Goodwill is a capital gains tax asset, and selling a business disposes of it. The amount the contract allocates to goodwill sets the size of the gain, which is why the ATO applies four conditions before it accepts that allocation. Goodwill built through years of trading carries almost no cost base, so nearly the whole allocation becomes assessable.
The general CGT discount and the small business concessions reduce the result where the tests are met. Goodwill of a business commenced before 20 September 1985 sits outside CGT entirely, subject to Division 149. Blackwattle Tax advises middle market vendors on the capital gains position when selling a business, including how the sale price is allocated.
What Goodwill Is for Tax Purposes
Goodwill is a CGT asset, and for tax it takes its meaning from general law rather than from the accounting standards.
That distinction changes the answer. Under the accounting definition, goodwill is the residual left once identifiable net assets are subtracted from the sale price, so a business sold below its asset value has none. Under general law, goodwill exists in relation to a business regardless of its value. The general law definition governs CGT.
Goodwill is a single indivisible asset. It cannot be split into parts and disposed of separately, however many things contribute to it. Trade names, logos, customer relationships, location and staff are sources of goodwill, not goodwill itself.
Selling a business and transferring its goodwill triggers CGT event A1. Goodwill is only a separate disposal in an asset sale. In a share sale, the vendor disposes of shares, and goodwill sits inside the value of those shares.
Why Your Goodwill Cost Base Is Lower Than You Think
Self-generated goodwill carries almost no cost base, so nearly the entire amount allocated to it becomes a capital gain.
Purchased goodwill is different. Where a business was bought at arm’s length, the cost base of its goodwill is the consideration paid for it.
Goodwill built through trading is not automatically nil, though it comes close. Certain second, third and fifth element expenditure can be included, most commonly capital expenditure incurred to establish, preserve or defend title to the goodwill.
Fourth element expenditure is specifically excluded. Capital expenditure incurred to increase the value of goodwill creates no cost base and may not be recognised for tax at all. Money spent building the business does not reduce the gain on selling it.
Also excluded from the goodwill cost base:
- working expenses and the cost of trade operations
- the owner’s own effort and services in generating goodwill
- costs of acquiring knowledge or information
- costs of establishing and maintaining the get-up of the business
- amounts already sitting in the cost base of another asset
The result catches vendors out. The accounts carry nothing for goodwill, and then the full allocation lands as an assessable gain.
How the Sale Price Is Allocated to Goodwill
The amount the contract allocates to goodwill determines the size of the capital gain, which makes it the most consequential number in the sale agreement.
Vendor and purchaser want it allocated in opposite directions. The purchaser wants weight on depreciating assets and trading stock, because those produce deductions and cost base. The vendor wants weight on goodwill, because that is the only line reaching the CGT discount and the small business concessions.
Where the parties are not dealing at arm’s length, the market value substitution rule can replace the allocated figure with market value.
The four conditions the ATO applies
The ATO will generally accept the amount the vendor and purchaser allocate to goodwill, provided all four of the following hold.
- The vendor owns the goodwill, is entitled to dispose of it, and has actually disposed of it in disposing of the business.
- The parties deal with each other at arm’s length both in transacting the sale and in allocating the proceeds.
- No amount properly attributable to a separately identifiable asset is allocated to goodwill, with a carve-out for restrictive covenants.
- The amount allocated to goodwill, added to every other asset allocation, equals the total proceeds for the sale.
Run the draft contract against those four before signing. Condition 4 fails more often than the others, usually because the schedule does not reconcile to the headline price.
A worked allocation
A business sells for $1,800,000. Figures are illustrative.
Contract line | Allocation | Tax treatment |
Trading stock | $150,000 | Ordinary income |
Plant and equipment | $250,000 | Balancing adjustment |
Restrictive covenant | $100,000 | Separate CGT asset |
Goodwill | $1,300,000 | Capital gain, discount and concessions available |
Total | $1,800,000 |
One line in that schedule reaches the concessions. The other three do not.
What the Goodwill Gain Actually Costs You
Goodwill qualifies for the general CGT discount and for the small business concessions where the relevant tests are met.
The general discount is 50% for individuals and trusts and one third for complying superannuation funds. Companies do not receive it. The asset must have been acquired at least 12 months before the CGT event, and for self-generated goodwill that period runs from when the owner started the work that created it.
Goodwill can also be an active asset, which opens the four small business CGT concessions.
Concession | Effect on the goodwill gain |
15-year exemption | Disregards the whole gain where the ownership period and the age and retirement conditions are satisfied |
50% active asset reduction | Halves the remaining gain, applied after the general discount |
Retirement exemption | Exempts an amount up to a lifetime cap, contributed to superannuation where the vendor is under the relevant age |
Rollover | Defers the gain where a replacement active asset is acquired within the required period |
The concessions stack, and the order they are applied in changes the final number. Eligibility turns on the aggregated turnover test or the maximum net asset value test, and it is decided across the vendor’s whole group rather than the business alone. Our guide to small business CGT concession eligibility sets out how each test works.
Test eligibility before the allocation is agreed, not after settlement.
When Goodwill Is Pre-CGT, and When That Status Is Lost
Goodwill of a business commenced before 20 September 1985 is a pre-CGT asset, so a gain on its disposal is disregarded.
Division 149 removes that status where the majority underlying interests in the asset change. For a company or trust holding a pre-CGT business, ownership changes over decades are the most common way the exemption is lost without anyone noticing.
