JOINT SUBMISSION BY. The Institute of Chartered Accountants in Australia, the Taxation Institute of Australia, CPA Australia, Taxpayers Australia

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1 JOINT SUBMISSION BY The Institute of Chartered Accountants in Australia, the Taxation Institute of Australia, CPA Australia, Taxpayers Australia Draft Taxation Ruling TR 2004/D21 Income Tax: goodwill: identification and tax cost setting for the purposes of Part 3-90 of the Income Tax Assessment Act 1997 Date: 14 January 2005 The Professional Bodies welcome the opportunity to comment on Draft Taxation Ruling TR 2004/D21 ( the draft ruling ). GENERAL COMMENTS We welcome the ATO s initiative to provide formal guidance in relation to the application of the consolidation law concerning cost setting issues for goodwill and synergistic goodwill issues on formation, joining a group and leaving issues. In our view however, the draft ruling has a number of technical and compliance problems that must be addressed in relation to its precise formulation of the residual value method of determining goodwill (in particular paragraphs 4, 5 and 21ff. which propose a mandated modified residual value method). In addition we have a number of issues concerning the draft ruling s discussion of synergistic goodwill issues resulting on and after the formation of a group. In relation to the draft ruling s discussion of a mandated modified residual value method of calculating goodwill, we submit that: The ruling section of the document is currently not fully consistent with the explanations section. The analysis of valuation methodologies to be applied to the assets and liabilities for purposes of the residual value approach is incomplete. For example there is no alternative view section which outlines the conventional accounting approach and its underpinnings of conventional approaches to valuation of assets and liabilities and its relation to Murry s case in detail. The approach to valuation of components of the residual value approach is not generally in line with commercial practice which has been adopted in relation to consolidation in over 3 years practice in this area. As a result, the ruling will generally be problematical for taxpayers to comply with. The proposals do not result in a market value goodwill calculation from a commercial standpoint. What is being asked for would not have been performed to date by valuers. We also note that the ruling is different to the ATO s consolidation reference manual (CRM) material that issued in December 2003 and that has not been discussed subsequent to that. On that basis we see this as a change of policy operating

2 retrospectively and we suggest that any such change of approach, if ever introduced, should operate prospectively. We see some potential merit in the approach taken in paragraph 5 of the draft, provided that the use of this approach was optional for taxpayers (in relation to formation cases for groups entering consolidation in the 2003 and 2004 financial years). The potential merit arises from the potential ability to use the precise calculations used for allocable cost amount ( ACA ) and asset-allocation purposes as a proxy in relation to liabilities and assets values. This could in some cases reduce some uncertainty arising from the use by valuers of conventional valuation approaches, by adopting a more mechanical approach to calculations that otherwise involve questions of judgment. We address a number of the above issues in further detail below. SPECIFIC COMMENTS Determining the Value of Goodwill The consolidation law (Part 3-90 of the Income Tax Assessment Act 1997 ( ITAA 1997 ) broadly requires the market value of assets of a joining entity to be determined in order to apply the consolidation rules for spreading the ACA calculated for that entity over its reset cost base assets in order to set those assets tax value for the consolidated group. A potential asset of many joining entities that requires ACA to be allocated to it will be goodwill although some entities will not have any goodwill present for various reasons. Draft ruling approach to calculating goodwill and its valuation The draft ruling outlines the proposed ATO approach to calculating goodwill as follows: Determining the value of goodwill 3. Goodwill is valued for the purposes of Part 3-90 of the ITAA 1997 using the residual value approach. This is consistent with the view of the High Court in Murry The residual value approach 4. The residual value approach to identifying and valuing goodwill when a subsidiary member joins a consolidated group entails working out the difference between: (a) (b) the market value of the entity; and the market value of the net identifiable assets of the entity. 5. The assets and liabilities taken into account for the residual value calculation are the same assets and liabilities used when working out the tax cost setting amount under Division 705 of the ITAA Reset cost base assets are included at market value. Retained cost base assets are included at their retained value. The value of excluded assets is disregarded in the entity s market value for the purpose of the residual value calculation. Liabilities are taken at the same value as they

