Walpole, Michael --- "The Fate of Goodwill after Ralph" [2000] JlATax 24; (2000) 3(5) Journal of Australian Taxation 344

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This article takes stock of the position of goodwill in the taxation system after the Ralph reforms. Although the reforms to capital gains tax have ended the unusual emphasis on goodwill as a means to obtain a capital gains tax concession for small business taxpayers, this article identifies a continuing important role for goodwill as an asset subject to capital gains tax, especially in relation to the "active asset" requirements of the new capital gains tax concessions for small business. The article also identifies other areas in which goodwill will remain an important consideration for tax purposes, such as stamp duty and goods and services tax.

1. INTRODUCTION

Given the change of focus that has come with tax reform, is goodwill still important for tax purposes? This is the question some are asking themselves, and the answer is clearly an affirmative. Goodwill used to be important primarily because of the favourable treatment afforded goodwill under the superceded Subdiv 118-C (s 118-250) of the Income Tax Assessment Act 1997 (Cth) ("ITAA97").^[1] It is because of this that goodwill has been an important consideration in analyses of the impact of capital gains tax ("CGT") on taxpayers selling businesses. For CGT, the approach was to maximise the value of the business that could be classed as goodwill in order to claim the concession. In stamp duty too, goodwill has been important. Often there has been a reflex of the approach adopted by the taxpayer for CGT purposes, in the stamp duty provisions that have applied to that taxpayer because, in most jurisdictions, property subject to stamp duty on transfer or conveyance includes goodwill. In stamp duty, the incentive has been to keep the value attributable to dutiable property (including goodwill) down as much as legally possible. The Federal Government's response to the Review of Business Taxation's ("RBT") proposal for the reform of business tax will change the special CGT treatment of goodwill, broadening the relief from CGT which is available to small business and changing one of the principal tax considerations relating to disposals of goodwill by small business taxpayers. This change does not mean that goodwill will become unimportant. It will remain an important asset to which the new small business reliefs apply.

In addition, if the cash flow/tax value method of calculating tax liability (the so-called "Option 2") is introduced,^[2] goodwill appears to be destined for special treatment under that regime.^[3] Meanwhile, the importance of goodwill to the tax bases, especially the stamp duty base, of the states and territories will be unabated by the changes to state taxes occasioned by tax reform.

The purpose of this paper is to examine the proposed changes and determine those situations in which goodwill remains an important consideration. Whatever the changed status of goodwill under the CGT rules, its role and treatment under the stamp duty rules of the various states and territories should not be lost sight of. As long as stamp duty applies to transactions such as the conveyance or transfer of property, it will apply to transfers of goodwill. As will be argued further below, the value of goodwill in a corporation may also make the difference between the application of the so-called land-rich entity provisions to a corporation or not. In addition, as is also discussed further below, goodwill may have relevance when applying the Goods and Services Tax ("GST") to sales of businesses in the form of going-concerns.

2. THE REVIEW OF BUSINESS TAXATION AND ITS CHANGES

The RBT proposes profound changes to the Australian taxation system. Government rapidly implemented many of the proposals.^[4] The bulk of the CGT changes received royal assent in December 1999.^[5] There were a number of changes to CGT generally and a number with specific application to small business. The general changes include:^[6]

In addition to the changes to the CGT regime, the government has also rationalised and extended the concessions for small business (which is now defined as a business with the net asset value of which, together with that of related entities, is $5 million or less), allowing a full exemption from CGT for some taxpayers. The concessions for small business are as follows:

Although it will be evident from this that, as has been said, the specific concentration on goodwill as the main focus of CGT concessions for small business has been changed to a focus on active assets more generally, these changes nevertheless have implications for goodwill as one of those active assets. Aspects of this are discussed further below.

2.1 Recommendations Applicable To Individuals Only

As has been alluded to, there is now available a general 50 percent CGT discount by which any "discount capital gain" may be reduced. The requirements for access to this discount are that the entity making the gain acquired the asset at least 12 months before the CGT event causing the gain and has opted not to use the indexed cost base of the asset in determining the cost base of the asset.^[13] The qualifying discount capital gain must be made by an individual, a complying superannuation fund (which enjoys a discount not of 50 percent but of 33 percent)^[14] or a trust. Special rules apply to trusts to "ensure that the appropriate discount percentage is applied and to let beneficiaries apply their capital losses against their share of the trust's capital."^[15] To be a discount capital gain, the gain must result from a CGT event happening after 21 September 1999^[16] and the indexed cost base method of valuing the asset's cost base must not have been used.^[17] The use of the indexed cost base method, with indexation frozen at 21 September 1999, may still be used by individuals and superannuation funds for CGT events after that date but these gains cannot count as discount capital gains to which the relevant CGT discount may apply.

