Journal of Australian Taxation
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"THE CAT, THE DOG, THE RAT AND THE RABBIT":
IDENTIFYING AND VALUING "GOODWILL" AFTER FC OF T V MURRY
By Primrose Mroczkowski
The concept of goodwill has challenged both lawyers and accountants alike. The High Court decision in Murry 98 ATC 4585 has injected much needed clarity in the law in respect of issues such as the scope of the concept and on how to properly allocate a "value" to goodwill for tax purposes. Whilst the decision re-affirms some of the traditional principles established by the common law, some interesting observations were made in the majority decision on the "value" of goodwill in respect of non-profitable businesses and also businesses where the goodwill is "largely [derived] from using an identifiable asset or assets".
Once upon a time, a person by the name of Merlin stumbled on to the concept of goodwill and decided to write about it using some of the members of the animal kingdom. So the custom of "the cat, the rat and the dog" was created.[1] It might have been Merlin's way of making some sense of a baffling concept. Little did he know that goodwill was to challenge others for years to come and that his somewhat quaint analogy would survive some 60 years of the common law. With the handing down of the High Court decision in FC of T v Murry,[2] interest in Merlin, or more particularly, in the custom of his animals, has been renewed in Australia.
The decision represents the long-awaited authoritative development in the law on a concept that has been a challenge to both accountants and lawyers[3] alike.[4] Significantly, it has injected some clarity into the important issues of the meaning of goodwill and how to properly ascribe a value to it for tax purposes. This was an area of the law that had previously been regarded as both unclear and unsatisfactory.[5]
It is often the case that when a business is sold, some amount of the sale consideration is allocated to goodwill. The objective valuation of goodwill may then become an issue. For tax purposes, in contrast to conventional accounting treatment, goodwill, or more accurately, acquired goodwill, is not depreciated.[6]
As will be discussed below, the issue of how to assign an appropriate value to the goodwill of a business when the business is sold may be of particular significance by virtue of the potential application of certain capital gains tax ("CGT") provisions, previously contained in Pt IIIA of the Income Tax Assessment Act 1936 (Cth) ("ITAA36"), and which are now substantially[7] embodied in Pt 3-1 and Pt 3-3 of the Income Tax Assessment Act 1997 (Cth) ("ITAA97").[8]
For the purposes of the CGT provisions, goodwill is a CGT asset.[9] If a business commenced prior to the introduction of the CGT provisions,[10] any capital gain accruing on the disposal of the business and its assets, including its goodwill, escapes tax.[11] Where the business and the goodwill are post-September 1985 assets, then capital gains or losses may have to be brought to account pursuant to the provisions of Pt 3-1 and Pt 3-3 of the ITAA97.
Relief from tax is however, available to particular taxpayers. The policy underpinning these concessions appears to be to enable small business taxpayers to have greater access to funds for retirement or expansion. The concessions are the following:
• CGT roll-over relief is available to taxpayers operating a small business with net assets of $5 million or less, where the taxpayer disposes of some or all of his/her business and reinvests the proceeds ("small business roll-over").[12]
• Where the proceeds of a disposal of an active asset of a business are used for retirement, a capital gain arising from that disposal is exempt from tax ("retirement exemption").[13]
• Taxpayers who operate a business or have an interest in a business with net assets of $2.248 million or less (this value including the net value of any related businesses of the taxpayer) are eligible for a 50% exemption of the goodwill component of a capital gain accruing from the disposal of the business or of an interest in the business ("the goodwill exemption").[14]
In contrast to the provisions relating to the small business roll-over and the retirement exemption, the provisions in respect of the goodwill exemption, which are the focus of this article, are contained in the ITAA97.[15]
The central provision for the goodwill exemption is contained in s 118-250 of the ITAA97. It provides in effect that, where there is a change in the ownership of a business, or of an interest in a business, or a business or an interest in it comes to an end, and the taxpayer makes a capital gain attributable to the goodwill of the business, the capital gain on the goodwill is reduced by half,[16] provided that, in simple terms, the taxpayer's interest in the net value of that business and of any related businesses is less than the "business exemption threshold[17] for the income year in which the CGT event occurred."[18]
To calculate the capital gain or capital loss arising from the disposal of goodwill, the CGT provisions require a comparison to be made between the capital proceeds from the disposal and the cost base of the goodwill.[19] The capital proceeds are generally the amount of the sale proceeds attributable to the disposal of the goodwill,[20] as distinct from the disposal of the other assets in the business. It follows that ifs 118-250 applies, the higher the amount of the sale proceeds for the goodwill, the larger the capital gain attributable to it, and therefore, the larger the quantum of the tax benefit.
Taxpayers wishing to utilise the goodwill exemption would, logically, attempt to maximise the sale consideration allocated to goodwill as opposed to that allocated to the other assets of the business.[21] In an arm's length dealing, one might expect that the parties to the sale will attribute to goodwill an amount that should "properly" be attributable to it, without necessarily obtaining an expert valuation of the goodwill in question. It may also be reasonable to assert that the amount attributed will be a function of what the parties to the agreement perceive the value of the goodwill to be.
The issue is how to distinguish between the "value" of goodwill and the value of the other assets in the business to determine if the amount allocated to goodwill is the amount that should properly be attributable to it. Some legal definition of the concept of goodwill and of its scope has to be established.
The complexity lies with the nature of the concept itself. Goodwill is a unique "asset" or attribute in that its creation and its existence are inextricably connected to the conduct of a business, which conduct invariably involves the employment of other assets and processes in the business.[22] Put simply, given this "connection", to what extent is the value of goodwill independent of the value of the other assets used in the business? The law has been unclear as to the nature of the relationship between the goodwill of a business and the other assets of the business in the context of assigning to goodwill, as distinct from the other assets, a value for tax purposes.[23]
For example, as was the case in Murry, the holding of a statutory licence by the proprietor of a particular business may be a precondition to the conduct of that business. When the business and the licence are sold, to what extent could it be argued that the consideration which the parties agree was paid for the goodwill of the business should in fact be properly characterised as consideration for the licence? Because the licence is integral to the conduct of the business, could it be said that the value ascribed to the licence for tax purposes also contains some of the value of the goodwill of the business? It may be that the value of the licence has been considerably enhanced by virtue of its employment in the business. What if the asset involved is not a CGT asset? Does goodwill encompass intangibles or items non-proprietary in nature which are present in the business and which have contributed to the creation of goodwill and therefore, in assigning to goodwill an appropriate value, the value of these items have to be taken into account?[24] To what extent could it be argued that the value of the goodwill of a business is reflected in an enhancement in the value of the other assets of a business, or at least, in the value of those assets which have contributed in some meaningful way to the creation of that goodwill?[25]
This article examines, in the light of the High Court decision in Murry, the issues of the meaning of goodwill and its appropriate "valuation" in the context of the operation of the goodwill exemption.[26] As a result of the decision, where the operation of the predecessor to s 118-250 of the ITAA97[27] was considered, the scope of the exemption is now arguably less murky. Predictably, the Australian Taxation Office ("ATO") has issued Draft Taxation Ruling TR 98/D13[28] on the matter (detailed in Part 10).