3 The issues have for the purposes of Step 2 under section of the ITAA 1997 and are subject to the same adjustments. Legislative basis for the ATO s approach The consolidation law does not prescribe any methodology for how a calculation is to be made to determine the market value of an asset including goodwill. The position taken in paragraph 5 of the draft ruling of creating a mandated modified residual value method in the interpretation of an undefined term, therefore does not have legislative support. We request that a statement concerning the absence of a legislative methodology should be included at the start of the ruling to explain the context of the ruling as being the ATO s interpretation of how a goodwill calculation should be made. Ordinary meaning of goodwill The absence of a legislative methodology for how a calculation is to be made to determine the market value of goodwill would result in a prima facie position of using ordinary concepts. We note this approach of using ordinary concepts was adopted in relation to the consolidation treatment of assets in Taxation Ruling TR 2004/13. A view has been outlined in NTLG meetings, including the NTLG consolidation goodwill working group, that goodwill can be determined on the basis of a standalone valuation of the goodwill or using the approach suggested in the obiter of the High Court in Murry s case as follows: 49. When a business is profitable and expected to continue to be profitable, its value 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. This conventional accounting approach can be expressed as the value of the business minus the value of gross identifiable assets plus the value of liabilities to deliver the goodwill as the residual element. This can be represented as follows: Gc = Ev Ac + Lc where: Gc is the goodwill under the conventional accounting approach, Ev is the enterprise value, Ac represents the value of assets determined on a stand alone basis under the conventional accounting approach and Lc represents liabilities under the conventional accounting approach.

4 As discussed below, the conventional accounting approach to valuing goodwill is merely a potential method and this method was not prescribed in Murry s case as the only method that should be adopted for valuing goodwill. That being said, we understand however that a conventional accounting residual value approach would generally be used by valuers for determining the goodwill of a profitable enterprise. ATO s mandated modified residual value method The approach taken in the draft ruling (at paragraph 5) is essentially to mandate that: (i) (ii) the assets and liabilities used in the calculation of goodwill should be those which are used for consolidation purposes; and the values ascribed to the assets and liabilities used in the calculation of goodwill should be those which are used for consolidation purposes, instead of their normal valuations as determined using conventional valuation approaches or express limitations set out in the statute. The proposed goodwill formulation under consolidation can be represented as follows: MMGc = Evtc Atc + Ltc2 where: Evtc is the enterprise value determined after disregarding excluded assets, Atc represents assets as identified and valued for tax consolidation purposes Ltc2 represents liabilities identified and valued for tax consolidation purposes at ACA step 2 with all the adjustments in , -75, -80 and 85. MMGc represents a proposed mandatory modified goodwill under consolidation using these different building blocks. The mandated modified residual value calculation does not accord with the potential conventional accounting approach to valuing goodwill and does not align with normal commercial approaches to the valuation of assets and liabilities in the determination of goodwill. Importantly, there typically may be significant differences in valuations for assets and liabilities between each method, even if there are identical assets and liabilities under both. There may also be some differences in the identification of liabilities that are tracked for consolidation purposes vis-a-vis those which are tracked from a commercial perspective. We note that, unlike the wording of the ATO CRM, at section 2-1 page 35, the draft ruling does not recognise that other methods may also be appropriate so the approach is apparently mandated by the ATO. Given the likelihood of divergence particularly between the valuation amount recognised for liabilities from a commercial viewpoint and liabilities as proposed in the words of the draft ruling, the goodwill which would emerge would inevitably differ from the goodwill value determined under commercial concepts. The differences might or might not be material in

