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Monash University Department of Business Law and Taxation
An examination of the development and meaning of goodwill and the
possibility of achieving a synthesis between its legal and accounting
concepts
Ian Hamilton Tregoning BA GradDipSysAnalysis GradDipAcc SAIT GradDipLegStud Flinders
MBA Adelaide MTaxLaw Deakin
Thesis submitted for the degree of
Doctor of Philosophy
November 2010
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Table of Contents
Table of Contents.......................................................................................................... i
Summary .................................................................................................................... vii
Declaration .................................................................................................................. ix
Acknowledgements ...................................................................................................... x
Chapter 1: Introduction .............................................................................................. 1
1.1 The elusive concept ............................................................................................... 1
1.2 Definitions of goodwill......................................................................................... 2
1.3 The divergence of the concepts of goodwill......................................................... 4
1.4 The focus of the paper .......................................................................................... 5
Chapter 2: The Evolution of Goodwill....................................................................... 6
2.1 Goodwill as a commercial concept....................................................................... 6
2.2 Early case law ....................................................................................................... 7
2.2.1 Early custom............................................................................................. 7
2.2.2 Goodwill emerges .................................................................................... 8
2.3 The development of the concept in the nineteenth century .................................. 9
2.4 Towards the modern concept of goodwill .......................................................... 11
2.5 The absence of statutory definitions of goodwill ............................................... 13
2.6 Conclusion ......................................................................................................... 14
Chapter 3: The Elements of Goodwill .................................................................... 15
3.1 Introduction........................................................................................................ 15
3.2 Sources of goodwill ............................................................................................ 16
3.3 Site goodwill ....................................................................................................... 17
3.3.1 The development of site goodwill ........................................................... 18
3.3.2 Inherent and adherent goodwill.............................................................. 21
3.4 Personal goodwill ............................................................................................... 23
3.5 Name goodwill.................................................................................................... 29
3.6 Product goodwill................................................................................................. 30
3.7 Monopoly goodwill ............................................................................................ 31
3.8 Interests in land................................................................................................... 34
3.9 Conclusion .......................................................................................................... 35
Chapter 4: The Legal Nature of Goodwill.............................................................. 36
4.1 Introduction......................................................................................................... 36
4.2 Goodwill as property .......................................................................................... 37
4.3 Goodwill as one whole item of property ............................................................ 41
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4.4 Goodwill is inseparable from the business ......................................................... 42
4.5 Is goodwill separate from the assets which contribute to it? .............................. 43
4.6 A ‘same business’ requirement?......................................................................... 45
4.7 Internally generated goodwill ............................................................................. 47
4.8 Divisional goodwill ............................................................................................ 48
4.9 Synergistic goodwill ........................................................................................... 49
4.10 ‘Illegal’ goodwill .............................................................................................. 50
4.11 In conclusion...................................................................................................... 51
Chapter 5: Goodwill and Partnerships.................................................................... 52
5.1 Introduction........................................................................................................ 52
5.2 The nature of partnership.................................................................................... 52
5.3 The treatment of goodwill in creation and variation .......................................... 53
5.3.1 Goodwill on variation in partnerships .................................................... 54
5.3.2 Goodwill in the creation of a partnership............................................... 54
5.4 The termination of partnerships.......................................................................... 57
5.4.1 Early case law......................................................................................... 59
5.4.2 Lord Eldon’s view.................................................................................. 59
5.4.3 Nineteenth century uncertainty .............................................................. 61
5.4.4 The need for sale? .................................................................................. 65
5.4.5 Professional partnerships........................................................................ 66
5.4.6 Taxation matters.................................................................................... 68
5.5 Conclusions........................................................................................................ 69
Chapter 6: Goodwill and Restrictive Covenants .................................................... 71
6.1 Introduction........................................................................................................ 71
6.2 The development of legal restraint of trade........................................................ 72
6.3 Sale of goodwill does not imply a restrictive covenant ..................................... 75
6.4 The solicitation of former customers .................................................................. 78
6.5 The exception for fraud ..................................................................................... 82
6.6 Sales by trustees in bankruptcy.......................................................................... 84
6.7 Conclusion ......................................................................................................... 85
Chapter 7: Goodwill and Stamp Duties................................................................... 87
7.1 Introduction........................................................................................................ 87
7.2 Goodwill as property .......................................................................................... 88
7.3 Goodwill and land: the early UK case law ......................................................... 90
7.4 Goodwill and land in Australia pre-Murry ........................................................ 95
7.5 A right analogous to goodwill?......................................................................... 100
7.6 FCT v. Murry.................................................................................................... 103
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7.7 Goodwill and land in Australia post-Murry...................................................... 105
7.8 Goodwill as a chattel?...................................................................................... 113
7.9 The location of goodwill................................................................................... 114
7.10 Conclusion ..................................................................................................... 117
Chapter 8: Goodwill in the Context of Licensing, Leasing and Franchising... 118
8.1 Introduction...................................................................................................... 118
8.2 The meaning and nature of goodwill ............................................................... 119
8.3 Goodwill and Licences .................................................................................... 120
8.3.1 Licences in general.............................................................................. 120
8.3.2 Hotel licences ...................................................................................... 121
8.4 Franchising ...................................................................................................... 125
8.5 Goodwill on termination of a franchise agreement ......................................... 133
8.6 Can goodwill be licensed or leased?................................................................ 135
8.7 Taxation issues................................................................................................. 139
8.7.1 Capital gains tax ................................................................................... 140
8.7.2 Stamp duties ......................................................................................... 143
8.8 In Conclusion................................................................................................... 143
Chapter 9: Goodwill and Passing-off..................................................................... 145
9.1 Introduction...................................................................................................... 145
9.2 Goodwill emerges ............................................................................................. 147
9.2.1 Spalding v. Gamage ............................................................................. 147
9.2.2 Burberrys v. Cording............................................................................... 149
9.3 The meaning and nature of goodwill ................................................................ 150
9.3.1 Goodwill as property............................................................................ 151
9.3.2 Sources of goodwill.............................................................................. 152
9.3.3 Value of goodwill................................................................................. 154
9.3.4 The concept of goodwill before Spalding v. Gamage.......................... 155
9.4 ‘Business or goodwill’...................................................................................... 155
9.5 Elements of early passing-off cases................................................................... 157
9.5.1 The need for fraud ................................................................................ 157
9.5.1 The need for property........................................................................... 158
9.5.2 Rights other than property.................................................................... 160
9.6 Goodwill in early case law ............................................................................... 160
9.6.1 The origins of passing-off .................................................................... 161
9.6.2 The place of trade marks ...................................................................... 165
9.6.3 Place names .......................................................................................... 170
9.6.4 Damage to business and profits........................................................... 171
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9.6.5 Personal reputation............................................................................... 173
9.7 The relationship of goodwill to business .......................................................... 177
9.7.1 Can goodwill be separate from the business? ...................................... 177
9.7.2 Is goodwill extinguished on cessation of business? ............................ 179
9.8 Jurisdictional issues .......................................................................................... 181
9.8.1 Goodwill v. reputation......................................................................... 182
9.8.2 The location of goodwill ...................................................................... 183
9.8.3 The recognition of ‘future goodwill’? .................................................. 184
9.9 Conclusion ........................................................................................................ 184
Chapter 10: Goodwill and Compensation ............................................................. 187
10.1 Introduction........................................................................................................ 187
10.2 The relationship of goodwill to real property .................................................. 188
10.3 Damage to business ......................................................................................... 194
10.4 Compensation under promissory estoppel....................................................... 195
10.5 Conclusion ...................................................................................................... 196
Chapter 11: Goodwill and Taxation Issues ......................................................... 197
11.1 Introduction..................................................................................................... 197
11.2 Goodwill and GST.......................................................................................... 198
11.3 Capital expenditure and goodwill .................................................................... 202
11.4 The CGT small business concessions............................................................. 205
11.5 Goodwill as an active foreign business asset................................................... 207
11.6 Goodwill and the consolidation regime.......................................................... 208
11.6.1 An entity joining a group .................................................................. 210
11.6.2 The formation of a group ................................................................... 211
11.6.3 An entity leaving a group ...................................................................... 211
11.6.4 The nature of goodwill in consolidations.............................................. 212
11.7 Goodwill and the Stamp Duty Land Tax (UK) .............................................. 213
11.7.1 The HMRC position ........................................................................... 214
11.7.2 The Australian situation ..................................................................... 215
11.7.3 UK case law ....................................................................................... 216
11.7.4 The final word .................................................................................... 216
11.8 Conclusion ...................................................................................................... 217
Chapter 12: The Valuation of Goodwill ............................................................... 218
12.1 Introduction..................................................................................................... 218
12.2 Early case law ................................................................................................. 220
12.3 Current issues in the valuation of goodwill .................................................... 225
12.3.1 Valuation of partnership goodwill...................................................... 227
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12.3.2 Valuation issues in bankruptcy .......................................................... 230
12.3.3 Valuation issues in divorce ................................................................ 232
12.4 Conclusion ....................................................................................................... 234
Chapter 13: The Origins and Development of Accounting Goodwill.............. 236
13.1 Introduction..................................................................................................... 236
13.2 The early period to WWI................................................................................ 238
13.2.1 Early accounting definitions of goodwill ........................................... 239
13.2.2 The beginnings of the literature ......................................................... 242
13.2.3 Emerging issues.................................................................................. 244
13.2.4 Summary of the period to WW1 ........................................................ 257
13.3 Between the wars ............................................................................................ 258
13.3.1 Continuing themes.............................................................................. 258
13.3.2 New views .......................................................................................... 260
13.4 Conclusion ...................................................................................................... 263
Chapter 14: Modern Accounting Goodwill........................................................ 264
14.1 Introduction..................................................................................................... 264
14.2 Theoretical and practical issues ...................................................................... 265
14.2.1 Is goodwill an asset? .......................................................................... 266
14.2.2 The treatment of goodwill .................................................................. 269
14.2.3 Internally generated goodwill............................................................. 271
14.2.4 Negative goodwill .............................................................................. 271
14.3 Standard setting in Australia.......................................................................... 272
14.4 The Australian position under the old standards ............................................ 274
14.4.1 Accounting definitions of goodwill.................................................... 274
14.4.2 Internally generated goodwill............................................................. 274
14.4.3 The treatment of goodwill .................................................................. 275
14.5 Adoption of International Accounting Standards ........................................... 275
14.6 Goodwill under the new standards ................................................................. 276
14.6.1 Internally generated goodwill............................................................. 278
14.6.2 Treatment of goodwill ........................................................................ 278
14.7 The nature of accounting goodwill ................................................................. 280
Chapter 15: Final Analysis and Conclusions ........................................................ 284
15.1 Introduction..................................................................................................... 284
15.2 Summary of the topics .................................................................................... 286
15.3 The recognition and nature of goodwill.......................................................... 290
15.4 Goodwill and its sources................................................................................. 292
15.5 The co-incidence (overlap) of the two concepts............................................. 293
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15.6 Opposite viewpoints?...................................................................................... 295
15.7 The breadth of the concepts ............................................................................ 295
15.8 A property of a business or property of a business?....................................... 297
15.9 A fallacious approach? ................................................................................... 297
15.10 The final word............................................................................................... 299
15.11 Areas for further research ............................................................................. 300
TABLE OF CASES ................................................................................................. 302
TABLE OF STATUTES ......................................................................................... 308
BIBLIOGRAPHY.................................................................................................... 310
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Summary
This paper addresses the topic of goodwill and the possibility of achieving a synthesis
between its legal and accounting concepts. The genesis for this topic was the assertion
by the High Court in FCT v. Murry that the legal and accounting concepts of goodwill
were different to the extent that a synthesis between the concepts could not be
achieved.
The approach taken involves an examination of the evolution, nature and treatment of
goodwill in both the legal and accounting contexts. The major focus is on the legal
concept, but significant attention is also given to the accounting concept to enable an
examination of the possibility of a synthesis between the two. Thus chapters 2-12 deal
largely with the legal concept of goodwilland chapters 13-14 deal with the accounting
concept. Chapter 15 contains the final analysis and conclusions.
Chapter 1 introduces the topic and addresses a range of definitions of goodwill, both
legal and accounting definitions. Chapter 2 examines the evolution of goodwill as a
commercial legal concept dating back to early references in the sixteenth
century.Chapter 3 carries on the examination of the legal concept from the point of
view of it major elements and sources. Chapter 4 deals with important issues which go
to the heart of our understanding of legal goodwill. The essential issues concern the
concept of goodwill as one whole item of property, inseparably attached to a business
but separate from its sources. Chapters 5-12 examine the concept in a range of specific
legal contexts in order to determine what they add to our understanding and also to
determine how the essential nature of legal goodwill holds up in these various
contexts.Chapter 5 deals with goodwill in the context of partnerships. Much of the
case law involving goodwill in this context arose in the nineteenth century in relation
to the termination of partnerships.Chapter 6 examines goodwill in relation to
restrictive covenants designed to protect the goodwill of a business. The history of the
law of restrictive covenants can be traced back to the fifteenth century, where an
incipient notion of goodwill may be seen to be emerging.Chapter 7 examines goodwill
in the context of stamp duties, a tax with a long pedigree stretching back to the late
seventeenth century.Chapter 8 examines the authorities concerning the nature and
treatment of goodwill in the contexts of licensing, leasing and franchising.In chapter 9
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the legal concept of goodwill is examined in the broad-ranging context of the tort of
passing-off. Goodwill plays a central part in the modern tort as the element of
business to be protected from damage by the act of passing-off.
As discussed in chapter 10, the field of compensation law presents certain treatments
of goodwill which strictly run counter to its legal nature, particularly in respect of
counting goodwill as part of land in calculating an amount of compensation. However,
as explained in this chapter, this is no more than a deeming device for the specific
purposes of calculating compensation and thus should not be taken to deviate from the
normal concept of goodwill.Chapter 11 deals with goodwill in a number of tax
contexts not covered elsewhere in this paper. The relationship between tax and
goodwill has been an uneasy one with a degree of friction between the concept of
goodwill and its tax treatment.The last of the chapters focussing on legal goodwill,
chapter 12, addresses issues concerning valuation in the legal context.
Chapters 13 and 14 deal with the accounting concept of goodwill. Chapter 13
examines the origin and development of goodwill. It plots the evolution of accounting
goodwill from its recognizable beginnings in the 1880s to WWII. Chapter 14 carries
on with the examination of accounting goodwill in the modern period, identified as the
period after WWII with an emphasis on the time from the early 1980s. As noted in the
conclusion to that chapter, the definition, valuation and treatment of accounting
goodwill have changed little in substance from the earlier periods pre-WWII.
The conclusion in chapter 15 is that goodwill is essentially the same concept in both
law and accounting, but a compound concept comprising different facets which apply
in different contexts. Therefore, the need strictly to determine a synthesis is rendered
redundant by this concept of goodwill.
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Declaration I declare that this thesis does not incorporate without acknowledgement any material previously submitted for any other degree or diploma in any university or other institution, and that to the best of my knowledge it does not contain any material previously published or written by another person except where due acknowledgement is made. Under the Copyright Act 1968 this thesis must be used only under the normal conditions of scholarly fair dealing. In particular, no results or conclusions should be extracted from it, nor should it be copied or closely paraphrased in whole or in part without the written consent of the author. Proper written acknowledgement should be made for any assistance obtained from this thesis. I certify that I have made all reasonable efforts to secure copyright permissions for third-party content included in this thesis and have not knowingly added copyright content to my work without the owner’s permission.
Ian Hamilton Tregoning
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Acknowledgements
This work had its genesis quite some time ago at another university. My first
supervisor at that university was Professor Rick Krever who was replaced for a time
by Dr David Smith until he unfortunately fell ill and Rick again took up the challenge.
During his period of supervision David proved to be most accessible and helpful and I
am indebted to his contribution. On Rick’s move back to Monash several years ago I
was fortunate to be able to follow him and transfer my enrolment to this university in
the Department of Business Law and Taxation. Rick proved to be very patient and
helpful in the saga which this paper became. While judging some of my first drafts of
chapters to resemble Agatha Christie novels, he was able to help me solve the
mysteries therein. I am very grateful that he managed to stay the course and see me
through to completion. His contribution has been most valuable and essential.
Others, of course, inevitably get drawn into a lengthy work such as this. My long-
suffering partner, Teri, has kept me going with endless cups of coffee and other
stimulants, all delivered to my office desk at regular and frequent intervals. I must also
make a special mention of my little granddaughter Chloe who, I am sure, will be the
real academic of the family. She is already reaching for the stars through her new
telescope.
Finally, I should mention two other people who have shown significant interest in this
work. First, my brother Mark has been assiduous in checking my progress, having
completed his own doctoral thesis some years ago. Secondly, my friend and erstwhile
neighbour Clem Elston has been a constant well-wisher, providing subtle
encouragement along the way.
1
Chapter 1: Introduction
1.1 The elusive concept
Goodwill has proved to be an elusive concept in both law and accounting.
Consequently, there has been much debate amongst members of these professions
concerning matters such as its identification, definition, measurement, and treatment.
The imperative for much of the recent legal attention has come from taxation matters,
such as its treatment as an asset for capital gains tax purposes and as property for
stamp duties purposes. However, goodwill also features in other areas of law such as
in actions for passing-off and in relation to restrictive covenants entered into to protect
it, to take a couple of examples. At the same time, the accounting concept of goodwill
is central to the preparation of accounting statements and financial records.
The legal concept of goodwill has proved to be contentious as well as elusive, with
courts struggling to develop a clear understanding and firm definition across diverse
areas of law. This raises the question whether there should be one concept of goodwill
for all areas of law or whether there should there be different concepts to suit different
legal situations. In accounting, goodwill has also proved to be contentious with issues
tending to reflect technical recognition and measurement involving questions such as:
What constitutes goodwill? Should purchased goodwill be written off immediately, be
amortised, be written down periodically to reflect fair value, or tested for impairment?
Should internally generated goodwill be recognized? The complexities of the legal
concept of goodwill and the difficulties which courts have experienced in defining it,
as well as the similarities and differences between the legal and accounting concepts,
form the focus of this paper.
In FCT v. Murry,1 a majority of the High Court concluded that the legal and
accounting concepts of goodwill are inherently and fundamentally different, so that
the accounting concept is of limited assistance in understanding the legal concept. In
this case, the majority2 stated:
1 (1998) 98 ATC 4585. 2 The majority comprised Gaudron, McHugh, Gummow and Hayne JJ. The sole dissenting judge was Kirby J.
2
Goodwill is also an accounting and business term as well as a legal term. The
understanding of accountants and business persons as to the meaning of the term differs
from that of lawyers. That has added to the difficulty of achieving a uniform legal
definition of the term, particularly since accounting and business notions of goodwill
have proved influential in the valuation of goodwill for legal purposes.3
Later, after considering a range of accounting and legal aspects, the majority said:
Such considerations seem to make it impossible to achieve a synthesis of the legal and
the accounting and business conceptions of goodwill. … the accounting and
commercial view of goodwill should not be regarded as an accurate statement of the
legal definition of goodwill.4
This paper investigates whether this proposition that it is impossible to achieve a
synthesis of the legal and accounting concepts of goodwill applies in all cases. In
order to undertake this investigation, the meaning of ‘synthesis’ used in this context
should be considered. Synthesis is a term used in a range of contexts with different
shades of meaning, as a reference to any good standard dictionary will indicate.5
However, the meaning applicable here may be taken to encapsulate the idea of
constituent parts or elements being combined to produce a compound whole. As a
necessary context for this investigation, the paper examines in detail both the legal and
accounting concepts of goodwill, including their historical development.
1.2 Definitions of goodwill
As noted above, goodwill has proved to be an elusive concept in the law. The elusive
nature of goodwill may be clearly discerned from the pronouncements of an array of
judges who have been called upon to deliberate in one form or another on this nature.
For example, in 1883 Cotton LJ in Cooper v. Metropolitan Board of Works observed
that ‘really “goodwill” is a word of which few people understand the meaning.’6
Following the same theme, Lord Macnaghten said in CIR v. Muller and Co’s
Margarine Ltd: ‘What is goodwill? It is a thing very easy to describe, very difficult to
define.’7 One early answer to this type of question was that it is ‘nothing more than a
3(1998) 98 ATC 4585 at 4589. 4 Id at 4590. 5 See, for example, The Shorter Oxford English Dictionary, vol. 2. 6 (1883) 25 Ch D 472 at 479. 7 [1901] AC 217 at 223.
3
hope grounded upon a probability’,8 an apt allusion to its elusiveness. The difficulty of
defining goodwill has remained a theme in cases up to the present time, as is attested
by references to this difficulty in the High Court cases of Hepples v. FCT9 and FCT v.
Murry.10
At this early stage, a general understanding of goodwill from both the law and
accounting viewpoints may be gained by recourse to a selection of formal definitions.
For example, Osborne defines goodwill at law as:
The benefit or advantage which a business has in its connections with its customers. It
is based on the probability that the old customers will continue to resort to the old place
of business, or to continue to deal with the firm of the same name. Goodwill is an asset
of a business, and on the sale of a business with goodwill, the purchaser usually obtains
the premises and the right to use the name of the old firm. The vendor of a business
may be restrained from soliciting his former customers (Trego v. Hunt [1896] AC 7).11
Osborne’s definition is a classic one, including some of the traditional aspects of
goodwill which will be examined in depth in this paper. A definition of a more
contemporary tone may be found in The CCH Macquarie Dictionary of Law:
Goodwill [is] an intangible property right constituted by the value of the reputation of a
business, its technical know-how, good location, market penetration, effective
advertising and management, and good relations with its suppliers, customers and
employees. It is distinct from other intangible industrial property rights (eg patents,
designs and trademarks).12
This legal definition focuses on goodwill as a property right, while accounting
definitions, on the other hand, typically focus on it as an asset and on the issue of its
valuation for the purposes of accounting for it. Further, in accounting there is also an
emphasis on the unidentifiable nature of the sources of goodwill, a characteristic
8Parsons on Partnership quoted in Allan, C. E. 1889, The Law relating to Goodwill, Stevens and Sons
Ltd, London, 10. 9 See (1991) 91 ATC 4808 at 4823 where Dawson J stated that goodwill was notoriously difficult to define, with reference to Lord Macnaghten’s abovementioned observation about this difficulty in Muller. 10 (1998) 98 ATC 4585 at 4589 per Gaudron, McHugh, Gummow and Hayne JJ in their joint judgment. Their Honours cited Dawson J’s view in Hepples and continued by way of explanation that ‘[o]ne reason for thisdifficulty is that goodwill is really a quality or attribute derived from other assets of the business’ (at 4589). This view is considered in detail in this paper. 11 Osborne, P. G. 1964, A Concise Law Dictionary, 5th ed., Sweet & Maxwell, London, 147. 12 1993, The CCH Macquarie Dictionary of Law, 2nd ed., CCH, Sydney.
4
which is not so apparent in legal definitions. For example, The CCH Macquarie
Dictionary of Accounting defines goodwill as:
1. an intangible asset arising from unidentifiable benefits such as the reputation of a
business, its good location, market penetration, effective advertising and management,
good labour relations and relations with its customers. It is distinct from other
intangible industrial property rights (such as patents, designs and trademarks), and is
difficult to measure since it is not possible to quite sever it from other assets of the
business entity. … 2. the future benefits from unidentifiable assets.13
This dictionary definition closely reflects the definition of goodwill for the purposes
of Australian accounting standards: namely, ‘an asset representing the future
economic benefits arising from other assets acquired in a business combination that
are not individually identified and separately recognised.’14
While the accounting profession has defined goodwill in its standards, legislatures
have avoided defining goodwill in statutes for the purposes of law, apparently in
recognition of the difficulty involved. For example, in Whiteman Smith Motor
Company Limited v. Chaplin Scrutton LJ alluded to this difficulty in observing: ‘One
would have expected a statutory definition of “goodwill”, but Parliament was unable
to frame one and left the matter to be determined by the Courts.’15 In FCT v. Murry
also, the High Court noted that the income tax legislation did not contain a definition
of goodwill because of this difficulty.16 As a consequence, the definition and meaning
of goodwill at law is to be found in case law which will be examined throughout this
paper to gain an understanding of goodwill as a legal concept.17
1.3 The divergence of the concepts of goodwill
On the basis of the High Court’s view in Murry and the differences in the legal and
accounting definitions it appears that, in the Australian jurisprudence at least, the legal
and accounting concepts of goodwill are viewed as separate. Furthermore, there
appear to be differences within the legal concept as understood and applied in
13 1991, The CCH Macquarie Dictionary of Accounting, CCH, Sydney, 111. 14 AASB 3 Business Combinations, Appendix A, Defined Terms. 15 [1934] 2 KB 35 at 41. 16 (1998) 98 ATC 4585 at 4589. 17 For an extensive collection of definitions of goodwill, dating from 1882, see Courtis, J. K., ‘Business Goodwill: Conceptual Clarification via Accounting, Legal and Etymological Perspectives’, (1983) 10(2) Accounting Historians Journal 1, Appendix 1. The bulk of the definitions have an accounting or commercial origin, but several arise from the legal side.
5
different areas of the law. Goodwill had developed into a well-known concept by the
beginning of the nineteenth century but it seems that somewhere along the line the
legal and commercial meanings parted company, at least in emphasis, giving rise to
the current legal view that they are two distinct concepts, with the High Court in
Murry concluding that ‘it is impossible to achieve a synthesis of the legal and the
accounting and business conceptions of goodwill.’18
1.4 The focus of the paper
The initial focus of this paper is on the development of the legal concept of goodwill
in the UK jurisdiction, followed by the Australian jurisdiction. This encompasses
areas of law including partnerships, restrictive covenants to protect goodwill, licensing
and leasing, passing-off, compensation, and Australian taxation including the capital
gains provisions of the income tax legislation, goods and services tax and stamp
duties. These are important areas of the law which have a significant impact on
commercial activity and have produced a large body of case law dealing with various
aspects and applications of goodwill. In addition, as indicated above, there is an
enquiry into goodwill for accounting purposes in order to examine whether a synthesis
between the two concepts can be achieved or whether this is even necessary.
Significant attention is paid to the historical development of the two concepts to
determine their evolution into their present conceptions.
Much of the analysis of the evolution of goodwill, particularly legal goodwill, takes
place in the English jurisdiction where it was recognized at an early stage. Later
analysis involves the Australian jurisdictions which provide the setting for the paper.
From the accounting viewpoint, the current concept and the definition are found to a
large extent in standards promulgated by the relevant accounting bodies. The
evolution of goodwill as an accounting concept, from the latter part of the nineteenth
century, is found in the literature, both contemporary and historical.
18 (1998) 98 ATC 4585 at 4590.
6
Chapter 2: The Evolution of Goodwill
2.1 Goodwill as a commercial concept
Early references to goodwill as a commercial concept may be found in The Oxford
English Dictionary. An obsolete meaning of the term – ‘permission to enjoy the use
(of a tenement)’ – is derived from an example dated 1562. Furthermore, the OED also
notes that Oliver Goldsmith in The Vicar of Wakefield, first published in 1766, made
reference to a similar meaning thus: ‘My farm consisted of about twenty acres of
excellent land, having given an hundred pound for my predecessor’s good-will.’19 The
context of this statement makes it clear that it was the lease of the land which was
acquired. Another reference in the OED to the commercial concept is dated 1571 and
is from a will made by a quarry owner in Gateshead, England. In this will the testator
devised: ‘I give to John Stephen … my whole interest and good will of my Quarrel
[quarry] …’.20 Here the term ‘good will’ is clearly used in a commercial context,21 but
without its meaning being entirely clear. It may simply mean a proprietary interest in
the quarry, but on the other hand it could also arguably be construed as the goodwill
of the business involving the quarry, thus giving it a more contemporary meaning.
These early references to goodwill reveal an emergent concept related in the main to
interests in real property. This, of course, is rather removed from the modern
conception concerning goodwill as property of a business and its value as part of the
business. However, it is not surprising that the early commercial conception related to
real property as that was a major measure and store of wealth at that time. But as
business activity developed and commercial concepts grew more sophisticated so did
the idea of goodwill as revealed by the later cases considered in the following
sections. By the seventeenth century there is evidence of the modern conception
developing, and this is largely the tenor of the case reports examined. Nonetheless, the
19 Goldsmith, O. 1962, The Vicar of Wakefield, J M Dent & Sons Ltd, London, 19. 20 1835, Wills and InventoriesPart 1, Surtees Society, London, 352. 21 The etymology of goodwill relates to the idea of ‘good will’ (now generally written as one word) meaning being well-disposed towards another. See Onions, C. T. (ed.) 1966, The Oxford Dictionary of
English Etymology, OUP, London under ‘good’ for a brief etymology. In its commercial sense, this term refers to the benefit a person in business may derive from customers well-disposed to buy goods or services from that business. As noted by Coomber, R. R., ‘The Nature and Value of Goodwill’, (July 1935) Accountants Journal 197 at 197, ‘In its widest sense, goodwill means just “good will”, a state or relationship between two parties, leading to mutual respect support and reliance’. The etymology of goodwill is discussed in Courtis, J. K., ‘Business Goodwill: Conceptual Clarification via Accounting, Legal and Etymologiocal Perspectives’, (1983) 10(2) Accounting Historians Journal 1 at 15-18.
7
real property concept apparently lingered on into the early nineteenth century as
indicated by the 1820 case of Baxter v. Conolly22 where Lord Eldon LC used goodwill
to refer to an interest in land. This case will be examined later in this chapter.
2.2 Early case law
2.2.1 Early custom
A few early cases may be identified as making reference to the concept of goodwill
without referring to it by that name. Rather, the term ‘custom’, indicating a form of
trade or business, is used, and typically in the context of restraint of trade questions.23
Accordingly, as early as 1620 there is a reference to the selling of custom in Broad v.
Jollyfe24 where the question concerned the validity of a promise by the defendant not
to keep a mercer’s shop in opposition to the plaintiff who had purchased all of the
defendant’s stock. The consideration for this promise in the mind of the plaintiff was
the amount he paid for the defendant’s ‘old and sullied wares’ above their real value.
He claimed to have paid the new price of £300 for old stock worth no more than £100
on the understanding that the defendant would not continue in the business. However,
the defendant had broken his promise by restocking his shop with new wares and
continuing to trade to the alleged detriment of the plaintiff. The court found for the
plaintiff in holding that the voluntary promise for consideration was good. In reaching
this decision, the court observed that in respect of this type of promise ‘he who gives
that consideration expects the benefit of his customers’25 and that the promise ‘is but
the selling of his custom, and leaving another to gain it’.26
In the 1711 case of Mitchel v. Reynolds,27 Parker CJ reviewed the cases and principles
on the law of restraint of trade, noting the circumstances in which such agreements
were legal. One such circumstance which he cited was ‘the case of an old man, who
finding himself under such circumstances either of body or mind, as he is likely to be
22 (1820) 1 Jac & W 576; 37 ER 487. 23 There are a few old cases where traders had relinquished their businesses to others and entered into covenants restricting them from competing. Some of these were held to be void, mostly because of lack of sufficient consideration. The general approach taken by the courts was that restrictive covenants were enforceable where there was sufficient consideration and they were suitably limited in their scope: Mitchel v. Reynolds (1711) 1 P Wms 181; 24 ER 347. Restrictive covenants as a means of protecting goodwill, including consideration of some of these old cases, are dealt with in chapter 6. 24 (1620) Cro Jac 596; 79 ER 509. This case has been recognized as the oldest known decision on goodwill: see, for example, Preinreich, G. A. D., ‘The Law of Goodwill’, (1936) 21 The Accounting
Review 317. 25 Ibid. 26 Id at 597. 27 (1711) 1 P Wms 181; 24 ER 347.
8
a loser by continuing his trade, in this case it will be better for him to part with it for
consideration, that by selling his custom, he may procure to himself a livelihood,
which he might probably have lost, by trading longer’.28 Thus by this time it may be
accepted that goodwill, in the guise of custom, had been established in the law as
valuable and saleable property to be protected by restrictive covenants.
2.2.2 Goodwill emerges
Goodwill as property independent of personal covenants not to compete with the
purchaser of a business was recognized in 1743 by Lord Hardwicke LC in Gibblett v.
Read.29 This case involved an action brought by the children of a testator, who had
carried on newspaper printing business, against the testator’s widow as executrix of
his estate. The business had been continued after his death and under the will the
children had claimed the interest in the profits attributable to his share in the business.
The Lord Chancellor held this share to be part of the testator’s personal estate and thus
found for the plaintiffs in holding that the executrix must account to them for the
profits. By analogy, Lord Hardwicke referred to the business of a shoemaker carried
on with the stock of the deceased and opined that the executor would be accountable
for the profits of the business. And to further the analogy, he posited: ‘Suppose the
house were a house of great trade, he must account for the value of what is called the
good-will of it.’30 Here is a reference to goodwill by name and as a separate asset of a
business. Gibblett v. Read is apparently the first case to refer to goodwill by name and
to recognize goodwill as an asset with value in its own right.31 Thus this case
represents a significant step forward in the development of the concept of goodwill.32
In line with the decision in Gibblett v. Read, it was held in Worral v. Hand33 in 1791
that money received by an executrix for the sale of the goodwill of a public house was
28 Id at 191. 29 (1743) 9 Mod 459; 88 ER 573. 30 Id at 460. 31 In support of this view, see Allan, C. E. 1889, The Law Relating to Goodwill, Stevens and Sons Ltd, London, 3. 32 By the latter part of the eighteenth century it appears that a general understanding of goodwill in the wider community had emerged as indicated by the following reference in anarticle in a contemporary periodical: ‘On her marriage with the knight, she had sold the good-will of her shop and warehouse.’ (No. 79 The Lounger, Sat 5 Aug 1786, 93.) 33 (1791) Peake NP 105; 170 ER 95. This case was decided by Lord Kenyon CJ of the King’s Bench rather than in Chancery where most goodwill cases were heard. However, in his decision Lord Kenyon referred to the Chancery practice of considering all beneficial interests as assets.
9
an asset in her hands. Furthermore, in Hammond v. Douglas34 in 1800 goodwill was
recognized as an asset of a partnership, and one which survived the death of a
partner.35 Accordingly, recognition of goodwill as an asset in its own right had been
well established by the end of the eighteenth century. To this point, however,
recognition had not led to explicit definition. There is no evidence of any attempt to
define goodwill in the case reports of this time, notwithstanding suggestions of a
generally understood meaning from the apparently familiar references to the term in
these reports.36 Nonetheless, while goodwill had been clearly recognized by this time,
it was in the nineteenth century where the law of goodwill really evolved.
2.3 The development of the concept in the nineteenth century
The nineteenth century emerges as the critical period in the development of the legal
conception of goodwill, containing a very large body of case law in marked contrast to
the relative paucity of case law in the previous centuries. It was during this century
that goodwill was defined and evolved into its reasonably settled modern form, even
though, as noted earlier, its meaning and application are still causing problems today.
34 (1800) 5 Ves Jun 539; 31 ER 726. 35 That goodwill survives the dissolution of a partnership, either by the death of a partner or by other means, was called into question by Lord Eldon LC in Crayshaw v. Collins (1808) 15 Ves Jun 218; 33 ER 736. On this question, Sir John Romilly MR said in Wedderburn v. Wedderburn (1856) 22 Beav 84 at 104: ‘… in reported cases, Lord Eldon held that a share of [goodwill] properly and of right belonged to the estate of the deceased partner. It does not survive to the remaining partners, unless by express agreement … .’ This, of course, accords with modern partnership law which requires a proper accounting to all partners for all assets, including goodwill, on the dissolution of a partnership: Re
David and Matthews [1899] 1 Ch 378. This issue is discussed in detail in chapter 6. 36 In Bunn v. Guy (1803) 4 East 190; 102 ER 803 counsel for the defendant made reference to goodwill of trades enforced by actions at law at every sittings, suggesting that goodwill was recognized as a common subject of sale by that time. However, reported cases from the courts of law do not bear out this assertion that goodwill was commonly recognized. An examination of the reports of the Courts of the King’s Bench and Common Pleas in the period of the late eighteenth century to the time of Bunn v.
Guy does not reveal cases involving express reference to goodwill, with the exception of Worral v.
Hand. Nonetheless, goodwill comes into consideration by implication in a few cases. For example, in the King’s Bench case of Cooper v. Watson (1784) 3 Dougl 413; 99 ER 724 a restrictive covenant binding one partner from competing against the other on his own account after leaving the partnership was held to exist on the Court’s construction of the partnership articles. Counsel for the plaintiff had argued successfully that the covenant was intended to protect the trade, and therefore by implication the goodwill, of the continuing partner. In addition, there is the Chancery case of Webster v. Webster (1791) 3 Swans 493; 36 ER 949 which was raised in argument in two later cases where name goodwill was involved: Levy v. Walker (1879) 10 Ch D 436 and Re David and Matthews [1895-9] All ER 817. However, it was dismissed as not being on the point by the judges in both cases because, rather than dealing with goodwill itself, it dealt with an action by an executor to restrain the defendant from using the name of the testator in the business which both parties had carried on in partnership. The action was to protect the estate from any liabilities arising from the use of the deceased’s name, rather than to protect any goodwill in connection with the name.
10
While it was not the first case involving goodwill, Cruttwell v. Lye37 in 1810, presided
over by Lord Eldon LC,38 provides the earliest definition of the term. This case
concerned an application for an injunction to prevent a bankrupt carrier from setting
up business in competition with the plaintiff who had purchased part of the bankrupt’s
business from his assignees in bankruptcy, as trustees in bankruptcy were called then.
The business purchased comprised a long established carrying trade between Bristol,
Bath and London with its associated goodwill and extensive premises in Bath. Lord
Eldon determined that there was no implied covenant on the part of the bankrupt not
to engage in a similar trade on his release from bankruptcy and refused to grant the
injunction. In considering the nature of goodwill in this case, he said:
The good-will, which has been the subject of sale, is nothing more than the probability
that the old customers will resort to the old place.39
In the light of the modern framework employed later, this particular form of goodwill
may be seen as site goodwill.40 It may be noted at this early stage that this pioneering
definition was subjected to a certain degree of criticism, or at least ambivalence, on
the part of some later judges who saw it as limited.41 However, it is plainly evident
that this is a crisp definition perfectly appropriate for the facts of the case where
customers were used to patronising a familiar place of business, the carrying terminal.
Here it is obvious that this definition was designed to suit this particular case and
nothing more. Lord Eldon spoke of ‘the’ goodwill and ‘the’ subject of sale, where the
definite article indicated specific reference to the case at hand. Clearly he did not
37 (1810) 17 Ves Jun 335; 34 ER 129. 38 Lord Eldon, John Scott 1751 to 1838, was Lord Chancellor for the periods 1801 to 1805 and 1807 to 1827. He was recognized as the outstanding judge of his day, with his reputation based largely on his mastery of equity and the development of its principles and on his contribution to the development of trademark and bankruptcy law. However, as will be revealed in this paper, he also made a considerable contribution to the development of goodwill as a legal concept. See also Tregoning, I., ‘Lord Eldon’s Goodwill’, (2004) 15(1) King’s College Law Journal 93. 39 (1810) 17 Ves Jun 335 at 346. 40 In fact, counsel for the defendant and the assignees may be seen as the authors of this first definition in offering the following conclusion regarding the nature of the goodwill in question: ‘… the subject of sale under this description of good-will is merely the advantage, attached to the premises, as having been long the scite [sic] of a particular trade; and following that trade into whosesoever hands it may come’ ((1810) 17 Ves Jun 335 at 340). 41 For example, Lord Herschell in Trego v. Hunt [1895] AC 7 at 17 said: ‘If the language of Lord Eldon is to be taken as a definition of goodwill of general application, I think it is far too narrow, and I am not satisfied that it was intended by Lord Eldon as an exhaustive definition.’ And in the same case Lord Macnaghten said (at 23): ‘Generally speaking, it means more than what Lord Eldon took it to mean in the particular case actually before him in Cruttwell v. Lye.’ Furthermore, as noted in the text above, Wood V-C also expressed similar sentiments in Churton v. Douglas (1859) 28 LJ Ch 841.
11
intend to formulate a general definition applicable to all types of circumstances in the
mould of the broader definition from Lord Macnaghten referred to below. The issue of
the perceived limitations of this first definition will be dealt with again at the
appropriate time.
Later in the century in 1856, in Wedderburn v. Wedderburn, Sir John Romilly MR
deliberated on the meaning of goodwill and the difficulty of accurately defining it,
suggesting some appreciation of its complexity and multi-faceted nature. He said:
‘[goodwill] seems to be that species of connection in trade which induces customers to
deal with a particular firm. It varies almost in every case, but it is a matter distinctly
appreciable, which may be preserved (at least to some extent), if the business be sold as
a going concern, but which is wholly lost if the concern is wound up … .’42
2.4 Towards the modern concept of goodwill
In 1859 in Churton v. Douglas Wood V-C, as one of the critics of Lord Eldon’s
definition, said in relation to that definition that ‘it was rather too narrow a view … to
say it is confined to that.’43 However, Wood V-C did opine in Lord Eldon’s defence
that he was only giving illustrations of what goodwill was in his cases which involved
site goodwill.44 As a consequence of his concern about the narrowness of Lord
Eldon’s definition, Wood V-C went on to propose the following broader definition:
Goodwill … must mean every advantage − affirmative advantage, if I may so express
it, as contrasted with the negative advantage of the vendor not carrying on thebusiness
himself − that has been acquired by the old firm by carrying on its business, everything
connected with the premises, or the name of the firm, and everything connected with or
carrying with it the benefit of the business.45
This is a definition more in accord with the modern concept of goodwill as discussed
below. In fact, it may be proposed as the first modern definition, recognizing as it does
the several elements which may comprise goodwill, including site and name goodwill
42 (1856) 22 Beav 84 at 104; 52 ER 1039 at 1047. 43 (1859) 28 L J Ch 841 at 845. 44 Apart from Cruttwell v. Lye, Wood also referred to Shackle v. Baker (1808) 14 Ves Jun 468; 33 ER 600 and Kennedy v. Lee (1817) 3 Mer 441; 36 ER 170, both of which were Lord Eldon’s cases and will be discussed later. 45 (1859) 28 L J Ch 841 at 845.
12
specifically.46 Nonetheless, as in many other cases involving other judges, Lord
Eldon’s definition and expositions of goodwill generally were drawn upon as a
starting point by Wood V-C in this case. Furthermore, site goodwill remains a
significant aspect of goodwill for many businesses, particularly those many smaller
ones which rely on local patronage. This issue, amongst others, will be taken up in the
next chapter on the elements of goodwill.
Notwithstanding the definition provided by Wood V-C in Churton v. Douglas, the
first definition of goodwill generally recognized as representing the modern concept
arises in 1901 in the form of the following frequently cited definition provided by
Lord Macnaghten in CIR v. Muller and Co’s Margarine Ltd:
It [goodwill] is the attractive force which brings in custom. It is the one thing which
distinguishes an old-established business from a new business at its 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. One element may predominate here
and another element there.47
Thus Lord Macnaghten essentially defined goodwill as that ‘attractive force which
brings in custom,’ while at the same time recognizing that it is ‘composed of a variety
of elements.’ Some of these elements were identified by Lord Lindley in the same
case as ‘situation, name and reputation, connection, introduction to old customers, and
46 While this may be taken as the first modern definition of goodwill in the UK jurisdiction, an early definition from the US federal jurisdiction is worth noting for comparison. In Metropolitan Bank v. St
Louis Dispatch Co, 149 US 436 (1893) the Supreme Court defined goodwill as ‘the advantage or benefit, which is acquired by an establishment, beyond the mere value of the capital, stock, funds, or property employed therein, in consequence of the general public patronage and encouragement which it receives from constant or habitual customers, on account of its local position, or common celebrity, or reputation for skill or affluence, or punctuality, or from other accidental circumstances or necessities, or even from ancient partialities, or prejudices’ (at 446). This definition was in fact taken from an earlier text by Story J on Partnerships published in 1841 and in it may be discerned site and name goodwill, plus an intimation of personal goodwill. One hundred years later it was cited by the majority of the Supreme Court in Newark Morning Ledger Co v. United States, 507 US 546 (1993), making it a definition which has stood the test of time. 47 [1901] AC 217 at 223-4. Previously, in Trego v. Hunt [1896] AC 7 at 24, Lord Macnaghten had warmed to the task of defining goodwill by referring to it as ‘the very sap and life of the business, without which the business would yield little or no fruit. It is the whole advantage, whatever it may be, of the reputation and connection of the firm, which may have been built up by years of honest work or gained by lavish expenditure of money.’
13
agreed absence from competition.’48 Later, in Box v. FCT the High Court of Australia
provided the following definition, referring to ‘considerations’ as the sources of
goodwill:
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.49
These elements or considerations were substantially echoed much more recently in the
form of the four ‘aspects’ of goodwill identified from the authorities and discussed in
detail by Hill J of the Federal Court of Australia in FCT v. Krakos Investments Pty
Ltd:50 namely, site goodwill, name goodwill, personal goodwill and monopoly
goodwill. As the High Court noted in FCT v. Murry,51 these aspects are helpful
descriptions of goodwill used in particular contexts. Consequently, they are used in
this paper also as helpful and convenient descriptions, forming a framework against
which to examinethe concept and its development. These aspects, or elements as they
are generally described,52 are the subject of the next chapter.
2.5 The absence of statutory definitions of goodwill
As noted in chapter 1, while accounting has formally defined goodwill in professional
standards, the law has eschewed statutory definitions, leaving the work to the courts.
No doubt, the oft-cited difficulty of defining goodwill has provided a good reason to
leave the definitions in the realm of the common law. As Scrutton LJ observed in
Whiteman Smith Company Limited v. Chaplin: ‘One would have expected a statutory
definition of “goodwill,” but parliament was unable to frame one and left the matter to
be determined by the Courts.’53 The difficulty of defining goodwill had been
recognized at an early stage as in, for example, the 1842 case of England v.
48 Id at 235. 49 (1952) 86 CLR 387 at 397 (per Dixon CJ, Williams, Fullagar and Kitto JJ). 50 (1996) 96 ATC 4063 (Full Federal Court). 51 (1998) 98 ATC 4585 at 4593 (as noted in chapter 3). 52 The term ‘elements’ rather than ‘aspects’ is generally used in this paper because the High Court in Murry used ‘aspects’ in a different sense, ie the majority referred to goodwill as having three different aspects: property; sources; and value. These aspects will arise for consideration in various parts of this paper. 53 [1934] 2 KB 35 at 41. This case involved the Landlord and Tenant Act, 1927 (UK).
14
Downswhere Lord Langdale MR referred to the difficulty ‘everybody feels in
accurately defining what is meant by the expression “the goodwill of a trade”.’54
Further examples of the difficulties of understanding and defining goodwill may be
found in later cases.55
2.6 Conclusion
While goodwill was arguably recognized as a commercial concept as early as the
seventeenth century, its evolution was rather slow. It was not until the nineteenth
century that the legal concept of goodwill evolved into its modern form. This
evolution took place in the common law, in the absence of statutory definition. Thus,
in the legal sphere, the meaning of goodwill must be gained from case law. And, in
order to gain this meaning, the nature of goodwill and it relationship to the business
must be understood. To this end, chapter 3 examines the aspects or elements of
goodwill, based on its sources, and chapter 4 examines critical issues concerning the
essential nature of goodwill. The understanding of goodwill gained from these
chapters sets up a platform for the examination of goodwill in a range of legal
contexts, with an ultimate view to considering a synthesis between the legal and
accounting concepts of goodwill.
54 (1843) 6 Beav 269 at 276; 49 ER 829 at 832. 55 For example, see observations made in Cooper v. Metropolitan Board of Works (1883) 25 Ch D 472 and CIR v. Muller and Co’s Margarine Ltd [1901] AC 217. Both of these observations were referred to in chapter 1.
15
Chapter 3: The Elements of Goodwill
3.1 Introduction
The major elements of goodwill were identified and classified in chapter 2 as site
goodwill, name goodwill, personal goodwill and monopoly goodwill.56 This
classification is one used for general convenience and provides a framework which
stands up well in the light of the authorities. In recognizing the usefulness of these
elements, the High Court said in FCT v. Murry:
It is true … that cases contain many statements referring to site goodwill, personal
goodwill, name goodwill and monopolies giving rise to goodwill. But these descriptions
of goodwill are used because, in particular contexts, they are helpful in explaining, for
example, where goodwill is situated or why some other asset has or has not been
transferred with the goodwill of the business or why the transfer or mortgage of an asset
also transfers or mortgages the goodwill of the business or why the goodwill of a
business which has been sold arises from a monopoly and was not ‘attached to or
connected with land a lease or which is granted assigned or surrendered’.57
56 A more colourful classification of the elements of goodwill may be found in Whiteman Smith Motor
Company Limited v. Chaplin [1934] 2 KB 35 where Scrutton LJ referred to these elements as the ‘cat’, ‘rat’ and ‘dog’, and Maugham LJ introduced a fourth metaphorical element, the ‘rabbit’. Scrutton LJ explained this classification thus (at 42):
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 probability of their custom may be regarded as an additional value given to the premises by the tenant’s trading. 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.
Maugham LJ considered that ‘there should be a fourth animal, the rabbit, to indicate the customers who come simply from propinquity to the premises; and … it will be apparent that the rabbit may be much bigger than the cat … ’ (at 50). However, while these elements from the animal kingdom may be of some interest because of their colourful allusions, they do not offer much to our understanding of goodwill, a point effectively admitted by Maugham LJ himself (see 50). Moreover, in Mullins v.
Wessex Motors Ltd [1947] 2 All ER 727 Evershed LJ found the notion of ‘cat’ goodwill to be misleading in considering the same legislation which was at issue in Whiteman Smith. Nonetheless, in the cat and the rabbit there may be seen reflections of site goodwill, while the dog suggests personal goodwill. The rat does not fit any element used in this paper, but rather suggests the antithesis of goodwill – custom lost to the business. In FCTv. Williamson (1943) 67 CLR 561 at 564, Rich J found some passing use for these ‘zoological’ classifications ‘as a reminder that the goodwill of a business is a composite thing … , many customers being no doubt actuated by mixed motives in conferring their custom.’ 57 (1998) 98 ATC 4585 at 4593.
16
These elements are not meant to be an exhaustive group; other elements or concepts of
goodwill may be found and considered where appropriate.58 As discussed in the
previous chapter, the legal concept of goodwill began to take a recognizable shape in
the early nineteenth century and evolved during that century into what may be taken
as largely its modern concept. The purpose of this chapter is to examine the
development of each of the above elements. Splitting the examination into these
elements may be seen as somewhat arbitrary, but it helps to make the task more
manageable, given the complex nature of the concept. Nonetheless, no element can
necessarily be dealt with in isolation from another, particularly as the goodwill of a
business will often involve more than one, and perhaps all, of these elements.
Consequently, the various elements may be involved in the discussion of any one of
them.
3.2 Sources of goodwill
In the above section, goodwill has been identified as having elements for the purpose
of classification. As the High Court in FCT v.Murry59 observed in response to cases
such as CIR v. Muller and Co’s Margarine Ltd,60 it had been common to describe
goodwill as being composed of elements. However, in what may be seen as a more
perceptive and accurate assessment of the nature of goodwill, the High Court saw it as
having sources rather than elements. In the words of the Court:
… goodwill is a quality or attribute that derives inter alia from using or applying other
assets of the business. Much goodwill, for example, derives from the use of trade marks
or a particular site or from selling at competitive prices. But it makes no sense to
describe goodwill in such cases as composed of trade marks, land or price, as the case
may be. Furthermore, many of the matters that assisted in creating the present goodwill
of a business may no longer exist. It is therefore more accurate to refer to goodwill as
having sources than it is to refer to it as being composed of elements.61
Nonetheless, the High Court did not see itself as providing a new definition of
goodwill in making this observation. Rather, it invoked Lord Lindley in Muller in
support of its view in asserting that ‘Lord Lindley referred to goodwill as adding value
58 For example, ‘product goodwill’ and goodwill as an interest in land are both addressed in this chapter. 59 (1998) 98 ATC 4585. 60 [1901] AC 217. 61 (1998) 98 ATC 4585 at 4591.
17
to a business “by reason of” situation, name and reputation, and other matters and not
because goodwill was composed of such elements.’62 Thus the High Court recognized,
most significantly, that the so-called elements of goodwill were in fact the sources of
that goodwill.63
The sources of goodwill are those qualities of a business which generate the goodwill.
They may be other property of the business and also non-proprietary things such as
effective marketing, superior management, and good customer relations.64 The
identification of goodwill as having sources represents a notable and significant
contribution to the jurisprudence of goodwill by the High Court. It enables goodwill to
be posited as an item of property in its own right, separate from the sources which
generated it. This matter is taken up in chapter 4 on the nature of goodwill. However,
for the purposes of this chapter the major elements of goodwill referred to in the
introduction will be used as the framework for an examination of the development of
the legal concept of goodwill. Of course, these elements may now be recognized as
major sources of goodwill in the wake of Murry.
3.3 Site goodwill
As noted in chapter 2, Lord Eldon’s first definition in Cruttwell v. Lye65related to what
may be termed site goodwill in modern terms. This aspect of goodwill was identified
by Hill J in FCT v. Krakos Investments Pty Ltd 66 as that which depends on the habit
of customers resorting to a particular site or location of business. His Honour referred
62 Ibid. As already noted, some of these elements were identified by Lord Lindley in the same case as ‘situation, name and reputation, connection, introduction to old customers, and agreed absence from competition’ ([1901] AC 217 at 235). 63 The idea of goodwill having sources may be found in Anonymous, ‘An Inquiry into the Nature of Goodwill’, (1953) 53 Columbia Law Review 660 at 663 where it was proposed that a distinction should be made between an element and a source of goodwill. In this context, an element was understood to be an advantage implicit in goodwill, essentially the goodwill itself. (In this sense, element was used differently from the way it was used in Muller.) A source was explained as a factor that could be removed without destroying the advantage of the goodwill, an indication of a source of goodwill as used in Murry. A patent was given as an example of such a source because, it was explained, ‘[w]hen the patent expires, the business will retain an advantage based on customer preferences developed during the period of patent protection’. Goodwill was also identified as having sources in Seed, H. E. 1937, Goodwill as a Business Asset, Gee & Co Limited, London, 9, but in this case the author did not view the sources as necessarily separate from the goodwill. 64 In respect of typical sources of goodwill, the High Court in Murry said: ‘Many of the sources of goodwill are not themselves property. Nor are they assets for accounting purposes. Thus, manufacturing and distribution techniques, the efficient use of the assets of a business, superior management practices and good industrial relations with employees, may be sources of the goodwill of a business because they motivate service or provide competitive prices that attract customers. Yet they are neither property, nor assets for accounting purposes’ ((1998) 98 ATC 4585 at 4591). 65 (1810) 17 Ves Jun 335; 34 ER 129. 66 (1996) 96 ATC 4063.
18
to the joint judgment of Dixon CJ, Williams, Fullagar and Kitto JJ of the High Court
in Box v. FCT67 in which they proposed that premises may have site goodwill as a
result of being favourably located or may acquire such goodwill from customers
becoming accustomed to attending a site over a number of years. The High Court in
FCT v. Murry saw the fundamental importance of site goodwill in holding:
In some businesses, price and service may have little effect in attracting custom. The
goodwill of such businesses may derive almost wholly from their location. This will
often be the case where there is no nearby competitor and custom is drawn from nearby
residents or those who must pass by the site of the business.68
Thus, while site goodwill may be seen as a basic element of goodwill, it nonetheless
remains a significant one for many businesses, particularly those many smaller ones
which rely on local patronage. Dating back to the first definition in Cruttwell v. Lye,
site goodwill has a long pedigree which justifies a detailed study of its development
and application over the last two centuries.
3.3.1 The development of site goodwill
Lord Eldon was not required to consider site goodwill per se in any case other than
Cruttwell v. Lye, but this element of goodwill was involved or raised in several of his
other cases,69 even though the issues concerned other matters. This is to be expected,
of course, because business location would have been a common basis for goodwill in
Lord Eldon’s time. Furthermore, in Chissum v. Dewes soon after Lord Eldon’s
Chancellorship, Sir John Leach MR dealt with this element in holding that:
The good-will of the business is nothing more than an advantage attached to the
possession of the house; and the mortgagee, being entitled to the possession of the
67 (1952) 86 CLR 387 at 398. Similar recognition of site goodwill by the High Court may be found in FCT v. Williamson (1943) 67 CLR 561, Berry v. FCT (1953) 89 CLR 653 and FCT v. Connolly (1953) 90 CLR 483. 68 (1998) 98 ATC 4585 at 4591. 69 Site goodwill was raised by counsel in Williams v. Williams (1818) 2 Swans 253; 36 ER 612, Cook v.