From the accounting viewpoint, the above valuation issues do not arise because of the profound practical differences between the accounting and legal concepts of goodwill.
The Australian Accounting Standard AASB 1013/AAS18 Accounting for Goodwill defines goodwill as "the future benefits from unidentifiable assets".[29] Unidentifiable assets are those assets that are not capable of being "both individually identified and specifically recognised."[30] Examples of unidentifiable assets set out in the commentary to the Standard are "market penetration, effective advertising, good labour relations and a superior operating team."[31] Assets that are intangible assets and which are capable of being individually and separately recognised or identified are not unidentifiable assets.[32]
For accounting purposes, goodwill is in essence a residual item measured as the difference between the acquisition cost of a business and the fair value of the identifiable net assets of the business.[33] Identifiable net assets include both identifiable tangible and intangible assets less the liabilities of that business.
By virtue of the way in which goodwill is defined and measured for accounting purposes, the valuation difficulties for tax purposes do not arise. Further, because of the requirement that acquired goodwill must be written off,[34] the amount ascribed to goodwill for accounting purposes is invariably, minimised.
There is no legislative definition of goodwill for tax purposes. There is, however, a large body of case law on its meaning. Perhaps one of the more contentious aspects of this body of law is the apparent diversity in the various legal formulations. This is arguably attributable to a wide range of factors, including discipline,[35] and variations in the context within which the courts have been called upon to examine the concept.
The Shorter Oxford English Dictionary on Historical Principles[36] defines goodwill as:
... [t]he privilege, granted by the seller of a business to the purchaser, of trading as his recognised successor; the possession of a ready formed connection of customers, considered as an element in the saleable value of a business, additional to the value of the plant, stock in trade, book debts etc.
It is interesting to note that this definition is in substance consistent with the common law definitions considered below. As will be noted below, the majority justices in Murry also make reference to goodwill as a "privilege". Similarly, the notion of "a ready formed connection of customers" is consistent with traditional legal definitions of the term, in particular, the definition provided by Sir George Jessel in Ginesi v Cooper.[37] Another interesting aspect of the lexical definition is the fact that the value of goodwill is defined as something additional to the value of the other assets of a business.
Perhaps the oldest cited legal definition of goodwill is in Cruttwell v Lye[38] where Lord Chancellor Eldon stated that goodwill was "nothing more than the probability, that the old customers will resort to the old place."
Sir George Jessel alluded to the essence of this definition[39] when his Lordship stated that:
... [a]ttracting customers to the business is a matter connected with the carrying of it on. It is the formation of that connection which has made the value of the thing that the late firm sold." Similarly, Lord Herschell in Trego v Hunt[40] emphasized that, "[i]t is the connection thus formed, together with the circumstances, whether of habit or otherwise, which tend to make it permanent, that constitutes the goodwill of a business. It is this which constitutes the difference between a business just started, which has no goodwill attached to it, and one which has acquired a goodwill.
The significance of an "established" business as a prerequisite for the existence of goodwill was repeated some five years later in the often-cited speech of Lord Macnaghten in Muller[41] where his Lordship held that goodwill "is the attractive force which brings in custom. It is the one thing which distinguishes an old-established business from a new business at its first start."
Whilst the Lord Chancellor's simple definition in Cruttwell served as a useful starting point for many of the earlier decisions, broader formulations soon emerged and the focus of subsequent legal definitions shifted to aspects other than patronage. For example, goodwill was referred to as being a form of "advantage". Wood V-C in Churton v Douglas[42] held that:
... [g]oodwill, I apprehend, must mean every advantage − every positive advantage, ... that has been acquired by the old firm in carrying on its business, whether connected with the premises in which the business was previously carried on, or with the name of the late firm, or with any other matter carrying with it the benefit of the business.
Similarly, in Muller,[43] Lord Macnaghten referred to goodwill as "the benefit and advantage of the good name, reputation and connection of a business."
The concept of "added value" was also a focus in some of the decisions.
In Muller,[44] Lord Lindley held that:
... [g]oodwill 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 absence from competition, or any of these things, and there may be others ...
In Box v C of T,[45] the High Court held that, "[g]oodwill includes whatever adds value to a business, and different businesses derive their value from different considerations."
Before exploring the High Court decision in Murry, it is worth noting the Full Federal Court decision in FC of T v Krakos Investments Pty Ltd,[46] the often-cited "authority"[47] prior to Murry on the issue of the meaning of goodwill and its relationship to the other assets in a business.
In Krakos, the taxpayer sold a hotel business. As ownership of the freehold upon which the business was conducted was retained by the taxpayer, a lease of the freehold was granted to the purchaser. The sale agreement provided for the purchase consideration to be allocated between plant and equipment and goodwill. No part of the consideration was allocated to the grant of the lease, the liquor licence or the hotel name. Consistent with his view expressed at the time in Income Taxation Ruling IT 2535,[48] the Commissioner argued that the consideration attributable to goodwill should in fact be characterised as a lease premium and therefore be brought to account as a capital gain under s 160ZS of the ITAA36.[49] The Commissioner's argument was based upon the premise that the goodwill of a hotel business was inseparable from the premises. As the benefit of the location was made available through the granting of the lease, the consideration described as being for goodwill was in reality therefore, a payment for the grant of that lease.
The Full Federal Court found, however, that in the circumstances, there was nothing to suggest that the payment was for the grant of the lease and accordingly, it could not be characterised as a premium for the purposes of s 160ZS. Though strictly, it was unnecessary, Hill J considered in some detail the meaning of goodwill and its relationship to the other assets in a business. His comments, albeit obiter dicta, have been the subject of critical analysis by practitioners.[50]
His Honour held that, "[t]here are various kinds of goodwill, all of which, with the exception of personal goodwill,[51] attach to property.[52] Site goodwill[53] clearly attaches to the site ... Name goodwill[54] clearly attaches to the trade name and
at least where this involves a trade mark ... this name will be property. ... Monopoly goodwill[55] attaches to the statutory monopoly right."[56] This type of goodwill, according to Hill J, could attach to other types of statutory licences or monopolies.[57]
His Honour also questioned the correctness of the proposition that goodwill is indivisible and inseparable from a business[58] and held that "a business may have both goodwill attaching to a name and goodwill attaching to premises. There seems no reason why each of these aspects of the goodwill of such a business could not be dealt with separately."[59]
Although his Honour left open the possibility that goodwill was still capable of being "a separate species of property", Hill J was of the view that:
... [h]aving regard to the disparate nature of these rights which together make up the goodwill of a particular business and which to some extent can be dealt with separately, I do not think it can be correct today to say that although comprised of separate elements goodwill is to be treated as inseverable. It is, however, correct to say that to the extent that the goodwill attaches to a species of property it may only be dealt with together with that property. But this is not to say that it is not capable of being dealt with as a separate species of property or as being the subject of a bargain and sale at a price.[60]
Hill J's view suggests that the value assigned to a particular asset in a business, on its disposal, could also reflect the value of the particular type of goodwill that is attached to that asset.[61] In simple terms, the value of the goodwill of a business may be reflected in an enhancement in the value of particular assets in the business. The controversial aspect of his Honour's view is the apparent suggestion that, contrary to the generally accepted legal and business notions of goodwill, it is capable of disposal independently of a business through disposal of the asset in respect of which the goodwill (or some part of the goodwill of the business) is attached.
