Goodwill and Taxation Issues

Michael Walpole

Abstract
This paper considers the legal meaning of goodwill and thereafter identifies sources of goodwill such as licences, marks, and designs. The discussion of assets as sources of goodwill leads to a discussion of Div 40 and subsequently to the application of CGT to goodwill. There is detailed discussion of a number of cases on goodwill (especially Murry) including the sometimes fictional attempts made at goodwill licensing (such as in the Just Jeans case). The final part of the article considers goodwill and comparative aspects of CGT’s application to know-how and show-how.

Introduction and Overview
This paper will attempt to take readers across what turns out to be one of the more complex, and fascinating, areas of Australian taxation - the impact of tax on dealings in goodwill.  The paper is structured so as to identify what goodwill is legally (after all, tax is a law); it then identifies some sources (note not types) of goodwill such as licences, marks and designs; these assets lead to a discussion of Div 40 and then of the application of CGT to goodwill; in the course of these discussions the paper addresses the sometimes fictional attempts made at goodwill licensing (a la Just Jeans); finally the paper considers goodwill and CGT, especially comparative aspects of CGT’s application to know-how and show-how.

The meaning of goodwill in Australian law
It is critical to a tax system which includes as many rules relating to goodwill as Australia’s for there to be a clear understanding of what goodwill is and of when an asset is goodwill or something else.  The author argues that a clear meaning of goodwill does not actually exist under tax rules.  In a commercial environment where intangible property, including goodwill, seems to be becoming increasingly important, this is a signal shortcoming of our system. Furthermore a client cannot operate using “I don’t know” advice so an attempt is made to settle on a workable meaning relying on what has been said in the cases.
The paper traces the development of the concept of goodwill through the legal cases and it considers the perspectives of goodwill to be found in the disciplines of accounting.  Thus it explores the legal cases and the accounting standards dealing with goodwill.
Australian tax has had an unusual focus on the meaning of the term ‘goodwill’.  This is attributable to three influences.  One arose because of the imposition of income tax on premiums paid by lessees on entering into a lease (see for example s 83 of the Income Tax Assessment Act 1936-1946 (Cth) and ITAA 1936 s 26AB applicable to assignments of leases granted before 20 September 1985).  Prior to the removal of such transactions from the scope of the income tax into the CGT rules in 1985, taxpayers argued that certain payments made at the commencement of some leases were payments for goodwill (and capital in nature) not premiums subject to income tax.
Secondly, and more recently, during the period between the introduction of CGT in Australia in 1985 and its reform in 1999, the meaning of the term ‘goodwill’ was important in the application of CGT to disposals of goodwill of small businesses in Australia on account of the relief provided under ITAA 1936 s 160ZZR.  The concession created a focus of attention on goodwill for small business taxpayers.  Attempts to access the concession meant that there was greater attention given to what assets might have their value included in the value of goodwill so as to take full advantage of the concession.  As will be apparent from the cases discussed below, much of the focus on goodwill came in the context of the attribution of value between goodwill and licences.
Thirdly, at much the same time as goodwill was a focus under the CGT rules, it became of increasing interest and concern to practitioners advising their clients on stamp duty and on duty.  Not all Australian jurisdictions tax the value of goodwill transferred between taxpayers but many do and NSW is most prominent amongst them.
The imposition occurs under the NSW Duties Act which imposes duty on various ‘dutiable transactions’  including transfers of ‘dutiable property’ which is defined to include the goodwill of a business if a sale of goods or services, or goods and services, has been made to a New South Wales customer of the business during the previous 12 months.  
These provisions at the state level are a disincentive to place too much value in goodwill if it might be placed in some or other asset that might not be dutiable.  This gives immense importance to the boundary between goodwill, and assets or features of a business that are not goodwill but are related to goodwill.
The result of the interplay of these three distinct influences has been, inevitably, several court cases on the question.  Other cases, not involving tax, have also considered the meaning and attributes of goodwill.  The matter of what is to be included in the definition has not been fully resolved, although in the case of Murry the High Court of Australia has given a clear indication of where the High Court seems to believe the boundaries lie.
Case law definitions of goodwill
Goodwill, for our purposes, is an intangible feature of a business or part of a business that will often represent the business’s reputation or following with customers.  It will be noted from the cases, the Accounting Standards, and the economic literature discussed below that business is the key element in goodwill and that goodwill represents the capacity of a business to attract custom.  All of the cases demonstrate variations on this theme of attracting custom.
The most colourful account of goodwill’s capacity to attract customers is to be found in the UK case of Whiteman Smith Motor Co v Chaplin (‘Whiteman Smith’), which was recognised in Australia in FCT v Williamson.  In Whiteman Smith, Scrutton and Maugham LJJ considered an application for renewal of a lease under the Landlord and Tenant Act 1927 (UK), 17 & 18 Geo 5, c 36.  Scrutton LJ described a zoological classification of goodwill that had found its way into a book by Merlin (no doubt the S.P.J. Merlin who was counsel for the appellant).
A division of the elements of goodwill … appears in Mr. Merlin’s book as the ‘cat, rat and dog’ basis. The cat prefers the old home to the person who keeps it, and stays in the old home though the person who has kept the house leaves. The cat represents that part of the customers who continue to go to the old shop, though the old shopkeeper has gone; … The dog represents that part of the customers who follow the person rather than the place; these the tenant may take away with him if he does not go too far. There remains a class of customer who may neither follow the place nor the person, but drift away elsewhere. They are neither a benefit to the landlord nor the tenant, and have been called ‘the rat’ for no particular reason except to keep the epigram in the animal kingdom.
This analogy is mentioned in many of the cases on goodwill.  Diverting though it may be, the analogy is not always helpful and can be misleading. The idea of the rat, for example, unless one has read the explanation above, might well cause confusion.  The classifications given can also vary greatly depending on the business.  Although it can be superficially helpful in describing some of goodwill’s features, the analogy’s failure is revealing of the difficulties associated with identifying goodwill.
There is a subset of cases amongst the many on goodwill that provide the most assistance in understanding the current meaning of goodwill in Australian law, and in demonstrating the key aspect of my personal thesis - that such definitions can be material to the tax outcomes in circumstances where there is an opportunity for tax arbitrage (because the goodwill gets one tax treatment and related intangibles get different treatment).  The cases also demonstrate how judicial understandings of goodwill have swung in favour of a perception of goodwill as something that is separable from a business and then swung back again to something more closely tied to the business.  The cases in question are described below.
The Rosehill Racecourse case
The case of Rosehill Racecourse Co v Commissioner of Stamp Duties (NSW) (‘Rosehill Racecourse’) is a good starting point because of how it dealt with the separability of goodwill from other assets.  The High Court had to consider the question of the duty that should be paid on separate but practically simultaneous transfers of both land and the business.  At the time it was only the value of the land conveyed that was subject to stamp duty.  The question that arose was whether the value of the goodwill was to be added to the value of the land that passed.
Barton J said that it was not to be.  He observed that local goodwill does not always pass with land.  It was the respondent’s assertion that, because the new company was acquiring the land with an intention to continue the racecourse business there, the intention must have been to include goodwill in the land and the goodwill is inseparable from it.  His Honour found no authority in the cases for the proposition that goodwill necessarily passes with the land unless “…that consequence arises from the construction of a Statute, as in the case of Commissioners of Inland Revenue v. Glasgow and South-Western Railway Co…, or unless there is an intention of the parties to that effect evinced in the document which is the subject of construction.”
He observed further, in relation to the severability of the goodwill from the land, that there was nothing in either the Stamp Duties Act or the documents before the court which prevented a conclusion that the goodwill here was separable and had been separated by the parties.  He found no evidence of an intention to include the goodwill in the land and thus to make the transfer of land a transfer of goodwill.  
The separability of goodwill concept is important.  Barton J placed great reliance on the decision of A L Smith and Rigby LJJ ‘…that the goodwill was not merely an enhancement of the value of the leasehold premises, but was capable of being sold independently of them’.  He said that the effect of that decision is that ‘goodwill is as capable of being sold as a separate entity for what it is worth as is the tenant’s interest in the lease.’ This is worth noting because this approach later surfaced as a view expressed in Krakos that there are distinct and separable types of goodwill.
Barton J observed that a lease might include a term to the effect that the tenant’s interest in the lease and the goodwill must be sold to the same purchaser, but that did not prevent their sale ‘as separate and distinct entities’.  In such a case his Honour considered that ‘goodwill, in my judgment, is property, and is clearly not land’.
In Rosehill Racecourse he noted that all the things that were to pass as a result of the sale (the land, goodwill and other property and choses in action) were separately mentioned.  This separateness went further and separate contractual consideration was allocated to groups of separate assets in which context goodwill was not mentioned so the ‘…description clearly does not comprehend or include the goodwill and business,…’
Dismissing the Revenue’s arguments that the sale of the land involved the sale of the goodwill he decided that the parties could transfer the goodwill and the land together, but only if they wished to do so and that would have required a change in the instrument used to make the transfer. 
Aside from dealing with separability of goodwill the Rosehill Racecourse case is also important because it demonstrates how concepts of goodwill can vary according to context.  O’Connor J stressed that goodwill should always be considered in the context of the particular case and in context it may be clear whether or not the goodwill passes with land that passes. 
He relied for this on a decision of the House of Lords:
There is a very good explanation of what is goodwill in the judgment of Lord Herschell in Trego v. Hunt…, where he cites several definitions of goodwill and, amongst others, one by Lord Eldon in which he said: ‘The goodwill which has been the subject of sale is nothing more than the probability that the old customers will resort to the old place.’ And again …quoting from what was said by Sir George Jessel in Ginesi v. Cooper… he said: ‘Attracting 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, and they really had nothing else to sell in the way of goodwill.’ … Lord Herschell went on to say: ‘I cannot myself doubt that they were right. It 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 former trader has to seek out his customers … The latter has a custom ready made.’
As for the goodwill of the Rosehill Racecourse, his Honour pointed out that it was heavily reliant on the Jockey Club’s regulation of racing.  He observed that the racecourse together with the buildings and other improvements and the goodwill had no value as a racecourse unless operated under the rights of registration with the Australian Jockey Club, which are personal rights of the Rosehill Race Company.  Thus the goodwill of the racecourse was not as simple as that of a business operating in a less regulated environment and it was not possible to regard the goodwill and the land so inseparably attached as to prevent the parties separating them.  His Honour had identified a type of goodwill based on the Jockey Club’s registration which differentiated it, and this had implications for the normal expectations relating to transfer of goodwill when land passes.  In the circumstances the goodwill was separable from the land and had been separated by the parties.
The outcome of the case is obviously heavily dependant on its facts, but it was an early indication by the High Court that goodwill will not always follow the transfer of land.  The case, ostensibly about site goodwill, also raises issues related to the goodwill associated with a licence or registration.  Furthermore, it indicates a readiness to accept the power of parties to separate goodwill from other assets.  It is submitted that it is this readiness to separate goodwill and attempt to deal with it as they wish that is a precursor to problems with the way parties deal with goodwill to their own advantage as much for tax purposes as for other purposes.  This view as to separability of goodwill was not fixed however, and in Bacchus Marsh Concentrated Milk Co Ltd (in Liquidation) v Joseph Nathan & Co Ltd (‘Bacchus Marsh’) the High Court commented on the nature of goodwill once again.  On this occasion it was the inseparability of goodwill that was stressed.  Isaacs J observed that not only is goodwill inseparable from business; it is inseparable from a particular business.
The case of Box v Commissioner of Taxation
Later the High Court reiterated some of its views on site goodwill in Box v FCT (‘Box’).  This decision is authority for the principle that goodwill will not automatically exist where a particular site is simply part of the business structure, and the goodwill may be attributable to aspects of the business other than the site.  In Box the High Court considered whether the payment of an amount for goodwill constituted a premium as defined in s 83(1) of the Income Tax Assessment Act 1936-1946.  The facts revealed that a bakery business had been carried on by the vendor of the business on his own premises.  Most of its sales (94 per cent) were attributable to the delivery round of the business, which was physically situated in a poor shopping zone.  The bread delivery round was the subject of a statutory licence, in favour of the vendor, for the delivery of bread.  The vendor sold the business and leased the premises to the purchaser for 10 years.  He also received a separate payment of £1 750 in return for a 10 year restrictive covenant preventing the vendor competing with the purchaser within an agreed area.  The question that arose was whether the payment of £1 750 was a taxable premium as defined.
The majority on the High Court: Dixon CJ; Williams, Fullagar and Kitto JJ, (Taylor J dissenting), concluded that the payment was made in connection with the goodwill of a business.  The entire court concluded that the goodwill in question was not, however, attached to or connected with the land.  In the course of their decision the majority judges stated with regard to such restrictive covenants that the £1 750 was paid for entering the covenant rather than for the purchase of the goodwill.  Such a covenant, however, enhances the value of the goodwill as it protects the purchaser from direct competition by the vendor.
In the course of a thorough examination of the meaning and features of ‘goodwill’ as discussed in the cases, the majority judges noted an expansive trend in what is regarded as goodwill.  It had originally meant no ore than the probability that customers would resort to the old place of business but had expanded to mean ‘…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 carried on, or with the name of the firm, or with other matter carrying with it the benefit of the business.’  They also noted the famous quote in Inland Revenue Commissioners v Muller and Co.’s Margarine Ltd that goodwill ‘…has no meaning except in connection with some trade, business, or calling….[And] include[s]  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 which do not occur to me. ...’.
The High Court observed, furthermore, that Lord Lindley had also said that goodwill can be regarded, in some instances, as having a distinct locale such as in the case of a public house or retail shop.  In case shwere the goodwill adds value to land or buildings it is annexed to them.    
The High Court in Box said that, because goodwill is very broadly defined and because businesses can be very varied and different, the term ‘goodwill’ might include many different things.
Goodwill includes whatever adds value to a business, and different businesses derive their value from different considerations. The goodwill of some businesses is derived almost entirely from the place where they are carried on, some goodwills are purely personal, and some goodwills derive their value partly from the locality where the business is carried on and partly from the reputation built up around the name of the individual or firm or company under which it has previously been carried on….In the case of a monopoly such as letters patent, or an exclusive licence to sell a commodity only obtainable from the licensor, such as a newspaper, in a particular area, the real value of the goodwill would lie in the fact of sole ownership and, so far as it has a locality, would be situated in the area over which the monopoly extended: Phillips v. Federal Commissioner of Taxation…
It is noticeable from this extract that the court recognised the value of goodwill inherent in a monopoly such as ‘letters patent’ or an ‘exclusive licence’.  The recognition of such diverse sources of goodwill could support an argument (as happened later) that some aspects of goodwill can be separated from others, each carrying with it ‘part’ of the goodwill of the business.
Turning to the specifics of the case before them, the majority gave detailed consideration to the concept of site goodwill.  They concluded that in the instant case the significance of the location of the premises was such that the premises did not contribute to the goodwill of the business, which was principally a delivery based bakery, and the goodwill of the business did not add value to the site.  This was because of the limited volume of sales at the site and the fact that there was no large number of customers who had formed the habit of calling at the shop for bread.  As the site was not a real element in the value of the business the goodwill was not connected with the land.