Collingridge (1823) Jac 607; 37 ER 979, and Dakin v. Cope (1827) 2 Russ 170; 38 ER 299. It was also referred to by counsel in Bunn v. Guy (1803) 4 East 190; 102 ER 803, a case referred to the King’s Bench by Lord Eldon for its opinion on the validity of a contract of sale. Furthermore, there are intimations of the importance of site or locality in Shackle v. Baker (1808) 14 Ves Jun 468; 33 ER 600 and Kennedy v. Lee (1817) 3 Mer 441; 36 ER 170.
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house, is entitled to the whole of that advantage. I cannot separate the good-will from
the house.70
And earlier in 1817 in Harrison v. Gardner, Sir Thomas Plumer V-C had alluded to
site goodwill in his insightful observation that:
A person, not a lawyer, would not imagine that when the goodwill and trade of a retail
shop were sold, the vendor might the next day set up a shop within a few doors, and
draw off all the customers.71
From these early nineteenth century cases site goodwill became a fixture on the
commercial landscape. It is interesting to note that it was prevalent in cases involving
public houses, a situation which has persisted to this day.72 The need for such
businesses to be licensed sets them aside from many other businesses, a distinguishing
feature noted as far back as 1842 by Lord Langdale MR in England v. Downs.73 This
feature, with the added issues it brings to the sale of such a business, may account for
the prevalence of goodwill cases involving public houses. Amongst the earliest of
these public house cases was Dakin v. Cope74 argued before Lord Eldon on appeal.75
The nature of the goodwill was not a primary issue in this case, but counsel for the
plaintiffs made the pertinent observation that ‘[t]he value of a public-house consists,
in great measure, of the good-will attached to it.’76 In Ex parte Punnett, Sir George
Jessel MR came straight to the point on this issue in pronouncing with splendid
finality:
70 (1828) 5 Russ 29 at 30; 38 ER 938 at 938. 71 (1817) 2 Madd 198 at 219; 56 ER 308 at 316. 72 For example, see FCT v. Krakos Investments Pty Ltd (1996) 96 ATC 4063. 73 (1842) 6 Beav 269 at 276; 49 ER 829 at 832. Upon the particular facts of this case, the court found that the goodwill of the public house was attached to, and included with, the trading stock and licence, the subjects of a trust for the benefit of one party, and not to the premises which passed to another party. This decision was reached despite the court’s view that the goodwill of this business was ‘the chance or probability that custom would be had at a certain place of business in consequence of the way in which that business has been previously carried on’ (at 276-7). However, the court determined that the goodwill was generated by the stock and licence, and thereby was annexed to them rather than to the premises. 74 (1827) 2 Russ 170; 38 ER 299. 75 An even earlier case was Worral v. Hand (1791) Peake NP 105; 170 ER 95 in which it was held by the King’s Bench that an executrix was required to account for the money received from the sale of the goodwill of public-house as an asset in her hands. The nature of the goodwill is not indicated in the brief report of the case, but it is reasonable to surmise that the location of the public house was a major consideration. 76 (1827) 2 Russ 170 at 179; 38 ER 299 at 302-3.
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It is quite plain that the goodwill of a public-house passes with the public-house. In
such a case the goodwill is the mere habit of the customers resorting to the house. It is
not what is called a personal goodwill. Therefore as to that there is really no more to be
said.77
The Earl of Halsbury LC in CIR v. Muller and Co’s Margarine Ltd expressed a
similar view in a more circumspect manner in saying:
In the case of a public-house, owing to the convenience of its situation and its being
known as a favourite place of resort, the advantages of its situation are so mixed up
with the goodwill of the business that, as a matter of fact, it may well be that it is very
difficult to sever them … .78
Later cases followed this view. For example, in Tooth & Co Ltd v. CSD79 both Pring
and Sly JJ saw the goodwill of a hotel as attached to the premises and thus inseparable
from the lease. Similarly, in Daniel v. FCT Knox CJ referred to a significant number
of English cases, including Ex parte Punnett and Muller and Co’s Margarine Ltd, and
stated:
If, having regard to the decisions and dicta in these cases, I am at liberty to express an
opinion on the abstract question whether the goodwill of a licensed victualler’s business
is separable from the premises in which it is carried on, my opinion is that while it
cannot be said to be absolutely and necessarily inseparable from the premises or to have
no separate value, prima facie at any rate it may be treated as attached to the premises
and whatever its value may be should be treated as an enhancement of the value of the
premises.80
However, as noted above, the issue of the goodwill of a public-house or hotel is
complicated by statutory licensing requirements. A basic requirement is that the
premises be licensed. While the licence remains with the premises, it must add value
to them, thus being a major contributor to site goodwill. This relationship between the
premises and the licence was recognized in Anthoness v. Anderson where Holroyd J
said:
77 (1880) 16 Ch D 226 at 233. 78 [1901] AC 217 at 239. Lord Lindley supported this view with his comment that: ‘in some cases and to some extent goodwill can and must be considered as having a distinct locality … . The goodwill of a public house or of a retail shop is an instance’ (at 235). 79 (1909) 9 NSWSR 652. 80 (1928) 42 CLR 296 at 302-3.
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The right to have the licence … was part of the goodwill. The two things went together,
and although the licence could be assigned at law, it was so attached to the premises,
and so considered as part of the goodwill, that it was inseparable from it … .81
Notwithstanding the indications from these cases, goodwill of course is not part of
premises, even though those premises may be a major source of the goodwill. This
matter is discussed at some length in chapter 7.
3.3.2 Inherent and adherent goodwill
In Whiteman Smith Motor Company Limited v. Chaplin two separate but related forms
of site goodwill were identified: inherent goodwill and adherent goodwill. In
deliberating on the value of business premises to a landlord, Scrutton LJ made
reference to these forms in saying:
… a proportion of the profit … will remain attached to the premises after the tenant has
gone and left them, taking with him what he can. Some of this ‘remaining profit’ will
have nothing to do with the tenant; for instance, the possibility of profit from the
advantageous site of the premises … . But some portion of the increased value of the
premises to the landlord when the tenant leaves at the end of the term may be the direct
result of tenant’s carrying on the business during the tenancy, and it this portion that the
landlord gains when the tenant leaves … the landlord is gaining an increased value in
the premises due directly to the work of the tenant, the probability of the old customer
resorting to old shop.82
Maugham LJ also addressed the difference between these forms and gave them their
names:
If the term ‘adherent goodwill’ is used, it is essential to define it. I shall use the phrase
‘net adherent goodwill’ as meaning the goodwill, if any, which will remain attached to
the premises, not including the ‘site goodwill,’ that is, irrespective of customers who
would come to a new tenant, starting a new business, simply because of their
convenient situation. In a sentence it is important not to confuse site goodwill, which is
inherent, with net adherent goodwill.83
81 (1887) 14 VLR 127 at 145. 82 [1934] 2 KB 35 at 41. 83 Id at 48-9.
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In the above passage, Maugham LJ distinguished adherent goodwill from site
goodwill for the specific purpose of the legislation in question.84 As a general
approach, however, this would be a somewhat semantic and unnecessary distinction to
make because both forms relate to goodwill emanating from the site of the business.
In general it would be preferable to refer to one as ‘inherent’ site goodwill and the
other as ‘adherent’ site goodwill. Accordingly, ‘inherent’ site goodwill would be that
goodwill which arises from the convenient location of the business premises, with the
attendant probability of trade resulting from that convenience. In short, the goodwill is
inherent in the location. On the other hand, ‘adherent’ site goodwill would be that
goodwill which arises from the trading on the premises. This is goodwill which
adheres to the premises, rather than being inherent in the location of those premises.
Adherent goodwill is the association customers make with the business which has
been conducted on the premises; they are likely to continue patronising a new
business of the same kind conducted on those premises. The distinction between these
two forms of site goodwill was recognized by Dixon CJ, Williams, Fullagar and Kitto
JJ in their joint judgment in Box v. FCT where they observed:
Some premises have a site goodwill because the site has some particular advantage for
carrying on a business as where premises adapted for a shop are situated in a position
specially favourable for the business in a busy shopping centre or where a licence can
be obtained for carrying on a business such as that of a publican on a suitable site on
which it would otherwise be unlawful to carry it on. Other premises may have acquired
a site goodwill, as in the case of a retail store, because a profitable business has been
carried on there for a number of years and people have become accustomed to resort to
that site to do their business.85 In Mullins v. Wessex MotorsLtd
86 the same legislation as in Whiteman Smith was
under consideration. In deliberating on the amount of goodwill adherent to the
84 The legislation in question was contained in s. 4(1) and s. 5(1) of the Landlord and Tenant Act 1927 (UK). Subsection 4(1) provided for an amount of compensation to be paid to a tenant on termination of the tenancy where the premises would command a higher rent as a result of the tenant’s business having been conducted on those premises. That is, the premises would have been made more valuable from the association with the business. This is the ‘adherent’ goodwill referred to by Maugham LJ. Subsection 5(1) provided for the granting of a new lease where the amount under s. 4(1) would not compensate the tenant for the loss of goodwill from moving premises. See Haley, M., ‘The Statutory Regulation of Business Tenancies: Private Property, Public Interest and Political Compromise’, (1999) 19(2) Legal
Studies 207 for the history and policy behind this statute and its successor, the Landlord and Tenant Act 1954. 85 (1952) 86 CLR 387 at 398. 86 [1947] 2 All ER 727.
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premises, Evershed LJ was pointedly critical of the relevance of ‘cat’ goodwill,
holding that such goodwill included (inherent) site goodwill as well as adherent
goodwill which was the subject of the provision of compensation under the
legislation. Here Evershed LJ referred to the site goodwill as the animus revertendi,
the intention of returning, and opined that was also included in the so-called ‘cat’
goodwill which he dismissed in saying: ‘… if it is true that a cat has nine lives, we
express the hope that in relation to the Landlord and Tenant Act it has lived the last of
them and may now be decently interred.’87 In fact, the whole zoological classification
does not add anything of consequence to the general concept of goodwill and should
therefore be ‘interred’ as a whole.88
3.4 Personal goodwill
Personal goodwill depends on the personal characteristics of a person or persons
associated with the business. Thus such goodwill, relying on the person, is
independent of the site of the business premises. As was recognized in 1883 by Cotton
LJ in Cooper v. Metropolitan Board of Works,89 these are different kinds of goodwill.
Lord Eldon, who had such a great influence on the law of goodwill, clearly recognized
goodwill that was personal in nature. But he had reservations about the ability to
transfer such goodwill, particularly where it involved professional businesses. In his
view, the very personal nature of this form of goodwill made it incapable of being
transferred. As early as 1803 he saw fit to refer the case of Bunnv.Guy90 to the King’s
Bench for that court’s opinion on the validity of a contract for the sale of a solicitor’s
practice. Included in the contract of sale was an agreement by the vendor to
recommend his clients to the purchasers of his practice, a standard means of
conveying personal goodwill. The King’s Bench found the contract to be valid at law,
thus effectively recognizing the sale of personal goodwill in a professional business.
Notwithstanding this decision, however, Lord Eldon remained unconvinced that
87 Id at 729. 88 However, the zoological classification from Whiteman Smith Motor Company lived on in the collective mind of Her Majesty’s Revenue and Customs in the UK until very recent times. HMRC relied on this classification to support their approach to imposing duty on certain land transactions under the Stamp Duty Land Tax. See a consideration of this approach by HMRC in Chapter 11: Goodwill and Taxation Issues. See also Tregoning, I., ‘Goodwill and the Stamp Duty Land Tax’, [2007] (5) British Tax Review 650. However, since January 2009 the HMRC have dispensed with these animals for being unhelpful: see chapter 11, para. 11.7.1. 89 (1883) 26 Ch D 472. 90 (1803) 4 East 190; 102 ER 803. Counsel for the plaintiff in this case argued that the personal nature of goodwill made it incapable of transfer, but without adducing any authority for this position.
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professional persons could recommend their clients to the purchasers of their business,
as is plainly evident in the case of Candler v. Candler91considered later.
So while the courts of law might have been comfortable with the idea of the sale of
the personal goodwill of a professional business, Chancery clearly was not, as is
further evidenced by Bozon v. Farlow92 heard by the Master of the Rolls in 1816. This
case involved a bill filed by the plaintiff for specific performance to compel the
defendant to pay for the purchase of his attorney’s practice as purportedly agreed
between them. The agreement was vague in some particulars and Sir William Grant
MR found it difficult to identify just what would constitute the plaintiff’s business
which should be conveyed to the defendant if he were compelled to pay the agreed
amount. Nevertheless, the reported facts of this case indicate, inter alia, that the
plaintiff was to introduce his clients to the defendant and the plaintiff expected that the
clients would follow his recommendation. However, the personal nature of an
attorney’s business, depending so heavily on the personal relationship between
attorney and client, inhibited Grant MR from finding anything that could be conveyed
under an order for specific performance.93 He felt especially inhibited in this regard
because there was no express restrictive covenant in the agreement to protect any
goodwill of the business,94 and on the authority of Cruttwell v. Lye such a covenant
could not be implied. Furthermore and most importantly, he was clearly influenced by
his understanding of Lord Eldon’s general doubts about contracts for the sale of
solicitors’ practices. With reference to Bunn v. Guy, Grant MR postulated that the
‘Lord Chancellor doubted not only the propriety, but the legality of [some of the
conditions of sale]; and, though it was ultimately determined that they were not
illegal, I think that he would hardly have decreed them to be specifically executed.’95
The Master of the Rolls dismissed the bill accordingly.
91 (1821) Jac 225; 37 ER 834. 92 (1816) 1 Mer 459; 35 ER 742. 93 In Austen v. Boys (1858) 27 LJ Ch 714, Lord Chelmsford LC was also of the opinion that an agreement to sell the goodwill of a solicitor’s practice was ‘incapable of being enforced by specific performance’ (at 718). Doubts were also expressed in Arundell v. Bell (1883) 52 LJ Ch 537 regarding the existence of goodwill in a solicitors’ practice. Both of these cases are dealt with in this paper. 94 The absence of a protective restrictive covenant, although most unwise, would not, as Grant seems to suggest, necessarily mean the absence of goodwill also. The absence of such a covenant, however, would be expected to affect the value of the goodwill if the vendor set up in competition. 95 (1816) 1 Mer 459 at 472-3; 35 ER 742 at 747. As a decision of the King’s Bench, Bunn v. Guy did not report Lord Eldon’s supposed doubts, of course. But counsel for the defendant in Bozon v. Farlow argued that Lord Eldon ‘had expressed his great disapprobation of that species of contract, and
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Later, in 1821, Lord Eldon himself addressed the issue of the transferability of what
was in essence personal goodwill in Candler v. Candler96where lawyer Henry Candler
left all his estate to his widow as executrix for the benefit of their ten children. Shortly
after his death, his eldest son, also named Henry, entered into an agreement with his
mother as executrix to carry on his father’s law practice97 and to account to her for a
moiety of the net profits. It was agreed that the mother would supply the son with
sufficient money to carry on this business. Further, there was a clear expectation
concerning ‘the influence which mother and family would retain with his father’s
clients and connections’.98 In other words, Henry Candler expected to have the benefit
of the goodwill of his father’s business, although the term ‘goodwill’ was not referred
to in the judgment.99 To this end, his mother covenanted ‘to use her utmost
endeavours and influence to induce her friends and connections to employ him’.100
The motion before Lord Eldon in Candler v. Candler was to dissolve an injunction
regarding the collection of debts of the business. But in his deliberations he went to
the question of the validity of the agreement between the mother and the son for the
son to carry on the law practice, relying on the father’s former clients, and for the
sharing of the profits with her.101 Lord Eldon expressed reservations about such
arrangements, but took a pragmatic view of their acceptance at law, stating:
considerable doubts of its legality’ (at 466). These views, together with those of Grant MR himself, strongly suggest a general understanding of Lord Eldon’s views although, as would be expected, counsel for the plaintiff seemed less taken with ‘whatever be represented to have been the opinion of the Lord Chancellor’ (at 470). However, as discussed in this paper, Lord Eldon made his doubts clear in the later case of Candler v. Candler (1821) Jac 225; 37 ER 834. 96 (1821) Jac 225; 37 ER 834. 97 The practice was described as a ‘business of an attorney or solicitor and conveyancer’. 98 (1821) Jac 225 at 225. 99 Goodwill is not expressly referred to in all of the early cases, but in those cases lacking express reference it is still clear that it is goodwill, inter alia, under consideration. Matters relating to the conveyance of custom or business from one party to another imply the transfer of goodwill. As Malins V-C observed in Shipwrightv.Clements (1871) 19 WR 599 at 600: ‘The sale of a business is a sale of goodwill. It is not necessary that the word “goodwill” should be mentioned.’ This principle has been given support by the High Court in FCT v. Connolly (1953) 90 CLR 483 and FCT v. Murry (1998) 98 ATC 4585 at 4592 where the majority said: ‘The sale of hotel premises, for example, may involve the sale of goodwill although the contract does not refer to goodwill.’ See also Aidinis v. Hotchin [1971] SASR 446 at 449 (per Wells J). 100 (1821) Jac 225 at 226. 101 In this case certain statutes were referred to concerning the prevention of unqualified persons from being involved in businesses of attorneys or notaries and holding themselves out to be qualified in these professions. (The statutes were 22 Geo 2, c 46 for the regulation of attorneys and 41 Geo 3, c 76 for the regulation of public notaries.) However, Lord Eldon found that the mother in this case had not held herself out to be in partnership with her son in contravention of these statutes, notwithstanding her sharing in the profits. In fact, women were not admitted to the legal profession in England until 1919 when the barrier to their admission was removed by the Sex Disqualification (Removal) Act, 1919.
26
I have thought that, consistently with the policy of the law, agreements could not be
made by which they contract to recommend those who succeed them. I doubted
whether professional men could be recommended, not for skill and knowledge in their
profession, but for a sum of money paid and advanced. I knew this would rip up many
transactions, and I was happy that the Court of King’s Bench was of a different opinion,
though I never could entirely reconcile myself to their doctrine.102
Smale v. Graves103in 1850 represents a move away from the doubts espoused by Lord
Eldon to an acceptance of personal goodwill in a professional business. This case
involved the sale of the business of a deceased surgeon-dentist to another in the same
profession by the deceased’s widow as executor of his estate. Included in the sale was
the goodwill of the business for an amount of 500 pounds payable to the
widow/executor for her recommendations and personal introductions of patients of the
former business to the purchaser. It was argued by counsel on the authority of Farr v.
Pearce104 and Spicer v. James (unreported) that ‘the law does not recognise the
existence of the goodwill of a profession’,105 distinguishing a professional business
from a commercial one. But Knight-Bruce V-C was not persuaded and effectively
accepted the existence of goodwill in his decision. Nonetheless, this decision did not
put the issue to rest, as is shown by the contrary view of Lord Chelmsford LC in
Austen v. Boys106 in 1858 where he stated that ‘the term “goodwill” seems wholly
inapplicable to the business of a solicitor, which … is entirely personal, depending
upon the trust and confidence which persons may repose in his integrity and ability to
conduct their legal affairs.’107 Furthermore, reservations regarding personal goodwill
in professional businesses persisted, as evidenced by comments made obiter by the
102 (1821) Jac 225 at 231. It is interesting to note Lord Eldon’s acceptance, albeit equivocal, of the law courts’ opinions of these particular contracts, given his firm view that Chancery was not in fact bound by the opinions of these courts and his rejection of them regarding other matters. In Lansdowne v.
Lansdowne 2 Bligh 60 at 86; 4 ER 250 at 259-60, he said: ‘… although it is highly useful, in legal questions, to resort to the assistance of the Courts of Law, yet it must be well known to those experienced in the practice of Courts of Equity that they are not bound to adopt the opinion of the Courts of Law to which they send for advice.’ See also Prebble v. Baghurst (1818) 1 Swans 309 at 320; 36 ER 402 at 406 and Wood v. Griffith (1818) 1 Wils Ch 35 at 45; 37 ER 16 at 21. Bunn v. Guy ((1803) 4 East 190; 102 ER 803), referred to earlier, was just such a case, sent to the King’s Bench for its opinion on the legality of the contract in question. 103 (1850) 3 De G & S 706; 64 ER 670. 104 (1818) 3 Madd 74; 56 ER 437. 105 (1850) 3 De G & S 706 at 712; 64 ER 670 at 673. 106 (1858) 27 LJ Ch 714. 107 Id at 718.
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Court of Appeal in the 1880s. Thus in May v. Thomson108Jessel MR appeared to
recognize only begrudgingly the possibility of personal goodwill in a medical practice,
while in Arundell v. Bell109 he and his fellow judge, Baggallay LJ, expressly doubted
its existence in a solicitors’ practice.
If the question of personal goodwill in a professional business may be taken as part of
the broader question of whether there could be any type of goodwill in the
professions, then the acceptance of name goodwill in such businesses, discussed
below, would have gone some way at least towards breaking down the barrier to
personal goodwill. In that respect, in 1855 Wood V-C accepted name goodwill in a
solicitors’ practice in Aubin v. Holt110 and by the end of the century name goodwill of
a solicitors’ partnership was recognized by Lindley MR in Burchell v. Wilde.111
Whether goodwill can exist in all professions, however, is another matter. For
example, while goodwill may readily be identified in the case of a solicitor’s practice,
it would be more problematic in a barrister’s practice owing to the particular personal
nature of such a practice.112 Nonetheless, it has been proposed that some goodwill,
although not personal in nature, might attach to barristers’ chambers.113 However, as
noted by Hamilton J in A-G v. Boden,114 in the end it must be a matter of fact whether
any goodwill of a business is found to exist and be the subject of sale. So, in a sense,
the concept of personal goodwill went through a full cycle in the nineteenth century.
Personal goodwill started out as a doubted, but still accepted, concept on the part of
Lord Eldon, based on the views of the courts of law which he considered should
108 (1882) 20 Ch D 705. In this case Bacon V-C at first instance had held that he could not decree specific performance because he could not give meaning to the vague stipulations in the letters of negotiation, including that the vendor introduce his patients to the purchaser. The Court of Appeal judges found that no contract had been concluded and consequently there was nothing to perform. 109 (1883) 52 LJ Ch 537. 110 (1855) 2 K & J 66; 69 ER 696. 111 [1900] 1 Ch 551. 112 This distinction between solicitors and barristers was recognized in the latter part of the nineteenth century by an eminent economist of the period: see Fawcett, H. 1883, Manual of Political Economy, 6th ed., MacMillan and Co., London, 529 wherein he said: ‘The income of a barrister is wholly lost to his family at his death, but the income which a solicitor obtains from his business may be partly enjoyed by his family after his decease, since the good-will of his practice may be sold … .’ In Re Lazarus (1940) 11 ABC 249, a bankruptcy case, the judge observed: ‘… legal practices and the goodwill thereof are bought and sold every day in this community. I think it is generally accepted that goodwill attaches to a solicitor’s business in the same way as to any other business’ (at 257). 113 See Slater, A. H., ‘The Nature of Goodwill’, (1995) 24 Australian Tax Review 31. 114 [1912] 1 KB 539 at 559.
28
prevail for pragmatic reasons.115 But it was rejected in a number of later cases, and
argued against by counsel in others. Then there was recognition at the end of the
century and in the early twentieth century, which again represents a pragmatic, factual
view. For example, on the sale of personal goodwill in a medical practice, Scrutton J
observed in Corbin v. Stewart:
One could not sell a doctor’s patients like slaves … yet there was no doubt that doctors
were ready to pay some sum calculated upon the profits of a doctor’s business. It
seemed … that they paid in respect, firstly, of an unreasonable propensity in human
beings to keep on going to the old house, which gave a doctor’s house a certain value,
and, secondly, of the fact that if people were told that B was the successor of A, they
would go to B for that reason.116
This pragmatic view remains today as illustrated in Murry where the majority said:
… where goodwill is largely the product of the personality of the owner or one or more
of the 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.117
In other words, while goodwill may be reduced in value if a major source such as a
person departs a business, goodwill still exists even if its value is diminished.118
115 However, Lord Eldon was not required to consider the existence of professional goodwill as part of the ratio of any of his decisions and this could explain why Chancery judges such as Leach did not follow his view. By this time the principles of equity had been formalized and Lord Eldon insisted on the binding force of precedent as evidenced by his famous statement in Gee v. Pritchard 2 Swan 402 at 414: ‘Nothing would inflict on me greater pain than the recollection that I had done anything to justify the reproach that the equity of this court varies like the Chancellor’s foot.’ Nonetheless, there is also evidence that at times he seemed to express some ambivalence about the application of these principles: see Klinck, D. R., ‘Lord Eldon on “Equity”’, (1999) 20(3) The Journal of Legal History 51. 116
Corbin v. Stewart (1911) 28 TLR 99 at 100. 117
FCT v. Murry (1998) 98 ATC 4585 at 4596. 118 For a comparative US perspective on personal goodwill of professional businesses and its valuation, see Epstein, P. H., ‘The Transfer of Professional Goodwill’, (2006) 8(3) Corporate Business Taxation
Monthly 45. In this article, Epstein discusses a distinction made in the US courts between personal goodwill and ‘professional’ goodwill which relates to other sources such as the site of the business. In other words, professional goodwill is that goodwill which is generated by sources other than a person. See also Kelly, A. B., ‘Sharing a Piece of the Future Post-Divorce: A More Equitable Distribution of Professional Goodwill’, (1999) 51 Rutgers Law Review 569 who looks at the same distinction in the context of US divorce settlements.
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3.5 Name goodwill
Name goodwill relates to the name or reputation which attaches to a business and
which attracts custom to it. Often this element of goodwill involves a name or
trademark which is recognized and protected by law. Lord Macnaghten recognized
this important aspect in referring to goodwill as ‘the benefit and advantage of the good
name, reputation, and connection of a business’.119 At the beginning of the nineteenth
century in Hogg v. Kirby,120 Lord Eldon was requested by the plaintiff to order an
injunction to restrain the defendant from publishing a magazine with a title very
similar to one which had been published by the plaintiff. He granted an injunction to
prevent the defendant from representing to the public that his magazine was a
continuation of the plaintiff’s. While goodwill was not referred to specifically in his
deliberations, Lord Eldon clearly placed considerable importance on the value of a
name (in this case, a magazine title) and acted to protect it accordingly. From this
position, it is only a short step to recognizing a name as an element or source of the
goodwill of a business. It is readily arguable that this step was taken in Bunn v. Guy, a
King’s Bench case referred to earlier in relation to personal goodwill of a solicitor’s
practice. Apart from personal goodwill, the contract of sale of this practice also
included permission for the purchaser to use the vendor’s name as part of the new
firm’s name, a plain reference to name goodwill. The use of a name in this way was
found to be acceptable at law by the court and there is no evidence that Lord Eldon
had any reservations about this aspect of the decision, unlike his views on personal
goodwill.
While Lord Eldon did not deal explicitly or directly with name goodwill in the first
quarter of the century, later nineteenth century cases concerning both professional and
non-professional businesses routinely involved this element of goodwill.121 The only
issue with a purchaser’s using the old name, or part of it, is that the vendor should not
be exposed to the risk of any liabilities incurred by the purchaser under that name.122
Otherwise, the well-established name of a business has become an important element
119
CIR v. Muller and Co’s Margarine Ltd [1901] AC 217 at 223. 120 (1803) 8 Ves Jun 215; 32 ER 336. 121 For example, see Labouchere v. Dawson (1872) LR 13 Eq 322 (brewery business), Ginesi v. Cooper (1880) 14 Ch D 596 (stone merchants), and Aubin v. Holt (1855) 2 K & J 66; 69 ER 696 and Burchell
v. Wilde [1900] 1 Ch 551 (solicitor’s practices). These cases are referred to in various parts of this paper. See also Cooper v. Hood (1858) 26 Beav 293; 53 ER 911 where trademarks were held to be elements of goodwill. 122 See Thynne v. Shove (1890) 45 Ch D 577 as an example.
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of goodwill, commonly sold in the latter part of the nineteenth century and up to the
present time. However, it must be said that Lord Eldon was largely silent on this
element and thus did not contribute to its development, except in the passive sense of
not inhibiting it.123 This stands in contrast to his objection to personal goodwill in
professional businesses, an objection that resonated throughout other cases until laid
to rest as a general issue at the end of the century.
Name goodwill remains a readily identifiable element of goodwill, referring to names
in various forms associated with a business and providing a major source of goodwill.
Name goodwill was identified from the authorities by Hill J in FCT v. Krakos
Investments Pty Ltd124 and, as noted earlier, recognized as a useful description by the
majority of the High Court in FCT v. Murry.125
3.6 Product goodwill
Limited recognition has been given in the case law to what has been termed ‘product
goodwill’, arising from the products and associated trade names and marks of a
business. As Dawson J said in Hospital Products Pty Ltd v. United States Surgical
Corp:
Product goodwill as a legal concept is virtually unexplored. How and when it may exist,
if at all, as something distinct from the goodwill of the business which is the origin of
the product is something which has received little attention. Perhaps some explanation
of this fact is to be found in the position at common law where a trade mark is
assignable only in conjunction with the goodwill of the business in which the mark is
used. That was also the position for some time with registered trade marks.126
123 However, Lord Eldon did in fact deal with the use of names in the form of trademarks; that is, he granted injunctions in a number of cases to restrain persons from trading in goods bearing the name of another person. In this manner, he contributed significantly to the development of trademark law and also to the early law of passing-off. In Cruttwell v. Lye (1810) 17 Ves Jun 335; 34 ER 129, he espoused the essence of the principle thus: ‘… this Court would interpose against that sort of fraud, which has been attempted by setting up the same trade, in the same place, under the same sign or name, the party giving himself out as the same person’ (at 342). A trademark also may be seen as a valuable asset which may give rise to monopoly goodwill, as discussed elsewhere in this paper. Furthermore, in Aubin
v. Holt, Wood V-C based his acceptance of name goodwill on his apparent understanding of Lord Eldon’s acceptance of this type of goodwill in a solicitor’s practice in Candler v. Candler. However, there is no reference to name goodwill or its acceptance by Lord Eldon in the report of that case. 124 See (1996) 96 ATC 4063 at 4069 where Hill J said: ‘The proprietor of a business may have developed a particular reputation in a name which the law will protect. In such a case, custom may be attracted to the business by the very use of the name. In turn, the value of that name may be turned to account by its proprietor.’ 125 (1998) 98 ATC 4585 at 4593. 126 (1984) 156 CLR 41 at 144-5.
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In the passing-off case of Cadbury Schweppes Pty Ltd v. Pub Squash Co Pty Ltd,127
the Privy Council gave some recognition to the notion of goodwill associated with a
product. However, as a passing-off case, the Privy Council was required to consider
whether the alleged infringement, involving similar advertising, trade name and get-up
of the defendant’s product, damaged the goodwill of the plaintiff. Thus it was not
strictly ‘product’ goodwill as such which was under consideration, but the goodwill in
general of the business.
Nonetheless, to the extent that product goodwill may legitimately be recognized, it
may be seen as effectively part of, or as a subcategory of, name goodwill. As
discussed above, trade names and marks are typically seen as sources of name
goodwill.128 Consequently, the concept of product goodwill does not offer anything
more than the general term, name goodwill.129 As a supposedly separate legal concept,
therefore, it may safely be left unexplored without causing detriment to our
understanding of goodwill.
3.7 Monopoly goodwill
The final element of goodwill for the purposes of this analysis has been identified as
monopoly goodwill. This is goodwill arising from the absence of competition, not in
the negative sense arising from a restrictive covenant, but rather in the positive sense
of custom attracted by the sole ownership of a particular valuable asset, such as an
exclusive licence, a trademark or a patent.130 Concerning monopoly goodwill, Hill J
postulated:
127 (1981) 55 ALJR 333 (PC). 128 The association of trade marks and goodwill in connection with assignments, referred to by Dawson J in the above passage from Hospital Products Pty Ltd v. United States Surgical Corp,is discussed in chapter 9. 129 However, in the US jurisdiction, as a point of difference, ‘product goodwill’ has been recognized and classed as a type of goodwill separate from brands or names: see Bone, R. G., ‘Hunting Goodwill: A History of the Concept of Goodwill in Trademark Law’, (2006) 86 Boston University Law Review 547, note 11. Furthermore, product goodwill is noted in Anonymous, ‘An Enquiry into the Nature of Goodwill’, (1953) 53 Columbia Law Review 660 at 669, note 39, where it is distinguished from ‘institutional goodwill’. Here product goodwill is defined as goodwill arising from customers’ attitudes directed toward a particular product without reference to its manufacturer. The note further explains that other products produced by the same manufacturer would derive no benefit from the goodwill developed with respect to this particular product. ‘Institutional goodwill’, on the other hand, is said to be the favourable attitude directed toward the business as a whole, where goodwill developed with respect to one product would carry over and assist sales of other products. 130 In his pioneering work on the law of goodwill, Allan noted that goodwill had been employed ‘to denote what is in the nature of monopoly’, giving as examples rights to supply a district with gas or water and exclusive rights to provide refreshments at gatherings. In respect of the latter example, he
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… 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. Where a monopoly has been conferred upon a trader, that trader may develop
a custom which is tied to that monopoly. … Customers will revert to that trader not
because of the name of that trader, the place from which he or she trades or some
personal characteristic of the trader, but because of the statutory monopoly which the
trader has.131.
This element had been recognized earlier by the High Court of Australia in Box v.
FCT132 where the Court relied on the High Court decision in Phillips v. FCT
133 in
holding that:
In the case of a monopoly such as letters patent, or an exclusive licence to sell a
commodity only obtainable from the licensor … 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.134
In Phillips, the issue involved the sale of a newsagency comprising inter alia the
newspaper agencies and goodwill, together with the assignment of the lease of the
business premises. If the consideration received by the vendor for the goodwill had
been found to have been attached to the premises (as site goodwill, in effect) then that
consideration would have been a taxable premium in terms of the income tax
legislation of that time. In finding that the goodwill was not attached to the premises
but rather related to the exclusive newspaper agencies, Williams J of the High Court
reached straight back to Lord Eldon, invoking his words in Kennedy v. Lee135 that
‘goodwill of a trade follows from, and is connected with, the fact of sole
ownership.’136 Thus, immediately, a connection may be perceived on the face of it
between an aspect of Lord Eldon’s conception of goodwill and the modern day
conception of monopoly goodwill.
cited R v. Bradford (1815) 4 M & S 317 and Allison v. Monkwearmouth (1854) 4 El & Bl 13; 119 ER 6. (See Allan, C. E. 1889, The Law relating to Goodwill, Stevens and Sons Ltd, London, 9.) However, while both of these cases exhibited monopoly rights, they concerned the valuation of rents rather than any direct consideration of goodwill to which such rights might have contributed. 131
FCT v. Krakos Investments Pty Ltd (1996) 96 ATC 4063 at 4069-70. 132 (1952) 86 CLR 387. 133 (1945-49) 8 ATD 297. 134 (1952) 86 CLR 387 at 397. 135 (1817) 3 Mer 441; 36 ER 170. 136 (1945-49) 8 ATD 297 at 299.
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However, it is submitted that reference to Lord Eldon’s view in Kennedy v. Lee to
support the concept of monopoly goodwill is essentially a false attribution, because in
the context of that case Lord Eldon was actually referring to sole ownership in the
sense of not sharing with anyone else in partnership. In Kennedy v. Lee, the plaintiff
and defendant had carried on a business as nursery gardeners in equal partnership. The
plaintiff had given the defendant notice that he intended to dissolve the partnership
and as a consequence a series of letters had passed between the two resulting in a
purported agreement for the sale of the defendant’s half-share of the partnership
property to the plaintiff. The plaintiff claimed that these letters constituted a binding
contract and, as he was willing to pay the agreed price, he moved for an order of
specific performance to compel the defendant to convey the partnership property to
him. Counsel for the defendant argued that the plaintiff had not accepted the
defendant’s offer because he had not agreed to sell his share of the goodwill of the
business to the plaintiff, as the plaintiff had indicated in a letter purporting to be an
acceptance. In this letter the plaintiff had agreed to give 10,000 pounds for the
defendant’s interest in the ‘partnership premises, stock, business, and concern’.
Counsel contended that the words ‘business and concern’ must mean the goodwill of
the business, which the defendant had never intended to part with. In considering
whether goodwill formed part of the contract, Lord Eldon had the following to say:
Where two persons are jointly interested in a trade, and one by purchase becomes sole
owner of the partnership property, the very circumstance of sole ownership gives him
an advantage beyond the actual value of the property, and which may be pointed out as
a distinct benefit, essentially connected with the sole ownership. In the case of the trade
of a nursery-man, for instance, the mere knowledge of the fact that he is sole owner of
the property, and in the sole and exclusive management of the concern, gives him an
advantage which the other partner, supposing him to carry on the same trade, with the
other property, would not possess. In that sense, therefore, the good-will of a trade
follows from, and is connected with, the fact of sole ownership.137
Thus Kennedy v. Lee is not strictly an authority for the modern concept of monopoly
goodwill which relates more to the ownership of an exclusive asset which may
generate goodwill, as suggested by Hill J in Krakos Investments, rather than to the sole
ownership of goodwill itself. Lord Eldon was referring to the value of goodwill which
137 (1817) 3 Mer 441 at 452; 36 ER 170 at 174.
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is increased by sole ownership, all other things being equal. This view is supported in
fact by the reference to Kennedy v.Lee in Box where the High Court referred to Lord
Eldon’s opinion that the goodwill of a business is rendered even more valuable by the
protection of a restrictive covenant. While in Box there was present an exclusive
licence which conferred monopoly goodwill in its modern conception, there is no
reference to this type of goodwill in the reference to Kennedy v. Lee which cannot be
used legitimately to support the monopoly aspect of goodwill. The value of goodwill
enhanced by its sole ownership, on the one hand, and the ownership of an exclusive
licence, on the other hand, are not necessarily the same thing. The former has to do
with the value of the goodwill essentially, while the latter has to do more with the
source of the goodwill, although the value of that goodwill will obviously be based on
this source. One is tempted to see too much eagerness to invoke the venerable Lord
Chancellor in a case such as Phillips. But perhaps this may be taken as a distinct sign
of esteem, notwithstanding certain reservations about his definition of goodwill.
Moreover, it might be argued that Lord Eldon had a more accurate idea of the part
monopolies played in the question of goodwill than later authorities where there
appears to be confusion between goodwill itself and what contributes to it and its
value.138
3.8 Interests in land
In its modern conception, goodwill is always attached to a business and indeed is
deemed to be inseparable from that business.139 However, Lord Eldon was apparently
prepared to entertain a broader conception of the term as is indicated in Baxter v.
Conolly140 where he used ‘goodwill’ in a different sense, meaning an interest in land
rather than an interest in a business. This case involved the obtaining of a lease of a
block of land for building purposes, and it was the ‘goodwill’ in this property that was
the subject of the litigation. In his deliberations, Lord Eldon referred to ‘this piece of
land which was made the subject of bargain for interest or for goodwill.’141 There was
138 This confusion was much in evidence in the judgments of the majority of the Full Federal Court of Australia in FCTv.Murry (1996) 96 ATC 4703. The majority’s decision in this case was overruled by the High Court in FCTv.Murry (1998) 98 ATC 4585. See Tregoning, I., ‘FCT v. Murry: The Federal Court takes licence with goodwill’ (1996) 3 Deakin Law Review 201 for an analysis of the Federal Court judgments. 139 In CIRv.Muller and Co’s Margarine Ltd [1901] AC 217 at 235, Lord Lindley said that ‘goodwill is inseparable from the business to which it adds value.’ A similar view was expressed by Lord Macnaghten in that case. See also the High Court in FCTv.Murry (1998) 98 ATC 4585. 140 (1820) 1 Jac & W 576; 37 ER 487. 141 Id at 579.
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no goodwill in the sense of an asset of a business in this case; nor was there property
whose value might have been enhanced by having a successful business located on it
because this was vacant land. Lord Eldon declined to grant the injunction sought,
holding that there was ‘not a particle of equity in this application’, a conclusion which
may taken as reasonable in the circumstances. But he seems to have muddied the
waters for later judges142 in using the sale of a shop and its goodwill as an analogy in
his reasoning in saying:
The Court certainly will not execute a contract for the sale of a goodwill, … . Suppose,
for instance, there is a contract for the goodwill of a shop; it cannot be conveyed, and
the Court would say, go and make what you can of it at law; … we won’t assist you.143
However, this is an archaic meaning of goodwill which has not survived and must be
taken not to fit into the modern meaning of the term which relates to business.
Moreover, there is no evidence that it was part of the usual legal meaning in Lord
Eldon’s time, although it may reasonably be assumed that this particular meaning used
by him still had some currency at the time.
3.9 Conclusion
As major sources of goodwill, the elements of goodwill provide a convenient and
useful framework for an examination of the legal concept of goodwill, a point
recognized by the High Court in Murry. This framework enables a focus on the
development and nature of goodwill from the viewpoint of these major sources.
However, a problem with this approach to goodwill is the risk that the elements may
be seen as separate items of goodwill, contrary to established authority. This is a
matter addressed in the next chapter.
142 For example, see Lord Gifford MR in Coslake v. Till (1826) 1 Russ 376; 38 ER 146 where he expressed the view that Lord Eldon appeared to be of the opinion that a contract for the sale of goodwill could not be enforced in equity. Furthermore, in Thornbury v. Bevill (1842) 1 Y & CCC 554; 62 ER 1014, Sir J L Knight Bruce V-C saw fit to distinguish Baxter v. Conolly in a case where there was the transfer of a business, rather than ‘a mere sale or assignment of the goodwill’ (at 560). It is very difficult to see why Baxter v. Conolly needed to be referred to at all in this situation because it does not stand for the principle that goodwill cannot be transferred alone (even though that is the case). 143 (1820) 1 Jac & W 576 at 580.
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Chapter 4: The Legal Nature of Goodwill
4.1 Introduction
While the previous chapter explored the various elements of goodwill, this chapter
focuses on the characteristics which comprise its essential nature. In examining the
nature of goodwill, the following questions are considered: Is goodwill property? Is
goodwill one whole item of property or separate items stemming from its sources?
Can goodwill be separated from the business to which it is attached? Is goodwill
separate from assets which contribute to its existence? In addition, consideration is
given to the recognition of internally generated goodwill, to the question of whether
divisions within a business may have goodwill, and to the question of whether an
illegal business may have goodwill.
The most recent judicial reconsideration of goodwill, in terms of property, arose in the
Federal Court case of Krakos Investments Pty Ltd v. FCT144 where counsel for the
Federal Commissioner of Taxation argued that goodwill was not an asset because it
was not property. While this argument was perceived to have ‘intellectual attraction’
by the judge at first instance, Branson J,145 it was conceded by counsel that the
legislation in question had been drafted on the basis that goodwill was property.
Moreover, in the appeal to the Full Federal Court146 it was further conceded that
goodwill was defined specifically as an asset for purposes of the legislation. Thus in
the particular context of that case the question of the nature of goodwill as property,
and as an asset specifically, was rendered irrelevant. Nevertheless, addressing the
question whether goodwill is property at general law and, if so, what type of property,
is fundamentally important because it contributes to an understanding of the essential
nature of the concept. Furthermore, the related questions of whether goodwill is one
144 (1995) 95 ATC 4369. 145 Branson J said at (1995) 95 ATC 4369 at 4374: ‘Mr Slater argued that on a proper analysis goodwill is not an asset at all: that there is no element of goodwill that is not properly characterised as being some other kind of right or property. The argument has intellectual attraction – although it is perhaps inconsistent with accepted authority that goodwill is indivisible … .’ These comments are difficult to follow at face value; the use of ‘property’ in the first sentence must mean a property rather than property, which is consistent with Slater’s view expressed elsewhere and referred to in this chapter. Furthermore, the reference to the indivisibility of goodwill as inconsistent with counsel’s argument that goodwill is not an asset seems to be a non sequitur. Whether goodwill is divisible or not from the other assets of a business does not necessarily bear on the question of whether it is property and therefore an asset, unless it is considered that for something to be property it must always be capable of having a separate existence. The issue of divisibility concerning goodwill will be taken up later in this chapter. 146
FCT v. Krakos InvestmentsPty Ltd (1996) 96 ATC 4063.
37
whole item of property and whether it is separate from the other items of property of a
business which contribute to its existence and its value are also of fundamental
importance. These are questions which go to the heart of the meaning of the legal
concept of goodwill and have significant implications for other areas of the law,
particularly taxation.147 An understanding of these issues enables an informed
examination of goodwill in the broader context of a business and the other property of
that business. In addition, an understanding of the nature of the legal concept of
goodwill is necessary for a comparison with the accounting concept and an
examination of the possibility of a synthesis between the two concepts of goodwill.
4.2 Goodwill as property
The abovementioned counsel in Krakos Investments, A H Slater, had delivered a paper
in late 1994 on the nature of goodwill, later published as an article,148 echoes of which
may be detected in his argument before Branson J. In this article he advanced the
interesting argument that goodwill was not property at all, as in an asset of a business,
but rather a property or an attribute of a business. The essence of his position may be
found in the following passage:
The common assumption is that goodwill is property, that is, an asset, a thing of a
proprietary nature, capable of transfer. … The truth, however, is that goodwill is a
property, that is, a quality or attribute. There has been a conceptual elision from
goodwill being a property of a business to its being property comprised in a business.149
This argument has some interest and merit and, moreover, accords reasonably well
with an intuitive notion of goodwill as the essence of business. Nonetheless, it is also
a quixotic argument tilting at the windmills of well-established authority which holds
that goodwill is indeed property.150 In recognition of the weight of such authority and
147 As discussed later in this paper, questions concerning whether goodwill is one whole item of property separate from other property of a business and its relationship with the business as a whole are relevant to a range of taxes such as capital gains tax, stamp duties, and goods and services tax. 148 Slater A. H., ‘The Nature of Goodwill’, (1995) 24 Australian Tax Review 31. 149 Ibid. 150 However, as far back as 1860 a precursor to Slater’s view may be found in Robertson v.
Quiddington (1860) 28 Beav 529 where one of the counsel is reported as arguing that ‘goodwill is not property, but an incident of property’ (at 534). This counsel then went on argue that as a consequence goodwill could not be dealt with independently of the property or the business. In response to this proposition, inter alia, Sir John Romilly MR stated at the beginning of his judgment: ‘I fully concur in the observations on both sides, not only that the good-will is a valuable and tangible thing in many cases, but it is never a tangible thing unless it is connected with the business itself, from which it cannot be separated …’ (at 535). (Emphasis added.) On the face of it, this is a most curious statement in that Romilly MR referred to goodwill as a ‘tangible thing’, but only if connected with a business. Would it
38
with an apparent note of resignation, Hill J of the Full Court stated: ‘It is probably
now too late in the day for such an argument to succeed.’151
Osborn’s legal dictionarydefines property as: ‘That which is capable of ownership;
also used as meaning a right of ownership, as “the property in the
goods”.’152Butterworths Business and Law Dictionary holds that property is ‘[a] word
which can be used to describe every type of right (that is, a claim recognized by law),
interest, or thing which is legally capable of ownership, and which has a value.’153
These definitions of property are not necessarily comprehensive, but together they
give a sense of its meaning. Property is a broad concept which may encompass
tangible and intangible items and legal and equitable interests in them. Property may
be real or personal. The essence of property is ownership (which may mean exclusive
possession) and in general the right to dispose of, or deal with, the subject of it.
Property must also have value to have meaning.154
As indicated in earlier chapters, dating from relatively early times, the legal authorities
have indicated that goodwill is a type of property. Thus in 1743 in Giblett v. Read155
goodwill was recognized as valuable property, albeit as obiter dictum. Then in 1842 in
England v. Downs156 the goodwill of a public-house was treated as part of a property
settlement and in 1854 in Potter v. CIR157 Pollock CB held that the assignment of a
share of goodwill was an assignment of property for stamp duty purposes.158 To add
become intangible otherwise? Clearly goodwill is not tangible, but as a ‘thing’ one may assume that Romilly MR saw it as property, contrary to the above counsel’s argument with which he purported to ‘fully concur’. This is in addition to his judgment in this case which was based on inappropriate authority, as discussed in chapter 5. 151
FCT v. Krakos Investments Pty Ltd (1996) 96 ATC 4063 at 4067. 152 Osborn, P G. 1964, A Concise Law Dictionary (5th ed.), Sweet & Maxwell, London, 256. 153 2002, Butterworths Business Law Dictionary (2nd ed.), LexisNexis Butterworths, Chatswood NSW, 391. 154 As noted by the majority of the High Court in FCT v. Murry, the goodwill of a non-profitable business may be of little or nominal value, at least in accounting terms. However, such goodwill remains valuable in the eyes of the law: see (1998) 98 ATC 4585 at 4595. 155 (1743) 9 Mod 459; 88 ER 573. 156 (1842) 6 Beav 269; 49 ER 829. 157 (1854) 10 Ex 148; 156 ER 392. 158 An earlier case, Finch v. South (1837) 3 Bing (NC) 506; 132 ER 505 dealt with the recovery of money owing under an agreement for the sale of goods and goodwill. It was argued by the defendant that the plaintiff could not tender this sale agreement in evidence because it was not stamped for duty. Under the Stamp Act of that time there was an exception to this sanction in the case of an agreement for the sale of goods only. Thus the plaintiff argued that the agreement was for the sale of goods only because goodwill had no meaning in law and therefore could not form the subject of a legal transfer. In other words, the plaintiff argued that goodwill was not property. Tindal CJ found difficulty with this argument and declined to lay down a rule for the small amount in dispute. However, he did suggest obiter that such an argument would not hold in the case of a much larger amount. Consequently, it may
39
considerable weight to these opinions there is the House of Lords decision in CIR v.
Muller and Co’s Margarine Ltd where Lord Macnaghten said:
It is very difficult, as it seems to me, to say that goodwill is not property. Goodwill is
bought and sold every day. It may be acquired, I think, in any of the different ways in
which property is usually acquired. When a man has got it he may keep it as his own.
He may vindicate his exclusive right to it if necessary by process of law. He may
dispose of it if he will – of course under the conditions attaching to property of that
nature.159
In this passage Lord Macnaghten clearly placed goodwill within the general concept
of property, seeing it as a thing which may be bought and sold,160 and in respect of
which the owner may enforce exclusive rights.
Moreover, the majority in FCT v. Murry was in no doubt that goodwill is property,
stating:
Goodwill is correctly identified as 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. It is a right or privilege that is inseparable from
the conduct of the business.161
Finally, goodwill is classified as a species of personal property162 and accordingly it is
distinguishable from real property interests. This is a relevant consideration regarding
be inferred that he saw goodwill as property capable of transfer. (In this particular case, however, Tindal CJ gave the plaintiff the opportunity to stamp the document.) See chapter 7 for discussion on goodwill as property for stamp duty. 159 [1901] AC 217 at 223. 160 In somewhat similar vein to Slater, Michael Inglis has questioned whether goodwill should be classed as property on the basis that it can be bought and sold, suggesting in fact that such an idea is delusional. In his own words: ‘As to the assertion that because goodwill is “bought and sold every day” it must be property, I am forcibly reminded of the story concerning the emperor who had no clothes. As you may recall, the emperor thought that he was buying some clothes and, because of the silence of those around him, was allowed to continue in his self-delusion until a small boy tipped over the proverbial apple cart. Despite this, it is too late in the day for me to mount an argument that goodwill is not property, particularly given the united voices of countless eminent judges over countless years … .’ See Inglis, M., ‘Inglis on CGT’, (Nov 1995) Charter 44. As Inglis admitted, similarly to Hill J in Krakos Investments, it is far too late to change the course of jurisprudence on the matter of goodwill as property. 161 (1998) 98 ATC 4585 at 4591. 162 See, for example, CIR v. Muller and Co’s Margarine Ltd [1901] AC 217 at 236-7 (per Lord Lindley), The Rosehill Racecourse Company v. CSD(NSW) (1906) 3 CLR 393, R J Reuter Co Ltd v.
Ferd Mulhens [1953] 2 All ER 1160 at 1179, and recently Primelife (Glendale Hostel) Pty Ltd v.
CSR(Vic) (2004) 9 VR 665 (Supreme Court of Victoria).
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its treatment and valuation where land may be a source of the goodwill and is taken up
in this paper where it arises as an issue.
The fact that goodwill is property means, of course, that it is also classed as an asset
for purposes of the law. The terms ‘property’ and ‘asset’ are often used
interchangeably in respect of goodwill. In FCT v. Murry, the High Court held that:
… goodwill is an asset of the business because it is the valuable right or privilege to use
the other assets of the business … to produce income. It is the right or privilege to make
use of all that constitutes ‘the attractive force which brings in custom.’163
Previously, in Hepples v. FCT, Toohey J had identified goodwill as ‘a continuing asset
of a business, though its content and value may vary.’164 In the same case, McHugh J
noted that ‘goodwill is the collective name for various intangible sources of the
earnings of a business which are not able to be individually quantified and recorded in
the accounts as assets of the business.’165 This view is more closely aligned with the
accounting concept of goodwill where it is defined and treated as an asset, as noted in
chapter 1. In fact, the recognition of goodwill as an asset is the paramount
consideration for accounting purposes. The accounting viewpoint, however, will be
examined later in chapters concerning accounting goodwill.
Goodwill is specifically defined as an asset for purposes of the Australian capital
gains tax (CGT) provisions in the Income Tax Assessment Act 1997 (Cth).166 Thus a
disposal of goodwill will be an event which gives rise to a capital gain or loss under
the CGT system. Moreover, in this system goodwill is recognized as an asset in
relation to a range of small business concessions167 and, earlier, had been recognized
as an asset for a partial exemption of the capital gain arising from its disposal as part
of the sale of a small business as discussed in FCT v. Murry below.
163 (1998) 98 ATC 4585 at 4590-1. 164 (1991) 91 ATC 4808 at 4826. 165 Id at 4837. McHugh J based this view on statements made by Lord Lindley in CIR v. Muller and
Co’s Margarine Ltd [1901] AC 217. 166
Inter alia, s. 108-5 defines a CGT asset as ‘any kind of property’ in s. 108-5(1)(a) and specifically includes goodwill under s. 108-5(2)(b). 167 Under this system of concessions for small business found in Div. 152 of the Income Tax
Assessment Act 1997 (Cth), goodwill is recognized as an active asset: see s. 152-40(1)(b). In essence, an active asset is an asset used in carrying on a business. See Walpole, M., ‘The Fate of Goodwill after Ralph’, (2000) 3(5) Journal of Australian Taxation 344.
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4.3 Goodwill as one whole item of property
The question of whether goodwill can be broken down into separate parts and dealt
with accordingly continues to arise in spite of settled authority that it is one whole
item of property. Specifically on the point, Lord Macnagthen in CIR v. Muller and
Co’s Margarine Ltd stated: ‘The goodwill of a business is one whole, and … must be
dealt with as such.’168 In Geraghty v. Minter, Barwick CJ was firmly of the view that
goodwill is one whole item of property in saying that ‘[g]oodwill in itself is
indivisible’169 and his fellow judge, Stephen J, described it as an ‘inseverable
whole’.170
Notwithstanding the settled authority that goodwill is one whole item of property, the
reduction of goodwill into composite parts, typically based on its major sources,171
continues as a surprisingly common practice. That is, the confusion of goodwill with
its sources leads to an incorrect view of goodwill as separate items of goodwill
representing these sources, such as personal goodwill and site goodwill as typical
examples. This view, for instance, has supported the persistent myth that so-called
personal goodwill cannot be sold or transferred.172 The Australian Taxation Office
continues to promulgate this view in its rulings173 in the face of the clear authority to
the contrary. A similar view is espoused by Her Majesty’s Revenue and Customs
(HMRC) in the UK.174 Of course, the personal skills and qualities of a person cannot
be transferred apart from the person. However, as goodwill is one whole item of
168 [1901] AC 217 at 224. 169 (1979) 142 CLR 177 at 181. 170 Id at 193. 171 These sources were identified as elements of goodwill in chapter 2 – namely, site goodwill, name goodwill, personal goodwill, and monopoly goodwill – and discussed in chapter 3. 172 For a discussion on this issue, see Tregoning, I., ‘Goodwill: Another View’, (2005) 9(1) The Tax
Specialist 22 and Tregining, I., ‘The meaning and nature of goodwill in the tax context’, (2010) 39(3) Australian Tax Review 123. 173 See Taxation Ruling TR 1999/16 and Goods and Services Tax Ruling GSTR 2002/5. (However, in Interpretative Decision ID 2002/248 the ATO appears to take a different view, consistent with the legal position on personal goodwill. This ID concerned the transfer of goodwill on the disposal of a sole practice to a company incorporated by the sole practitioner who continued in the practice as an employee of the company. Several years later the practice was transferred back to the individual taxpayer who recommenced carrying it on as a sole practitioner. The goodwill had originally been pre-CGT in the sole practice, but the individual had acquired it back post-CGT from the company. The essence of the ID was that the sole practitioner had acquired the goodwill at the time of transfer and consequently could not claim pre-CGT status for it. The ID stated: ‘This remains so despite the fact that the personal attributes of the taxpayer were always the source of the goodwill of the business.’ Thus here the ATO appears to accept that ‘personal’ goodwill is transferable. However, in this particular case the same person was the source of the goodwill under both the individual and company ownerships, a fact that might make it distinguishable from the usual transfer of personal goodwill.) 174 See HRMC’s Stamp Duty Land Tax Manual and Capital Gains Manual.