5 different groups, which would flow on to consideration of the ultimate impact for market valuation under the market valuation guidelines. The draft ruling s approach of introducing a mandated modified residual value method and apparently withdrawing the use of any other approach to valuing goodwill is therefore not appropriate. Is there skewing of goodwill and does this matter? The approach of the draft ruling in relation to the use of the mandated modified residual value method seems to be influenced by a desire to avoid skewing of goodwill values as referred to in paragraph 22 of the draft ruling: If the assets and liabilities taken into account under the residual value method are not the same assets and liabilities used for tax cost setting purposes, the value of goodwill would be skewed. Consequently the allocation of the cost of acquiring the joining entity among the assets that the entity brings into the consolidated group would also be skewed. However the approach of using a mandated modified residual value method to construct a goodwill value based on non-commercial and therefore unreal notions of assets and liabilities and to apply these to a real commercial value being the enterprise value, produces its own skewing. In other words, in its perceived desire to avoid skewing, the draft ruling suggests an approach that will merely create a different skewing. This is a critical point. There is no way that some neat approach can be developed to harmonise perfectly the commercially driven valuation and identification of goodwill with the inherently artificial notion of liabilities for consolidation purpose, and the slightly less artificial notion of assets for consolidation purposes. The determination of tax cost setting amounts has two distinct processes: (a) The calculation of ACA pursuant to the rigidly defined methodology adopted by the consolidation rules in section ff. (b) Allocating the outcome of the ACA calculation over the portfolio of assets in the relevant joining entity using the rules in section ff. Business and professionals operating in consolidation fully accept the divergence between the ACA quantum and its allocation. It is but one of many skewing features in consolidation which include: Differential treatment of retained cost and reset cost base assets. Numerous caps and limitations on asset values that expressly recognise that there will be excess ACA as compared with asset values. We reiterate this point. It is not commercially or administratively feasible for the ATO to determine, in late 2004 and 2005, that the approach to be used in the valuation of assets and liabilities for purposes of determining goodwill in consolidation allocation projects is to be an approach that is unrelated to normal commercial practice. We consider that: (a) there is no statutory provision requiring a unique consolidation-driven valuation approach;

6 (b) this is not the approach used by business or indeed the ATO risk-reviewing compliance officers in the period to date; (c) any change in relation to formation case calculations could involve significant costs and complexity for most consolidation entrant groups; and (d) while we can understand the desire of the ATO for some integrated model to the determination of ACA and its allocation we have demonstrated above that for the ATO to seek to use some integrated model of this type is not feasible given the artificiality of the determination of ACA for formation cases, and indeed the modifications of the allocation rules in relation to formation cases. We do not reject the use of the paragraph 5 valuation approach out of hand. As discussed below in more detail, we see some potential merit in the approach taken in paragraph 5 of the draft provided that (in relation to formation cases for groups entering consolidation in the 2003 and 2004 financial years) this approach was optional for taxpayers to take. The potential merit arises from the potential ability to use the precise calculations used for ACA and assetallocation purposes as a proxy in relation to liabilities and assets values. This could potentially reduce some uncertainty arising from the use by valuers of conventional valuation approaches using a more mechanical approach to calculations that otherwise involve questions of judgment. We remain of the view that the method must be optional not mandatory because of its distortionary impact as explained below. Divergences from conventional value of assets and that proposed in the draft ruling The differences between valuations that would be required under the draft ruling s approach and valuations under a valuer s commercial approach could arise because of differences in the value attributed to the following assets for example: - Trading stock - Doubtful debts - Capitalised costs/prepayments - FITB (excluded asset also considered below) - Franking credits (in rare cases) - Various insurance company assets Divergences from conventional definition and approach to liabilities proposed in the draft ruling A major difference will arise in respect of the valuation of liabilities for these purposes because the liabilities identification and values adopted under the ACA calculation approach will differ from those used under the conventional accounting approach. Drivers of divergent identification of liabilities include issues arising from liabilities not recorded on financial statements but which are nonetheless commercially real exposures. Many of these identification issues (for example in relation to financial derivatives and their

