What is goodwill when you sell a business, and how is it taxed?.

What goodwill actually is.

Goodwill is not a thing you can point to. In law it is the value that flows from a business's ability to attract custom: its reputation, its location, its customer base and the way it operates. It is inseparable from the business as a whole, which is why selling a single asset on its own does not transfer any goodwill. It is usually the largest component of the price and the part most argued over, because it is where the tax advantages sit. If you are selling, our business sale and purchase service sets the goodwill in the contract.

Why goodwill matters for tax.

Goodwill is a capital asset, so a gain on it falls under the capital gains rules rather than being taxed as income. For a business commenced before the capital gains tax regime began, the goodwill component can be exempt. For a later business, goodwill can attract the general discount and the small business CGT concessions, which is why sellers usually want as much of the price as possible attributed to it. The flip side is the apportionment tension with the buyer, who gets no depreciation on goodwill. The real savings turn on the structure you hold the goodwill in.

When goodwill does not exist.

Not every business has goodwill for tax purposes. The courts look at whether the business genuinely attracts custom in its own right. Goodwill is unlikely to exist where the business is leased out to someone else who runs it, where there is no recognised customer base or repeat trade, where it depends on a licence that is not exclusive, or where it is a one-person professional practice or trade whose custom follows the individual rather than the business. Licences and franchise rights, even where valuable, are valued separately from goodwill, because they authorise activity rather than attract custom themselves.

Law referenced: Income Tax Assessment Act 1997; Commissioner of Taxation v Murry.