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property attached to a business, it is transferred with business, regardless of a person
being the major source of that goodwill. As a practical matter, where goodwill is
largely personal, whatever is required to transfer the custom to the new owner needs
to be done, such as personal introductions and recommendations to customers and the
protection of a restrictive covenant. Any difficulties with the transfer of custom in
such a case would be expected to affect the amount paid for the goodwill in the sale,
but not the legal position that goodwill is transferred. In fact, the transfer of personal
goodwill on the sale of a business was recognized as early as the middle of the
nineteenth century in Potter v. CIR.175
In a somewhat similar manner, site goodwill has often been treated as part of the land
which generates it as a major source. Thus the state revenue offices made a general
practice of including the value of site goodwill in the value of land for stamp duty
purposes, although this practice has effectively ceased in the wake of the High Court’s
decision in Murry.176 HMRC also take a similar approach in including the value of
‘inherent’ site goodwill in the value of land for the purpose of the Stamp Duty Land
Tax.177 As a separate whole item of property in its own right, however, goodwill
cannot be divided into elements (eg site goodwill and personal goodwill) in this
manner. Furthermore, as a species of personal property, goodwill obviously cannot be
treated as part of real property.
4.4 Goodwill is inseparable from the business
A fundamental characteristic of goodwill is that it is an item of property which is
attached inseparably to the business; it cannot exist independently of that business. A
consequence of this characteristic is that goodwill cannot be sold or transferred apart
from the business. Furthermore, while goodwill may have considerable value to a
business, the value would amount to nothing without the business. In this regard, Lord
Lindley pronounced in Muller that ‘goodwill is inseparable from the business to which
it adds value.’178 This view was supported by Lord Macnagthen in the same case
where he proposed:
175 (1854) 10 Ex 147; 156 ER 392. 176 See Tregoning, I., ‘Goodwill and Stamp Duties: the Legacy of Murry’, (2006) 6(2) Oxford
University Commonwealth Law Journal 183. This matter is also dealt with in chapter 7. 177 For a critical examination of this approach, see Tregoning, I., ‘Goodwill and the Stamp Duty Land Tax’, [2007] (5) British Tax Review 650. 178 [1901] AC 217 at 235.
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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.179180
That these authoritative statements from the Lords have become the established law
may be clearly gleaned from various pronouncements on the matter by the High Court
of Australia. For example, in the relatively early case of The Bacchus Marsh
Concentrated Milk Company Ltd (In Liquidation) v. Joseph Nathan & Company Ltd
Isaacs J said that: ‘Goodwill … is inseparable from a particular business.’181 And in
Geraghty v. Minter, Barwick CJ said: ‘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.’182 Stephen J also
expressed the same view in that case.183 In Hepples v. FCT, McHugh J relied upon
Muller and Co’s Margarine Ltd and Geraghty v. Minter in holding: ‘Goodwill … is
inherently inseverable from the business to which it relates … . It does not survive the
cessation of the business and cannot be dealt with independently of that business
….’184 Similarly, the majority in FCT v. Murry proclaimed that ‘[i]t is the right or
privilege that is inseparable from the conduct of the business.’185 Hence, there is
overwhelming weight of authority for the rule that goodwill cannot be severed from
the business to which it is attached.186
4.5 Is goodwill separate from the assets which contribute to it?
It has been clearly established that goodwill is not severable from, and cannot exist
apart from, the business. However, there is another question concerning the
179 Id at 224. 180 In his deliberations on the nature of goodwill in FCT v. Krakos Investments Pty Ltd, Hill J cited this passage from Lord Macnaghten and proclaimed:
‘Whether this proposition is universally correct must be doubted. For example, a business may have 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.’
However, it is unclear whether Hill J doubted the proposition that goodwill is ‘one whole’ or the proposition that it ‘has no independent existence’, or both propositions. Thus Hill J introduced, albeit obiter, a note of ambiguity, suggesting a lack of conceptual clarity in the law of goodwill. Nonetheless, on either count any such suggestion must be seen to be at odds with established authority. 181 (1919) 26 CLR 410 at 438. 182 (1979) 142 CLR 177 at 181. 183 Id at 193. 184 (1991) 91 ATC 4808 at 4837. 185 (1998) 98 ATC 4585 at 4591. 186 See also CT(Qld) v. Ford Motor Company of Australia Pty Ltd (1942) 66 CLR 261 at 272 (per Latham CJ and
Rich J).
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independent existence of goodwill, and one which bears directly on its nature. That is,
does goodwill exist as an asset with an identity separate from the other assets of the
business which contribute to its existence and value? This was the essence of the issue
before the Full Federal Court in FCT v. Murry,187 a case concerning whether a capital
gain on the sale of a taxi licence was subject to the 50% exemption for goodwill.188 In
other words, did the sale of the taxi licence constitute the disposal of goodwill for the
purpose of that exemption? The respondent taxpayer had sold her taxi business and
claimed that the amount received for the licence, which was the bulk of the sale price,
was in fact for the sale of goodwill.189 The appellant, the Federal Commissioner of
Taxation, argued inter alia that the sale of a specific asset like a licence was not the
sale of goodwill but rather the sale of an asset that contributed to goodwill. The
majority of the Court found for the taxpayer in holding that the licence was goodwill
and therefore the capital gain from its sale was subject to the exemption. One of the
majority held that there was ‘a settled line of authority’ for finding that the licence,
although an asset in its own right, was also goodwill for the purpose of the exemption.
The other judge in the majority reached the same conclusion by way of different
reasoning in a separate judgment. The dissenting judge, however, was not persuaded
that the authorities supported the view that an asset contributing to goodwill could be
treated as goodwill itself.190
In the subsequent High Court appeal, FCT v. Murry,191 the majority overturned the
Federal Court decision, holding inter alia that the licence was not the goodwill of the
taxi business.192 Their Honours said:
187 (1996) 96 ATC 4703. 188 Under the legislation that applied at the time, a capital gain on disposal of goodwill might be subject to concessionary treatment in the form of a 50% reduction pursuant to s. 160ZZR(1) of the Income Tax
Assessment Act 1936 (Cth). To qualify for this concession, it was required that the taxpayer dispose of a business, or an interest in a business, that included goodwill, or an interest in goodwill, and that the net value of the business, or the interest in the business, be less than a stipulated exemption threshold for the year in question. This threshold was calculated in accordance with s. 160ZZRAA which set the threshold at $2,000,000 before the 1993-94 income year and indexed it from that year. This treatment was continued in rewritten legislation in the Income Tax Assessment Act 1997 (Cth) until its repeal in 1999-2000 in favour of a broader range of small business concessions enacted in response to recommendations from the Ralph Review of Business Taxation. 189 On the pre-printed sale form, the words ‘Goodwill (Licence Value)’ were printed. An amount of $189,000, out of a sale price of $220,000, was attributed to this item. 190 For an analysis of all three judgments in this case, see Tregoning, I., ‘FCT v. Murry: The Federal Court takes licence with goodwill’ (1996) 3 Deakin Law Review 201. 191 (1998) 98 ATC 4585. 192 In fact, the High Court based its decision on a finding that a business had not been disposed of as required by the legislation. However, the Court took the opportunity to deliberate in detail on the nature
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In our opinion, the appeal should be allowed. Section 160A defines ‘asset’ to include
‘goodwill’, but neither Pt IIIA nor the Act generally attempts to give any special
meaning to the term. Goodwill is inseparable from the conduct of a business. It may
derive from identifiable assets of a business, but it is an asset that is legally distinct
from the sources – including other assets of the business – that have created the
goodwill. Because that is so, goodwill does not inhere in the identifiable assets of a
business, and the sale of an asset which is a source of goodwill, separate from the
business itself, does not involve any disposition of the goodwill of the business.
(Emphasis added.)193
Thus the authorities clearly state that goodwill is separate from any other assets of the
business which might contribute to its existence.194 This position recognizes goodwill
as property and an asset in its own right.
4.6 A ‘same business’ requirement?
In considering the nature of goodwill, the High Court in Murry made some interesting
and pertinent observations concerning its relationship with business. The High Court
considered that for goodwill to remain the same goodwill, the business had to remain
the ‘same business’. This issue, of course, has implications for CGT in that if it can be
said that because a business has changed, so has its goodwill, meaning that any pre-
CGT status may be lost. But, as the High Court said:
of goodwill and its relationship with a business and its other assets. These deliberations amount to a considered exposition of the legal nature of goodwill and, as such, may be seen as persuasive ‘judicial’ dicta rather than mere obiter dicta. This important distinction is explained in Halsbury’s Laws of
England, 4th ed., vol. 26, 294: ‘Statements which are not necessary to the decision, which go beyond the occasion and lay down a rule that is unnecessary for the purpose in hand are generally termed “dicta”. They have no binding authority on another court, although they may have some persuasive efficacy. Mere passing remarks of a judge are known as “obiter dicta”, whilst considered enunciations of the judge’s opinion on a point not arising for decision, and so not part of the ratio decidendi, have been termed “judicial dicta”.’ Inglis emphasized the importance of these dicta in Murry by saying that the actual decision in that case became secondary to them: see Inglis, M., ‘Michael Inglis on Tax’, (1998) 69(10) Charter 28. The actual ratio based on the finding that the taxpayers had not disposed of a business may be seen as somewhat moot because it is arguable that sufficient assets were sold to constitute a business: see, for example, an expression of this view in Raitt, G., ‘Licences, Goodwill and CGT’, (1998) 72(8) Law Institute Journal 78. Nonetheless, the ‘judicial dicta’ are what is important (and they could arguably be taken to constitute an alternative ratio because they would lead to the same decision). 193 Id at 4587. The capital gains provisions relevant to this case were contained in Part IIIA of the Income Tax Assessment Act 1936 (Cth). The term ‘asset’ for the purpose of this legislation was defined in s. 160A of Part IIIA. The purpose of Part IIIA was to include in assessable income for income tax certain realized capital gains that had accrued to a taxpayer on the disposal of assets acquired on or after 20 September 1985. These provisions have been rewritten in the Income Tax Assessment Act 1997 (Cth) with the same general effect. 194 See also CT(Qld) v. Ford Motor Company of Australia Pty Ltd (1942) 66 CLR 261 where the High Court held that valuable contractual rights to buy and sell products did not constitute goodwill.
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… 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.195
Therefore, if a business changes over time, does the goodwill change such that it
becomes a different asset (and loses any pre-CGT status)? This would appear to be the
view of the High Court in the example given of inner city hotels in Sydney.196 The
majority suggested that, as such hotels extended their customer base beyond the local
area to appeal to a wider base, they turned into new businesses in the process. Thus
the majority claimed it is arguable that the goodwill of such a business is not the same
as earlier goodwill because it is not the same business. However, this is a proposition
which is very difficult to accept. Of course, it may be argued that if a business changes
fundamentally, then the goodwill will not be the same asset as a result of that change.
But the example cited by the High Court refers to what is really no more than the
organic growth of the same business; all that is exhibited in the example is broader
marketing to break free of location alone as a source of the goodwill. The suggestion
that if the sources of the goodwill change the goodwill will change into a different
asset is difficult to sustain. As Holmes J said of business in Truax v. Corrigan: ‘It is a
course of conduct and like other conduct is subject to substantial modification
according to time and circumstances …’.197 That is, Holmes J recognized, most
reasonably, that business may change substantially over time in response to changing
circumstances. It is reasonable to expect that successful businesses will be dynamic,
reacting to changing economic and social circumstances. There is no reason, however,
to see such a business’s goodwill as changing to a different goodwill as a
consequence. Moreover, the High Court itself stated that goodwill should be
distinguished from its sources.198 Thus the fact that the sources of the goodwill in a
business may change over time and circumstance should not mean that the goodwill
has changed. If, on the other hand, a business could be shown to have changed to the
extent that it has ceased to exist in its old form, then it would be reasonable to say that
195 (1998) 98 ATC 4585 at 4594. 196 Id at 4595. 197 257 US 312 at 342-3 (1921). This case was cited by the majority of the High Court in support of the proposition that business is a course of conduct, not property. 198 For example, the majority said: ‘Care must be taken to distinguish the sources of the goodwill of a business from the goodwill itself’ ((1998) 98 ATC 4585 at 4592).
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the goodwill of the old business had ceased also. This is consistent with the settled
view of goodwill as inseparable from the business and not able to exist without it.
While these comments by the High Court are clearly obiter dicta, they raise some
concerns in the CGT context. As already noted, pre-CGT status of the goodwill may
be lost and, furthermore, other CGT implications may arise in respect of post-CGT
goodwill, such that it may be destroyed and invoke CGT events where a business is
seen to change so as not to be the same business any longer.199 Concerns about these
matters, particularly the loss of pre-CGT status, have been raised by a number of
commentators.200 However, the Australian Tax Office has sensibly ruled that it will
view the expansion of business as merely an accretion of pre-CGT goodwill in such a
case.201
4.7 Internally generated goodwill
Where a business is purchased the goodwill forms part of the property of that business
and is recognized accordingly. However, in the case of a new business rather than a
purchased one, the question of the recognition of goodwill and when it comes into
existence arises. This type of goodwill is generally referred to as internally generated
goodwill and is not recognized for accounting.202 Only purchased goodwill is
recognized for accounting purposes, as opposed to the situation at law.
At law goodwill, whether purchased with a business or created in a new business, will
be recognized. For example, in Chia v. Ireland203 the court held that the internally
generated goodwill of a partnership business was of value and should be taken into
199 These issues are dealt with in chapter 5 in the context of creating partnership businesses out of previous businesses. 200 For example, see: Walpole, M., ‘When is Goodwill not Goodwill?’, (1999) 2(1) Journal of
Australian Taxation 48; Chiert, G., ‘Murry: Ending the Mysteries of Goodwill or Creating New Commercial Pitfalls’, (1999) 73 The Australian Law Journal 659; and Higgins, R. and Do, V., ‘Is your pre-CGT goodwill really that good?’, (2007) 42(3) Taxation in Australia 155. 201 See Taxation Ruling TR 1999/16, para. 60. However, in para. 62 of this ruling, it is stated: ‘Whether an increase in business operations or in the scale of activity constitutes an expansion of an existing business, or a new and separate business in its own right, is a question of fact dependent on the circumstances of each particular case.’ Furthermore, in Taxation Ruling TR 1999/9 concerning the ‘same business test’ for company losses the Commissioner also states: ‘The organic growth of a business through the adoption of new compatible operations will not ordinarily cause it to fail the same business test provided the business retains its identity …’ (para. 13). 202 See AASB 138 Intangible Assets, para. 48. The accounting treatment of goodwill is discussed in chapter 14. 203 [2000] SASC 47.
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account in determining the amount to be paid to a retiring partner.204 This view is
consistent with the legal concept of goodwill as property inseparable from the
business and, moreover, property which every business is deemed to have, regardless
of its profitability and value.205 Furthermore, in CIR v. Muller and Co’s Margarine
Ltd Lord Macnaghten stated that goodwill ‘is the one thing which distinguishes an
old-established business from a new business at its start.’206 The implication in this
statement is that goodwill of a new business must begin to be created at the time the
business starts. And when the business starts is a question of fact.207
In Taxation Ruling TR 1999/16 the Australian Taxation Office deals with the time of
acquiring internally generated goodwill in applying s. 109-10, item 1 of the CGT
legislation208 relating to the acquisition of assets which are created rather than
acquired from another person. At para. 52, the ruling states: ‘… the goodwill of the
business is acquired when the taxpayer starts work that results in the creation of the
goodwill … . When a taxpayer starts work resulting in the creation of goodwill of a
business is a question of fact dependent on the circumstances of each particular
case.’209
4.8 Divisional goodwill
While the authorities are clear that goodwill is one whole item of property attached to
a business, the question remains whether divisions within a business may have
separate items of goodwill attached to them. In Geraghty v. Minter, Stephen J said:
‘Goodwill of a … 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 one business entity carries
204 While Chia v. Ireland concerned partnership law, it is clear that in other areas of law also there is generally no concern for whether the goodwill of a business has been acquired with an established business or internally generated in a new business. 205 See the High Court in FCT v. Murry (1998) 98 ATC 4585 at 4590. 206 [1901] AC 217 at 224. 207 In CIR(NZ) v. City Motor Service Ltd [1969] NZLR 1010 at 1017, Turner J stated that ‘ordinarily, a business commences with beginning of “current operations”’. Here ‘current operations’ mean the actual trading activities of the business as opposed to preliminary activities of establishing the capital of the business. For consideration of matters concerning when a business starts, see Softwood Pulp and Paper
Ltd v. FCT (1976) 76 ATC 4439 and Ferguson v. FCT (1979) 79 ATC 4261. 208
Income Tax Assessment Act 1997 (Cth). 209 See also paras. 122-3 of TR 1999/16. In Taxation Ruling IT 2328, para, 2, the ATO takes the straightforward and logical view that goodwill is acquired at the time of commencement of a new business. However, when the business commences remains a question of fact, of course.
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on.’210 In this passage Stephen J in effect recognized the notion of divisional goodwill,
an issue in the accounting debate on goodwill. However, recognition of divisional
goodwill is not inconsistent with the idea of goodwill as one whole, as divisions in a
business may be seen as essentially independent in the appropriate circumstances, a
point also noted by Chiert.211 The essential question would be whether a division of a
business could stand alone as a separate business if it were to be set up independently
within a group of entities of the original business or, alternatively, could be sold to
another party as a going concern. Whether a division of a business may be treated as a
business in its own right will always be a question of fact and degree, dependent on
the circumstances of the particular case.
The question of what constitutes sufficient assets to constitute a business arose in
Westpac Banking Corporation v. CSD(Qld).212 Westpac had acquired a component of
another bank, comprising loans and other receivables, and the Commissioner had
assessed it for stamp duty as the purchase of a business. However, the court found that
Westpac had not acquired sufficient assets to constitute the acquisition of a business.
In reaching this decision, the court considered whether there was goodwill associated
with the acquisition. It found that Westpac had not acquired goodwill in the legal
sense of the attractive force which brings in custom and therefore it followed that the
assets purchased were not sufficient to constitute a business. The essential principle
which may be taken from this decision is that a business is not transferred unless there
are sufficient assets transferred to take the goodwill with it.
4.9 Synergistic goodwill
In para. 4.7 the idea of divisional goodwill was discussed. Now brief consideration is
given to what might be seen as the opposite idea, that of so-called ‘synergistic’
goodwill. Synergistic goodwill refers to the collective goodwill of a group of business
entities where the value of that collective goodwill is greater than the total of the
individual goodwill assets of the members of the group. In other words, there is
considered to be a synergy between the individual assets of the group. As a result it
may be said that each member’s goodwill is more valuable as part of the group than as
210 (1979) 142 CLR 177 at 193. 211 Chiert, G., ‘Murry: Ending the Mysteries of Goodwill or Creating New Commercial Pitfalls’, (1999) 73 The Australian Law Journal 659. 212 [2003] QSC 483; (2003) 55 ATR 50; 2004 ATC 4135.
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an individual entity. In Hepples v. FCT McHugh J recognized the notion of synergistic
goodwill, in the accounting context, as arising ‘from the combination or inter-
relationship of entities or groups of assets’.213
What is clear about ‘synergistic’ goodwill is that it is essentially an accounting
concept, rather than a legal one, and as such it is considered in chapter 14 on Modern
Accounting Goodwill. It is also considered in chapter 11: Goodwill and Taxation
Issues in connection with the consolidation regime in para. 11.6. For the purposes of
tax consolidation, the value of synergistic goodwill is allocated to the value of the
goodwill of an entity joining a group. However, this allocation does not change the
legal character of the goodwill held by an individual group member.214 Further
discussion may be left to these later chapters.
4.10 ‘Illegal’ goodwill
Can an illegal business have goodwill? Goodwill as a legal concept takes the form of a
‘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.’215 Goodwill, therefore,
is in essence a legally enforceable right. Consequently, at law it must be concluded
that goodwill of an illegal business cannot exist because a court would not be expected
to recognize and enforce a contract to sell goodwill as part of the sale of such a
business. A contract for the sale of an illegal business would be treated as void on the
grounds of public policy. While there is no case law on this question specifically, a
contract to sell an illegal business would seem to fall within the general category of
contracts which are invalidated because they are made for an unlawful purpose.216 In
213 (1991) 91 ATC 4808 at 4837. (McHugh J referred to Statement of Accounting Standards AAS 18 – which applied at the time – as authority for this accounting concept.) 214 That synergistic goodwill is not a legal concept, and not an asset, was accepted by the NTLG Consolidation Subcommittee (meeting minutes of 8 June 2006, agenda item 3: Synergistic goodwill). The fact that synergistic goodwill is recognised and taken into account for the purposes of consolidation in Part 3-90 (of the Income Tax Assessment Act 1997 (Cth)) does not change this view, the subcommittee indicated. It was agreed that synergistic goodwill is not itself an asset, but a value that is allocated to an entity’s goodwill on joining a group, where that value is a premium arising from the synergy of the group. 215
FCT v. Murry (1998) 98 ATC 4585 at 4591 (HC). 216 For a discussion of contracts for an illegal purpose and of illegal contracts generally, see Seddon, N. C. and Ellinghaus, M. P. 2008, Cheshire and Fifoot’s Law of Contract, 9th ed., LexisNexis Butterworths, Chatswood NSW, ch. 18. See also Clarke, P. et al. 2008, Contract Law: Commentaries,
Cases and Perspectives, Oxford University Press, Melbourne, 414-6 and Davis, J. L. R. (ed.) 2006, Contract: General Principles, Thomson, Pyrmont NSW, [7.2.770] – [7.2.780].
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this type of case, the unlawful purpose would be the conduct of the illegal business by
the purchaser.
However, in accounting, by way of contrast, it may be argued that goodwill may exist
because the accounting concept of goodwill does not require recognition at law. Both
in theory and in practice there is no reason why an illegal business could not be sold
(but, of course, not under a legally enforceable contract). If such a sale were to take
place, goodwill could arguably form part of the sale and its value would therefore be
expected to appear on the balance sheet as an asset of the business, as in the case of a
legitimate business. An analysis like this must necessarily assume regular accounting
practices, at least for ‘internal’ purposes. However, for obvious reasons, such an
assumption may not be totally realistic in many cases.
4.11 In conclusion
It has been firmly settled that goodwill is one whole item of personal property which
is separate from its sources but inseparable from the business. Notwithstanding this
clear and settled position at law, certain myths and misunderstandings concerning the
nature of goodwill persist. Some of these have been identified in this chapter and will
be taken up in more detail in later chapters where appropriate. Aside from those
particular matters, an understanding of the nature of goodwill and its relationship with
business and other property of the business is fundamental to the theme of this paper.
It is fundamentally important to understand the nature of goodwill as a basis for
examining the legal concept of goodwill in various important contexts. These contexts
are examined in subsequent chapters and comprise: partnerships; restrictive
covenants; stamp duties; licences and leases; passing-off; compensation; and taxation
in general. Moreover, the legal nature of goodwill bears on an understanding of the
accounting concept, particularly as it evolved originally from the legal concept.
Accordingly, later chapters also deal with the accounting concept to enable an
examination of the relationship between the legal and accounting concepts of
goodwill.
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Chapter 5: Goodwill and Partnerships
5.1 Introduction
Apart from sole traders, partnerships are the oldest217 and simplest form of business
structure and are very common to this day. As a consequence, they have produced a
large body of law, including issues concerning the recognition and treatment of
goodwill as a partnership asset.
This chapter examines issues concerning goodwill in the context of partnerships,
including the effects of partnership creation and variation, the recognition and
treatment of goodwill on termination, and its treatment for taxation purposes,
particularly in respect of capital gains tax (CGT).218 How the courts have dealt with
goodwill in relation to these issues, and the resultant case law, contributes importantly
to an understanding of the legal concept of goodwill. Thus, while goodwill in a
partnership business is essentially the same in character as in any other business
structure, the context of a partnership provides a different and useful approach to its
examination.
5.2 The nature of partnership
In Australia, the law relating to partnerships is governed by mostly uniform
Partnership Acts of the states and territories,219 based closely on the Partnership Act
1890 (UK),220 and by a large body of case law.221 In the Partnership Act 1891 (SA),
217 Fletcher explains that forerunners of modern partnerships may be found in medieval times in commercial associations in the form of the commenda and the societas. The commenda was a relationship between a lender who shared in the profits but was not liable for losses beyond his investment and an active business participant who also shared in the profits but bore the full risks and any losses. Accordingly, it may be seen as a forerunner of the modern limited partnership. ‘The societas’, in Fletcher’s words, ‘was the forerunner of the modern general partnership. It was a more or less permanent association between two or more associates often trading under a distinctive firm name. Each had capacity to represent the others and to bind them in contracts made for the firm. Each shared a personal and unlimited liability to the creditors of the firm.’ (Fletcher, K. L. 2001, The Law of
Partnership, 8th ed., LBC, Sydney, 4.) 218 Goodwill is also an important item of property for stamp duty purposes and is given separate treatment in chapter 7. 219 These are the Partnership Act 1891 (SA), 1891 (Qld), 1891 (Tas), 1892 (NSW), 1895 (WA), 1958 (Vic), 1963 (ACT) and 1997 (NT). 220 This Act and the Australian Acts based upon it were not intended to be an exclusive code, but to act in concert with other rules of equity and common law that relate to partnerships. See the Privy Council in Cameron v. Murdoch (1986) 63 ALR 565 and Graw, S. 2007, An Outline of the Law of Partnership, 3rd ed., Lawbook Co, Sydney. 221 Because of the nature of the relationship of partners, founded on matters of mutual confidence and trust and thus giving rise to fiduciary considerations, most of the earlier case law arose in equity in the Court of Chancery. Equitable considerations still govern many partnership issues. See Fletcher, K. L. 2001, The Law of Partnership, 8th ed., LBC, Sydney, 6.
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taken as an example, s. 1 defines a partnership as ‘the relation that subsists between
persons carrying on a business in common with a view to profit.’ The requirement that
a partnership must carry on a business means that the partnership will hold goodwill
attached to that business, bearing in mind that at law any business, profitable or not,
will have goodwill.222
In FCT v. Everett223 the High Court noted thateach partner has a beneficial interest in
each asset of the partnership and this interest is an equitable one because it is
enforceable in equity rather than at law.224 For CGT, consistent with that position,
each partner holds an undivided fractional interest in each asset of the partnership
business, including the goodwill. Such an interest is defined to be a CGT asset,225 as is
an interest in goodwill specifically.226
5.3 The treatment of goodwill in creation and variation
The creation of goodwill in a partnership business is no different from that of any
other business. That is, goodwill is acquired with a business when it is purchased227or,
in the case of a new business, commences to exist when the business commences.228
These positions follow from the understanding of goodwill as an integral part of a
business, in the form of an asset inseparable from that business. In Taxation Ruling
TR 1999/16 the Commissioner invokes s. 109-10, item 1, in ruling that internally
generated goodwill is acquired when work that resulted in its creation started. He goes
on to state that when such work starts ‘is a question of fact which depends on the
222 As the High Court stated in FCT v. Murry (1998) 98 ATC 4585 at 4590: ‘… the attraction of custom … 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.’ 223 (1980) 80 ATC 4076 at 4079. 224 See also Canny Gabriel Castle Jackson Advertising Pty Limited v. Volume Sales (Finance) Pty
Limited (1974) 131 CLR 321 at 327-8 and United Builders Pty Ltd v. Mutual Acceptance Ltd (1980) 144 CLR 673 at 688. No distinction is made between interests in tangible and intangible assets by the High Court in these cases. For a summary of the law relating to partnership property, see Latimer, P. 2006, Australian Business Law, 25th ed., CCH, Sydney, para. 10-390. 225 Paragraph 108-5(2)(c), Income Tax Assessment Act 1997 (Cth). 226 Paragraph 108-5(2)(b), Income Tax Assessment Act 1997 (Cth). 227 See FCT v. Murry (1998) 98 ATC 4585 at 4595. 228 The High Court in Murry alluded to the difficulty in identifying the date when goodwill was acquired in the case of a new business. However, contrary to the position in accounting, the High Court recognized as a matter of law that a business may have goodwill although it is not shown in the accounts ((1998) 98 ATC 4585 at 4595). In other words, internally generated goodwill is recognized at law, but not in accounting where goodwill must be purchased to be recognized. As noted above, the submitted position is that goodwill commences, and is therefore acquired, when the business commences. There does not appear to be any real difficulty with this approach in principle. But, of course, when a business commences is a question of fact and determining this may present some difficulty in practice.
54
circumstances of each particular case’.229 But, to restate the position above, the start
should be when the business itself starts, given the nature of goodwill and its
relationship with the business.
The matter ceases to be quite so straightforward, however, in the case of variations in
partnership membership and interests. If the membership of a partnership changes,
then the equitable and beneficial interests in each partnership asset, including
goodwill, will change. This has implications for the valuation of the goodwill to be
paid to departing partners or paid by new partners. Furthermore, it has potential
taxation implications, particularly in respect of CGT, where either members change or
membership interests change without a change in the members themselves.
5.3.1 Goodwill on variation in partnerships
A change in beneficial ownership of the goodwill constitutes a CGT event A1.230
Consequently, whenever the membership of a partnership changes, including shares
between existing partners, such a CGT event must strictly be generated in respect of
goodwill, as well as in respect of other partnership assets. The practicable and
practical issues in tracking beneficial changes in partnership assets where there is no
more than a change in existing members’ interests, however, would seem to be a
matter not worth pursuing, constituting essentially internal adjustments. It is
submitted, on the other hand, that the events generated by partners entering or leaving
a partnership should be seen in a different light. The CGT gains or losses from these
events should be taken into account for tax purposes because of their ‘external’ nature.
However, the determination of the relevant proceeds and costs bases of the goodwill
transactions (as for the other assets involved) are matters of valuation outside the
scope of this paper.
5.3.2 Goodwill in the creation of a partnership
Interesting issues arise in the creation of a partnership from the merger of businesses,
such as those of sole practitioners or traders. That is, to take a simple example, the
merger of two sole practitioners into a partnership raises the question of what happens
to the goodwill of the two practices when they are transferred to the new partnership.
229
Taxation Ruling TR 1999/16, paras. 122-3. 230
CGT event A1 is defined in s. 104-10, Income Tax Assessment Act 1997 (Cth), and happens where there is the disposal of a CGT asset: s. 104-10(1). Disposal requires a beneficial change in ownership: s. 104-10(2).
55
Does the goodwill of each business survive in the form of merged goodwill in the
partnership or does it cease to exist on the creation of the partnership? In either case
there will CGT implications in that CGT events will be generated. In the former case,
there will be a CGT event A1 constituting a beneficial transfer of the goodwill of each
sole practice to the partnership. In the latter case, the extinction of the goodwill should
give rise to either CGT event C1 or CGT event C2.231 But which of these two events
should apply? Pearson232has argued that the goodwill of the sole practices would be
destroyed rather than transferred to the partnership, and that CGT event C1 is the
more appropriate of the two events. The same view is found in Taxation Ruling TR
1999/16, para. 68.
However, should CGT event A1 be dismissed? The first question to resolve, it is
submitted, is whether the creation of a partnership in the above circumstances, by the
merger of two sole practitioners, may constitute a CGT event A1 in respect of the
goodwill of each sole practice. This will require the goodwill of the sole practitioners
to continue to exist in the new partnership business, rather than being destroyed, with
the changes in beneficial interests giving rise to the events. The argument presented by
Pearson relies on the premise that the goodwill is not transferred because a new
business is created in the partnership with a new goodwill. Authority for this view is
taken from obiter dictum in Murry in which the High Court proposed that goodwill
could only survive where the ‘same business’ continued.233 This ‘same business’ test
was borrowed from the test in the former s. 80E234 concerning company income tax
losses. In Avondale Motors (Parts) Pty Ltd v. FCT,235 it was determined by the High
Court that the same business in that section meant the identical business, not merely
231
CGT event C1 is defined in s. 104-20, Income Tax Assessment Act 1997,and happens where a CGT asset is lost or destroyed: s. 104-20(1). CGT event C2 is defined in s. 104-25 and happens where a taxpayer’s ownership of an intangible CGT asset ends in a range of ways set out in s. 104-25(1). 232 Pearson, G., ‘The Goodwill Roll-off Effect in Partnerships’, (2000) 3(1) Journal of Australian
Taxation 56. 233 The High Court stated: ‘The sources of the goodwill of a business may change and the part that various sources play in maintaining the goodwill may vary during the life of the business. 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.’ ((1998) 98 ATC 4585 at 4594). For general consideration of the implications of the ‘same business’ approach to goodwill, see:Walpole, M., ‘When Is Goodwill Not Goodwill?’, (1999) 2(1) Journal of
Australian Taxation 48; Chiert, G., ‘Murry: Ending the Mysteries of Goodwill or Creating New Commercial Pitfalls’, (1999) 73 The Australian Law Journal 660;and Higgins, R. and Do, V., ‘Is your pre-CGT goodwill really that good?’, (2007) 42(3) Taxation in Australia 155. 234
Income Tax Assessment Act 1936 (Cth). Now rewritten as s. 165-210 in the Income Tax Assessment
Act 1997 (Cth). 235 (1971) 71 ATC 4101 (HC).
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the same kind of business. However, it is at least debatable whether this test is
applicable to the question at hand, given that it was a statutory test designed for a
specific purpose in the different context of allowing income tax deductions for
company losses. In fact, this issue of context was noted by Gibbs J in Avondale
Motors where he said that ‘[t]he meaning of the phrase “same as”, like that of any
other ambiguous expression, depends on the context in which it appears.’236
At law, goodwill is inseparable from the business to which it is attached. Thus, if the
business is transferred, so is the goodwill, or, if the business ceases to exist, so does
the goodwill. However, whether a business is transferred, or instead ceases to exist, is
a question of fact in the particular circumstances. As a consequence, the fundamental
question in the situation under consideration is whether the businesses of the sole
practitioners are transferred to the partnership. A ready answer is that they are indeed
transferred because that is the very purpose of the exercise: that is, to take the two
previous businesses and combine them for the ‘synergistic’ benefit of the new
partners. Against that, it may be argued that the partnership business is in fact a new
business, albeit arising out of a combination of the previous businesses. In the usual
course, most the assets of the previous businesses will continue to exist in the new
business, allowing for the disposal of any unwanted or excess assets. However, given
the particular nature of goodwill, its continued existence necessarily depends on the
continued existence of the business, a course of conduct rather than property in its
own right. But does the business strictly have to be the ‘same business’? Can goodwill
survive a business combination where the previous business may not be separately
identifiable any more, but still effectively exist in a factual sense in the new business –
as a combined asset?
236 Id at 4106. Prima facie, this issue appears to be an example of what has been called ‘the fallacy of the transplanted category’ by Neil Brooks in ‘The Responsibility of Judges in Interpreting Tax Legislation’, in Cooper, G. S. (ed.) 1997, Tax Avoidance and the Rule of Law, IBFD Publications, Amsterdam, 122. Brooks argues that courts have exhibited a marked tendency to import terms from one area of the law into another area without regard for the different context and the different meaning that should be ascribed to a term in a new context. Brooks claims that this ‘one-word, one-meaning’ fallacy isroutinely committed in the tax law, but the same claim could be made in other areas of the law. Professor Rick Krever supports this view in respect of tax law in Krever, R., ‘Taming Complexity in Australian Income Tax’, (2003) 25 Sydney Law Review 467.An example ofjudicial recognition of this type of issue may be found in Gartside v. IRC [1968] AC 553 at 617 (per Lord Wilberforce).For an exposition of issues turning on statutory words having different shades of meaning, see Glesson, M., ‘Justice Hill Memorial Lecture – statutory interpretation’, (2009) 44(1) Taxation in Australia 25.
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On balance, it is submitted that the most reasonable view is that the old businesses
cease on their merging in the new partnership with the result that the goodwill of the
old businesses also ceases to exist. Consequently, CGT event C1 should be applied to
the goodwill, taking it to have been destroyed in the merger.237
However, an analysis of the application of CGT event C1 and also CGT event C2, and
their competing claims, is outside the scope of this paper.238 The critical concern is
what these issues bring to our understanding of goodwill, of its relationship with
business, and of its treatment when the business is merged in a partnership. The nature
of goodwill as an asset inseparable from the business, and not able to exist without the
business, is at the basis of the conclusion that goodwill is destroyed when a business is
transferred to a partnership. This is the result of the fact that the business cannot be
said to continue in such circumstances. What is produced is a new business arising
from the old businesses. The fate of the goodwill is, by its very nature, determined by
the fate of the business.
5.4 The termination of partnerships
As noted at the beginning of this paper, goodwill is an elusive concept. Such a concept
has given rise to many problematic issues, especially during the early period of its
evolution, and these are well illustrated in the context of the termination of
partnerships. During the nineteenth century in particular, important issues concerning
the recognition and treatment of goodwill arose in this context.The nature of the
goodwill itself, the nature of the partnership business (whether professional or
commercial), and the mode of termination of the partnership are all matters which
came before the courts during this time, even though they were matters which were
not necessarily addressed or even recognized in many cases.
The termination or dissolution of partnerships raises certain issues concerning the
ownership of and interests in goodwill relating to businesses carried on by them.
Partnerships may be terminated by agreement or in a number of other ways, including
by the retirement, death or bankruptcy of a partner, and in each type of situation
consideration must be given to the treatment of the goodwill for the benefit of the
237 See s. 104-20(1). 238 For an analysis of these issues, see Pearson, G., ‘The Goodwill Roll-off Effect in Partnerships’, (2000) 3(1) Journal of Australian Taxation 56.
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individual partners or their estates.239 Partnership law requires a proper accounting to
all partners for all assets, including goodwill, on the dissolution of a partnership: Re
David and Matthews.240 On the dissolution of a partnership, therefore, goodwill does
not survive to the remaining partners unless by express agreement.241 In accordance
with the general principle, an appropriate share of the goodwill belongs to a retiring
partner or to the estate of a deceased partner, and therefore must be accounted for.242
At the beginning of the nineteenth century, however, this principle had not been
firmly established. Its subsequent establishment owes much to the influence of Lord
Eldon LC and the views he expressed on the matter in the first quarter of the
nineteenth century, subject to reservations he had regarding professional goodwill.243
This part of the chapter explores and examines a selection of critical matters relating
to partnerships and their termination. First, the earliest relevant case law is noted as
the starting point in plotting the treatment of partnership goodwill. Secondly, the
views of the influential Lord Eldon244 are addressed. It is seen that his early views
became accepted as the law on the treatment of goodwill on termination of
partnerships, but only after considerable judicial inconsistency and uncertainty as
discussed in the third section of this part. Fourthly, the question of the need for a sale
of a partnership business to settle the interests in goodwill of departing partners is
addressed. Fifthly, the treatment of goodwill in so-called professional partnerships is
239 For a review of the issues involved in the dissolution of partnerships, see Raphael, D., ‘Dissolution of Partnership’, (1998) 27(2) Australian Tax Review 79. 240 [1899] 1 Ch 378; [1895-9] All ER 817. See also McFadden v. CSD(NSW) (1980) 80 ATC 4343 (NSW CA). 241 The Partnership Act 1895 (WA) expressly provides in s. 51 that on the dissolution of a partnership every partner shall be entitled, in the absence of an agreement to the contrary, to have the goodwill of the business sold for the common benefit of all partners. But the Partnership Acts of the other Australian states and the Partnership Act 1890 (UK) do not have an equivalent provision, relying instead on the common law represented by cases such as Re David and Matthews. 242 In Chia v. Ireland [2000] SASC 47 the Full Court of the SA Supreme Court made a distinction between ‘technical’ or ‘notional’ dissolution of a partnership where a partner retires but the business carries on and general dissolution where the partnership business winds up. This was a case of technical dissolution and the Court held that the retiring partner was entitled to be paid her share at fair value of the partnership capital including goodwill. However, the strict legal position is that on the retirement of a partner the partnership ceases and a new partnership comprising the remaining partners is formed: see, for example, S J Mackie Pty Ltd v. Dalziell Medical Practice Pty Ltd [1989] 2 Qd 87 and Cyril
Henschke Pty Ltd v. CST(SA) 2008 ATC 9269. By way of comparison, under the Uniform Partnership Act (USA) a partnership is dissolved on the retirement of a partner unless there is an agreement to the contrary. Where such an agreement exists and the partnership business continues, the retiring partner must be paid his partnership interest, including goodwill, in the normal course: see Ribstein, L. E., ‘A Theoretical Analysis of Professional Partnership Goodwill’, (1991) 70(1) Nebraska Law Review 38. 243 These reservations are discussed in chapter 3. 244 The contribution which Lord Eldon made to the law of goodwill is addressed in chapter 2.
59
considered in order to examine the early view that such goodwill is to be treated
differently from goodwill in other partnerships. Finally, to round off this part, the
taxation treatment of goodwill in this context is addressed.
5.4.1 Early case law
As noted in chapter 2, in 1743 in Gibblett v. Read245 Lord Hardwicke LC held that the
profits of a deceased partner’s share in a printing business were part of his personal
estate. And by analogy he pronounced that if the business had been ‘a house of great
trade, [the executor] must account for what is called the good-will of it’.246 But if Lord
Hardwicke was of the view that a partner’s share of goodwill became part of his
estate, Lord Loughborough LC took the contrary view in 1800 in Hammond v.
Douglas247where he held that the goodwill of a partnership carrying on the trade of
snuff-makers survived the death of a partner, being the property of the surviving
partner. This was a partnership without articles, so it appears that the Lord Chancellor
was of the opinion that for the estate to be entitled to a share of the goodwill, an
express clause to that end would have been required, in direct contrast to the present
position. Lord Loughborough’s view was part of the ratio decidendi of his judgment,
whereas Lord Hardwicke’s view in the earlier case was simply obiter dictum, thus it
may be taken that Hammond v. Douglas represented the law at that time, even though
it was later critically doubted by Lord Eldon.
5.4.2 Lord Eldon’s view
The proposition that goodwill survives the dissolution of a partnership, either by death
of a partner or by other means, was called into question by Lord Eldon in Crawshay v.
Collins.248 This case involved an action by the plaintiffs, as assignees in bankruptcy,
to be declared entitled to a share of profits accruing on the interest of the bankrupt
partner in the partnership at the time of his bankruptcy and beyond that point of profits
accruing to the remaining two partners, the defendants. The resolution of the case249 is
245 (1743) 9 Mod 459; 88 ER 573. 246 Id at 460. 247 (1800) 5 Ves Jun 539; 31 ER 726. 248 (1808) 15 Ves Jun 218; 33 ER 736. The partnership had carried on the business of pump and engine manufacturers. 249 A Commission of Bankruptcy had been issued against the bankrupt partner on 1803 and a suit instituted in 1804. An original decree was made by the Master of the Rolls in 1805 and the case was heard initially in 1808 with a later hearing by Lord Eldon in 1820 after a further Master’s report. Then the final decree was not made until 1826. Thus, in keeping with the reputation of the Court of Chancery of this time for dilatoriness, this case took over 20 years to determine. Much of the blame for this
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of little importance here, but reference to goodwill in passing helps to cast some light
on the understanding of goodwill at that time. Sir Samuel Romilly for the plaintiffs
referred to Hammondv. Douglas and expressed doubt that goodwill survived the
termination of a partnership, a doubt with which Lord Eldon agreed.250 The basis for
this doubt may arguably be found earlier in the same case in Lord Eldon’s general
pronouncement on the law regarding partnership property on dissolution:
In the instance of a partnership, without articles, the respective proportions of capital
contributed by the partners, and the trade being carried on either for a certain period, or
the connection dissolvable at pleasure, the time being expired, or, in the other case,
notice to determine being given, it cannot be contended that, if the remaining partners
choose to carry on the trade, they can consider the whole property as their own; … The
obligation implied among partners is that they are to use the joint property for the
benefit of all, whose property it is.251
In other words, all partnership property, including goodwill, should be dealt with for
the benefit of all partners, meaning that goodwill specifically should not be the sole
preserve of the surviving partners. Furthermore, support for this view may be found in
the decree arising from Cook v. Collingridge252 where Lord Eldon declared that the
goodwill of the partnership business of coachmaking had value which should be taken
into account in determining a deceased partner’s share of it from the sale of the
business.
reputation has been attributed to the indecision and tardiness of Lord Eldon, who was referred to as ‘Lord Endless’ by his contemporary, Jeremy Bentham: see Melikan, R. A. 1999, John Scott, Lord
Eldon, 1751-1838, Cambridge UP, 313. (Bentham was clearly no friend of Lord Eldon as may be discerned in Bentham, J. 1825, Indications Respecting Lord Eldon, J and H L Hunt, London wherein he made a range of serious allegations against Lord Eldon concerning his supposed maladministration of the Court of Chancery.) Lord Eldon’s tarnished reputation has lived on into modern times: see, for example, Windeyer, W. J. V. 1957, Lectures on Legal History (2nd ed. revised), Law Book Co, Sydney, 268-270 and Pannick, D. 1987, Judges, OUP, Oxford, 86-7. However, a more contemporary writer presented a quite different view in a long and detailed analysis of Lord Eldon’s performance as Lord Chancellor: see Twiss, H. 1844, The Public and Private Life of Lord Chancellor Eldon, John Murray, London, ch. LXIII. Writing at a time much closer to his Chancellorship, Twiss argued cogently, citing many facts and figures, that Lord Eldon’s reputation for tardiness was undeserved. While he admitted that Lord Eldon tended to be over-cautious in delivering his judgments in a few critical cases, he argued that most of the delays were not in fact his fault and his clearance rates in general were at least as good as eminent predecessors such as Lord Hardwicke. Chancery at the time was a court under siege by a huge number of actions and Lord Eldon assumed a very heavy judicial work-load on top of his significant parliamentary duties. At the time of writing in the 1840s, Twiss stated that there were three Vice-Chancellors as well as the Master of the Rolls doing the work earlier undertaken by Lord Eldon alone. (In fact, two additional Vice-Chancellors were appointed in 1842.) 250 The note to Hammond v. Douglas 1 Ves Jun 531; 34 ER 907 also refers to Lord Eldon’s doubt on this point. 251 (1808) 15 Ves Jun. 218 at 226; 33 ER 736 at 740. 252 (1825) 27 Beav 456; 54 ER 180.
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In Hammond v. Douglas the dissolution of the partnership was caused by death of a
partner, whereas in Crawshay v. Collins bankruptcy was the cause. But Lord Eldon
did not see the need to make any distinction in expressing his doubt on the
survivorship of goodwill. It may reasonably be concluded, therefore, that Lord Eldon
did not see the mode of partnership dissolution as an issue in his view on the treatment
of goodwill. Furthermore, the nature of the goodwill does not seem to have been an
issue in his mind, with the exception of personal goodwill in professional businesses
as noted in chapter 3. Apart from his reservations about the transmission of personal
goodwill, Lord Eldon paid no attention to the nature of partnership goodwill.
5.4.3 Nineteenth century uncertainty
Although Lord Eldon did not deal with the survivorship of partnership goodwill in the
ratio of any reported case, such was his influence that his comments obiter were taken
as the law nonetheless in certain cases. As early as 1810 in Featherstonhaugh v.
Fenwick,253 Sir William Grant MR had held that a retiring partner was entitled to a
share of the goodwill of the partnership business of glassmaking on the authority of
Crawshay v. Collins. As might be expected, Lord Eldon approved this decision when
the opportunity arose in a later case.254
Notwithstanding Lord Eldon’s important early influence, however, the question of
survivorship was not finally settled until the end of the nineteenth century. A review
of cases through this century reveals an inconsistency by the courts in their treatment
of goodwill in the termination of partnerships. The courts oscillated between deciding
that goodwill survived in some cases and did not survive in others. The growing
significance of goodwill as a business asset is evident in these cases and arguably
offers some explanation for the inconsistency in the courts’ decisions; the value of the
goodwill was important to the parties and it is apparent that courts endeavoured to
hand down equitable decisions which led to different decisions in different
circumstances. This apparent seeking to ‘do equity’ is evident in this section and in
the following two sections on the need for sale and on the treatment of professional
partnerships, both of which deal with specific issues connected with the courts’
decisions in this period.
253 (1810) 17 Ves Jun 298; 34 ER 115. 254
Cook v. Collingridge (1823) Jac 607; 37 ER 979.
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In Lewis v. Langdon255in 1835, for example, Shadwell V-C was prepared to hold that
goodwill, in the form of a name, survived in the case of a pencil-making partnership.
It might be arguable that in fact Shadwell V-C was applying the law at that time,
given that apart from Featherstonhaugh v. Fenwick there was no case that dealt
directly with the question in its ratio. Nonetheless, he made an attempt to distinguish
Lord Eldon’s view in saying that Lord Eldon was referring to site goodwill in his
observation in Crawshay v. Collins, whereas this case involved name goodwill. But
while counsel did refer to site goodwill in his proposal that Hammond v. Douglas was
incorrect, Lord Eldon in fact made no reference to the nature of the goodwill,
suggesting that it had no bearing on his view. However, Shadwell V-C then struck out
on his own course with the novel argument that if goodwill is to be considered a
saleable partnership asset then it must follow that the surviving partner must carry on
the trade after his partner’s death in order to preserve this saleable asset. This
requirement therefore gave the survivor the discretion to determine what was to be
done with the goodwill, consequently making it his property. But notwithstanding this
doubtful approach to the question, there is a reference to a clause in the partnership
agreement which Shadwell V-C held allowed the surviving partner the right to use the
disputed name in his own firm. Hence, it might be proposed that this was a
distinguishable situation on the basis that the goodwill survived by express agreement,
thus rendering the above argument redundant. So while on the face of it this case
appeared not to conform to Lord Eldon’s view, particularly in respect of the survivor’s
right to the goodwill, the decision might still be seen to be in line with it after all, by
virtue of the partnership agreement. Nevertheless, to the extent that it stood for the
survivorship of goodwill, this decision seemed to have had little effect on later
decisions,256 and by 1856 in Wedderburn v. Wedderburn257 Sir John Romilly MR felt
able to pronounce without qualification that:
255 (1835) 7 Sim 421; 58 ER 899. 256 However, the wavering Romilly MR followed Lewis v. Langdon in Robertson v. Quiddington, a case mentioned later in this section.At the end of the century, Shadwell J’s decision scored a mention by Romer J of the Chancery Division in Re David and Matthews [1899] 1 Ch 378; [1895-9] All ER 817 where it was dismissed as not representing the law at this later time. But Romer J was prepared to concede that Shadwell J had based his decision on Hammond v. Douglas as ‘probably’ representing the law at the time of that decision, notwithstanding other cases pointing to the contrary before Lewis v.
Langdon. Nonetheless, apart from the decision in Featherstonhaugh v. Fenwick and perhaps that in Farr v. Pearce, the law to this time seems to have been contained only in the dicta of these cases, albeit strong dicta from the Lord Chancellor. 257 (1856) 22 Beav 84; 52 ER 1039.
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in reported cases, Lord Eldon held that a share of [goodwill] properly and as of right
belonged to the estate of the deceased partner. It does not survive to the remaining
partners, unless by express agreement … .258
Romilly MR also applied this principle in Smith v. Everett259 in 1859 in holding that
the executor of a deceased partner’s estate was entitled to an appropriate share of the
partnership goodwill.
However, if these decisions appear to suggest that the law on the question of
survivorship was settled by this time, other decisions, including those of Romilly
himself, suggest otherwise. As is shown by the cases which follow, it was near the end
of the nineteenth century before the question was finally settled in line with Lord
Eldon’s view. This point was recognized by Romer J in Re David and Matthews
where he said that ‘up to comparatively recent times it was considered that the right to
the goodwill belonged to the surviving partner, and it is only recently that the
importance of goodwill and the necessity of preventing its improper appropriation has
been fully recognised.’260 As authority for this opinion he adduced the 1896 House of
Lords’ case of Trego v. Hunt,261 discussed in chapter 6.
In Hall v. Hall262 in 1855 Romilly MR appeared to revive the law of Hammond v.
Douglas and Lewis v. Langdon in deciding that no amount was to be paid to a retiring
partner for a share of the goodwill of brewery business because there was no express
provision for this in the partnership articles. This decision seems to fly in the face of
not only Lord Eldon’s view but also Romilly MR’s own view of the law as evidenced
in other cases such as Wedderburn. Furthermore, the reported details of the
partnership agreement might arguably have been construed as providing for goodwill
on dissolution, notwithstanding the absence of an express provision. No authorities
were cited to support this decision and it appears from the report that Romilly MR was
influenced by what he saw as the plaintiff’s unsatisfactory case and sought an
equitable, pragmatic solution for the good of both parties, rather than one based on
258 Id at 104. 259 (1859) 27 Beav 446; 54 ER 175. 260 [1895-9] All ER 817 at 820. 261 [1896] AC 7. 262 (1855) 20 Beav 139; 52 ER 555.
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principle.263 Consequently, this decision had no impact on the law, essentially being
confined to its own facts.
Romilly MR again deviated from the principle he espoused in Wedderburn in the
1860 case of Robertson v. Quiddington264 where he resurrected Lewis v. Langdon in
using that case as authority for deciding that goodwill in the form of the business
name of the partnership belonged to the surviving partner. This decision is rather
perplexing, given that it cannot be justified readily on its facts, as distinct from what is
arguably the case in Hall v. Hall. The best one can say is that the principle concerning
the survivorship of partnership goodwill was still not completely settled at this time, at
least in the mind of the Master of the Rolls.265
However, moving ahead to 1878, Hall V-C in Reynolds v. Bullock266 was clearly of
the view that goodwill did not survive except by express agreement. But lest anyone
should think that the question was by now settled, very soon after this case the Court
of Appeal handed down its decision in Steuart v.Gladstone267 in the same year where
all three judges made general observations about a partner’s right to a share of
goodwill on retirement, observations which can only be construed as running counter
to the view originally espoused by Lord Eldon. While these observations may be seen
as obiter dicta, with the decisions themselves being based on a construction of the
partnership articles, they nevertheless added significant confusion to the question.268
The essence of the judges’ opinions was that, because any goodwill would have been
internally generated and thus not recognized in the balance sheet, it either did not exist
or was not capable of valuation and so was not available to the plaintiff partner on his
departure from the partnership. But the partnership’s business of commission agents in
India and England was a very well established and profitable one which should have
commanded a significant amount of goodwill on sale. Accordingly, an appropriate
share of an estimate of the value of that goodwill at the time of retirement should have
263 In Steuart v. Gladstone (1878) 10 Ch D 626, Fry J at first instance remarked that he did not understand upon what principle Hall v. Hall was decided and also considered it inconsistent with later authority. 264 (1860) 28 Beav 529. 265 Romer J in Re David and Matthews, from the relative vantage point of the end of the century, was more blunt in opining that Robertson v. Quiddington was based on the erroneous supposition that Hammond v. Douglas was a binding authority. 266 (1878) 47 LJ Ch 773. 267 (1879) 10 Ch D 626. 268
Steuart v. Gladstone was followed by North J in Hunter v. Dowling [1895] 2 Ch D 223 on a similar contruction of similar articles of partnership, which might have justified the decision.
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formed part of the retiring partner’s payout, in the absence of provision to the contrary
in the articles. In the usual case, and consistent with modern practice, a retiring or
deceased partner would have been expected to have contributed to the development
and worth of the goodwill and therefore he or his estate should have been entitled to
an appropriate share of it.
5.4.4 The need for sale?
It is clearly evident in a number of these earlier cases that the courts were of the
opinion that for goodwill to be recognized and valued the business had to be actually
sold, which could have been contrary to the wishes and interests of the surviving
partners in many cases. For example, in the early case of Farr v. Pearce269 in 1818
Leach V-C was swayed by this opinion in holding that the goodwill of a professional
partnership survived to the remaining partner. Moreover, much later in 1883 in
Arundell v. Bell,270 Lindley LJ of the Court of Appeal was still holding to this opinion,
viewing goodwill as something saleable which therefore did not exist outside a sale,
presumably to a third party. Accordingly, he saw such a sale as upsetting any
arrangement for the surviving partners to carry on the business. Hence this opinion
may be taken to have represented a strong inhibitor to finding that the retiring or
deceased partner was entitled to a share of goodwill.