Goodwill acquired later can merge into pre-CGT goodwill, but only where the two businesses genuinely become one, and the pre-CGT business keeps its essential character. Where the acquired business stays separate and distinct, its goodwill remains post-CGT. A pre-CGT business overwhelmed by a much larger post-CGT acquisition does not convert that acquisition.
What counts as the same business
Whether the original business has continued is a question of fact and degree, and it decides whether the goodwill kept its original acquisition date.
These do not create new goodwill on their own:
- organic growth, or expansion and contraction of activities
- changing the way the business is carried on
- adopting new compatible operations
- servicing different clients as the business evolves
- offering improved products or services
- discarding parts of the operation in an ordinary commercial way
These do:
- a planned, systematic change to the essential nature or character of the business
- a sudden and dramatic change through acquiring or shedding activities on a considerable scale
Where the original business ceases, its goodwill ceases with it, and the new business acquires goodwill of its own, carrying a new acquisition date for both the discount and the 15-year exemption.
Payments in the Contract That Are Not Goodwill
Several contract lines are routinely bundled into the goodwill figure and taxed differently once separated.
A restrictive covenant is a separate CGT asset. The ATO allows a vendor and purchaser dealing at arm’s length to allocate proceeds to goodwill rather than to the covenant, provided they do not specifically allocate an amount to the covenant. Naming a covenant figure in the contract removes that option and creates a separate asset with its own treatment.
Work in progress, know-how, and get-up capable of separate identification belong on their own contract lines. Trading stock produces ordinary income. Depreciating assets produce a balancing adjustment against adjustable value. None of those three reach the CGT discount.
Where part of the price depends on how the business performs after settlement, earnout tax treatment governs when that amount is assessed.
When a Sale Transfers No Goodwill At All
Goodwill only transfers where the purchaser receives a whole business they could continue to operate.
Selling a collection of assets without the rights needed to carry on the same business transfers no goodwill, because goodwill is inseparable from the business itself. Where proceeds exceed the market value of those assets, the excess is not a goodwill payment. It increases the capital proceeds for the assets sold and is apportioned across them on a reasonable basis.
The purchaser does not have to keep running the business for goodwill to transfer. Businesses are regularly acquired and folded into a larger operation, or bought from a competitor and closed. What matters is whether enough assets and legal rights moved to allow the same business to be carried on.
Goodwill Held Through a Partnership
Partnership goodwill is owned by the individual partners, not by the partnership.
Each partner holds a share of the goodwill as a CGT asset. On sale, each partner reports their share of the capital gain in their own return and applies the discount and any concessions against their own circumstances.
Eligibility is therefore tested partner by partner. Two partners selling the same business on the same day can reach different outcomes, because one satisfies the net asset value test or the retirement conditions and the other does not.
Professional Practices and Personal Goodwill
Value tied to one individual may not be transferable goodwill at all.
Personal goodwill is a source of goodwill rather than a separate asset. It cannot be carved out and sold on its own, and a key person leaving disposes of no part of the goodwill even though the value falls.
The risk runs the other way. Where what is really being sold is the vendor’s continuing personal service rather than transferable business goodwill, the amount can be characterised as ordinary income, which removes the discount and the concessions. The ATO maintains separate administrative guidance for interests in professional partnerships operating on a no goodwill basis.
Stamp Duty on the Goodwill Component
Duty on the transfer of business assets, including goodwill, is a state tax and the position differs between jurisdictions.
Some states assess duty on the goodwill component of a business transfer and others do not. Where a business trades across state lines, goodwill may be apportioned by reference to sales generated in each state. Check the position in every state the business operates in before the allocation is settled.
Goodwill Terms to Settle Before the Contract Is Signed
The allocation is fixed when the contract is signed, and every tax outcome that follows is decided by it. Four items are worth resolving before that point.
- Allocation: Test the draft schedule against the four conditions the ATO applies, starting with whether the lines reconcile to the headline price.
- Cost base: Identify what can legitimately sit in the goodwill cost base before accepting that it is nil.
- Restrictive covenant: Decide whether a covenant amount is separately named, and price what that decision costs.
- Pre-CGT status: Where the business predates 20 September 1985, confirm the status has survived Division 149 before the price is agreed.
Our Chartered Accountants advise vendors on capital gains tax, small business concessions and sale price allocation across the middle market. Book a free 30-minute strategy session with one of our directors before the contract is signed.
Goodwill Tax Questions Sellers Ask
Do you pay tax on goodwill when selling a business?
Yes. Goodwill is a CGT asset, and the amount allocated to it in the sale contract less its cost base is a capital gain. The discount and the small business concessions can reduce or remove that gain where the tests are met.
Is goodwill an active asset?
Goodwill of a business can be an active asset, which is what allows the small business CGT concessions to apply to it. Eligibility still depends on the aggregated turnover or maximum net asset value test and the vendor’s wider group position.
Can you claim a deduction for goodwill you paid for a business?
No. Purchased goodwill is a capital asset, not a depreciating one. The amount paid forms the cost base and only affects tax when the goodwill is later disposed of.
How is goodwill accounted for compared with how it is taxed?
The accounting standards recognise goodwill only where a sale price exceeds identifiable net assets, so internally generated goodwill never appears on the balance sheet. For CGT, the general law definition applies instead, under which goodwill exists in relation to a business regardless of what the accounts show.
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Disclaimer: We endeavour to make sure the information provided in this guidance is up to date and accurate. Please note, that the information is only intended to be a guide, with a general overview of information. This guidance is not a comprehensive document and should not be interpreted as legal advice or tax advice. The information is general in nature. You should seek the assistance of a professional opinion for any legal and tax issues related to your personal circumstances.