7 treatment) have been resolved in the process of rulings on treatment of liabilities but not all of these divergent identification of liabilities have been resolved. Drivers of divergent valuation include including the requirements of adjustments under sections to to ACA step 2 calculations which would produce significantly different values for liabilities under the draft ruling as compared to commercial valuation practice. We refer the ATO to their CRM for how step 2 and its adjustments work rather than discussing the operation of the law in any detail here. The following examples illustrate some differences that arise between use of a conventional accounting approach and the ATO s modified residual value approach. Example 1: Retained cost base assets have a market value less than their tax cost setting amount The enterprise value = $1,000. Retained cost base assets, including trading stock (assuming it is a continuing majority owned entity) and doubtful debts have a market value of $300 and a tax cost setting amount of $600. Plant has a market value of $400. Applying the mandated modified residual value method values required by paragraph 5, the market value of goodwill under the residual method is $1,000 - ($600 + $400) = Nil. Applying conventional accounting methods, the market value of goodwill is $1,000 - ($300 + $400) = $300. Self-evidently in this instance the actual market value of the goodwill is $300 and paragraph 5 produces the wrong result and is in conflict with s705-35(1)(c) which requires allocation of ACA to reset cost base assets in proportion to their actual market values - it does not sanction some constructed market value when the allocation is to goodwill. Example 2: Market value of liabilities exceeds step 2 of ACA amount The enterprise value = $1,000, including liabilities = $200. However the liabilities of $200 comprise an intra-group liability which was acquired at a cost of $100 on an arm's length basis, when the enterprise had a lower value than it has on joining - since its acquisition, the market value of the intra-group liability has risen to its face value of $200. Retained cost base assets have a market value and tax cost setting amount of $300. Reset cost base assets other than goodwill have a market value of $400. Applying the residual method, using actual market values, the market value of goodwill is $1,000 - ($300 + $400) = $300. However, applying paragraph 5 requires that the liability taken into account when applying the mandated modified residual value method is the liability determined in accordance with item 1 of the table in subsection (2) which is the cost base of the liability being $100. This

8 gives a mandated modified residual value method for the goodwill of $900 - ($300 + $400) = $200, which is the wrong result. Excluded assets At paragraph 23 of the draft ruling it is stated that the value of losses and other excluded assets is excluded from the market value of the joining entity for the purposes of the residual value calculation. We do not necessarily agree with the ATO s modified residual valuation approach to excluded assets and this requires further consideration. For example, some excluded assets are taken into account in the value of liabilities arrived for the purposes of Step 2 under section of ITAA 1997, this is the value for liabilities used when applying the residual value approach per paragraph 5. To this extent it would seem incorrect to exclude them from the market value of the entity. Furthermore, clarification is required on the valuation of excluded assets, ie is book value or market value to be adopted. Circular operation in relation to deferred tax liability Under the draft ruling, liabilities are to be measured using Step 2 concepts. In the joining case, it will be necessary to re-measure PDITs (DTLs) where cost bases have been reset under subsection (1A). This process already recognises circular calculations in recalculating DTLs and re-allocating ACA. The draft ruling brings an added dimension to the circularity as the re-measurement of goodwill will arise from the process of recalculating PDIT(DTL). This approach would seem to be practicably difficult to apply (and seems to require that the potential "uplift in tax deductions" be factored into the market valuations). This would seem to even further divorce the concept of goodwill from its commercial reality. Impact arising from subsequent changes to calculations The approach used in the draft ruling of tying goodwill outcomes to the outcomes of the ACA calculation and consolidation asset identification process, would represent a major compliance problem and in our view would be unworkable. Consider future changes to formation-case ACA calculations in a joining entity for any one of many reasons. Under the approach of the draft ruling, such ACA changes would then result in the amount calculated for goodwill on forming or joining being altered as well. Compliance issues We are also concerned how the ATO s position interacts with consolidation compliance in the 2-1/2 years since consolidation was introduced. A change in the proportionate market value of goodwill (as compared to other reset cost base assets) could alter the amount of ACA allocated to other reset cost base assets including depreciating assets. There are significant compliance issues that need to be considered with the ATO s approach, should the ATO seek to retrospectively apply the methodology contained in the draft ruling. For example the ATOs methodology could require:

9 a recalculation of the amount of ACA allocated to depreciable assets under section ; a recalculation of the allocation of ACA allocated to depreciable assets under section where there is a change in the excess from a previous calculation; a recalculation of the allocation of ACA under section where a change in the ACA allocated to depreciables results in a change in over-depreciated amounts; amendments to income tax returns for the consolidated group for the period from 1 July 2002 to 30 June The above changes could also result in a retrospective change to the opening written down value of assets contained in the fixed asset register. Where the register contains a significant number of assets, this could result in significant compliance burdens where the consolidated group is required to update the register from 1 July The position raises questions about how it interacts with materiality considerations and ATO guidance in the market valuation guidelines. Inconsistency with the CRM valuation guidelines As you are aware, the issues in the draft ruling are also discussed in section 2-1 of the ATO s CRM, albeit in a different form. For example, at section 2.1 page 35 the CRM says: Other methods may also be appropriate. We note that section 4-1 of the CRM discussion of the approach to take in relation to market valuation of goodwill is inconsistent with section 2-1 of the CRM and the draft ruling as it does not contain the constrained or prescribed approach to assets and liabilities for goodwill purposes. Section 4-1 says: When a group forms, either of two approaches can be adopted to determine goodwill. While the group can choose which approach to follow, the second is recommended where the transitional option of retaining existing tax costs has been applied to one or more entities. 1. The first approach is to value the joining entities on a group basis and apply the residual method. That is, all the forming entities (or group) can be valued as well as the group s net identifiable assets. In determining the goodwill for the group, adjustments need to be made for intragroup membership interests and intragroup assets and associated liabilities. The resulting group goodwill must be apportioned to the businesses (and therefore the relevant member entities) of the group on an appropriate basis; a reasonable method is in proportion to the value of the businesses. 2. The second approach is to determine goodwill on a standalone basis: i.e. the goodwill is calculated by reference to only the entity in question. Is the use of a constrained prescriptive approach to valuation supported by Murry s case? We provide for completeness our observations on the use of Murry s case as the draft ruling s authority for the use of a residual value method for determining the value of goodwill.

10 Essentially Murry s case was a High Court decision about whether the CGT goodwill concession, which taxed 50% of the capital gain made on goodwill, was available to the taxpayer in the circumstances before the Court 1. On the facts of Murry s case (which involved the disposal of a taxi licence which had been leased to a third party), the majority of the Court said, In the present case the taxpayer and her husband did not dispose of a business within the meaning of the exempting provision The taxpayer and her husband sold a licence to use a taxi together with shares in a taxi co-operative company.. The sale of the licence was not a disposition by the taxpayer of the goodwill of (the licensees) business nor did it dispose of the goodwill of the business of the taxpayer and her husband in so far as that business involved the running of another taxi and the leasing of the licence which is the subject of this appeal. (emphasis added) The learned judges then proceeded to detail the nature of goodwill; whether goodwill was property; the sources of goodwill; and the legal protection afforded goodwill all of which lent support to the primary view that Mrs Murry did not dispose of a business which included goodwill. In this regard, the comments made in relation to the existence of goodwill could be regarded as ratio decidendi. There were five paragraphs allocated to a discussion by the majority judges in relation to the value of goodwill. A number of observations can be made about the discussion in those paragraphs: The discussion on value is obiter that is the discussion is unnecessary to the finding in the case and therefore, whilst persuasive, is not binding on subsequent courts. The discussion distinguishes between the goodwill of a profitable business and the goodwill of non-profitable business. For the present purposes, the discussion regarding the valuing of goodwill for a profitable business is relevant. In that regard, the majority of the High Court said: The value of goodwill 48. Goodwill has value because it can be bought and sold as part of a business and its loss or impairment can be compensated for by an action for damages. An existing business is the sine qua non of goodwill which cannot exist independently of the business which created and maintains it. The value of the goodwill of a business is therefore tied to the fortunes of the business. It varies with the earning capacity of the business and the value of the other identifiable assets and liabilities. It is seldom constant for other than short periods. (i) A profitable business 49. When a business is profitable and expected to continue to be profitable, its value 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 1 The concession applied where there was a disposal of a business (or an interest in a business) that included Goodwill.