In Taylor v. Neate,271however, Chitty J was confronted with having to decide, on the
dissolution of a partnership, whether to order a distribution of assets in specie or to
order that the partnership business be placed in the hands of a receiver and manager to
enable a sale as a going concern to protect the value of the goodwill.272 While he
admitted it was impossible to lay down a hard and fast rule in a case like this because
businesses varied so much, he opted for the latter course, a sale as a going concern,
because to do otherwise would be to sell the business and its goodwill at a
disadvantage.273
269 (1818) 3 Madd 74; 56 ER 437. 270 (1883) 52 LJ Ch 537. 271 (1888) 39 Ch D 538. 272 In Pawsey v. Armstrong (1881) 18 Ch D 698, also, it was held that a partner could insist on a sale of a business as a going concern as a result of the dissolution of a partnership. 273 Of course, it would not have been possible to sell the goodwill if the distribution had been made in
specie because the business would have ceased.
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Nonetheless, in keeping with the confused and confusing judicial approach to the
question during this period, other cases reveal an understanding that goodwill did not
need to be sold in order to be accounted for on dissolution of a partnership. For
example, in 1863 in Hall v. Barrows274 no less an authority than the Lord Chancellor,
Lord Westbury, made a direct and clear reference to the practical problems involved
in using a sale of the business as a going concern for the purpose of valuing goodwill.
In this case the surviving partner had an option in the articles of partnership to carry
on the business on paying to the personal representatives of the deceased partner the
value of his share. A sale was obviously inappropriate in such a situation and
accordingly the Lord Chancellor directed that a valuation of the partnership property,
including the goodwill, be made by the Court.
In Broughton v. Broughton,275 to take another example, Jessel MR276 held that the
estate of a deceased partner was entitled to a share of the partnership goodwill as
valued at the time of death, and there was no requirement to sell the business to
ascertain this goodwill. The business was sold some time later, in fact, but Jessel MR
held that that later time was not the appropriate time to value the amount of goodwill
owing to the deceased estate. Furthermore, in Re David and Matthews Romer J stated
that ‘[f]or the purpose of valuing … goodwill, no difference can properly be drawn
between a contract to sell to one of the partners and a contract to sell to a stranger.’277
In other words, a valuation may be made without a sale where it is appropriate to do
so.278
5.4.5 Professional partnerships
An added complication to the general question of survivorship may be found in the
question of the survivorship of goodwill in professional partnerships as opposed to
commercial partnerships. As early as 1818 in Farr v. Pearce, Sir John Leach V-C was
called upon to decide whether the plaintiff as the legal representative of a deceased
partner was entitled to a share of the goodwill of the partnership business, a medical
274 (1863) 4 De G J & S 150; 46 ER 873. 275 (1875) 44 LJ Ch 526. 276 On a slightly ironical note perhaps, Jessel MR also sat on the Court of Appeal in Arundell v. Bell. However, he did not contradict himself in that case because he, unlike Lindley LJ, did not deal specifically with the question of the need for sale of goodwill in his decision. 277 [1895-9] All ER 817 at 821. 278 A modern example of this approach may be found in Cyril Henschke Pty Ltd v. CST(SA) 2008 ATC 9269; [2008] SASC 360.
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practice,279 on its sale to another party. The Vice-Chancellor found that there was no
provision in the articles of partnership to give the benefit of the goodwill to the estate
of the deceased and therefore found against the plaintiff. In support of this decision, he
opined:
… I think it would have been difficult to maintain that where a partnership is formed
between professional persons, as surgeons, and one dies, the other is obliged to give up
his business and sell the connection for the joint benefit of himself and the estate of his
deceased partner. When such partnerships determine, unless there be stipulations to the
contrary, each must be at liberty to continue his own exertions; and where the
determination is by the death of one, the right of the survivor cannot be affected.280
Leach V-C then went on to pronounce that professional281 partnerships were very
different from commercial partnerships, but gave no reasons for making this
distinction.282 The distinction which may perhaps be inferred is that professional
people generally rendered services, while commercial people were more likely to be
involved in trading activities, at least at that time. There appears to be no express
authority for this view and, moreover, the cases where Lord Eldon addressed in
passing the question of survivorship did not involve professional businesses.
However, Lord Eldon’s strongly expressed doubts about the existence of personal
goodwill in professional businesses283 could well have been influential, given the lack
of case law at the time on the treatment of goodwill in professional partnerships
specifically. That is, it might be postulated that professional goodwill was seen as
largely personal in nature and therefore of no account on the dissolution of a
professional partnership. Furthermore, Leach V-C was dealing specifically with
279 The practice provided the services of a surgeon, apothecary and man-midwife. 280 (1818) 3 Madd 74 at 78-9; 56 ER 437 at 439. 281 While the term ‘professional’ is difficult to define with any precision, Leach V-C probably had in mind members of the three traditional professions of divinity, law and medicine. More generally, a professional person may be seen as a member of a skilled occupation, such membership usually requiring formal qualifications and adherence to a code of ethics. 282 According to Melikan, R. A. 1999, John Scott, Lord Eldon, 1751-1838, Cambridge UP, 313, ‘Leach … was criticised [by the legal profession] for his impatience and unwillingness to listen to arguments’. Twiss makes a similar claim about Leach in stating that, ‘… jumping to his conclusions, he often heard with impatience the arguments at the bar, and, when points were earnestly pressed, was not always courteous to Counsel’: see Twiss, H. 1846, The Public and Private Life of Lord Chancellor Eldon, 2nd ed., John Murray, London, vol 1, 558. These observations may offer some clue to the decision in this case where, it is interesting to note in the light of the above criticism, Leach is recorded as stopping the defendant’s counsel from presenting argument before delivering his decision, albeit in the defendant’s favour. 283 See chapter 3.
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dissolution on death in this case, and there may be an indication in his concern for the
right of the survivor to be able to continue in his profession that his views on
survivorship might have been confined to such a situation, rather than by other forms
of dissolution. But the survivor of a professional partnership (or a commercial one, for
the matter) is not obliged to give up his business, because he may buy the share of the
deceased partner. This fact was recognized by Sir John Romilly MR in Smith v.
Everett284 where he opined that the surviving partner could carry on the same
business, and in the same premises, as before. Again this was a commercial business
of banking rather than a profession, but plainly there should be no difference in
principle.285
Nevertheless, cases to this time and for some time beyond, apart from Farr v. Pearce,
dealt with commercial businesses rather than professional ones. Consequently,
Leach’s view regarding professional partnerships, strictly speaking, remained largely
unchallenged until the end of the century. But it is clear that Farr v. Pearce was not
taken as an authority for the principle that goodwill survived in a professional
partnership because it was largely ignored in the case law, dying a quiet and unnoticed
death. As noted above, the broader question of the existence of professional goodwill
cropped up from time to time in the case law, but not the specific question of its
treatment on dissolution of a professional partnership.
By 1899 professional goodwill, in the form of name goodwill, had been recognized in
Burchell v. Wilde. Moreover, by 1905 in Hill v. Fearis,286 involving a stockbroking
partnership, it may be taken as having been settled that professional goodwill was to
be treated in the same way as goodwill in any other business on the dissolution of a
partnership.
5.4.6 Taxation matters
Consistent with the treatment of goodwill in the creation and variation of partnerships,
the CGT treatment of goodwill should also be considered on their termination. First,
where the partnership business is sold as part of the termination, the sale of each
284 (1859) 27 Beav 446; 54 ER 175. 285 By 1889 it was recognized by Allan that this distinction did not in fact exist because, as he said, the same rules of law must apply to both professional practices and to trades and other businesses. See Allan, C. E. 1889, The Law relating to Goodwill, Stevens and Sons Ltd, London, 41. 286 [1905] 1 Ch 466.
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partner’s interest in the goodwill, along with the interests in the other business assets,
gives rise to CGT event A1 in respect of each asset. Similarly, the retirement or death
of a partner also gives rise to CGT event A1 in that the departing partner disposes of
his interest in the goodwill to the remaining partners. In both of these types of
situation, the business remains in existence together with its goodwill.
However, in the type of situation where the partnership is dissolved and the business
is split amongst the partners, a different result will arise. A simple example of this
type of situation is where two partners part company and become sole practitioners by
taking their shares of the business with them. This is the reverse of the example
presented in 5.3.2 where a partnership was formed by the merger of two sole
practitioners. Here, as in that situation of merger, the partnership goodwill ceases to
exist along with the partnership business,287 thus also generating CGT event C1.
5.5 Conclusions
The nature of a partnership involving contractual and fiduciary relationships between
the partners raises a range of issues in relation to goodwill. Variations to the
composition of a partnership, both in terms of membership and the sharing
arrangements between the partners, raise contentious issues about the treatment of
goodwill in these circumstances. Included in these issues are questions of the
application of CGT as a result of these variations. Goodwill is a significant asset for
CGT purposes, as it is in law and commerce generally. What is made particularly clear
about the nature of goodwill in the partnership context is its attachment to, and
dependence on, business. Where partnership interests change, so do the interests in
goodwill as a partnership asset, with potential legal implications.
Historically, much of the interest and issues concerning goodwill arose in the context
of the termination of partnerships in the nineteenth century. In spite of the tortuous
path taken, by the end of that century the question of survivorship of partnership
goodwill may be accepted as having been settled in accordance with Lord Eldon’s
view espoused in the first decade of the century in Crayshaw v. Collins. And, it should
be said, settled in accordance with the fair and equitable principle that a retiring
partner, or a deceased partner’s estate, is entitled to a share of all property of the
business, including goodwill. Cases such as Re David and Matthews and Hill v.
287 This was essentially the approach taken in Old v. Hodgkinson [2008] NSWSC 697.
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Fearismade it clear that, in the absence of any provision to the contrary in the
partnership articles, goodwill must be accounted for on dissolution of the partnership.
Lord Eldon’s view had finally prevailed.
The development of the law on the treatment of goodwill in the termination of
partnerships largely mirrors the development of the concept of goodwill itself.
Throughout the nineteenth century, the judiciary had trouble in understanding and
dealing with the general concept of goodwill and also in dealing with it specifically in
the context of partnership termination. However, it is clear that the concept of
goodwill in question during this period was the commercial law one commonly
understood today. That is, it was seen as valuable property and an asset of the
partnership business. Moreover, there is ample reference to goodwill as typically
arising from the sources discussed in chapter 3.
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Chapter 6: Goodwill and Restrictive Covenants
6.1 Introduction
The essence of restrictive covenants, or agreements in restraint of trade, is the
protection of a business and its goodwill on sale. These covenants restrict the vendor
of a business from competing with the purchaser to the detriment of the business and
goodwill.288 Restrictive covenants may also apply to employees on leaving an
employment, as in the case of Hepples v. FCT,289 where the employment contract of
the appellant included restraint of trade conditions. In such a situation, the employee
may be bound, for example, not to enter into the employment of a competitor, not to
divulge trade secrets to third parties, or not to set up business in competition with the
former employer. The object of the agreement in this type of situation is also to
protect the goodwill of the former employer. As a result of its long history, this is an
area of the law which offers insight into the nature of goodwill and its development as
a legal concept.
The relationship between the sale of business with its goodwill and restrictive
covenants has raised a range of pertinent issues concerning goodwill. As the essential
purpose of a restrictive covenant is to protect goodwill, these cases provide a
particular focus on the concept and contribute significantly to an understanding of its
development. However, in early times restrictive covenants were not readily
recognized by the courts, raising issues about the importance of goodwill and its
protection in the face of freedom of trade. Furthermore, the absence of restrictive
covenants on the sale of business, not such a rare thing in apparently more innocent
earlier times,290 also provides insight into the nature of goodwill and the importance of
its place in business.
288 Furthermore, as noted by the High Court in Geraghty v. Minter (1979) 142 CLR 177, a restrictive covenant would be expected not only to protect goodwill, but also to increase its value. 289 (1991) 91 ATC 4808. This is an important High Court tax case referred to in several places in this paper. 290 Support for the view that appropriate restrictive covenants were often absent in sales up to at least late in the nineteenth century may be found in Anonymous, ‘The Law as to Goodwill’, (18 January 1896) The Accountant 43 which discussed the implications of the House of Lords’ case of Trego v.
Hunt [1896] AC 7 (see later in this chapter). This article ended with the advice that ‘the purchasers of goodwills will in future be well advised to obtain some special covenenant from the vendor in partial restraint of trade’ (at 44).
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This chapter plots the development of goodwill in the context of restrictive covenants
from a nascent concept discernible in early cases dating as far back as the early
fifteenth century. Thus the starting point is an examination of the development of the
law of restraint of trade, taking it up to its modern conception as a major protector of
goodwill. Then several related issues are examined. First, the question of whether the
sale of goodwill in itself implies any general protection, without a specific restrictive
covenant, is examined. Secondly, consideration is given to a limited form of
protection, concerning the solicitation of former customers, which developed in the
latter part of the nineteenth century. Thirdly, the exception for fraud is considered;
where fraud was involved, the courts took a different approach, with a view to
protecting the public rather than the goodwill of a purchaser. Finally, sales of
businesses by trustees in bankruptcy are examined. These situations reveal the
development of goodwill as a valuable business asset in various settings. They
demonstrate the important nature of goodwill during the period of its development.
6.2 The development of legal restraint of trade
The law of restraint of trade has a long history before emerging into its modern form
late in the nineteenth century. As noted in chapter 2, as early as 1711 in Mitchel v.
Reynolds,291 Parker CJ reviewed the law of restraint of trade and the circumstances
where agreements in restraint of trade, or restrictive covenants, were legal. The basic
position at this time, with some exceptions, was that restrictive covenants were
generally recognized at common law where they were reasonable in the scope of their
restraint. However, there remained some doubt as to the necessity of adequate
consideration to make them enforceable. Later the law was modified in that the
strictness of the tests for reasonableness of restraint was reduced and the adequacy of
the consideration ceased to be an issue.292
The early history of restrictive covenants in the case law provides an interesting
background to the development of business and the freedom to trade without
interference. An incipient concept of goodwill may be inferred from the early law
relating to the validity of restraints on business. The general position was that
291 (1711) 1 P Wms 181; 24 ER 347. 292 Allan, C. E. 1889, The Law relating to Goodwill, Stevens and Sons Ltd, London, ch. VII, provides a useful review of the early development of restraint of trade law until the latter part of the nineteenth century. For a modern perspective of this development, see Heydon, J. D. 1999, The Restraint of Trade
Doctrine, 2nd ed., Butterworths, Sydney, ch. 1.
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competition was paramount and therefore people should be free to enter any trade or
business. In this regard, there was an aversion to the creation of monopolies which
restricted free entry to trade. For example, in 1410 there was the notable case of
Hamlyn v. More(The Gloucester Grammar School Case)293 where two school masters
brought a writ of trespass in the Court of Common Pleas against another master who
had set up a school in competition with them with the result that they had to lower
their fees. The plaintiffs failed in their action because the Court held that they had no
proprietary interest in school teaching such that they could exclude another from
entering the field, even though the competition was to their financial detriment. But,
from the general position that business could not be interfered with, some exceptions
emerged later which allowed a person to sell his business or trade and protect the
purchaser by entering into a restrictive covenant not to compete within reasonable
bounds. It is from these covenants that notions of goodwill as a valuable aspect of a
trade or business may be seen to evolve.
While there was no restrictive covenant in Hamlyn v. More, there were cases which
followed involving such covenants, bringing the question of their validity to the
attention of the courts. Thus in 1414 there was the even more notable Dyer’s Case294
where it seems, according to Parker CJ in Mitchel v. Reynolds, ‘some designing
fellow’ took advantage of a ‘poor weaver,’ in a fit of depression about some reverses
suffered in his trade, by prevailing on him to enter into a bond to leave the trade for a
trifling consideration. The court found this bond in restraint of trade to be
unenforceable, but apparently as much for the unconscionable behaviour of the
‘designing fellow’ as for the inadequate consideration.
A few other cases in similar vein followed over the next two centuries. In 1587295 a
bond in restraint of trade between blacksmiths was held to be void on the authority of
Dyer’s Case. It appears that consideration was meant to be paid, but as a result of
default in payment the obligee sued for it. According to Parker CJ in Mitchel v.
293 (1410) YB Hil 11 Hen IV, fo 47, pl 21. This case may be found in Kiralfy, A. K. R. 1957, A Source
Book of English Law, Sweet & Maxwell Limited, London, 126 and in Baker, J. H. and Milsom, S. F. C. 1986, Sources of English Legal History, Private Law to 1750, Butterworths, London, 613. 294 (1414) YB Pas 2 Hen V, fo 5, pl 26. This case is referred to in Allan 1889, 2 and 139, and in Heydon 1999, 6, and is noted in Baker, J. H. 2002, An Introduction to English Legal History, 4th ed., Butterworths, London, 449. It is also considered in Mitchel v. Reynolds (1711) 1 P Wms 181 at 193-4; 24 ER 347 at 351, as noted in the text above. 295 (1587) Anon 2 Leon 210; 74 ER 485.
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Reynolds again, the bond was void for lack of consideration. However, the tenor of the
report suggests that the court would have voided it regardless of consideration, which
leaves the position of the law at that time somewhat unclear. And the position is not
made any clearer by Colgate v. Bacheler296 in 1602 where there appears to have been
a penal clause in the bond to the effect that a breach by the defendant voided the bond
and also placed him under obligation to pay the plaintiff 20 pounds. The court again
relied on Dyer’s Case in holding that the bond was void at law because the defendant
‘ought not to be abridged of his trade and living.’297 Parker CJ also put this case under
the heading of restraints without consideration, but it is not clear from the report that
that was the situation. It is difficult to believe that anyone would give up or limit his
livelihood for no, or inadequate, consideration unless he were taken advantage of, as
might have been the situation in Dyer’s Case. However, it is not evident from these
rather limited reports whether any other consideration passed for the sale of the
business; consideration for the business itself might explain the absence of
consideration specifically for the restrictive covenant.
Nonetheless, it became clear by 1613 in Rogers v. Parrey298that the courts were
prepared to recognize restraints of trade where there was consideration and more
importantly, it seems, the restraint was suitably limited in time and scope. The
limitation in restraint was important because the King’s Bench in this case made it
clear that a general restraint remained contrary to law. Furthermore, the 1620 case of
Broad v. Jollyfe,299 referred to in chapter 2, maintained the view that such restraints
were good at law. Thus if there had been doubts before this period about the legal
status of restraints of trade, even with adequate consideration, they were clearly
dispelled by these cases. While Parker CJ had distinguished the earlier cases by
holding that the restraints were voided for lack of consideration, this position does not
clearly emerge from the reports; if anything, the general tenor of the earlier reports
suggests that the courts saw all restraints as void. Whatever might have been the
original position, however, reasonable restraints of trade became firmly accepted at
common law, as was made clear by Lord Macnaghten in Nordenfeldt v. Maxim
296 (1602) Cro Eliz 872; 78 ER 1097. 297 Ibid. 298 (1613) 2 Bulst 136; 80 ER 1012. 299 (1620) Cro Jac 596; 79 ER 509.
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Nordenfeldt Guns and Ammunition Company Ltd where he neatly summarized the
position thus:
The public have an interest in every person’s carrying on his trade freely: so has the
individual. All interference with individual liberty of action in trading, and all restraints
of trade of themselves, if there is nothing more, are contrary to public policy, and
therefore void. That is the general rule. But there are exceptions: restraints of trade and
interference with individual liberty of action may be justified by the special
circumstances of a particular case. It is a sufficient justification, and indeed it is the
only justification, if the restriction is reasonable – reasonable, that is, in reference to the
interests of the parties concerned and reasonable in reference to the interests of the
public, so framed and so guarded as to afford adequate protection to the party in whose
favour it is imposed, while at the same time it is in no way injurious to the public. That,
I think, is the fair result of all the authorities.300
Thus reasonable restrictive covenants had become accepted as an integral part of
commerce, being the means of protecting goodwill on sale. Accordingly, in Bacchus
Marsh Concentrated Milk Co Ltd v. Joseph Nathan & Co Ltd, Isaacs J of the High
Court recognized that ‘when the goodwill of a business is sold, a reasonable covenant
on the part of the vendor against competition is valid in order to protect what is bought
and sold’.301 But the situation where goodwill was not protected by a covenant was
another matter. A certain degree of implied protection evolved in the latter part of the
nineteenth century, taking the legal position beyond the earlier view that there was
effectively no protection at all for goodwill in the absence of a restrictive covenant.
6.3 Sale of goodwill does not imply a restrictive covenant
It is well settled that the sale of goodwill does not imply a restrictive covenant.302
Without the protection of such a covenant, the vendor of a business may set up in
direct competition to the purchaser, as Lord Eldon made clear in Shackle v. Baker.303
In this case, the plaintiff sought an injunction to restrain the defendants from
encouraging their sister to set up business in nearby competition to him as the
purchaser of their millinery business. As well as this encouragement, the plaintiff
claimed that the defendants were also inducing their former customers to deal with
300 [1894] AC 535 at 565. 301 (1919) 26 CLR 410 at 441. 302 For example, see Trego v. Hunt [1895] AC 7 (HL). 303 (1808) 14 Ves Jun 468; 33 ER 600.
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their sister. The plaintiff had purchased the goodwill of the defendants’ business for
2,000 pounds and had proposed that they enter into a covenant restricting them from
setting up the same business, or permitting others to set up such a business, in a
stipulated area for 10 years. The defendants had objected to this covenant on the
grounds that it was ‘an impeachment of their honour, and unnecessary’ and
accordingly it was, unwisely as it transpired, ‘waived by the plaintiff upon the mere
undertaking of the defendant and his wife’.304 The motion was brought on the grounds
that the defendants had acted in bad faith in their subsequent actions. Lord Eldon
refused the motion, stating:
I cannot see my way to grant an Injunction in this case. If it had been nothing more than
a purchase of the good-will of this trade, the vendor would be at liberty to set up the
same trade in any other situation. Against that the purchaser has the choice of several
securities. He may rest upon the assurance of the vendor: he may require a covenant:
but, resting upon a covenant, he can have nothing more than an action for damages; and
the observation, that such an action is an extremely imperfect remedy, has been
repeatedly made.305
Later in Cruttwell v. Lye306 Lord Eldon maintained the view that the vendor of a
business was free, in the absence of a restrictive covenant, to set up a similar business
in competition with the purchaser, and also to solicit directly the old customers, so
long as the vendor did not claim that it was the same business. To make such a claim
would be a fraud. However, this case dealt with the distinguishable situation where the
business had not been purchased directly from the owner but from his assignees in
bankruptcy and, as such, it will be considered later in this chapter in a separate
section. In addition to these cases, the same view is evident also in Lord Eldon’s
orders in Cook v. Collingridge.307
304 Ibid . 305 Id at 469. Why Lord Eldon stated that only damages, rather than an injunction, were available as a remedy where a purchaser relied on a restrictive covenant is unclear, particularly as later in Williams v.
Williams (1818) 2 Swans 253; 36 ER 612 he granted an injunction for a breach of such a covenant. Furthermore, he had indicated that he would have granted a similar injunction in Scott v. Macintosh (1813) 1 V & B 503; 35 ER 196 if the facts had been sufficient to determine a breach of a restrictive covenant in that case. 306 (1810) 17 Ves Jun 335; 34 ER 129. 307 (1825) 27 Beav 456; 54 ER 180.
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Where a valid restrictive covenant existed, however, it would be enforced. An
example from this early periodisthe case of Harrison v. Gardner308 which was heard
by Sir Thomas Plumer V-C309 and involved the plaintiff’s seeking an injunction to
restrain the defendant from carrying on business of a cheesemonger in competition
with the plaintiff in the same street or in the immediate vicinity of his similar business.
The plaintiff and defendant had been partners in this business until the partnership had
been dissolved by agreement and the business, including the goodwill, bought by the
plaintiff. The plaintiff contended that there was a clear understanding between them
that the defendant would not set up in competition to him in the vicinity, but he had in
fact set up a similar business just sixteen doors from the plaintiff’s shop. On the issue
of the sale of goodwill of a business and the protection afforded the purchaser, the
Vice-Chancellor observed:
A person, not a lawyer, would not imagine that when the goodwill and trade of a retail
shop were sold, the vendor might the next day set up a shop within a few doors, and
draw off all the customers. The goodwill of such a shop, in good faith and honest
understanding, must mean all the benefit of the trade, and not merely the benefit of
which the vendor might the next day deprive the vendee. The authorities, however, are
strong to shew that the sale of a goodwill does not import restraint, and that a person
selling the goodwill of a business, for however large a consideration, is not prevented
setting up the trade.310
In this case, however, the Vice-Chancellor accepted from the evidence that there was
a binding understanding that the defendant would not compete with the plaintiff and
308 (1817) 2 Madd 198; 56 ER 308. 309 Sir Thomas Plumer was the first Vice-Chancellor, a judicial position created in 1813 to assist the Lord Chancellor with the huge workload in Chancery and also to allow him more time to attend to his parliamentary duties. Plumer was perceived to be inept and unsatisfactory in the performance of his duties, thus giving rise to increased litigation in the form of appeals from his decisions. As the Vice-Chancellor’s position was created to lessen the load on the Lord Chancellor, this must have been an ironic and perplexing outcome.See Melikan, R. A. 1999, John Scott Lord Eldon, 1751-1838, CUP, Cambridge, ch. 16. However, Twiss presented a more equivocal picture of Plumer (Twiss, H. 1846, The
Public and Private life of Lord Chancellor Eldon, John Murray, London, vol. 1, 515-6). On the one hand, he quoted highly critical comments by Sir Samuel Romilly (a leading counsel of the time) who damned him for his lack of legal knowledge in critical areas and his consequent incapacity to discharge the duties of the position. But, on the other hand, Twiss also reported that Lord Eldon did not view Plumer in the ‘same unfavourable light’ and that indeed he ‘turned out to be, if not a great judge, in the opinion of the legal profession, a competent one’ (515). Moreover, Plumer suffered persistent ill health which elicited a degree of sympathy and tolerance from Lord Eldon. In fact, as a result of his illnesses, Plumer died in judicial office, as Master of the Rolls, in 1824. Nonetheless, notwithstanding his controversial reputation, no issue can be taken with Plumer’s decision in Harrison v. Gardner. 310 (1817) 2 Madd 198 at 219; 56 ER 308 at 316. These observations were agreed with in substance by Lord Macnaghten in Trego v. Hunt [1896] AC 7 at 23.
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his actions therefore constituted a fraud. Accordingly, he granted the injunction,
distinguishing the decisions of Lord Eldon in Shackle v. Baker and Crutwell v. Lye
where no restrictive covenants were in evidence. The decision in this case, therefore,
is consistent with Lord Eldon’s view that the sale of goodwill did not imply a
restrictive covenant not to compete with the purchaser. Any such covenant had to be
expressly entered into to be effective, as in the later case of Williams v. Williams311
where the presence of an express restrictive covenant provided grounds for Lord
Eldon to grant an injunction to prevent the defendant competing against the plaintiff.
6.4 The solicitation of former customers
The absence of a restrictive covenant notwithstanding, the idea of goodwill as the
purchaser’s valuable property which should at least be protected from depredation by
the vendor by the soliciting of old customers, as also occurred in Shackle v. Baker, had
not evolved in the mind of Lord Eldon. Thus it may be reasonable to assume that it
was not a principle of equity at the time. However, in 1872 in Labouchere v.
Dawson312 Lord Romilly MR was required to consider a question concerning the
defendant’s right to solicit the customers of a business which he had sold. The
defendant had sold a brewery business, with its goodwill including the exclusive right
to use the name of the firm, to the plaintiffs without the protection of a restrictive
covenant. Then, only a few months later, the defendant had commenced a new
brewery business in another town, albeit a considerable distance away. However, he
had given out that it was the continuation of the old business313 and had solicited the
customers of that business. Consequently, the plaintiffs moved for an injunction to
restrain the defendant from soliciting the old customers. Since he could not find any
case authority dealing specifically with this situation, Romilly MR saw this as a new
question. However, he felt able to fall back on the principle of equity that ‘persons are
not at liberty to depreciate the thing which they sold’314 in deciding to grant an
injunction to prevent the defendant’s personal solicitation of customers of the old firm
311 (1818) 2 Swans 253; 36 ER 612. 312 (1872) 13 LR Eq 322. 313 Giving out that it was a continuation of the old business would indicate a fraud on the authority of Cruttwell v. Lye. But while the original motion before the Court included this issue, it was later confined to the question of direct solicitation of the old customers. 314 (1872) 13 LR Eq 322 at 325. In applying this principle, Romilly MR divined an implied covenant to the effect that a person who sells a thing cannot destroy the value of it.
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which had been sold to the plaintiffs. As discussed later, this decision was approved
by the House of Lords in Trego v. Hunt.315
But why did Romilly MR see this as a new question in the light of Shackle v.
Baker?316 The facts of the two cases would seem to be fundamentally similar; both
involved the solicitation of former customers to the detriment of the purchaser of the
business. There is no indication that Shackle v. Baker was argued before Romilly MR,
who did not refer directly to it in his reported judgment. He did state,however, that he
could not find any authority on the question in any of the cases decided by Lord
Eldon, a distinct indication that he did not view Shackle v. Baker as a relevant
authority. And to add to the mystery, Lord Eldon, the generally acknowledged master
of equity of his time, appeared not to recognize the equitable principle applied by
Romilly MR in the latter case.317 It might be proposed that a factor distinguishing the
two cases was that the parties who benefited from the solicitation were different in
each case. In Shackle v. Baker, on the one hand, the defendants were not soliciting the
old customers to deal with their own business, but rather soliciting them to deal with
the business set up by their relative in competition with the plaintiff. In
Laboucherev.Dawson (as in Ginesi v. Cooper below), on the other hand, the
defendants were soliciting their old customers for a new business which they
themselves had started up. Nonetheless, it is difficult to see this distinction as a
material one. In both cases the vendor of the goodwill was seeking to depreciate it;
whether the beneficiary of that type of action is the vendor or a third party hardly
315 [1896] AC 7. 316 On this point, Romilly MR said: ‘I have considered the matter very carefully, and although the point is suggested or hinted at in one or two cases, yet in no case I have been able to find has this simple question come before the consideration of the Court’ ((1872) 13 LR Eq 322 at 325). Lord Herschell also saw it this way in Trego v. Hunt [1896] AC 7 in stating (at 11): ‘The question whether a person who sold the goodwill of his business was entitled afterwards to canvass the customers of that business came first before the courts for decision in Labouchere v. Dawson.’ Later (at 15) his Lordship cited Cruttwell v. Lye as the earliest case having any bearing on the point. None of the Lords in Trego v.
Hunt made any reference to Shackle v. Baker, although counsel for the appellant made a passing reference to it in respect of Lord Eldon’s definition of goodwill. 317 The origin of this principle that a person may not derogate from his grant is obscure, with little consideration given to it in standard texts on equity. For example, Meagher, R. P. et al. 1992, Equity,
Doctrines and Remedies, 3rd ed., Butterworths, Sydney, 553 make a brief unadorned reference to the availability of an injunction where the vendor of a business wrongfully solicits the former customers of the business on the authority of Trego v. Hunt. And Spry, I. C. F. 1990, The Principles of Equitable
Remedies, 4th ed., The Law Book Company Limited, Sydney, makes no mention at all of the principle. Nevertheless, the principle was given the imprimatur of the House of Lords in Trego v. Hunt, as noted in this paper. In fact, Lord Macnaghten saw it as an elementary proposition, which might go some way to explaining its lack of consideration in texts. Furthermore, in Curl Brothers Limited v. Webster [1904] 1 Ch. D. 685 Farwell J referred to it as an old principle, suggesting also that it had a reasonable pedigree, even though it was not recognized by Lord Eldon just a century before.
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seems to be a relevant consideration. In fact, in support of this contention, the order in
Labouchere v. Dawson also included a restraint on the more general action of simply
asking any former customer not to deal with the purchasers, rather than to deal
specifically with the defendant. Moreover, approval for this more general form of
restraint may be seen in Trego v. Hunt. Nevertheless, for reasons that are not clear,
Shackle v. Baker did not have much impact on later cases and is cited hardly at all.
Labouchere v. Dawson was followed in 1880 by Sir George Jessel MR in Ginesi
v.Cooper.318 The plaintiff Ginesi purchased a stone merchants business, comprising
plant, stock and goodwill, from the defendants, Cooper and Hampson, who also
assigned the lease of the business premises to the plaintiff and at the same time
executed an agreement to allow him to use the defendants’ names in his business
name in the form of ‘Cooper, Hampson & Company’ for two years. On the day of this
agreement the defendants advised their customers by circular that they had sold their
business to the plaintiff, recommending him as their successor. Two years later,
however, the defendants recommenced business as stone merchants under the name
‘Samuel Cooper & Company’ and proceeded to solicit their old customers with some
success. The plaintiff consequently moved for an injunction to restrain the defendants
from soliciting his customers and in any other way prejudicing his business. Jessel
MR had no hesitation in granting the injunction, righteously opening his deliberations
thus:
The Lord Justice James has said that the command ‘Thou shalt not steal’ is as much a
portion of the law of Courts of Equity as it is of Courts of Law.319
Having set the tone of his judgment, he invoked Labouchere v. Dawson, stating:
That case is an authority for saying that a man who has sold his goodwill of his trade or
business must not solicit the old customers to deal with him; but I go further, and say
that he must not deal with the old customers.320
Jessel MR’s further assertion about not dealing with the old customers was not
relevant to the motion before him and therefore was obiter dictum only. But it is
interesting to note how far he would have been prepared to go if called upon to do
318 (1880) 14 Ch D 596. 319 Id at 598. 320 (1880) 14 Ch D 596 at 598-9.
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so.321 The question of whether Jessel MR would have been going too far was soon
directly answered by the Court of Appeal in Leggott v. Barrett322 where just such a
restriction in an injunction was refused.323 Support for this refusal, moreover, may be
found in dicta of the Lords in Trego v. Hunt.324In this case, in fact, Lord Davey was of
the opinion that the injunction ordered by Jessel MR in Ginesi v. Cooper still went
beyond that ordered in Labouchere v. Dawson because it also prevented public
advertising, thus taking it to an extent he found unsupportable. As noted below, the
Lords granted the injunction in Trego v. Hunt to prevent direct solicitation of old
customers, not public solicitation.
In Trego v. Hunt the appellant and the respondent had been in business in partnership
and the agreement between them had included a provision that the goodwill of the
business would be the sole property of the appellant. The appellant had found that the
respondent had been employing a clerk to copy names of the partnership’s customers
for the admitted purpose of canvassing their custom when the partnership came to an
end and he set up business for himself. The House of Lords was required to determine
whether the trial judge and then the Court of Appeal had been correct in refusing to
grant an injunction to prevent the respondent from copying the names of customers to
the potential detriment of the appellant’s goodwill. Lord Herschell was of the opinion
that both courts had had no alternative but to refuse the injunction on the authority of
the Court of Appeal in Pearson v. Pearson325 which had held by majority326 that the
321 Jessel MR made it clear he would have gone this far in that he said ‘if I had been asked, I certainly should have prevented their dealing with the old customers’ ((1880) 14 Ch D 596 at 599). 322 (1880) 15 Ch D 306. This case was an appeal from the decision of Jessel MR who had granted an injunction which included, inter alia, a restriction against actually dealing with the old customers (in keeping with his dictum in Ginesi v. Cooper). The appeal related to this specific restriction only. 323 Spry states that Jessel MR had a tendency to be quick and careless in his judgments, therefore causing him ‘to make many observations that cannot be defended’: Spry, I. C. F. 1990, The Principles
of Equitable Remedies, 4th ed., The Law Book Company Ltd, Sydney, 3. And Jessel, as Solicitor General, had been counsel for the plaintiffs in Labouchere v. Dawson, a fact which might have contributed to his evident enthusiasm and zeal for the principle he applied in Ginesi v. Cooper. 324 [1896] AC 7. 325 (1884) 27 Ch D 145. It has generally been the rule that the Court of Appeal is bound by its past decisions, with very limited exceptions: see Cross, R. 1968, Precedent in English Law, 2nd ed., OUP, London. 326 Baggallay and Cotton LLJ both held Labouchere v. Dawson to be wrongly decided and accordingly declined to follow it, while Lindley LJ (dissenting) held it to be correctly decided. Baggallay LJ, in fact, was the leading counsel, as Sir Richard Baggallay QC, for the defendant in Labouchere v. Dawson, where he unsuccessfully argued for the right to directly solicit the old customers. In this case it would seem that he had the chance to put things right, until the Lords intervened in Trego v. Hunt. Earlier in Walker v. Mottram (1881) 19 Ch. D. 355, Baggallay LJ had taken the opportunity obiter to cast doubt on the correctness of Labouchere v. Dawson, perhaps suggesting something of a crusade against this decision on his part.
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direct solicitation of old customers was lawful.327 The Lords, however, overruled the
Court of Appeal’s decision and granted the injunction, thereby also overruling
Pearson v. Pearson in the process.
The Lords in Trego v. Hunt approved the decision in Labouchere v. Dawson in
holding that a person may not derogate from his grant; that is, he may not depreciate
the thing which he has sold, to use Lord Romilly’s expression. They found that this
fundamental principle of equity which was applied in that earlier case also applied
equally to the present case where there was an agreement that the goodwill belonged
to one partner only. In reaching their conclusion, they made it clear that the injunction
should apply only to actions intended to depreciate the goodwill by directly soliciting
old customers (as opposed to soliciting them indirectly or incidentally through public
advertising, for instance). Furthermore, the injunction was not against setting up a new
business in competition with the old one, in the absence of a suitable restrictive
covenant. In other words, there may be an implied covenant not to solicit directly the
old customers in the sale of goodwill, but not an implied covenant to prevent
competition otherwise. The latter point was held by the Lords to be firmly settled by
the authorities.328
6.5 The exception for fraud
While the sale of goodwill does not imply a restrictive covenant, Lord Eldon opined in
Cruttwell v. Lye329that a person could not hold out that he was carrying on a business
which he had sold. In this case the business was sold by the assignees in bankruptcy
(as trustees in bankruptcy were called then) to the plaintiff without a restrictive
covenant. On his release the bankrupt set up in business again in competition with the
plaintiff, including the direct solicitation of the old customers. The plaintiff objected
to this direct solicitation, rather than to the competition itself, and moved for an
injunction. Lord Eldon saw the question as whether the defendant was carrying on the
327 It is curious that in Pearson v. Pearson the appeal was against only one part of the restriction, relating to direct solicitation, and not against the issue of a circular which formed the other part of the order granted by the primary judge. One might have expected that the appellant would have objected also to the restriction on this more public form of reaching customers. 328 See Lord Herschell at [1896] AC 7 at 20 and Lord Davey at [1896] AC 7 at 27. As Lord Davey explained, covenants in restraint of trade would not be enforceable if they were larger than required to protect the businesses in question. Therefore he held it to follow that a general covenant cannot be implied because, in effect, such a covenant would be too broad, not being appropriately limited by way of express stipulation. 329 (1810) 17 Ves Jun 335; 34 ER 129.
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plaintiff’s trade. In answer he said that ‘there can be no doubt that this Court would
interpose against that sort of fraud which has been attempted by setting up the same
trade, in the same place, under the same sign or name: the party giving himself out as
the same person.’330 As he found that the defendant was not carrying on the same
trade, only a similar one, Lord Eldon held that no such fraud existed and refused the
injunction. Such a fraud, however, was held to exist in Churton v. Douglas331 where
Wood V-C found that the defendant was giving the distinct impression in his actions
that he was carrying on the same business which he and his former partners, the
plaintiffs, had carried on before they bought his share. The defendant had refused to
be bound not to compete by a covenant and was therefore free to set up in direct
competition to his former partners. But on the authority of Cruttwell v. Lye the Vice-
Chancellor held thathe was not free to claim, fraudulently, that he was carrying on the
old business which he had sold, and accordingly restrained him from doing so.
However, in Laboucherev.Dawson in addition to the solicitation of old customers, on
which the case was decided, there was unrefuted evidence that the defendant was also
giving out that his new business was a continuation of the old one which he had sold –
a clear case of fraud, one would think, and thus the basis for an injunction.
Nonetheless, as discussed above, Romilly MR chose to ignore this matter in favour of
the novel approach he took.
Later both Jessel MR in Ginesi v. Cooper and the Lords in Trego v. Hunt dealt with
the question of fraud. Jessel MR distinguished Cruttwell v. Lye in holding that there
was a fraud on the contract in his case and opining that Lord Eldon would have
granted the injunction if he had found fraud in that earlier case. The fraud which Jessel
MR saw took the form of the solicitation of the old customers, as discussed earlier,
and not any assertion that the defendants were carrying the business that they had sold
to the plaintiffs. In Trego v. Hunt Lord Macnaghten went straight to the point in
stating:
A man may not derogate from his own grant; the vendor is not at liberty to destroy or
depreciate the thing which he has sold; there is an implied covenant, on the sale of
330 (1810) 17 Ves Jun 335 at 342. 331 (1859) 28 LJ Ch 841.
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goodwill, that the vendor does not solicit the custom which he has parted with: it would
be a fraud on the contract to do so.332
On the face of it, treating this equitable principle as another form of fraud333 might
appear to run counter the distinction that Lord Eldon seemed to be making in
Cruttwell v. Lye where he indicated that fraud on the contract would have led him to a
different decision, remembering that there was in fact direct solicitation of the old
customers in that case. However, this case dealt with the distinguishable situation of a
business sold by assignees in bankruptcy, rather than by the bankrupt himself. As
discussed in the next section, this type of sale effectively places the bankrupt outside
any contractual or equitable obligations to the purchaser.
6.6 Sales by trustees in bankruptcy
In Cruttwell v. Lye,as already noted, Lord Eldon refused the injunction on the grounds
that there was no fraud committed by the defendant. In the absence of a restrictive
covenant, he did not have to decide the further question whether such a covenant
would bind a bankrupt whose business had been sold by his assignees rather than by
himself. Nonetheless, this case appeared to lay down the rule that a bankrupt was not
restrained from directly soliciting the customers of his old business, and was used as
an authority for such a rule in later cases.
In Walker v. Mottram334 the defendant had his brewery business, the ‘Sun Brewery’,
placed in the hands of trustees in bankruptcy who subsequently sold it with the
goodwill to the plaintiff. After the defendant had been discharged from his bankruptcy
he purchased another brewery close by, with the similar sounding name of the ‘Swan
Brewery’, and proceeded to solicit business directly from his old customers. As a
consequence, the plaintiff moved for an injunction to restrain the defendant from this
solicitation. Jessel MR at first instance distinguished Labouchere v. Dawson in
holding that it did not apply to sales of bankrupts’ businesses by their trustees and
refused the motion. The plaintiff’s subsequent appeal to the Court of Appeal was
dismissed. In a joint judgment, Lush and Lindley LLJ agreed with Jessel MR in
332 [1896] AC 7 at 25. 333 In the mind of Lord Herschell in Tregov.Hunt, any distinction between an equitable principle that a vendor may not depreciate what he has sold and an implied contract not to deprive the purchaser of what has been sold to him was not material. In either case, he was satisfied that the obligation existed and should be enforced in equity: see [1896] AC 7 at 21. 334 (1881) 19 Ch D 355.
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holding that Labouchere v. Dawson applied only to voluntary sales rather than to sales
by trustees in bankruptcy. They were of the opinion that a right of action existed
against the trustees if they infringed the business, but none existed against the
bankrupt who had not been party to the sale. Lord Eldon held sway in their decision in
that they said:
Cruttwell v. Lye is a clear authority that, if the assignees of a bankrupt sell his business
and goodwill, the purchaser cannot restrain the bankrupt either from commencing a
similar business himself or from soliciting his old customers to deal with him in his new
business.335
Baggallay LJ substantially agreed with his fellow judges, but took the opportunity to
cast doubt on the correctness of Labouchere v. Dawson, albeit admitting that this was
not necessary in making his decision. The decision in Walker v. Mottram was
effectively approved by the Lords in Trego v. Hunt where, for example, Lord
Macnaghten said:
There is all the difference in the world between the case of a man who sells what
belongs to himself, and receives the consideration, and a man whose property is sold
without his consent by his trustee in bankruptcy, and who comes under no obligation,
express or implied, to the purchaser from the trustee.336
6.7 Conclusion
From the early part of the nineteenth century, the influential Lord Eldon LC laid down
the starting position in holding that there was no protection for goodwill in the
absence of an express restrictive covenant. However, his bald assertion that there was
no satisfactory remedy for an assault on goodwill in such a circumstance was
ameliorated in later cases where a more reasonable principle was developed. Hence
the Lords in Trego v. Hunt affirmed the principle that without a protective covenant
the vendor could set up in competition to the purchaser, but held that the vendor could
not directly solicit the old customers. Nonetheless, Lord Eldon’s view that a bankrupt
was not subject to any implied covenant was maintained by the Lords in that case. By
335 Id at 363. 336 [1895] AC 7 at 23.
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the 1890s the law had been largely settled, as evidenced by cases such as Trego v.
Hunt and Nordenfeldt v. Maxim Nordenfeldt Guns and Ammunition Company Ltd.337
The history of restraint of trade reveals an incipient notion of goodwill emerging at an
early stage, dating back to the fifteenth century. Even at this early time, business was
clearly perceived as something valuable and worthy of protection, notwithstanding
reservations in the courts about restraint of trade. In fact, it may be reasonably argued
that this area of the law provides the first indications of an understanding of goodwill
as the essence of a business and worthy of protection. As such, restraint of trade may
be seen as making a most important contribution to the concept of goodwill. While
goodwill was not formally recognized by name in the courts until the eighteenth
century, there are indications of an awareness of its existence and importance. A more
formal understanding of it as property and an asset of a business arrived later, but it
formed the basis of this understanding and the legal concept of goodwill which
evolved from it.
337 [1894] AC 535.
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Chapter 7: Goodwill and Stamp Duties
7.1 Introduction
Stamp duties are a tax with a long pedigree, dating from 1671 in England in the form
of an Act338 to impose duty on a range of legal instruments and pleadings. This Act,
which expired in 1680, was replaced by another Act339 of 1694 which broadened the
range of dutiable instruments and also improved the collection mechanisms. The Act
of 1694 was intended at first to last four years, as a war-time measure, but finished up
being extended to a term of 99 years, and following legislation enacted at various
times since has ensured that stamp duties in one form or another have existed to this
day.340 The early Acts imposed fixed rates of duty on stipulated instruments, with ad
valorem duty first imposed on conveyances on sale in 1808.341 While the application
of English stamp duty to the Australian colonies appears not to have been finally
decided,342 stamp duty was specifically imposed in New South Wales in 1865.343 This
lead was followed by the other colonies,344 and presently all the Australian states and
territories impose stamp duties.345
338 22 and 23 Charles II, c 9. This Act came into effect on 1 May 1671 and was to continue for nine years: see Hughes, E., ‘The English Stamp Duties, 1664-1764’, (1941) 56 The English Historical
Review 234. Earlier, Holland had introduced the generally accepted first stamp duty in 1624, followed by France in 1651: see Hill, D. G., ‘Stamp Duty: A Brief Historical Overview’, (1998) 27 Australian
Tax Review 14. 339 5 and 6 William and Mary, c 21. 340 Stamp duty, notoriously, was introduced in the American colonies in 1765, culminating in the War of Independence and England’s loss of those colonies. 341 48 Geo III c 149, commencing on 11 October 1808: see Tilsley, E. H. 1871, A Treatise on the Stamp
Laws (3rd ed), Stevens and Sons, London. (Hill op. cit. cited this Act as 48 Geo II c 48, presumably a typographical error.) 342 In Walker & Co v. Appleton & Co (1838) (reported in the Sydney Herald of 17 September 1838), Dowling CJ of the Supreme Court of New South Wales noted that the colony had no stamp laws at that time. However, he held that a document executed in England required an English stamp before it could be admitted in the NSW Court. 343 Act 29 Vic No 6, effective from 1 July 1865. 344 For example, stamp duty was introduced in South Australia in 1886, based on the UK Stamp Act of 1870, suspended during World War I, and later consolidated into the current Act, the Stamp Duties
Act1923 (SA). 345 In order to harmonise the laws relating to stamp duties, New South Wales, Victoria, Queensland, Tasmania, the Australian Capital Territory, and Western Australia have rewritten their legislation in recent years. See Mann, J., ‘The Stamp Duty Rewrite Project’, (1997) 5(5) Taxation in Australia (Red
Edition) 232 for details. The rewritten Acts are: Duties Act 1997 (NSW); Duties Act 2000 (Vic); Duties
Act 2001 (Qld); Duties Act 2001 (Tas); Duties Act 1999 (ACT); and Duties Act 2008 (WA). Traditionally, stamp duties have been imposed on instruments rather than on the transactions underlying those instruments. However, the above jurisdictions have moved from the traditional instrument-based approach to imposing duty to a transaction-based approach. On the other hand, South Australia (Stamp Duties Act 1923) and the Northern Territory (Stamp Duty Act 1978) have retained their earlier legislation and the traditional approach. Regardless of the approach to imposing duties, all
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This chapter focuses on goodwill as viewed and understood in the context of stamp
duty, a tax which has produced a very significant body of law since its introduction in
the seventeenth century. First, in para. 7.2, the historical development of the concept
of goodwill as property for stamp duty purposes is examined. The finding is that
goodwill is property, consistent with other areas of law. The relationship between
goodwill and other property of a business, particularly land, has become a fertile field
for producing issues concerning the nature of goodwill and its value for duty purposes.
As a consequence, the historical development of the relationship between goodwill
and land in the UK jurisdiction is examined in detail in para. 7.3. This relationship
between goodwill and other property that may generate that goodwill has been
examined in detail by the High Court in the landmark case of FCT v. Murry346 which
is considered in para. 7.6. Moreover, the important difference in the approach to this
relationship before and after the High Court’s decision in Murry is given due attention
in the Australian jurisdictions. To this end, para. 7.4 deals with the relationship
between goodwill and land pre-Murry, including consideration of rights supposedly
analogous to goodwill in para. 7.5, and para. 7.7 deals with this relationship post-
Murry. The distinct differences found in the treatments pre- and post-Murry illustrate
most clearly the difficulties which have been experienced in understanding the legal
concept of goodwill and its relationship to other property of a business, notably land.
Post-Murry the Australian stamp duty jurisdictions have viewed goodwill as property
separate from land, in line with the High Court’s view that goodwill is separate from
any other property in the business which may be its source. Finally, questions of
whether goodwill may be classed as a chattel (para. 7.8) and whether goodwill as
intangible property may have a physical location (para. 7.9) are addressed. What
emerges from the issues examined in this chapter, particularly in the period post-
Murry, is a concept of goodwill which is consistent with the general concept of
goodwill as property in its own right and separate from other property of a business.
7.2 Goodwill as property
Conveyances have been a subject of duty from the beginnings of stamp duty. In the
1671 Act, item 5 referred to ‘every conveyance … which shall be enrolled in any
of these jurisdictions, with the exceptions of Victoria and Tasmania (from 1 July 2008), impose ad
valorem duty on conveyances of goodwill. 346 (1998) 98 ATC 4585.
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court of record … per skin 5s’.347 However, as the 1816 case of Lyburn v.
Warrington348 reveals, initially conveyances of goodwill were not recognized as
conveyances of property for stamp duty purposes.349 According to Tilsley,350 this case
was taken as authority for the practice of excluding goodwill from the application of
ad valorem duty in the sale of businesses. Nevertheless, goodwill was afforded some
recognition as property for stamp duty purposes from at least as early as 1837 in the
case of South v. Finch351 where Tindal CJ gave equivocal support to the idea of
goodwill as property in its own right. However, no equivocation is to be found by
1854 in Potter v. CIR352 where goodwill was held to be property for purposes of the
Stamp Act.353 Pollock CB held that the assignment of goodwill as part of a business
was the conveyance of property within the meaning of the Act and liable for ad
valorem duty. By way of explanation, he stated:
… very frequently the goodwill of a business or profession … is made the subject of
sale, though there is nothing tangible to it: it is merely the advantage of the
recommendation of the vendor to his connections, and his agreeing to abstain from all
347 See Hughes at 236. 348 (1816) 1 Stark 162; 171 ER 434. 349 In essence Lyburn v. Warrington involved a question of whether a deed of sale of a shop should have born an ad valorem stamp as the conveyance of property pursuant to the applicable Stamp Act (48 Geo III c 149, the first Act to impose ad valorem duty on conveyances). The business comprised the lease of the premises, the name of the plaintiff vendor (to be used jointly with the defendant’s name), and fixtures. According to the case report, this Act imposed ad valorem duty on every conveyance ‘upon the sale of any lands, tenements, rents, annuities, or other property, real or personal, heritable or movable, or of any right, interest, or claim, into, out of, or upon any lands, tenements, rents, annuities, or other property’ ((1816) 1 Stark 162 at 162; 171 ER 434 at 434). One would have thought that the sale of this business would have included property, for example leasehold and fixtures, whose value would have been subject to ad valorem duty under this broad provision. But Lord Ellenborough did not think so in holding that:
The agreement is, that the defendant shall have these as auxiliary to the carrying on the business, and since there is no mention of any distinct substantive property exclusive of trade, I cannot think that in fair construction the case falls within the operation of this clause of the Act ((1816) 1 Stark 162 at 162; 171 ER 434 at 434).
What Lord Ellenborough meant by this observation is somewhat unclear. It may be concluded that he thought that the ‘trade’ was the essential subject of the sale and that was not property for this provision. The subject of sale indicates that goodwill in the form of both site goodwill and name goodwill would also have been included in this sale in accordance with modern concepts. But as goodwill was not explicitly mentioned in the sale, it is reasonable to assume that it would not have been considered at that time. 350 Tilsley, E. H. 1871, A Treatise on the Stamp Laws (3rd ed), Stevens & Sons, London, 198. However, Tilsley went on to say that this practice did not last because in a later case in 1854 (Potter v. CIR (1854) 10 Ex 147; 156 ER 392, referred to in this chapter) the Court stated that goodwill was clearly property within the meaning of the Stamp Act, albeit a later Act. 351 (1837) 3 Bing (NC) 506; 132 ER 505. 352 (1854) 10 Ex 147; 156 ER 392. 353 13 and 14 Vic, c 97.
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competition with the vendee. Still it is a valuable thing belonging to himself, and which
he may sell to another for pecuniary consideration.354
Pollock CB was referring to what is commonly called personal goodwill, but there is
no reason evident in the case report to conclude that goodwill from any other source
would have been treated differently. Moreover, it was expressly stated that goodwill
was property for purposes of stamp duty by the Court of Appeal in CIR v.Angus & Co
in 1889.355 The last word on this question may be left to the House of Lords’ stamp
duties case of CIR v. Muller and Co’s Margarine Ltd356 in 1901 where the Lords were
clear that goodwill was property. For example, in response to an argument that
goodwill was not property, Lord Macnaghten stated: ‘It is very difficult … to say that
goodwill is not property. It is bought and sold every day.’357
Of course, goodwill was rightly recognized as property for stamp duty as it was at law
generally.358 There was no reason, in statute or common law, to view goodwill
differently in the context of stamp duty. Nonetheless, as discussed in this chapter,
stamp duties have produced a large body of law dealing with a range of issues
concerning its nature as property and its relationship with other property of a business,
particularly land.
7.3 Goodwill and land: the early UK case law
While it had been settled in the nineteenth century that goodwill was property, the
relationship between goodwill and land was another matter, and one that was not
finally settled until very recent times, at least in the Australian stamp duty
jurisdictions. Until the High Court’s pronouncements on goodwill in FCT v. Murry,
discussed in para. 7.4, there had been a tendency to include the value of goodwill in
the value of land for stamp duty, particularly in Victoria where ad valorem stamp duty
is not imposed on goodwill itself.359 In fact, it has not been settled yet in the UK in the
354 (1854) 10 Ex 147; 156 ER 392 at 396. 355 See (1889) 23 QBD 579 at 590 (per Lord Esher MR). In a contemporary article (Anonymous, ‘Goodwill and the Stamp Act 1870’, (10 August 1889) The Accountant 419) the view that goodwill was property was stated as seeming ‘to be in agreement with the views of lawyers and certainly with the practice of mercantile men including accountants’ (at 419). 356 [1901] AC 217. 357 Id at 223. 358 See chapter 4, para. 4.2, for goodwill as property. 359 See Tregoning, I., ‘Goodwill and Stamp Duties: the Legacy of Murry’, (2006) 6(2) Oxford
University Commonwealth Law Journal 183. Since 1 July 2008, Tasmania has also abolished duty on goodwill in its general abolition of duty on the transfer of ‘non-real business assets’. However, the State
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light of the approach taken by Her Majesty’s Revenue & Customs (HMRC) in respect
of the Stamp Duty Land Tax.360 HMRC still include the value of site goodwill361 in
the value of land for the purpose of imposing duty on the land.