The taxpayer[62] in Murry was in a partnership which conducted what was described in the evidence as a "taxi business". The partnership owned a taxi licence issued by the Queensland Department of Transport, and shares in a taxi co-operative. The shares were a prerequisite to the operation of a taxi in a particular area in the Queensland Sunshine Coast. The taxpayer in fact, leased the taxi licence out to the owner of the taxi covered by the licence.
On disposal of the licence, the partnership realised a capital gain and the taxpayer sought the benefit of the goodwill exemption. The question before the High Court was whether, for the purposes of s 160ZZR of the ITAA36,[63] the amount received for the sale of the taxi licence by the partnership could be characterised as consideration[64] for the disposition of the goodwill of the taxpayer's business.
Applying Hill J's reasoning[65] in Krakos, it could be argued that "monopoly goodwill" attached to the taxi licence. This form of goodwill attached to a licence because customers were "attracted" to the licence-holder's business by virtue of the absence or partial absence of competition resulting from the licensing system. At the Full Federal Court level,[66] where the taxpayer in Murry was successful, Beaumont J[67] held that the value of the licence is itself a form of goodwill, expressed as a monopoly or quasi-monopoly (or oligopoly) goodwill. His Honour added that "it should be accepted that those drafting s 160ZZR(1) must have been aware that, technically, 'goodwill' could extend to pick up the licence value itself, even if no commercial reputation (in the dictionary sense) were involved."[68] Accordingly, prior to the High Court decision, it was not unreasonable to suggest that the value of a taxi licence could include the value of the goodwill of a taxi business.
However, by a majority,[69] the High Court held that the disposition of a taxi licence alone did not involve a disposition of the goodwill of a taxi business for the purposes of s 160ZZR. The essence of their Honours' reasoning may be summarised in the following passage from their judgment:[70]
Goodwill is inseparable from the conduct of a business. It may derive from identifiable assets of a business, but it is an indivisible item of property, and it is an asset that is legally distinct from the sources – including other assets of the business - that have created the goodwill. Because that is so, goodwill does not inhere in the identifiable assets of a business, and the sale of an asset which is a source of goodwill, separate from the business itself, does not involve any disposition of the goodwill of the business.
The majority justices explored in detail the nature of the concept of goodwill and concluded that its essence remains "the attraction of custom".[71] Goodwill, according to their Honours, "is an asset of [a] business"[72] and it has three aspects. These aspects, property, sources and value, were united through the conduct of a business.
Whilst it is clearly a CGT asset, the question of whether goodwill is property has not been completely free from doubt.
The majority justices considered the legal authorities on this issue and concluded that goodwill "is correctly identified as property".[73] However, it has been argued that goodwill is in truth, not property, but rather, that it is a property.[74] Slater argues that goodwill is a quality or an attribute rather than something that is proprietary in nature and capable of assignment. The misconception that goodwill is property, according to Slater, "has passed into legal folklore" and is the result of a "conceptual elision from goodwill being a property of a business to its being property comprised in a business".[75] Slater's argument is based upon the premise that, because goodwill is "inseparable from the conduct of a business", it lacks the characteristic of transferability, which, it has been held, is an essential attribute of property. If goodwill is incapable of transfer apart from the business from which it was created, then goodwill should more properly be characterised as a quality or an attribute rather than as something proprietary in nature.[76]
However, in the light of the weight of the legal authorities favouring the view that it is property, particularly with the High Court decision in Murry, it is now too late to argue otherwise.
Consistent with the view that it is property, the majority justices referred to goodwill as a legal right or privilege. In formulating a definition, their Honours found useful the definition of goodwill in an old United States decision,[77] where Swain J[78] stated that:
... [a] going business has a value over and above the aggregate value of the tangible property employed in it. Such excess of value is nothing more than the recognition that, used in an established business that has won the favour of its customers, the tangibles may be expected to earn in the future as they have in the past. The owner's privilege of using them, and his privilege of continuing to deal with customers attracted by the established business, are property of value. This latter privilege is known as goodwill.
It appears that this formulation provided a basis for the majority justices' definition of goodwill, the essence of which is embodied in the following passage in their joint judgement:
... [goodwill] is the right or privilege to make use of all that constitutes "the attractive force which brings in custom"... it is the legal right or privilege to conduct a business in substantially the same manner and by substantially the same means that have attracted custom to it. It is a right or privilege that is inseparable from the conduct of the business.[79]
The above passage confirms the well established common law principle that goodwill is indivisible and is inseparable from the conduct of a business.[80] This accordingly puts an end to the suggestion that the goodwill of a business[81] could be "severed" from a business through independent disposal of an asset. Their Honours held that no disposition of goodwill is involved in the mere disposal of an asset of a business unless "the sale of the asset is accompanied by or carries with it the right to conduct the business."[82]
Another important aspect of the majority justices' definition of goodwill is the reference to goodwill as "having sources"[83] as opposed to being "composed of elements".[84]
That is, while their Honours recognised that the goodwill of a business is the "product of combining and using the tangible, intangible and human assets of a business for such purposes and in such ways that custom is drawn to it"[85] it is more accurate to view goodwill as an independent species of property rather than as an adjunct to other property in the allocation of a value to goodwill.
As a species of property distinct in its own right from the other assets in a business, the value assigned to goodwill is therefore independent of the value assigned to the other assets of the business. The value of goodwill is not represented in the value of the other assets in a business or in the form of an enhancement in the values of those other assets. The reference to "monopoly goodwill"[86] attaching to a licence for example, is therefore an imprecise description. The value of the licence is exclusive of the value of the goodwill which has been generated in the business through the use of the licence.[87] More accurately, goodwill attaches to a business the conduct of which may be subject to the proprietor holding a licence.
However, apart from the employment of the tangible and intangible assets in a business, goodwill may often be the product of a smorgasbord of sources, factors or processes which may not necessarily be CGT assets or items proprietary in nature,[88] or for accounting purposes, they may be incapable of being individually quantified and recorded as assets of the business. Because of the potential difficulty in assigning values to these items, apart from the issue of properly identifying them, to what extent does goodwill or the value assigned to it, encompass the value of these other factors?[89]
Where there is a profitable business involved, the approach suggested by the majority justices is to distinguish between the identifiable assets and the goodwill of the business. Although their Honours held that the legal concept of goodwill is narrower than the accounting one,[90] their Honours accepted that for the purposes of ascribing a value to the goodwill of a business which is profitable and which is expected to be profitable, the "conventional accounting approach of finding the difference between the present value of the predicted earnings of the business and the fair value of its identifiable net assets"[91] may be appropriate.[92] Accordingly, their Honours held that "the value of goodwill for legal and accounting purposes will often, perhaps usually, be identical"[93] in the case of a profitable business.