11 identifiable net assets. Admittedly this approach can cause problems in valuing goodwill for legal purposes because 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. However in a profitable business, the value of goodwill for legal and accounting purposes will often, perhaps usually, be identical. (emphasis added) Nowhere in the decision does the High Court use the term residual value method, prescribe that the residual value method is the only method to be used for valuing goodwill or prescribe or constrain the method of determination of net identifiable assets. To summarise: the High Court discussion around value must be regarded as nothing more than obiter (as the decision does not rely on the outcomes of that discussion); the High Court has not prescribed the residual value method as the method for valuing goodwill but proffers the conventional accounting approach in its discussion; the High Court has not prescribed or in any way limited the assets and liabilities which must be taken into account in determining the net identifiable assets; the High Court has not constrained the valuations to be made of such assets and liabilities so as to adopt approaches which differ from those used in conventional valuation practice. Commercial valuations should not be substituted by the ATO We reiterate that in the absence of legislative rules to the contrary (except in respect of synergistic goodwill) the commercial accounting approach to valuations should be the acceptable approach for all valuations. We refer you to the AAT case of RE: Zoffanies Pty Ltd and Federal Commissioner of Taxation [AAT Case [2002] AATA 758] for a discussion of valuations, as an example to demonstrate the various commercial approaches to valuations conducted by commercial valuers. We also note that in that decision the valuation techniques used by the taxpayer s valuers and their valuation conclusions were accepted by the Tribunal notwithstanding the ATO s experts different conclusions. In this respect relevant Tribunal comments include: at para 38: In the context of what was no more than an estimate of value, care needs to be taken when substituting one valuer s opinion for another without good reason. at para 42: The conclusion reached by the Tribunal in the light of Dr Smeaton s view of the worth of the technology, and of the value attributable to Bresatec by virtue of Cyanamid s investment in its shares, is that a competent and independent valuer other than Dr Venning might have made a similar valuation. The Tribunal is not satisfied that his valuation, which was conducted using the most widely accepted methodology, was flawed such that the Tribunal should substitute a different valuation. The Tribunal finds, having regard to the matters set out in s 73B(31)(c), (d) and (e), that Dr Venning acted professionally, from an informed scientific and economic background, and that there is insufficient evidence to suggest that the relevant expenditure would have been any less

12 had the valuation been made by a different competent and independent valuer undertaking the valuation in This further supports that it is inappropriate for the ATO to substitute a taxpayer s commercial valuation for its modified residual value approach valuation. ATO s modified residual value method may be of benefit to some taxpayers if it is not mandatory We note that some taxpayers might potentially be attracted to the idea of a constrained approach to valuing assets and liabilities and thus calculating goodwill under the residual value method. We mention this only because if some taxpayers are attracted to this then this might have some value as an optional shortcut to be expressed in a practice statement or some other ATO instrument, which is additional to the reasoned analysis of the legislation which is needed in a tax ruling. We suspect that any consolidated group which has commissioned valuations (internally or externally prepared) will have valuations that follow the conventional accounting approach or some other approach and will not be interested in complete revisions of those valuations which produce quite a different notion of goodwill. The constrained residual value method using mechanical calculations in place of actual asset of liability values might be useful in some cases, where groups might consider that this more mechanical approach reduces some fine decisions, analyses and questions of judgment by valuers in setting goodwill values. For some groups this could provide significant compliance cost savings. However the constrained approach to goodwill valuation will still involve the need to properly assess the value of liabilities and to filter these through the step 2 modifications in section 705. It is critical however that the constrained residual value method, if introduced, must be optional not mandatory for the reasons discussed above. Splitting goodwill One issue which might benefit from mention in the draft ruling or a resulting TD is the practical challenge of splitting of entity valuations into different business units and: how this might be done or, more realistically, the need to recognise that valuers and taxpayers will perform these allocations on a best endeavours basis with some ATO recognition of practical difficulties here. Synergistic Goodwill We raise a number of issues concerning the synergistic goodwill sections of the draft ruling: valuations problems with identifying and calculating synergistic goodwill; the exclusion for valuing synergistic goodwill on formation; problems with tracking additions and reductions to synergistic goodwill over time for calculation on exit; and