The question of whether goodwill, particularly site goodwill with its source in the
land, should be included in the value of the land for the imposition of stamp duty
arose in a number of early cases in the UK (and also in Australia as discussed in para.
7.5). Nonetheless, early intimations that goodwill should be considered separate from
land may be found in cases in the nineteenth century. Thus in the previously
mentioned case of Potter v. CIR362 in 1854 there are indications, albeit rather
ambiguous, that goodwill was separate from land even though the goodwill of a
business located on that land might enhance its value.363 Later in 1880, in Ex parte
Punnett, In re Kitchen364 Jessel MR stated that the goodwill of a public-house passed
with the public-house. However, this need not be taken to mean that the goodwill was
part of the premises; all it may mean is that goodwill must pass with the hotel business
as an inseparable part of that business. In fact, Jessel MR went straight on from the
above statement to opine that the goodwill in such a case ‘is the mere habit of
Revenue Office seems to have overlooked the current jurisprudence on goodwill and real property in advocating that the value of site goodwill should be included in the value of real property for duty purposes. See the Draft Guideline 2008 ‘Apportionment of Goodwill Value in respect of Real Property Transactions’ issued by the State Revenue Office, 23 August 2008. 360 For a critique of HMRC’s approach, see Tregoning, I., ‘Goodwill and the Stamp Duty Land Tax’, [2007] (5) British Tax Review 648. 361 HMRC call this site goodwill ‘inherent goodwill’ in their relevant manuals dealing with the definition and elements of goodwill, namely the Stamp Duty Land Tax Manual and the Capital Gains
Manual. 362 (1854) 10 Ex 147; 156 ER 392. 363 In Potter v. CIR, Pollock CB observed: ‘The trade, or goodwill of a trade, sometimes enhances the value of real property, as a well-accustomed tavern or shop will, on account of the habit of persons to frequent it, sell for much more, and the duty on a conveyance of the place where the business is carried on ought pro tanto to be augmented; and very frequently the goodwill of a business or profession, without any interest in land connected with it, is made the subject of sale, though there is nothing tangible in it: it is merely the advantage of the recommendation of the vendor to his connexions, and his agreeing to abstain from all competition with the vendee’ ((1854) 10 Ex 147 at 157; 156 ER 392 at 396). But then Pollock CB said immediately following the above passage that ‘[s]till it is a valuable thing belonging to himself, and which he may sell to another for a pecuniary consideration’ ((1854) 10 Ex 147 at 157; 156 ER 392 at 396). This last statement may be interpreted as Pollock simply making a distinction between two types of goodwill, namely site goodwill and name goodwill, and saying that both are property which may be the subject of sale. This interpretation is supported in the next paragraph where Pollock said specifically that the goodwill of a trade fell within the description of property which may be the subject of sale. And in doing so, he made no distinction between different types of goodwill. The ready implication, therefore, is that goodwill is a separate item of property, regardless of its sources, rather than a part of real property as might be suggested in the case of site goodwill. 364 (1880) 16 Ch D 226 (CA).
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customers resorting to the house.’365 That is, it may be postulated that he saw the
goodwill as site goodwill arising from the premises, thus connected with the premises
as its source but not as an integral part of that property.366
Nevertheless, in 1883 in Cooper v. Metropolitan Board of Works Cotton LJ
reintroduced some ambiguity in stating:
It is obvious that there are certain kinds of goodwill to which a mortgagee will be
entitled. The goodwill which attaches to a particular house increases the value of that
house, and therefore the mortgagee is entitled to that. If, for instance, there is a well-
known public-house, and from its position being well known, people frequent it, the
goodwill attaches to the house and adds to its value. But there may be other kinds of
goodwill attaching to personal reputation which a man has made for himself. Of course
that does not go the mortgagee of the house, but is a thing personal to the man whose
skill and whose name have acquired that goodwill.367
The first sentence of the above passage might be taken to suggest that goodwill may
be part of the premises in certain circumstances. However, the fact that the goodwill
‘attaches’ to the premises and adds to their value does not make the goodwill part of
the property. The mortgagee is not entitled to the goodwill as such because that is
personal property connected with the business rather than real property. Certainly, the
mortgagee or the lessor, as the case may be, is entitled to the enhanced value of the
real property resulting from its location and a successful business being operated on it.
But goodwill, by its very nature, is an item of property in its own right and is not part
of any other property, even if that other property is the source of the goodwill. The
High Court of Australia in FCT v. Murry made this point clearly in stating:
Care must be taken to distinguish the sources of the goodwill of a business from the
goodwill itself. Goodwill is an item of property and an asset in its own right.368
Moreover, the High Court referred to the particular example of a hotel in respect of
this issue in stating:
365 Id at 233. 366 In another hotel case of the same period, Rutter v. Daniel (1882) 30 WR 724, it was held that the hotel licence rather than the premises was the critical source of goodwill because the licence was necessary to enable the business to be carried on. Thus in this case there was no link at all made between the premises and the goodwill. 367 (1883) 25 Ch D 472 at 479. 368 (1998) 98 ATC 4585 at 4592.
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The sale of hotel premises, for example, may involve the sale of goodwill although the
contract does not refer to goodwill. Similarly, the mortgage of land used as a business
may involve the mortgage of the goodwill of the business although the mortgage does
not mention goodwill. But the reason that is so is that, by necessary implication, the
sale or mortgage of such a site includes the sale or transfer of the business conducted on
the site. Unless 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. The validity of that proposition was recognised by Lord Lindley in Muller
when he said:
‘The goodwill of a business usually adds value to the land or house in which it is
carried if sold with the business.’ (Emphasis added by the High Court.)369
Therefore, whether in any particular case goodwill may be seen to enhance the value
of real property is irrelevant to its standing as separate property at law.
By the end of the nineteenth century, English courts appeared to be coming to this
conclusion as evidenced by The West London Syndicate Limited v. CIR370 In this case
the Court of Appeal by majority held goodwill to be property other than land for
stamp duty purposes under the Stamp Act, 1891.371 This case involved an agreement
to sell a hotel business comprising inter alia the assignment of the lease of the
premises and the sale of the goodwill. The commissioners had imposed ad valorem
duty on the values attributed to the lease and goodwill and to the book debts under s.
59 of the Act which applied to agreements to sell any equitable interest in any
property or to sell any interest in any property except land or merchandise. At first
instance372 it had been held that the goodwill was inseparable from the leasehold
premises and therefore came within the exception for land, meaning that it was not
subject to ad valorem duty pursuant to s. 59. In the Court of Appeal, A L Smith LJ
saw goodwill as a ‘separate entity’, rather than the mere enhancement of premises,
and as such property373 in its own right and not part of any land. This view that
369 Ibid. The passage from CIR v. Muller and Co’s Margarine Ltd is found at [1901] AC 217 at 235. 370 [1898] 2 QB 507. 371 In Danubian Sugar Factories Limited v. CIR [1901] 1 QB 245 at 251, Collins LJ recognized both West London Syndicate and the earlier Potter as deciding ‘that the goodwill of premises, apart from the premises, was itself property.’ 372
The West London Syndicate Limited v. CIR [1897] 1 QB 226. 373 Smith LJ cited Potter v. IRC (1854) 10 Ex 147 as authority for holding that goodwill was property.
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goodwill was ‘capable of being sold as a separate entity’374 did not ipso facto lead to a
conclusionthat it was capable of a separate existence. Rather, such a view indicated
that goodwill was capable of recognition and sale as a separate item of property for
stamp duty, notwithstanding that it had no existence separate from a business.375
Likewise, Rigby LJ held that goodwill was certainly property for stamp duty in
accordance with s. 59 and that any interest in goodwill must equally be property.
Moreover, he saw it as property separate from land, stating:
It is to me exceedingly difficult to see how in any case goodwill can be land, … . Even
if inseparably connected with land, supposing such a case possible, it is not like fixtures
attached to the soil so as to be part of the land.376
Rigby LJ also considered the nature of goodwill and its sources. He suggested that the
premises of the hotel did not contribute a large amount to the goodwill of the business.
Instead he attributed a great part of the goodwill to the name of the hotel rather than to
its specific location. In other words, it was the view of Rigby J that the goodwill in
this case was more name goodwill than site goodwill. Furthermore, he saw personal
goodwill also as playing a part in this business, owing to the personal connections of
the vendor which he suggested contributed significantly to the value of the goodwill.
Hence, Rigby LJ exhibited an appreciation of the multiple elements or sources of
goodwill which make it property and an asset in its own right, while still being
separate from those sources.
Support for the position that goodwill was not part of land may be found in CIR v.
Muller and Co’s Margarine Ltd, where Lord Davey made reference to the appellant’s
position that the goodwill in question should in effect be apportioned, with only the
part attached to the business premises located in Germany being outside the reach of s.
59(1) of the Stamp Act, 1891. In response to this, Lord Davey said that he was ‘not
aware that you can split up goodwill into its elements in that way, and I see great
374
The West London Syndicate Limited v. CIR [1898] 2 QB 507 at 513. 375 Later support for this view may be taken from the House of Lords in CIR v. Muller and Co’s
Margarine Ltd. [1901] AC 217. 376
The West London Syndicate Limited v. CIR [1898] 2 QB 507 at 523.
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difficulty in doing so.’377 In other words, goodwill is one whole item of property and
independent of its sources, as noted elsewhere in this paper.
7.4 Goodwill and land in Australia pre-Murry
The relationship of goodwill to land was the subject of litigation in Australia with
mixed results in the period before the High Court’s decision in FCT v. Murry,378
particularly in regard to the question of whether the value of goodwill should be
included in the value of land for the purpose of imposing ad valorem duty. Such a
question was raised before the High Court of Australia in The Rosehill Racecourse
Company v. CSD(NSW)379 early in the twentieth century. The Rosehill Racecourse
Company, a racing club, was voluntarily liquidated in a capital reconstruction and its
assets, comprising its land and buildings, undertaking, business and goodwill, were
transferred to a new company of the same name, the appellant in this case. In addition,
the Australian Jockey Club had agreed to transfer the racing licence, which it had
issued, from the old company to the new company which was to continue the business
of a racing club. The consideration comprised an issue of shares in the new company,
fully paid to a total value of £32,792, to the old shareholders. For the purpose of
imposing stamp duty, the real property conveyed between the companies was valued
at £10,000, with the intention of this amount only being subject to ad valorem duty.380
The Commissioner for Stamp Duties, however, assessed ad valorem duty on the full
amount as the real consideration for the conveyance of the real property. As a result,
the company appealed to the Supreme Court of New South Wales which upheld the
assessment on the grounds that the business and goodwill of the company were
inseparable from the land and accordingly passed with the transfer of the land.
However, the company’s subsequent appeal to the High Court was upheld by all three
judges in separate judgments, wherein they concluded that the land was conveyed
separately from the other assets including the goodwill. Thus ad valorem duty was
chargeable on the agreed value of the land only. Griffith CJ saw the licence, rather
than the land, as the major source of the goodwill and therefore concluded that only
the land was the subject of the conveyance, with goodwill having no connection with
377 [1901] AC 217 at 227. 378 (1998) 98 ATC 4585. This case is considered in para. 7.6. 379 (1905) 3 CLR 393. 380
Stamp Duties Act 1898 (NSW), s. 4, sch. 11.
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it. Somewhat similarly, O’Connor J saw the goodwill arising from the rights conferred
by the licence, and these rights were personal in nature rather than part of the land.
Taking a different approach, Barton J saw the land only as passing under the
applicable real property legislation which governed real property conveyances. In the
judgments of both O’Connor and Barton JJ, however, there are suggestions that they
were willing to entertain the possibility of goodwill being transferred as part of the
land in the right circumstances. While such a view would be contrary to Murry, the
decision in this case was nonetheless correct.
A hotel was the subject of sale in Tooth & Co Ltd v. CSD(NSW),381 with the
legislation under consideration being the same as that for Rosehill. The owner of the
hotel sold it to the appellant in a sale comprising the hotel lease, licence, goodwill, and
furniture. The total price was £2,500, of which £800 was allocated to the value of the
lease for ad valorem duty under the Stamp Duties Act 1898 (NSW). The
Commissioner for Stamps, however, assessed the true value for duty as £2,320,
derived by taking the total amount of £2,500 and deducting £180 as the value of the
furniture. The licence and the goodwill, it was therefore implied, were part of the
conveyance of the lease. The question for the Supreme Court of NSW was whether
the Commissioner’s assessment was correct. By majority, the court held that the site
goodwill of the business passed with the lease and the value of that goodwill therefore
was properly part of the assessment. In reaching this decision, the majority made a
distinction between site goodwill and personal goodwill, finding that both aspects
were present but that only the site goodwill was part of the leased premises and
subject to ad valorem duty.
The majority’s decisions in Tooth contained two fundamental errors. The first error
was that the goodwill could be split into separate components. While it may have
several sources, such as the site and the personal characteristics of the licensee,
goodwill is one whole item of property. The second error was that the goodwill could
inhere in the sources such as the premises. Goodwill is a separate item of property in
its own right, although inseparable from the business to which it attaches. Thus the
Tooth case again demonstrates the confusion found in the courts concerning the legal
concept of goodwill and its relationship to other property of a business. The idea that
381 (1909) 9 SR(NSW) 652.
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goodwill was an indivisible whole attached to a business, rather than to other property
of the business, had not been fully understood and accepted at this time,
notwithstanding influential cases such as Muller382 and particularly The West London
Syndicate dealing with a similar question.
Confusion concerning the relationship between goodwill and land for stamp duty has
persisted to relatively recent times. Typically, the key question has remained whether
the value of goodwill should be included in the value of the conveyed land for the
purpose of imposing ad valorem duty, as in the old cases of Rosehill and Tooth. A
prime example of the earlier confusion in a modern case may be found in the 1997
case of EIE Ocean BV v. CSD(Qld).383 This case before the Queensland Court of
Appeal concerned the value of land conveyed for purposes of the ‘land rich’
provisions of the Queensland stamp duty legislation384 which applied at that time. The
case involved the sale of shares in a ‘land rich’385 company where the Commissioner
of Stamp Duties had assessed higher duty on the sale of the shares on the basis that the
unencumbered value of the land held by the company had exceeded 80% of the
unencumbered value of all property held by the company as set down in the
legislation. The Commissioner contended that the value of the land should include an
amount for goodwill, thus taking the total value of the land above the 80% threshold.
Further, the Commissioner had allowed nothing for goodwill in the value of the
company’s property other than the land. In other words, the Commissioner had valued
the land above the threshold by including the entire value of the goodwill of the
company’s business in the value of the land.
382 However, as Muller dealt with the specific question of the location of goodwill, resulting from the location of the business, it might have been seen as distinguishable. Nonetheless, it still addressed the nature of goodwill and its relationship with the business. 383 (1997) 97 ATC 4013 (Macrossan CJ, Pincus JA, and Williams J). 384
Stamp Act 1894 (Qld). 385 All the jurisdictions have so-called ‘land rich’ provisions in their duties’ legislation. These are essentially anti-avoidance provisions which apply to the transfer of shares in certain companies or units in unit trusts where (1) those entities hold land whose unencumbered value reaches a stipulated threshold and (2) that value in relation to the total value of their property reaches a stipulated threshold percentage. (These thresholds vary between the jurisdictions, ranging from nil to $2m for the value of the land and either nil or 60% for the percentage.) These provisions apply ad valorem rates of duty to the transfer of the shares or units, as effectively the conveyance of land, rather than the lower rates payable on shares and units.
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In considering whether the value of goodwill should be included in the value of land,
Pincus JA, who gave the leading judgment, referred to the distinction between site
goodwill and personal goodwill and pronounced that the authorities held that personal
goodwill could not possibly be included in land value. But this, of course, left open
the possibility of site goodwill being so included, as contended by the Commissioner
who obviously viewed the goodwill in this case as entirely site goodwill. In reaching
his decision that the value of site goodwill was included in the land, Pincus JA sought
authority from a range of cases, including Rosehill and Tooth. The flaws in the
arguments supporting the view that goodwill is part of land in those cases have
already been exposed. However, it must be remembered that, notwithstanding some
clear pointers to the contrary from cases such as Muller and The West London
Syndicate, this case preceded the High Court’s definitive pronouncements on goodwill
in Murry.
Apart from the more directly relevant cases of Rosehill and Tooth, Pincus JA drew
from a range of other cases dealing with aspects of goodwill in different contexts.
Notably, he referred to the High Court case of FCT v. Williamson386 where Rich J
made a distinction between site goodwill and personal goodwill and went straight on
to say:
There seems to be no good reason for holding in the present case that any goodwill
other than local goodwill is, for the purpose of valuation, inseverable from the land; that
is, if in the present case there is goodwill which can properly be characterized as
personal, its value cannot be included in land value.387
However, there is no clear authority in Williamson for the proposition that goodwill
from any source may be taken as part of land for the purpose of valuation. In this
casethe issue concerned whether the taxpayer was entitled to an income tax
deduction388 for a premium paid for the purchase of a chemist shop comprising stock,
386 (1943) 67 CLR 561. 387 (1997) 97 ATC 4013 at 4022. 388 The goodwill had been purchased for consideration of £500, of which the taxpayer had claimed a proportionate amount of £96 as a deduction under s. 88 of the Income Tax Assessment Act 1936 (Cth) (as then enacted). Section 88 allowed such a proportionate deduction of any premium paid in respect of land or premises inter alia used to produce assessable income. Subsection 83(1) defined ‘premium’ as ‘any consideration … for or in connection with any goodwill … attached to or connected withland a lease of which is granted assigned or surrendered’. The goodwill referred to in this definition was obviously site goodwill with its source in the business premises, and such goodwill was to be treated as a premium for purposes of the income tax legislation at the time.
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fittings, goodwill, and the lease of the premises from the vendor. A premium for the
purpose of this legislation was defined as any consideration connected with goodwill
attached to or connected with leased land. Such goodwill was clearly site goodwill
with its source in the land, but this does not constitute authority for the proposition
that the land includes site goodwill. In fact, the legislation referred to goodwill
‘attached to or connected with’ land, indicating that the goodwill and land were
considered separate items of property. In this regard, Rich J in Williamson said:
… the goodwill referred to is the local goodwill attached to the premises. … it
necessarily goes with the premises and the seller is bound to do nothing positive except
hand over the premises.389
Of course, he could have mentioned that the business also needed to be handed over,
which it was in this case. The Commissioner had argued that the goodwill was not
connected with the land and therefore the deduction was not available to the taxpayer.
The judge was able to determine, however, that the goodwill was site goodwill and
accordingly satisfied the legislative requirements for deduction. Beyond that point he
was not required to deliberate on what he called ‘the inherent nature of
goodwill’.390Williamson does not therefore lend authority to the proposition that site
goodwill is part of the land as suggested in EIE Ocean.
In response to the decision in EIE Ocean to include the value of site goodwill in the
value of the land, Grace and Lim said:
If the decision of the Court of Appeal in EIE Ocean is correct, then the expression ‘site
goodwill’ appears to be meaningless. In light of this decision, any reference to site
goodwill is really a reference to land, and the value of any site goodwill (if such a thing
exists) is really part of the land.391
This view of EIE Ocean sums up the issue in a succinct manner: the case law up to
and including this case largely rated site goodwill as part of the land, for stamp duty
purposes at least. However, in the light of the High Court’s decision in Murry, there
389 (1943) 67 CLR 561 at 565. 390 Id at 564. 391 Grace, T. and Lim, J., ‘EIE Ocean and goodwill – Some stamp duty issues for consideration’, (1997) 19 Weekly Tax Bulletin 414 at 414.
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may be perceived a distinct change in this view, as argued in the section on the post-
Murry cases.
The relationship of goodwill and land has also arisen in contexts other than stamp
duties, as illustrated by the above income tax case of Williamson. In another income
tax case, Daniell v. FCT,392 Knox CJ pondered in passing ‘on the abstract question
whether the goodwill of a licensed victualler’s business is separable from the
premises’ and opined that ‘prima facie at any rate it may be treated as attached to the
premises and whatever its value may be should be treated as an enhancement of the
value of the premises’.393 More particularly, compensation cases have suggested that
the value of goodwill should be included in the value of land. Thus in Minister for
Home Territories v. Lazarus394 the High Court accepted that the value of site goodwill
of a hotel business should be included in the value of the land in computing the
compensation to be paid for the compulsory acquisition of the property. Later, in
Commonwealth v. Reeve,395 the High Court again held that the value of site goodwill
of a coffee shop should be included in the calculation of compensation to be paid for
the loss of the business premises under a compulsory acquisition order. However,
compensation cases have specific requirements concerning the calculation of suitable
recompense for the loss of business, and should be viewed in that light.396 They should
not therefore be taken as authority for the general proposition that goodwill, at least as
site goodwill, should be included in the value of land.
7.5 A right analogous to goodwill?
Not long before the EIE Ocean decision, the Queensland Court of Appeal, although
differently constituted, also deliberated on goodwill for stamp duty purposes under the
Stamp Act 1894 (Qld) in Suncoast Milk Pty Ltd v. CSD(Qld).397 A statutory authority,
the Queensland Dairy Industry Authority, had awarded a lease of a milk run under its
statutory powers to the taxpayer company. This lease provided the taxpayer with a
right to sell milk to a particular group of customers for a limited period. Associated
with this lease was the provision of a licence by the authority to sell the milk. The
392 (1928) 42 CLR 296. 393 Id at 302-3. 394 (1919) 26 CLR 159. 395 (1949) 78 CLR 410. 396 This view is supported by the High Court in Murry (at 4594). 397 (1996) 96 ATC 4914.
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essential question for the Court was whether the contract for the lease of this milk run
constituted the sale of property under s. 54(1) of that Act. Subsection 54(1) provided
that any contract for sale of any property be charged with the same duty as if it were
an instrument of conveyance of the property. Accordingly, a contract deemed to be a
conveyance under this provision would be subject to ad valorem duty. The
Commissioner of Stamp Duties had applied this provision, inter alia, in assessing the
taxpayer at the ad valorem rate.
Fitzgerald P was of the view that the right to sell to a particular group of customers
was ‘of the nature of, or perhaps technically, goodwill or a component of goodwill, in
that concept’s basic sense of a probability that the customers constituting its “milk
run” will resort to Suncoast for their purchases of milk.’398 In expressing this opinion,
however, he made the qualification that the temporary nature of the right (that is, its
limited term under the contract) needed to be ignored. Just why this should be
necessary, he did not explain. It might have been that he considered that goodwill
might not survive a business arrangement with a limited life. But the essential test for
goodwill is whether it may be sold as part of the business; specifically in this case,
whether Suncoast would have a milk run to sell in the future. This question was not
directly addressed by Fitzgerald P or by either of his fellow judges.399 However, he
viewed the right to sell milk under the contract as a right in the form of property,
which in turn he viewed as goodwill or a right analogous to goodwill. As he noted,
goodwill has consistently been held to be property for the purposes of stamp duty.
With that thought in mind, he opined that ‘Suncoast’s “right” to “operate” its “milk
run” … is plainly “property” according to ordinary concepts; even if technically not
goodwill, it consists of a right analogous to goodwill.’400 (Emphasis added.) Then,
having reviewed a number of authorities, he concluded that ‘“property” is a broad
concept for stamp duty purposes and, in my opinion, Suncoast’s “right” to “operate”
its “milk run” is clearly “property” within the meaning of s. 54(1) of the Stamp
Act.’401
Thus Fitzgerald P was able to find that the right to operate a milk run under the
contract of lease and the associated licence constituted a property right. This would 398 Id at 4922. 399 Fryberg J and McPherson AJ, with the latter dissenting on the question under consideration. 400 (1996) 96 ATC 4914 at 4925. 401 Ibid.
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seem to be a most reasonable finding, particularly as he saw property to be a broad
concept for stamp duty purposes. However, it is interesting that he felt inclined to
identify the right as goodwill or ‘a right analogous to goodwill’. As a business, the
milk run would have goodwill at law as the attractive force that brings in custom. But
whether that goodwill would have been conveyed under the contract of lease, even
with the granting of the licence, for the purpose of s. 54(1) is a moot point. Seeing the
property right as goodwill, or more particularly as analogous to goodwill, might have
been a way of dealing with the question, but it seemed unnecessary given that the
rights under the lease and licence were found to constitute property for the purposes of
stamp duties. Furthermore, it is unclear just what a ‘right analogous to goodwill’ is
meant to be. One can only assume that Fitzgerald P still had doubts about whether
goodwill in the normally understood sense was conveyed, an issue raised above.
McPherson JA, dissenting, had no doubt that goodwill was not conveyed in this
contract, stating:
It cannot be considered a contract for sale of goodwill because goodwill is the tendency
of customers to continue dealing with their former supplier or place of supply; and here
there was no such tendency until the contract to lease was made.402
As this judge had said earlier in his judgment, what was transferred to the taxpayer in
a practical sense was a statutory monopoly to sell milk to specified shops. In the
normal course this would give rise to monopoly goodwill in the taxpayer’s business.
However, at the time the monopoly right was transferred, it was not monopoly
goodwill. That would arise only after the monopoly was acquired under the contract.
While this was part of a dissenting judgment, it may be argued to be the correct
position concerning goodwill in the case of a leased business. That is, goodwill will
not come into existence until the lessee commences the business.403
Consequently, a ‘right analogous to goodwill’ is not goodwill per se, but rather a right
which will be the source of goodwill on acquisition.
402 Id at 4935. 403 This issue is addressed in chapter 8.
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7.6 FCT v. Murry
The High Court case of FCT v. Murry404 has been introduced and referred to in earlier
chapters, playing a significant part in explaining the legal concept of goodwill.
However, as it is of specific importance to considerations in this chapter, it is included
here again for the convenience of the reader.
In Murry the Federal Commissioner of Taxation had appealed from the decision of the
Full Federal Court wherein the majority in separate judgments had in effect held that a
taxi licence was goodwill for the purpose of a goodwill concession in the capital gains
provisions of the income tax legislation applicable at the time.405 The taxpayer had
acquired in partnership with her husband what was described as a ‘taxi business’,
comprising a licence to hire issued by the appropriate state authority and shares in a
taxi co-operative company operating within a defined area. The taxpayer and her
husband did not operate the business themselves, but purported to lease the taxi
licence to another person, the owner of the taxi vehicle, for a fixed monthly fee.
Several years later the partnership entered into an agreement to sell this business
comprising the licence and the shares. At the same time the owner of the vehicle
agreed to sell it to the purchasers and the assets of both vendors were entered on the
one sale form provided by the state authority. The form contained details of the
vehicle for a sale price of $6,000, the shares for $25,000, and the licence for $189,000.
The reference to the licence was part of the printed form and was described as
‘Goodwill (Licence Value)’.
The question on appeal was whether the amount received for the licence, or some part
of that amount, constituted a payment for goodwill for the purpose of the relevant
provision. The majority406 of the High Court allowed the Commissioner’s appeal in
deciding that the taxpayer and her husband had not disposed of a business as required
by that provision to qualify for the concession. Rather, they found that she and her
husband had sold a licence to use a taxi together with shares in a taxi co-operative
404 (1998) 98 ATC 4585. 405 Section 160ZZR of the Income Tax Assessment Act 1936 (Cth) provided a concession in the form of a 50% reduction in the capital gain arising from the sale of the goodwill of a small business with a net value below a certain threshold. 406 The majority comprised Gaudron, McHugh, Gummow and Hayne JJ who wrote a joint judgment. Kirby J dissented.
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company.407 These assets did not constitute a business, thus the taxpayer could not
have disposed of a business and its goodwill.
However, in their joint judgment, the majority of the High Court deliberated in detail
on the nature of goodwill and its relationship with the business and its other property
and assets. Their Honours’ fundamental view of the place of goodwill in a business
may be found early in their judgment where they said:
Goodwill is inseparable from the conduct of the business. It may derive from
identifiable assets of a business, but it is an indivisible item of property, and it is an
asset that is legally distinct from the sources – including other assets of the business –
that have created the goodwill. Because that is so, goodwill does not inhere in the
identifiable assets of a business, and the sale of an asset which is a source of goodwill,
separate from the business itself, does not involve any disposition of the goodwill of the
business.408
In reviewing the nature of goodwill and its relationship to the business, the majority
referred to several cases from the nineteenth and early twentieth centuries, the most
notable being the House of Lords’ case of CIR v. Muller & Co’s Margarine
Limited.409 The Lords’ major contribution to the legal concept of goodwill was that
goodwill is one whole item of property which is inseparable from the business.410But
notwithstanding the importance of the Lords’ statements on the nature of goodwill in
Muller, they appear not to have had a significant impact on the understanding of
goodwill in Australian stamp duty cases.411 Thus it has been left to Murry to provide a
reminder of the established jurisprudence concerning the nature of goodwill as an
indivisible whole item of property, inseparable from the business but separate from its
407 See (1998) 98 ATC 4585 at 4587. 408 Ibid. 409 [1901] AC 217. In his frequently cited definition of goodwill from this case, Lord Macnaghten said inter alia: ‘The goodwill of a business is one whole, … goodwill has no independent existence. It cannot subsist by itself. It must be attached to a business’ (at 224). In similar vein, Lord Lindley said that ‘goodwill is inseparable from the business to which it adds value (at 235).’ 410 While the Lords’ pronouncements on the nature of goodwill were clear and authoritative,it is notable that the Lords adduced no direct authority for these pronouncements. However, this decision was delivered at a time when the concept of goodwill was just emerging in a more finished form from the nineteenth century when much of the jurisprudence concerning its meaning evolved in the courts. 411 The irony of this is that Muller itself was a stamp duty case.
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sources.412 If Murry has added anything to this jurisprudence, it is the definitive view
that goodwill is legally separate from its sources.413
7.7 Goodwill and land in Australia post-Murry
In 2005, after the High Court’s decision in Murry, a South Australian ‘land rich’
stamp duties case came before that state’s Supreme Court in the form of HSH Hotels
(Australia) Ltd v. CSD(SA).414 Unlike the Queensland Supreme Court in EIE Ocean,
the judge in this case, Anderson J, had the benefit of Murry and he paid regard to that
decision in his judgment. In HSH Hotels, the appellant contested the Commissioner’s
original assessment of stamp duty and the subsequent Treasurer’s increased
assessment. At issue were the land rich provisions of the Stamp Duties Act 1923 (SA).
The appellant had acquired the business and freehold of a major beachside hotel by
purchasing all the units of a unit trust which had owned the hotel. The Commissioner
had assessed stamp duty under the ‘land rich’ provisions on the basis that the
unencumbered value of the real property exceeded $1,000,000 in the first place and
also exceeded 80% of the value of all property acquired.415 In fact, he had determined
the real property value to be 86.86% of all property and then the Treasurer had
increased this percentage to 88% and had imposed ad valorem stamp duty on the
value of the real property on that basis. HSH Hotels contested the value of the real
property originally used by the Commissioner in making his assessment.
Anderson J saw the main question for the court as involving the value of the real
property passing on the sale and whether any goodwill, in the form of site goodwill,
passed with it. The Commissioner had allowed nothing for goodwill in determining
the whole value of the business property. This was partly explained by the fact that
there was no goodwill in the balance sheet, because all the goodwill at the time of sale
412 It should be noted that Murry did not introduce a new jurisprudence, but essentially restated the law based on long-established authority: see, for example, Bevan, C., ‘Resuscitating the Old Jurisprudence on Goodwill’, (1998) 27 Australian Tax Review 148 and Tregoning, I., ‘Goodwill: Another View’, (2005) 9(1) The Tax Specialist 22. Nonetheless, this established authority was largely overlooked in the stamp duty cases pre-Murry. 413 The Federal Commissioner of Taxation publicly recognized this view in Taxation Ruling TR 1999/16 issued in the wake of the High Court’s decision in Murry. See, for example, para. 97 of that ruling. 414 2005 ATC 4067; [2005] SASC 39. 415 Subsection 94(1) of Part 4 of the Stamp Duties Act 1923 (SA) required the lodgment of a statement by a person who had acquired a majority interest in a private company or a scheme, including a unit trust, where these thresholds were reached. HSH Hotels had failed to lodge this statement and the Commissioner had accordingly made an assessment of duty as he was empowered to do under s. 100(2) of the Act.
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was internally generated and therefore not recognized in the accounts in accordance
with accounting standards.416 However, the Commissioner also submitted there was
no need to include goodwill in this case because the business acquired by HSH Hotels
was not the same business as had been conducted by the vendors. The
Commissioner’s argument behind this submission seems inventive, to say the least,
and warrants some consideration. According to Anderson J, this argument relied on
the termination of the management agreement which had been entered into by the
vendor with a particular management company which had operated the hotel. His
Honour went straight on to say:
It was also argued that any goodwill of the business prior to the sale was shared
between the entities, that is the trustee as owner and investor, and the operator, [the
management] company, and that therefore it was not possible to transfer any goodwill
in which [the management] company and the trust were jointly interested because [the
management] company was not part of the transaction involving HSH. Therefore it is
said that HSH paid only for the physical assets of the trust and paid what it believed
was the value to it of the earning power of those assets.417
An immediate response to this argument is that it was the hotel business which was
sold, as a going concern; this was not a sale of individual assets of that business. The
fact that the purchaser intended to institute different management is hardly of
consequence; this is common enough in the sale of businesses. Consequently, from the
legal viewpoint, goodwill would have been transferred on the sale of this business, a
point recognized and found to be the case by Anderson J.418
The issue of its value, however, was another matter and one which formed a
significant part of Anderson J’s judgment. As noted above, he paid regard to the High
Court’s view in Murry concerning goodwill and its relationship to other property. At
the outset, Anderson J stated that he believed that the overall result of both the
416 At the time both accounting standards dealing with goodwill, AASB 1013 and AAS 18, directed that internally generated goodwill should not be recognized as an asset in the accounts (see para. 4 in both standards). This matter is dealt with in chapter 14 of this paper. 417 2005 ATC 4067 at 4080. 418 Anderson J said, somewhat equivocally, in respect of this point: ‘The fact that a large business was up and running and included considerable infrastructure, that there were probably advance bookings and that the hotel business was, in general terms, successful, would tend to indicate on the face of it that there was some goodwill involved. … In my view, … it is likely that some goodwill attached to the conduct of the business and in the efficient use of the assets of the business, and was therefore transferred with the business in addition to the real property, and I find accordingly.’ (2005 ATC 4067 at 4082).
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assessment and a valuer’s valuation to be consistent with the reasoning of the High
Court in Murry. Neither had included goodwill in his respective calculations. His
Honour’s belief was based on the High Court’s view that goodwill is a separate item
of property associated with the business and not part of real property. Nonetheless, he
found that the real property was the source of most of the goodwill and also that this
property accounted for the major part of the value of the business. From this he
concluded that any goodwill would be relatively low in value in comparison to the fair
value of the land itself. As a consequence, he found that it was likely that the 80%
threshold would still be exceeded if a small amount of goodwill were included in
calculations and therefore saw no reason to disturb the assessment.
The key part of the reasoning in HSH Hotels was the recognition, based on Murry,
that goodwill is separate from its sources including other property and, further, that
the value of the goodwill is accordingly separate from the value of the other property,
such as land. This was the case even though Anderson J found that the goodwill of the
business derived almost wholly from the location. This therefore represents a marked
difference from the other cases considered so far in this chapter. However, one is left
with the feeling that site goodwill may be somewhat marginalized by a decision of this
nature. In the end, it does not seem so much different, in effect, from the result in EIE
Ocean. Nevertheless, Murry has brought some intellectual rigour and clarity to the
debate, with goodwill being recognized as property in its own right with its own value,
albeit relatively small in a case such as HSH Hotels.
Several cases decided post-Murry were referred to in HSH Hotels and warrant
consideration in their own right.419 Thus in Kizleap Pty Limited v. Chief Commr of
Stamp Duties (NSW)420 the Supreme Court of New South Wales was required to
determine whether the ‘land rich’ provisions of the stamp duties legislation421 applied
to the sale of a business comprising a caravan and camping park. The taxpayer had
acquired a majority interest in the shares of the park operator and the Commissioner
had contended that the unencumbered land value exceeded the 80% threshold. In his
419 As a more recent example of the influence now exerted by the High Court in the stamp duty field, the Court of Appeal of the Northern Territory in CTR (NT) v. Alcan (NT) Alumina Pty Ltd 2008 ATC 9226 based its considerations concerning the application of the ‘land rich’ provisions on, inter alia, the position that goodwill was separate from any other property which might be its source. 420 2001 ATC 4095. 421
Stamp Duties Act 1920 (NSW).
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calculations, the Commissioner conceded that an amount for goodwill should be
allowed in the total value of the business, but considered its value to be relatively
insignificant and thus did not bring the value of the land below the threshold. Adams J
saw the crucial question for the court to be the value of the land, as the key component
of the calculations concerning the threshold, but recognized the value of the goodwill
as material in those calculations.
In his deliberations, Adams J considered the nature or sources of the goodwill of this
particular business and found that the major source was personal in nature rather than
arising from the site. That is, he found that the positive personal relationships between
management and the customers of the park were more important in generating profits
than the location of the park. Then he stated that ‘as a matter of common sense, it is
difficult to understand how the value of land can be increased or decreased depending
on the quality of management of the business that is undertaken upon it.’422 The result
was that Adams J found for the taxpayer in finding that the value of the land was
significantly below the 80% threshold, with the personal goodwill being taken as part
of the total property but not part of the land value.
However, while the distinction between personal and site goodwill might have been
justified by the particular facts of this case, it cannot be said to be a decisive
consideration. As Adams J in fact recognized, the High Court in Murry held that
goodwill is property in its own right and separate from its sources. Thus, whether the
source of goodwill be personal or the site of the business, or any other source for that
matter, the goodwill remains distinct from the site and accordingly its value is not part
of the site value. Adams J, therefore, could have decided the case without resorting to
distinctions between the sources of goodwill. The legacy of Murry is that goodwill is
indivisible as property, as well as being separate from its sources.
In CSR (Vic) v. Uniquema Pty Ltd,423 before the Victorian Court of Appeal, the
Commissioner of State Revenue had included the value of goodwill in the value of
land in the sale of a manufacturing business. The primary question for the court,
therefore, was whether the Commissioner was entitled to do so; that is, was the value
422 2001 ATC 4095 at 4100-1. 423 2004 ATC 4579.
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of the goodwill part of the value of land for stamp duty.424 The basis of the
Commissioner’s assessment was that the whole of the goodwill sold was attributable
to the site value of the land. Ormiston JA, with whom the other two judges agreed,
rejected the Commissioner’s assessment on this basis, placing reliance on Murry.
However, his Honour still felt inclined to spend a significant part of his judgment in
arguing that the goodwill could not, as matter of fact, have had its source in the land in
this case. In this sense, he took an approach similar to that of Adams J in Kizleap.
Nonetheless, he did recognize the High Court’s view that goodwill is separate from its
sources and sold as a separate item of property with the business. Consequently, it was
unnecessary to examine the sources of the goodwill and then argue, inter alia, that the
value of the goodwill could not be attributed to other assets of the business as possible
sources of the goodwill. Murry is clear that goodwill is separate from its sources and
carries with it its own value on sale. Thus, as there was no dispute that the values
attributed to the land and to the goodwill respectively in this sale were fair values, it
logically followed that the land value, without the value of the goodwill, should be the
amount subject to assessment.
There appears from these cases a reluctance to let go entirely of the old pre-Murry
jurisprudence, where there was the tendency to include the value of goodwill in land
value where the land was the source of the goodwill. This reluctance is apparent from
the need for the judges still to address in detail the arguments, albeit to dismiss them,
that goodwill may be part of land in such a situation. Further evidence for this view
may be found in Primelife (Glendale Hostel) Pty Ltd v. CSR (Vic),425 before Harper J
of the Supreme Court of Victoria. In fact, early in his judgment he took a misleading
approach to the question of whether goodwill should be included in the value of land
for stamp duty purposes, seeming to suggest that it should be, before suddenly turning
round and holding that it should not. This apparent U-turn in the judgment is a prime
example of this reluctance to give up the old jurisprudence. In this case, the appellant
taxpayers had purchased two aged care facilities, a retirement village and a hostel,
each by way of three separate contracts for (1) the land and buildings, (2) the
businesses including goodwill, and (3) allocated places subject to government
424 Under the Stamps Act 1958 (Vic) goodwill was not subject to stamp duty as a conveyance, (as is also the case under the new legislation, the Duties Act 2000). Hence there was an incentive for the Commissioner to include the value of goodwill in the value of the land where it would attract ad
valorem duty. 425 2004 ATC 4644.
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funding. The Commissioner argued, inter alia, that the value of the real property for
ad valorem duty should be enhanced by the value of the goodwill.
Harper J addressed the decision in Uniquema, noting that it had a basis in the finding
that the land was not a source of the goodwill in that case. However, he opined that in
Primelife the goodwill had a multiplicity of sources, including the land. Then, on the
authority of EIE Ocean, he suggested it would ‘be right to exclude from [the
calculation of stamp duty] at least so much of the value of that goodwill as does not
have its source in the real property …’.426 Later in his judgment, after having
determined that the goodwill of the businesses in Primelife had it sources partly in the
good management and reputation of the facilities, Harper J stated:
To say this, however, is to leave open the possibility that the assessment of duty …
should include the value of so much of the goodwill of a business as has its source in
the land.427
By this point, the reader might well become suspicious that his Honour was intent on
following the line in EIE Ocean that the value of site goodwill formed part of the land
for stamp duty purposes. This suspicion is reinforced by his reference to Morvic Pty
Ltd v. CSR(Vic)428 wherein the value of goodwill was included in value of the land,
‘despite the fact that several elements of the goodwill of the business in question were
not attributable to the land’429 in the words of Harper J, suggesting that his main
concern was that the source of the goodwill was not entirely the land.
However, there is then a hesitation, where Harper J pronounced:
Goodwill which has its source in land is, in a sense, inseparable from the land. It is also,
and perhaps in a more relevant sense, inseparable from the business with which it is
associated.430
From this notion that goodwill is more relevantly associated with the business, he was
able to turn about and state that:
426 Id at 4651. 427 Id at 4652. 428 2002 ATC 4459. 429 2004 ATC 4644 at 4652. 430 Ibid.
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… it does not logically follow that merely because goodwill passes with land, it is to be
included in the amount brought to tax pursuant to … the Stamps Act. Even when
goodwill and land are transferred together, the former does not lose its character as
personal property and become part of the transferred real estate.431
Finally, on the authority of Murry, he decided:
… goodwill is property which is not only inseverable from a business, but is also
indivisible. It is, consistently with this, legally distinct from the sources – including
other assets of the business, such as the land on which the business is conducted – by
which goodwill has been created. Accordingly, it seems to me that, with those
characteristics, goodwill cannot be included, for the purposes of the assessment of
stamp duty, in the value of real property as if it were an element of that real property. I
am therefore also of the opinion that it is wrong to cumulate the value of goodwill in the
dutiable value of land merely on the basis that the two have been transferred in the one
transaction, albeit by separate contracts.432
Thus, while he took a circuitous route, Harper J as least arrived at the correct decision.
The same cannot perhaps be said for Pagone J in Morvic Pty Ltd v. CSR(Vic),433 a case
referred to by Harper J in Primelife. In this case, the taxpayers purchased a motel
business by entering into two interdependent contracts, one for the sale of the land and
the other for the sale of the business. The Commissioner contended that the value of
the goodwill in the sale of business contract was assessable with the sale of the land
because, he argued, the sole source of the goodwill was the land. Pagone J paid some
regard to passages in Cresswell Nominees Pty Ltd v. CSR434 wherein the tribunal
opined that site goodwill ‘in some sense’ passes with the transfer of land. However, it
acceded on the authority of Murry that a purchase of land is not a purchase of
goodwill and that, as a matter of law, the payment for land is not the payment for
431 Id at 4653. In respect of goodwill as personal property, Harper J provided later what amounted to an alternative argument for concluding that goodwill was not part of the value of the land. He stated: ‘There is, it seems to me, a fundamental reason why not. Goodwill is an asset of business. A business is a species of personal property. So, therefore, is goodwill. Land is a species of real property. It is real property or, rather, instruments of transfer of real property, which are subject to assessment for duty under … the Stamps Act’(at 4654). This is simply another way of saying that goodwill is separate property from the land, but the interesting part is his assertion that business is a species of personal property. While a business may consist of various property, including goodwill, it is not itself property but rather a course of conduct: see Murry at 98 ATC 4585 at 4596. 432 Id at 4656. 433 2002 ATC 4459. 434 VCAT, 7 November 2001 (unreported). The passages from this tribunal case (per Nettle QC) were cited by Pagone J at 2002 ATC 4459 at 4462-3.
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goodwill. Nonetheless, the tribunal proposed that, as a matter of fact, the value of the
goodwill derived from the land affected the value of that land. ‘These passages’, said
Pagone J, ‘correctly emphasise the importance of the facts of each case to the
determination of the question concerning the extent to which goodwill will inform or
affect the value of land acquired by a transaction.’435 Pagone J went on to hold that the
appellant taxpayers had not ‘discharged the burden of proof to establish that the
goodwill attaching to the business was not purchased with the land.’436 Thus it seems
that he was of the opinion that the value of site goodwill could enhance the value of
the land, at least in a factual sense, and could therefore be included in that value for
stamp duty (in line with earlier cases). But as Harper J said in Primelife, in response to
this opinion, goodwill ‘does not lose its character as personal property and become
part of the transferred real estate.’ Harper J’s position was essentially a legal one, and
factual questions of the respective values of land and goodwill, and the interplay
between them, may remain important issues for argument and resolution in particular
cases. However, once these questions have been resolved, the legal position is that
goodwill is not part of the land in the sale of a business.
Harper J was to the fore in yet another case, Palace Hotel (Hawthorn) Pty Ltd v.
CSR(Vic),437 dealing with the same issue. The appellant had previously acquired a
hotel business on leased premises. Under a deed of compromise, it had subsequently
acquired the freehold in these premises. The Commissioner had assessed stamp duty
on an amount that included the value of the goodwill of the business with the value of
the land, as with the other Victorian cases. In a much more direct and economical
judgment than the one in Primelife, Harper J allowed the appeal in the appellant’s
favour, holding that the value of goodwill should not be included in the land value.
Having noted the High Court’s view of goodwill in Murry, Harper J stated:
It is … perhaps confusing to speak of goodwill that has its source, or part of its source,
in the land, as enhancing the value of the land. That enhancement, if any, arises from
the capacity of the land to produce income. … The land is valuable (or not) because it is
435 2002 ATC 4459 at 4463. 436 Ibid. 437 2004 ATC 4550.
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(or is not) attractive to prospective and actual tenants, and therefore likely (or unlikely)
to generate correspondingly attractive (or less than attractive) rental income.438
There was, however, an interesting side issue which occupied the mind of Harper J
and seemed to have some bearing on his decision. In this particular case, the appellant
already conducted the hotel business on the land which it then acquired under the
arrangement under consideration. Therefore, he concluded that the goodwill could not
have been transferred with the freehold of the land because the appellant already
owned the goodwill as part of that business. While such an argument might have been
taken to add strength to the appellant’s case, the authorities indicate that the position
would still have been the same if the business had been transferred with the freehold.
The value of the land would not have been enhanced by the value of the goodwill in
such a situation, as Harper J himself reasoned in this case.
7.8 Goodwill as a chattel?
In the preceding Victorian cases of Uniquema, Primelife and Morvic, the
Commissioner had contended as an alternative argument that goodwill was a ‘chattel’
in terms of the relevant provision, s. 63(3),439 of the Stamp Act 1958 (Vic) which was
applicable at the time. This provision provided that real property included chattels
held or used in connection with the real property in the sale of the business. Because
chattels real were the subject of other provisions of this Act, the Court of Appeal in
Uniquema concluded that only chattels personal were the subject of s. 63(3).
However, while goodwill is personal property, the Court was not persuaded that it was
intended that it be treated as a chattel under this provision. It held rather that the
meaning was to be restricted to movable chattels, where ‘movable’ meant physical or
tangible items of property in accordance with the narrower traditional meaning of
chattel.440 Thus the Commissioner did not succeed with the contention that goodwill
was a chattel for the purposes of this provision of the Act. The concept of a chattel as
438 Id at 4554. 439 Paragraph 63(3)(a) provided that ‘real property or property includes a reference to chattels … held or used in connexion with a business carried on or in connexion with the real property –
(i) that, by reason of the sale of or agreement to transfer the real property or property to the transferee, are transferred to the transferee…’
440 For example, in Osborn, P. G. 1964, A Concise Law Dictionary (5th ed.), Sweet & Maxwell, London, it is stated in the definition of chattels that: ‘Chattels personal are movable, tangible articles of property.’
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tangible personal property precluded goodwill. The same conclusion was reached in
the other two cases.
Notwithstanding the restricted definition of chattels as tangible personal property,
there are many instances of it having been given a broader meaning in a range of
legislative contexts, encompassing incorporeal property such as choses in action, for
example. Harper J at first instance in Australian Rice Holdings Pty Ltd v.
CSR(Vic)441canvassed a number of cases where ‘chattels’ was given a broader
meaning to suit the requirements of particular legislation and found that water rights
came within the meaning of chattels for the purpose of s. 63(3).442 Likewise, Ormiston
JA in Uniquema conceded that the term has been given a wider meaning to include
choses in action and other intangible personal property in other contexts. While there
is no case evident where goodwill has been specifically treated as a chattel, there must
be scope for such treatment, given that it is personal property. As noted in Halsbury’s
Laws of England, ‘Chattels personal are, strictly speaking, things movable, but in
modern times the expression is used to denote any kind of property other than real
property and chattels real.’443
7.9 The location of goodwill
The landmark goodwill case of CIR v. Muller and Co’s Margarine Ltd444 has been
referred to frequently in other chapters and also in this chapter already. It is generally
recognised as providing the legal definition of goodwill as essentially ‘the attractive
force which brings in custom.’445 As discussed in chapter 4, this House of Lords’ case
re-affirmed the legal position that goodwill is property. However, the principal
question in this case centred on whether the goodwill was ‘property locally situate out
of the United Kingdom’ for the purpose of s. 59(1)446 of the Stamp Act, 1891. If the
goodwill were found to be situated outside the UK then a contract for its sale would
441 2002 ATC 4052. 442 On appeal to the Court of Appeal in Australian Rice Holdings Pty Ltd v. CSR(Vic) 2004 ATC 4193, the question of whether water rights were chattels was left open, with the appeal being decided on another basis. 443 1994, (4th ed. reissue), vol. 35, Butterworths, London, at para 1204. 444 [1901] AC 217. 445 Id at 223 per Lord Macnaghten. 446 Subsection 59(1) read: ‘Any contract or agreement made in England … for the sale of any estate or interest in any property whatsoever, or for the sale of any estate or interest in any property except lands, tenements hereditaments, or heritages, or property locally situate out of the United Kingdom … shall be charged with the same ad valorem duty, to be paid by the purchaser, as if it were an actual conveyance on sale of the … property contracted or agreed to be sold.’ (Emphasis added.)
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not be subject to ad valorem stamp duty under s. 59(1). Thus this case raised the
question of whether goodwill, as intangible property, could have a physical location.
Lord Macnaghten certainly thought so in stating that ‘if there is one attribute common
to all cases of goodwill, it is the attribute of locality.’447 His rationale for this opinion
was that as goodwill cannot exist independently of a business it must therefore be
situated where the business is located. However, it may not always be easy to
determine the location of a business, a problem recognised by Lord Macnaghten448
despite his comment on the locality of goodwill as a common attribute. Nonetheless,
in this particular case he was able to decide that the goodwill was at least situated
outside the UK, without having to go any further, so as to be outside the application of
s. 59(1).
Lord Robertson was not persuaded that the geographical location of business premises
necessarily decided the question because, as he reasonably said, the customers may
reside elsewhere, for example in the UK rather than in Germany. Thus in a case where
the customers were in England he would have found it difficult to say that the
goodwill was located outside the UK. Nonetheless, in this particular case the business
was contained entirely in Germany and thus he had no difficulty in finding that the
goodwill was located outside the UK.
It was argued by the appellant that goodwill, as intangible or incorporeal property,
could not be locally situated anywhere and thus could not fall within the exception in
s. 59(1). However, Lord Lindley opined that ‘the legal conception of property appears
to me to involve the legal conception of existence somewhere.’449 He went on to say
that goodwill, as a form of personal property, must therefore be situated somewhere.
Earlier in his speech, Lord Lindley had decided that as goodwill was inseparable from
the business and the business as a matter of fact was situated in Germany, then the
goodwill was also situated in Germany.
The dissenting views of The Earl of Halsbury LC in Muller provide an interesting
insight into some of the confusion concerning the concept of goodwill. The Lord
447 [1901] AC 217 at 224. 448 Lord Macnaghten said ([1901] AC 217 at 224): ‘No doubt, where the reputation of a business is very widely spread, or where it is the article produced rather than the producer of the article that has won popular favour, it may be difficult to localise goodwill.’ 449 [1910] AC 217 at 236.
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Chancellor appeared to hold a view of goodwill which was separate from its sources,
consistent with the High Court’s view in Murry, in stating:
The advantages which may be conferred upon a business either by its local situation or
by its attractive appearance have nothing to do with the goodwill although they may
have originally contributed to procure it, and may, to some extent be connected with the
nature of the business, which itself, however, is very different thing. The goodwill … is
a thing which be assumed to exist separately.450
He then went on to observe that he was ‘wholly unable to see that goodwill itself is
susceptible of having any local situation.’451 The major flaw in this line of argument is
that, while goodwill may be separate from its sources within the business, it is not
separate from the business itself. Thus, as stated by Lord Macnaghten, goodwill will
be located where the business is located, notwithstanding any difficulties in
determining the location of the business in any particular case.
In an earlier case, Benjamin Brooke & Co Limited v. CIR,452 the court was called upon
to decide a similar question concerning the application of s. 59(1). The appellant
entered into an agreement to purchase a soap manufacturing business in the USA. The
sale comprised the freehold works in the USA, machinery, furniture, stock-in-trade,
debts, goodwill, trademarks and business names. The major part of the consideration
for the business was attributed to the goodwill and trademarks. The soap’s trademark
was registered in England and the brand was widely advertised in the UK, with the
result that about two-thirds of the vendor’s sales had occurred in the UK.
Consequently, although the soap was manufactured in the USA, the court held that the
trademark and goodwill were property located in the UK in terms of s. 59(1).
What these cases reveal about the location of goodwill is that it is located where the
business is located, as in Muller, or at least where major activities of the business may
be found, as in Benjamin Brooke. The location of a business and its activities involves
questions of fact, of course, and these may be difficult to determine in particular
circumstances, as noted above. But in view of the concept of goodwill as inseparable
from the business, the logical conclusion must be that it is located with the business.
450 Id at 238. 451 Id at 240. 452 [1896] 2 QB 356.
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7.10 Conclusion
For the purposes of stamp duty, as for law generally, goodwill is now treated as
property. From the beginning of stamp duty in the seventeenth century, conveyances
of property have been subjected to this duty. But there is no evidence of goodwill as
property for stamp duty until the relatively late time of 1837 in the case of South v.
Finch.453 By the middle of the nineteenth century, however, it had been settled that
goodwill was property for stamp duty as noted in Potter v. CIR454 in 1854.
The location of goodwill as incorporeal property came under consideration in CIR v.
Muller and Co’s Margarine Ltd455where the balance of opinion was that as property it
should have a location, and this was where the business was located. This was a
reasonable view, given that the Lords held that goodwill is inseparable from the
business. Nonetheless, they only had to determine whether goodwill was outside the
UK for the purpose of the legislation under consideration; beyond that point they did
not have to consider any broader issues concerning the location of goodwill. However,
consistent with the later thrust of Muller, the court in Benjamin Brooke found
goodwill located in the UK as a result of business activity being found there.
The relationship of goodwill to real property has been a contentious issue for stamp
duty over a long period because generally conveyances of real property have been
charged with ad valorem duty under various stamp duty legislation. Revenue officials,
therefore, have routinely contended that the value of land is enhanced by the value of
any site goodwill sold with that land. This is a contention that has finally been laid to
rest in the Australian stamp duty jurisdictions.The essential understanding derived
from stamp duty cases is that goodwill is property and, further, that it is property in its
own right, connected with the business rather than any particular property such as land
which may be its source.
453 (1837) Bing (NC) 506; 132 ER 505. 454 (1854) 10 Ex 147; 156 ER 392. 455 [1901] AC 217.
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Chapter 8: Goodwill in the Context of Licensing, Leasing
and Franchising
8.1 Introduction
The areas of licensing, leasing and franchising raise a range of issues concerning the
nature and treatment of goodwill. Licences play a fundamentally important part in the
existence and conduct of many businesses and in the production of their goodwill.