In contrast, there are difficulties in respect of the case of "a business trading at a loss or with less than industry average profitability".[94]
Their Honours held that it was still possible to have goodwill for legal purposes, even though "[the] trading losses [of the business] are such that its sale value would be no greater than its 'break-up' value".[95] That is, a business could still have goodwill for legal purposes even if for accounting purposes, its value may only be nominal. Their Honours acknowledged that the value of goodwill in this case "may be difficult to assess".[96] The view that there may be goodwill in a business of this nature is based upon the premise that goodwill is a species of intangible property which a court will protect "irrespective of the profitability, or value of the business".[97]
However, the process of assigning a value to the goodwill of such a business, in practice, may be a difficult one and only a nominal amount may be at issue. If accounting principles are to be abandoned, then some other acceptable valuation methodology is warranted. The difficulty with trying to put a value on goodwill in the case of a non-profitable business is based upon the fact that the business seems to lack the very thing that gives value to goodwill.[98] If goodwill is the right or privilege to "conduct a business in substantially the same manner and by substantially the same means that have attracted custom to it",[99] it would seem that the value of that right or privilege[100] is minimal if the business has not been successful in attracting custom, the very essence of goodwill. Some of the comments of the majority justices in their decision in fact, seem to support this view.[101]
Some interesting comments were made by the majority justices on the value of the goodwill of a business where the goodwill is "largely [derived] from using an identifiable asset or assets".[102]
Their Honours held that the value of the goodwill of such a business may be small because:
... the earning power of the business will be largely commensurate with the earning power of the asset or assets. If the goodwill of a business largely depends on a trade mark, for example, and the trade mark is fully valued, the real value of goodwill can only reflect a value that is similar to the difference between the business as a going concern and the true value of the net assets of the business including the trade mark. A purchaser of the business will not pay twice for the same source of earning power.[103]
Earlier in their joint judgment, their Honours referred to the "potential use value" of an asset. Their Honours held that "the potential use of an asset which is transferred out of the business may give it a value which approximates to the value of the goodwill which the business derived from the use of the asset. ... [I]n some cases the value of the goodwill of a business may be reliable evidence as to the value of the asset or its potential use."[104]
This concept of the potential use value of an asset[105] is interesting in that, one could take the view that, potential use value, in substance, represents the enhanced value of an asset, the enhancement in value resulting from the employment of the asset in a business. This is perhaps not unlike the concept of "adherent goodwill" referred to by Slater.[106] In other words, the consideration that is paid for the asset when it is sold along with the business may be greater than what it otherwise might be if it was sold "sterilised from the benefit of any lingering reputation [created by the conduct of a business] attached to it."[107]
The scope of this notion of the potential use value of an asset is not clear. It could be argued that, in the case of a business characterised as having its goodwill largely attributable to the use of identifiable assets, the consideration properly attributable to goodwill for tax purposes might be minimal.[108]
Although only a draft ruling, Draft Taxation Ruling TR 98/D13[109] provides a valuable insight into the Commissioner's approach to the issue of allocating a value to goodwill.
In essence, the Commissioner will accept the amount attributed to goodwill by the parties to a sale of business agreement where they are dealing at arm's length with each other.[110] The important qualification to this however, is that the parties have not included in the value of goodwill "an amount that should be properly attributed to an 'identifiable asset' (in terms of the accounting standards)".[111] The Commissioner indicates that the total proceeds received for the sale of a business should equal the sum of the amount attributed to goodwill and the proceeds "for all other identifiable assets of the business".
It appears that the Commissioner therefore accepts that, at a basic minimum, the value attributed to goodwill should be exclusive of the value of all the other identifiable assets[112] of the business.[113] This approach relies upon principles similar to the conventional accounting method for valuing goodwill and is consistent with the approach suggested by the majority justices of the High Court in Murry.[114]
Significantly, Draft Taxation Ruling TR 98/D13 provides that in determining if the parties are dealing at arm's length, one relevant circumstance will be whether the amount allocated to goodwill is "above or below the market value of the goodwill".[115] Although the Commissioner
does not elaborate specifically on what is meant by "market value", it is apparent from the examples provided in Draft Taxation Ruling TR 98/D13 itself that this is a reference to "the difference between the market values of all other identifiable net assets disposed of and the total sale proceeds received for the business in an arm's length dealing".[116] The Commissioner's preferred valuation methodology is therefore based upon a consideration of the market values of the identifiable assets of a business.
In the case of a sale of a non-profitable business, the Commissioner's approach seems to be that the same method of valuing goodwill as that applied for the sale of a profitable business should be adopted. If it is not adopted, the Draft Ruling states that the Commissioner "expect[s] ... goodwill [to] be valued by a method supportable by some other valuation methodology".[117] The position is therefore unclear as to what valuation methodology is acceptable to the Commissioner in such an instance.
For practical purposes, given the Commissioner's view, it may be difficult to justify attributing to goodwill any value at all in the case of a less than profitable business because its market value would arguably be insignificant.
The High Court decision has provided much needed clarity on the law in respect of the scope and the meaning of goodwill and how to properly ascribe a value to it for tax purposes.[118]
The majority justices have relied on traditional principles as a basis for the definition of goodwill and have confirmed some of the established common law principles on its nature. From the aspect of "valuing" goodwill, it is interesting that, while recognising that "it is impossible to achieve a synthesis of the legal and the accounting and business conceptions of goodwill",[119] their Honours then relied on conventional accounting principles for the purposes of allocating a value to the goodwill in respect of a profitable business. There is much to be said for adopting accounting principles when the presence of other alternatives is unclear.[120] However, one practical implication may be that the value assigned to goodwill is minimised and in the case of a non-profitable business, it may be difficult to justify attributing any amount other than a nominal one.[121]
Further, it remains to be seen how far the concept of the potential use value of an asset is taken in the process of attributing a value to goodwill, in particular, from the Commissioner's viewpoint. One might also speculate that perhaps, this is what Hill J, in essence, was referring to in his judgement in Krakos.
It is still unclear to what extent the concept of goodwill and therefore the value that is assigned to it, encompasses "aspects" of the business (which contribute to the creation of goodwill) but which are not necessarily proprietary in nature or which are incapable of being individually quantified and recorded as assets under conventional accounting principles. If the value of some of these factors is recognised independently of the value of goodwill, then the value assigned to goodwill may be further diminished. This may further restrict the scope of the goodwill exemption.