This general exemption was proposed in the RBT Report,^[18] but the legislation which was introduced by the government was slightly different to that originally proposed. At one point it appeared that there would be some importance in the distinction between "eligible assets" which were to include goodwill and such other assets as restrictive covenants and any other goodwill related assets that were not "eligible assets". Recommendation 18.2 of the RBT Report proposed that individuals be afforded the choice between having capital gains on "eligible assets", which they have held for at least one year and disposed of after 30 September 1999, either taxed on half the realised nominal gain without indexation; or taxed on the whole of the gain between the realised price of the asset and the indexed cost base of the asset as at 30 September 1999.^[19] Goodwill was one of the listed "eligible assets."^[20] The Government accepted this proposal in general terms and it is now reflected in s 102-3 and Subdivs 115-A and 115-B of ITAA97. When accepting the proposal, the Treasurer did not mention "eligible assets" however, nor does the Act now do so. It appears from the RBT Report that goodwill was to be favourably treated and subject to a more generous CGT regime than, for example, a restrictive covenant.^[21] No explanation or comment was made on the dropping of the "eligible assets" classification.

With the "eligible asset" requirement removed from the proposal, the significance of goodwill as distinguished from its sources no longer has major tax implications in terms of the discount on the capital gains on goodwill derived by individuals. Had the distinction remained it would have been possible to discern a difference in treatment between the goodwill - an eligible asset giving rise to the CGT concession and, for example, a restrictive covenant which would not have been an eligible asset affording access to the CGT concession. As the High Court, in FC of T v Murry^[22], identified a restrictive covenant as a potential source of goodwill,^[23] there would have been considerable incentive to attribute value to goodwill sourced in a restrictive covenant rather than to the covenant itself. As the "eligible asset" requirement has been removed this is fortunately not an issue.

An aspect of the new concessions which is worth considering more closely in the context of goodwill, however, is the fact that not all CGT events will give access to the "discount capital gain" provisions in Div 115 of ITAA97. The point deserving particular consideration is that one of the threshold requirements for the concession is that the asset giving rise to the capital gain must have been acquired at least 12 months before the CGT event.^[24]

This requirement means that for some CGT events, the circumstances will dictate that there is no discount capital gain. This is spelt out in ITAA97 and s 115-25(3) lists 11 specific CGT events which do not give rise to a discount capital gain because the 12 month rule is not met.^[25] The events in question are:

CGT event	Explanation
D1	Creating contractual or other rights - s 104-35
D2	Granting an option - s 104-40
D3	Granting a right to income from mining - s 104-45
E9	Creating a trust over future property - s 104-80
F1	Granting a lease - s 104-110
F2	Granting a long term lease - s 105-115
F5	Lessor receives payment for changing lease - s 104-130
H2	Receipt for event relating to a CGT asset - s 104-155
J2	Change in status of a CGT asset that was a replacement asset in a roll-over under Subdiv 152-E - s 104-185
J3	A change happens in circumstances where a share in a company or an interest in a trust was a replacement asset in a roll-over under Subdiv 152-E - s 104-190
K1	Partial realisation of intellectual property right – s 104-205

Of these events, events D1, F1 and K1 immediately spring to mind as likely to impact on dealings in goodwill. The creation of contractual rights that might constitute a source of goodwill (such as a restrictive covenant) would fall under event D1. The entering of a lease which might give access to a site which constitutes a source of goodwill would fall under event F1 and the partial realisation of an intellectual property right such as copyright in a process that is a source of goodwill would be covered by event K1. It may be profitable to consider the effect of the exclusion of these events by way of a few examples. In the case of CGT event D1, the exclusion might have the following effect. If an individual were to dispose of the goodwill of a business not by means of a simple disposal triggering CGT event Al but by means of a contract for the use of that goodwill by the other contracting party this would trigger CGT event D1 under which the disponor would be subject to tax on the difference between the gain from the contract and the incidental costs (such as legal fees etc) of entering into it. Circumstances similar to these occurred in the case of Roussos v Commr of Stamp Duties (Tas)^[26] in which case the owner of a restaurant licensed another party to operate and conduct the restaurant business subject to certain terms and conditions. The licensee had the option to purchase the business at a later date at which time the price would be allocated between the plant and equipment, at their written down value, and the goodwill of the business. The issues in the case turned on how this business licence was to be treated for Tasmanian stamp duty purposes but the case is relevant here as an example of a situation in which proceeding as the parties did might result in a CGT event D1 and deny the restaurant owner the discount that would have been available had the goodwill and plant and equipment been disposed of in a way that could be regarded as CGT event A1 which requires a change of ownership, or event B1 which requires either a change in title or a potential change in title.