The Box case is helpful in its recognition of an increasingly expansive view of what goodwill may include, but its principal value in this paper is the recognition of the goodwill value inherent in an exclusive licence to trade in a commodity.  In Box we begin to see recognition by the courts of the goodwill in a licence, which in later cases was argued as being separate from the other aspects of the business.
The case of Geraghty v Minter
Geraghty v Minter was the next important case concerning goodwill in a tax context.  The case brought the severability and separability of aspects of goodwill into focus once again, this time in the context of partnership.  It was held the goodwill of the partnership could not be broken up and distributed amongst the partners.  The judgment becomes strikingly important when read in conjunction with the court’s decision, some 20 years later, in Murry.
The High Court in Geraghty v Minter was called upon to determine the reasonableness and effectiveness of a covenant in restraint of trade contained in a partnership agreement and applicable to partners on their leaving the partnership.  The agreement had also reserved to each partner their share of the goodwill of the partnership and Barwick CJ and Stephen J examined the concept of goodwill.  Barwick CJ found that the benefit of the restrictive covenant under consideration was not personal to the majority partner in the dissolved partnership, and both the benefit of the restrictive covenant and the goodwill itself were assignable.  The covenant also, in the Chief Justice’s opinion, ‘formed part of the goodwill’ and ‘might be expected to increase its worth’ and ‘[t]hough given to the major partner, it enured for the benefit of the partnership and not for that of the covenantee…’.
The statement that the covenant was ‘part of the goodwill’, and similar statements, could contribute to a view that goodwill could be a separable part of something else.  Elsewhere in the judgment, however, the Chief Justice noted, relying on the words of Lord MacNaghten in IRC v Muller & Co’s Margarine Ltd (‘Muller & Co’s Margarine Ltd’) that ‘…goodwill is not something which can be conveyed or held in gross: it is something which attaches to a business. It cannot be dealt with separately from the business with which it is associated…’.
He stressed the requirement that goodwill be attached to a business saying ‘…I think that if there is one attribute common to all cases of goodwill it is the attribute of locality. For goodwill has no independent existence. It cannot subsist by itself. It must be attached to a business.’
And he noted that goodwill is indivisible ‘…in itself…, though its value, when realized, may be shared in proportions.’
Stephen J also discussed the general features of goodwill.  He also noted peculiar characteristics relating to the goodwill of the parties involved here, highlighting the difficulty in transferring personal goodwill.  He noted that the customers of this loss adjusters’ business would be insurance companies and that personal relationships with representatives of those companies would be the main goodwill of a loss adjuster partnership.  The only other goodwill would be likely to be in the name of the firm, and only that would be transmissible to others.  Similar observations could be made, he noted, concerning the goodwill of barristers.  This excursus into the specifics of the goodwill involved illustrates the unique features of goodwill in relation to particular types of business, and highlights that, whatever the desired tax consequences, some goodwill cannot be transferred when a business changes hands.
On the facts, the attempt by the parties in the Geraghty v Minter case to ‘carve up’ the goodwill of the partnership and allow each of them to use some of it when they had agreed to reserve the use of the name to only two of the partners, was an attempt to ‘confer upon goodwill qualities which it is incapable of possessing.’  His Honour went on to explain that the goodwill of a partnership may be made up of distinct parts each referable to a distinct and different business activity:
Goodwill of a partnership business is an inseverable whole unless, of course, it consists in fact of a series of separate goodwills, each applicable to distinct areas in which the one business operates or to distinct business activities which the one business entity carries on.
His Honour’s qualification in this explanation is significant.  If a business can have a series of ‘separate goodwills’ that are ‘applicable to distinct areas…or to distinct business activities…’ this comes close to the severability of distinct goodwills, which is not subsequently adequately dealt with by the High Court in the Murry case, and which may, prior to that, have encouraged tax advisers into too readily recognising different ‘goodwills’ in an effort to take advantage of the small business CGT concession for goodwill.  His Honour also noted, as the High Court did in Murry, that goodwill is inseverable from the business – ‘[t]he reason is simple: since it reflects and is dependent upon the reputation of that business, to sever it from the business destroys it.’
Stephen J’s judgment explored the change in the nature of goodwill that occurs when a business is purchased and then operated subject to a restraint of trade on the part of the vendor.  He explained that when a partnership ends but its business is continued under the same name ‘...the old goodwill will tend, at least initially, to adhere to that business. As time passes the business, under its new management, will acquire for itself its own distinctive goodwill which will gradually take the place of the old goodwill.’  He explained that restraint of trade agreements are designed to ‘…ensure that this initial adherence of goodwill is not interfered with by the activities of the former owners of the business.’
In his Honour’s view, goodwill established by one proprietor of a business wastes away gradually and is supplanted by the goodwill created by the new owners.  This accords with accounting practice and with the subsequent view of the High Court in Murry, although it is sensibly (for reasons of the practical difficulty of enforcement) not followed by the Commissioner in all cases involving the pre-CGT status of businesses whose existence spans the introduction of CGT.
Stephen J’s judgment also recognises, seemingly contrary to the idea that goodwill is inseverable from a business, the fact that goodwill can be attributed to different sources and thus a split of its sources may result in a split of the goodwill: ‘Where one partner has agreed that on dissolution his former partner shall retain the exclusive use of the firm name he has thereby agreed to the other having, on dissolution, so much of the goodwill of the partnership business as passes with the name.’
Some parts of goodwill may, however, not be transmissible, eg because they are personal to a particular party.  Although not transmissible, the party that has the right to that goodwill may nevertheless exclude themselves from the right to use it.  This was the case in Geraghty v Minter.  The former partner had acquired all the transmissible goodwill and had secured an extinguishment of the other partners’ right to use their non transmissible personal goodwill.  The result was that the personal goodwill ‘…element, having departed from the firm…simply expired.’
In certain instances the Federal Court of Australia has also made important decisions affecting our understanding of goodwill. One such case is the landmark Just Jeans case, which is considered next.
The Just Jeans case
The Full Federal Court’s decision in Just Jeans considered goodwill in relation to a transaction entered into by the taxpayer that purported to transfer its goodwill to a company in the Netherlands.  It is one of the most emphatic statements in our law as to the inseverability of the goodwill of the business from its name and trade mark and it demonstrates that many attempts to separate out – and then licence goodwill are doomed to failure.
In Just Jeans the taxpayer had entered into an agreement with a Netherlands company in terms of which it assigned to it the name ‘Just Jeans’ and the associated logo.  The taxpayer used the consideration received in order to expand its business.  The Dutch company was then to grant to the taxpayer (exclusively) a licence to use the name and logo in return for agreed licence fees.  These fees were to be paid in advance (to provide the non-resident with the funds to pay for the assignment) and the taxpayer sought to deduct these fees, for income tax purposes, as expenditure incurred in the production of income.  The Commissioner disallowed the deduction of these fees and the matter eventually came before the Full Federal Court.
The Commissioner contended, inter alia, that the trade name and unregistered trade mark were not property that could be dealt with separately from the business to which they related and therefore could not be transferred separately from the business, which the taxpayer retained and continued to operate.  As the payments under the agreement were made without consideration because nothing had passed, they could not rank for deduction.  In respect of the goodwill of the business, and the name as part of that goodwill, the Court agreed.
The Court made some helpful observations concerning the relationship between the name and the goodwill of the taxpayer, taking the view that the two could not be effectively separated.  The comments made are particularly pertinent to franchise arrangements:
In our view… [i]t is true that a franchisor … may effectively licence a franchisee to use that name in a particular geographic area. But in doing so he is merely indicating that, for a price, the franchisee may share in the goodwill attaching to the name and will not be sued by the franchisor … . Whether the franchisee acquires any right to transfer the business, and with it the name, to a successor will depend upon the terms of his contract. In each such case the right to use the name would be expected to be accompanied by an obligation to observe the standards of quality and service which have established the franchisor’s reputation.
The name … remains closely allied to the expanding goodwill of the whole operation. It is a far cry from the present case, where the name was purportedly sold to a purchaser which had no capacity for, or intention of, using it itself, could obtain no benefit from it by transferring it to any third party - except, theoretically, in areas where the vendor was already operating - and so, for practical purposes, had no use it could make of it except to hire it back to the vendor.
The arrangement was thus highly artificial ….  
The Court considered the entire arrangement so unusual that it found little or no authority for the contention that such a transaction could be effectively undertaken and, according to the cases, aspects of goodwill like name, trade mark, slogans, etc can be protected by passing off actions but ‘…goodwill as a whole can only be transferred with the business to which it relates’.  Although authority could be found for the argument that rights to use a name might be transferred, they were rights of use only.  The Court relied for this on the decision in Bacchus Marsh in which the High Court considered a contract that attempted to transfer the right to use processes and the right to sell the (milk) product of the processes.  The High Court had found that the so-called ‘exclusive’ right was no more than a ‘…personal right to exclude [the vendor] from further carrying on its business of selling dried milk in Australia…’.   This could not amount to a transfer of goodwill.  Isaacs J had said that goodwill is inseparable from the particular ‘going concern’ whose ‘…identity … is essential to the conception of goodwill.’  In Bacchus Marsh Isaacs J said that the vendor might have assumed that the right to the trade mark passed because it was associated with a particular method of manufacture, but legally unless the goodwill was transferred the trade mark was not transferred and the goodwill did not pass because the vendor’s enterprise had not passed.
In Just Jeans the Federal Court was adhering to the view that it is not possible to separate the business and its name, and thus the goodwill associated with its name.  It might be possible to allow another to share in the goodwill for a fee – but not to have the goodwill in an independent form.
The Federal Court subsequently, however, was far more amenable to recognising a split between the goodwill of a business and the goodwill associated with assets of the business.  The case in which it recognised this split was FCT v Krakos Investments Pty Ltd (‘Krakos’), which will be discussed next.
The Krakos case
Krakos is one of the landmark decisions in the developing jurisprudence on goodwill, considering as it did the juxtaposition of goodwill and a licence.  The Full Federal Court (Hill J, von Doussa and O’Loughlin JJ concurring) accepted that the amount allocated by the taxpayer to goodwill was not a lease premium and that it had passed to the acquirer with the sale of the hotel business and transfer of its liquor licence.  As goodwill, the amount (half the purchase price of $840 000) ranked for application of the then section 160ZZR small business CGT concession of 50 per cent of the capital gain made on the disposal of goodwill.  In finding in the taxpayer’s favour on these matters the court engaged in an extensive exploration and description of the various features of goodwill for the purpose of considering whether a payment received by the taxpayer for goodwill was a premium assessable to tax as a capital gain under Part IIIA of the ITAA 1936.  This landmark case moved the jurisprudence to a view that goodwill could be of different types, and that the types of goodwill could be separated from one another.  The case involved, as was coming to be common at the time, a licence, and the attribution of goodwill value to the licence so that it could be said to fall within the small business CGT concession for goodwill.  The taxpayer operated a hotel on premises it owned.  It sold the hotel business, and leased out the hotel premises to the purchaser for five years, renewable for a further two terms of five years.  $420 000 of the sale price was allocated to the plant and equipment and $420 000 to the goodwill of the hotel business.  The purchasers had the option to require the taxpayer to buy the goodwill of the business back at the end of five years.
The Commissioner contended that the payment for the goodwill was a lease premium and was assessable under the capital gains tax provision, s 160ZS (1) of the ITAA 1936.  
Hill J undertook a detailed analysis of the previous cases involving goodwill.  He repeated the oft heard statement that goodwill is difficult to define ‘…at least in an exhaustive way’.  He explained that the economic concept of goodwill is that it is ‘…the difference in value between the tangible assets of a business and the value of the business if sold as a “going concern”’.  In some cases, he said, the Courts have attempted more useful and all embracing definitions.  One of these, he indicated, is the discussion of goodwill in the case of Muller & Co’s Margarine Ltd saying that:
Although goodwill was described in … [Muller & Co’s Margarine Ltd]… (at 223) as ‘... the benefit and advantage of the good name, reputation, and connection of a business. It is the attractive force which brings in custom’ that description is, as Lord MacNaghten recognised, inadequate. Goodwill is, as his Lordship then said, ‘composed of a variety of elements’. Indeed these elements are so disparate as to suggest that the different elements of goodwill are in fact different species of property or at least different kinds of valuable rights.  However, in Muller & Co’s Margarine Ltd, Lord MacNaghten said (at 224):
‘The 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 business.’
Justice Hill had reservations about the dependent nature of goodwill asserted by Lord MacNaghten and he stated that he doubted ‘[w]hether this proposition is universally correct’ .
For example, 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.
He then described the ‘…different aspects of goodwill that have been recognised in the cases…’, identifying ‘site goodwill’; ‘personal goodwill’; and ‘name goodwill’.  He observed that ‘[t]here may also be other kinds of goodwill such as monopoly goodwill…’.
His Honour then emphasised the importance of Maugham LJ’s distinction ‘between “adherent goodwill” and “net adherent goodwill”’, explaining that ‘net adherent goodwill’ remains attached to premises aside from ‘site goodwill’ and so exists irrespective of customers who would visit a new tenant in new business because of the convenient location.  ‘Adherent goodwill’ he explained as ‘…the totality of the goodwill related to the site, that is to say, the net inherent goodwill together with the site goodwill.’  Hill J explained that the importance of the distinction between adherent and net adherent goodwill is that ‘site goodwill’ may be simply the added value of the site reflecting the fact that the convenience of the site is what attracts some customers.  His Honour explained that ‘[s]ite goodwill is usually referred to as the “mere habit of the customers resorting to the site”’ and referred to the Box case for a description of it.
Hill J then went on to explain the concept of personal goodwill, by means of illustration.  His example was ‘…a pastry shop or restaurant whose customers return not because of the location of the business but because of some personal characteristic (such as the culinary talents) of the proprietor or chef.’  This kind of goodwill is unrelated to the premises and follows the person with the (eg culinary) talents.  Such personal goodwill, his Honour explained, cannot be assigned but might be accessed by ‘…securing the services of the person to whom the goodwill attaches and perhaps by that person agreeing not to work for another or in competition.’  Because of this his Honour concluded that such goodwill might not be ‘strictly accurately’ referred to as ‘property’.
Then his Honour explained what is meant by ‘name goodwill’.  For a business to have this form of goodwill its owner ‘…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. In turn, the value of that name may be turned to account by its proprietor.’
His Honour pointed to examples of name goodwill in the Muller & Co’s Margarine Ltd case and Rosehill Racecourse.  He acknowledged that it may be difficult to transfer a trade name independently of a business (referring here to Just Jeans) but he departed from the trend against separability of aspects of goodwill from the business.  He stated that ‘…modern experience makes it clear that names may be turned to account by means other than assigning or leasing a business: cf Commissioner of Stamp Duties (NSW) v JV (Crows Nest) Pty Ltd (1986) 7 NSWLR 529.’  His Honour also recognised, ‘…the enormous value which accrues to brand names…’, specifically mentioning ‘Coca Cola’ and ‘McDonalds’.