There is perhaps some merit in Kirby J's argument, in his dissenting judgement in Murry, that a broad view of the concept of goodwill should be adopted to achieve the legislative purpose behind the goodwill exemption.[122]
Primrose Mroczkowski is an Assistant Lecturer in taxation law in the Department of Business Law and Taxation at Monash University. She holds LLB and BEc degrees and has gained admission to the Supreme Court of Victoria. She recently completed her Master of Taxation at Monash University.
[1] This is a reference to the zoological classification of custom (or goodwill) into those categories in Whiteman Smith Motor Co v Chaplin [1934] 2 KB 35, 42 ("Whiteman"). The cat, rat and dog classification appears to be the work of a counsel in the case, a Mr SPJ Merlin. Maugham LJ, a judge in Whiteman, introduced the rabbit classification. When referring to this classification. Rich J in FC of T v Williamson [1943] HCA 24; (1943) 67 CLR 561, 564 ("Williamson") held that "[t]he cat prefers the old home to the person who keeps it, and stays in the old home although the person who has kept the home leaves, and so it represents the customer who goes to the old shop whoever keeps it, and provides the local goodwill. The faithful dog is attached to the person rather than to the place; it will follow the outgoing owner if he does not go too far. The rat has no attachments, and is purely casual. The rab-bit is attracted by mere propinquity. It comes because it happens to live close by and it would be more trouble to go elsewhere. These categories serve as a reminder that the goodwill 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 Kirby v Thorn EMI Pty Ltd [1987] BTC 462, 468. Thorn EMI's reputation in certain trades was described as "dog" goodwill as distinct from "cat, rat or rabbit" goodwill.
[2] 98 ATC 4585 ("Murry").
[3] In IR Commrs v Muller & Co's Margarine Ltd [1901] UKLawRpAC 20; (1901) AC 217, 223 ("Muller"), Lord Macnaghten held that goodwill "is a thing very easy to describe, very difficult to define." More recently, in Murry 98 ATC 4585, 4598, Kirby J lamented, "[t]he amount of trouble which the concept of goodwill has occasioned to revenue law (not to say in other areas of discourse) is remarkable."
[4] See eg generally, G Cathro, "Goodwill: 'Now You See It, Now You Don't'" (1996) 25 Australian Tax Review 169.
[5] Ibid.
[6] Australian Accounting Standard AASB 1013/AAS18 Accounting for Goodwill, para 5.2 states that "[p]urchased goodwill must be amortised".
[7] There are still provisions contained in Pt IIIA of the ITAA36 which continue to remain applicable.
[8] The sale of a business is in fact the sale of the various assets that comprise the business. The CGT implications of a sale of a business therefore turn upon the application of the CGT provisions to the individual assets such as trading stock, depreciable plant, a lease of premises, business names and logos, items of intellectual property such as a patent or a copyright, and licences. If a business is conducted by a company, the business could be effectively sold through the disposal of the issued shares of the company. The goodwill exemption, which will be discussed later in this article, is unlikely to apply in such a case.
[9] Consistent with the High Court decision in Murry, the Commissioner's view expressed in Draft Taxation Ruling TR 98/D13 is that goodwill is a single CGT asset for the purposes of the CGT provisions (paras 88-95). With the introduction of the ITAA97, what were previously "assets" pursuant to the ITAA36 are now called "CGT assets". Section 108-5(2) of the ITAA97 (previ-ously, s 160A of the ITAA36) defines "CGT asset" to include "goodwill or an interest in it". The meaning of what was then an "asset" for CGT purposes has been a contentious one from the time the CGT provisions were first introduced. For a discussion of the issue of what it constitutes, see eg. S Barkoczy, "Part IIIA: The Meaning of 'Asset'" (1994) 2 Taxation in Australia (Red edition) 275.
[10] Where the goodwill is internally generated through the taxpayer conducting a business, goodwill will usually not appear in the balance sheet (Australian Accounting Standard AASB 1013/AAS18 Accounting for Goodwill, para 4). For tax purposes, the goodwill in this case is acquired at the time when the taxpayer starts the work that results in the creation of the goodwill, which often means when the business commenced (s 109-10, item 1 of the ITAA97). If the goodwill is acquired from a business owner on the acquisition of a business under a contract, the acquisition date of the goodwill is the date the contract was entered into (s 109-5(2), event A1, case 1 of the ITAA97).
[11] ITAA97, s 104-10(5)(a). The whole of the goodwill of a business is either pre-CGT goodwill (subject to Div 149 of the ITAA97 which relates to when an asset stops being a pre-CGT asset; that is, provided the "same business" continues to be car-ried on) or post-CGT goodwill. In their joint judgement, the majority justices in Murry 98 ATC 4585, 4594-4595, Gaudron, McHugh, Gummow and Hayne JJ, made some interesting observations on the question of when the "same business" is being car-ried on; that is, when is the goodwill acquired or created by a taxpayer the same asset as that which is disposed of when the busi-ness is otherwise sold or disposed of. For a discussion of this aspect of the judgement, see G Cathro, "Capital Gains Tax" (1999) 28 Australian Tax Review 57. See also the Commissioner's view in Draft Taxation Ruling TR 98/D13, paras 88-94.
[12] ITAA36, Div 17A of Pt IIIA.
[13] ITAA36, Div 17B of Pt IIIA. A taxpayer must elect for rollover relief under either Divs 17A or 17B. Relief cannot be obtained in respect of the same disposal of the same asset under both Divisions (ITAA36, s 160ZZPQA).
[14] The exemption is not available if the taxpayer has elected to obtain roll-over relief under either of Divs 17A or 17B of Pt IIIA of the ITAA36 (ITAA97, s 118-255).
[15] Taxation Laws Amendment Bill (No 4) 1999 rewrites Divs 17A and 17B of Pt IIIA of the ITAA36 into Subdiv 118-F and Div 123 of the ITAA97. The Bill has passed both Houses of Parliament and received Royal Assent on 16 July 1999.
[16] For the period before 26 February 1992, the reduction was only 20%.
[17] $2,248,000 for the 1998/99 year. The exemption threshold was originally $1 million. From 27 February 1992 to 30 June 1993, it was increased to $2 million and since the latter date it has been indexed annually.
[18] ITAA97, s 118-250(2).
[19] ITAA97, s 104-10(4).
[20] ITAA97, s 116-20(1).
[21] In contrast, the Commissioner's argument might be that the consideration allocated by the parties to goodwill is in fact attrib-utable to some other asset or is to be characterised as something other than payment for goodwill. An example is in FC of T v Krakos Investments Pty Ltd 96 ATC 4063 ("Krakos"), although the applicability of the goodwill exemption was not the issue in this case. In Krakos, the Commissioner's argument was that the consideration which the parties allocated to goodwill in the sale of the business was in reality a lease premium and therefore was to be brought in as a capital gain under s 160ZS of the ITAA36 (now contained in ss 104-110(1), 104-110(3) and 116-20(2) of the ITAA97). Section 104-110 requires a capital gain or a capital loss to be brought to account in the circumstances of a grant, renewal or extension of a lease.