Similar concerns arise if the purported disposal amounts (as it might have done in Roussos) to a CGT event D2, the creation of an option rather than a change in ownership or anticipated change in ownership. How one deals with goodwill, it seems, will continue to be critically important to the access to CGT concessions.

2.2 Measures Specific to the Small Business Sector

Similar remarks to those made in the context of the reliefs available for individuals may be made in the context of the concessions available for small business. Recommendation 17.5 of the RBT Report recommended a streamlining and simplification of the concessions available to small business. These specific small business measures have been listed, briefly, above. It proposed (inter alia) that the s 118-250 50 percent CGT goodwill exemption for small business be replaced with a small business assets exemption of 50 percent of all capital gains on disposal of all active assets subject to CGT. It also proposed that the eligibility requirements for the Div 17A and Div 17B small business roll-over and small business retirement relief^[27] be applied to the more general 50 percent reduction and the 15 year retirement exemption.

Recommendation 17.6 proposed that the retirement relief and roll-over relief for small business be available in addition to the new 50 percent reduction on "active assets". Small businesses are those with net assets held by the taxpayer or connected entities of up to $5 million. Most of the proposed exemptions now apply from 21 September 1999.

This proposal, which was readily accepted by the government, is now to be found in Subdiv 152-A of ITAA97. Thus, access to the general 50 percent exemption will follow the criteria for the extant small business roll-over (replacement of business assets) and retirement ($500,000 lifetime limit) reliefs and will be subject to a $5 million net asset threshold. In addition, in the case of sole traders and partnerships, the small business concessions will be applied after the individuals concerned have taken the general 50 percent exclusion. This is very generous indeed and goes much further than the original 50 percent CGT exemption on disposals of goodwill. Even more generous in light of previous restrictions is the fact that small business taxpayers may have access to the small business reliefs, as they wish. As Evans explains:

The 50 percent CGT concession under s 118-250 was only available for small business taxpayers, the net values of whose business and related businesses was (for the 1998-99 income year) under $2,248,000.^[29] This means that more businesses than before will enjoy concessional treatment of their goodwill along with the new concessional treatment of other active assets.

2.3 Goodwill as an "Active Asset"

It will be apparent that the "active asset" requirement is a threshold which must be passed in order to access any of the small business concessions and that the meaning of the term "active asset" is important from the point of view of the Treasurer's proposal of a retirement/incapacity^[30] concession as well as from the point of view of the general exemption of the 50 percent of the CGT on "active assets". The term "active asset" had already been defined for the purposes of the roll-over and the retirement reliefs. According to s 152-40 of ITAA97, a CGT asset is an "active asset":

Thus, goodwill is most certainly an active asset because it is "an intangible asset that is inherently connected with a business that you carry on". Even were it not for the example given in s 152-40(l)(b), a restrictive covenant is plainly also an active asset if sufficient connection between it and the business can be established. So too must be leases and licences if the same connection can be established. However, in a case where the lease or licence is used for the purposes of deriving rent or royalties, respectively, the list of exceptions appears to change the position. In the case of these assets disposed of under the "active asset" exemption they would have to be used in the business in an active way (for example, the licence to produce widgets used by a widget manufacturer) or if used in a "passive" way to earn rent or royalties they would have to have been used developed, altered or improved in such a way as to substantially enhance their market value. As licences and leases can constitute sources of goodwill and contribute to its value, there may be importance in ensuring that the full and correct amount of value is attributed to goodwill if the lease or licence would be disqualified from concessional treatment under the exceptions to the assets which are "active assets".^[31]

The point may best be illustrated by means of an example. Archie, a sole trader, manufactures "Archie's Home Made Ice Cream". He distributes and sells this ice cream in New South Wales, Queensland and Victoria. The bulk of his income is derived from sales. He also has contracts to permit the use of his product name on ice cream sold by regional ice cream manufacturers in Western Australia, South Australia, Tasmania and the Northern Territory. The ice cream is ordinary ice cream but there is a ready demand, the name is well recognised, and it sells well. Archie derives significant royalties from the licence holders in those states and territory.

Archie sells his business including the rights to the name "Archie's Home Made Ice Cream" and the rights under the contracts to sell ice cream under that name in the three states and territory already mentioned. With respect to the licences to sell the ice cream in Western Australia, South Australia, Tasmania and the Northern Territory, it cannot be said that these licences were substantially developed, altered or improved by Archie. It cannot fairly be said that Archie has engaged in any substantial promotion or other similar development of the name to which the licences relate. The existence of the licences, however, contributes to the goodwill value of the name of the ice cream because, as a result of the licences, it is widely known throughout Australia. Its attractive force is felt further afield and it is therefore able to attract a greater number of consumers than it would otherwise be able to do.^[32]

When Archie sells the various assets constituting the business, his actions would trigger a CGT event (probably CGT event A1). The goodwill would certainly fall within the category of "active assets". There may, however, be some doubt about the licences on the grounds that they could fall within the category of assets excepted from the definition. Although they may have been created by Archie, can it be said that they were "substantially developed, altered or improved ... so that [their] market value has been substantially enhanced"? It is not clear that this would be so.