Moreover, licensing and leasing in the context of franchising, a very popular form of
business operation, raise pertinent questions about the transfer and treatment of
goodwill between franchisor and franchisee. In addition, the leasing of property gives
rise to important sources456 of goodwill for lessees. For example, the leasing of real
property such as business premises provides the traditional source of site goodwill,457
an aspect of goodwill which gives rise to tax questions involving capital gains and
stamp duties in particular.
This chapter examines the authorities concerning the nature and treatment of goodwill
in the context of licensing, leasing and franchising. The licensing and leasing of
business assets in general, and in relation to franchising in particular, are examined
throughout this chapter to determine how the goodwill of a business is understood and
treated, both at the start of a business and at its termination. At the outset, in para. 8.2,
the relevant meaning and nature of goodwill are discussed as a basis for the
examination and analysis undertaken in this chapter. Then, in para. 8.3, the
relationship between goodwill and licences is examined, with a particular focus on
hotel licences which have generated significant issues in this area. Paragraph 8.4
addresses the popular business form of franchising, involving both licensing and
leasing arrangements. Paragraph 8.5 considers what happens to goodwill on the
termination of a franchise agreement. In para. 8.6 the question of whether it is possible
to license or lease goodwill as a distinct subject separate from other related assets is
specifically considered. The nature of goodwill as an integral part of a business
incapable of an independent existence appears to preclude it from being the subject of
456 The High Court of Australia in FCT v. Murry (1998) 98 ATC 4585; 193 CLR 605; 39 ATR 129 identified goodwill as having sources, being other property and attributes of a business which generate the goodwill. This matter is addressed in this chapter. 457 Site goodwill has been identified as an aspect of goodwill, based on the site or location of the business as a source, in a number of cases. For example, see FCT v. Krakos Investments Pty Ltd (1995) 32 ATR 7; 61 FCR 489; 96 ATC 4063 (FFC).
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a license or lease agreement separate from a business. Finally, in para. 8.7
consideration is given to capital gains tax and stamp duties questions concerning
licensing and leasing arrangements. Goodwill as property and an important business
asset is potentially the subject of both of these tax regimes.
8.2 The meaning and nature of goodwill
As indicated in various parts of this paper, goodwill has been, and remains, a much
misunderstood concept. This misunderstanding has led to confused analyses and a
lack of clarity in the treatment of goodwill in a range of legal contexts. An
understanding of the legal nature of goodwill, therefore, is necessary for an
examination and analysis of its place in the context of licensing, leasing and
franchising. The leading authority on the legal meaning of goodwill, referred to in
various parts of this paper, is the case of FCT v. Murry458 where the High Court held
goodwill to be one whole item of personal property, separate from its sources, but
attached inseparably to the business. In arriving at this view of goodwill, the High
Court essentially followed a settled line of authority dating back to the beginning of
the twentieth century in the House of Lords’ case of CIR v. Muller & Co’s Margarine
Limited459 where Lord Macnaghten provided the classic definition of goodwill as: ‘…
the benefit and advantage of the good name, reputation, and connection of a business.
It is the attractive force which brings in custom’.460 In considering its nature, the
Lord’s view of goodwill was that it was one whole item of property, while consisting
of elements, and one which could not exist by itself but had to be attached to a
business. Lord Macnaghten went on to state that goodwill was composed of elements
which may vary from business to business. Lord Lindley, in the same case, identified
some of these elements as ‘situation, name and reputation, connection, introduction to
old customers, and agreed absence from competition’.461
However, the High Court in Murry made a significant contribution to the
jurisprudence on goodwill in identifying clearly that, rather than consisting of
elements as such, goodwill was generated by sources within the business. That is, it
458 (1998) 98 ATC 4585; 193 CLR 605; 39 ATR 129. 459 [1901] AC 217. 460 Id at 223. 461 Id at 235.
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identified the so-called elements of goodwill as in fact the sources of goodwill.462
Accordingly, the High Court provided a clearer conception of the nature of goodwill
and posited it more accurately and clearly as a separate item of property in the
business, while still being inseparable from the business itself. In this regard, the High
Court said: ‘Goodwill is inseparable from the conduct of the business. It may derive
from identifiable assets of a business, but it is an indivisible item of property, and it is
an asset that is legally distinct from the sources – including other assets of the
business – that have created the goodwill. Because that is so, goodwill does not inhere
in the identifiable assets of the business … .’463Thus the High Court made it clear that
goodwill is distinctly separate from other property of the business which might
constitute its sources. These sources, the High Court noted, need not be confined to
property of the business, but may also include non-proprietary components such as
‘manufacturing and distribution techniques, the efficient use of the assets of the
business, superior management practices and good industrial relations with
employees’.464
This concept of goodwill – as one indivisible item of personal property, separate from
its sources, but attached inseparably to the business – is important in the examination
and analyses which follow.
8.3 Goodwill and Licences
8.3.1 Licences in general
Many businesses require licences, whether statutory or otherwise, in order to operate.
Licences, therefore, are a species of property critical to those businesses and hence
may be an important source of goodwill also. As Mason J observed in Appleby v.
Attard: ‘[a]n agreement to sell the goodwill of a business will in general import an
obligation to assign to the buyer any existing licence relating to the business held by
the vendor’.465 In view of the attachment of goodwill to the business, the business
itself must be sold to sell the goodwill.466 It follows, moreover, that necessary licences
462 See (1998) 98 ATC 4585 at 4591; 193 CLR 605 at 615-6 for the High Court’s deliberations on the ‘elements’ of goodwill as more accurately constituting sources of goodwill. 463 (1998) 98 ATC 4585 at 4587. 464 Id at 4591. 465 (1974) 48 ALJR 430 at 431 (HCA). 466 Goodwill cannot be assigned in gross because it must be attached to a business: see, for example, FCT v. Murry (1998) 98 ATC 4585, Geraghty v. Minter (1979) 142 CLR 177, and CIR v. Muller &
Co’s Margarine Limited [1901] AC 217.
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must usually be assigned or re-issued to the purchaser in the sale of the business. As
such, a generally close relationship between these licences and the goodwill may be
found.467 Hill J, for example, noted in FCT v. Krakos Investments Pty Ltd that licences
may be the source of ‘monopoly’ goodwill.468 However, whether any business licence
might be a source of goodwill would be a question of fact in any particular case. For
instance, in FCT v. Murry the High Court expressed the view that a taxi licence was
not a source of goodwill because it did not attract the custom to the taxi; rather, it was
the ‘get-up’ of the taxi vehicle which attracted the custom.469 Thus, while the taxi
licence was a necessary requirement to conduct the business, it did not of itself attract
business. Nonetheless, it is clear that licences may be recognised as a source of
goodwill in appropriate cases, particularly where they confer monopoly status on the
business. In Box v. FCT,470 for instance, the appellant’s monopoly and goodwill arose
from a statutory licence to conduct a bakery in a designated zone.471
8.3.2 Hotel licences
Apt examples of the relationship between goodwill and licences may be found in the
hotel industry. Hotels have particular licensing requirements which have given rise to
a range of issues concerning licences and goodwill extending back to cases in the
nineteenth century. These issues typically involve questions concerning the sources of
goodwill in a hotel business, such as whether the licence is the source or whether it is
some other aspect of the business like its location or the qualities of its staff. These
questions go to the heart of the legal concept of goodwill, turning on the relationship
between various sources of goodwill, including the licence, and the relationship of
goodwill to the business itself.
467 Such a close relationship between licences necessary to conduct a business and goodwill was recognised in Duncan v. Ridd [1976] 2 NSWLR 105 per Yeldham J. 468 In respect of monopoly goodwill, Hill J said (96 ATC 4063 at 4070): ‘where a statutory licence or monopoly has been conferred, that licence may come to have attached to it a type of goodwill, in a sense that it is the holding of the licence which attracts custom.’ 469 See FCT v. Murry (1998) 98 ATC 4585 at 4598. However, by way of contrast, Kirby J in dissent found the taxi licence to be fundamentally important to the taxi business and its goodwill, holding that ‘the statutory licence … is the sine qua non of the business’s goodwill’ (at 4601). 470 (1952) 86 CLR 387. 471 In a manner somewhat similar to licences, agencies also may give rise to goodwill in that they confer certain business advantages such as absence from competition in a defined area. For example, in Phillips v. FCT (1947) 75 CLR 332 the taxpayer held a newspaper agency which he sold. The court found that in this case the source of the newsagency’s goodwill was the agency agreement, rather than the premises as contended by the Commissioner.
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Some of the confusion and misunderstanding of the concept of goodwill may arguably
be attributed to the treatment of goodwill in the context of hotel businesses. Cases
may be found which attach goodwill to licences, to premises, or to other property or
attributes of the businesses.472 However, these cases run counter to the now settled
jurisprudence on goodwill which holds that it is one whole item of property, separate
from other property, and attached to the business itself, rather than to other property of
the business. Nonetheless, the idea that goodwill may be attached to other property or
aspects of the business which may be its source has persisted. For example, in spite of
Murry’s case, the Australian Taxation Office has persisted in its view that so-called
personal goodwill (where a person is its source) cannot be transferred with the
business because it is considered to be attached to the person, in effect.473 The flaw in
this view is that it overlooks the concept of goodwill as one whole item of property,
independent of its sources, and one which is attached to the business.
Hill J recognised the particular nature of hotel licensing in observing in FCT v. Krakos
Investments Pty Ltd that ‘[t]here is a tendency in many of the cases to treat the
goodwill of a public house as requiring the application of principles different from
those applicable to other businesses’.474 Then Hill J went straight on to say that he did
not think this was a correct approach. However, the particular nature of hotel
businesses, with strict licensing requirements relating to both the licensee and the
premises, has contributed a great number of cases concerning the issue of goodwill, as
noted above. Hill J in fact recognised this aspect in stating:
The goodwill of a public house is like other businesses in part referable to locality, in
part to the way in which the business is conducted, in part to the personality of the
publican and, perhaps, in part by the name of the public house to which some reputation
may attach … . What makes the situation of a public house unique is the system of
licensing applicable to the sale of liquor.475
472 Some of these cases are noted in this chapter: see England v. Downs (1842) 6 Beav 26, 49 ER 829; Rutter v. Daniel(1882) 30 WR 724; Booth v. Curtis(1869) 17 WR 393; and Anthoness v.
Anderson(1888) 14 VLR 127. 473 See Taxation Ruling TR 1999/16 and Goods and Services Tax Ruling GSTR 2002/5. A similar view is espoused by Her Majesty’s Revenue and Customs in the UK in its Stamp Duty Land Tax Manual and Capital Gains Manual: see Tregoning, I., ‘Goodwill and the Stamp Duty Land Tax’ [2007] (5) British
Tax Review 648. 474 96 ATC 4063 at 4070. 475 Id at 4071.
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The hotel licence itself has been held to be the major source of the goodwill in a
number of cases of early vintage. Thus in the 1842 case of England v. Downs476 Lord
Langdale MR held that the goodwill of a hotel business was incidental to the licence
rather than the premises, and thus passed with the licence (as the major source of the
goodwill in modern terms). A similar conclusion was reached in the later case of
Rutter v. Daniel.477 In contrast to those cases where the licence was held to be the
major source of the goodwill, there may be found other cases where the goodwill was
sourced in the premises, as effectively site goodwill. Such a case was Booth v.
Curtis478where the court held that the goodwill of a hotel could not be separated from
the fee simple interest in the premises. However, this was a Chancery case concerning
an intestacy where it is possible, from what may be gleaned from a very limited
report, that the Vice-Chancellor reached this conclusion in order to deliver an
equitable result for the petitioner, the widow of the intestate.479
The colonial Victorian case of Anthoness v. Anderson480 provided what might be
termed a hybrid position on goodwill in a hotel. While one judge, Higinbotham CJ,
stated that the goodwill was dependent on occupation of the premises, his fellow
judge, Holroyd J, saw the goodwill as having its sources in both the licence and the
premises, stating:
The right to have the licence … was part of the goodwill. The two things went together,
and although the licence could be assigned at law, it was so attached to the premise, and
so considered as part of the goodwill, that it was inseparable from it… .481
The result was, according to Holroyd J, that on resumption of the premises the
landlord owned the goodwill. This view is strictly incorrect, of course, because
goodwill is attached to a business rather than to premises. Nonetheless, it would seem
to reflect the unique nature of liquor licensing, noted by Hill J in Krakos Investments
476 (1842) 6 Beav 269; 49 ER 829. England v. Downs was an early case where the observation was made that the licence needed for a publican’s trade created some differences between the goodwill of a hotel and that of other businesses. It also saw the Master of the Rolls reflecting on the difficulty of defining goodwill, a difficulty which has continued to this day. 477 (1882) 30 WR 724. 478 (1869) 17 WR 393. 479 The petitioner had claimed that the price given for the lease at the auction of the hotel was in fact consideration for the goodwill which, as personal estate, was divisible as such and accordingly she was entitled to a share. 480 (1888) 14 VLR 127 (Full Court of the Victorian Supreme Court). 481 Id at 145.
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above, where typically the licence is granted in effect to both the person and the
premises. As Hill J observed in relation to South Australia, ‘licences to sell alcohol are
limited both to the person licensed and the premises licensed.’482
In Krakos Investments Hill J made the observation that ‘some cases … may suggest
there is a universal principle of law that the goodwill of a public house, in the sense of
goodwill in all its aspects, must always pass with the house’.483 However, the above
early cases of England v. Downs and Rutter v. Daniel, for example, suggest rather that
the goodwill was attached to the licence. And Hill J himself also rebutted that
suggestion in recognizing that there were other cases pointing in different directions
and cited Knox CJ in Daniel v. FCT484 as taking the correct position that whether the
goodwill of a public house in all its elements attaches to the land is a question of fact
to be determined in each case. This seems a reasonable general position, as the sources
of goodwill are essentially factual questions which may vary from business to
business. However, as the High Court inMurry reminds us, it is not entirely correct to
speak of goodwill as having aspects or elements. Rather, goodwill is an indivisible
whole which is inseparable from the business. It does, however, have sources which
may include premises and licences in appropriate cases.
While it is convenient and useful to view and label goodwill in accordance with its
major sources – such as site goodwill, name goodwill, personal goodwill and
monopoly goodwill485 – the goodwill attached to any business remains one whole item
of property at law, as well as one asset for accounting. Moreover, the sources of
goodwill may often be much broader than the four major sources cited above. For
example, highly motivated staff and good customer relations would be obvious
contributors to goodwill. Thus there may be a range of sources of goodwill and these
may vary from business to business.486
482 96 ATC 4063 at 4072. The relevant legislation in South Australia at the time was the Liquor
Licensing Act 1985 (SA). 483 96 ATC 4063 at 4071. 484 (1928) 42 CLR 296. 485 These elements of goodwill based on these major sources are surveyed in FCT v. Krakos
Investments Pty Ltd(1995) 96 ATC 4063; 32 ATR 7; 61 FCR 489. 486 In West London Syndicate Limited v. CIR[1898] 2 QB 579 (CA),for instance, Rigby LJ noted that the goodwill of the hotel in that case arose in large part from its name and from personal connections of the vendor. He saw these sources as more important than the leasehold of the hotel and in fact gave no credit at all to the hotel licence as a source.
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There are many goodwill cases concerning hotels, resulting in part at least from the
particular licensing requirements attached to such businesses, as noted by Hill J in
Krakos Investments. The liquor licence may be identified as a key source of goodwill
in a typical hotel business, because without the licence there could be no business (or
at least not a legal business). To the extent that the premises are also considered to be
a source of the goodwill of an hotel, the licence issued in respect of those premises
will still be, in effect, the key source. However, these cases indicate, consistent with
business more broadly, that the sources of goodwill are multiple and vary in nature
and impact from business to business, notwithstanding the important part the licence
necessarily plays. The key point to remember is that, regardless of its sources,
goodwill is not attached to any of the other property of the business individually, but
rather to the business itself.
8.4 Franchising
Franchising has a long history dating back some centuries.487 In modern times it has
developed into a very significant means of conducting and expanding business
operations, having become prevalent in Australia and other developed countries. The
Franchising Task Force Final Report noted that ‘franchising represents one of the
most important marketing techniques for the distribution of goods and services in
Australia now and in the future and its methodology will appeal to many more
industry sectors in the future.’488 The Corporations Act 2001 (Cth), s. 9, defines a
franchise as ‘an arrangement under which a person earns profits or income by
exploiting a right, conferred by the owner of the right, to use a trade mark or design or
other intellectual property or the goodwill attached to it in connection with the supply
487 Williamson claims that franchising began in feudal times when lords of the manor granted use of their agricultural land to their serfs for a share of the produce. Australia’s first franchise, he further claims, came about when Governor Macquarie of the Colony of New South Wales granted the right to sell rum to a builder in return for providing the materials and labour to build the colony’s first hospital. (Williamson, G. 1999, Franchising in Australia, 3rd ed., Allen & Unwin, St Leonards NSW.) Shannon notes that to franchise means to grant a freedom to do or use something in a certain place, and that the concept of a franchise has existed in English common law for several centuries. (Shannon D. 1982, Franchising in Australia, The Law Book Company Limited, Sydney.) 488 The Franchising Task Force Final Report (Better Printing Service, Queanbeyan NSW, December 1991) at vi. The Supplement to this report, Franchising – Australia and Abroad, March 1992, reveals that franchising is used extensively in the USA. See also Terry, A., ‘The E-business Challenge to Franchising’ (2002) 30 Australian Business Law Review 227 for the importance and development of franchising, particularly from the mid-twentieth century. For a concise overview of franchising, see Paterson, J., ‘Good faith in Commercial Contracts? A Franchising Case Study’ (2001) 29 Australian
Business Law Review 270 and Andary, R. and Butler, M., ‘Franchise Fixings Part 1: Structures and Fees’ (1996) 31(6) Taxation in Australia 300.
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of goods or services.’489 The Franchising Task Force Final Report at 3-4 reported that
franchises have the following characteristics:
• An arrangement between a franchisor who grants to a franchisee rights to the
use of a trade mark (whether registered or unregistered) or name to be used in
connection with sale and or distribution of goods or services.
• The business of the franchisor is substantially identified by the public as being
associated with the above name or mark.
• The franchisee is required to conduct the business, or that part of the business
subject to the franchise agreement, in accordance with the marketing, business
or technical plan or system specified by the franchisor.
• The franchisor provides on-going marketing, business or technical assistance
during the life of the franchise agreement.
In addition, it reported that many, but not all, franchise systems also have the
following components:
• The franchisee is required to pay the franchisor an initial franchise fee and/or
an ongoing royalty or service fee which is normally a percentage of gross
sales or a fixed amount.
• The franchisee may be required to purchase specified product from the
franchisor.
• The franchise agreement has a fixed term, generally with an option to renew,
with such option being able to be exercised by the franchisee upon certain
terms and conditions.
The nature of franchising, typically comprising licensing and leasing arrangements,
has given rise to a number of issues concerning the recognition and treatment of the
489 However, the rights conferred on the franchisee do not have goodwill attached to them in modern terms; rather, these rights may be seen as the sources of the franchisee’s business goodwill, as discussed in this chapter.
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goodwill in franchised businesses.490 A prime example is the case of McDonald’s
Australia Holdings Ltd v. CSR (Qld)491which raises several interesting issues
concerning the nature and treatment of goodwill in a franchised business and
accordingly warrants a detailed examination. This case concerned the application of
stamp duty to an arrangement involving fundamentally the extinguishment of licences
relating to two franchise businesses. The question was whether there was a dutiable
conveyance of goodwill in the businesses on the extinction of these licences. There
were two applicants involved in the action. The first applicant held rights under
licence from McDonalds Corporation in the USA to use the ‘McDonald’s System’ in
restaurants in Australia. As a consequence of holding this licence, the first applicant
undertook its business activities in two ways. First, it operated a large number of
restaurants which were owned or leased by the second applicant in this action.
Secondly, it licensed others to conduct restaurants in premises leased from the second
applicant. In this case, the first applicant had granted licences to two companies
owned by the same person to conduct two McDonald’s restaurants. After some years
of operation, the owner of these companies wished to terminate these two businesses.
To give effect to this, two deeds were entered into by the first applicant, the second
applicant, the two licensee companies and their owner. One was a ‘deed of
termination’ which terminated the leases of the restaurants before the expiration of
their terms and also transferred the plant and equipment and stock in trade to the first
applicant at agreed values. The other was a ‘deed of extinguishment of rights’ which
cancelled the licences which had been granted to the companies by the first applicant.
Consideration totalling $2.6m. was paid by the first applicant to the licensees for
giving up their rights under the licences. The first applicant took over the operation of
both restaurants.
Both deeds were lodged with the respondent Commissioner of State Revenue with a
submission that no duty was payable. However, the Commissioner required the
lodgment of a statement, a ‘form S(a)’, pursuant to s. 54A of the Stamp Act 1894
490 For example, see Saltzman, D. and Klaric, K., ‘Franchising – whose goodwill?’ (1991) 65Law
Institute Journal 81, Cooper, T., ‘Business franchises: Capital Gains Aspects’ (1994) 2(5) Taxation in
Australia Red Edition 288, and Andary, R. and Butler, M., ‘Franchise Fixings Part 2: Goodwill and Compliance’ (1997) 31(7) Taxation in Australia 355. These articles contain interesting discussion on the nature of goodwill, its ownership under franchising, and certain taxation issues. However, they suffer somewhat from being written before the High Court judgment in FCT v. Murry (1998) 98 ATC 4585 and contain some propositions which now cannot be supported in the light of that case. 491 (2004) 2004 ATC 4970.
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(Qld) to enable the assessment of stamp duty. Section 54A applied to an acquisition
of, or an agreement to acquire, a business and deemed the inclusion of all goods, other
movable chattels, all licences and goodwill in the acquisition. The statement was to be
charged with duty as a conveyance or transfer of property under the Act. The
Commissioner had treated the consideration paid to the licensees under the deed of
extinguishment as payment for the goodwill of the businesses operated by the
licensees. On application to the court, the essential question came down to whether a
business had been acquired in terms of s. 54A. As Chesterman J said:
Most of the evidence explored at the trial was concerned with whether or not the
licensees had any goodwill in the restaurant businesses, and the nature of that goodwill,
in particular, whether it could be the subject of transfer for consideration.
…
If the licensees had no goodwill in their restaurants, or if there was no goodwill of a
kind which could be transferred to, or acquired by the applicants, the … assessment
made on it could not stand.492
Then Chesterman J, having noted the High Court’s view in Murry that goodwill is the
legal right or privilege to conduct a business and that it is inseparable from the
business, stated that ‘the sale of an asset or assets of the business does not transfer
goodwill unless the sale of the assets is accompanied by or carries with it the right to
conduct the business’.493 In practical terms, Chesterman J opined, the transfer of the
licensees’ businesses required the transfer of the licences as the ‘essential ingredient’.
However, he found that the deed of extinguishment did not transfer the licenses but
simply cancelled them. Moreover, the first applicant did not need these licences
because it already held a licence to conduct McDonald’s restaurants from the
company in the USA. In these circumstances, Chesterman J decided that there could
not have been the transfer of a business as required by s. 54A.
The Commissioner had labelled the consideration paid to the licensees for the
cancellation of the licences as payment for the goodwill of the businesses. Thus, on
this view, the deed of extinguishment taken together with the deed of termination
492 Id at 4979-80. 493 Id at 4980.
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which transferred other tangible assets constituted the transfer of a business. However,
on a strict legal interpretation of the deed of extinguishment, Chesterman J would
seem to be correct because the deed did cancel, rather than transfer, the licenses.
Without the transfer of those essential licences, it may be arguable that there could not
be the transfer of a business and its accompanying goodwill on this strict
interpretation.
Nonetheless, from a practical viewpoint, it is difficult to see this arrangement as other
than the transfer of the businesses. The licensees had conducted restaurant businesses
and then effectively transferred them to the first applicant which conducted them in
the same premises, with the same plant and equipment, and even with the same
employees. The deeds had effected the transfer of the necessary assets and had also
effected the transfer of existing employees to the new owner. As Chesterman J in fact
noted, ‘[t]he businesses operated without interruption prior to and following the
handover date’.494 It is submitted that a business may be transferred even where an
‘essential’ item of property is not also transferred because the new owner already
holds that form of property. This was the situation in this case where the first applicant
already held the necessary licences. Thus it may be argued that businesses were
indeed transferred in satisfaction of s. 54A.
The question would remain, however, whether any goodwill were transferred in such a
situation. In view of the legal concept of goodwill as that ‘attractive force which
brings in custom,’495 any business may have some goodwill.496 And typically goodwill
may have a number of sources such as monopoly licences, the site of the business,
trademarks, brands, get-up, and good customer relations. Chesterman J’s view was
that any goodwill in these restaurants arose from the licensed ‘McDonald’s System’
and in effect disappeared with the cancellation of the licences. Chesterman J formed
the opinion that it was not therefore necessary to decide whether the licensees had any
goodwill capable of transfer because he apparently saw the goodwill as residing with
the first applicant which held the licence for the ‘McDonald’s System’. This system
494 Id at 4979. 495 Per Lord Macnaghten in CIR v.Muller & Co’s Margarine Limited [1901] AC 217 at 224. This view was cited with approval by the majority of the High Court in FCT v. Murry (1998) 98 ATC 4585 at 4590. 496 The proposition that a business may have legal goodwill even where it is unprofitable is supported by the High Court in FCT v. Murry (1998) 98 ATC 4585 at 4595.
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involving trademarks, trade names and service names generated the goodwill in the
restaurants, in his opinion. But, counter to that view, there is the well-established view
that the sale or transfer of a business means the sale or transfer of goodwill, without
even the need to mention goodwill in the agreement.497 On this view, there would
have been goodwill in the licensees’ businesses in this case. Goodwill would arise, for
example, from the name, the location and the geographical monopoly afforded the
licensee by holding the licence to operate the restaurant. The real question would be
the value of the goodwill, rather than its existence. Should it have been the amount
paid for the cancellation of the licences, as contended by the Commissioner, or some
other amount?
In a case like McDonald’s the transfer of a business should be expected to take with it
the goodwill of that business built up during the time it was operated by the
franchisee. If the business is capable of being transferred as a going concern, then the
goodwill of necessity will be transferred with it. This would be the case even though
the licences did not need to be transferred.
While not a franchise arrangement, a somewhat similar issue concerning the
relationship of licences and goodwill arose in Eastern National Omnibus Company
Limited v. Commissioner of Inland Revenue.498 This case involved the sale of a public
bus business to the appellant. The sale agreement included land, buses, stocks of fuel
and certain covenants binding the vendor not to compete with the appellant. On the
face of it and as contended by the appellant, the sale did not include any property such
as goodwill subject to ad valorem stamp duty.499 The critical part of the appellant’s
contention that there was no goodwill turned on the need for the road traffic authority
to grant licences to operate the buses to the appellants in place of the vendor. As these
licences were not transferable by the appellant to the vendor but granted anew at the
absolute discretion of this authority, the appellant argued that no goodwill could be
transferred under the sale agreement. On the other side, the Commissioner argued that
497 See Shipwright v. Clements (1871) 19 WR 599 where Malins V-C stated (at 600): ‘The sale of a business is the sale of goodwill. It is not necessary that the word “goodwill” should be mentioned’. Furthermore, in Ex parte Punnett, In re Kitchen (1880) 16 Ch D 226, the sale of a hotel included the sale of the goodwill even though the sale contract did not refer to goodwill. This latter case was mentioned with approval by the High Court in FCT v. Murry (1998) 98 ATC 4585 at 4592. 498 [1939] 1 KB 161. 499 Stamp Act 1891 (UK). Subsection 59(1) of that Act imposed ad valorem duty on property generally, but excepted inter alia certain property including land, business wares and merchandise. Goodwill, however, was not excepted.
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the sale included goodwill, which was a form of property not exempted from ad
valorem duty under the relevant provision. The essence of the Commissioner’s
argument was that the sale agreement transferred a business which necessarily meant
that the goodwill which the vendor had previously enjoyed must be included. The
court found for the Commissioner in deciding that the sale must include some
goodwill and that part of the consideration attributed to the restrictive covenants must
be applicable to that goodwill. The need for the granting of new licences did not
persuade the court that no goodwill was transferred. Therefore, while a licence might
be an essential element of a business, issues concerning its transfer do not necessarily
militate against the presence of goodwill in the business.
The question of the existence of goodwill in a franchise arose in Parnell v.
CST(WA)500where the appellant was a partner in a partnership operating a business of
farm machinery dealers and fuel agents. The appellant’s husband, another partner, had
died and the Commissioner had endeavoured to assess the deceased’s interest in the
goodwill of the partnership for death duty. The appellant, as executor of her husband’s
estate, had objected on the grounds that the partnership had no goodwill. The court
found that the partnership derived most of its business and hence its goodwill from the
three franchised machinery dealerships that it held. It further found that the
franchisors would have been very unlikely to transfer the dealerships to any purchaser
of the partnership business. Accordingly, the court held that any purchaser of the
business would not have been prepared to pay anything for goodwill and upheld the
appeal. Moreover, without the dealerships, the partnership would not have had much
of a business to sell. In effect, it would probably have meant the termination of the
business, a particular issue with franchises, it would seem, and a matter dealt with in
the next section. While, as a going concern, the partnership business had goodwill, it
was not a ‘saleable asset’ where there was effectively no business to sell and therefore
it did not meet the test of goodwill as set down by the court.501 Whether this should
have been the test for the application of the then applicable Death Duty Assessment
Act 1973-1974 (WA) is another matter, however. As a general principle, where a
500 (1979) 79 ATC 4286; 9 ATR 811 (SC of WA). 501 The court said (per Jones J): ‘A business proprietor who has ‘know-how’ and ability, and the personality to attract and hold customers, no doubt may be said to possess those customers’ goodwill. This will certainly be of value to him, and just as certainly will increase his profits; but it does not thereby become, for the purpose of commercial law, “goodwill”. It is not a saleable asset. That is the test’ ((1979) 9 ATR 811 at 813).
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partner dies his estate is entitled to a share of the partnership’s goodwill as valued at
the time, unless there is agreement to the contrary. The partnership business does not
have to be sold to realize the goodwill in this type of situation.502 As a going concern,
a business will have goodwill, which may be quite valuable if the business is
successful.
The nature of goodwill transferred under a franchising arrangement came under
consideration in CSD(NSW) v. JV (Crows Nest) Pty Limited.503 McHugh JA saw the
provision to the franchisee of knowledge about the business, including programs,
systems and techniques, as partof the goodwill of the business. In the light of Murry,
issue must be taken with seeing non-proprietary sources of goodwill (that is,
knowledge or ‘know-how’) as part of goodwill, at least in a legal sense.504 Moreover,
it was implied in McHugh JA’s judgment that the goodwill of the franchised business
was transferred to the franchisee as an integral part of that business. However, as
discussed elsewhere in this chapter, this would not be possible in a new franchise.
Instead, the provision of the ‘know-how’, inter alia, would constitute the sources of
the goodwill which would arise in the new franchised business
In summary, the essence of franchising is the licensing and leasing as appropriate of
necessary property and non-proprietary elements of the business to the franchisee to
enable him to conduct the business. In the case of a new franchise, goodwill will not
be licensed to the franchisee; the goodwill of the franchised business will arise on the
commencement of this business.505 The goodwill attached to the business of the
franchisor, on the other hand, remains with that business; the franchisor’s goodwill is
not licensed to the franchisee.506 The franchisee’s goodwill is not the goodwill the
502 Partnership law requires a proper accounting to all partners for all assets, including goodwill, on the termination of the partnership: see Re David and Matthews [1899] 1 Ch 378, McFadden v. CSD (NSW)
(1979) 10 ATR 67; (1980) 80 ATC 434 (NSW CA), and Chia v. Ireland [2000] SASC 47. 503 (1986) 86 ATC 4741; 17 ATR 1086 (NSW CA). 504 For accounting purposes, items of ‘know-how’ would constitute unidentifiable assets which would be taken up under the umbrella of goodwill. Accounting Standard AASB 3, Business Combinations, defines goodwill as the future economic benefits arising from assets that are not capable of being individually identified and separately recognised. See AASB 3, Appendix A, Defined Terms. However, the focus of this chapter is on the legal concept of goodwill rather than the accounting concept. 505 The Australian Taxation Office takes the view that goodwill is acquired at the time of commencement of a new business: see Taxation Ruling IT 2328, para. 2. 506 This position is supported in Zeekap (No 56) Pty Ltd v. CSD(Tas) (1999) 99 ATC 4745 at 4747; 42 ATR 295 at 297 (Full Supreme Court of Tasmania) where Wright J said: ‘The person who gives a lease of personal or real property to another may himself be conducting a business which involves, as part of its activity, the leasing of property, but he is not ipso facto conducting the business which is operated with the use of the leased property by the lessee. Merely because some residual value may accrue to
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franchisor holds in his own franchising business as such – he would retain that – but
instead is the goodwill of the franchised business itself sourced in the systems, know-
how, get-up, brand names, logos, and the like, which are subject of the agreement.
One author507 refers to franchising as involving the franchisee in ‘sharing’ in the
goodwill established by the franchisor. While that is a reasonable view in a practical
sense, it is not strictly correct at law. Rather, the franchisee is licensed to use rights
owned by the franchisor to create his own goodwill. This goodwill would be sold if
the franchisee were able to sell the business, or may be compensated by agreement on
termination of the franchise. However, on termination rather than sale, the goodwill of
the franchised business would disappear with that business unless the business were
continued by the franchisor or sold by him, as discussed below.
8.5 Goodwill on termination of a franchise agreement
According to the Full Federal Court in Ranoa Pty Ltd v. BP Oil Distribution Ltd508 the
general law position is that ‘the benefit of goodwill built up by reason of a tenant
carrying on business from leased premises enures to the benefit of the landlord at the
expiration of the term’.509 This, the Court indicated on the authority of Llewellyn v.
Rutherford510, is the position unless there is an express stipulation to the contrary in
the agreement. Thus in the absence of such an agreement, or an applicable statute to
that effect, the landlord or lessor takes any benefit supposedly in the form of goodwill
attached to the premises (that is, site goodwill) in accordance with this authority.
In Ranoa the appellant had been the franchisee of a service station. The respondent
had leased the service station premises to the appellant and had also granted a
franchise to the appellant under a dealer trading agreement to operate the business of a
service station.511 After several renewals of the lease, the respondent gave notice that
it did not intend to renew the current lease, thus terminating the franchise. The
appellant consequently took action to claim compensation provided for under
him if the second man’s business ceases and the use and enjoyment of the property reverts to the owner, does not alter the position.’ 507 Shannon, D. 1982, Franchising in Australia, The Law Book Company Limited, Sydney, 16. 508 (1989) 91 ALR 251. (The Court comprised Lockhart, Wilcox and Gummow JJ.) 509 Id at 256. 510 (1875) LR 10 CP 456. 511 Later the respondent in fact assigned the dealer trading agreement to a second respondent, while the first respondent remained the lessor of the service station premises. However, this is not material to this analysis and therefore only one respondent is referred to.
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legislation concerning the acquisition of property otherwise than on just terms.512 The
question for the Court was, in effect, whether the respondent had acquired property in
the form of ‘some species of goodwill’ from the appellant on unjust terms such that
the respondent had an obligation to pay compensation to the appellant pursuant to this
legislation. Having stated the general position at law, as noted above, the Court then
considered the application of the legislation. It found that the legislation did not apply
in this particular case where the respondent was within its statutory rights not to renew
the lease and dismissed the appeal accordingly.
However, the joint judgment in Ranoa revealed a certain view of goodwill in the
context of franchises and of leases more generally. The question the judges were
required to consider concerned the nature of the property supposedly acquired
otherwise than on just terms. The question as formulated for their deliberation
assumed that the property constituted ‘some species of goodwill’.513 The general law
position, as stated above, was that the benefit of goodwill built up by a tenant or lessee
reverted to the landlord or lessor on termination of the lease. Such a position assumed
that the goodwill was site goodwill, arising from the benefit to the business of its
location rather than from any other source such as the person of the lessee for
example. However, as the High Court stated in Murry, goodwill as a matter of law is
one whole item of property, regardless of its sources, and is inseparable from the
business to which it attaches. Consequently, it cannot be correct at law to say that
goodwill enures to the lessor on termination of a lease. The goodwill is an inseparable
part of the business which has been conducted on the leased premises; it is not
therefore capable of transfer to the lessor at the termination of the lease unless the
business is also transferred. Nonetheless, it may still be reasonable to say that the
benefit of the goodwill passes to the lessor in the sense that he may have a more
desirable and valuable property as a consequence of a successful business having been
conducted on it. Accordingly, it could reasonably be expected that the lessor could
command a premium or higher rent, or both, under a new lease.514 But such a benefit
could not be said to be ‘some species of goodwill’, or other form of property for that
512 Section 23 of the Petroleum Retail Marketing Franchise Act1980 (Cth). 513 See (1989) 91 ALR 251 at 252 for the question. 514 The majority of the High Court in Murry addressed this type of point in stating: ‘If the lease expires and is not renewed and the business ceases to exist, the goodwill comes to an end. A new lease to a person commencing a … business from the premises may command a premium, but no part of the premium is paid for goodwill’ ((1998) 98 ATC 4585 at 4597).
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matter, in terms of the question before the Federal Court in Ranoa. Therefore, on this
basis, it is doubtful that the legislation in question could have provided any
compensation to the franchisee because nothing in the form of property would have
been acquired on the termination of the lease and the franchise agreement.
The original position concerning the treatment of goodwill on the termination of a
lease in Llewellyn v. Rutherford was founded on the reasonable principle that the
lessee should be able to contract to be paid the value the goodwill built up in his
business on the termination, given that he had not been able to realize that goodwill on
the sale of the business. Llewellyn v. Rutherford applies to the situation where the
lessee loses his business on termination of the lease and hence loses his goodwill,
notwithstanding being able to sell other assets of the business. In such a situation it is
reasonable to agree that compensation for this loss be paid, particularly where the
lessor had a more valuable property as a result. However, it must be noted that at
common law such protection must be specifically agreed in the lease, as there is no
protection otherwise.
8.6 Can goodwill be licensed or leased?
In a summary of McDonald’s Australia Holdings by McMahon and MacIntyre515 the
editors appended a comment that the source of the goodwill constituted the rights held
by the first applicant.516 While it is not clear from his judgment that this is what
Chesterman J really intended to say, it raises the question of whether goodwill can be
licensed because this is the situation suggested by this editorial comment. That is, this
interpretation would suggest that there was only one goodwill involved in the
licensing arrangement and that was owned by the first applicant which effectively did
no more than license it to the licensees by means of the licence agreements. This is the
basis of their conclusion that the goodwill remained with the first applicant. However,
any business may have goodwill in a legal sense. The indivisible nature of goodwill as
espoused in Murry relates to its relationship with the particular business to which it
attaches. Murry does not support a proposition that where the licensor has goodwill
the licensee is precluded from also having goodwill in its own business (which arises
515 McMahon, P. and MacIntyre, A., ‘No goodwill transfer on extinguishment of a franchise’ (2004) 13 Duties Law in Focus 4. 516 In this comment, the editors had previously stated (at 5): ‘If goodwill were understood as one asset that is indivisible (FCT v. Murry 98 ATC 4585), then it is difficult to see how any separate goodwill could have vested in the licensee in the first place.’
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from the rights conferred under the licence). To the contrary, each business will have
its own goodwill attached to it.
At a Taxation Institute of Australia convention, David Cominos raised the issue of
‘leasing’ goodwill which in effect may be taken as the same as licensing it in this
context.517 He said:
In recent years, there have been suggestions that it may be possible to ‘lease’ goodwill
in much the same way as one might lease real property or a chattel (and in contexts
going well beyond a lease of real property to which ‘local goodwill’ might be said to
attach). One of the advantages suggested for this course is that the lessor might thereby
preserve any pre-CGT status of the goodwill … or avoid a disposal of the goodwill. The
concept is worthy of analysis although I have as yet been unable to entirely convince
myself that it really works in a manner suggested for it. So far as I can ascertain there
are no cases which establish in any positive way that goodwill can as a general rule be
‘leased’, and the concept encounters (as an initial hurdle) the kinds of issues discussed
in Just Jeans.518
In FCT v. Just Jeans519, the case referred to by Cominos above, the Full Federal
Court520 considered whether a business name and logo, constituting a common law
trade mark, could be assigned apart from the business itself. Effectively, the
arrangement constituted a sale and lease back (or ‘license back’) of the name and logo
by the respondent taxpayer to a third party in order, it was claimed, to raise funds.521
The Court held that at law it was not possible to transfer the name and logo as
purported in the agreement between the taxpayer and the third party. In respect of the
arrangement, the Court said:
517 The terms ‘leasing’ and ‘licensing’ are used somewhat interchangeably in this context, suggesting an arrangement where the owner of goodwill may permit its use by another as the lessee or licensee. However, a lease and a licence are not strictly the same thing. The key distinction is that a lease of property connotes the exclusive use or possession of that property by the lessee, while a licence does not necessarily provide such exclusivity to the licensee: Woodley, M. (ed.) 2005, Osborn’s Concise
Law Dictionary, 10th ed., Sweet & Maxwell, London; Butterworths Business and Law Dictionary, 2nd ed., LexisNexis Butterworths, Chatswood NSW. See also Origin Energy Power Limited v.
Commissioner of State Revenue (WA) [2007] WASAT 302.The question whether goodwill should be licensed or leased under any arrangement, however, effectively becomes irrelevant when the nature of goodwill and its relationship to the business is considered. That is, it is not possible either to license or to lease goodwill itself as a separate item of property; it must be attached to a business. 518 Cominos, D., ‘Goodwill’, Joint NSW/Queensland State Convention, April 1995, 32 at 42. 519 (1987) 87 ATC 4373; 18 ATR 775. 520 Woodward, Neaves and Wilcox JJ. 521 However, the arrangement was held to be ineffective to achieve an income tax deduction (under s. 51(1) of the Income Tax Assessment Act 1936 (Cth)) because, since no property was transferred in the first place, there was nothing leased by the taxpayer to justify a deduction for the payments made.
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… authority is hard to find.522 There appears to be no authority to support the view that
a bare name is capable of transfer independently of goodwill. What the authorities do
say is that the name of a business is one aspect of its goodwill ... .523
Then the Court went straight on to say that goodwill in turn can only be transferred
with the business to which it relates. This position is consistent with the authorities
which hold that goodwill is inseparable from the business.524 Accordingly, Just Jeans
simply recognises, effectively, that the licensing or leasing of goodwill alone is not
possible at law in the light of established authority; goodwill must be transferred with
the business.525
The place of goodwill in the licensing of a business was directly considered in
Roussos v. CSD(Tas)526where the appellants had entered into a licensing agreement
with the owner of a restaurant business to operate that business. In terms of the
agreement the business comprised plant and equipment, stock-in-trade, goodwill, and
the registered business name. The leased restaurant premises were also sub-leased to
the appellants. The Commissioner of Stamp Duties contended that the licensing
agreement operated as a sale or disposition of personal property comprising the assets
set down in the agreement, and was dutiable as such. The court, however, held that no
property in the business assets passed under the agreement. In relation to the goodwill
specifically, the court said that ‘[t]he goodwill does not pass to [the appellants] under
the agreement, merely the right to avail themselves temporarily of the benefits
522 However, some authority may be found in Thorneloe v. Hill [1892] 1 Ch 569 where Roma J held that a common law trademark could not be validly assigned in gross. 523 87 ATC 4373 at 4382. In the House of Lords’ case of The Singer Manufacturing Company v. Loog (1882) 8 App Cas 15, Lord Blackburn opined that trade names were in a certain sense property but that the right to use them passed with the goodwill of the business. 524 The Federal Court cited the High Court case of Bacchus Marsh Concentrated Milk Co Ltd (in
Liquidation) v. Joseph Nathan & Co Ltd (1919) 26 CLR 410 as authority. More recently, FCT v. Murry (1998) 98 ATC 4585 also stands for the position that goodwill is inseparable from the business. 525 What constitutes sufficient assets to effect the transfer of a business is a question of fact and degree. Such a question arose in Westpac Banking Corporation v. CSD(Qld) [2003] QSC 483; (2003) 55 ATR 50; 2004 ATC 4135. Westpac had acquired a component of another bank, comprising loans and other receivables, and the Commissioner had assessed it for stamp duty as the purchase of a business. However, the court found that Westpac had not acquired sufficient assets to constitute the acquisition of a business. In reaching this decision, the court considered whether there was goodwill associated with the acquisition. It found that Westpac had not acquired goodwill in the legal sense of the attractive force which brings in custom and therefore it followed that the assets purchased were not sufficient to constitute a business. The essential principle which may be taken from this decision is that a business is not transferred unless there are sufficient assets transferred to take the goodwill with it. Looked at from the other direction, goodwill cannot be transferred without the business. 526 (1992) 92 ATC 4370 (Tas SC).
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attaching to it’.527 On this basis, the leasing or licensing of goodwill would seem
possible, because this is effectively what happened in this case. In fact, if a business
were leased as a going concern then goodwill would go with it as an inseparable asset.
The so-called leasing528 of goodwill, it is arguable, involves the leasing or licensing,
as appropriate, of the assets and other aspects of the business to which the goodwill is
attached. On this view, the goodwill itself as an asset or item of property need not be
specifically leased; rather, the other things necessary to transfer the business as a
going concern to the lessee may be leased or licensed and the goodwill transferred
with the business. As discussed elsewhere in this paper, goodwill is not a separate
item of property and thus does not exist independently of the business; it can only be
transferred with the business. Goodwill cannot be transferred in gross.529 However, the
right to use the goodwill of the business may still be licensed to the lessee of the
business, as in the licensing agreement in Roussos.530 Nonetheless, given the
relationship of goodwill to the business, it is debatable whether this is strictly
necessary.
What happens to the goodwill of the leased business? Does its ownership remain with
the lessor? Or does the lessee own it for the duration of the lease? Since the goodwill
is inseparable from the business, its status must be the same as the other property of
the business. That is, it is arguable that title remains with the lessor who also has title
to the other business property. The business itself is not property, rather it is a course
of conduct.531 Therefore, the business itself cannot be the subject of the leasing
arrangement, but only the property necessary for it to be carried on as a going concern
by the lessee.
527 Id at 4732. 528 As noted in footnote 517, the terms ‘leasing’ and ‘licensing’ tend to be used interchangeably in discussing these matters. However, in respect of the transfer of a single business, as opposed to franchising multiple businesses, the term ‘lease’ has been used because in such a case the ‘lessee’ may be taken to have exclusive rights to the property comprising the business. Support for this approach may be found in Murry where it was revealed that the taxi licence was ‘leased’ by the taxpayer to another party. 529 See the High Court in Geraghty v. Minter (1979) 142 CLR 177 (per Barwick CJ) and other cases referred to in footnote 466. 530 This was also noted by Andary and Butler in the context of franchising in ‘Franchise Fixings Part 2: Goodwill and Compliance’ (1997) 31(7) Taxation in Australia 355 at 356. 531 See FCT v. Murry (1998) 98 ATC 4585 at 4596; 193 CLR 605 at 626.
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On termination or expiry of the lease, the business would revert to the lessor, the
original owner. As noted above, under the leasing arrangement it may be argued that
the lessor remains the owner of the property of the business, including the goodwill
specifically. But, on the other hand, it may also be argued that, as the goodwill
attaches to the business itself – a course of conduct rather than property – it is
therefore the property of the lessee for the term of the lease during which the lessee is
the business proprietor. Goodwill has been recognised in Murry as the right to carry
on the business in substantially the same manner as has attracted custom to it.
However, even that property right would revert to the lessor with the business on
termination of the agreement. Hence, the preferred position, it is submitted, is that the
goodwill is also the property of the lessor and is effectively leased to the lessee with
other property comprising the business. In the final analysis, however, the important
point to note is that goodwill remains attached to the business and cannot be leased or
licensed, or otherwise dealt with, separately from it.
8.7 Taxation issues
The issue of whether it is possible to license or lease goodwill is of particular interest
and significance concerning capital gains tax (CGT) and stamp duties. For CGT
purposes, it has been suggested that leasing of goodwill rather than selling it would
avoid the application of CGT and enable the retention of any pre-CGT status of that
goodwill.532 Furthermore, consideration should be given to questions of the CGT
effects on goodwill where a franchise ends or where a business ceases because a lease
is not renewed.
For stamp duty purposes, the licensing or leasing of goodwill may be a means of
avoiding its conveyance and thus in turn avoiding the imposition of ad valorem duty
on such a conveyance.533 These considerations have relevance to matters such as
restructuring business entities where, for example, a professional practice is
incorporated.
532 Goodwill is defined specifically as an asset – a CGT asset – for CGT purposes in s 108-5 of the Income Tax Assessment Act 1997 (Cth): see s 108-5(2)(b). CGT applies to assets acquired on or after 20 September 1985, so assets acquired pre-CGT (before 20 September 1985) are not subject to tax: see s 104-10(5)(a)), Income Tax Assessment Act 1997 (Cth). 533 Generally, goodwill is recognized as property which is subject to duty on its conveyance in the sale of a business. In Australia, with the exception of Victoria and Tasmania (from 1 July 2008), ad valorem duty is imposed by the states and territories on the conveyance of goodwill. See Tregoning, I., ‘Goodwill and Stamp Duties: the Legacy of Murry’ (2006) 6(2) Oxford University Commonwealth Law
Journal 183 for the treatment of goodwill for stamp duty.
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8.7.1 Capital gains tax
8.7.1.1 Leasing not under a franchise
As discussed earlier in this chapter, the leasing of a business not under a franchise
would mean that the ownership of the property remained with the lessor. Thus, as the
title to the assets of this business would remain with the lessor, CGT event A1 would
not apply.534 Consequently, any pre-CGT status of goodwill or of any other CGT asset
of the business should be retained in the hands of the lessor.
While the leasing of goodwill would not invoke CGT event A1, which requires a
disposal, the leasing of property rights may give rise to other CGT implications. In
accordance with s. 104-35(1),535 CGT event D1happens where an entity creates a
contractual right or other legal or equitable right in another entity. If goodwill were
the subject of the licensing of an established business, thus invoking this event, what
would be the specific right created in relation to this goodwill? In Murry the High
Court stated that ‘[g]oodwill is … identified as 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’.536 Here the High Court
identified goodwill as property in the form of a legal right. However, the right created
in terms of CGT event D1 would constitute a separate right vested in the lessee in
relation to the leased goodwill. For example, if the lessor of the goodwill did not
provide some necessary and agreed service to effect the transfer of the benefit of the
goodwill under the lease, such as the introduction of customers to the lessee, then the
lessee would have the right to legally enforce such an agreement. Such a right is
personal in nature and not a proprietary right like goodwill.537 Any capital gain or loss
arising under CGT event D1 in respect of the goodwill would not relate to the value of
the leased goodwill, but rather to any capital amount paid by the lessee to the lessor in
respect of the created right to the goodwill, less any incidental costs incurred by the
lessor in the creation of the right, as set down in s. 104-35(3). In fact, the right created
534 The CGT system is based on capital gains or losses arising from a range of defined CGT events. CGT event A1 concerns the disposal of CGT assets which gives rise to capital gains or capital losses: s 104-10, Income Tax Assessment Act 1997 (Cth). 535
Income Tax Assessment Act 1997 (Cth). 536 (1998) 98 ATC 4585 at 4591. 537 Personal rights under a contract or the grant of a lease or licence are not considered to be of a proprietary nature: see, for example, Commissioner of Stamp Duties (NSW) v. Yeend (1929) 43 CLR 235 and Poulos Bros (Wholesale) Pty Ltd v. William George Abbott No. 1282/1991 Judgment No. A88/1994.
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under CGT event D1 would arise out of the agreement leasing the goodwill as part of
leasing the business to which the goodwill would be attached. An agreement of this
nature would be expected to vest in the lessee a range of rights required to lease a
business as a going concern. Whether the leasing agreement confers one right or
multiple rights invoking multiple CGT events is a question which may arise,538 but is
arguably a question of little consequence in considering the legal and taxation
implications of leasing a business and its goodwill. The essential question must be
whether the agreement is effective in vesting in the licensee rights to operate a
business.
8.7.1.2 Where franchise ends and business reverts to the franchisor
Where a franchise ends and the business reverts to the franchisor, the goodwill will
revert also, as discussed in this chapter. This would constitute a CGT event A1
because it would constitute a disposal of the goodwill from the franchisee to the
franchisor in terms of s. 104-10(1).539 A capital gain or loss may be made in
accordance with s. 104-10(4) which subtracts the cost base of the goodwill from the
capital proceeds from its disposal. Where the franchisee is paid compensation for the
goodwill this would constitute the capital proceeds. Where no compensation is paid,
market value of the goodwill at the time of the event would be taken as the capital
proceeds in accordance with s. 116-30(1).540 As the cost base of the goodwill may be
of little or no value,541 unless it has been purchased with the business from another
franchisee, this may produce a significant capital gain in the hands of the franchisee.
538 This question would appear to depend on the particulars of the agreement. In Taxation
Determination TD 93/86the Commissioner addresses the question of whether, for CGT, the totality of rights under a contract constitutes one asset or each right constitutes a separate asset. He states that this will depend on the facts of each particular case, but adds that generally the initial approach will be to regard the totality of rights as the one asset. This determination refers to the old CGT law of Part IIIA of the Income Tax Assessment Act 1936 (Cth) where the system depended on the disposal, or deemed disposal, of assets rather than on the CGT events nominated in the new law where, as in CGT event D1, the disposal of an asset as such is not involved. Nonetheless, it may be taken that the same principles apply to the determination of rights created under the new law. 539
Income Tax Assessment Act 1997 (Cth). 540 Subsection 116-30(1) is in Div. 116 of the Income Tax Assessment Act 1997 (Cth) which sets down the rules for determining the capital proceeds arising from a CGT event. Included in these rules is a modification rule for the substitution of market value where no capital proceeds are received from the event, in this case the disposal of the goodwill as a CGT asset. 541 The rules for determining the cost base of a CGT asset are found in Div. 110 of the Income Tax
Assessment Act 1997 (Cth), particularly s. 110-25 which provides for up to five elements or classes of expenditure to be included. The first element in s. 110-25(2) comprises any consideration paid for the asset, which will not exist if the goodwill is not purchased. The fifth element in s. 110-25(6) which includes capital expenditure incurred to establish, preserve or defend the asset may provide opportunity
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8.7.1.3 Business ending with the franchise or lease
Where a business comes to an end as a result of a franchise agreement ending or a
lease expiring and the goodwill thereby ceases to exist, there are two CGT events
which may potentially apply to the goodwill: CGT event C1 and CGT event C2. CGT
event C1 applies where a CGT asset is lost or destroyed in accordance with s. 104-
20(1). CGT event C2 applies where ownership of an intangible CGT asset ends in one
of the ways stipulated in s. 104-25(1). In a case where either of these events may
possibly apply, s. 102-25(1) directs that the one which is more specific to the situation
should be used.
Where a franchise agreement ends and the business ceases as a result (as opposed to
the business reverting to the franchisor), the goodwill obviously ends with the
business. This would give rise to CGT event C2 in terms of s. 104-25 which happens
where, as noted above, an intangible CGT asset ends in a range of stipulated ways,
including expiry of the asset: see s. 104-25(1)(c). In this type of case, the goodwill
may be said to expire with the ending of the franchise agreement and the business.
This view that goodwill expires, it is submitted, is more specific than the loss or
destruction of goodwill required for the application of CGT event C1. In the absence
of any amount of compensation paid for the goodwill, the question of market value
being substituted as the capital proceeds in accordance with s. 116-30(1) arises. In this
case, however, relief may be afforded by s. 116-30(3) which provides that s. 116-
30(1) does not apply to a CGT event C2 arising from an expiry of a CGT asset: see
specifically s. 116-30(3)(a)(i). The market value substitution rule should therefore not
apply in this type of case with the result that there would be no capital gain generated.
In fact, if a reduced cost base were produced, then a capital loss in terms of s. 104-
25(3) would be generated.
Where a lease expires in a situation which is not a franchise and the business ceases as
a result, then the goodwill will necessarily cease also. It is proposed that this will give
rise to CGT event C1 under s. 104-20 in respect of the goodwill because it may be
argued that the goodwill is lost or destroyed,542 rather than coming to an end in any of
for some relevant expenditure to be counted in appropriate circumstances. It should be noted that the fourth element in s. 110-25(5) relating to increasing or preserving the value of the CGT asset is not applicable to goodwill per s. 110-25(5A). 542 It is also the view of the ATO that CGT event C1 applies in this type of situation: see Taxation
Ruling TR 1999/16, para. 136.