Hill J then articulated a new concept, explaining that another kind of goodwill may be found in the fact that a taxpayer might, somehow, have the benefit of a monopoly in the business that is undertaken.  According to his Honour, ‘…common experience suggests that there is at least one other kind of goodwill. It has received some mention in the cases. I shall adopt here the name “monopoly goodwill” to refer to it.’  He explained that some businesses develop a customer base on their monopoly and he used the example of a patent for a process ‘…so unique that the mere ownership of a patent brings with it custom.’  In these instances the patent is the real attraction of custom.  Other monopolies might be founded on statutory licences such as, in his Honour’s example, ‘…a Crown monopoly to sell a commodity such as salt.’  In instances such as this kind of monopoly, the place of business and personality of the trader are irrelevant as it is the monopoly that attracts business.
Hill J used a reference by the High Court in Box to Phillips v FCT as justification for the existence of monopoly goodwill.  The High Court had explained that the goodwill’s ‘real value’ is to be found, in such cases as Box, in the ‘sole ownership’ and this ‘…would be situated in the area over which the monopoly extended.’  He used this quotation from Box to demonstrate that there may be such a thing as ‘monopoly goodwill’.  An alternative construction of the quoted words, it is submitted, is that the High Court was doing no more than explaining the source of the most valuable aspect of the goodwill of such a business and, with respect, Hill J may have placed too much reliance on the statement in coming to his own conclusion.
Nevertheless, his Honour observed in Krakos that ‘[i]t may well be that a liquor licence should be treated, for present purposes, as the grant of a statutory monopoly in a limited area and that significant goodwill may, in the result, attach to the licence.’  He later returned to a fuller analysis of the idea of monopoly goodwill arising from a licence.
Justice Hill then embarked on a lengthy and detailed discussion of the cases dealing with the goodwill of a public house.  He considered the issue whether the goodwill of a public house should be regarded as a form of property itself, or should be regarded as an addition to the property where the business is conducted.  He concluded that the goodwill of a public house is a form of property, in the same way as is the goodwill of any other business, but that the liquor licensing system ‘…makes the situation of a public house unique…’  He stated that the prima facie rule that the goodwill of a public house attaches to its premises is one that deserves to be reconsidered given the legal differences between the liquor licensing laws in the UK and South Australia, and the different social role of the public house in the two jurisdictions.  The most important difference his Honour noted was that the liquor licence in South Australia can be moved from one suitable premises to another and thus ‘…at least some part of the goodwill of the business must attach to the licence rather than the premises.’
His Honour concluded, from the thorough review of cases and of the operation of the licensing laws, that
…there are various kinds of goodwill, all of which, with the exception of personal goodwill, attach to property. Site goodwill clearly attaches to the site, although in the case of a public house the conclusion that all aspects of goodwill attach to the site ignores the significance in South Australia of the licence. Name goodwill clearly attaches to the trade name and at least where this involves a trade mark (registered or unregistered), this name will be property. A mere business name may not be property. Monopoly goodwill attaches to the statutory monopoly right.
In light of the many rights that his Honour noted contribute to the goodwill of a business, and that could be separately dealt with, he concluded that it is no longer ‘…correct … to say that although comprised of separate elements goodwill is to be treated as inseverable.’
This statement as to severability established a high water mark in the stream of cases dealing with the severability or otherwise of goodwill from its business.  Hill J was of the view that if goodwill attaches to a specific item of property, then it might be dealt with only together with the property in question, although it may also be ‘…dealt with as a separate species of property or as being the subject of a bargain and sale at a price.’
He noted that the parties had dealt with the elements of the goodwill of the business in different ways, splitting the contract and the proceeds between them.  The monopoly goodwill would be transferred through the contractual terms regarding transfer of the liquor licence; the transfer of the personal goodwill would be addressed through the vendor’s requirement to provide assistance after the transfer of possession and the covenant not to compete; the name goodwill was dealt with through the assignment of the name; and the lease transferred the site goodwill.
As a result of the Krakos decision the severability of goodwill and its relationship with licences became a major issue in practice, the view being taken by some that individual assets representing ‘types’ of goodwill could be disposed of and the taxpayer could benefit from the small business goodwill concession in CGT in the case of each disposal of an asset that represented a portion of the goodwill of the business.  It is the High Court’s attempt, in the Murry decision, to clarify the question of what is goodwill, possibly in response to this trend, certainly at the same time as it, that has caused the greatest amount of difficulty in recent times.
The Murry decision
The factual context
In Murry the taxpayer, in partnership with her husband, had disposed of a taxi licence and shares in a taxi cooperative.  The taxpayer sought to have a large proportion of the sale price (that portion attributable to the licence being $189 000 of a total price of $220 000) treated as a disposal of goodwill and thus subject to the small business 50 per cent capital gains tax exemption on disposals of goodwill under s 160ZZR of the ITAA 1936.  The matter had been decided in the taxpayer’s favour in the Administrative Appeals Tribunal and then in the Full Federal Court.  In the High Court (Gaudron, McHugh, Gummow and Hayne JJ; Kirby J dissenting) access to the small business goodwill concession was denied, principally on the grounds that the taxi had been let out to a driver.  The taxpayer’s investment was therefore passive, and she had disposed of neither a ‘business’ nor an ‘interest in a business’ within the meaning required by s 160ZZR.
Although this would have adequately dealt with the matter, the High Court chose to discuss goodwill and its features at extraordinary length.  Its statements regarding goodwill are therefore obiter dicta insofar as the decision in the instant case is concerned.  Notwithstanding this, the remarks of the majority judgment must be regarded as highly persuasive statements of the High Court concerning goodwill and indicative of how it will decide such matters in the future.
Definitions of goodwill
In relation to the nature of goodwill, the majority judges noted the extreme difficulties encountered in attempting to define the term and reminded us of the statement by Dawson J in Hepples v FCT (‘Hepples’) that goodwill is ‘notoriously difficult’ to define.  Their Honours explained that a reason for this is that:
…goodwill is really a quality or attribute derived from other assets of the business…. Its existence depends upon proof that the business generates and is likely to continue to generate earnings from the use of the identifiable assets [such as] locations, people, efficiencies, systems, processes and techniques…. 
Thus goodwill is what I call ‘adjectival’.   It is an attribute derived from other assets – although it is also an asset in itself.  It depends for its existence on the fact that the business generates earnings from identifiable assets and is likely to continue to do so.  There must thus be a link to identifiable assets and a link between those identifiable assets and earnings.  Thus the nature and features of the individual business can influence whether there is goodwill and on what feature of the business it is based.
The majority judgment also explained that another reason why goodwill can be so difficult to define is ‘…that courts have been called on to define and identify goodwill in greatly differing contexts.’  The enquiries of the courts have often had a different focus, depending on the case, some being concerned with value of goodwill, others with the sources of goodwill, etc.  Importantly, the High Court pointed out that the difference between the accounting and legal definitions of goodwill has complicated matters.  The most acute difficulty has often been encountered in relation to the question of valuation of goodwill because ‘…accounting and business notions of goodwill have proved influential in the valuation of goodwill for legal purposes.’
Their Honours elaborated on the meaning of goodwill from the perspectives of accounting, and of ‘business people’, explaining that the Australian Accounting Standards
…describe goodwill as comprising ‘the future benefits from unidentifiable assets which, because of their nature, are not normally individually brought to account.’… Some accounting theorists see goodwill as representing the difference between the present value of the future earnings of the business and the normal return on its identifiable assets….
and according to the Accounting Standard, ‘…“[g]oodwill which is purchased by the company shall be measured as the excess of the cost of acquisition incurred by the company over the fair value of the identifiable net assets acquired.”’
In contrast, the approach of ‘business people’ is less scientific and concentrates on ‘…the notion of excess value, a notion colourfully expressed in the statement of an American funds manager that “[i]f you pay $450 million for a TV station worth $2.5 million on the books, the accounts call the extra $447.5 million ‘goodwill’…”’.
Their Honours noted that the definitions of goodwill have gradually changed over time.  Originally there was an emphasis on ‘…the patronage of the business’.  Subsequently the focus shifted from this to a ‘wider view’ which took in “every positive advantage” of the business and these may be connected with the premises, the name or other beneficial features. 
Their Honours referred also to Lord Lindley’s definition of goodwill in Muller & Co’s Margarine Ltd, which emphasised the property aspect of goodwill:
Goodwill regarded as property has no meaning except in connection with some trade, business, or calling. In that connection … [it] include[s] 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 which do not occur to me. In this wide sense, goodwill is inseparable from the business to which it adds value, and … exists where the business is carried on. Such business may be carried on in one place or country or in several, and if in several there may be several businesses, each having a goodwill of its own.
And their Honours noted the words of Lord MacNaghten:
What is goodwill? …. It is the benefit and advantage of the good name, reputation, and connection of a business. It 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. The goodwill of a business must emanate from a particular centre or source. However widely extended or diffused its influence may be, goodwill is worth nothing unless it has power of attraction sufficient to bring customers home to the source from which it emanates. Goodwill is composed of a variety of elements. It differs in its composition in different trades and in different businesses in the same trade.
They also noted that in relation to whether goodwill is property or not Lord MacNaghten had said that ‘[i]t is very difficult … to say that goodwill is not property…’.  Lord MacNaghten’s reasons included the fact that goodwill is routinely acquired in the same way as property and, once obtained, may be protected and disposed of in the same way as property.
US jurisprudence on goodwill
Aside from the UK cases, the majority in Murry also referred to some American jurisprudence on goodwill pointing to the case of Haberle Crystal Springs Brewing Co v Clarke (‘Haberle Crystal Springs’) which emphasised the ‘going concern’ aspect of goodwill and stated that a ‘going concern’ has a value that exceeds the value of the tangibles used in the business, explaining that the excess ‘…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 quotation from Haberle Crystal Springs also noted that the ‘privileges’, of the owner of a business to use the assets of the business to earn income in this way and to continue to deal with the customers who have been attracted to the business, ‘…are property of value…[t]his latter privilege [of continuing to deal with customers] is known as goodwill.’
In Murry the majority judges placed some weight upon this American judicial definition of goodwill because in their view it ‘…comes close to achieving a synthesis between the legal, accounting and business definitions of goodwill.’  Nevertheless the High Court decided that the legal and other concepts of goodwill could not be reconciled and a business may still have ‘goodwill for legal purposes’ despite its sale value (as a ‘going concern’) being as low as its ‘break-up value’ because of trading losses.  Importantly, the majority view was that there may be legal goodwill in a business even in these circumstances because of the centrality of the attraction of custom at the core of legal goodwill.
Once the courts rejected patronage as the touchstone of goodwill in favour of the ‘added value’ concept, it might seem impossible for a business to have goodwill for legal purposes when its value as a ‘going concern’ does not exceed the value of the identifiable assets of the business. But the attraction of custom still remains central to the legal concept of goodwill. Courts will protect this source or element of goodwill irrespective of the profitability or value of the business. Thus, a person who has sold the goodwill of a business will be restrained by injunction from soliciting business from a customer of the old firm … even though the value of that firm is no greater than the value of its identifiable assets.
No reconciliation of competing views on goodwill
The heavy reliance of the High Court on this view that goodwill exists in any circumstances where there might be grounds for an action against passing off is completely at odds with the value based approach in accounting.  Accordingly, the High Court abandoned any attempt to ‘…synthesis[e] … the legal and the accounting and business conceptions of goodwill.’  It did so because ‘[a]ccounting and business conceptions of the term emphasise the necessity for the business to have some value over and above the value of the identifiable assets’ whereas the legal approach to defining goodwill does not emphasise such a difference in value.
It is probably beyond this paper to seriously consider whether such a synthesis or rationalisation of the accounting/business and the legal concepts of goodwill can, in fact, be achieved.
The main features of goodwill
The majority of the judges in Murry explored the meaning and features of goodwill found in the cases.  They identified three aspects of goodwill namely: ‘…property, sources and value…’ which ‘…combine to give definition to the legal concept of goodwill…’, and are united by ‘…the conduct of a business.’  They reiterated the point from Geraghty v Minter that ‘…goodwill is not something which can be conveyed or held in gross: it is something which attaches to a business’, and goodwill may not ‘…be dealt with separately from the business with which it is associated.’
Their Honours also considered goodwill from other perspectives viz: goodwill considered as a form of property; the sources from which goodwill springs; legal protection of sources of goodwill; and transfer of sources of goodwill.  With regard to goodwill as property, they indicated that goodwill is property ‘…because 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.’  They regarded this right as one that is ‘…inseparable from the conduct of the business.’  According to the judges, business owners and those who subsequently acquire a business see goodwill as an asset ‘…because it is the valuable right or privilege to use the other assets of the business as a business to produce income.  It is the right or privilege to make use of all that constitutes “the attractive force which brings in custom”.’
It is respectfully submitted that it may not necessarily follow that because something is a right or privilege, and because it is both valuable and recognised as constituting the potential to earn income, it is necessarily property.  Nevertheless it seems unlikely that in Australian law a contrary conclusion could be successfully argued.
Sources of goodwill
In reviewing the sources of goodwill the majority saw goodwill as a ‘…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.’  They stressed that ‘[i]t is … more accurate to refer to goodwill as having sources than it is to refer to it as being composed of elements.’  They made it very clear that goodwill should not be said to be ‘composed of’ trade marks or land etc, it is merely derived from such things.
The court identified a number of typical sources of goodwill, many of which the judges considered not to be property, nor assets for the purposes of accounting.  They are nevertheless sources of goodwill ‘…because they motivate service or provide competitive prices that attract customers.’  Examples include ‘…manufacturing and distribution techniques, the efficient use of the assets of a business, superior management practices and good industrial relations with employees…’.  Different businesses will owe their goodwill to a greater or lesser extent to different sources.  In particular their Honours noted that a restrictive covenant might enhance business goodwill and that ‘[t]he existence of statutory monopolies in respect of the products of a business such as patents or trade marks may also attract custom to an extent that is unachievable in similar businesses.’
The judgment reiterated the established rule that some revenue expenditure may result in the creation of goodwill.  Examples given included ‘…money spent on advertising and promotions,…[which] may generate brand, product or business name recognition…[a]nd part at least of the moneys expended on wages, labour relations and customer services may result in creating goodwill for a business.’
In addition, ‘[g]oodwill may also be the product in whole or in part of circumstances external to the business or its locality. Thus, the revenues of a business may be largely due to imperfect or inefficient competition or extensive market penetration.’
Concerning legal protection for sources of goodwill, the majority judgment explained that the protection of goodwill will usually also extend to its sources even where those sources cannot be individually recorded and accounted for.  This necessarily involves an awareness of what assets are sources of goodwill.  Thus their Honours stated that care should be taken to distinguish the sources from the goodwill itself.  Goodwill is property in its own right and ‘[f]or legal … and accounting … purposes, it must be separated from those assets and revenue expenditures of a business that can be individually identified and quantified in the accounts of a business.’  But goodwill, they said ‘…as property, is “inherently inseverable from the business to which it relates”….’  Their Honours concluded from this that things which are capable of separate transfer, away from the business, might be sources of goodwill whilst they are held and used by the business but cannot be part of the goodwill.  If there are any legal protections for such assets which are sources of goodwill, they exist in their own right and ‘…the right to the remedies arises from the legal properties of the asset and not from the existence of goodwill in the business.’  They gave as an example a building from which business is conducted.  If the building were destroyed the business proprietor could do everything that the building owner could do vis a vis the third party who damaged the building.  The business proprietor could probably seek damages for injury to the goodwill ‘[b]ut injury to the goodwill of the business is not to be confused with injury to the building.’