[22] The importance of a business as a going concern in the generation of goodwill has been highlighted in cases such as Hill v Fearis [1901] 1 Ch 466, 471 and Box v C of T [1952] HCA 61; (1952) 86 CLR 387, 396 ("Box"). The features of a business which attract cus-tomers to it vary significantly. In Williamson [1943] HCA 24; (1943) 67 CLR 561, 564 (per Rich J) it was held that "to determine the nature of the goodwill in any given case, it is necessary to consider the type of business and the type of customer which such a business is inherently likely to attract as well as all the surrounding circumstances."
[23] See Cathro, above n 4.
[24] In FC of T v Just Jeans Pty Ltd 87 ATC 4373, 4383, the Full Federal Court held that the assignment of a trade name and unreg-istered trademark was ineffective without a transfer of the underlying goodwill: "[A]t common law a distinctive name is one manifestation of the goodwill of the business".
[25] See Cathro, above n 4, 175. He draws a distinction between what he terms the "umbrella asset approach" and the "separate asset approach".
[26] In recognition of the difficulties associated with the operation and the administration of this exemption, the Ralph Business Tax Review Committee in A Platform for Consultation, Discussion Paper 2 Building a Strong Foundation, February 1999, Chap-ter 11 "CGT Provisions for Small Business", has in fact suggested the possibility of replacing the goodwill exemption with a generalised exemption, say of 20%, of all capital gains accruing on the disposal of the active assets of a small business.
[27] ITAA36, s 160ZZR.
[28] Draft Taxation Ruling TR 98/D13 Income Tax: Capital Gains: Goodwill of a Business was issued in November 1998.
[29] Paragraph 13.
[30] Ibid.
[31] Ibid.
[32] The commentary sets out the examples of "patents, licences, rights and copyrights."
[33] Australian Accounting Standard AASB 1013/AAS18 Accounting for Goodwill, para 5.7.
[34] Ibid, para 5.2.
[35] The majority justices in Murry 98 ATC 4585, 4589 recognised this when they held that. "[g]oodwill is also an accounting and business term as well a legal term. The understanding of accountants and business persons as to the meaning of the term differs from that of lawyers. That has added to the difficulty of achieving a uniform legal definition of the term, particularly since accounting and business notions of goodwill have proved influential in the valuation of goodwill for legal purposes."
[36] Third Ed. Vol I, Oxford at the Clarendon Press.
[37] [1880] UKLawRpCh 70; 14 Ch D 596 ("Ginesi").
[38] [1810] EngR 542; (1810) 17 Ves Jun335 34 ER 129, 134 ("Cruttwell").
[39] Ginesi 14 Ch D 569.
[40] [1895] UKLawRpAC 49; [1896] AC 7, 17.
[41] [1901] UKLawRpAC 20; (1901) AC 217, 223.
[43] [1901] UKLawRpAC 20; (1901) AC 217, 223.
[44] Ibid 235.
[45] [1952] HCA 61; (1952) 86 CLR 387, 397 (per Dixon CJ, Williams, Fullagar and Kitto JJ).
[46] 96 ATC 4063 (per Hill J, Von Doussa and O'Loughlin JJ concurrring).
[47] This term is used loosely here in that the relevant comments, which were made by Hill J on the meaning of goodwill and its relationship to the other assets in a business, were obiter dicta.
[48] Income Taxation Ruling IT 2535 has since been withdrawn and is replaced by Taxation Ruling TR 96/24 which sets out the Commissioner's view on goodwill and lease premiums.
[49] See above n 21.
[50] For example, by Cathro, above n 4, and F Zumbo, "'Monopoly Goodwill'" (1997) 5 Taxation in Australia (Red edition) 139.
[51] That is, patronage is related to some personal characteristic of the proprietor of the business.
[52] The proposition that goodwill or its value could be attached to the value of an asset of a business is not a novel one. The courts have held that the value of the goodwill of the business of public houses or licensed premises could be attached to or be part of the value of the property upon which the business is conducted and that the value of goodwill in such cases may in fact, be insep-arable from the value of the land. In Ex parte Punnet: In re Kitchin [1880] UKLawRpCh 271; (1880-1881) 16 Ch D 226, 233, Jessel MR by way of obiter, stated that "[i]t is quite plain that the goodwill of a public house passes with the public house. In such a case the goodwill is the mere habit of the customers resorting to the house. It is not what is called a personal goodwill". Similarly, in Ricket v Metropol-itan Ry. Co. [1864] EngR 383; (1867) 2 LR H L 175, 204-205 ("Ricket") Lord Westbury held that, in the context of the issue of injury to a public house, "[i]t is a fallacy, almost a mockery, to answer, 'the custom is one thing and the house another; and the injury is to the cus-tom, not to the house.' You cannot sever the custom from the house itself". On the other hand, in West London Syndicate v IRC [1898] UKLawRpKQB 154; [1898] 2 QB 507, 513-514 a majority of the Court of Appeal held that the goodwill of a hotel business was not inseparable from the premises in which the business was carried on and that it could have some value separate from that of the value of the land. AL Smith and Rigby LJJ held that, "goodwill is as capable of being sold as a separate entity for what it is worth as is the ten-ant's interest in the lease. It may be that by the terms of a lease each must be sold if sold at all, to the same person; but that does not prevent them being sold as separate and distinct entities; and if so sold goodwill ... is property, and is clearly not land." Sim-ilarly, in Muller [1901] UKLawRpAC 20; [1901] AC 217, 239, the Lord Chancellor held that, "[i]n the case of a public-house, owing to the convenience of its situation and its being known as a favourite place of resort, the advantages of its situation are so mixed up with the good-will of the business that, as a matter of fact, it may well be that it is very difficult to sever them, and to say how much is good-will and how much is local situation. But those difficulties of fact will not necessarily make their separate existence impossible." In Daniell v FC of T [1928] HCA 17; (1928) 42 CLR 296, 302-303 Knox CJ held that, "[i]f, having regard to the decisions and dicta in these cases, I am at liberty to express an opinion on the abstract question whether the goodwill of a licensed victualler's business is separable from the premises in which it is carried on, my opinion is that while it cannot be said to be absolutely and necessarily inseparable from the premises or to have no separate value, prima facie at any rate it may be treated as attached to the premises and whatever its value may be should be treated as an enhancement of the value of the premises." The above authorities suggest that the value of goodwill could be reflected in the value of an asset of a business. However, these authorities must be consid-ered in the context within which they were decided. Many of the cases relating to the goodwill of licensed premises involved the licensing system of 19th century England where licences could not generally be removed from one location to another even though they could be transferred between different persons. The relevance of this issue was raised by Hill J in Krakos 96 ATC 4063, 4073 when he held that, "[g]iven the legislative difference between the situation existing in South Australia and that exist-ing in 19th century England, it may well be there is a need to rethink the prima facie rule that the whole goodwill of a public house attaches to the premises." Further, cases such as Ricket dealt with the issue of compensation resulting from injury to premises.