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the ways listed in respect of CGT event C2 in s. 104-25. The market value substitution
rule in s. 116-30 does not apply as a consequence of s. 116-25 which does not apply
this rule to CGT event C1. This is obviously an advantage to the taxpayer as no capital
gain will arise from this event. To the contrary, a capital loss could arise where the
taxpayer has paid for goodwill in the purchase of the business (or perhaps has a cost
base consisting of elements other than the purchase price).
8.7.2 Stamp duties
The essential question for stamp duties is whether goodwill may be leased while
avoiding a transaction or conveyance543 subject to ad valorem duty. If assets of an
existing business, including its goodwill, are leased or licensed, then there will be a
conveyance of property in the form of rights to use these assets.544 However, in the
particular case of a franchised business, other considerations may arise. On the one
hand, the franchising of a new business will typically involve the licensing and leasing
of necessary property and know-how to the franchisee to enable the operation of the
business. While this may constitute a dutiable transaction, goodwill will not be part of
the transaction because it will not come into existence until the business commences.
In the case of an existing franchised business, on the other hand, its transfer will
include the goodwill as part of a dutiable transaction. The issue of stamp duty on
transfers of goodwill, however, should cease to be an issue in the various state
jurisdictions in the next few years as they have agreed to remove such duties in
response to the introduction of the Goods and Services Tax.545
8.8 In Conclusion
The analysis and the treatment of goodwill in this chapter are based on the concept as
expounded by the High Court in Murry. That is, goodwill is one whole item of
property, separate from its sources, but attached to the business. On this basis, the
matters canvassed raise certain contentious ‘structural’ issues concerning the
treatment of goodwill within franchises and on the restructuring of businesses.
543 Traditionally, stamp duty has been imposed on instruments, which is the system still applicable in South Australia and the Northern Territory. However, New South Wales, Victoria, Queensland, Tasmania, the ACT, and Western Australia have moved to the imposition of duties based on transactions. 544 As noted in Suncoast Milk Pty Ltd v. CSD (Qld) ((1996) 96 ATC 4914 at 4925; 34 ATR 82 at 93), property is a broad concept for stamp duty purposes. 545 This agreement is contained in the Intergovernmental Agreement on the Reform of Commonwealth-State Financial Relations of 1999.
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Fundamental to these issues is the question of whether goodwill may be licensed or
leased apart from other assets of the business (for certain tax advantages). The weight
of authority indicates that this is not possible. This conclusion is consistent with the
view of goodwill as inseparable from the business to which it attaches. However, if
other business assets or property of an established business (as a going concern) are
licensed or leased as appropriate, then the goodwill will follow whether it is
specifically identified as part of the agreement or not. These business assets, inter alia,
will constitute the sources of the goodwill. If, on the other hand, it is a new business
which is subject to the agreement, as in the case of a new franchise, then the goodwill
will arise when the business starts. In this type of case, there is no existing goodwill to
transfer to the franchisee. However, any goodwill which a franchisor has in its own
business, as distinct from the franchised business, remains with the franchisor.
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Chapter 9: Goodwill and Passing-off
9.1 Introduction
The modern tort of passing-off is said to comprise three elements, namely
misrepresentation, damage, and goodwill.546 In the House of Lords’ case of Erven
Warnink BV v. J Townsend & Sons (Hull) Ltd (the Advocaat case) Lord Diplock
identified the following five characteristics, including these elements, which must be
present for a valid cause of action for passing-off:
(1) a misrepresentation (2) made by a trader in the course of trade, (3) to prospective
customers of his or ultimate consumers of goods or services supplied by him, (4) which
is calculated to injure the business or goodwill of another trader (in the sense that this is
a reasonably foreseeable consequence) and (5) which causes actual damage to a
business or goodwill of the trader by whom the action is brought or … will probably do
so. 547
Passing-off has produced a significant body of case law, particularly since it was
apparently first recognized by that name in 1842.548 However, the ‘classical’ form of
the modern tort requiring property in the nature of goodwill to be the subject of
damage is claimed to be a development dating from 1915 in the House of Lords’ case
of A G Spalding & Bros v. A W GamageLtd.549 As Lord Diplock noted in his speech in
546 See Wadlow, C. 2004, The Law of Passing-off, 3rd ed, Sweet and Maxwell, London, 6 (hereinafter Wadlow). Wadlow notes that these three elements are sometimes referred to as the ‘classical trinity’ of passing-off and proposes that variations to them are possible, such as the substitution of reputation for goodwill. See also, for example, Nourse LJ in Consorzio del Prosciutto di Parma v. Marks & Spencer
plc [1991] RPC 351 at 368-9 where he refers to these elements as constituting the ‘classical approach’ to passing-off. 547 [1979] 2 All ER 927 at 932-3. Moreover, in Reckitt and Colman Products Ltd v. Borden Inc (1990) 17 IPR 1 (HL), both Lord Oliver of Aylmerton and Lord Jauncey of Tullichettle restated the three classical elements as constituting an action for passing-off. 548 Wadlow (at p 12 in n 28) suggests that the term ‘passing-off’ comes from Perry v. Truefitt (1842) 6 Beav 66; 49 ER 749. In fact, in that case the term ‘pass off’ was used, but only in the headnote. Expressions such as using or adopting the name of another were used in the report itself. However, it is interesting to note that in the same year in Crawshay v. Thompson (1842) 4 Man & G 357; 134 ER 146 both ‘pass off’ and ‘passing off’ specifically were used on several occasions by both counsel and the judges. It seems, therefore, that this latter case has a stronger claim to having provided the name for this tort. Furthermore, Norma Dawson reveals an even earlier use of the term ‘passing off’ in a legal context, but not in a case report, concerning a trade mark dispute dating from 1740: see Dawson, N., ‘English Trade Mark Law in the Eighteenth Century: Blanchardv. Hill Revisited – Another ‘Case of
Monopolies?’, (2003) 24 Journal of Legal History 111. 549 (1915) 32 RPC 273. As a matter of minor interest, the founder of the firm of A G Spalding & Bros was named Albert Goodwill Spalding.
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Erven Warnink concerning the earlier House of Lords’ case of Reddaway & Co v.
Banham & Co:550
Although it was a landmark case in deciding that the use by a trader of a term which
accurately described the composition of his own goods might nevertheless amount to
the tort of passing off if that term were understood in the market in which the goods
were sold to denote the goods of a rival trader, Reddaway v. Banham did not extend the
nature of the particular kind of misrepresentation which gives rise to a right of action in
passing off beyond what I have called the classic form of misrepresenting one’s own goods
as the goods of someone else nor did it provide any rational basis for an extension.
This was left to be provided by Lord Parker of Waddington in[Spalding v. Gamage]. In
a speech which received the approval of the other members of this House, he identified
the right the invasion of which is the subject of passing-off actions as being the property
in the business or goodwill likely to be injured by the misrepresentation.551
Similar views concerning Lord Parker of Waddington’s contribution have been
expressed by the Privy Council in Cadbury Schweppes Pty Ltd v. Pub Squash Co Pty
Ltd552 and by Lord Jauncey of Tullichettle in Reckitt and Colman Products Ltd v.
Borden Inc553 where he said that the precise rights to be protected were ‘finally
resolved’ in Spalding v. Gamage. Moreover, Lord Diplock himself had also expressed
such a view in Star Industrial Company Limited v. Yap Kwee Kor.554
In this chapter the legal concept of goodwill is examined in the context of the tort of
passing-off.555 Goodwill has played a fundamentally important part in passing-off
since its formal recognition as an element in that tort in the landmark case of Spalding
v. Gamage in 1915.556 This has given rise to a range of issues canvassed in this
chapter. First, the situation before Spalding v. Gamage and the approach taken to
passing-off actions which led to the recognition of goodwill in that case is examined.
550 [1896] AC 199 (HL). 551 [1979] 2 All ER 927 at 931-2. 552 (1981) 55 ALJR 333 (PC). 553 (1990) 17 IPR 1 (HL). 554 [1976] 2 FSR 256 at 269 (PC). 555 For a useful summary of the development of passing-off and concept of goodwill within the action, see Naresh, S., ‘Passing-Off, Goodwill and False Advertising: New Wine in Old Bottles’, (1986) 45(1) Cambridge Law Journal 97. 556 For a review of the case law preceding Spalding v. Gamage and support for Lord Parker of Waddington’s recognition of goodwill as an element of passing-off, see Tregoning, I., ‘What’s in a Name? Goodwill in Early Passing-off Cases’, (2008) 34(1) Monash University Law Review 75.
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The sources of goodwill are given prominence in an examination of these early cases
to determine whether damage to the sources of goodwill may be detected in them.
Where there is damage to the sources of goodwill there is necessarily damage to the
goodwill itself. Thus the chapter examines these cases to determine whether a concern
for the protection of goodwill, by way of protecting its sources, may be discerned in
these earlier actions. Evidence of protecting the sources of goodwill from damage will
justify, it is argued, the identification of goodwill as an element of passing-off. This
examination goes to the roots of the legal concept of goodwill in an important period
in its development and thus takes an historical perspective. Secondly, the relationship
of goodwill to business is examined in the context of passing-off. Particularly,
questions whether goodwill can exist after the cessation of business or without the
need for business for the purposes of the tort are examined. These questions provide a
different slant on the concept of goodwill and thus contribute other facets to its
meaning. Thirdly, jurisdictional questions often arise in passing-off actions. For
example, does a plaintiff have a sufficient business connection with a particular
jurisdiction to justify a right of action in that jurisdiction? That is, is goodwill present
in the jurisdiction and, if not, does it need to be? There is a significant amount of case
law on these questions and they provide, again, another slant on the concept of
goodwill.
9.2 Goodwill emerges
The recognition of goodwill as an element attributed to Lord Parker of Waddington in
Spalding v. Gamage prompts the question of where it seemingly suddenly sprang
from. It is most curious that a tort whichcan be traced back to the sixteenth century
should have been part of the common law until the early twentieth century without the
need for an express recognition of goodwill as an element. Nonetheless, as argued in
this chapter, there is a basis for the finding of goodwill as the element damaged in
passing-off. But first an examination of the case is required.
9.2.1 Spalding v. Gamage
In Spalding v. Gamage the defendants advertised for sale footballs of a superseded
rubber type which had been manufactured by the plaintiffs. However, it was found by
the House of Lords that the advertisements were likely to deceive customers into
thinking that they were purchasing a new type of football manufactured by the
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plaintiffs and, furthermore, for a bargain price. Having found that misrepresentation
existed in the advertisements, Lord Parker of Waddington said that ‘the
misrepresentation so established was, in my opinion, of such a nature as to give rise to
a strong probability of actual damage to the plaintiffs in both their retail and wholesale
trades’.557 But there is no mention of damage to goodwill in this statement, which
effectively represents his Lordship’s decision. It appears that he had slipped back,
perhaps unconsciously, to an earlier less explicit conception of the passing-off action.
Earlier in his speech, however, Lord Parker of Waddington had made what has been
taken as the ‘landmark’ pronouncement concerning goodwill in passing-off, stating:
There appears to be considerable diversity of opinion as to the nature of the right, the
invasion of which is the subject of what are known as passing-off actions. The more
general opinion appears to be that the right is a right of property. This view naturally
demands an answer to the question – property in what? Some authorities say property in
the mark, name, or get-up improperly used by the defendant. Others say property in the
business or goodwill likely to be injured by the misrepresentation. Lord Herschell in
Reddaway v. Banham expressly dissents from the former view; and if the right invaded
is a right of property at all, there are, I think, strong reasons for preferring the latter
view.558
This is all that Lord Parker of Waddington had to say about the place of goodwill in
the action and, on the face of it, it is a rather curious statement inviting close scrutiny.
First, he suggested there was considerable diversity of opinion regarding the nature of
the right invaded, but did not refer to any sources of this diversity of opinion.
Secondly, he invoked the more general opinion that the right was a right of property,
again without any authority. Thirdly, he set up a debate between authorities on the one
hand saying it was property in the mark, name or get-up of the plaintiff and authorities
on the other hand saying it was property in the ‘business or goodwill’ of the plaintiff.
Then he invoked Lord Herschell’s dissension from the former view, thus seemingly
by default accepting the latter view involving property in the business or goodwill,
with the qualification ‘if the right invaded is a right of property at all.’ This
qualification reveals that Lord Parker of Waddington was somewhat equivocal about
the need for property. Much appears to ride on this equivocal view of property and its
557 (1915) 32 RPC 273 at 287. 558 Id at 284.
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place in passing-off; it hardly amounts to a compelling case for goodwill as the
property subject to damage in such an action. This is especially so in view of the fact
that Lord Parker of Waddington did not identify the authorities he invoked in the
above passage. Nonetheless, as a result of this mention of goodwill, and then only as
an alternative to business, Spalding v. Gamage has been accepted as the landmark
case on goodwill as an element in passing-off.
9.2.2 Burberrys v. Cording
However, there may be found an earlier and more explicit statement of the place of
goodwill in a passing-off action in 1909 in Burberrys v. J C Cording & Co Ltd,559 a
statement made by Lord Parker of Waddington himself sitting as Parker J at the time.
This case concerned an action by the plaintiffs to restrain the defendants from using a
certain word to describe the coats they made, a word the plaintiffs claimed was
distinctive of these coats. Parker J stated:
The principles of law applicable to a case of this sort are well known. … If an
injunction be granted restraining the use of a word or name, it is no doubt granted to
protect property, but the property, to protect which it is granted, is not property in the
word or name, but property in the trade or goodwill which will be injured by its use. If
the use of a word or name be restrained, it can only be on the ground that such use
involves a misrepresentation, and that such misrepresentation has injured, or is
calculated to injure another in his trade or business.560
Here there is not the equivocation found in Spalding v. Gamage. Parker J simply and
directly identified the property to be protected as ‘property in the trade or goodwill’,
and he asserted, moreover, that the applicable principles of law were well known. This
suggests that it was well known that goodwill formed an element of passing-off – a
notable observation given that goodwill was not explicitly referred to in earlier cases.
Furthermore, it should be noted that Parker J only referred to goodwill as an
alternative to trade or business and did not refer to goodwill at all in the second
reference to ‘trade or business’. But, to this day, goodwill is still generally cited as an
559 (1909) 26 RPC 693 (Chancery Division, High Court). 560 Id at 701.
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alternative to business or trade,561 apparently without affecting its recognition as an
element.
9.3 The meaning and nature of goodwill
The meaning and nature of goodwill has already been canvassed in earlier chapters,
but it is useful to revisit certain aspects of goodwill in the context of passing-off. Lord
Macnaghten provided the classic definition of goodwill in IRC v. Muller and Co’s
Margarine Ltd:
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 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. One element may predominate here and another
element there.562
Thus Lord Macnaghten defined goodwill essentially as that ‘attractive force which
brings in custom’, while at the same time recognizing that it is ‘composed of a variety
of elements’. Some of these elements were identified by Lord Lindley in the same
case as ‘situation, name and reputation, connection, introduction to old customers, and
agreed absence from competition’.563 From these pronouncements on goodwill it may
be seen that it is closely connected with custom and hence trade or business, and with
elements such as names, marks and reputation. In a detailed analysis in FCT v.
Murry,564 the High Court of Australia pointed out that the authorities565 reveal that
goodwill consists of three different aspects: property, sources, and value.
561 For example, Lord Diplock’s five characteristics of a valid passing-off action from Erven Warnink, cited at the beginning of this chapter, included a reference to ‘business or goodwill’, with goodwill still only an alternative to business. 562 [1901] AC 217 at 223-4. 563 Id at 235. 564 (1998) 98 ATC 4585. 565 The High Court referred specifically to the definitions of goodwill of Lords Lindley and Macnaghten in Muller and of Judge Swan in Haberle Crystal Springs Brewing Co v. Clarke 30 F 2d 219 (2nd Cir) (1929).
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9.3.1 Goodwill as property
Notwithstanding its elusive and intangible nature, it is well settled that goodwill is
property. For example, goodwill had been recognized as property by the time of
PottervCIR566 in the middle of the nineteenth century, and other nineteenth century
cases which held that goodwill was property include CIRv.Angus & Co567 and The
West London Syndicate Limited v.CIR.568 Thus, as Lord Macnaghten stated in Muller:
It is very difficult … to say that goodwill is not property. Goodwill is bought and sold
every day. It may be acquired … in any of the different ways in which property is
usually acquired. When a man has got it he may keep it as his own. He may vindicate
his exclusive right to it if necessary by process of law. He may dispose of it if he will –
of course under the conditions attaching to property of that nature.’569
The High Court in Murry elaborated on the idea of goodwill as property in stating:
Goodwill is correctly identified as 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. It is a right or privilege that is inseparable from
the conduct of the business.570
Accordingly, goodwill is an item of property inseparable from the business to which it
attaches. It is the right to benefit from that attractive force which brings in custom.
Furthermore, it is an item of property that is one indivisible whole,571 notwithstanding
that it may be seen as being composed of elements or having a range of different
sources as noted below. On the authority of Muller and earlier cases, goodwill had
clearly been recognized as property, often very valuable property, of a business before
the time of Spalding v.Gamage.
566 (1854) 10 Ex 147. In this case, Pollock CB observed: ‘… very frequently the goodwill of a business or profession … is made the subject of sale, though there is nothing tangible to it … it is a valuable thing belonging to [the vendor] , and which he may sell to another for pecuniary consideration’ (at 157). 567 (1889) 23 QBD 579 (CA). 568 [1898] 2 QB 507 (CA). 569 [1901] AC 217 at 223. 570 (1998) 98 ATC 4585 at 4591. 571 See, for example, Lord Macnaghten in Muller ([1901] AC 217 at 224) and Stephen J in Geraghtyv.Minter (1979) 142 CLR 177 at 193.
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9.3.2 Sources of goodwill
As the High Court in Murry observed in response to cases such as Muller, it had been
common to describe goodwill as being composed of elements. However, in what may
be seen as a more perceptive and accurate assessment of the nature of goodwill, the
High Court saw it as having sources rather than elements. In the words of the Court:
… goodwill is a quality or attribute that derives inter alia from using or applying other
assets of the business. Much goodwill, for example, derives from the use of trade marks
or a particular site or from selling at competitive prices. But it makes no sense to
describe goodwill in such cases as composed of trade marks, land or price, as the case
may be. Furthermore, many of the matters that assisted in creating the present goodwill
of a business may no longer exist. It is therefore more accurate to refer to goodwill as
having sources than it is to refer to it as being composed of elements.572
Nonetheless, the High Court did not see itself as providing a new definition of
goodwill in making this observation. Rather, it invoked Lord Lindley in Muller in
supporting its view by asserting that ‘Lord Lindley referred to goodwill as adding
value to a business “by reason of” situation, name and reputation, and other matters
and not because goodwill was composed of such elements.’573 Thus the High Court
recognized, importantly, that the so-called ‘elements’ of goodwill were in fact the
sources of that goodwill.
Some key sources of goodwill have, in fact, provided names for categories or types of
goodwill: notably, personal goodwill, site goodwill, name goodwill, and monopoly
goodwill.574 Personal goodwill arises from the personal characteristics of a person or
persons associated with the business. Site goodwill relates to the site or location of the
business. Name goodwill arises from the name or reputation associated with a
business, where trade marks and brands may play important parts. Finally, monopoly
goodwill recognizes goodwill arising from a monopoly conferred on the business by
exclusive rights from statutory licences and patents, for example. However, as noted
572 (1998) 98 ATC 4585 at 4591. 573 (1998) 98 ATC 4585 at 4591. As already noted, some of these elements were identified by Lord Lindley in the same case as ‘situation, name and reputation, connection, introduction to old customers, and agreed absence from competition’ ([1901] AC 217 at 235). 574 For example, in FCT v. Krakos Investments Pty Ltd (1996) 96 ATC 4063, Hill J of the Federal Court identified these four categories of goodwill from the authorities.
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by the High Court in FCT v. Murry,575 while these categories may be helpful
descriptions of goodwill used in particular contexts, care must be taken to avoid
seeing these descriptions as separate items of goodwill. Goodwill remains one whole
item of property. Rather, these descriptions reflect major sources of the goodwill in
terms of the High Court’s view in Murry.
The mid-nineteenth century case of Churton v. Douglas576 provided what might be
taken as the first general definition of goodwill in the English jurisdiction, including
references to what may be seen as important sources of the goodwill. Wood V-C
approached the concept thus:
Goodwill, I apprehend, must mean every advantage – affirmative advantage, if I may so
express it, … – that has been acquired by the … firm by carrying on its business,
everything connected with the premises, or the name of the firm, and everything
connected with or carrying with it the benefit of the business.577
Then Wood V-C went on to say in respect of names and trademarks:
The name of a firm is a very important part of the goodwill. … There are cases every
day in this court with regard to the use of the name of a particular firm, connected
generally, no doubt, with the question of trade-marks. … The firm stamps its name on
the articles. It stamps the name of the firm which is carrying on its business on its
articles as a proof that they emanate from that firm, and it becomes the known firm, to
which applications are made.578
Consequently, from this early point, it may be seen that names and trade marks, inter
alia, were viewed as important sources of goodwill.
In Murry the High Court identified the sources of goodwill as many and varied.579 But
in essence the sources are those things that attract custom and generate business.
Consequently, aspects of business such as custom,580 trade, profits, reputation, names
575 (1998) 98 ATC 4585. 576 (1859) 28 L J Ch 841. 577 Id at 845. 578 Ibid. 579 See (1998) 98 ATC 4585 at 4591 where the High Court reflected on the typical sources of goodwill. 580 The term ‘custom’ was used in some early case as more directly a synonym for goodwill. In Churton
v. Douglas (1859) 28 L J Ch 841; 846, Wood V-C said emphatically that custom was what was meant by goodwill. And references to custom as effectively a synonym for goodwill may be found in early
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and marks may readily be seen as sources of goodwill and, as addressed in this
chapter, these were terms commonly used to refer to the subject of damage in passing-
off cases in the period before Spalding v. Gamage. As will be revealed, there is
plentiful reference to injurious effects to these aspects of business in these cases. It
necessarily follows, therefore, that damage to these sources constituted damage to
goodwill. This is central to the argument in this chapter: that goodwill was indeed the
property damaged in earlier passing-off cases, although not made explicit in the
judgments.
9.3.3 Value of goodwill
As property and an asset of a business, goodwill has value to that business. Again to
cite Murry, ‘[g]oodwill 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.’581 Of course, loss or impairment of goodwill is an element of passing-off
and a basis for remedy. The valuation of goodwill is based on the profitability of a
business, thus anything adversely affecting profits will reduce the value of goodwill
and the value of the business. Business profits have been used as a basis for
calculating the value of goodwill from at least early in the nineteenth century. For
example, in 1825 in Cook v. Collingridge582 Lord Eldon LC advanced the view that
goodwill should be valued on the basis of the ‘last three or fours years’ profits’583 of
the business. Later in 1858 in Austen v. Boys584 Lord Chelmsford LC pronounced as a
general proposition that ‘in determining [goodwill’s] value the profits are necessarily
taken into account, and it is usually estimated at so many years’ purchase upon the
amount of those profits’.585 In line with these views, Charles Allan in his pioneering
work on the law of goodwill published in 1889 noted that ‘[t]he usual basis of
valuation is the average net profits made during the few years preceding the sale’.586
Consequently, damage to trade and profits would invariably mean damage to
goodwill, and this was certainly recognized in the nineteenth century.
cases before the term goodwill had entered general legal parlance: for example, Broad v. Jollyfe (1620) Cro Jac 596, 79 ER 509 and Mitchel v. Reynolds (1711) 1 P Wms 181; 24 ER 347. 581 (1998) 98 ATC 4585 at 4595. 582 (1825) 27 Beav 456; 54 ER 180. 583 Id at 459. 584 (1858) 27 LJ Ch 714. 585 Id at 718. 586 Allan, C. 1889, The Law relating to Goodwill, Stevens and Sons Ltd, London, 84.
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9.3.4 The concept of goodwill before Spalding v. Gamage
It is clear that by the time of Spaldingv.Gamage in 1915 the concept of goodwill, and
its relationship with the business, had developed into essentially its modern form. The
Lords’ case of Muller in 1901 amply demonstrates this. As a consequence, it may be
taken that the nature and the composition of goodwill, arising from sources or
elements, were well understood at that time. Furthermore, the effect of business
profits on its value was also well understood. Thus it may reasonably be inferred that
there existed a well-formed judicial appreciation of the nature of goodwill and its
sources by this time.
9.4 ‘Business or goodwill’
In Spalding v. Gamage Lord Parker of Waddington identified the property to be
protected from damage as ‘property in the business or goodwill likely to be injured by
the misrepresentation.’587 Thus the element identified in that case,and also generally in
later cases, was not goodwill alone but rather the compound notion of ‘business or
goodwill’. Taken at face value, this presents a conceptual problem because business is
not property. As noted earlier, it is well settled that goodwill is property of a business.
However, a business itself is not property, although of course it typically involves the
use of various property, including goodwill. On the nature of business, the majority of
the High Court said in FCT v. Murry:
A business is not a thing or things. It is a course of conduct carried on for the purpose
of profit and involves notions of continuity and repetition of actions.588
Hence the High Court saw business as a course of conduct, rather than property, as it
had previously done so in Hope v. Bathurst City Council.589 Similarly, in Truax v.
Corrigan, Holmes J had the following to say about the nature of a business:
An established business no doubt may have pecuniary value and commonly is protected
by law against various unjustified injuries. But you cannot give it definiteness of
contour by calling it a thing. It is a course of conduct and like other conduct is subject
587 (1915) 32 RPC 273 at 284. 588 (1998) 98 ATC 4585 at 4596. 589 (1980) 144 CLR 1.
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to substantial modification according to time and circumstance both in itself and in
regard to what shall justify doing it harm.590
Nonetheless, is it possible to give business a meaning flexible enough to be able to
treat it as a species of property for the purpose of passing-off? Strictly speaking, it
seems that the answer is no. For example, in Smith v. Anderson Jessel MR attributed a
flexible meaning to business, saying it was ‘a word of extensive use and indefinite
signification’,591 but nowhere in that case did he indicate that a business in itself was a
species of property.592
However, if it is property which must be protected in passing-off, how does business
as opposed to goodwill fit into the action, given it is not property? Sense may be made
of the element when it is expressed as ‘the property in the goodwill of the business’ in
line with the approach taken in Draper v. Trist where Goddard LJ identified the
plaintiff’s right of property as ‘the right to the goodwill of his business.’593 But this
tidy resolution of the issue is not generally evident in the case law. In fact, in a
number of the earlier cases there was no explicit concern for damage to property at all.
Nevertheless, where the protection was directed to property in the business, it may be
argued that it boiled down to goodwill as the essence of business. In Star Industrial
Company Limited v. Yap Kwee Kor, Lord Diplock put the position succinctly:
A passing-off action is a remedy for the invasion of a right of property not in the mark,
name or get-up improperly used, but in the business or goodwill likely to be injured by
the misrepresentation made by passing off one person’s goods as the goods of another.
Goodwill, as the subject of proprietary rights, is incapable of subsisting by itself. It has
no independent existence apart from the business to which it is attached.594
These comments on the relationship of goodwill to business essentially echo those of
Lord Lindley in Muller where he said that ‘[g]oodwill regarded as property has no
meaning except in connection with some business, trade or calling. … goodwill is
590 257 US 312, 342-3 (1921). 591 (1880) 15 Ch D 247 at 258. 592 It is interesting to note that business was said to be a species of personal property in Primelife
(Glendale Hostel) Pty Ltd v. CSR [2004] VSC 214, a stamp duties case. However, this view must be seen as inconsistent with established authority. 593 [1939] 3 All ER 513 at 526. 594 [1976] 2 FSR 256 at 269 (PC).
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inseparable from the business to which it adds value … .’595 Therefore, in the light of
this relationship, damage done to a business amounts to damage done to its goodwill,
and vice versa. And such a relationship effectively resolves any conceptual problem
arising from the fact that business in itself is not property. This clears the way for an
examination of the place of property in the form of goodwill in the early case law.
9.5 Elements of early passing-off cases
9.5.1 The need for fraud
The elements of passing-off in the early cases preceding Spaldingv.Gamage were not
firmly established. Misrepresentation or deception has from the beginning been ‘the
very gist of the conception of passing off.’596 However, the misrepresentation was
routinely required to be fraudulent in nature until 1838 when fraud was held not to be
an issue in equity by the Lord Chancellor in Millingtonv.Fox.597 This was naturally
followed in another equity case, Perry v. Truefitt598 in 1842, where Lord Langdale MR
noted that the deception in a passing-off action did not need to be intentional.599
However, notwithstanding these early views, fraudulent deception remained the form
of misrepresentation required for an action to succeed, at least at law, in cases until the
end of the nineteenth century.600 Thus fraud was still playing a part in passing-off as
late as 1896 in Reddaway & Co v.Banham & Co601 in the House of Lords wherein
595 [1901] AC 217 at 235 (HL). 596 Per Green MR in Draper v. Trist [1939] 3 All ER 513 at 518. 597 (1838) 3 My & Cr 338; 40 ER 956. Lockhart J of the Federal Court of Australia recognized the significance of this case in Conagra Inc v.McCain Foods (Aust) Pty Ltd (1992) 23 IPR 193 at 200 where he proposed that ‘[i]t has been clear since 1838, when Millington v.Fox … was decided, that equity does not require proof of intention to deceive as a necessary ingredient in the course of action.’ 598 (1842) 6 Beav 66; 49 ER 749. 599 A fraudulent misrepresentation may still add evidentiary weight to an action, of course. This appeared to be the case in Franks v.Weaver (1847) 10 Beav 297; 50 ER 596 where Lord Langdale MR himself found that misrepresentation in question was fraudulent, but without stating that the fraud was necessary. In the later equity case of Dixonv.Fawcus (1861) 3 El & El 537; 121 ER 544, it was also held that fraud was not required for an action to succeed, indicating that fraud had ceased to be a requirement in equity. 600 In fact, fraudulent misrepresentation was considered a requirement in Australia as late as 1929 by the High Court in Turnerv. General Motors (Australia) Pty Ltd in the light of Isaacs J’s view that ‘[t]he court interferes solely for the purpose of protecting the owner of a trade or business from a fraudulent invasion of that business by somebody else’ ((1929) 42 CLR 352 at 362). However, Isaac J viewed the fraud as ‘not necessarily such as would support an action of deceit, but would be constituted by persistence after notice’ (at 362). Thus he seemed to see fraud in this context as a form of wilful misrepresentation. For a discussion of the historical differences between equity and law in passing-off and a reconciliation between them, see Morison, W., ‘Unfair Competition and “Passing-off”’, (1956) 2 Sydney Law Review 50. Lord Parker of Waddington in Spalding v.Gamage also made mention of the different approaches between equity and law, with only the latter requiring fraud: see (1915) 32 RPC 273 at 283. 601 [1895-9] All ER Rep 133 (HL).
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Lord Herschell stated that a person ‘has a right to insist that [a trade mark] shall not be
used … if such a use would be an instrument of fraud.’602 Nonetheless, it was
recognized in Spalding v.Gamage that fraud was not necessary, and this is clearly the
modern view as observed by Lord Oliver of Aylmerton in Reckitt and Colman Ltd v.
Borden Inc.603
9.5.1 The need for property
Regardless of the question of fraud in early passing-off cases, it is the question of the
presence of property which is of greater importance in this chapter. It will be argued
that a concern for protection of property, in essence goodwill, may be detected in
cases preceding Spalding v. Gamage.The protection of property of a business is at the
heart of an action for passing-off, explicitly so in its usual modern form. Moreover, it
is clear that it was also at the heart of many earlier cases, particularly those in equity.
Lord Eldon LC stated the fundamental position in Macaulay v. Shackell where he said
that ‘[a] court of equity has no criminal jurisdiction, but it lends its assistance to a man
who has … a right of property … .’604 The intention to protect property in passing-off
actions in the courts of equity was made clear by Malins V-C in Springhead Spinning
Company v. Riley where he said:
The jurisdiction of this Court is to protect property, and it will interfere by injunction to
stay any proceedings, whether connected with crime or not, which go to the immediate,
or tend to the ultimate, destruction of property, or to make it less valuable or
comfortable for use or occupation. It will interfere to prevent the destruction of
property.605
Thus the need for property in some form was evident from an early stage in the courts
of equity,606 although it was not so evident in the courts of law during at that time.
Nonetheless, property, effectively in the form of goodwill as argued in this chapter,
may be detected as an element in many of these cases, including those in the courts of
law. And, as discussed later, evidence of harm to goodwill stretching back to the late
sixteenth century may be detected.
602 Id at 142. 603 See (1990) 17 IPR 1 at 7 (HL). 604 (1827) 1 Bligh (NS) 96 at 127; 4 ER 809 at 820. 605 (1868) 6 LR Eq 551 at 558-9. 606 For example, Millington v.Fox in 1838 involved the protection of a proprietary right in a common law trade mark.
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However, notwithstanding the general lack of an explicit need for damage to property,
it is obvious that a plaintiff would need to have perceived some damage to his
reputation or business to justify taking action, as would be the case now. Thus in
Reddaway & Co v.Banham & Co607 Lord Herschell referred to property as something
appropriated or infringed by the defendant, which therefore was part of or evidence of
the deception or misrepresentation. Damage to property, therefore, may be inferred
from the case reports, with such damage often taking the form of loss of business and
profits. While business and profits were not property in themselves, damage to them
still amounted to damage to the goodwill of the business.
An issue commonly at stake in early passing-off cases concerned the infringement of
common law trade marks, which typically involved the use of a name or design to
mark distinctively the goods as those of the manufacturer.608 Whether property existed
in common law trade marks was a contentious issue. For example, Page Wood V-C in
1857 in The Collins Company v. Brown denied there was property in a trade mark,
saying that ‘[it] is now settled law that there is no property whatever in a trade
mark.’609 However, later in 1868 in Springhead Spinning Company v. Riley Malins V-
C took the contrary view in holding that trade marks were property for purposes of
protection. Lord Diplock certainly considered that common law trade marks were
property, but with certain limitations.610 Notwithstanding any doubt about property in
common law trade marks, it was recognized in The Collins Company v. Brown that
there was still a right to use such a mark to identify a person’s goods and to prevent
others from using that mark in a fraudulent manner. Consequently, a right, even if not
necessarily a property right, was still fundamental to the action.
607 [1895-9] All ER Rep 133; [1896] AC 199 (HL). 608 In General Electric Co v.The General Electric Co Ltd [1972] 2 All ER 507 (HL) Lord Diplock explained the nature of common law trade marks thus: ‘The use by manufacturers of distinctive marks on goods which they had made is of very ancient origin, but legal recognition of trade marks as a species of incorporeal property was first accorded by the Court of Chancery in the first half of the 19th century. … To be capable of being the subject-matter of property a trade mark had to be distinctive, that is to say, it had to be recognisable by a purchaser of goods to which it was affixed as indicating that they were of the same origin as other goods which bore the same mark and whose quality had engendered goodwill. Property in a trade mark could therefore only be acquired by public use of it as such by the proprietor and was lost by disuse. The property was assignable, transmissible and divisible, but only along with the goodwill of the business in which it was used’ (at 518-9). 609 (1857) 3 K & J 423 at 426; 69 ER 1174 at 1176. 610 See footnote 608 for Lord Diplock’s explanation of common law trade marks.
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9.5.2 Rights other than property
An early example where rights other than property rights were protected may be found
in the 1833 case of Blofeld v. Payne.611 In this case the plaintiff manufactured hones
for sharpening blades and wrapped them in a distinctive envelope to distinguish them
from other manufacturers’ hones. The defendants used envelopes resembling the
plaintiff’s to wrap their hones, whereupon the plaintiff claimed he had lost sales and
had also suffered injury to his reputation because the defendants’ hones were inferior.
On appeal, Littledale J stated that ‘[t]he act of the defendants was fraud against the
plaintiff; and if it occasioned him no specific damage, it was still, to a certain extent,
an injury to his right.’612 While it is unclear from this case just what right was injured,
it appears that it was simply a right to be protected against fraud613 rather than a
property right. Similarly, in Croft v. Day614 in 1843 the right was again identified as
the right to be protected against fraud. Moreover, as late as 1900 in Magnolia Metal
Companyv. Tandem Smelting Syndicate Ltd 615 and Payton & Co Ltd v. Snelling,
Lampard & Co Ltd616 the House of Lords felt comfortable in not considering any
specific rights or property such as goodwill as the subject of the claimed passing-off
infringements.
In the light of these cases, it is evident that the protection of property rights in the
early passing-off cases was not generally a specific requirement. Often, the right in
question was no more than a right to be protected against fraudulent
misrepresentation. Thus these cases differed in at least two respects from the usual
modern form of the action where fraud is no longer necessary and property in business
or goodwill must be damaged. Nonetheless, as argued in the next section, these
passing-off actions typically involved the protection of the sources of goodwill.
9.6 Goodwill in early case law
As already discussed, the early passing-off cases tended to focus on misrepresentation,
fraudulent or not, as the fundamental element, with other matters assuming various
611 (1833) 4 B & Ad 410; 110 ER 509. 612 Ibid. 613 This was noted by Lord Diplock in Erven Warnink BV v. J Townsend & Sons (Hull) Ltd [1979] 2 All ER 927 where he observed that the earlier law as represented by Reddaway v. Banham [1896] AC 199 did not extend beyond the particular form of misrepresentation which gives rise to a right of action, with no invasion of property required. 614 (1843) 7 Beav 84; 49 ER 994. 615 (1900) 17 RPC 477 (HL). 616 (1900) 17 RPC 628 (HL).
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levels of importance in the judgments. Nonetheless, judgments implying concern for
effectively protecting goodwill may be discerned from the earliest cases. In this
regard, it has been argued that goodwill has its sources in custom and hence trade or
business, including sales and profits, and in trade marks, names and reputation. And
damaging these sources in turn damaged goodwill.
Accordingly, in this section the origins of the passing-off action are first examined
with a view to detecting early evidence of damage to the sources of goodwill. Then a
selection of later cases will be examined under a range of headings representing
classifications of sources of goodwill to demonstrate their presence as the subject of
damage in these cases. Evidence of damage to these sources, it is argued, provides
support for the finding in Spalding v. Gamage that goodwill was the property in the
business damaged by the passing-off. Because goodwill typically may have more than
one source, these classifications are necessarily somewhat arbitrary, but serve the
purpose of examination. The first classification includes cases from the early period of
1584 to 1810 where the origins of passing-off may be found, together with concerns
for the sources of goodwill. Trade marks in general constitute the second classification
because infringement of trade marks was a common form of passing-off and trade
marks are a common source of goodwill. Place names as a specific source of trade
marks and trade names constitute the third classification. Fourthly, consideration is
given to damage to business and profits which has a direct effect on goodwill. Finally,
damage to personal reputation as a source of goodwill is discussed.
9.6.1 The origins of passing-off
As far back as 1618 in the case of Southern v. How617 there is a reference by
Doderidge J of the King’s Bench to what may be seen as a passing-off action in an
even earlier case from the Elizabethan period.618 The report states:
Doderidge said that 22 Eliz an action upon the case was brought in the Common Pleas
by a clothier that whereas he had gained great reputation for his making of his cloth, by
617 (1618) Poph 143; 79 ER 1243. 618 This case is cited as 22 Eliz. Baker, J. H. (2002, An Introduction to English Legal History, 4th ed., Butterworths, London, 459 – hereinafter Baker), reveals this case to be JG v. Samford (1584) (unreported). See also Baker J. H. and Milsom S. F. C. 1986, Sources of English Legal History, Private
Law to 1750, London, Butterworths, 615. Baker (at 459) comments on inconsistencies found in the printed references to this case, but nonetheless reports that the manuscripts of the case show that it was the first action for infringing a trade mark. However, Baker states that it seems no judgment was given in the case.
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reason thereof he had great utterance to his great benefit and profit, and that he used to
set his mark to his cloth, whereby it should be known to be his cloth: and another
clothier perceiving it, used the same mark to his ill-made cloth on purpose to deceive
him, and it was resolved that the action did lie well.619
This appears to be a classic case of passing-off, with the defendant practising a
deception in using the plaintiff’s common law trade mark to divert the plaintiff’s trade
to himself. In this case the plaintiff had gained a great reputation for his cloth and on
that basis had built up a profitable business, which he sought to protect with his
mark.620 This case is again referred to by Doderidge J in Dean v. Steel,621 which was a
case of defamation rather than deceit as in Southern v. How.622 Consequently,
Morison623 claims that this left the origins of passing-off somewhat ambiguous, but
nonetheless the clothier’s case was taken to be authoritative in later nineteenth century
cases.624 While fraudulent misrepresentation was obviously the basis of the action in
the Elizabethan clothier’s case,625 it may readily be seen that the elements of business
619 (1618) Poph 143 at 144. 620 Two other reports of Southern v. How may be found in The English Reports: (1618) Cro Jac 468; 79 ER 400 and 2 Roll Rep 26; 81 ER 635. The fact that there are three reports adds some confusion concerning the nature of the action in the Elizabethan case. For example, Wadlow (at 19) states that the former report has the clothier bringing and winning the case (contrary to the apparent reference to the customer), while the report cited above (Poph 143; 79 ER 1243) he claims cites the customer as the plaintiff. While is not entirely clear, it appears that it is more likely to be the clothier in this case. These differences illustrate the fact that these old and limited nominate reports are not reliable, especially so in this case where the third report (2 Roll Rep 26; 81 ER 635) apparently denies that Doderidge J identified the plaintiff but speculates that it was the customer. However, Morison W. L. (‘Unfair Competition and “Passing-off”’, (1956) 2 Sydney Law Review 50) reminds us that it is made explicit in the report of another case from the same period, Dean v. Steel (1626) Latch 188; 82 ER 339, where Doderidge J again brought the Elizabethan case to mind, that it was the clothier who was the plaintiff (see 54). Wadlow (at 19) questions the significance of this case, holding it to be an isolated one which does not appear to contribute much to the development of passing-off. Nonetheless, it may still be taken to be of significant historical interest, revealing an early basis for the later passing-off action. This was in fact recognized in a number of important nineteenth century cases. For example, it is referred to as an authority in Crawshay v. Thompson (1842) 4 Man & G 357; 134 ER 146, and in Burgess v. Burgess (1853) 3 De GM & G 896; 43 ER 351, a case which turned on a question of fraudulent misrepresentation, where Knight Bruce LJ remarked regarding such misrepresentation that ‘[t]he law on the subject is as old as Southern v. How …’ (at 906). Furthermore, Lord Halsbury LC recognized the Elizabethan case as the origin of passing-off in Magnolia Metal Company v. Tandem Smelting
Syndicate Ltd (1900) 17 RPC 477. 621 (1626) Latch 188; 82 ER 339. 622
Southern v. How involved an action to recover money paid by the plaintiff for what turned out to be counterfeit jewels – a case of fraud. It is stated at the beginning of the report of (1618) Cro Jac 468; 79 ER 400, inter alia, that ‘[d]eceitfully using the mark of a trader is actionable’, an obvious reference to passing-off, regardless of the substance of the action for fraud in this case. 623 Morison, W. L., ‘Unfair Competition and “Passing-off”’, (1956) 2 Sydney Law Review 50. 624 See footnote 620 for examples. 625 This essentially remains the case in the modern conception of the action, as Greene MR noted in saying that deception ‘is the very gist of the conception of passing off’ in Draper v. Trist [1939] 3 All
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and goodwill were a consideration also. It may be inferred that the action was
primarily sought to protect the plaintiff’s business and therefore his goodwill, even
though the concept of goodwill had not been formally developed at that time.626
Blanchard v. Hill627 in 1742 was another early passing-off case wherein the plaintiff
held a monopoly in the production of playing cards which he identified by way of a
distinctive mark. He complained that the defendant had used his mark to the prejudice
of his business by taking away his customers. This might appear to be a clear-cut case,
but Lord Hardwicke LC refused to grant an injunction against the defendant,
reportedly stating that:
Every particular trader has some particular mark or stamp; but I do not know any
instance of granting an injunction here to restrain one trader from using the same mark
with another; and I think it would be of mischievous consequence to do it.628
This seems to be a strange position to take, on the face of it. However, it appears from
the report that the Lord Chancellor took a set against the monopolistic playing card
charter which he deemed to be illegal and that may provide in large part the reason for
this decision. Norma Dawson confirms this view in a detailed analysis of this case in
its broader commercial context.629 Nevertheless, regardless of its basis, this decision
had very little impact on later cases.630 John Adams631 reports that, in a period shortly
ER 513 at 518. Of course, it is no longer necessary that the deception or misrepresentation be fraudulent. 626 The first case law reference to goodwill by name may be found in Gibblett v. Read (1743) 9 Mod 459. 627 (1742) 2 Atk 484; 26 ER 692. 628 Id at 485. 629 Dawson, N.,‘English Trade Mark Law in the Eighteenth Century: Blanchardv.Hill Revisited – Another ‘Case of Monopolies’?’, (2003) 24 Journal of Legal History 111. In summary Dawson states: ‘In Lord Hardwicke’s analysis, to enforce Blanchard’s “right” to the mark was to enforce the company’s monopoly before its validity had been established at common law (and he clearly doubted whether an action at law would succeed). Both principle and precedent precluded injunctive relief’ (at 134). 630
Blanchard v. Hill was reported by John Atkyns who had a very poor reputation for accuracy. This may perhaps provide some explanation for its apparent lack of influence as a precedent. Allen, C. K. 1964, Law in the making (7th ed.), Clarendon Press, Oxford states that Atkyns was a member of a class of reporters of little value and whom Lord Mansfield forbade to be cited to him. Furthermore, Wallace J. W. 1882, The Reporters (4th ed.), Carswell & Co, Edinburgh, said of Atkyns, amongst others: ‘… presenting frequently a defective state of facts; that the arguments, both of counsel and court, are often far from lucid, and that even the decree is sometimes wrongly given’ (at 511). More generally,Baker holds that the reports of the period 1650-1750 were mostly of an inferior nature, intended more for private use than for publication. See also Abbott L. W. 1973, Law Reporting in England1485-1585, The Athlone Press, London, 247-8. 631 Adams, J.,‘Intellectual Property Cases in Lord Mansfield’s Court Notebooks’, (1987) 8 Journal of
Legal History 18.
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after Blanchard v. Hill from 1769 to 1783, Lord Mansfield dealt with six passing-off
cases and states that his notebooks suggest that it had been settled at least by 1769 that
the law would protect names and marks. In the last of these cases, Singleton v.
Bolton,632 the defendant had sold a medicine under the same name as that used by the
plaintiff to sell his medicine. The plaintiff had not obtained a patent for this product.
Accordingly, Lord Mansfield found that the defendant had simply used the name and
mark of the original inventor, as had the plaintiff, and therefore the plaintiff had no
right of action. However, it would have been a different matter, according to his
Lordship, if the defendant had sold his own medicine under the name or mark of the
plaintiff; that would have been fraud. The only other ground for an action, Lord
Mansfield said, would have been to protect the property of the plaintiff, but since he
did not have a patent there was no property to protect. Thus Lord Mansfield did not
see this as a case of passing-off, but apparently one of legitimate business
competition. Nonetheless, the hallmarks of a classic early passing-off action may be
seen in the references to fraudulent deception and the protection of property as a
ground for the action. Of course, the protection of such property would have
amounted to protection of the business and its goodwill.
In Hogg v. Kirby633 in 1803 the defendants published a magazine under a title similar
to that used by the plaintiff, holding out that it was a continuation of the plaintiff’s
magazine. Lord Eldon LC held that the defendants’ actions were fraudulent and
granted an injunction restraining the defendants from publishing the work as that of
the plaintiff’s. However, Lord Eldon nonetheless gave consideration to the property to
be protected, finding it to be ‘literary property’ or copyright. Furthermore, he held that
the plaintiff had a right to have his sales of the magazine protected. Here, the
protection of a critical magazine copyright and the sales of that magazine may been
seen as the protection of the business and its goodwill. Fraud again featured in the
later landmark ‘goodwill’ case of Cruttwell v. Lye in 1810 where Lord Eldon said that
‘there can be no doubt that this Court would interpose against that sort of fraud which
has been attempted by setting up the same trade, in the same place, under the same
632 (1783) 3 Dougl 294; 99 ER 661. In contrast to the Atkyn’s work, this is a report by Sylvester Douglas who is rated by Baker as a reporter of a high standard. Allen also rates him as a superior reporter of the period. 633 (1803) 8 Ves Jun 215; 32 ER 336.
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sign or name: the party giving himself out as the same person.’634 But while fraud was
obviously occupying the mind of Lord Eldon, it is clear that protection of property in
the business was still his fundamental concern.
These early cases clearly indicate that the protection of business property from the
depredations of misrepresentation was a fundamental element. Accordingly, it may be
inferred from these cases that a nascent concept of goodwill arising from the
protection of trade marks and business was at the heart of the actions.
9.6.2 The place of trade marks
Imitating or infringing a trade mark was a common form of misrepresentation in the
developing days of passing-off. Thus in Sykes v. Sykes635 in 1824 the defendants had
marked their inferior goods with words and marks very similar to those used by the
plaintiff with the intention of deceiving the ultimate purchasers into thinking that the
goods were those manufactured by the plaintiff. The plaintiff’s declaration reveals that
he had suffered both a loss of sales and injury to his reputation as a result of the
defendants’ activities. Accordingly there may be seen an obvious reference to damage
to a business and its goodwill. While deceit was at the heart of the action, business and
goodwill may readily be perceived as a basic element of it. It would seem unlikely that
such an action would have been brought if the plaintiff had suffered no damage to his
business.636
The important equity case of Millington v. Fox637in 1838 required Lord Cottenham LC
to consider a bill by the plaintiffs seeking an injunction to prevent the defendants from
using common law trade marks and names associated with the plaintiffs’ manufacture
of steel. In this particular case, the defendants’ use of the marks had been innocently
undertaken as a result of their thinking that the marks and names were common
descriptions in the steel industry, and not those of the plaintiffs whom they did not
634 (1810) 17 Ves Jun 335 at 342; 34 ER 129. Cruttwell v. Lye provides the first definition of goodwill to be found in the case law. In this case Lord Eldon said: ‘The good-will, which has been the subject of sale, is nothing more than the probability that the old customers will resort to the old place’ (at 346). This is what is commonly known as site or local goodwill, that is, goodwill arising from customers’ familiarity with the site of the business and the activity it thus generates. 635 (1824) 3 B & C 541; 107 ER 834. 636 However, in Blofeld v. Payne (1833) 4 B & Ad 410; 110 ER 509, a case referred to in this chapter, the plaintiff succeeded in his action without producing proof of harm to his business. It did seem, however, that he considered that he had suffered harm, which no doubt motivated him to proceed with his action. 637 (1838) 3 My & Cr 338; 40 ER 956.
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know. Consequently, the Lord Chancellor accepted that there was no fraudulent
intention638 by the defendants in using the marks, which he considered distinguished
this case from the usual type. But he nonetheless granted the injunction because he
held that ‘there was sufficient in the case to show that the plaintiffs had a title to the
marks in question, and they undoubtedly had a right to the assistance of a court of
equity to enforce that title.’639 Here the property at stake was identified as the
plaintiffs’ title to the trade marks, but it was argued by the plaintiffs that the
defendants had been marking steel of inferior quality and thus had ‘injured the repute
of the plaintiffs’ manufacture.’640 Such injury to business reputation would be
expected to damage business and goodwill.
In 1842 in Perry v. Truefitt action was taken by the plaintiff to restrain the defendant
from selling ‘a greasy composition for the hair’ under a name that closely resembled
the name the plaintiff had been using to sell a similar hair product. The plaintiff
claimed that the name had developed great value to him as a trade mark and its
adoption by the defendant had deceived customers into buying the defendant’s
product to the detriment of his business. Lord Langdale MR was of the opinion that,
even at this early stage, the principle involved in a case such as this was ‘very well
understood’. He stated:
A man is not to sell his goods under the pretence that they are the goods of another
man; he cannot be permitted to practise such a deception, nor to use the means which
contribute to that end. He cannot therefore be allowed to use names, marks, letters, or
other indicia, by which he may induce purchasers to believe, that the goods which he is
selling are the manufacture of another person. I own it does not seem to me that a man
can acquire a property merely in a name or a mark; but whether he has or not a property
in the name or mark, I have no doubt that another person has not a right to use that
name or mark for the purposes of deception, and in order to attract to himself that
course of trade, or that custom, which, without that improper act, would have flowed to
638 As noted elsewhere in this chapter, the need for fraud in passing-off largely disappeared from equity following Millington v. Fox, but the need for it lingered longer in the courts of law. The modern position is that fraud is no longer material, as noted by Lord Oliver of Aylmerton in Reckitt and
Colman Ltd v. Borden Inc (1990) 17 IPR 1 (HL). 639 (1838) 3 My & Cr 338 at 352. 640 Id at 345.
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the person who first used, or was alone in the habit of using the particular name or
mark.641
Lord Langdale MR also added that the deception did not need to be intentional, but
regardless of intention, ‘a man … shall not be allowed to adopt the marks by which
the goods of another are designated, if the effect of adopting them would be to
prejudice the trade of such other person.’642 In this case, it was the ‘trade’ or ‘custom’
of the plaintiff which was under consideration, and such terms are obvious sources of
goodwill. Lord Langdale’s reference to the prejudice of the trade of the plaintiff as the
consequence of the passing-off can only mean damage to the value of the goodwill of
the business.
Then in the same year as Perry v. Truefitt there was also the case of Crawshay v.
Thompson643 where the plaintiff was an iron manufacturer and exporter who marked
his iron bars with a distinctive mark. This iron was claimed to be of a superior quality
which gave rise to a good reputation and high demand. The defendant, according to
the plaintiff’s claim, had impressed his inferior iron with a mark similar in appearance
to that of the defendant’s with the intention of injuring his sales and depriving him of
significant profits. To emphasize his plight, the plaintiff claimed that his reputation
and business had been injured. The plaintiff ended up being unsuccessful in his action,
but again there can be clearly seen the presence of harm to business and hence
goodwill as the basis of the claimed passing-off.
The question whether common law trade marks constituted property, as already raised
in this chapter, cropped up as an issue from time to time in the nineteenth century,
with the balance of judicial opinion finding them to be property. For example, in the
trade mark infringement case of Edelsten v. Edelsten644 in 1863, the plaintiff was a
manufacturer of wire which had acquired a high reputation in the trade. The defendant
had adopted a similar trade mark in order to profit from the plaintiff’s reputation as a
manufacturer of superior wire for which he was able to charge a higher price. Lord
Westbury LC stated that the question was whether the plaintiff had property in the
trade mark such that the defendant’s use of a similar mark would constitute an
641 (1842) 6 Beav 66 at 73. However, in this case the judge declined to grant an injunction, finding in effect that the evidence for it was not compelling enough. 642 Ibid. 643 (1842) 4 Man & G 357; 134 ER 146. 644 (1863) 1 De G J & S 185; 46 ER 72.
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invasion of this property. He answered the question in the affirmative and upheld the
injunction previously imposed on the defendant at trial. In this case, as in others
discussed in this chapter, the trade mark may readily be seen as an important source of
goodwill of the business. The adoption of another’s mark, with a consequent detriment
to his profits, constitutes an invasion of that person’s business goodwill.
The House of Lords certainly saw property in trade marks, as in the case of Leather
Company Co v. American Leather Cloth Co645 where Lord Cranworth was of that
view. This view is further illustrated by a later appeal to the House of Lords in The
Singer Manufacturing Company v. Loog646 in 1882 where the plaintiff had complained
that the defendant had been using the trade name ‘Singer’ in connection with his
sewing machines for the purpose of passing them off as the manufacture of the
plaintiff. While the resolution of the case is of no consequence here, Lord Blackburn
thought it settled on the authority of Hall v. Barrows647 that both trade marks and trade
names were in a certain sense property and that the right to use them passed with the
goodwill of the business. Thus Lord Blackburn was prepared to view common law
trade marks as a form of property with rights to be protected.648 But to the extent that
marks and names constituted property they were annexed to goodwill, as later
propounded by Lord Diplock in General Electric Co v. The General Electric Co
Ltd.649 Consequently, once again, it may be seen that effectively goodwill was the
property to be protected.
