from the value of the business, the value

^ 2 AUSTRALIAN TAX REVIEW - VOLUME 28

Capital Gains Tax

of all other identifiable tangible and intangible put to suggest that assets should be valued assets. While the court recognises that these other differently when they are dealt with as part of a assets must be properly valued, it is unclear whether dealing with an entire business. Such an approach, the court would think that it was appropriate to whilst not departing from the court's formulation of value these assets differently, depending upon the nature of goodwill as property, would ensure whether they are sold as individual assets on their that the treatment of goodwill in the capital gains own, or are sold as part of the sale of an entire context was more consistent with Parliament's business. There are strong arguments which can be original intention.

March 1999 "~ 63~