In the circumstances, it would be important for Archie to ensure that the value of the goodwill acquired by the purchaser fully reflected the value attributable to the existence of the licences because the licences themselves might not benefit from the concessional treatment. Any value attributed to them directly would not enjoy the preferential treatment afforded under the new rules.

The example is worth considering from the point of view of the licensees too. Although the accession of the purchaser to Archie's rights as licensor would not impact the licensees, their disposal of their licences to another licensee might well trigger a CGT event (probably Al, once again) affecting them. Were this to occur it is submitted that they would probably be able to access the concession on the grounds that in their hands the licences in question would be active assets being intangible assets inherently connected with their business. The listed exceptions would not apply to them because their main purpose would not be to derive interest, rent, royalties etc. They would pay royalties but their use of the assets in their business would be to derive sales income.

The upshot of this analysis is that there is still an important distinction possible in the application of the CGT provisions, between goodwill and sources of the goodwill of the business if the source of the goodwill is capable of falling within the exceptions to the list of "active assets". Correct attribution of value to the goodwill and to its source will be critically important in order to ensure that the maximum value is attributed to the "active asset" and can therefore enjoy the relevant CGT relief.^[33]

3. GOODWILL UNDER OPTION 2

Under the proposed adoption of an Option 2 method of calculating taxable income which was proposed by the RBT, there is to be a special treatment afforded to goodwill. In Press Release No 81^[34], it was announced that although the government is fully in favour of its adoption, the introduction of the Option 2 method of determining taxable income would be deferred beyond the original implementation date of 1 July 2001. One of the reasons for this was that "there are many detailed issues that need to be resolved".

Without detailed knowledge of the discussions surrounding the adoption of Option 2 at the government and consultation levels it is difficult to know with certainty, but it is submitted that not the least of the difficulties referred to must be the treatment of goodwill and other intangibles. At present, goodwill is recognised for accounting purposes only when it is acquired. The relevant accounting standard requires that it be amortised over a number of years when it is acquired.^[35] For tax purposes it is not regarded as having any effect. There is no deduction of the amount of the depreciation each year,^[36] but deduction of expenditure incurred in creating or maintaining goodwill, such as general advertising expenditure, is often allowed.

Under Option 2, it appears that the same result will be achieved but a different mechanism, which singles goodwill out for special treatment will be used to achieve it. Under Option 2, "taxable income" will be "net income" plus "income tax law adjustments" less any unused "tax losses".^[37] Of these concepts, "net income" is comprised of receipts less payments, added to the difference between closing and opening "tax value" of assets, less the difference between closing and opening "tax value" of liabilities. It is in this part of the formula that goodwill is singled out for special treatment.

The key point is that the value of goodwill will be ignored unless it is both acquired goodwill and disposed of during the tax period. This is achieved as follows.

The tax value of goodwill is specifically dealt with in s 6-40 (Subdiv 6-C) of the Draft Legislation which accompanied the RBT Report^[38] which sets out (as shown in the extract below) the tax value of various assets eg trading stock, depreciating assets etc.

It will be noted that goodwill is separately dealt with as item 12 of the Table in s 6-40 and its tax value is stated to be its cost when acquired. The Bill contains a definition of "cost"^[39] which identifies two elements in the cost being the amount(s) you have paid in order to hold the asset^[40] (the "first element") and the value of any economic benefit that has contributed to bringing the asset to its present condition (the "second element").^[41] In the context of goodwill, the latter seems to mean the value added by expenditure incurred in getting the goodwill to its present value, if that value is greater than the first element. This means that if these rules were to apply to goodwill at the end of a tax period, any appreciation in the value of the purchased goodwill would increase its cost, and therefore tax value, and result in a difference between the opening value of the goodwill and the closing value of the goodwill. This would be offset by expenditure incurred in deriving the benefits represented by the increase in the tax value of the goodwill and thus (presumably) offset the increase. If the two match there will be no overall tax effect. The problem would be, however, that the expenditure in question would not be regarded as a deduction for income tax purposes because the deduction would be offset by the increase in tax value of the goodwill. This would depart from the present treatment of goodwill.