[53] In Box [1952] HCA 61; (1952) 86 CLR 387, 398, site goodwill is described as arising "because the site has some particular advantage for car-rying on a business as where premises adapted for a shop are situated in a position specially favourable for the business in a busy shopping area or where a licence can be obtained for carrying on a business such as that of a publican on a suitable site on which it would otherwise be unlawful to carry it on. Other premises may have acquired a site goodwill, as in the case of a retail store, because a profitable business has been carried on there for a number of years and people have become accustomed to resort to that site to do their business."
[54] Hill J in Krakos 96 ATC 4063, 4069, describes name goodwill as existing where, "[t]he proprietor of a business may have developed a particular reputation in a name which the law will protect. In such a case, custom may be attracted to the business by the very use of the name."
[55] Ibid 4069-4070. Hill J in Krakos explains this type of goodwill through example: "Where a monopoly has been conferred upon a trader, that trader may develop a custom which is tied to that monopoly. ... Customers will revert to that trader not because of the name of that trader, the place from which he or she trades or some personal characteristic of the trader, but because of the statutory monopoly which the trader has."
[56] Ibid 4073.
[57] "[W]here a statutory licence or monopoly has been conferred, that licence may come to have attached to it a type of goodwill, in the sense that it is the holding of the licence which attracts custom. For example, a crown monopoly to sell a com-modity such as salt may come to have a special value to its holder over and above the cost of obtaining the monopoly.": Ibid 4070.
[58] Ibid 4068.
[59] Ibid.
[60] Ibid 4073.
[61] For example, monopoly goodwill could be an element in the value of a statutory licence.
[62] The taxpayer was successful in the Administrative Appeals Tribunal Case 59 95 ATC 473 and at the Full Federal Court 96 ATC 4703.
[63] As previously discussed, the predecessor to s 118-250 of the ITAA97.
[64] Either wholly or in part.
[65] Krakos 96 ATC 4063, 4069-4070.
[66] 96 ATC 4703, 4709.
[67] One of the majority justices who found for the taxpayer.
[68] 96 ATC 4703, 4709.
[69] Gaudron, McHugh, Gummow and Hayne JJ; Kirby J dissenting.
[70] Murry 98 ATC 4585, 4587.
[71] Ibid 4590.
[72] Ibid 4591.
[73] Ibid. Goodwill has been recognised as a species of personal property: Muller [1901] UKLawRpAC 20; (1901) AC 217.
[74] AH Slater QC, "The Nature of Goodwill" (1995) 24 Australian Tax Review 31.
[75] Ibid.
[76] However, with respect, it could be argued that this is an unduly narrow view. In Milirrpum & Ors v Nabalco Pty Ltd & The Commonwealth (1971) 17 FLR 141, 272, Blackburn J held that "property, in its many forms, generally implies the right to use or enjoy, the right to exclude others, and the right to alienate. I do not say that all these rights must co-exist before there can be a proprietary interest, or deny that each of them may be subject to qualifications." Further, although it has been held that a right or an interest is characterised as property if it is "definable, identifiable by third parties, capable in its nature of assumption by third parties, and have some degree of permanence or stability" (National Provincial Bank Ltd v Ainsworth [1965] UKHL 1; (1965) AC 1175, 1247, per Lord Wilberforce), Mason J in R v Toohey & Anor; ex parte Meneling Station Pty Ltd & Ors [1982] HCA 69; (1982) 158 CLR 327, 342 ("Toohey"), after quoting Lord Wilberforce's above statement, held that assignability is not an essential characteristic of proper-ty in all circumstances. In Hepples v FC of T [1982] HCA 69; 44 ALR 63, 64, Gummow J referred to the decision in Toohey and also held that "assignability was not an essential characteristic of a right of property". He held that "by statute some forms of property being expressed to be inalienable, nonetheless it was generally correct to say that a proprietary right must be capable in its nature of assumption by third parties." In National Trustees Executors & Agency Co of Australia Ltd v FC of T [1954] HCA 71; (1954) 91 CLR 540, 583, Kitto J held that it may be said "categorically that alienability is not an indispensable attribute of a right of property according to the general sense which the word 'property' bears in the law". His Honour went on to hold that a right may be incapable of assignment because assignment is incompatible with its nature, however, this did not preclude that right from being characterised as property. Recently, the comments of Kitto J were referred to with approval by Gaudron, McHugh, Gummow, Kirby and Hayne JJ in FC of T v Orica Ltd 98 ATC 4494.
[77] Haberle Crystal Springs Brewing Co v Clarke 30 F 2d 219, 221-222 (2nd Cir) (1929).
[78] The majority justices noted that whilst Swain J's definition could not be regarded as exhaustive, it came "close to achieving a synthesis between the legal, accounting and business definitions of goodwill." Murry 98 ATC 4585, 4590.
[79] Ibid 4590-4591.
[80] In Muller [1901] UKLawRpAC 20; [1901] AC 217, 224 (per Lord Macnaghten), it was held that "[t]he goodwill of a business is one whole, and ... must be dealt with as such ... goodwill has no independent existence. It cannot subsist by itself. It must be attached to a busi-ness." Similarly, in The Bacchus Marsh Concentrated Milk Company Ltd. (In Liquidation) & Anor v Joseph Nathan & Compa-ny Ltd. [1919] HCA 18; (1919) 26 CLR 410, 438 (per Isaacs J), it was held that "[g]oodwill is property, but, as such, is inseparable from a par-ticular 'business' in the sense of a particular going concern. It is an asset of that business, and enhances its value." The insepa-rability of goodwill from a business was reiterated by the High Court again in Geraghty & Anor v Minter & Anor (1979) 142 CLR 177, 181 and 193.
[81] The majority justices however, recognised that the value of the goodwill of the business may be diminished as a result of the independent sale of an asset. Murry 98 ATC 4585, 4592.
[82] Ibid.
[83] Ibid 4589.
[84] Ibid.
[85] Ibid 4591.
[86] Ibid 4593. The majority justices are unequivocal in their rejection of Hill J's concept of goodwill being "attached" to partic-ular assets.
[87] Ibid 4598. The majority justices in Murry in fact, held that the holding of a non-exclusive licence is not a source of goodwill but merely gives the licence-holder the right to enter a market. In contrast, their Honours held that an exclusive licence could be regarded as a source of goodwill.
[88] Ibid 4591. The majority justices in Murry recognised that " [m]any of the sources of goodwill are not themselves property. Nor are they assets for accounting purposes." Their Honours cited as examples, "manufacturing and distribution techniques, the efficient use of the assets of a business, superior management practices and good industrial relations with employees".
