Apportioning the purchase price in a sale of business agreement among the various assets being sold and purchased may help avoid tax headaches in the future.
A sale of business comprises the sale and purchase of multiple assets, such as goodwill, trading stock, depreciating assets, buildings (including post 1979 capital works), and trademarks, which are all treated differently for tax purposes.[1]
If the parties deal with each other at arm’s length and apportion the purchase price in the relevant sale of business agreement to each specific asset, then the ATO will generally accept that apportionment.[2]
In the absence of apportionment of the purchase price, and subject to certain statutory rules[3], the ATO accepts that each party can make their own ‘reasonable’ apportionment. As to what is a ‘reasonable’ apportionment, this will depend on a case-by-case basis on the assets that were sold and purchased as part of the transaction.
Goodwill
In relation to goodwill, which is a CGT asset, a ‘reasonable’ apportionment would have regard to the market value of the goodwill at the time of the making of the contract.[4] This can result in costly and lengthy disputes with the ATO (or other State revenue bodies in relation to duty on sale of business transactions).
In the recent case of Placer Dome[5], the High Court revisited the legal definition of ‘goodwill’, and confirmed that it “is notoriously difficult to define”.[6] In practical terms, this legal difficulty is compounded by the differing interpretations of ‘goodwill’ used by valuers, accountants and otherwise in general business parlance.
Generally speaking, ‘accounting goodwill’ is the difference between the market value of the whole enterprise, less the market value of the specifically identifiable assets that are not goodwill. This is also known as the ‘top down’ valuation method.
On the other hand, ‘legal goodwill’ is difficult to define, in part, because it is used in differing factual and legal contexts, such that “[t]he definition in one context is more often than not inappropriate in another context”.[7] For example, in the earlier case of Murry[8], the High Court had to consider the definition of ‘goodwill’ in relation to the application of capital gains tax on the sale of a taxi licence[9] and some shares. Whilst in Placer Dome, the High Court had to consider the definition in relation to the application of Western Australian duty on the sale of shares in a landholding company that conducted a gold mining enterprise.
The landholding company in Placer Dome had been acquired for $15.346 billion, and the central question in dispute was whether at that time the value of the company’s land was 60% or more the value of all its property, including goodwill. The purchaser’s external accountants valued all of the company’s identifiable assets at $8.84 billion, and concluded that the difference between this amount and the purchase price was the value of the company’s goodwill (i.e. $6.506 billion).[10] The High Court found that the duty was payable as Placer Dome was a land rich company.
Despite the very different factual and legal contexts, the majority judgment of the High Court in both Murry and Placer Dome confirmed that the ability of a business to attract customers is central to the legal concept of goodwill.[11] Goodwill, that is custom, may be generated from a number of sources, such as physical location, service, personality, price or habit, however such sources must be distinguished from the goodwill itself.[12] For example, a trademark may be a significant source of goodwill, and its value would reduce the value of the goodwill accordingly.[13]
The majority judgment in Murry concluded that a taxi licence is a valuable item of property that allows the licensee to conduct a taxi business, however the licence is not and does not contain any element of goodwill.[14] The value of the goodwill of a taxi business is likely to be small, because most of the custom of a taxi business is new custom, as opposed to repeat custom, and a taxi business is unlikely to generate above average industry earnings.[15]
The majority judgment in Placer Dome concluded that the taxpayer had no sources of goodwill for legal purposes that could add value to its business by attracting customers.[16] The goodwill valued by the taxpayer’s external accountants at $6.506 billion did not equate to the value of its goodwill for legal purposes. The taxpayer submitted that goodwill is a bundle of rights and privileges to use assets of a business to generate income, known as the ‘added value approach’, however this was rejected by the majority.[17] The majority also rejected the taxpayer’s submission that goodwill equates to going concern value, which is the ability of a business to generate income, and stated that going concern value may exist even when there is no goodwill.[18] Unfortunately, the majority judgment did not explain what the premium of $6.506 billion paid by the purchaser in addition to the market value of the taxpayer’s assets relates to, but only that it was not ‘goodwill’.
Practical issues
In practical commercial terms, the relevance of Placer Dome is that it confirms the limited legal definition of goodwill and the difficulties associated with valuing it. In a sale of business scenario, failure to apportion the purchase price may result in a party having difficulty justifying to the ATO (or a State revenue authority, where applicable) that its apportionment of the purchase price in relation to goodwill and other assets is reasonable[19].
Therefore, in order to avoid costly and lengthy disputes with the ATO (or a State revenue authority, where applicable), it is advisable to apportion the purchase price in the sale of business agreement, even if this requires some commercial haggling with the other party[20]. Assuming that the parties are dealing at arm’s length, it is unlikely that the ATO (or a State revenue authority, where applicable) would seek to review the apportionment of the purchase price. However, where the parties are in any way related the ATO may test whether their dealing was at arm’s length in any audit situation.
If you would like to discuss this article, please contact Laszlo Konya or Robert Gordon on (03) 9614 7707.
[1] For example, goodwill, buildings and trade marks are CGT assets. Depreciable assets, which includes copyrights, patents and registered designs, that are wholly used for business purposes and trading stock are taken out of the CGT net (by s.118-24 and s.118-25 of the Income Tax Assessment Act 1997 (ITAA 1997)). Any profit or loss on depreciating assets is the subject of the balancing adjustment provisions of Division 40 ITAA 1997. Therefore, the general CGT discount (currently 50%) and the small business concessions are not available in relation to them. Capital works deductions are dealt with in Division 43 ITAA 1997 and, although there is no “claw-back” of previously claimed deductions (e.g. for building works), the deductions do reduce the cost base of the asset.
[2] TD 98/24 in relation to CGT assets; ATO ID 2002/818 in relation to depreciable assets. For an example of where the parties were at arm’s length but they were not dealing at arm’s length, see Collis v FC of T 1996 ATC 4831.
[3] In relation to depreciated assets, reasonable apportionment is mandated by s.40-310 ITAA 1997. In relation to trading stock, there is a provision requiring symmetry between the vendor and the purchaser: s.70-95 ITAA 1997. In relation to capital works, the purchaser (e.g. of an income producing building) is entitled to deduct over time, the cost of the works that have not been deducted by the vendor.
[4] TD 98/24.
[5] Commissioner of State Revenue v Placer Dome Inc [2018] HCA 59 (Placer Dome).
[6] At [52].
[7] At [55].
[8] Commissioner of Taxation v Murry [1998] HCA 42 (Murry).
[9] At the time, s160ZZR Income Tax Assessment Act 1936 (ITAA 1936) provided a 50% CGT exemption for small businesses on the sale only of ‘goodwill’.
[10] Placer Dome at [39].
[11] Murry at [20]; Placer Dome at [63].
[12] Murry at [30]; Placer Dome at [64].
[13] Murry at [51].
[14] Murry at [67]-[68]. As the current small business CGT concession focus on the disposal of all ‘active assets’, not just ‘goodwill’, the concessions are much wider than s160ZZR (which became s118-250 ITAA 1997).
[15] Murry at [60]-[61].
[16] Placer Dome at [111].
[17] Placer Dome at [86].
[18] Placer Dome at [98].
[19] TR 1999/16 at [43].
[20] Note that in relation to capital works, whilst there is an obligation for the vendor to provide the purchaser with information concerning the vendor’s undeducted capital works expenditure (under s262A (4AJA) ITAA 1936) within 6 months of the end of the year in which the disposal occurred, it may be better to contract to obtain that information at an earlier date.