Item	For this kind of asset:	The tax value at that time is:
11	An asset that is capable of ownership (except an asset covered by an earlier item, and goodwill)	The * cost of the asset as at that time
12	Goodwill	(a) To the extent (if any) that the goodwill includes goodwill that you have acquired from another taxpayer -the * cost of the acquired goodwill when you acquired it; and
13	Any other asset that you have acquired from another taxpayer	The * cost of the asset as at that time
14	Any other asset	Nil

However, it seems that this is not intended to be the case and the reference in item 12 of the Table in s 6-40 to the "cost ... when you acquired it" means that subsequent expenditure which would constitute the second element is to be ignored. This means that each year the goodwill would be brought to account for tax purposes at an equal sum for both opening and closing tax value. Thus, there will be no tax effect, as is the case now. The only time there will be a tax effect will be when the goodwill is disposed of and when proceeds of the disposal may be shown as receipts.

For this analysis to work it is critical that the asset, which appreciates in value by reason of the expenditure, is indeed goodwill. If it is not goodwill but some other asset, it may be that the limitation to acquisition cost cannot apply and it will not be possible to obtain an immediate deduction for expenditure on, for example, advertising which contributes to the value ("economic benefit") of the goodwill in the current year. That there are problems with this is evidenced by the comments of Abbey who writes:

That the deduction definitely is available in relation to certain other intangibles is evident from the note to item 14 of the Table, which says:

The problem perceived by Abbey would probably be clarified quite simply by further elaboration of the operation of Option 2. It is submitted that the effect of the operation of Option 2 should be that expenditure on an input such as advertising which, on a given set of facts, adds to the value of goodwill rather than to the value of some other asset (of which given the extent of the other definitions there can be but few) would be deductible simply on the basis that it is an expense falling within the payments part of the formula. There is nevertheless possibly a difference in treatment between goodwill and other assets that are neither goodwill nor any other asset described in the items 1 to 13 in the Table and which therefore would constitute an item 14 "any other asset" and that is that whereas goodwill would have to be given a tax value based on its acquisition cost for both its opening and closing tax value, an item 14 asset will have an opening and closing tax value of nil. In the latter case, the immediate deductibility of expenditure such as advertising expenses is clear, in the case of goodwill it is only clear if it is accepted that the use of the phrase "cost of the acquired goodwill when you acquired it" does indeed eliminate the second element of the definition of "cost".

It will be clear from this discussion that if Option 2 is adopted there will be special rules for the treatment of goodwill and some of these may have to be refined to ensure that expenditure which is normally deductible under the current regime continues to be deductible under Option 2. Whether or not this refinement does take place, taxpayers will need to take care to recognise goodwill and expenditure related to that goodwill to ensure that appropriate deductions are secured.

4. OTHER AREAS OF THE TAX SYSTEM

4.1 Stamp Duty

As mentioned, whatever changes the RBT and government's response may bring about in relation to the role and importance of goodwill, it must still be considered in the context of the state and territory taxes. In the context of stamp duty, goodwill may be significant for two reasons. It may be dutiable property on which stamp duty is charged or it may be an asset whose value is so significant to a particular corporation that it means the difference between the so-called land-rich entities provisions applying to that corporation or not. These points are discussed further below.

Several jurisdictions impose duty on the value of goodwill conveyed under a sale of a business or conveyance of property or transfer of dutiable property. For example, New South Wales imposes ad valorem stamp duty on transfers of dutiable property. Dutiable property includes a "business asset" and that, in turn, includes goodwill of a business, certain intellectual property (such as rights to use such things as trading names, trade marks, industrial designs, patents designs and processes), and certain statutory licences (under Commonwealth or NSW law).^[43] It will be apparent from this list that goodwill will remain important as a part of the NSW tax base. In addition, not only is goodwill important, but the types of rights and contracts that overlap with goodwill such as licences, leases and covenants in restraint of trade will also be important. It should be noted that on the NSW formulation, they attract stamp duty at the same rate as goodwill itself and for stamp duty purposes it will not matter whether they are on the various lists of "eligible assets" or "active assets" for CGT purposes. Indeed the claim of an exemption or partial exemption from CGT under the proposed changes should trigger a stamp duty consequence as this would be a recognition that a transfer of dutiable property for stamp duty purposes has taken place.

It is not clear whether under the proposed reform of taxation this will always be so. When the reform of business taxation was initially announced, the government indicated that there would, amongst the abolition of other state taxes, be an end to stamp duty on conveyances of business property from July 2001.^[44] This abandonment of the states' taxes was to be in return for revenue collected by the Commonwealth Government from the GST. It was not clear at the time whether transfers of goodwill and similar property would be relieved of stamp duty because of this, although it certainly appeared to be so. In any event, because the revenue likely to be raised from the GST was reduced when it was agreed that food would be GST-free, it became clear that the states would nevertheless need their stamp duty base and the proposed abolition of stamp duty on conveyances of business property other than real property has now been postponed, if not abandoned.^[45] It appears goodwill will remain important as part of the states' and territories' tax base at least in the medium term and probably longer.