The implication of this is that the site of the business is not itself imbued with goodwill, the goodwill attaches to the business not the site, ‘[u]nless a business is transferred to the person to whom an asset of the business is transferred, the transfer of the asset does not transfer any part of the goodwill of the business.’  Thus, as their Honours explained, the sale of an asset of a business could reduce the value of goodwill in the business but does not involve a sale of goodwill or part of the goodwill of the business.  This statement by the High Court put a stop to arguments that the sale of parts of a business (like a taxi licence) might entitle the seller to the small business CGT concession on the sale of goodwill.
However there may be an identity between the value of the asset which is a source of goodwill and the value of the goodwill itself.  Their Honours stressed that the potential inherent in an asset, which increases its value by reason of what it adds to goodwill, is ‘…merely an attribute of an asset…’ and is not itself goodwill.  The latter is property, the former is not.  This is so ‘…notwithstanding that in 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.’
Criticism of the Krakos decision – goodwill is indivisible
At the conclusion of a lengthy analysis of the meaning and attributes of goodwill their Honours embarked upon a detailed criticism of the decision in Krakos which had rejected the ‘…proposition that goodwill has no meaning or existence except in relation to a business…’.  They noted that Hill J had expressed doubt that the ‘goodwill of a business is one whole’ and that it must be attached to business in order to exist.  Hill J had observed that the goodwill attaching to the name of a business and the goodwill attaching to its premises might be dealt with separately. Hill J had also noted that the cases had recognised different aspects of goodwill including ‘site’, ‘personal’, ‘name’ and, possibly, ‘monopoly’ goodwill.
The majority of the High Court rejected Hill J’s reasoning, saying that ‘…it erroneously identifies the concept of goodwill as property with the sources of the goodwill…’ and thus ‘…does not distinguish between the potential use value of an asset of a business and the goodwill of the business that is derived from the use of that asset.’
According to the High Court, the ‘logical conclusion’ of Hill J’s reasoning must be that goodwill is not one asset ‘…but a series of assets that inhere in other assets of a business.’  This view ‘…contradicts the two fundamental premises of the law of goodwill, that is to say, that goodwill has no existence independently of the conduct of a business and that goodwill cannot be severed from the business which created it.’
The High Court referred again to the decisions in the House of Lords in Muller & Co’s Margarine Ltd, and its own decisions in Bacchus Marsh, Box, Geraghty v Minter, and Hepples and said that these cases had accepted these two premises as fundamental and stated that ‘…it is too late for them to be now called into question.’
Their Honours singled out for criticism the fact that: 
…the claim that the totality of the assets of a business contain all or most of that which represents the goodwill of the business has led some accounting writers to argue that goodwill has meaning only in so far as it describes the benefits flowing from such immeasurables as good business management and the lack of competition by reason of monopolistic privileges. On this theory, most of the attributes of goodwill attach to specific assets: favourable location affects the value of land, the reputation of the business is inseparable from its trademarks and trade names and so on.
According to the High Court, such a view cannot be supported and ‘… [w]ith the possible exception of some compensation cases…’ the case law (‘when properly understood’) does not support the argument that goodwill is divisible and can either be transferred as a whole or can be transferred as part of the transfer of an asset.  The descriptions of goodwill as ‘site’, ‘personal’, ‘name’, etc are only used, according to the High Court, in an explanatory sense, in order to explain the location of goodwill, why an asset has not been transferred with the goodwill, etc.
The High Court singled out the compensation cases involving goodwill in order to deal with the suggestion that goodwill is sometimes inseparable from the premises at which the business is carried on.  Their Honours reminded us, however, of the statement by Lord Halsbury in Muller & Co’s Margarine Ltd that a public house may owe so much to its location and the reputation of the location as a place to go for refreshment that its location and the goodwill of the business become ‘so mixed’, that ‘…as a matter of fact, it may well be that it is very difficult to sever them, and to say how much is goodwill and how much is local situation.’  According to Lord Halsbury, however, the difficulties of separation of the goodwill from the advantages of the location ‘…will not necessarily make their separate existence impossible.’ 
One might comment of this authority for the High Court’s view that merely because Lord Halsbury said that the difficulty of separation does not necessarily make separate existence of site advantages and goodwill impossible, this does not mean that their separate existence will always be the case.  Lord Halsbury’s statement was much less emphatic than the High Court’s is.
More supportive of their Honours’ argument, however, is the example they give of the judgment of Isaacs and Rich JJ in Minister for Home and Territories v Lazarus in which the court considered the value to be attributed to land on which a victualler’s business was conducted.  They observed that business goodwill is personal and does not add to the value of land but if ‘…it is attributable wholly or partly to the land, it pro tanto enhances its value, and that value is recoverable, not as goodwill eo nomine but as part of the value of the land.’  This statement is much more supportive of the idea that goodwill can influence the value of a site which is implicated in the goodwill of the business but that the site does not itself constitute goodwill or part of the goodwill.  The statement was approved and the principle applied by Dixon J in Commonwealth v Reeve and, in the words of the High Court the two cases, although compensation cases, ‘…establish that, although the value of the site goodwill of a business may be a persuasive guide to the value of land on which a business is conducted, it is the potential use of the land and not the goodwill deriving from the use of the land that is valued…’
An exception to indivisibility of goodwill and the business
The High Court clearly stated in Murry that the goodwill of a business is one indivisible whole.  The judgment is not clear, however, on whether this applies where the ‘business’ in question actually amounts to several businesses.  If what is ostensibly a single business is in fact a number of divisions, each of which (probably using some or other attendant assets) is capable of independent operation, can individual divisions be transferred independently of the others together with the goodwill attributable to the business of that independent division?  It is submitted that the statement concerning the indivisibility of the goodwill of a business does not apply to the ‘fused’ goodwill of several potentially independent businesses, each of which is capable of independent operation.  Murry was silent on this but this view has been taken by the Supreme Court of South Australia in the case of Chia v Ireland and by the Supreme Court of New South Wales in CSRP Apartments Pty Ltd v Workcover Authority of NSW.
Creation and acquisition of goodwill
Having established that goodwill is inseparable from the business to which it relates, the High Court moved on to consider the questions of creation and acquisition of goodwill, particularly as these have relevance to the operation of CGT.  Their Honours were particularly focussed on the fact that CGT does not arise in respect of natural persons’ disposals of assets that were acquired before 20 September 1985.
Working from the principle that ‘…goodwill as property…[is] the legal right or privilege to conduct a business in substantially the same manner and by substantially the same means which in the past have attracted custom to the business…’, the High Court said that a person acquires goodwill ‘…when he or she acquires that right or privilege.’  The sources of the goodwill become significant at this point because they may change from time to time (usually incrementally) and the degree to which the various sources contribute to the goodwill may vary in relation to one another but ‘…as long as the business remains the “same business” …, the goodwill acquired or created by a taxpayer is the same asset as that which is disposed of when the goodwill of the business is sold or otherwise transferred.’  The goodwill may itself wax and wane, and its sources may vary over time, but the goodwill will be the same goodwill for capital gains tax purposes.  A logical exception to this, perhaps, is that if a business were to commence and to be transferred on the same day – thus having no ‘track record’ of operation, then it could not be said that it is possible to conduct the business, as the High Court put it, ‘…in the same manner and by substantially the same means which in the past have attracted custom to the business…’.  Thus, although it would presumably still have a right to protection from unlawful competition and thus to preserve its ‘attractive force’, there would be no substance to the right that is goodwill.  This concern falls away, however, and certainly would have no real implications when applied in a practical situation, because such a business would probably have no saleable goodwill anyway, even if there were doubt as to whether it did have ‘legal’ goodwill.  A further response to the apparent exception may also be that the instant of commencement of trading – no matter how short a period the business may have been trading for - could be regarded as the moment of creation of the goodwill with no emphasis required on the question whether and how much custom has in fact been attracted to the business.
The incremental change in sources of goodwill of a business might, according to the High Court, amount to a change in the business itself if those sources change to a sufficient degree – ‘…the sources of the goodwill may have changed so much that, although the business is of the same kind as previously conducted, it cannot be said to be the same business.’  To illustrate this, the majority judgment described the change in clientele of the hotels in the Sydney suburb of Paddington, which, having experienced ‘urban renewal’ and a change in fashion, experienced a change in clientele from exclusively local residents to persons attracted to Paddington, for refreshment and entertainment, from further afield.  The hotels continue to rely on ‘site goodwill’ but it became ‘…of a different kind. While previously it derived from the proximity of residents to the hotel, it is now derived from the fact that the hotel is in the same locality as other hotels seeking to attract custom from patrons with the same interests.’
According to the Court, this means that the goodwill of these hotels may be a different asset to the asset that it was in the past, because the business is not in fact the same.  This analysis may prove problematic for taxpayers.  Fortunately the Commissioner does not currently treat disposals of goodwill whose sources have significantly changed as disposals of post-CGT goodwill. The practical difficulties of determining when an incremental change of this nature has resulted in new goodwill may be considerable, but in an appropriate case the Commissioner may well attempt to argue that new goodwill has been created.
Simpler issues arise in the case of transfers of goodwill between persons, and the High Court explains that ‘…the date of transfer will be the date on which the asset was acquired.’  But:
More difficult questions arise in the case of goodwill created by a taxpayer in the course of conducting a new business. One difficulty in such a case is to identify the date when the goodwill was acquired. It is clear as a matter of legal principle that a business may have goodwill … [see Hepples] although it is not shown in the accounts of the business ….
That a business may have legal goodwill without it being shown in the accounts creates a significant gap between the law and the accounting principles that apply to dealings with goodwill.  The High Court also recognised that there can be difficulties in identifying the cost of acquiring goodwill – but noted that there would be no need in the Murry case to examine this issue.  This is unfortunate as had the High Court explored this aspect its discussions of goodwill may have been even more helpful to our understanding of the concept.
Valuing goodwill and its sources
Although it did not concern itself with the cost of acquiring goodwill, the High Court did consider its valuation, explaining that the value of goodwill is a fluid thing that is ‘… 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. It is seldom constant for other than short periods.’
As the fortunes of the business are determinative of the value of goodwill in the business it will be important how profitable the business is.  The High Court considered the matter from the perspective of a business that is profitable, and one that is not.  In relation to a profitable business that is expected to remain so, the value of its goodwill ‘…may be measured by adopting 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.’  Their Honours conceded, however, that the method suggested is not without problems because if ‘…valuing goodwill for legal purposes … the identifiable assets need to be valued with precision. Particular assets, as shown in the books of the business, may be under or over valued and may require valuations of a number of assets and liabilities which may be difficult to value.’  Despite these difficulties, where a business is profitable ‘…the value of goodwill for legal and accounting purposes will often, perhaps usually, be identical.’
This author is not, with respect, persuaded that, generally speaking, valuing goodwill for legal purposes requires that much greater ‘precision’ than valuing it for accounting purposes.  Nevertheless, it is probably correct that in a profit making enterprise the goodwill will have the same value for accounting and legal purposes.
The problems are likely to arise where the business is not profitable.  In relation to this, the High Court stated that the value of the goodwill for legal purposes and the value of the goodwill for accounting purposes may be very different because 
…goodwill for legal purposes includes everything that adds value to the business … As a result, a business may have valuable goodwill in the eyes of the law although an accountant would conclude that the business either has no goodwill or that, if it has, it is of nominal value only. The value of such goodwill may be difficult to assess. Having regard to the likely future of the business, often it may have only nominal value. But in some cases, the value of the goodwill may be more than nominal. It may be the difference between the revenues generated by the relevant advantages and the operating expenses (other than a share of the fixed costs) incurred in earning those revenues.
It is submitted that more likely than there being ‘valuable goodwill in the eyes of the law’ and either no or only nominal goodwill for accounting purposes, there may be legal goodwill that has no value at the same time as there is no accounting goodwill.  The difference here may prove problematic.  If there is legal goodwill in a business – and in this it seems that the feature of the right to continue to do business in such a way as to attract customers as before is more telling than the definition of ‘everything that adds value’ because the latter definition suggests that there is some added value – it may be that an accountant could find nothing in the business on which to establish a value for the goodwill.  Thus one would have goodwill but no means to value it, rather than be in a position to say, as an accountant would, that there is no goodwill because there is no value in excess of the value of the identifiable assets.  This disparity between the legal and accounting meanings of goodwill could be extremely significant.
Finally, the High Court noted that where identifiable assets are a significant source of the goodwill of the business, there may be an overlap between the value of the goodwill and the value of the identifiable assets, such that the separate value of the goodwill alone is quite small ‘…because the earning power of the business will be largely commensurate with the earning power of the asset or assets.’
In the Court’s description of such a circumstance, where there is a close identity between the value of the goodwill and the value of an identifiable asset that is a source of goodwill the identifiable asset will be regarded as having the value attributable to it and the ‘overlap’ value in the goodwill will be ignored.  Only the excess of value will be allocated to the goodwill and this may be minimal.  The learned judges explained:
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. 
They said that someone purchasing the business would not ‘…pay twice for the same source of earning power.’  A purchaser would not pay an amount representative of the trade mark’s earning power and also pay an amount representative of the business’s earning power.  ‘Nevertheless, the earning power of the trade mark is unlikely to equal the earning power of the business.’
Their Honours pointed out a further complication that may arise when attempting to value goodwill, namely that ‘…although the goodwill of a business may be derived from one or more sources, it can continue to exist notwithstanding that the sources of the goodwill have gone.’  This is because the behaviour of customers and ordinary business circumstances may mean that goodwill survives the disappearance of its sources.  Thus:
When a trade mark is sold it will continue to be a source of goodwill for the business if the business continues. That is because the trade mark will have built up favourable custom which will or may continue after the trade mark is transferred or expired. Similarly, where goodwill is largely the product of the personality of the owner or one or more employees of a business, much of the goodwill of the business will disappear upon the cessation of the connection between that person or persons and the business. Nevertheless, habit may continue to draw custom although the owner or employee has no further connection with the business.
The outcome for the taxpayer
Having discussed these issues and identified the various features of goodwill their Honours considered the taxpayer’s circumstances specifically.  In particular what was required was an answer to the question whether the taxpayer and her husband sold an asset of a business, or sold a business.  Their Honours held that, as goodwill is an indivisible item of property that does not attach to assets, the taxpayer could not have disposed of goodwill simply by selling an asset.   They explained that, as the ‘get up’ of the taxi and the skill of the driver in choosing good locations to stand or cruise for hire are the attractive force of a taxi business in attracting passing trade and as the advertising and telephone system are what attract calls from customers booking taxis, ‘…a taxi licence is not itself a source of goodwill.’  Because the taxpayer and her husband exploited the taxi licence by leasing it to others who actually ran the taxi business they did not have a business themselves.  Their Honours illustrated the point with the example of an owner of retail premises who rents them to someone who conducts a business.  The goodwill in such a case belongs to the business owner, and if the lease ends and the business closes the goodwill ends.  A new tenant may be prepared to pay a premium to take on the premises under a new lease ‘…but no part of the premium is paid for goodwill.’
