Navigating CGT issues: Goodwill from an expanded business – can it be integrated with existing business?

Goodwill is inherently connected with a business and is an intangible asset for capital gains tax (CGT) purposes. If a business was established before the introduction of the CGT provisions, goodwill is a pre-CGT asset (subject to Division 149 – when an asset stops being a pre-CGT asset). For a business that commenced on or after 20 September 1985, goodwill is a post-CGT asset. This means any capital gain from its disposal will be taxable, unless CGT rollover relief or small business CGT concessions are available.

As a business grows it may undertake a wider range of activities and so a critical question arises: is goodwill from the expanded business a separate and distinct CGT asset, or simply an expansion of the existing business goodwill? The correct CGT treatment of the expanded business goodwill may have significant taxation implications. If the original business maintains its essential nature and character, then even though the business has grown, any goodwill accrued from the expansion may be viewed as an extension of the original business goodwill.

Consider a business that started before 20 September 1985. If the expansion occurs after this date and the business remains the same business for CGT purposes, the goodwill generated in conducting that expanded business could arguably be treated as merely an accretion to the pre-CGT goodwill. In this case if the business is later sold, the capital gain attributable to goodwill will be exempt from tax subject to Division 149 applying.

The correct CGT treatment of expanded business goodwill is also important in scenarios involving the sale of pre-CGT shares. Any capital gains arising from the sale of pre-CGT shares are generally exempt from tax unless CGT event K6 is triggered. This will occur if the market value of the post-CGT property of the underlying company is 75% or more of the total value of all assets it owns. The effect is a portion of the capital gain attributable to pre-CGT shares will become taxable.

Consider a company that has pre-CGT goodwill and adds to that business an additional business purchased post 20 September 1985. If the post-CGT goodwill is treated as a separate asset from the pre-CGT goodwill and the post-CGT grows considerably in value, there is a risk that CGT event K6 could be triggered. This will depend on the relative market value of its post-CGT assets (including the business goodwill) compared to the market value of its pre-CGT assets.

Further, the CGT treatment of business goodwill (whether there is discrete post-CGT goodwill or integrated into the original goodwill) can impact a taxpayer’s eligibility for the small business 15-year exemption. For example, consider a taxpayer who operates a car wash outlet and later expands to a second location 15 years later. Upon selling the consolidated business, a key question arises: is the goodwill associated with the new location considered to have been acquired when the original business started 15 years prior?

If the car wash operations at each location are treated as separate businesses, the goodwill of the original location may qualify for the small business 15-year exemption, while the goodwill from the second location would not. Conversely, if the expanded business is integrated into the original operation—effectively there is only one business—then the combined goodwill may also qualify for the exemption.

Taxation ruling TR 1999/16 Income Tax: capital gains – goodwill of a business (TR 1999/16) considers, amongst other things, if goodwill can remain a single asset on the expansion of an existing business. It is a question of fact and degree whether the expansion causes the original business to cease its existence and new business goodwill is acquired or the same business is being carried on. TR 1999/16 states:

“21…a business owner may expand or contract activities, or change the way in which a business is carried on, without ceasing to carry on the same business provided the business retains its essential nature or character. Organic growth, expansion or diversification of a business by, for example:

(a) adopting new compatible operations;

(b) servicing different clients; or

(c) offering improved products or services

does not of itself cause it to be a new business provided the business retains its essential nature or character”.

Determining whether the same business is being carried on is a matter of fact and degree, and ultimately depends on the circumstances of each particular case. According to TR 1999/16 the test to use for whether the same business is being carried on is not the same test as that described for the purposes of the company loss provisions. Factors to consider include the nature or character of the business, its location and size, the extent of changes in the assets and resources of the business, the activities of the business – whether the activities constitute, or are treated by the business owner as constituting, separate or distinct activities, enterprises, divisions or undertakings – and the way in which the business is structured, carried on, managed and controlled.

For taxpayers contemplating business expansion, understanding the CGT treatment of goodwill may assist with accessing potential tax reliefs, particularly in situations involving pre-CGT goodwill and pre-CGT shares or trust interests. It may also help taxpayers qualify for the small business 15-year exemption, particularly if they have been operating their original post-CGT business for many years. Taxpayers who view that their business expansion is a result of organic growth should obtain evidence to substantiate the position taken as this will be crucial in the event of disputes with the ATO.

——-