There is another aspect of the stamp duty rules applied in the various jurisdictions that is relevant to the study of goodwill in the tax system. It is another area where incentives are given to taxpayers to recognise acquired goodwill in the balance sheet and give it a value. The area referred to here is the so-called "land-rich" provisions applicable to the application of marketable securities duty. In most jurisdictions, duty is charged on the transfer of listed marketable securities at the rate of 30 cents per $100 worth of marketable security, and on transfer of unlisted marketable securities at the rate of 60 cents per $100.^[46] Each jurisdiction has provisions intended to levy stamp duty at (ad valorem) land conveyance rates on transfers of shares or units in certain "land-rich" corporations and unit trusts. These rules are important as they ensure that the higher ad valorem duty on transfers of land is not avoided by transferring the shares or units in the land-holding entities (at a rate of 60 cents per $100) rather than the land itself. Thus the "land-rich" provisions in each jurisdiction impose duty on the acquisition of interests in "land-rich" private companies or private unit trust schemes at the same rates applicable to transfers of the land itself.

Normally, the acquisition of the shares or units should give rise to the acquirer achieving or increasing a "majority interest"^[47] in the land-rich^[48] entity such that the acquirer would be entitled to, in the event of a winding up, a distribution of more than 50 percent of the value of distributable property.^[49] There are also rules in most jurisdictions to ensure that a series of acquisitions over time cumulatively constitutes an acquisition of a majority interest.

Before the relevant provisions can apply, the "land-rich" entity in question must be one (other than a publicly listed company) which has land holdings in the jurisdiction with a value of not less than $lm and 80 percent of the unencumbered value of the entity's property consists of land holdings in Australia.^[50]

The latter 80 percent rule is applied after deducting from the total unencumbered value of the entity's property certain liquid and non-arm's length assets^[51] (and assets deemed by the Commissioner principally to have been acquired for the purposes of defeating the provisions).^[52] As a general rule the value of the real property of the entity is then used to determine the applicable stamp duty at ad valorem rates.

The role of goodwill in this is, it is submitted, that when taxpayers are confronted with the prospect of having to pay the higher ad valorem rate of duty, a close examination of the assets of the entity is undertaken in order to establish whether, perhaps, 80 percent of the value of the entity is not in real property because the other assets are worth more than was originally believed. Frequently, it is submitted, goodwill, which is notoriously subjective in its valuation, figures in this. Although it is not possible to offer empirical evidence of this practice, it is submitted that the inclusion of acquired goodwill in the net assets of such entities for these purposes probably affords an opportunity for taxpayers to identify and value the assets of the entity which are not real property, and to ensure that the 80 percent threshold is not attained.^[53] If the goodwill is correctly valued, of course, there is nothing wrong with this and perhaps goodwill should not be singled out unfairly because there may be an opportunity for revaluation of other assets too.

4.2 GST

Goodwill will also be important in the context of GST. This is because of the special rules applicable when a taxpayer sells a business as a "going-concern". The A New Tax System (Goods and Services Tax) Act 1999 ("GSTA") recognises the futility of gathering GST from the seller of a business which is sold to a purchaser who will continue to operate it. Were it to do so, the net effect would amount to little more than a cash flow cost to the purchaser. This is because the vendor of the business would be required to remit GST on the basis that the sale constituted a taxable supply and in all likelihood the purchaser would claim an input tax credit for that GST in the first return submitted after acquiring the business. It is conceivable that both the collection of the GST from the vendor and the refund to the purchaser could take place in the same quarterly tax period. Truly a case of collecting from Peter to pay Paul.

The circularity and futility of the exercise is recognised in Subdiv 38-J of the GSTA which in s 38-325 treats such sales as GST-free if the supply is of a "going concern". This means that the vendor may enjoy any relevant input tax credits for GST incurred in making the sale of the entire business to the purchaser but does not have to pay GST on the sale. Similarly, the purchaser pays no GST component in the price for the acquisition of the business and thus is entitled to no credit for GST paid on something that will be used in the course of carrying on an enterprise. s 38-325 provides (inter alia) that;

It is para (a) of these requirements that raises concerns regarding goodwill. It seems now well established in light of Murry (and a number of predecessors) that the goodwill of a business and the business itself cannot be separated. The question that arises is whether the requirement that the supplier supplies "all of the things that are necessary" for the continued operation of an enterprise reinforces this. Can "all things necessary" have passed if the goodwill of the business does not? An example might be the sale of the premises of a printing and copy shop, together with all its equipment and stock on hand without the disposal of the name and without (perhaps) a covenant in restraint of the vendor's right to compete with the purchaser. Although unusual, such a case is by no means inconceivable. For example, the circumstances may be such that the purchaser already has an established name and intends to apply the printing and copy shop acquired in its already established chain of such shops. Presuming all the other criteria in s 38-325 of the GSTA are met, would this qualify as a sale of a going-concern that is GST-free?