Accordingly, their Honours found that the taxpayer had not in fact disposed of a business but of a licence.  Such a licence is a prerequisite of the conduct of a business such as this ‘[b]ut it is not a source of the goodwill of a business simply because it is a pre-requisite of a business or calling.’  This allowed the conclusion by the majority that although a licence and shares had been disposed of, there had not been a disposal of goodwill or of an interest in goodwill.
Cases following Murry
Although so much of it is obiter dicta, the Murry decision has been followed on several occasions in the inferior courts.  This has served to reinforce the decision and occasionally to expand on aspects of it.  For example, in Zeekap (No 56) Pty Ltd v Commissioner of Stamp Duties, which involved a sale of a fishing vessel, licence and permits which had been leased to another, the Supreme Court of Tasmania relied on the decision in Murry and approved the view expressed in Murry that ‘…a taxi licence is not itself a source of goodwill of a business. It merely confers a right to lawfully commence a business’.
In Chia v Ireland the Supreme Court of South Australia considered the appropriate treatment of the dissolution of a medical partnership.  It approved the principle of the inseverability of goodwill from a business expressed in Murry noting that the High Court had approved the view (expressed in Geraghty v Minter) that although goodwill may have three aspects (property, sources and value, united by the conduct of a business), goodwill is attached to a business and ‘…cannot be dealt with separately from the business with which it is associated’.  For the purposes of this paper it is noteworthy that, in Chia v Ireland, Williams J dwelt on the fact that accounting practice and legal and commercial practice differ in the manner of dealing with goodwill.  The appellants had argued that because the value of the partnership business included goodwill this should be disclosed in the partnership balance sheet.  The Court accepted expert evidence that it would not be proper accounting practice to do so and only purchased goodwill could be shown in this way.  The case highlights the need for a single clear meaning for goodwill.
Murry was also followed by the Court of Appeal of the NSW Supreme Court in the case of CSRP Apartments Pty Ltd v Workcover Authority of NSW.  The question was whether, for the purposes of certain rules relating to the calculation of insurance premiums, one company was the ‘predecessor’ of another.  On the facts, the one company had acquired the plant and equipment of the other in liquidation.  Their Honours (Mason P, Priestley JA and Ipp AJA) relied upon the High Court decision in Murry in finding that:
The fact that ‘goodwill has no existence independently of a conduct of a business’ and that ‘goodwill cannot be severed from the business which created it’, does not mean that if the business is split into two parts, and one part transferred to another, no goodwill can adhere to the part that is transferred. Their Honours’ remarks do not bear on this situation and, in reality, it is quite clear that - once part of a business is transferred to another - that part may form part of an existing business such that a new business is constituted with its own goodwill inherent in it.
The case illustrates that there are limits to the indivisibility of goodwill of a business where the ostensibly single business is sub divisible into parts.
In Morvic Pty Ltd v Commissioner of State Revenue (‘Morvic’), Pagone J considered goodwill in the context of stamp duty and apparently followed the Murry decision.  The Morvic case warrants discussion as it highlights one of the aspects of my theory that advantage may be taken by taxpayers where goodwill can be separated from other business assets.  In Morvic a taxpayer purported to sell land under one agreement and the business of a motel conducted on the land under another.  The contract to sell the business allocated a small amount of the purchase price for the chattels of the business and allocated in excess of $1 300 000 for goodwill.  The taxpayer sought not to pay stamp duty on the goodwill because it was sold as a separate transaction to the sale of the land.
The Commissioner for Stamp Duty in Victoria contended that the goodwill was either assessable along with the land or that it was also a chattel and thus was dutiable along with the land.  Pagone J questioned the assumption made by both parties that the contract for the sale of the business was effective to pass ownership of the goodwill.  In relation to that assumption his Honour observed:
An owner of land, upon which that owner conducts a business, may effectively transfer ownership of land and business separately; however, it does not follow that such an owner may separately convey the goodwill of a business once the premises are themselves transferred to the same buyer without restriction or without prior reservation of an adequate proprietary interest to secure the business and its goodwill.
Thus his Honour was of the view that the transfer of land and improvements by an owner who carries on a business results in an automatic transfer of the goodwill, if the facts are such that the goodwill was not preserved from transfer with the land.  The reasoning will be recognised as similar to that in Rosehill Racecourse (above).
Pagone J concluded from the facts that the appellants had been unable to show that the goodwill attaching to the business had not been purchased with the land.  It was ‘clear rather that they acquired through the sale of land contract ownership in both the land and in the improvements through which the business was to be conducted.’  He noted that the result might have been different ‘…if the right to conduct the business had been secured by a separate leasehold interest rather than flowing from ownership in the land and in the improvements upon the land’.
It is his Honour’s latter point that prompts this author to state that he ‘apparently’ followed Murry.  Pagone J explained that it had been ‘critical’ to the outcome that the appellants had bought both the land and the business, as only this fact led to the conclusion that ‘…the appellants had “acquired all of the goodwill which had its source in the land”’.  He considered what might have happened had the freehold interest in the land been sold to one person and the business been sold to another person with only a lease over the land, saying that in those circumstances ‘…the source of the goodwill of the business, albeit ultimately at root in the location, would have its proximate legal and commercially factual derivation from the leasehold interest protecting the business.’  He concluded that were this so, ‘[t]he proximate source of the goodwill of the business would thus be the leasehold interest rather than the reversionary title of the freehold’s owner.’
It would seem from this that although Pagone J was not prepared to depart from the rule, emphasised in Murry and elsewhere, that goodwill passes with a business and cannot readily be cut up and allocated to parts of its sources within the business, in this case it could be attributed to the land not only for valuation purposes, but also actually, because it passed when the land and ‘improvements’ – the essentials of the business - passed.
This means that different results might be achieved by taxpayers where the interests in the land and the interests in the business on the land are split.  On this point Pagone J said that although it might seem artificial that different results could arise through separating values by creating a proprietary interest alongside the freehold of the land this falls away when one realises that a leasehold interest is an important and valuable commercial asset, which separates the right to land and which reduces the rights of the holder of the freehold.   He said that ‘[t]he goodwill of a business conducted pursuant to a lease may enhance the value of the land owner’s reversion. Whether it does or not, and the extent to which it may, depends upon all the facts.’ 
The taxpayers in this appeal were probably not well served by their expert adviser who determined the value of the goodwill without seeking to ‘…determine any identifiable or distinct value for the business name, the RACV rating, the restrictive covenant or any other like entitlement which would distinguish “the” business from “a” business of like character…’.  This left the court with little option but to accept that the passing of the land and improvements also passed the goodwill sourced almost exclusively in the land on which the business was conducted.  The case leaves one with an uncomfortable sense of how the creation of rights in assets (eg through contract) can significantly affect the tax outcome, and it seems at odds with the idea from Murry that goodwill can never be split from the business.
Conclusions on the meaning of goodwill from the cases
Amongst other things, it can be concluded that the High Court has made it clear that it sees the ability to split goodwill from a business and to split off parts of goodwill as extremely limited.  Nevertheless, some splitting is possible where the facts support a conclusion that there is distinct goodwill capable of surviving a break up of a business into parts.
It is also clear that the High Court has affirmed a meaning for goodwill that is unique to law.  The clearer the legal meaning of goodwill through the cases becomes, the clearer it is that this differs from accounting.  This is highlighted below.
The salient features of the legal meaning of ‘goodwill’ for the purposes of comparison with the accounting meaning of the term, are that:
1.	Goodwill exists in law whenever it can be said that the business has ‘attractive force’ and the business owner has a right to protect it from unlawful competition.  This is the emphatic view of the High Court expressed in Murry relying principally on the established understanding of goodwill to be found in the Muller & Co’s Margarine Ltd case.  This seems to suggest that if a business has a right to sue, for example for ‘passing off’, the business has goodwill.  Thus many businesses have goodwill in law where they might not have any goodwill for accounting purposes;
2.	A new business can have goodwill the instant it is established.  This follows from the point made above.  If it can protect itself from competition it has goodwill.  This seems to be so even if it has no record of profitability etc.  This is quite at odds with the idea in accounting that goodwill is identified by the quantifiable capacity of the business to earn profits;
3.	Goodwill has multiple sources but it does not have ‘parts’ nor does it consist of ‘types’ of goodwill – it consists of one indivisible whole.  This view, emphatically put (again) in the Murry case precluded the opportunity, which some taxpayers might have seen, to split a business up into component parts each with an attendant portion of goodwill that might have benefited from the small business CGT concession for disposals of goodwill.  Sources of goodwill can include such aspects of the business as a name, a site, a licence (Krakos) or other monopoly;
4.	Goodwill can exist even where the value of the business does not exceed the identifiable assets and no one would pay for the goodwill.  This point follows from the reasoning in Murry that it is not value that identifies goodwill for legal purposes but the existence of an attractive force within a business.  It follows too from the view that if a business has a right to protect itself from unlawful competition it has goodwill, irrespective of what someone might be prepared to pay for it.  This point is the most fundamental departure from the accounting approach to identifying goodwill;
5.	There seems to be no strict rule for valuing goodwill in law because, unlike in accounting, it is identified by a process that is not based on what a purchaser is prepared to pay; and
6.	Goodwill can exist even where it has not been recognised in the books of account.  On this point accounting and law can agree, because accounting refuses to acknowledge the existence of goodwill, in the books, until it has been identified through having been purchased.  Logically, for it to be purchased it must first exist - even if it has not yet been recognised.
The features that have been noted as contrasting with the features of goodwill in accounting create confusion in tax.  Tax operates at the intersection of law, accounting and economics so it is perverse in the extreme that the definition to be found in one discipline overrides that employed in the other two.  The accounting discipline’s identification and treatment of goodwill follows in the next section of this paper.
The meaning of goodwill in accounting
The accounting approach to goodwill for ‘reporting entities’ under the Corporations Law is regulated through the Accounting Standards, set by the Australian Accounting Standards Board (‘AASB’).
Goodwill is addressed in a number of places in the accounting standards.  The use of the term ‘goodwill’ is somewhat tied up in the context of the standards in which it is used. In the standard dealing with Business Combinations (AASB3) an acquirer is required to recognise as an asset goodwill acquired in a business combination and to measure it at its cost – which is taken to be ‘…the excess of the cost of the business combination over the acquirer’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities recognised in accordance with paragraph 36’.  It will be noted there is a tendency to emphasis valuation processes in the accounting approach, a feature not shared by law.  There follows a ‘definition’ of goodwill as follows:
Goodwill acquired in a business combination represents a payment made by the acquirer in anticipation of future economic benefits from assets that are not capable of being individually identified and separately recognised.
Thus, to put the point crudely, goodwill is identified by means of a balancing figure demonstrating the difference between the value to the acquirer of identifiable assets and the unidentifiable assets.  This will have the consequence that where purchased assets cannot be separately identified any value in the purchase price not attributable to them will be attributed to goodwill.  The standard spells this out:
To the extent that the acquiree’s identifiable assets, liabilities or contingent liabilities do not satisfy the criteria in paragraph 37 for separate recognition at the acquisition date, there is a resulting effect on the amount recognised as goodwill (or accounted for in accordance with paragraph 56).  This is because goodwill is measured as the residual cost of the business combination after recognising the acquiree’s identifiable assets, liabilities and contingent liabilities. 
Once acquired, the goodwill (as has been mentioned in discussion earlier) is not actually depreciated but is shown at cost less any impairment identified annually or more frequently. 
In the standard dealing with accounting for intangible assets goodwill is dealt with so as to distinguish it from other intangibles.  The standard states that:  
The definition of an intangible asset requires an intangible asset to be identifiable to distinguish it from goodwill.  Goodwill acquired in a business combination represents a payment made by the acquirer in anticipation of future economic benefits from assets that are not capable of being individually identified and separately recognised.  The future economic benefits may result from synergy between the identifiable assets acquired or from assets that, individually, do not qualify for recognition in the financial report but for which the acquirer is prepared to make a payment in the business combination. 
This reinforces the approach in accounting that goodwill is something that a purchaser is prepared to pay for a business but which cannot be attributed to other assets, not even intangible ones.  This ‘balancing figure’ approach is different to law.  There seems to be a similarity however to the legal approach to the distinction between goodwill and other intangibles however in that it is clear from this quote from the standard that as in law goodwill is separate from other intangibles and it’s value is not the same as the value of other intangibles.
The accounting approach means that in that paradigm goodwill is defined by the (monetary) benefit to be derived from it.  This is less a definition of the unidentifiable intangible assets than a description of their value.
One of the strengths of this approach is that it makes it very clear that goodwill relates to a ‘going concern’.  There must be a business in existence for there to be goodwill because one would not pay more for assets than they are worth unless added value is to be derived from their combination in a business.  An obvious difficulty in the approach is the conceptual and terminological gulf between the accounting manner of defining goodwill and the legal method of defining it.  Nethercott and Hanlon have described this difference of approach in detail.
They explain: ‘…unidentifiable assets represent the future benefits an organisation derives, primarily through the efficiency, and effectiveness of the organisation, which cannot be recognised as an asset in the statement of financial position.’  This is illustrated by the statement in the Standards that the unidentifiable assets would normally include ‘…market penetration, effective advertising, good labour relations and a superior operating team.’  This requirement in the Standard sheds light on the remarks made in the Murry decision when the judges criticised the fact that ‘…some accounting writers … argue that goodwill has meaning only in so far as it describes the benefits flowing from such immeasurables as good business management and the lack of competition by reason of monopolistic privileges.’  The problem with this, in their Honours’ view, was that, as a result, the attributes of goodwill are ‘attached’ to individual assets, which undermines the concept of goodwill as a single asset linked to the business rather than its assets.
Nethercott and Hanlon point out that the result of the Standard is that, in accounting, identifiable intangibles cannot give rise to goodwill, only unidentifiable intangibles could do so.  The Standard lists the following identifiable intangibles: ‘…brand names, copyrights, franchises, intellectual property, licences, mastheads, patents and trademarks.’
The difference highlighted by this is pronounced.  Many of these items, especially brand names and marks, are sources of goodwill for legal purposes whereas in accounting they are required to be excluded from the process of identifying goodwill.  In fact, as Nethercott and Hanlon explain, in accounting ‘…goodwill would exclude assets of an intangible nature … capable of being both individually identified and specifically recorded, as may be the case with patents, licences, rights and copyrights.’
The difference between accounting and law is also noticeable in the fact that Accounting Standards permit the recognition of purchased goodwill only, whereas the legal approach recognises goodwill irrespective of whether it has been purchased or created.  According to the Accounting Standards, an entity is not permitted to recognise goodwill that it has generated ‘internally’.  The reason for this is reliability.  The existence of an external price provides a reliable measure of the value of goodwill, which can therefore be recorded in the entity’s financial statements.  No similarly reliable measure is available in the case of internally generated goodwill.