[89] Cathro, above n 4. Cathro suggests that goodwill, however defined, "will ultimately include within it a collection of other things, some of which are capable of being an asset in their own right. Otherwise, if all of the non-property rights created by a business, such as distinctive get-up, unregistered name or mark, know-how etc are treated as separate assets, it is conceivable that what is left as goodwill would be of little value."
[90] Murry 98 ATC 4585, 4590.
[91] Ibid 4595.
[92] Ibid. The difficulty associated with this approach, according to the majority justices, is with the fact that "the identifiable assets need to be valued with precision".
[93] Ibid.
[94] Ibid 4598. It could be argued that, on the basis of the analysis of the majority justices in Murry, a taxi business is the type of business that could fall within this category. The joint judgement stated that "[m]ost of the custom of a taxi business is new cus-tom. Repeat business is ordinarily accidental. That is not decisive against the existence of goodwill. But it is a powerful factor indicating that the business has no greater attraction than a similar business on its first day of operation. ... as with all those who sell goods or services that are virtually indistinguishable from the goods or services of others in a market and who have no spe-cial advantages over their competitors, above average industry earnings are difficult to achieve. And in the end, the value, as opposed to the existence, of goodwill for legal and commercial purposes is governed by the extent to which the earnings of a business exceed the norm."
[95] Ibid 4595.
[96] Ibid. The majority justices suggested that goodwill in this case could be valued on the basis of "the difference between the revenues generated by the relevant advantages and the operating expenses (other than a share of the fixed costs) incurred in earn-ing those revenues". See also generally, M Walpole, "When is Goodwill not Goodwill?" (1999) 2(1) Journal of Australian Tax-ation 48.
[97] Murry 98 ATC 4585, 4590. In particular, goodwill has been protected under the tort of passing-off. It has been held that this is a remedy for the invasion of a proprietary right in the goodwill or reputation of the business likely to be injured by the con-duct of the defendant (ConAgra Inc v McCain Foods (Aust) Pty Ltd [1992] FCA 159; (1992) 23 IPR 193). An element of this cause of action is the existence of goodwill or reputation in a specific trade or business (See eg, Burberrys v JC Cording & Co Ltd (1909) 26 RPC 693, (Ch), 701 per Parker J).
[98] Arguably, it is not that goodwill does not exist, it is merely of little value. It has been held that in an action for passing off, the plaintiff must establish reputation among "a substantial number of persons" (ConAgra Inc v McCain Foods (Aust) Pty Ltd [1992] FCA 159; (1992) 33 FCR 302; 106 ALR 465). Evidence of this may be in the form of volume of sales, frequency and extent of advertising and related promotional activities (W & A Gilby Ltd v Continental Liquers Pty Ltd [1960] HCA 21; (1960) 103 CLR 406; Turner v General Motors (Aust) Pty Ltd [1929] HCA 22; (1929) 42 CLR 352).
[99] Murry 98 ATC 4585, 4590-4591.
[100] In terms, for example, of what an arm's length buyer would pay for that right or privilege.
[101] For example, in Murry 98 ATC 4585, 4589, the majority justices held that the existence of goodwill "depends upon proof that the business generates and is likely to continue to generate earnings from the use of the identifiable assets, locations, peo-ple, efficiencies, systems, processes and techniques of the business." Their Honours also held that "[a]n existing business is the sine qua non of goodwill which cannot exist independently of the business which created and maintains it. The value of the goodwill of a business is therefore tied to the fortunes of the business. It varies with the earning capacity of the business and the value of the other identifiable assets and liabilities.": Murry 98 ATC 4585, 4595.
[102] Ibid 4595.
[103] Ibid 4595-4596.
[104] Ibid 4592.
[105] Arguably, the issue of ascribing an appropriate value to goodwill for tax purposes, that is, whether the value of goodwill is represented by a mere enhancement in the value of the other assets of a business or whether goodwill has a distinct value of its own, is a reflection of this dichotomy between the value of goodwill and the so-called potential use value of an asset or assets of a business.
[106] Slater, above n 74. For example, the location of a business may contribute to the generation of custom for the business. If the custom is characterised as being the consequence of the convenient location of the premises, this is "inherent goodwill". Where the custom arises because a profitable business has been carried on there for a number of years creating a reputation which attracts customers to the premises, this is "adherent goodwill".
[107] As expressed by Cathro, above n 4, 183.
[108] Arguably, this approach is not unlike that adopted by accountants.
[109] See above n 28.
[110] That is, in transacting the sale and in the allocation of the sale proceeds.
[111] Above n 28, para 55. "Identifiable asset" is defined in para 55 to include "(i)conventional work in progress (see also para-graph 114-120); (ii) the get-up of a business ... to the extent to which it is capable of being individually identified and specifi-cally recognised in financial statements; and (iii) scientific, technical, industrial or commercial knowledge or information ... to the extent to which it is capable of being individually identified and specifically recognised in financial statements."
[112] In the accounting sense.
[113] Where the parties to an agreement have not apportioned the sale proceeds between the disposal of goodwill and of the other identifiable assets, or the parties were not dealing at arm's length in the allocation of the sale proceeds and have attributed an unreasonably large amount of the proceeds to the disposal of the goodwill, s 116-40 of the ITAA97 enables the Commissioner to attribute a reasonable part of the proceeds to the goodwill and part to the other assets.
[114] In the Draft Ruling, the Commissioner states that while he accepts that there may be alternative approaches to the valuation of goodwill, in respect of the sale of a profitable business or a business expected to be profitable, he favours the approach adopt-ed in the accounting standards (paras 59-60). The value of goodwill therefore is represented by the difference between the total arm's length consideration received for the business and the sum of the "market values of all identifiable net assets (in terms of the accounting standards) other than goodwill" (para 59). The accounting standard actually refers to the "fair value" of the iden-tifiable assets.
[115] Above n 28, para 56.
[116] Ibid para 127.
[117] Ibid para 136. The Commissioner does not make any suggestions as to what these other methods might be.
[118] See also Cathro, above n 11.
[119] Murry 98 ATC 4585, 4590.
[120] For example, the concept of "fair value" (for the valuation of identifiable assets) for accounting purposes is based upon an arm's length transaction. "Fair value" is defined in para 13 of Australian Accounting Standard AASB 1013/AAS18 Accounting for Goodwill as "the amount for which an asset could be exchanged between a knowledgeable, willing buyer and a knowledge-able, willing seller in an arm's length transaction".
[121] Consistent with the conventional accounting approach perhaps, and in the light of concepts such as the potential use value of an asset.
[122] The writer gratefully acknowledges and thanks the following for their invaluable comments on this article: Nicholas Mroczkowski, Associate Director, Ferrier Hodgson Corporate Advisory, Daryl Murphy, Senior Tax Counsel, Australian Taxation Office (Brisbane) and Associate Professor Stephen Barkoczy, Department of Business Law and Taxation, Monash University, Consultant, Blake Dawson Waldron. The author is responsible for any errors or omissions contained in this article.
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