One argument might be that a business without goodwill is not a business as such but merely the assets with which to run a business and that the failure to pass the goodwill in the business in these circumstances is not a disposal of a going-concern but merely the disposal of assets. If this is so, the sale is not GST-free. The counter argument to this would probably be that the use of the indefinite article in the phrase "an enterprise" means that there is no expectation that the purchaser should conduct the same enterprise. Thus, it is intended that the requirement can be satisfied by a sale which does not transfer the goodwill of the business to the purchaser provided sufficient other things have passed to enable the purchaser to open up shop (and not even this is required, strictly speaking) the next day albeit under another name and livery, relying on other goodwill. If this view prevails, the sale contemplated in our example could be a GST-free sale of a going-concern.

Another possibility might be that whether the name has passed or not, goodwill of the business has nevertheless passed (although the parties have not recognised it) because it is sourced in attributes other than the name which have passed, such as the location of the premises. This latter argument would have to rely on very particular facts.

It may well be, however, that goodwill is not required to pass in every circumstance. It may depend on the nature of the concern whether goodwill, in the particular circumstances, was necessary for the purchaser to have received "all things necessary for the continued operation of an enterprise".

5. CONCLUSION - IS GOODWILL STILL IMPORTANT AFTER THE CURRENT ROUND OF TAX REFORMS?

It can be concluded that although goodwill is no longer as significant an asset in the CGT concessions for small business as it was, it will remain important. In particular, it seems that it will be necessary for small business to identify goodwill as one of the active assets of the business and to ensure that any goodwill associated with assets that are not readily recognisable as active assets is correctly demonstrated to be "inherently connected" with the business so as to also qualify as an active asset. If Option 2 is introduced, it will also be important to be able to identify goodwill to ensure it receives the special treatment that Option 2 affords it.

In the context of state taxes, as in the context of CGT, goodwill constitutes a tool by which the taxpayer may achieve a concession. Although marketable securities duty is to be abolished under tax reform from July 2001, the "land-rich" anti-avoidance measures will not be abolished (there will be even more need for them) and it can be expected that the role that goodwill plays in their application will endure for the time being. In addition, from the point of view of the revenue authorities, goodwill will evidently continue to be as significant a part of the stamp duty revenue base in the states and territories^[54] as it has been before the reform of taxation in Australia. All of the existing cases, rulings and opinions on goodwill, its nature, and its relationships to other forms of property or obligations will remain relevant for practitioners, administrators and commentators alike for years to come.

Furthermore, as GST becomes a tax commonly encountered by business, some of the effects of the impost may be softened by access to the GST-free "going-concern" provisions, which as we have seen, may or may not be affected by the goodwill passing along with other assets. It is submitted that for the time being in Australia the question whether goodwill must generally pass for the sale of a business as a going-concern to be GST-free is a moot point. The answer will always depend on the facts of each case. Given the many cases on the New Zealand equivalent of our going-concern requirement in GST there can be little doubt that the role of goodwill in the s 38-325 criteria will arise for consideration by the courts sooner rather than later.

Whereas it might once have been thought that the significance of goodwill to the tax regime had disappeared, it would appear its meaning, character and relationship to other assets will remain complex. For those readers who are intrigued by goodwill's many facets and abstract, sometimes chimerical nature, and who enjoy the intellectual stimulation of identifying it in so many transactions - that is part of the good news of tax reform!

Michael Walpole is a Senior Lecturer at ATAX within the Faculty of Law at the University of New South Wales. He was previously a legal practitioner in private practice and a tax consultant with Ernst & Young.

^[*]. The author, as so often when writing on the subject of goodwill, is grateful for the advice of Associate Professor Chris Evans, Associate Director, ATAX, University of new South Wales.

^[2] On 7 August 2000, the Treasurer announced that although the government is fully in favour of its adoption, the introduction of the cashflow/tax value method of determining taxable income would be deferred beyond the original implementation date of 1 July 2001: Press Release No 81 (7 August 2000) available at [http://www.treasury.gov.au].

^[3] Review of Business Taxation, A Tax System Redesigned (1999), 211 ("RBT Report") available at [http://www.rbt.treasury.gov.au]

^[6] This is a brief and incomplete list of the changes. A helpful summary of all the changes may be found in C Evans, "Taxation of Capital Gains: Ralph Implications for Business Big and Small" in Tony Rumble (ed), Australian Business Tax Reform Tax Laws and Policy - Strategic Issues Following the Review of Business Taxation (1998), 66-67.

^[7] This important change, which is to be found in ITAA97, Subdiv 152-B was not even canvassed by the RBT and was evidently introduced by government without prompting by the RBT.

^[16] Actually, after 11.45 am Australian Capital Territory time on 21 September 1999 - ITAA97, s 115-15.