In law, as a result of the Murry decision, it appears that a business may have goodwill even when the amount that would be paid for it would not exceed the value of its identifiable assets.  Under the accounting approach this is impossible as the very existence of goodwill in the accounting approach is reliant upon there being such a difference.  This is not inadvertent – the High Court was aware that the difference would be highlighted by their decision.
The different treatment of goodwill in law and accounting may well mean that a taxpayer or the Revenue might assert that goodwill exists even where there is no record of it in the accounts of the business and none could be found if Accounting Standards were followed.  It may mean that the sale of a business at ‘break-up’ value nevertheless involves a disposal of goodwill, although nothing has been paid for it.  What is not clear is how a value (if any) should be attributed to this goodwill for tax purposes.  The difference between the accounting and legal meanings of goodwill could also mean that a taxpayer disposing of a business without identifiable assets, for example one reliant entirely upon the operator’s knowledge and business contacts, could not argue that it has not disposed of a ‘CGT asset’.  This is because the legal approach means that there will almost invariably be goodwill in a business even if it has no or little value.  For the purposes of an indirect tax (such as duty) applicable to transfers of property it would be difficult for a taxpayer transferring such a business to argue that there is no property within the jurisdiction covered by the tax.  Goodwill is property and there will invariably be goodwill attached to any business that is transferred.  Similarly, the rule may have implications for the application of ITAA 1997 Subdivision 104-F to the taxation of lease premiums.  This is because whenever a business changes hands, even at less than ‘break-up’ value, some part of the consideration involved (perhaps even under a lease) will, according to the legal approach, be related to the goodwill of the business and may escape taxation as a lease premium on those grounds.

Intangibles as sources of goodwill
It will be clear from the discussion of the Murry case above that the High Court’s view of goodwill is that it cannot be goodwill of different types but it simply has a variety of sources.  This applies as much to intangibles as intangibles. Thus it is inappropriate nowadays to refer to “site goodwill” for example and is equally inappropriate to refer to more intangible concepts such as “name goodwill” – unless it is clearly understood that these labels indicate the origin and basis for the goodwill rather than a separate goodwill.  One can apply this reasoning to all sources of goodwill and so a licence, a trademark or a design may be a source of goodwill.
When engaged in transactions involving transfers of assets like trademarks, licences and designs it will be important to ensure that they are attributed with their proper value.  It needs to be borne in mind too that when one of these sources of goodwill passes – goodwill does not pass with it unless the business, or at least a viable part of the business passes too.  There may be valuation issues that are important in such a context – especially where a choice might have to be made between realising a capital gain on goodwill that might have no cost base and realising a capital gain on an indentifiable intangible source of goodwill that has a readily discernible cost base.
There is a significant feature of this link between sources of goodwill and goodwill itself in a legal context that deserves consideration.  The feature is that fully valued sources of goodwill may well leave little value for the goodwill itself.  This issue was raised, with a reliance on the Murry decision, in a relatively recent case in the Northern Territory Supreme Court.  In Alcan (NT) Alumina Pty Ltd v Commissioner of Taxes.  One of the issues in this stamp duty case involving the NT ‘land rich’ provisions was whether in determining the ratio of the value of interest in land in the Territory relative to value of interest in other assets, the non excluded property other than land exceeded 40% of the overall value.  The appellant argued that there was significant value in unidentified intangible assets whereas the Commissioner disagreed.  Having reviewed and reasserted the opinions of the High Court in Murry that goodwill in law is the attraction of custom and is different to accounting goodwill, Mildren J reasserted the High Court view ‘…that only goodwill in the legal sense is property and is an asset in its own right.’  Furthermore he explained, still relying on Murry, that ‘[m]any … sources of goodwill will often not be property…; nor will they be assests for accounting purposes…’  He gave as exmples ‘efficient use of the assest of the business, superior management practice and good industrial relations…’.  This explanation puts the finger on the critical difference between accounting views and legal views of goodwill.  The practices and circumstances mentiond by the judge in this case may be ragrded as goodwill under the accounting standards – but they cannot be so regarded in law, they are not goodwill nor are they assests nor property.  It therefore followed, in his Honour’s view, that such ‘unallocated residual assets’ as the appellant argued were present were not goodwill, not asstes, not property in their own right and therefore incapable of separate valuation.  These assest were therefore incapable of valuation separately from the land – thus impacting on how one viewed the ratio between value of land and value of other assets.
The significant point for our purposes is that this court was prepared to recognise that ‘[g]oodwill derived from an identified assest or assets may have little or no value becaseu the earning power of the business will largely be commensurate with the earning powere of the assest or assets.’  The implications are that if sources of goodwill are fully valued, the goodwill itself my have little or no value in tax law. Depending on the circumstances this could be to either a taxpayer’s or the Revenue’s advantage.  Thus a partner ostensibly disposing of ‘goodwill’ in a partnership and seeking to claim small business rioll over relief from CGT would need to ensure that its interest in souces of goodwill have also been diposed of in case the Rvenue were to challenge the claim that the transfer of goodwill gave rise to a sheletered gain and argue that a payment received is attributable to some other aspect of the transaction, perhaps even on reveue account, that is not subject to a tax shelter.
This discussion leads us to the discussion of goodwill and CGT that follows.          
Goodwill and taxation
Goodwill is a capital asset.  Nevertheless it frequently grows out of activities conducted on revenue account.  The Australian rules for the deduction of expenditure incurred by reason of depreciation in value of capital assets held for business purposes are dealt with by the ‘Uniform Capital Allowances’ regime in Division 40 of the Income Tax Assessment Act 1997 (Cth) (‘ITAA 1997’).  This uniform system applies to acquisitions from 1 July 2001.  The object of the Division 40 allowances regime is to enable the taxpayer to 
…deduct an amount equal to the decline in value of a depreciating asset (an asset that has a limited effective life and that is reasonably expected to decline in value over the time it is used) that … [the taxpayer] hold[s].  That decline is generally measured by reference to the effective life of the asset.…
The list of assets to which the depreciation rules apply is limited and the Uniform Capital Allowances apply in such a way that many intangibles are excluded under the limited definition of depreciating asset.  A depreciating asset is one with a limited ‘effective life’ that can ‘reasonably be expected to decline in value over the time it is used’.   Excluded from this are: land, items of trading stock, and intangible assets other than those specifically mentioned in s 40-30(2).  The latter lists the following intangibles as depreciables provided they are not trading stock: mining/quarrying/prospecting rights or prospecting information; items of ‘intellectual property’ as defined; in-house software; IRUs (ie indefeasible rights to use an international telecommunications submarine cable system); spectrum licences; and datacasting transmitter licences.
As its absence from the list shows, goodwill is not an asset for which depreciation in value may be deducted.  As goodwill may find its sources in many of these items, however, it is quite possible that assets that constitute the source of the goodwill of a particular business are depreciable.  An item of ‘intellectual property’ is an apposite example.  An item of ‘intellectual property’ ‘consists of the rights (including equitable rights) that an entity holds under a *Commonwealth law as: (a) the patentee, or a licensee, of a patent; or (b) the owner, or a licensee, of a registered design; or (c) the owner, or a licensee, of a copyright; or of equivalent rights under a foreign law.’
The rights of an owner or other legitimate holder of a patent may constitute a source of goodwill of a business.  It was said by the majority of the High Court in FCT v Murry  that:
The lack of competition resulting from an enforceable restrictive covenant may also enhance the goodwill of a business….The existence of statutory monopolies in respect of the products of a business such as patents or trade marks may also attract custom to an extent that is unachievable in similar businesses.
This means that, although the value of the goodwill attributable to the intellectual property in question cannot be depreciated for tax purposes, the value of the intellectual property itself might be.  
Thus the availability of depreciation deductions for one valuable asset and not the other may afford an incentive to shift value, (to the extent that this is legally, practically and ethically permissible) from the non-depreciable asset to the depreciable asset.  Secondly, the present system is not aligned with accounting practice, which currently requires reporting entities to subject purchased to an impairment regime and to deduct the amount of the depreciation from a company’s annual profits.
Another area in which the income tax system impacts on dealings in goodwill relates to the deductibility of expenditure incurred in creating, maintaining and repairing or expanding goodwill.  That will be discussed next.
Deductibility of expenditure on maintenance and creation of goodwill
The deduction of expenditure incurred in the derivation of assessable income is governed by the ‘general deduction provision’, which is s 8-1 of the ITAA 1997.  This section, and its predecessor s 51(1) in the ITAA 1936, permits the deduction of expenses to the extent that they are either incurred in gaining or producing assessable income or incurred in carrying on a business for that purpose.  Excluded from deduction are expenses in the form of capital or of a capital nature; expenses that are of a private or domestic nature; and expenses incurred in relation to gaining exempt income.  Also excluded are expenditures specifically excluded elsewhere in the Act.
Many types of expenditure on goodwill may be deducted under the general deduction provision.  The Australian courts have accepted that although goodwill is a capital asset, activities related to its creation and maintenance may be attributed to revenue account and may therefore be deductible for ordinary income tax purposes.  In Magna Alloys and Research Pty Ltd v FCT (‘Magna Alloys’) the taxpayer incurred expenditure on legal costs in defending several of its directors against criminal charges relating to the payment, in pursuance of the appellant’s business activities, of secret commissions.  It sought to deduct that expenditure for income tax purposes under s 51(1) of the ITAA 1936, on the grounds that it had been expended in the course of carrying on business.  The Commissioner of Taxation argued that the deduction should be denied on the grounds that: the outgoings were not incurred in gaining or producing assessable income, and were not necessarily incurred in carrying on a business; the outgoings were of a capital, private or domestic nature; and they were not deductible by reason of their character as payment of costs incurred in the defence of criminal proceedings.  The Full Federal Court dismissed the Commissioner’s argument on all grounds.
In relation to the argument that the expenditure had been incurred in carrying on the business, Brennan J examined the character of the expenditure and noted that it had been expended because ‘…the ends of the business required that an attempt be made to defend the impugned conduct, [of the directors on behalf of the business] and the attempt was made.’  This established the necessary connection between the business activities and the expenditure.
In relation to the capital nature of the expenditure, Brennan J said that despite goodwill being a capital asset it is often created through routine daily activities and thus ‘[t]he valuable if intangible asset of goodwill frequently grows out of activities the cost of which is a charge on revenue account: see Sun Newspapers …’.  Accordingly his Honour concluded that the taxpayer’s expenditure made in ‘attempting to vindicate’ their business methods and to overcome the problems associated with the prosecutions of its directors was ‘…properly to be regarded as a cost on revenue account.’
These views were subsequently approved by the High Court and Federal Court in several cases.  Accordingly, under current Australian law, some expenditure affecting the capital asset of goodwill is deductible for ordinary income tax purposes on the grounds that it is incurred on revenue account.  There are other more common examples of goodwill-related expenditure that is deductible because it is routine expenditure incurred in the course of carrying on a business.  Examples include expenditure on advertising, business promotion, and so on.  They are routine operating costs of business, but they also have the effect of growing or maintaining the goodwill of the business.
There are further examples of expenditure that relates to goodwill but that is specifically deductible under various special deduction provisions in the Act.  The special deductions provisions either have the effect of overriding one of the limitations in s 8-1 (eg the prohibition of deduction of expenditure of a capital nature) or of clarifying the parameters of deductibility for an item already likely to be deductible under s 8-1.  Some examples of these are given below.
‘Black hole’ expenditure
So-called ‘black hole’ expenditure may have a tenuous link to costs incurred in establishing goodwill.  ‘Black hole’ is a term applied to expenditure that is a legitimate business expense, arguably deductible on policy grounds because it relates to the earning of income, but usually too closely related to the business structure to escape the exclusion of expenditure of a capital nature.  As a result of reform of the Australian taxation system, many ‘black hole’ expenditures can now be written off over their statutory life.  Section 40-880(1) of the ITAA 1997 lists various commercial costs that qualify for deduction.  They are described as ‘Business related costs’ and include expenditure: to establish your ‘business structure’, such as expenses incurred in establishing a company, partnership, or trust; to convert a business structure to some other business structure; to raise equity for the business; to defend the business against takeover; to undertake or attempt to undertake a takeover.
Also included are costs incurred by a shareholder in liquidating a company that carried on a business; and costs to a shareholder in stopping the carrying on of a business. 
These ‘black hole’ expenses or ‘business related costs’ may be linked to goodwill in that goodwill is the ‘attractive force’ of a business and the costs identified here go to the existence of the business.  However, the link to goodwill is likely to be tenuous.  
The rate at which the expenses may be deducted is limited.  Section 40-880(2) restricts the amount that the taxpayer may deduct to ‘…20% of the expenditure …for the income year in which you incur it; and …for each of the next 4 income years.’  Other restrictions apply to the deduction of these expenses.
It is a moot point whether deduction of expenditure related to maintaining or creating goodwill would be prohibited as being in relation to ‘a lease or other legal or equitable right’.  Arguably owning goodwill confers the right to protect it from ‘passing off’.   This is an equitable right.  On the other hand it may be argued that expenditure on creating goodwill, if successful, creates property – a capital asset.
Legal expenses
Some other deductible business related expenses may also relate to goodwill in that they amount to the cost of establishing a source of goodwill within a business.  Although the deductibility of general legal expenses will stand or fall on the basis of the tests contained in s 8-1 of ITAA 1997, and so some may be deductible despite their relationship with the goodwill, while others are specifically deductible under special provisions.  Expenses related to lease documents fall into this category.  Section 25-20(1) ITAA 1997 allows the deduction of expenditure incurred ‘…for preparing, registering or stamping a lease of property; or an assignment or surrender of a lease of property…’ where it has been used for the purpose of producing assessable income.  A portion of the cost may be deducted where it has been used only partially for that purpose.  As the case law already discussed suggests, a lease may be a source of goodwill in some businesses, in which case the special deduction amounts to an allowance for the costs of establishing the goodwill of the business.  Obviously, whether this is so or not will depend on the particular role that the lease performs in that business.  It may be that the lease affords access to a locality, which provides local goodwill for the business, or it may afford access to some other asset, such as a right to use a name, process, or some similar source of goodwill.  Accordingly (and more clearly than is the case for the legal expenses related to business establishment/defence/expansion/etc identified in s 40-880(1)), s 25-20(1) allows deduction of legal expenses directly related to a contract that may be a significant source of goodwill.  The deduction is more generous than a deduction under s 40-880(1) in that the entire amount of the expenditure is deductible in the year in which it is incurred, rather than being deductible only over 5 years.
Trade, business or professional association memberships
Another special deduction that may be related to goodwill is the expenditure by a taxpayer on membership of a trade, business, or professional association.  In particular circumstances such a membership may be a source of goodwill.  For example, where it is advertised to customers and thus increases the standing and attraction of the member’s business, or because it brings the member into contact with potential customers.  The cost of such memberships is deductible, if not available under the general deduction provisions of s 8-1 then under s 25-55(1) of the ITAA 1997.  However, s 25-55(2) limits the available deduction to a ridiculous $42 of the cost incurred.