13 some sundry issues are also noted for development in the ruling. Identification problems We have been advised by valuers that it is difficult and indeed artificial to split synergistic goodwill from inherent goodwill and it may be impossible to perform this split even in respect of acquisitions. We raise whether the technical application of the consolidation synergistic goodwill sections on joining and leaving a consolidated group must be complied with in all circumstances. If it is practically too difficult to identify a synergistic goodwill component in a joining case, including for example because such an amount would be minor or immaterial in the overall valuation of a joining entity, then it should instead be acceptable for taxpayers to treat all goodwill on joining as inherent goodwill of the joining entity, at their option. We note that this approach may have consequences for a subsidiary member subsequently leaving the group. An earlier draft discussion paper put forward the view that it would only be in exceptional cases that goodwill would immediately accrete to the business(es) of an acquiring entity. We note that although the ATO s CRM offers the comment In many cases such synergistic benefits will not exist just after the joining time as required by subsection (3). They will often accrete (if at all) over a period of time the issue is not considered in the draft ruling. It would be helpful if the ATO s current thinking on this issue could be explained in the ruling. Exclusion for valuing synergistic goodwill on formation An exclusion from the need to value synergistic goodwill for the formation case is set out in paragraph 15 of the draft ruling. The draft ruling states however that the exclusion will only apply where the residual value method of identifying goodwill is used and the entity is valued using income projection methods of valuation. We request that a further explanation for this qualification to the exclusion be included in the ruling in relation to these conditions being necessary to prevent the duplication of synergistic goodwill on formation if a cashflow method of valuing goodwill is used for each entity. An example should also be provided. Tracking additions and reductions to synergistic goodwill Issues of recognised synergistic goodwill on entry needing to be matched to what goodwill leaves the group on exit remain. It will be problematic to work out what the amount is that leaves where there has been some time period in which businesses have been bought and sold. The draft ruling states at paragraph 9: The market value of subsection (3) goodwill is a component of the market value of the total goodwill of the joining entity worked out at the joining time using the residual value approach.

14 See also paragraph 37. There is no guidance in the ruling as to how this component should be quantified. We note however that there is some commentary on this in the CRM at C2-1 page 37 and suggest that, at a minimum, something similar could be included in the ruling. We request that the ruling address whether, where there are multiple businesses in the consolidated group, subsection (3) goodwill (S2 goodwill) would need to be broken down and attributed in part to each business. It would seem that this is necessary since businesses may enter and leave the group prior to a later application of subsection (2). Some, but not necessarily all, of the S2 goodwill will remain in the group at the time of applying subsection (2). The ruling does not cover this issue. If S2 is not broken down in this way, it seems that this could lead to the third condition in paragraph 47 of the ruling being sometimes failed? It would be helpful if an example could be provided. An issue was raised at an earlier meeting of the Goodwill working group relating to the following scenario: A Co is acquired by a consolidated group consisting of H Co and B Co. The business of A Co has some synergies with the business of B Co and A Co s goodwill can be broken down into three components being: Inherent goodwill = I Synergistic goodwill attached to A Co s business = S1 Synergistic goodwill attached to B Co s business = S2 At a later time, B Co (with its business) leaves the group, and A Co (and its business) remains in the group. It would be helpful if the ruling could include an example that addressed the following points in relation to this scenario: the rationale for the view that the cost base of S1 cannot be added to the tax cost setting amount for memberships interests in B Co under subsection (2). whether the cost base of S2 is included in the tax cost setting amount for membership interests in B Co under subsection (1); alternatively, whether S2 is extinguished at this time resulting in a capital loss to the group; what happens to the cost base of S2 of A Co and B Co leave the group at the same time.