^[20] Recommendation 4.10 which identifies the "Nominated asset classes eligible for capital gains tax treatment" as "(i) shares and other membership interests - excluding ordinary partnerships - other than where held before 1 July 2000 as trading stock or a revenue asset; (ii) land and buildings ...; (iii) goodwill; (iv) statutory licences, long-term crown leases on land and other rights which represent a permanent disposal of an underlying asset that would be taxed on a realisation basis; (v) collectables and other non-depreciable tangible assets (other than land) [subject to certain criteria]; and (vi) any other assets prescribed in the Income Tax Regulations." The Recommendation goes on to explain that "as a general rule, rights will be excluded from capital gains treatment, unless the granting of a right results in the permanent disposal of an underlying asset, or part of an underlying asset, that is eligible for such treatment. Capital gains treatment of rights would only apply where there is a permanent disposal of the underlying asset that is subject to the right."

^[21] This is because of the requirement that there be a "permanent disposal of the underlying asset". A restrictive covenant would extremely rarely constitute a permanent disposal of the underlying assets of the goodwill or right to trade. Other rights were destined for similar treatment, for eg rights under a licence or a lease.

^[27] Divisions of ITAA36 now in Subdivs 152-E and 152-D respectively of ITAA97 (after briefly being located in parts of Divs 118 and 123).

^[29] See Taxation Ruling TR 1999/16, para 40. The section required the net value of the business (and any related businesses) or the value of the taxpayer's interest in the net value of the business (and any related businesses) to be less than a business exemption threshold of $2 million (indexed from 1993-94) at the time of disposal.

^[30] Mention has already been made of the full exemption from CGT available on the disposal of an "active asset" which has been continuously held for a period of 15 or more years during at least half of which it has been an "active asset". This would be available where the taxpayer has disposed of the asset in order to retire because he or she has become incapacitated or has reached the age of 55 years: Should the asset in question be a "membership interest" (a share or a unit in a trust), it will be possible to attribute the interposed entity's eligible assets to the taxpayer so as to allow the benefit to flow through to the owner of the membership interest.

^[31] It should not be forgotten that such assets used in the business in a "passive" way may also be kept within the "active asset" category if their use for deriving rent (although evidently not royalties) was only "temporary" - whatever that inherently relative term may mean.

^[32] That goodwill is "the attractive force" of a business is evident from the cases. See Murry 98 ATC 4585 and Taxation Ruling TR 1999/16, para 85.

^[33] For a discussion of attribution of value to goodwill that is acceptable to the Commissioner, see Taxation Ruling TR 1999/16, para 47 onwards. It would appear from the High Court's opinions expressed (as obiter) in Murry that the licences constitute a source of goodwill and increase its value if the value cannot be attributed to identifiable assets with their own value (see the discussion in Murry 98 ATC 4585, 4591 and 4595-4596). Prior to the decision in Murry, principally on the strength of the opinion expressed by the Federal Court in FC of T v Krakos Investments Ltd 96 ATC 4063, it could have been argued that there was goodwill inherent in the value of the licences, indeed that they were themselves "types" of goodwill.

^[34] Treasurer, Press Release No 81 (7 August 2000) available at [http://www.treasury.gov.au].

^[35] AAS 1013 applies to non-corporate entities. The mandatory standard applicable to corporate entities is AASB 1013. Both have recently been revised.

^[36] It is of a "capital nature" and is broadly speaking excluded on those grounds.

^[37] Draft A New Tax System (Income Tax Assessment) Bill 1999, s 5-15 ("Draft Legislation") which accompanied the RBT Report.

^[42] P Abbey, "Issues Arising from Option 2 - The Cash Flow/Tax Value method", Working Paper, Australian Tax Teachers Association Annual Conference, Monash University (5 February 2000), 13.

^[44] See Treasurer, Press Release No 79 available at [http://www.treasury.gov.au/treasurer/pressreleases/1998/079.bsp].

^[45] It is unclear which. See Prime Minister, Press Release "Changes to the Goods and Services Tax (GST)" (31 May 1999) available at [http://www.pm.gov.au/media/pressrel/1999/changes315.htm] read together with the Intergovernmental Agreement On The Reform Of Commonwealth-State Financial Relations available at http://www.pm.gov.au/media/pressrel/1999/intergovernmental_agreement.htm].

^[46] Duties Act 1997 (NSW), s 33. Marketable securities duty is to be removed from 1 July 2001 under the reform of business taxation consequent on the introduction of GST. No doubt the "land-rich" provisions will remain.

^[53] In this regard perhaps IAS38 affords (reporting entities at least) an opportunity in that under that Accounting Standard intangibles may be revalued.

^[54] A notable exception being Victoria which essentially limits its stamp duty conveyance base to conveyances of real property.