Deduction for capital works and repairs
Under provisions set out in Division 43 of the ITAA 1997 the cost of constructing certain capital works may be written off at rates between 2.5 per cent and 4 per cent, depending on the capital works involved.  The deduction of most interest to businesses is that allowed for work on construction, extension, alteration and improvement of such structures as hotel and holiday apartment buildings; buildings used for industrial activities (manufacture, milling, processing, packing, etc); and research and development facilities.  The detailed operation of Division 43 is complex and well beyond the scope of this paper.  It suffices to say that the effect of Division 43 is that a deduction will be available to affected taxpayers for expenditure on capital works that constitute a source of goodwill of their business.
Similar links to goodwill may apply to the more general deduction provision applicable to repairs.  Section 25-10(1) allows a deduction for expenditure incurred ‘for repairs to premises (or part of premises), or a depreciating asset that you held or used solely for the purpose of producing assessable income.’  A suitably apportioned deduction is available for repairs to property only partly used for the purposes of producing assessable income.  If the asset repaired is a source of goodwill within the configuration of the particular business, the deduction of the cost of that repair will also be a deduction of a cost related to goodwill.  The difference between the deduction available for repairs and the deduction available for capital works is that no deduction is allowed under s 25-10(1) for repairs of a capital nature, whereas the Division 43 deduction regime applies specifically to capital expenditure.
Research and development expenditure
The High Court in the Murry case noted that: 
The existence of statutory monopolies in respect of the products of a business such as patents or trade marks may also attract custom to an extent that is unachievable in similar businesses.
Thus, the patents and trade marks in question may be a source of goodwill.  Australia has a specific regime intended to foster the technological competitiveness of industry. 
In appropriate circumstances, these so-called ‘R&D allowances’ permit a special deduction of up to 125 per cent of the expenditure incurred by an Australian company on, or related to, research and development (‘R&D’).  (This may be as much as 175 per cent if the relevant taxpayer has increased its R&D expenditure over its average R&D expenditure in the previous 3 years.)  Once again, the detailed contents of the provisions are beyond the scope of this paper, but it is important to note that qualifying expenditure may result in the establishment of a patent, design or similar asset that constitutes a source of goodwill.  Thus a deduction exceeding the expense is available for expenditure that may establish a source of goodwill within the business.  Indeed, the restrictions imposed on the type of R&D expenditure eligible for the deduction (or, in some cases, a refundable tax rebate) virtually guarantee that the product of the R&D activity will be unique and likely to constitute a source of goodwill not shared by other businesses.  This is because the R&D activity involved must be, inter alia, ‘experimental’ and ‘involve high levels of risk’.
CGT and the taxation of goodwill
Dealings in goodwill, because goodwill is not an asset subject to the depreciation rules in Div 40 are principally dealt with under the CGT rules.  These are in a separate chapter in the ITAA 1997 and are almost entirely self-contained.  Accordingly, the following sections of this paper consider the treatment of goodwill for CGT purposes separately from the preceding discussion of income tax.
Goodwill as a ‘CGT asset’
The view of the courts that goodwill is capital is also reflected in the CGT provisions.  CGT applies in Australia when a ‘CGT event’ happens and most ‘CGT events’ involve a ‘CGT asset’.  Section 108-5(1) of the ITAA 1997 gives the meaning of a ‘CGT asset’, which includes both ‘any kind of property’ and ‘a legal or equitable right that is not property’.  For avoidance of doubt, examples are listed that include ‘goodwill or an interest in it’.  Section 102-25(2) also lists a number of examples of ‘CGT assets’, such as land, buildings, shares, units in a unit trust, etc and s 102-25(3) lists a number of less well-known ‘CGT assets’ including ‘goodwill’.
The legislation is therefore emphatic that goodwill is a ‘CGT asset’ and CGT may apply to both a ‘CGT asset’ that is a source of goodwill, and to goodwill, which is itself defined as a ‘CGT asset’.  The importance of proper valuation of goodwill and other ‘CGT assets’ in cases where the CGT treatment of them may overlap is immediately apparent.  The Murry case raised important issues regarding other aspects of goodwill.  It articulated a particular problem involving the CGT status of goodwill.
CGT was introduced in Australia so as to have effect after 19 September 1985.  This means that for many ‘CGT events’ affecting ‘CGT assets’ there is no CGT if the asset was acquired before 20 September 1985.  Assets acquired before 20 September 1985 are commonly termed ‘pre-CGT assets’ and those acquired on or after 19 September 1985 are commonly termed ‘post-CGT assets’.  The effect of the pre-CGT asset exception is that it may be material whether the goodwill is pre-CGT goodwill or post-CGT goodwill.  Generally, in Australia, the goodwill of a business that was in existence prior to the advent of CGT is a pre-CGT asset and dealings with it do not attract CGT.  The Commissioner’s view on this, as expressed in Taxation Ruling TR 1999/16, is that goodwill of a business cannot be regarded as broken into parts that are either pre-CGT or post-CGT assets.
The whole of the goodwill of a business is either pre-CGT goodwill … or post-CGT goodwill.  The goodwill of a particular business cannot be characterised as partly pre-CGT goodwill and partly post-CGT goodwill.  Goodwill is a composite asset.
This approach means that it is important whether a business was established before or after the advent of CGT.  The Commissioner’s view is that any addition to goodwill assumes the character of the existing goodwill of a business and thus shares its pre-CGT or post-CGT status.  The Commissioner applies these principles in two contexts: purchased goodwill and goodwill that has been internally generated.  It is noted that this situation possibly affords an opportunity for a taxpayer to so structure its affairs as to render a post-CGT goodwill asset a pre-CGT asset and thus minimise CGT on an ultimate disposal of the goodwill.
Goodwill and the CGT goodwill small business concession
One of the more extreme distortionary influences imposed by the Act was removed with the discontinuation of the concession available to small business for dealings with their goodwill.  The special discount took the form of relief provided under s 160ZZR of the ITAA 1936.  By the 1997/1998 tax year the threshold for access to this 50% “discount” on the capital gain on disposals of goodwill was $2 248 000 and the exemption had become the most important shelter from CGT that was available to small business in Australia.  The author has mentioned elsewhere:
[w]hilst the goodwill exemption was in existence…in its various forms it created a focus of interest for small business taxpayers disposing of their business assets in appropriate circumstances.  The effect of the concession was to encourage small business taxpayers and their advisers, insofar as it was technically and ethically possible to do so, to inflate the value of the goodwill component of the business transferred so as to maximise the relief available.  The higher the value of the goodwill in the business, the greater the benefit to the taxpayer accessing the tax shelter.
The 50 per cent CGT goodwill concession was repealed with effect from 21 September 1999 and replaced by a series of more general small business reliefs found in Division 152 of the ITAA 1997.  Division 152 now gives a number of concessions for small business that apply to ‘CGT events’, which happen after 21 September 1999.  The concessions include goodwill amongst the assets affected, but do not single it out for special treatment as before.  It is not the purpose of this paper to describe the concessions in detail, but a brief explanation of a very complex area is necessary in order to provide context for the discussion of goodwill.  
The small business CGT concessions
The four CGT concessions aimed at small business are:
an exemption from CGT on certain assets that have been held for longer than 15 years;
an exemption from CGT for an amount of 50 per cent of the capital gain on certain assets;
a retirement concession for qualifying taxpayers disposing of their business assets in order to help fund their retirement; and
a rollover of CGT for certain gains on assets that are disposed of if the proceeds of the disposal are used to acquire replacement assets in the same or another business.
The conditions
There are several key requirements (set out in ITAA 1997 Subdivision 152-A) that must be satisfied for the concessions to apply.  These are:
each ‘CGT asset’ involved must be an ‘active asset’;
the maximum net value of the assets of the business (i.e. those of the taxpayer and of entities controlled by the taxpayer as well as those of any ‘small business affiliate’, such as certain family members - like a spouse or child under 18, over whom the taxpayer may have control) and those of any ‘related’ entities, must amount to $6 000 000 or less (assets that are not used in carrying on a business of the taxpayer are not included in this valuation); and
for assets consisting of a share or interest in a trust there must be a ‘significant individual’ consisting of the entity (or the spouse thereof) claiming the relief, immediately before the ‘CGT event’.  This applies for all concessions except the 15-year exemption for which there must be a controlling individual at all times.
Additional specific conditions apply to certain of the reliefs.
Some comments may be made concerning each of these criteria or sets of criteria:
The active asset test
Goodwill will certainly qualify as an active asset.  The active asset test as set out in s 152-40(1) is as follows:
A *CGT asset is an active asset at a given time if, at that time, you own it and: 
(a)	use it, or hold it ready for use, in the course of carrying on a *business; or 
(b)	it is an intangible asset that is inherently connected with a business that you carry on (for example, goodwill or the benefit of a restrictive covenant); or 
(c)	it is used, or held ready for use, in the course of carrying on a business by: 
(i)	your *small business CGT affiliate; or 
(ii)	another entity that is *connected with you.
Under these rules there is obviously a need to clearly distinguish between goodwill and assets, including intangibles such as restrictive covenants, which are a source of goodwill but not goodwill.  The process of distinguishing between the asset of goodwill and ‘the benefit of a restrictive covenant’ is likely to be a decidedly difficult one; indeed one is sometimes tempted to ask whether there is a difference at all.  The valuation of the respective assets is also important.
Subject to some exceptions, intangibles that have been used to earn ‘passive income’ are excluded from the category of active assets.  The exceptions are found in ITAA 1997 s 152-40(4)(e)(i) and (ii).  The exceptions apply if the asset yielding royalties, annuities, etc is:
 (i)	…[an] asset [that] is an intangible asset and has been substantially developed, altered or improved by you so that its market value has been substantially enhanced; or 
 (ii)	its main use for deriving rent was only temporary.
What is ‘temporary’ will simply be a question of fact.  More contentious is the question of whether or not an asset has been substantially developed, altered or improved.  This might raise possibilities for a taxpayer seeking the CGT concessions in circumstances that overcome what might be termed the ‘Just Jeans rule’ (i.e. that goodwill cannot be artificially separated from a business trade mark for the use of a third party – see further below).
Maximum net asset value test
Goodwill will fall amongst the business assets whose value is material for the purposes of the application of the $6 000 000 threshold.  The threshold net asset value is the excess of the total market value of all assets over the total liabilities related to those assets.  The difficulty this poses will be that a precise valuation of goodwill and of other assets, immediately before the ‘CGT event’ giving rise to the claim for the small business concessions, may be required.  This will not be easy in cases where the legal and accounting definitions of goodwill differ, thus leaving no approved accounting method by which the legal goodwill can be valued.
The 15-year exemption from CGT
Subject to the preceding basic conditions being satisfied, ITAA 1997 Subdivision 152-B gives a full exemption from CGT on the happening of a ‘CGT event’ after 21 September 1999, if the qualifying ‘CGT asset’ has been held continuously for 15 years; the taxpayer is at least 55 years old or retires on the grounds of permanent disability; and the ‘CGT event’ occurs in connection with the taxpayer’s retirement.  Similarly, the exemption will also apply to a disposal of an asset by a company or trust that has continuously owned the asset for 15 years and which has a controlling individual for the period of ownership, provided that, just before the ‘CGT event’, the controlling individual of the entity is at least 55 years of age or he/she is permanently incapacitated at that time and the ‘CGT event’ happens in connection with his/her retirement. ITAA 1997 s 152-125 thereafter applies to allow the distribution of this tax sheltered amount out of the company or trust to its controlling individual, or the spouse thereof, without further tax, provided the distribution takes place within 2 years.
Applying these requirements to goodwill, the effect of the concession is that qualifying goodwill is treated in the same way under the 15-year exemption rule as pre-CGT goodwill (assets held for 15 years also enjoy tax free distribution of the sheltered amount under s 152-125(2)).  The concession, if one is able to qualify for it, is very generous indeed, surpassing the former small business CGT discount of only 50 per cent of the CGT liability on the disposal of goodwill.
The concession makes it irrelevant to distinguish between goodwill and sources of goodwill that qualify for it, because both attract the concession described below.
The small business 50 per cent concession
Whereas the former small business concession was a discount of 50 per cent of the CGT on a disposal of goodwill, the 1999 reforms extended the discount to 50 per cent of the CGT on all qualifying assets of a small business.  Under ITAA 1997 Subdivision 152-C, subject to the basic conditions described above, for a ‘CGT event’ after 21 September 1999, a taxpayer receives a 50 per cent reduction in the capital gain.  Where the taxpayer has already benefited from the general 50 per cent concession for CGT under ITAA 1997 Division 115, (the general CGT discount, to be discussed below), the taxpayer achieves a 75 per cent reduction in CGT.
Retirement exemption
After the application of the 15-year exemption, and before or after (at the taxpayer’s discretion) the 50 per cent small business concession, the taxpayer’s capital gain may also be reduced by the retirement exemption or the small business rollover.  According to Subdivision 152-D, a taxpayer may escape tax on a capital gain of up to $500 000 if the proceeds of a ‘CGT event’ are applied to the payment of the taxpayer’s retirement benefit in the form of an Eligible Termination payment (‘ETP’).  The $500 000 limit is cumulative of all ETP amounts accumulated by the taxpayer during their lifetime.  Although the exemption is available to taxpayers of any age, if a taxpayer is less than 55 years of age the ETP cannot be paid to the taxpayer directly but must be rolled over into a superannuation fund. If the taxpayer is an entity such as a company or trust it must be controlled by one or two individuals, who have 50 per cent or more of the interests in the entity.  The ETP in such cases must be paid within seven days of receipt of the proceeds of the disposal of the asset, to the controlling individual/s or into their superannuation fund (if they are under 55).  The effect of the concession is that, in respect of goodwill and other active assets of the business, the taxpayer will be exempt from tax on the amount of the ETP up to a lifetime limit of $500 000.
Replacement asset rollover
Subject to the same basic requirements regarding active asset status, net asset value, etc, mentioned above, where some or all of the active assets of a small business are replaced, relief from CGT is available on the proceeds of the disposal under ITAA 1997 Subdivision 152-E.  This relief is available to any of: individual taxpayers, partners, companies and trusts.  Because the concession is a rollover rather than a full exemption, it is ‘held over’ until such time as the replacement asset is disposed of or loses its active status, at which point the original capital gain is crystallized.  The maximum net rollover amount that can be allocated to each replacement asset is equal to the cost base of the replacement asset.  Replacement assets must be active assets acquired sometime within one year before and two years after the disposal of the relevant rollover asset.  This would be straightforward in the case of goodwill.  If the replacement asset is a depreciable, however, different rules apply.  Gains made on depreciables (after 20 September 1999) are not subject to CGT if they have been dealt with under the uniform capital allowances rules.  Again, this may provide an incentive for a taxpayer to place greater value in the goodwill of a business than in its depreciable sources (such as patents, copyrights etc).
Conclusions on the small business CGT concessions
It suffices to say, at this stage of the paper, that the most striking feature about these concessions seems to be the inconsistent manner in which they apply to goodwill.
The small business reliefs are not the only CGT provisions which may apply to dealings in goodwill and other actions affecting the goodwill of a business.  The next section of this paper describes the application of the general CGT discount to dealings in goodwill.
The general 50 per cent CGT discount
Prior to September 1999, the capital gain on an asset affected by a ‘CGT event’ was calculated by reference to the capital proceeds less the asset’s cost base (taking into account such matters as the price paid to acquire an asset, expenditure incurred in improving it, etc) adjusted by the consumer price index (CPI) from the date of acquisition of the asset to the date of disposal.  The capital gain, for tax purposes, would then be the amount by which the amount received for the asset exceeded the indexed cost base and other allowable costs of disposal.  This procedure is still available for assets acquired prior to 21 September 1999, but the CPI indexation factor is frozen as at September 1999.
For assets both acquired and disposed of after 21 September 1999 and, if the taxpayer so elects, for post-CGT assets acquired prior to 21 September 1999 and disposed of thereafter, the system is simplified under Division 115 of the ITAA 1997.  According to this division, provided the ‘CGT asset’ concerned has been held by the taxpayer for a period of at least 12 months (excluding the day of acquisition and the day of disposal), 50 per cent of the unindexed capital gain is excluded from the capital income of a taxpayer who is an individual or a trustee of a trust.  In the case of a superannuation fund, the proportion excluded is 33.33 per cent.  This so-called ‘CGT discount’ is not available for companies, which must include the full net capital gain in assessable income.  If the asset concerned was acquired before 11.45 am on 21 September 1999, companies may still index the cost base of the ‘CGT asset’ up to 30 September 1999 using the ‘frozen indexation’ method.

Goodwill licensing – the fiction and its consequences
It seems to be often believed that it is possible to separate goodwill and its sources for the purposes of structuring to, for example, pay out an exiting owner for their goodwill, or so as to relocate parts of a business without moving all of it.  The case of FCT v Just Jeans Pty Ltd (‘Just Jeans’) is a cautionary tale to be heeded by those attempting to achieve such structures.  They are difficult to pull off. 
The Just Jeans case has been discussed already – but aspects of it are worth repeating under this head of the paper.  The facts were that, for purposes of Australian domestic tax and in order to raise operating capital, the taxpayer assigned the brand name and logo of ‘Just Jeans’ (the brand of a range of fashion garments and the chain of stores that sold them) to a company in the Netherlands.  That company granted the taxpayer a licence to use the name and logo in Australia for annual licence fees of 4 per cent of its annual turnover.  Payment for the assignment of the name and logo was to be made in instalments.  The taxpayer claimed a deduction under s 51(1) of the Income Tax Assessment Act 1936 (Cth) (‘ITAA 1936’) for the payment of the licence fees.  The Commissioner disallowed the deduction and, although unsuccessful in the Victoria Supreme Court, succeeded in the Full Federal Court, which held, inter alia, that on the facts the taxpayer had acquired no enforceable legal rights in return for the payment of licence fees.  It had always had the right to use its own name and had not validly transferred it because the acquirer could not in fact use it.  Therefore the payment of the licence fees was: entirely divorced from the day to day running of the business; artificial; and in respect of something incapable of legal achievement.  Thus, the licence fees were not deductible under s 51(1).  Furthermore, the taxpayer could not deal with its goodwill in the manner it purported to, because it appeared to the court that a bare name is not capable of transfer without the goodwill to which it relates, and goodwill can only be transferred along with the business to which it relates.
The case is an important Australian example of a corporation attempting to use its intangibles to gain a structural and tax advantage in addition to generating revenue in the conventional fashion. 
There are some important features discernible in the type of transactions that have been described above.  These include:
Licence arrangements to allow the use of a valuable intangible by another entity;
The intention to obtain a tax deduction for the licence fees paid for the use of the asset in question;
Such transactions frequently involve a ‘migration’ of intangibles to a holding vehicle, which enters into the licence for the use of the intangible;
The entity using the intangible is frequently the entity that originally owned and established the intangible;
Tax benefits were intended to help finance the acquisition being made;
The transactions involved (although not exclusively) intangible property in the form of brand names, and thus an intangible asset closely linked with goodwill; and
The transactions were largely unsuccessful from a tax point of view but were expected to be successful at the time they were carried out.
These listed features highlight the opportunities that will be sought for (hoped for) tax effective structuring of commercial relationships where moveable intangibles are involved.  The attractiveness of such attempts might well be attributable to the lack of clarity of where goodwill ends and related intangibles begin.  This lack of clarity provides, in cases where the goodwill and related intangibles are treated differently, opportunities for arbitrage by taxpayers who will shift value into the more favourably taxed asset.
Franchisees’ goodwill and what happens when franchises end?
A specific purpose of this paper is to consider this point.  It leads from the discussion above of the application of CGT to goodwill.  It should be assumed that a franchise that has been in existence for any reasonable length of time will consist of a business operation that is sufficient to have goodwill, indeed the entering into the franchise agreement would largely have been intended to give the franchisee access to the goodwill of the franchisor.
At the termination of the franchise it is submitted that two CGT events rank for consideration as having application to the franchisee and the franchisor.  In the case of each of them the contract under which the franchise operated ends.
It is possible that the most appropriate CGT event in the circumstances is CGT Event C1 which occurs when there has been a loss or destruction of a CGT Asset.  Section 104-20 provides as follows:
(1)  CGT event C1 happens if a * CGT asset you own is lost or destroyed. 
…
(2)  The time of the event is: 
     (a)  when you first receive compensation for the loss or destruction; or 
     (b)  if you receive no compensation - when the loss is discovered or the destruction occurred. 
(3)  You make a capital gain if the * capital proceeds from the loss or destruction are more than the asset’s * cost base. You make a capital loss if those * capital proceeds are less than the asset’s * reduced cost base. 
Exception 
(4)  A * capital gain or * capital loss you make is disregarded if you * acquired the asset before 20 September 1985. 
Thus the loss to the franchisee of the goodwill of the franchise at the end of the contract might be a CGT Event C1and this is certainly the view (although expressly excluding application to property management franchises) of the Commissioner expressed in TR 1999/16 ‘Income tax: capital gains: goodwill of a business’.  The actual consequences will depend on the proceeds that might be attributable to the Event.  In the Commissioner’s view the market value substitution rule does not apply by virtue of s116-25 (only modifications 2,3 and 4 apply).
The other possibility is that the ending of the franchise may give rise in relation to goodwill to a CGT Event C2.  Section 104-25 providing as follows:
Cancellation, surrender and similar endings: CGT event C2 
(1)  CGT event C2 happens if your ownership of an intangible * CGT asset ends by the asset: 
                     (a)  being redeemed or cancelled; or 
                     (b)  being released, discharged or satisfied; or 
                     (c)  expiring; or 
                     (d)  being abandoned, surrendered or forfeited; or 
                     (e)  … 
                     (f)  …. 
             (2)  The time of the event is: 
                     (a)  when you enter into the contract that results in the asset ending; or 
                     (b)  if there is no contract-when the asset ends. 
             (3)  You make a capital gain if the * capital proceeds from the ending are more than the asset's * cost base. You make a capital loss if those * capital proceeds are less than the asset's * reduced cost base. 
Note:   … 
             (4)  A lease is taken to have expired even if it is extended or renewed. 
Exceptions 
             (5)  A * capital gain or * capital loss you make is disregarded if: 
                     (a)  you * acquired the asset before 20 September 1985; or 
                     (b)  for a lease that you granted: 
                             … 
The arguments in favour of a C2 event applying are that there is not a loss or destruction of the goodwill held by the franchisee – it simply ends.  Thus it is closer to an ‘expiry’ covered by s104-25(1)(c) than any other event.  Unfortunately the application of s 104-25 and CGT Event C2 has a possible ugly consequence because of the market value substitution rules.  Where a C2 Event occurs the Act applies modifications 1,2,3, and 4 to the calculation of the capital proceeds.  Modification 1 in s116-30(1) states that where there are no capital proceeds from a CGT Event you are deemed to have received the market value of the CGT asset that is the subject of the event.  This is reinforced in relation to non arm’s length transactions and (specifically) CGT Event C2 by s 116-30(2) so that whatever the capital proceeds actually are – if they differ up or down from market value of the goodwill or cannot be valued – the market value of the goodwill is deemed to have been received.  It may be that the rule need not apply by virtue of s 116-30(3) which excludes the market value substitution rule where there is an ‘expiry’ of a CGT asset that you own (or a cancellation of a statutory licence).  However in the absence of this ‘expiry’ exception applying the Act requires that the market value be calculated as if the event triggering the capital gain had not occurred (s116-30(3A)).  This may leave one in the predicament of having to deem capital proceeds of the market value of the goodwill at the termination of the franchise at a market value of the goodwill in circumstances where the franchise has not been cancelled.  One would, in the circumstances, argue on behalf of the client that the goodwill has expired rather than been ‘cancelled’ ‘surrendered’ or ‘forfeited’ as expiry seems to take one within the narrow shelter of s 116-30(3).  The drafting of the franchise agreement and the nature of its termination will be relevant here because a franchise that has an end date can easily be argued to have ‘expired’.  A franchise agreement that allows a party to terminate on notice to the other but is not specific as to an end date would be harder to describe as ‘expired’ and thus there is a practice point here for those drafting such agreements. 
Even if the access to the safety afforded by the s116-3-(3) exception cannot be justified, all is not lost because the capital gain may be sheltered by the various CGT concessions, hopefully by the small business CGT concessions for disposals of active assets.  This will not be the case, however, for goodwill that was created by entry into a contract only within the previous 12 months.  The latter situation raises a question where the franchise contract was renewed within the last 12 months.  The issue in such a case is whether it can be said that the goodwill asset was created only with the renewal of the franchise, or whether it can be said that the goodwill existed prior to the renewal by virtue of the previous franchise agreement.  On the one hand it can be argued that the goodwill exists by virtue only of the contract, and so it is new goodwill created when the last renewal was entered into – thus it is younger than 12 months.  On the other hand it might be argued that all the renewal did was perpetuate the franchisee’s interest in existing goodwill which dates back to the original franchise, and may have accretions to it – but which certainly does not rely entirely on the renewal.  Thus it might qualify for the concessions made available through its having been held for more than 12 months although it is probably moot whether this might depend on the relative value of the goodwill attributable to the period since the renewal, or prior to it.

Goodwill – know how and show how – the differences and CGT consequences
Another area in which goodwill overlaps with its sources and which, in the context of the life cycle of a  business, is important is its relationship with the concepts of know how and of show how.  The terms of a franchise agreement, if it involves such things as processes may give rise to CGT implications.  There are (not so) subtle differences between these two intangible sources of goodwill and the implications for taxation.
What we term ‘know how’ is the knowledge of a particular process and may be either registered by means of a patented process, or unregistered.  An example of the latter would be a secret manner of operating.  The manner of operation example is important because so-called ‘system or business format franchising’ is apparently the most common form of franchising and involves the franchisor allowing the franchisee to use its unique manner of doing business in the franchisee’s own independently operated business.  As Andary and Butler point out, payments received by the franchisor in relation to the know how will ordinarily be on revenue account in line with such cases as the venerable Rolls Royce Ltd v Jeffrey although, as with nearly all capital/revenue distinctions particular facts might give rise to a different conclusion in particular circumstances.
In cases where the franchise fee is not income in nature we should consider how the CGT system would deal with it.  It may be regarded as capital proceeds of the creation of a right in the franchisee to be shown a secret process, or trained in a method of operation by the franchisor.  Where this occurs it takes us in to the realms of CGT Event D1 as the Act provides as follows:
Section 104-35 
Creating contractual or other rights: CGT event D1 
             (1)  CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity. 
Example:    You enter into a contract with the purchaser of your business not to operate a similar business in the same town. The contract states that $20,000 was paid for this. 
                   You have created a contractual right in favour of the purchaser. If you breach the contract, the purchaser can enforce that right. 
             (2)  The time of the event is when you enter into the contract or create the other right. 
             (3)  You make a capital gain if the * capital proceeds from creating the right are more than the * incidental costs you incurred that relate to the event. You make a capital loss if those * capital proceeds are less . 
Example:    … 
   (4)  The costs can include giving property….. 
Exceptions 
             (5)  CGT event D1 does not happen if: 
                     (a)  you created the right by borrowing money or obtaining credit from another entity; or 
                     (b)  the right requires you to do something that is another * CGT event that happens to you; or 
                     (c)  a company issues or allots * equity interests or * non‑equity shares in the company; or 
                     (d)  the trustee of a unit trust issues units in the trust; or 
                     (e)  a company grants an option to acquire equity interests, non‑equity shares or * debentures in the company; or 
                      (f)  the trustee of a unit trust grants an option to acquire units or debentures in the trust. 
Example:    You agree to sell land. You have created a contractual right in the buyer to enforce completion of the transaction. The sale results in you disposing of the land, an example of CGT event A1. This means that CGT event D1 does not happen.

In such a case the 50% CGT discount is unavailable because s115-25(3)(a) states that a capital gain from a CGT Event D1 is not a discount capital gain.  The small business concessions might, however, apply to the creation of the right in the franchisee as the event is inherently connected to the CGT asset of the taxpayer (s152-12).  Thus if the franchisor meets the other criteria for the small business CGT concessions (or has access to a capital loss) it may be advantageous for up front franchise fees to be treated as capital.
Another possible argument might be that, as a last resort, a CGT Event H2 is applicable. An H2 event occurs where an act or transaction occurs in relation to a CGT asset you own and the act/transaction does not result in an adjustment being made to the asset’s cost base.  The argument here would be that the show how transaction occurs in relation to a CGT asset of the franchisor – if nothing else, it would be in relation to its goodwill (setting aside the argument that an unregistered process is a source of goodwill but is not itself goodwill).  The payment for the transaction of sharing the process, as it does not involve an actual disposal of the process or goodwill, would not result in a cost base adjustment.  There might thus be CGT implications if the capital proceeds exceeded the franchisor’s incidental costs incurred that relate to the event.
These points may well be academic however, show how involving the sharing of know how is most often going to be a transaction on revenue account in which case the anti-overlap rule in s118-20 will reduce any capital gain to zero.  It would be rare for a transaction involving show how to give rise to capital proceeds rather than income in the form of a royalty or service fee.
Conclusion
It is hoped that this rather lengthy discussion of goodwill has given some cause for thought.  It will have been noted that there are difficulties in dealing with the sources of goodwill.  The last section of the paper has highlighted some of those, principally the spread of the CGT where any transaction involving goodwill or its sources risks CGT implications because the goodwill is a CGT asset.  The principal difficulty, however, is identifying this very ephemeral commodity.  It is not so much that the Accounting and Law definitions are different, because they do overlap significantly.  It is more the fact that the definitions drawn from the two disciplines start from very different perspectives.  The Accounting approach, being value based, is akin to deducing the presence of a solid body through the perception of its shadow.  The legal approach being an identification of a species of property through the existence of rights (to trade) in its owner.  In both cases the approaches are one step away from the asset concerned, derivative in character, resulting in an inevitable lack of clarity.  Perhaps a definition of goodwill would introduce greater certainty.