In his exposition of the history of trade marks in GEC, Lord Diplock stated that the
right of property in a common law trade mark had special characteristics, including
that ‘it was an adjunct of the goodwill of a business and incapable of separate
existence dissociated from that goodwill.’650 This common law position was reflected
in the Trade Marks Registration Act 1875 (UK) which introduced a system of
645 (1865) 11 HL Cas 523; 11 ER 1435. 646 (1882) 8 App Cas 15 (HL). 647 (1863) 4 De GJ & S 150; 46 ER 873. In this case Lord Westbury LC saw a common law trade mark as ‘a valuable property’ of a business and one which ‘may be properly sold’ with the business. 648 However, there seemed to remain some questions whether there could be property in a strict sense in a common law trade mark. For instance, Lord Parker of Waddington in Spalding v. Gamage entertained some doubt about the status of such trade marks as property: see footnote 655. Nonetheless, as indicated in cases considered in this chapter, the courts of equity were generally prepared to see property rights in common law trade marks and sought to protect those rights, while the courts of law were more inclined to focus on fraud as the basis for a passing-off action. 649 [1972] 2 All ER 507 (HL). 650 Id 518.
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registration of trade marks to provide statutory protection for such marks. Section 2 of
that Act provided, inter alia, that the trade mark when registered ‘shall be assigned
and transmitted only in connexion with the goodwill of the business’. Consequently, it
is apparent that goodwill was seen to be inextricably bound up with trade marks which
were commonly the subject of infringement in passing-off actions. If the property
being protected comprised limited rights under common law to protect a trade mark,
and that trade mark was connected with goodwill, then it may be argued that goodwill
also was being protected by association. In fact, Lord Diplock recognized trade marks
specifically as a source of goodwill in holding that goods bearing a particular mark
‘engendered goodwill.’651 And it appears from Lord Diplock’s exposition, and the
Trade Marks Registration Act 1875, that the relationship between trade marks and
goodwill was commonly recognized. Nevertheless, with perhaps one exception,652 this
is not directly evident from the passing-off cases themselves. If this somewhat simple
relationship had been commonly recognized, it would be reasonable to expect that it
would have been referred to in at least some of the cases before this Act came into
effect.653 But, instead, we have Lord Parker of Waddington advising us of the true
situation at the relatively late stage of the early twentieth century.
While the balance of judicial opinion supported property in common law trade marks,
some doubts remained. As noted previously, a contrary view of common law trade
marks as property, albeit an early one, may be found in The Collins Company v.
Brown654 where Page Wood V-C was of the opinion that there was no property in the
plaintiff’s trade mark. However, the Vice-Chancellor still held that the deliberate
passing off of the plaintiff’s trade mark by the defendant constituted fraud and
651 Id 519. 652 In The Singer Manufacturing Company v. Loog (1882) 8 App Cas 15 (HL), as noted elsewhere in this chapter, Lord Blackburn considered that the right to use trade marks and trade names passed with the goodwill of a business. 653 However, the relationship between goodwill, trade marks and the business was addressed in Shipwright v. Clements (1871) 19 WR 599 where Malins V-C said (at 600): ‘The sale of a business is a sale of the goodwill. It is not necessary that the word “goodwill” should be mentioned. … In the sale of a business a trade mark passes whether specifically mentioned or not.’ This was not a passing-off case, but in part concerned an action by the plaintiff to restrain the defendant from using a trade mark that he claimed had been assigned to him on the purchase of the business from the defendant. The plaintiff succeeded in view of the fact that the Vice-Chancellor saw the sale of an entire business as implying the sale also of both the goodwill and relevant trade marks of that business. Later, in Levyv. Walker (1879) 10 Ch D 436, the Court of Appeal dealt with the relationship between business, goodwill and a partnership business name. James LJ said that ‘the sale of the goodwill and business conveyed the right to the use of the partnership name’ (at 449). 654 (1857) 3 K & J 423; 69 ER 1174.
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therefore remedy was available. Thus the plaintiff had a right to restrain others from
using the trade mark for drawing customers away from its business to its detriment. In
a case like this, however, the infringement of the trade mark may be seen as no more
than evidence of passing-off. In retrospect, following Spaldingv.Gamage, the question
of whether common law trade marks constituted property may be seen as a non-issue,
because the property being protected from damage was effectively the goodwill in the
business. In fact, doubts about property in trade marks influenced Lord Parker of
Waddington’s identification of goodwill in Spaldingv.Gamage as the property harmed
in passing-off.655 In his landmark pronouncement, he preferred to see harm to property
in the goodwill rather than in a trade mark or name as an element of the passing-off.
9.6.3 Place names
The right to use a place name as a trade name or mark arose in Seixo v. Provezende656
in 1865 where the plaintiff was a port wine producer whose wine brand had acquired a
great reputation. This wine was known as Crown Seixo, based on the name of the
plaintiff, but a name claimed by the defendant to have a more general regional
meaning also. Thus the defendant had adopted branding for his wine using names and
marks similar to the plaintiff’s, arguing that he had a right to do so in view of the
regional nature of the name. However, Lord Cranworth LC held that the plaintiff was
entitled to all the advantages of the ‘celebrity’ of his product, including the greater
demand for and the higher price paid for a superior product. And this was the case
notwithstanding that the branding or mark allegedly related to a place name.
The question of rights associated with using a place name as a trade name also arose
in the House of Lords’ case of Montgomery v. Thompson657 in 1891 where the
plaintiffs had for many years brewed ales known as Stone Ales and Stone Ale, named
after the town of Stone where they had owned the only brewery in the town. Then the
defendant had set up a brewery at Stone, with the intention of using the name of the
town to designate his ales too. As these names were not registered trade marks, the
655 Lord Parker of Waddington had the following to say on common law trade marks ((1915) 32 RPC 272 at 284): ‘ … the property, if any, of the so-called owner is in its nature transitory, and only exists so long as the mark is distinctive of his goods in the eyes of the public or a class of the public. Indeed, the necessity of proving this distinctiveness in each case as a step in the proof of the false representation relied on was one of the evils sought to be remedied bythe Trade Marks Registration Act 1875, which conferred a real right of property on the owner of a registered mark.’ 656 (1865) LR 1 Ch 192. 657 [1891] AC 217 (HL).
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defendant argued that he had a right to use the name of the town. However, since the
plaintiffs’ ales had acquired an eminent reputation and were known by their names to
the consumers, the Lords affirmed the injunction imposed and upheld in the lower
courts. The brand was very well-known and clearly associated with the plaintiffs’
product in the minds of the consumers, such that Lord Macnaghten made the
memorable observation that ‘[t]hirsty folk want beer, not explanations.’658 In other
words, any attempt by the defendant to distinguish his ales while using the same name
as the plaintiffs’ would have been futile, with the consequent risk that consumers
would have confused the products to the detriment of the plaintiffs’ trade. Lord
Macnaghten had previously noted that the lower courts were satisfied that the
defendant had opened his brewery in Stone ‘simply with the object of stealing the
plaintiffs’ trade, and in the hope of reaping where he had not sown.’659 Of course,
reaping what is effectively the goodwill of others is a consistent theme in these early
cases. Again, whether these particular unregistered trade marks were property or not
was not an issue because the property damaged came down to goodwill resulting from
the damage to trade.
9.6.4 Damage to business and profits
In Croft v. Day660 in 1843 the plaintiffs were the executors of the estate of a blacking
manufacturer whose business they were carrying on. The defendant had been passing
off his blacking product as that of the plaintiffs’ by way of very similar bottling and
labelling and by using the same business name.661 Lord Langdale MR stated:
… in my opinion, the right which any person may have to the protection of this court
does not depend upon any exclusive right which he may be supposed to have to a
particular name, or to a particular form of words. His right is to be protected against
fraud, and fraud may be practised against him by means of a name, though the person
658 Id at 225. 659 Id at 223. 660 (1843) 7 Beav 84; 49 ER 994. 661 The use of the same business name was sharp device on the part of the defendant who happened to be the nephew of the deceased manufacturer, with the same surname of Day. The previous business name had been ‘Day and Martin’, after the names of the original partners. Martin had later transferred his interest in the business to Day, but allowed his name to continue in the business. The defendant had contrived to enter into partnership with a person of the name of Martin and then claimed he had a right to use the business name of ‘Day and Martin’ also. However, as noted by Jacob LJ in Reed Executive
plc v. Reed Business Information Ltd [2004] EWCA Civ 159, the attempted use of a family name in this general manner is prevalent in the case law.
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practising it may have a perfect right to use that name, provided he does not accompany
the use of it with such other circumstances as to effect a fraud upon others.662
In this particular case, Lord Langdale MR was of the opinion that the defendant was
acting in a way, including the use of a similar business name, ‘as to deceive and
defraud the public, and obtain for himself, at the expense of the plaintiffs, an undue
and improper advantage.’663 Here we have a fraud practised on both the public, the
customers presumably, and on the plaintiffs at the cost of their business and
consequently its goodwill.
The relationship between deception and damage to business or goodwill came under
consideration in the 1847 case of Rodgers v. Nowill664 where Wilde CJ took account
of injury to the plaintiffs by way of loss of profits as a consequence of the deception.
His fellow judge, Coltman J, saw damage as a condition for a successful action in
stating that ‘an action is clearly maintainable by the party whose name is fraudulently
used, if any damage results to him from the false representation.’665 Moreover, Maule
J opined that ‘such [deceptive] conduct towards a trader naturally imports damage.’666
Thus there was a clear recognition of the place of damage to the business in this case,
implying goodwill as an element. Goddard LJ in Draper v. Trist was of this view,
saying ‘I think that Rogers v. Nowill shows that, once one has established passing off,
there is injury to goodwill … .’667
In Payton & Co Ltd v. Snelling, Lampard & Co Ltd668 in 1900 the plaintiffs claimed
that the defendants had passed off their coffee in tins with labels similar to that of the
plaintiffs. The Lords affirmed the Court of Appeal’s decision to dismiss the claim,
with Lord Macnagthen saying of the defendants that he did not see any intention ‘to
662 (1843) 7 Beav 84 at 88. 663 Id at 90. 664 (1847) 5 CB 109; 136 ER 816. A major text on trade marks cites Rodgers v. Nowill as a prime example of a fundamental problem with seeking to protect common law trade marks against infringement: see Blanco White T. A. and Jacob, R. 1972, Kerly’s Law of Trade Marks and Trade
Names, 10th ed., Sweet and Maxwell, London, 5. The authors report that the case lasted five years and cost the plaintiff £2,211 without giving him the security of protection against any subsequent infringer. This problem was one of the evils intended to be remedied by the introduction of the Trade Marks Registration Act 1875. 665 Id at 126-7. 666 Id at 127. 667 [1939] 3 All ER 513 at 527 (CA). 668 (1900) 17 RPC 628 (HL).
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steal the trade of the plaintiffs’.669 This was a case which turned very much on the
evidence presented, with much consideration given to the ‘get-up’ in the defendants’
labels and their similarity to the plaintiffs.’ Lord Macnaghten, with whom the other
Lords agreed, seemingly felt comfortable in not considering any specific rights or
property as the target of the claimed passing-off infringement, even at this relatively
late time of 1900. But nevertheless protection of the plaintiffs’ trade, and hence
goodwill, was at the basis of the decision.
Again in 1900 in Magnolia Metal Company v. Tandem Smelting Syndicate Ltd670 the
House of Lords may be found deliberating on a question of passing-off by way of the
defendants’ appropriation of the names used by the plaintiffs for their products. Lord
Halsbury LC found this to be ‘a very well known and familiar form of action … well
recognized … certainly for the last 250 years’671 arising from Southern v. How where
the Elizabethan clothier’s case was cited.672 It is notable that the Lord Chancellor saw
this ancient case as authority for a right of action where there is an infringement of the
reputation which a person has in the goods of his manufacture. Beyond identifying
this right, however, he did not concern himself with the harm done to property in any
direct or explicit sense. Nevertheless, the reference to business reputation, as argued
elsewhere in this chapter, may be taken as a reference to an important source of profits
and of goodwill.
9.6.5 Personal reputation
Goodwill arises from business activities and is inseparable from the business, while
still being recognized as property in its own right. This raises a question about
passing-off where personal reputation and name are at the heart of business
operations.673 For example, it is common practice for well-known people or
669 Id at 634. 670 (1900) 17 RPC 477 (HL). 671 Id at 483. 672 This case has been discussed elsewhere in this chapter. 673 In this particular context, personal reputation needs to be distinguished from that form of goodwill which may be described as personal goodwill. This is goodwill that it is attached to a business and arises from the personal characteristics of a person associated with that business, as noted earlier. But personal reputation such as that enjoyed by celebrities is not itself goodwill because it is a personal characteristic or quality which is not transferable as property. However, as argued in this chapter, personal reputation may be an important source of personal goodwill. Personal goodwill, as distinct from personal reputation, may be conveyed as property with the business on sale, and in a practical sense by way of the person in question introducing and recommending customers to the purchaser of the business. The recognition of personal goodwill, however, was a contentious issue in the early period of its development as a legal concept during the nineteenth century, until general acceptance at the end
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‘celebrities’ to lend their names and reputations to others in sponsoring or endorsing
their goods or services, as part of a practice often referred to broadly as ‘character
merchandising’.674 Do such persons have sufficient standing to restrain in a passing
off action the false representation by others that their goods or services are sponsored
by the plaintiff? In other words, do persons in this type of situation have goodwill
which may suffer damage in order to support an action for passing-off? Wadlow
answers that:
… the concepts of trader and goodwill are very widely interpreted so as to cover
virtually every economic activity. The action for passing-off is therefore open to the
liberal professions, entertainers, artists, writers and almost anyone who can be said to
derive an income from the provision of goods or services.675
Moreover, in Erven Warnink Lord Diplock observed that ‘the concept of goodwill is
in law a broad one,’676 thus opening the way for a flexible approach in the context of
passing-off. Similarly, Gummow stated that ‘the tort is firmly tied to protection … of
business or commercial goodwill, however flexible the concept of goodwill may
be.’677 Authority for such a flexible approach may be found in the relatively modern
Australian case of Henderson v. Radio Corporation Pty Ltd.678 In this case the
defendant had placed the photograph of a well-known professional ballroom dancing
of that century: see Tregoning, I., ‘Lord Eldon’s Goodwill’, (2004) 15(1) King’s College Law Journal 93 at 97-100. 674 However, it may be argued that the term ‘character merchandising’ is more appropriately applicable to fictional characters where clearly there is property in the name or the image. See McKeough, J., ‘Character Merchandising: Legal Protection in Today’s Marketplace’, (1984) University of New South
WalesLaw Journal 97 for a discussion of the property protection which may be afforded fictional characters and images. Personal ‘celebrity’ endorsements, on the other hand, rely on the reputations of real persons and thus may be placed in a different category. Hence, these may be referred to as personal endorsements or sponsorships. See Terry, A., ‘Exploiting Celebrity: Character Merchandising and Unfair Trading’, (1989) 12 University of New South WalesLaw Journal 204 (note 1) for a reference to this distinction. See also Hylton, M. and Goldson, P., ‘The New Tort of Appropriation of Personality: Bob Marley’s Face’, (1996) 55(1) Cambridge Law Journal 56 concerning the appropriation of real persons’ images in passing-off. 675 Wadlow at 7. 676 [1979] 2 All ER 927 at 932. 677 Gummow, W. M. C., ‘Carrying On Passing Off’, (1974) Sydney Law Review 224 at 226. 678 [1960] SR (NSW) 576. The Full Court of the New South Wales Supreme Court upheld the grant of an injunction against the defendant. Manning J stated: ‘The result of the defendant’s action was to give the defendant the benefit of the plaintiffs’ recommendation and the value of such recommendation and to deprive the plaintiffs of the fee or remuneration they would have earned if they had been asked for their authority to do what was done’ (at 603). In addition, Evatt CJ and Myers J said that ‘the wrongful appropriation of another’s professional or business reputation is an injury in itself’ (at 595). Therefore, the action was successful on the basis of the loss of fees suffered by the plaintiffs from the passing off of their endorsement by the defendant. This bears a close resemblance to the early cases referred to in this chapter where a loss of profits was at the basis of the action.
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couple on the cover of a record which was marketed primarily for use by dancing
teachers. This amounted to an endorsement by use of the plaintiff’s image, which was
done by the defendant without the plaintiffs’ permission and without any payment to
them. In Australia, at least, it is clear that the modern form of the tort accommodates
character merchandising and personal endorsements as evidenced by cases such as
Henderson and Hogan v. Koala Dundee Pty Limited.679 A person who wrongfully
appropriates another person’s name or reputation for commercial purposes lays
himself open to an action for passing-off. To this end, the case law in Australia tends
to indicate that a person’s reputation may be treated as property for the purposes of
passing-off.680 Whether personal reputation is strictly property may be open to debate,
but it is still something of value which may be exploited commercially. However, in
keeping with the theme of this chapter, personal reputation may in fact be viewed as a
source of goodwill, thus rendering redundant the question of whether personal
reputation is property. This view is based readily on the premise that the activity of
providing endorsements may be taken as a business. Therefore, as a business, it will
have goodwill attached to it. In such a business, personal reputation may be seen as
the major, if not the sole, source of the goodwill. In terms of the categories of
goodwill introduced earlier, this type of goodwill may be categorized as name
goodwill. The unauthorized appropriation of a person’s name amounts to an assault on
his goodwill in this analysis. Consequently, this constitutes damage to the goodwill of
the person, either by damage directly to his reputation or by the loss of fees income.
Both have a deleterious effect on the sources of goodwill.
The issue of appropriating a personal reputation to the detriment of that person is not
new as evidenced by Archbold v. Sweet681 in 1832. In this case the plaintiff had sold
the copyright of his greatly esteemed law textbook to the defendant who then
published another edition of it, indicating on the title page that it had been edited by
the plaintiff, which it had not. This edition, unfortunately, was a sloppy piece of work
which contained many errors and as a result the plaintiff claimed that his credit as an
author had been injured by these mistakes. The jury found for the plaintiff. Even
679 (1988) ATPR 40-902. 680 See, for example, Hogan and discussion in Terry, A., ‘Exploiting Celebrity: Character Merchandising and Unfair Trading’, (1989) 12 University of New South Wales Law Journal 204. 681 (1832) 5 Car & P 219; 172 ER 947.
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earlier in 1816 in Lord Byron v. Johnston682 there may be found another example of
the passing off of literary work to the detriment of the plaintiff’s reputation. The
defendant had published a volume of poems, falsely claiming them to have been
written by Lord Byron who successfully moved for an injunction to restrain the
defendant.
In 1848 in Clark v. Freeman683 the plaintiff, an eminent physician, sought an
injunction to restrain the defendant from selling patent medicines by falsely
advertising them as sanctioned and prescribed by the plaintiff. This, the plaintiff
claimed, was injurious to his professional reputation and consequently calculated to
diminish his professional income. Lord Langdale MR saw the position thus:
My notion is that the Court can interfere in cases of mischief being done to property by
the fraudulent misuse of the name of another, by which his profits are diminished.
Where the legal right is established the Court usually interferes. … If … you find that
an injury is thereby done to the plaintiff’s property, or to his means of subsistence or of
gaining a livelihood, I will not say that in such a case the Court might not interfere by
injunction … .684
Lord Langdale refused an injunction in this case, however, finding that the action was
actually one of libel for which he held there was no remedy in a court of equity. This
decision was later deemed to be erroneous,685 but notwithstanding that, the Master of
the Rolls clearly still saw injury to the plaintiff’s capacity to make profits as an
element of a successful passing-off action.
These early cases reveal clear signs of the courts’ willingness to protect valuable
personal reputations, as was also the case in Henderson which may seen as a direct
descendant of these cases. Consequently, it is apparent that the law of passing-off has
not changed substantially since these early times when it comes to the protection of
personal reputation and the opportunity to exploit it commercially. As argued already,
harm to personal reputation of a commercial nature constitutes harm to a source of
682 (1816) 2 Mer 29; 35 ER 851. 683 (1848) 11 Beav 112; 50 ER 759. 684 Id at 117-8. 685 In Springhead Spinning Company v. Riley (1868) 6 LR Eq 551 it was suggested on the authority of Maxwell v. Hogg (1865) LR 2 Ch 307 that Clark v. Freeman could have been decided in favour of the plaintiff on the grounds that he had property in his own name. Whether a name in this sense is property is questionable, but the need for property of some sort was evident even in this period.
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goodwill. Furthermore, as also argued in this chapter, many of the early cases dealt
with the protection of goodwill by the protection of its sources, but there was not the
constraint of needing specifically to identify property as the subject of the passing off.
Moreover, if business rather than goodwill were to be treated as the subject then that
term, representing general commercial activity, would be flexible enough to
accommodate the broad range of situations where plaintiffs may suffer harm to their
income-earning potential as a consequence of passing-off. In fact, business as an
alternative to goodwill has generally been referred to as the primary subject of harm in
cases both before and after Spalding v. Gamage. And the nature of business, as
distinct from goodwill per se, has the flexibility to accommodate harm to income-
earning capacity in a broader sense. Nonetheless, it may be seen that any harm to
business will inevitably harm its goodwill and vice versa, given the inseparable
relationship between the two concepts.
9.7 The relationship of goodwill to business
9.7.1 Can goodwill be separate from the business?
At general law, goodwill is a particular species of personal property which is attached
inseparably to the business and cannot exist independently of it.686 However, is this
well-established position somehow different in the context of passing-off? Wadlow
raises this question and puts the position thus:
The form of words used by Lord Parker in Spalding v. Gamage and by Lord Diplock in
Star and Advocaat [Erven Warnink] contemplates that the damage which is the basis of
the action for passing-off may be caused either to the business or to the goodwill of the
claimant. This raises the question of whether the two can ever be separate. May the
claimant in a passing-off action have a business but no goodwill, or goodwill without a
business? To appreciate the significance of this it must be remembered that the English
tort of passing-off only protects a business or goodwill so far as it exists in England.
Although goodwill can probably only be created as a result of trading activities it does
not follow that trader must have a business in England for goodwill to exist here [in
England].687
Wadlow’s proposition is that goodwill may somehow exist apart from the business;
that is, goodwill may exist in a jurisdiction where there is no business presence, even
686 See ch. 4, para. 4.4. 687 Wadlow at 113.
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though business or trading is needed to create that goodwill. Wadlow seems to base
his view on the compound notion of ‘business or goodwill’, addressed earlier in this
chapter, raising a question of the possible separation of the two notions and then
answering the question with his proposition, for which he offers no authority. This
proposition, in fact, raises two related issues: (1) whether goodwill can be separated
from the business, an issue dealt with in this section; and (2) whether goodwill can
exist in a jurisdiction without the presence of business, an issue dealt with in the
following section. The related nature of these issues occasions some overlap between
them and some repetition necessarily arises in the following section as a result.
The existence of a business is a question of fact, as is its presence in a particular
jurisdiction. Given the legal position that goodwill is inseparable from the business,
the goodwill must be where the business is, and not somewhere else. However, some
questions have been raised in the case law about the appropriateness of taking the
legal meaning of goodwill from other areas of the law, notably revenue law, and
applying that meaning to passing-off. For instance, Lockhart J of the Federal Court of
Australia took up this question in Conagra Inc v. McCain Foods (Aust) Pty Ltd in
supporting the notion of reputation as the subject of protection in passing-off rather
than goodwill. In this regard, he said:
Reputation is the key business facet that passing-off protects. In my view, the
‘requirement’ of goodwill was not meant to have a different meaning to reputation and
its inclusion only serves to complicate the matter. Further, by using the notion of
reputation as distinct from goodwill, the law of passing off is not trammelled by
definitions developed in the field of revenue law.688
In Conagra, Lockhart J made an extensive survey of the case law, across several
jurisdictions, on the question of the required connection with a jurisdiction for a
successful passing-off action and came to the following conclusion:
688 (1992) 23 IPR 193 at 231-2. Lockhart J also cited the Canadian case of Orkin Exterminating Co Inc
v. Pesto Co of Canada Ltd (1985) 19 DLR (4th) 90 where he reported that Morden JA espoused a similar view concerning the appropriateness to passing-off of the definition of goodwill in Muller (23 IPR 193 at 221). Prima facie, these statements may be seen as examples of ‘the fallacy of the transplanted article’ as espoused by Neil Brooks and noted in chapter 5 at 5.3.2. However, it is arguable that the definition and concept of goodwill from other areas of the law are appropriate for passing-off. At least there is nothing of substance in the law of passing-off which clashes with the general law concept of goodwill, a matter dealt with in this chapter.
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… I am of the opinion that it is not necessary in Australia that a plaintiff, in order to
maintain a passing off action, must have a place of business or a business presence in
Australia; nor is it necessary that his goods are sold here. It is sufficient if his goods
have a reputation in this country among persons here, whether residents or otherwise, of
a sufficient degree to establish that there is a likelihood of deception among consumers
and potential consumers and of damage to his reputation.689
By substituting reputation for goodwill, Lockhart J sought to overcome a perceived
difficulty with the requirement for a business presence and goodwill in a particular
jurisdiction to support a passing-off action. However, is such an approach really
needed? The essence of passing-off involves misrepresentation leading to damage to
the goodwill of a business. If the misrepresentation can be shown, as a matter of fact,
to have damaged business activities and therefore the goodwill of the plaintiff, then
the need to prove the presence of business and goodwill in the jurisdiction in question
may be effectively dispensed with. In other words, the need to separate goodwill from
business may be dismissed as irrelevant. There is no reason for taking a different view
of goodwill from that of general law for the specific purposes of passing-off.
9.7.2 Is goodwill extinguished on cessation of business?
Wadlow asserts that ‘[i]t is well established that a passing-off action may succeed if
the goodwill of the former business still exists, even if the business itself ceased
several years ago.’690 He invokes the passing-off case of Norman Kark Publications
Ltd v. Oldhams Press Ltd691 as authority for this assertion. Later, the same author
similarly asserts that:
The goodwill in a business is not necessarily extinguished immediately if the owner
ceases to trade. This has been recognized by the Privy Council, and there are numerous
cases of claimants succeeding in passing-off actions even though they may have been
out of business for several years.692
However, given the nature of goodwill as inseparable from the business, it is most
difficult to see how goodwill could survive the cessation of the business. And, in fact,
Norman Kark does not support this position. The plaintiff company in this case owned
689 (1992) 23 IPR 193 at 235. 690 Wadlow at 113. 691 [1962] RPC 163. 692 Wadlow at 232.
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a magazine name, but the magazine had been amalgamated with another magazine
also owned by the plaintiff and the name became incorporated into the other
magazine. The plaintiff claimed that the name lived on as a valuable right, as a name it
might use again sometime in the future, and thus acted to restrain the defendant from
using the name for its magazine. However, the plaintiff lost the case because the court
held that it did not retain a right to the name such that it could exclude the defendant
from using it. Here it was the magazine name that had ceased to exist, in effect, and
not the business (of the plaintiff company) which owned the name. Consequently, no
support may be found in this case for the proposition that goodwill may survive the
cessation of a business. Furthermore, Wadlow cites Star Industrial Co Ltd v. Yap
Kwee Kor693 as authority for his second assertion on the same theme. Again, and with
respect, there is nothing in this Privy Council case to support this assertion. To the
contrary, the Privy Council stated that ‘[g]oodwill, as the subject of proprietary rights,
is incapable of existing by itself. It has no independent existence apart from the
business to which it is attached.’694 This position, of course, may be sourced back to
the House of Lords in Muller in 1901.
Therefore, it should be maintained that goodwill lives or dies with the business to
which it is attached, and that the law of passing-off does not provide any view to the
contrary. It is obviously possible for a reputation in a product (eg a brand name) to
persist for a time beyond the cessation of the business producing that product. But that
does not mean that goodwill lives on if the business has ceased. The brand name and
reputation may be seen as sources of the goodwill of the business, but the brand and
its reputation in themselves are not the goodwill. There is nothing in the law of
passing-off that supports a view that goodwill itself survives a business.
Nonetheless, there may be some scope for holding that goodwill still exists where a
business has not ceased completely. A temporary cessation of business may thus still
justify an action for passing-off where it can be shown that there is an intention to start
the business again at some time in the future. Whether a business has ceased
completely or only temporarily is a question of fact and degree, as is the general
693 [1976] FSR 256 (PC). 694 Id at 269.
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question of whether a business exists.695 In Ad-Lib Club Ltd v. Granville Pennycuick
V-C addressed this question in the context of passing-off, stating:
It must be a question of fact and degree at what point in time a trader who has either
temporarily or permanently closed down his business should be treated as no longer
having any goodwill in that business or in any name attached to it which he is entitled
to have protected by law.696
However, the existence of a business and its associated goodwill is always a question
of fact and degree, and this applies equally in determining the cessation, permanent or
temporary, of a business. To restate the point made above, there is nothing in the law
of passing-off which alters this position.
9.8 Jurisdictional issues
The legal concept of goodwill comprises legal rights which must be recognized and
enforced within a jurisdiction. Thus in passing-off it must be shown that there is a
connection with the particular jurisdiction where the action is taken, requiring
normally the presence of a business and its associated goodwill in that jurisdiction.
This requirement raises two questions. First, what constitutes a suitable connection
with a jurisdiction? The idea of goodwill having to be located somewhere was raised
in IRC v. Muller & Co’s Margarine Ltd where Lord Macnaghten opined: ‘one
attribute common to all cases of goodwill is the attribute of locality. … It must be
attached to a business.’697 Further, Lord Lindley in the same case said: ‘I am not
aware of any case in which goodwill, as property, has been treated as having no
locality for legal purposes.’698 Secondly, does the requirement of location in or
connection with a jurisdiction mean that a business will have a separate goodwill in
each jurisdiction in which it operates? In Star Industrial Co Ltd v. Yap Kwee Kor the
Privy Council said concerning goodwill that ‘[i]t is local in character and divisible; if
the business is carried on in several countries a separate goodwill attaches to it in
each.’699
695 For a review of the tests which courts may apply to determine the existence of a business, see Ferguson v. FCT (1979) 79 ATC 4261 (Full FC). 696 [1972] RPC 673 at 677. 697 [1901] AC 217 at 224 (HL). 698 Id at 237. 699 [1976] FSR 256 at 269.
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9.8.1 Goodwill v. reputation
In connection with the first question of a suitable connection with a jurisdiction,
Lockhart J asked in Conagra Inc v. McCain Foods (Aust) Pty Ltd ‘whether it is
necessary to sustain the tort of passing off that the plaintiff’s trade or business is in
fact carried on within the jurisdiction or whether it is sufficient that there is a
reputation within the jurisdiction in respect of that trade or business carried on
elsewhere.’700 Lockhart J later added that goodwill and reputation are often referred to
in conjunction in the context of passing-off. This is to be expected because the
presence of a business reputation in a jurisdiction would normally indicate the
presence of the business itself, or at least some part of it. As a consequence, reputation
and goodwill have at times been used interchangeably and at other times have been
confused. However, they are not the same thing, even though connected. Reputation,
in fact, would be a source of goodwill of the business, as noted earlier.
Two broad approaches to this question of a suitable connection with a jurisdiction
have emerged from the case law – a ‘soft line’ approach and a ‘hard line’ approach.701
The ‘soft line’ approach holds essentially that the presence of a business reputation in
a jurisdiction, rather than any actual business operations, is sufficient to support a
passing-off action. A prime example of this approach may be found in Maxim’s v.
Dye702 where the court granted an injunction to prevent the defendant from using the
restaurant name Maxim’s in England, even though the famous restaurant of that name
in Paris had no business connection with England. The restaurant, nevertheless, had a
well-known reputation in England andthe court therefore held that there was no
requirement at law for the plaintiff to have traded in England to succeed in a passing-
off action. It seems that the court in this case placed significant weight on the
reputation of the restaurant and the right of the plaintiff to protect that reputation in
the connection with any future business that might be set up in the jurisdiction. The
issue of future business and its goodwill is dealt with specifically later. In Conagra
Lockhart J was firmly of the opinion that a plaintiff did not need a business presence
in Australia to maintain a passing-off action, in stating:
700 (1992) 23 IPR 193 at 202. 701 Ng, S. K. in ‘Foreign Traders and the Law of Passing-off: the Requirement of Goodwill within the Jurisdiction’, [1991] Singapore Journal of Legal Studies 372 provides a useful discussion of these two approaches. 702 [1977] FSR 364.
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It is sufficient if [the plaintiff’s] goods have a reputation in this country … of a
sufficient degree to establish that there is likelihood of deception among consumers and
potential consumers and of damage to [the plaintiff’s] reputation.703
In distinction from the soft line, the ‘hard line’ approach holds that a business
presence in a jurisdiction is necessary to establish the presence of goodwill in that
jurisdiction. That is, unlike the soft line approach, more than a reputation in the
jurisdiction is required to establish goodwill and to sustain a passing-off action.In
other words, some user in the jurisdiction is required. This approach appears
consistent with the jurisprudence of goodwill which holds that goodwill is generated
by business and inseparable from it. However, it has not met with complete approval
in the courts as is clearly evidenced by the ‘soft line’ cases. Nonetheless, it appears
that the business presence in a jurisdiction need not be very great as demonstrated in
Alain Bernardin et Compagnie v. Pavilion Properties Ltd (the Crazy Horse case)
where Pennycuick J said: ‘... a trader cannot acquire goodwill in this country without
some sort of user in this country. His user may take many forms and in certain cases
very slight activities have been held to suffice.’704 Just what level of activity may be
required is not clear and, anyhow, would be expected to depend on the facts of the
particular case.705 However, it is reasonable to suppose that some discernible harm to
the business and goodwill would arise from the passing-off activity.
9.8.2 The location of goodwill
The second question concerning the location of goodwill in a jurisdiction should not
be an issue. Once there is a business activity or presence in the jurisdiction, the action
should be able to proceed because damage to this business activity will damage the
business as a whole and its goodwill. Location of the goodwill per se, therefore,should
703 (1992) 23 IPR 193 at 235. 704 [1967] RPC 581 at 584. 705 In BM Auto Sales Pty Ltd v. Budget Rent A Car System Pty Ltd (1977) 51 ALJR 254 the High Court of Australia recognized that very slight activities had been sufficient to establish a business reputation in England and held the approach taken by the majority in Turner v. General Motors (Australia) Pty Ltd (1929) 42 CLR 352was consistent with this approach found in the English authorities. Of course, in the modern ‘electronic’ world, global business may be conducted via the internet without regard to physical location. It seems, therefore, that reputation in a jurisdiction in such circumstances may suffice to establish a passing-off action, consistent with the soft line approach. This position was essentially recognized by Lockhart J in Conagra at the relatively early time of the early 1990s where he said: ‘The reality of modern international business is that contemporary consumers are not usually concerned about the actual location of the premises of a company or the site of its warehouse or manufacturing plant where the goods are produced, but they are concerned with maintenance of a high level of quality represented by internationally known and famous goods’ ((1992) 23 IPR 193 at 234).
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not be relevant. Consequently, there should be no need to divide and separate
goodwill across countries or jurisdictions as proposed by the Privy Council in Star
Industrial. Moreover, the conception of goodwill as one whole item of property, rather
than as separate items, is also consistent with the settled meaning of goodwill found in
Muller and Murry. This position was put particularly well byBrowne-Wilkinson V-C
in Pete Waterman Ltd v. CBS United Kingdom Ltd706 where he observed:
The essence of a claim in passing off is that the defendant is interfering with the
goodwill of the plaintiff. The essence of the goodwill is the ability to attract customers
and potential customers to do business with the owner of the goodwill. Therefore any
interference with the trader’s customers is an interference with his goodwill. The rules
under which for certain purposes a specific local situation is attributed to such goodwill
appear to me to be irrelevant. Even if under such rules the situs of the goodwill is not in
England, any representation made to customers in England is an interference with that
goodwill wherever it may be situate. … when a foreign trader has customers here, one
would expect the English Courts to protect his goodwill with those customers.
9.8.3 The recognition of ‘future goodwill’?
Can a passing-off action be brought in a jurisdiction where no business activity has
taken place at that time but may be undertaken in the future? In other words, does
passing-off recognize what might be termed ‘future goodwill’? This question in
essence echoes the question arising from the ‘soft line’ approach in that it deals with
what constitutes an appropriate presence, or a potential presence, in a jurisdiction. The
view discernible from the case law suggests that a reputation preceding an actual
business presence may be sufficient to support a passing-off action. However, while
the degree of connection with a jurisdiction is a critical question for the law of
passing-off, this view adds little to the concept of legal goodwill. Goodwill remains
welded to the business and cannot exist apart from it, regardless of the particular
requirements of passing-off actions.
9.9 Conclusion
The early cases preceding Spalding v. Gamage reveal a general concern for the
protection from damage to property, and to business more broadly, as the basis of the
706 Unreported, Chancery Division, 30 July 1990. See Ng, S. K., ‘Foreign Traders and the Law of Passing-off: the Requirement of Goodwill within the Jurisdiction’, [1991] Singapore Journal of Legal
Studies 372 at 392-4 for an examination of this case.
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passing-off action. Indeed, in respect of the early equity cases in particular, protection
of property was held to be a fundamental consideration. Moreover, it is obvious that
protection from damage to the plaintiff’s business in one form or another was a key
concern at law also. Typically, this damage involved the sources of goodwill,
including infringements of trade marks and names, damage to business and personal
reputation, and the loss of trade and profits. Consequently, damage to these sources
necessarily constituted damage to the goodwill itself. While goodwill was not
specifically referred to in these cases, it is clear that it was ultimately the subject of
these early actions. The connection between goodwill and business therefore may be
clearly seen from these cases.
Furthermore, support for the recognition of goodwill, in substance if not in name, in
the earlier cases may be distilled from the comments of Lord Diplock in General
Electric Co v. The General Electric Co Ltd707 concerning the necessary relationship
between common law trade marks and the goodwill which they engendered. This
relationship was reflected in the first piece of legislation to protect trade marks, the
Trade Marks Registration Act 1875 (UK). Of interest is the lack of explicit
recognition of this relationship in the cases leading up to the introduction of this Act.
However, as argued in this chapter, a relationship between trade marks as a source of
goodwill and goodwill itself may still be discerned from these cases.
This chapter has taken an historical approach,inter alia, to the relationship of goodwill
to business in the context of passing-off. It is clearly evident that goodwill as a legal
concept in a business setting was at the bottom of passing-off from the beginnings of
the action. The most significant and important matter which this area of the law brings
to our understanding of goodwill is that it is consistent with the concept of goodwill in
the broader field of law. The relationship of goodwill to business comes through
clearly in passing-off. While issues of whether goodwill may continue to exist after
the cessation of the business may be taken to be relevant to passing-off in certain
circumstances, they have no significant bearing on the legal concept of goodwill.
Rather, these issues may be confined to the law of passing-off and its requirements.
Moreover, the issue of whether goodwill for passing-off needs to be present in the
jurisdiction – the soft line v. the hard line approach – does not in the final analysis
707 [1972] 2 All ER 507 (HL).
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amount to an issue affecting the general concept of goodwill. The conclusion to be
taken from this ‘debate’ is that goodwill must be damaged as a result of the passing-
off; its location is in itself a matter of no real significance and does not change our
understanding of the concept. To the contrary, it reinforces our understanding from
other fields of law.
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Chapter 10: Goodwill and Compensation
10.1 Introduction
The law dealing with compensation often concerns payments for the loss of goodwill
in a range of circumstances where, for example, business is harmed or is required to
close down. Compensation cases reveal questions concerning not only the amount of
compensation to be paid for harm to or loss of goodwill but also the party to be
compensated for such harm or loss. The law in this area therefore contributes to the
legal concept of goodwill from the twin viewpoints of determining who should be
compensated for the goodwill and the amount of that compensation
As a general rule (and as illustrated in various legal contexts in other chapters in this
paper), courts have viewed goodwill as separate from its sources, such as real
property, but inseparable from the business itself. However, this general rule proves
impractical in the case of suits alleging damage to goodwill since it would mean the
courts would have no basis for calculating the value of damage suffered. There is, as
a result, an implicit segregation of goodwill from the underlying asset for the purpose
of ascertaining damages in cases of alleged damaged to goodwill.
In the landmark goodwill case of FCT v. Murry,708for instance, the majority of the
High Court made specific reference to several compensation cases in their
deliberations on the sources of goodwill, particularly site goodwill. What is made
clear by the High Court, and is born out by other cases also, is that compensation
cases take a different approach to the relationship of goodwill to the business and its
premises as a source of that goodwill. That is, these cases are typically concerned with
the value of the goodwill for the purpose of calculating an amount of compensation
payable for loss of business, rather than being concerned with the inherent nature of
that goodwill which is a major focus of this paper. This concern with valuation means
that the goodwill is essentially deemed to be part of the premises for the purpose of
calculation, contrary to the actual situation at law where goodwill is separate from its
sources. Moreover, deeming goodwill to be part of the premises raises questions
concerning the person who is to benefit from the compensation: for example, should it
be the lessor or the lessee in the case of leased premises?
708 (1998) 98 ATC 4585.
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This chapter takes the following approach to examining the concept of goodwill and
its treatment in respect of compensation. First, it examines the relationship of goodwill
to real property in the context of compensation cases. For the purpose of calculating
compensation claims, the value of site goodwill, arising from the premises as a major
source, may be included in the value of the premises where appropriate. Secondly,
damage to business itself as a basis for determining compensation is examined.
Thirdly, compensation for loss of goodwill paid as a result of the doctrine of
promissory estoppel is considered. What emerges is an approach which is particularly
adapted for the purposes of determining compensation involving goodwill without
necessarily producing a different legal concept of goodwill.
10.2 The relationship of goodwill to real property
The relationship of goodwill to property, particularly real property, is an important
issue dealt with in many compensation cases concerning the question of whether the
value of goodwill should be added to the value of real property in calculating
compensation payments. This type of relationship was also considered in chapter 7
concerning the value of property for stamp duty purposes. The view that the value of
goodwill may form part of real property has a long history. For example, in 1828 in
Chissum v. Dewes Sir John Leach MR held:
The goodwill of the business is nothing more than an advantage attached to the
possession of the house … . I cannot separate the goodwill from the lease.709
Hence, the Master of the Rolls saw goodwill, as site goodwill in this case, as part of
the value of the leasehold of the business premises. This represents a view that has
persisted in the face of jurisprudence to the contrary.710 Nevertheless, as noted below,
in the case of compensation payments the inclusion of goodwill in the valuation of
real property may be justifiable for the particular purpose of calculating the amount of
the payment.
In Rickett v. The Directors of the Metropolitan Railway Company711 the plaintiff’s
hotel business had been damaged by the actions of the defendant company in placing
709 (1828) 5 Russ 29 at 30; 38 ER 938 at 938. 710 As explained in various parts of this paper, goodwill is one whole item of property separate from its sources such as land: see, for example, FCT v. Murry (1998) 98 ATC 4585. 711 (1867) 2 LR HL 175.
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obstructions to ready access to the hotel in the course of undertaking lawful
construction activity. By majority, the Lords held that the plaintiff was not entitled to
compensation for loss of business under the relevant legislation.712 For compensation
to be payable the plaintiff had to suffer damage to interests in land and this was found
not to be the case by the majority because the plaintiff had only suffered loss of
business and not damage to the premises. Lord Westbury in dissent, however, linked
the loss of business to the value of the plaintiff’s interest in the premises in stating that
‘[t]he trade or custom is a thing appertaining to the premises and not to person of the
occupier.’713 He then pressed the point by saying that ‘[l]oss of profits by loss of
business is a loss to the goodwill of the premises, and the goodwill is part of the value
of the property.’714 While this was a dissenting view, there may be seen a connection
made between goodwill and business premises for the specific purposes of
compensation. This is a view commonly found in compensation cases.
Payment of compensation is routinely provided for under legislation where an agency
exercises its powers to compulsorily acquire property. Such was the case in Cooper v.
Metropolitan Board of Works715 where the defendant exercised its statutory powers to
acquire the plaintiff’s business premises. After negotiation between the parties it had
been agreed that the compensation payment would be apportioned between an amount
for the leasehold interest of the premises and an amount for personal compensation for
damage to the trade and occupation and for some other items of claim. Because the
lease had been mortgaged by the plaintiff and the mortgagee had apparently
disappeared, the amount for the leasehold was paid into a bank in the name of the
plaintiff and the mortgagee. At issue, however, was the other amount for personal
compensation which the plaintiff claimed should be paid to him. The defendant, to the
contrary, contended that this amount for loss of trade and occupation of the premises
constituted goodwill and that the mortgagee was entitled to it, not the plaintiff. Cotton
LJ responded to this contention thus:
But really ‘goodwill’ is a word of which few people understand the meaning. It is
obvious that there are certain kinds of goodwill to which a mortgagee will be entitled.
712 The Land Clauses Act and the Railways Clauses Consolidation Act, 1845. 713 (1867) 2 LR HL 175 at 205. 714 Ibid. Lord Wesbury indicated that he was adopting the observation of the Court of Exchequer in using these words. 715 (1883) 25 Ch 472.
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The goodwill which attaches to a particular house increases the value of that house, and
therefore the mortgagee is entitled to that. If, for instance, there is a well-known public-
house, and, from its position being well-known, people frequent it, the goodwill
attaches to the house and adds to its value. But there may be other kinds of goodwill
attaching to personal reputation which a man has made for himself. Of course that does
not go to the mortgagee of the house, but is a thing personal to the man whose skill and
whose name have acquired that goodwill.716
In this passage, Cotton LJ made a clear distinction between site goodwill and personal
goodwill, with the mortgagee being entitled to site the goodwill. However, he in effect
saw the amount in question being for personal goodwill which belonged to the
plaintiff and was independent of any interest in the leasehold of the premises. He thus
found that the amount should be paid to the plaintiff, with the other two judges in
agreement.
The concept of goodwill revealed in the above passage would not, on the face of it, sit
well with the modern concept as set out in Murry, or in the earlier case of Muller for
that matter. The idea of goodwill, albeit so-called site goodwill, being attached to the
premises so as to entitle a mortgagee (or a lessor) to its value is contrary to the
concept of goodwill as being independent of its sources and instead being attached to
the business. However, compensation cases may be seen as a comprising a special
category, with goodwill and its value being used as a component of the calculation of
compensation for the loss of property and business. It is apparent that these cases are
not so much concerned with the inherent nature of goodwill but rather with matters of
determining compensation.
Lord Halsbury in CIR v. Muller & Co’s Margarine Limited put the situation regarding
goodwill and compensation thus:
In compensation cases, … where a man is being turned out of his holding and has to be
put into the same position, so far as compensation can do it, by money which is to be
awarded to him, it is unnecessary to regard any such severance into the different
elements which make up the advantages of his holding. He is to be compensated for the
loss which he has sustained by the alteration of his premises, or the removal of his trade
from those premises, and for the extent to which his business may be injured under the
716 Id at 479-80.
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circumstances, and it would be quite unnecessary to consider how much he is to be
allowed for each element.717
This passage suggests that site goodwill, as an ‘element’ of goodwill as a whole, does
not have to be regarded as part of the business premises for the purposes of
compensation. It seems that Lord Halsbury viewed the needs of calculating
compensation as having its own specific requirements,718 consistent with the later
opinion of the High Court in Murry where the majority cited this view with
approval.719 Moreover, his Lordship’s view was cited to support a similar view in
Rosehill Racecourse Company v. CSD(NSW) where O’Connor J said:
In those questions, where the question was the assessment of compensation, no
difficulty arose as to whether the goodwill was separable from the land, because what
was assessed was the land with its potentialities, everything capable of going having
gone with it. And as the goodwill could go with the land, and was to be considered as
part of the value for which the owner had been compensated.720
Thus the question of whether goodwill was actually part of the land was not
considered to be relevant in these earlier compensation cases where valuation was the
matter under consideration.
In Whiteman Smith Motor Company Limited v. Chaplin721 a claim was made under the
Landlord and Tenant Act, 1927 (UK) for a renewed lease of business premises from
the landlords because the alternative payment of compensation for goodwill would not
compensate for the business loss arising from moving to new premises. As noted
earlier in this chapter, cases concerning compensation for the loss of goodwill should
be seen as being in a special category, being concerned with the basis for the
calculation of compensation for the loss of business rather than with the nature of
goodwill itself. In this case, in terms of the abovementioned Act, the court was
required to review a decision made at trial that the plaintiffs were not entitled to
compensation for goodwill on the termination of the lease of their business premises
717 [1901] AC 217 at 239. 718 Earlier, in CIR v. Glasgow and South-Western Railway Company (1887) 12 LR AC 315, Lord Halsbury LC had expressed a similar view in holding that an amount for goodwill lost with the business on compulsory acquisition of land on which business premises were located could be taken into account in determining the value of the land for compensation. 719 See (1998) 98 ATC 4585 at 4593. 720 (1906) 3 CLR 393 at 410. 721 [1934] 2 KB 35.
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and accordingly were not entitled also to the renewal of the lease. The Act provided
for the payment of compensation for the amount of goodwill generated by the
business conducted on the premises, rather than by the location of the premises. This
goodwill generated by the business was described as ‘adherent goodwill’ to
distinguish it from that generated by the location which was described as ‘inherent
goodwill’ or site goodwill.722 As noted by the court, this statute was intended to
provide for compensation based on the increased rent that the premises would attract
as a result of having the business on it. That is, it recognised the fact that land could be
made more valuable as a rental property where associated with a successful business.
This does not make goodwill part of the premises, of course, but it simply means that
a more valuable property in its own right has been produced. This type of situation
was noted by the High Court in FCT v. Murry723 in considering the contribution of
compensation cases to the understanding of goodwill.
Whiteman Smith Motor Company provided a colourful approach to the concept of
goodwill in its so-called zoological classifications of that concept, based on
classifications of various customers attracted to the business. Scrutton LJ referred to
these classifications as the ‘cat’, ‘rat’ and ‘dog’, and Maughan LJ introduced a fourth
metaphorical classification, the ‘rabbit’.724 However, as discussed in chapter 3, these
classifications, while colourful and amusing, offer nothing of substance to an
understanding of the nature of goodwill. This point was admitted by Maughan LJ who
said in respect of the first three animals: ‘To my mind this division, except as an
illustration, is of little value, and may be misleading.’725 To emphasise the point
further, he followed a little later with: ‘I regard the arbitrary division into thirds of the
goodwill into cat, rat, and dog goodwill as valueless unless all sorts of qualifications
are made’.726 These qualifications needed to be made for the purpose of using these
classifications as a basis for calculating the value of goodwill. These comments can
hardly be taken as an endorsement for this approach as a sound basis for an analysis of
the meaning of goodwill.
722 The concepts of adherent goodwill and inherent goodwill are discussed in chapter 3, para. 3.3.2. 723 See (1998) 98 ATC 4585 at 4594. 724 This zoological classification was considered in chapter 3, paras. 3.1 and 3.3.2. 725 [1934] 2 KB 35 at 49. 726 Id at 50.
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Two compensation cases727 before the High Court of Australia provide further insight
into the relationship of goodwill and property for the specific purpose of calculating
compensation. The first, Minister for Home and Territories v. Lazarus,728 concerned a
claim for compensation for the compulsory acquisition of land under statute. A hotel
business had been conducted on the land and the High Court was required to
determine the mount of compensation payable under the applicable legislation.729 The
issue turned on whether the value of the goodwill of the business should have been
included in the unimproved value of the land or in the improvements on the land.
Under the legislation the valuation of the land was to be undertaken at values
applicable in 1908 while the valuation of the improvements was at values applicable
at the later time of acquisition in 1916. The Court found that the goodwill enhanced
the value of the land, rather than the improvements, as it was in effect site goodwill
arising from the land. Hence, the value of the goodwill was treated as part of the land
valued at the earlier time. In the second case, Commonwealth v. Reeve,730 the High
Court took a similar approach in including the value of the goodwill in the value of the
rented premises of a coffee shop for the purpose of calculating the compensation
payable to the owners under a compulsory acquisition of the premises.
As noted in chapter 7, however, compensation cases entail specific requirements for
the calculation of compensation payments for the loss of business and property. Thus
they should not be taken to stand for a view that site goodwill is actually part of land.
Rather, the cases direct that the value of the goodwill resulting from the land should
be added to the value of the land for the purpose of calculating an amount of
compensation. This position was advanced by the High Court in Murry where the
majority said:
Lazarus and Reeve … do not support and indeed deny that the site goodwill of a
business can be transferred without also transferring the business. They establish that,
although the value of the site goodwill of a business may be a persuasive guide to the
value of land on which business is conducted, it is the potential use of the land and not
727 These cases – Minister for Home and Territories v. Lazarus (1919) 26 CLR 159 and Commonwealth
v. Reeve (1949) 78 CLR 410 – were discussed in ch. 7, para. 7.5.1. 728 (1919) 26 CLR 159 (Full High Court). 729
Lands Acquisition Act 1906 (Cth) and Seat of Government Act 1909 (Cth). 730 (1949) 78 CLR 410.
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the goodwill deriving from the use of the land that is valued in compensation cases
concerned with the acquisition of that land.731
Earlier the High Court had recognized that compensation cases may constitute an
exception to the rule that goodwill is indivisible and inseparable from the business.732
However, it is arguable that this exception is more apparent than real and is designed
to serve the particular purposes of compensation calculations. That is, the value of
goodwill is simply added to the value of the land for purposes of calculating the
amount of compensation. This does not represent a different view of the inherent
nature of goodwill; it is simply a practical approach to calculation.
10.3 Damage to business
Damage to the goodwill of a business as the result of the harmful conduct of another
party may give rise to the payment of damages, as in Typing Centre of NSW Pty Ltd v.
Northern Business College Ltd.733 In this case the applicant was awarded damages for
harm to its goodwill resulting from misleading or deceptive conduct in terms of s. 52
of the Trade Practices Act 1974 (Cth) and also from defamation on the part of the
respondents. The Court found that the applicant had incurred some financial loss as a
result of the respondents’ actions and determined an amount of damages accordingly.
This financial loss was held to have injured the goodwill of the applicant’s business
and thus the damages were in effect to compensate for the capital loss such an injury
represented. Here goodwill was essentially used to represent the capital of the
business for the purpose of determining a case for the payment of damages for harm to
that business. This approach, of course, reveals nothing of the nature of goodwill or its
relationship with the business. It would be just as appropriate to determine that the
business and its profits had been harmed and determine damages on that basis. In the
end, the critical factor in a case for damages such as this is the determination of the
loss suffered. Nonetheless, goodwill was used to represent the capital of the business
and thus taken as the essence of the business.
731 (1998) 98 ATC 4585 at 4594. 732 Id at 4593. 733 (1989) ATPR 40-943 (Fed. Crt).
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10.4 Compensation under promissory estoppel
According to the Full Federal Court in Ranoa Pty Ltd v. BP Oil Distribution Ltd734 the
general law position is that ‘the benefit of goodwill built up by reason of a tenant
carrying on business from leased premises enures to the benefit of the landlord at the
expiration of the term.’735 This, the Court indicated on the authority of Llewellyn v.
Rutherford,736 is the position unless there is an express stipulation to the contrary in
the agreement. Thus, in the absence of such an agreement, or an applicable statute to
that effect, the landlord or lessor takes any benefit supposedly in the form of goodwill
attached to the premises (that is, site goodwill) in accordance with this authority. In
other words, there is no common law protection for a lessee whose business is
terminated and whose goodwill is thereby lost as a result of the termination of the
lease by the lessor, at least insofar as the lessee loses goodwill. A specific agreement
providing for the payment of compensation for the loss of the business is required in
the absence of any statutory provision for such compensation.737
Notwithstanding the common law position, however, Saltzman and Klaric738 point out
that the equitable doctrine of promissory estoppel739 may apply to provide for the
payment of compensation for goodwill in certain circumstances of termination. They
cite the case of Bond Brewing (NSW) Ltd v. Reffell Party Ice Suppliers Pty Ltd740
where Waddell CJ of the Supreme Court of NSW applied this doctrine to compensate
Reffell for the loss of its hotel business as a result of Bond’s retaking possession of the
premises under the lease without payment of compensation. In negotiation for the
lease, Reffell had been given to understand that Bond would not retake possession of
the leased hotel without compensation, in spite of a letter from Bond to the contrary.
734 (1989) 91 ALR 251 (Lockhart, Wilcox and Gummow JJ). 735 Id at 256. 736 (1875) LR 10 CP 456. 737 This issue is also discussed in chapter 8. 738 Saltzman, D. and Klaric, K., ‘Franchising – whose goodwill?’,(1991)65 Law Institute Journal 81. See also Terry, A. and Giugni, P., ‘Freedom of Contract, Business Format Franchising and the Problem of Goodwill’, (1995) 23 Australian Business Law Review 241 at 245-6. 739 Saltzman and Klaric op. cit. describe the doctrine thus (at 83): ‘Where one party has made a promise or assurance to another party which was intended to affect the legal relations between them and to be acted upon accordingly, then, once the other party has acted upon this promise, the one who gave the promise or assurance cannot afterwards revert to the previous legal relations. Instead, he or she must accept the legal relations subject to the introduced qualifications, even though it is not supported in point of law by any consideration but only by his or her word.’ (Statement ascribed to Denning LJ in Combe v. Combe [1951] 2 KB 215.) 740 Unreported, NSW Supreme Court (Equity Division) No. 4312 of 1986, 17 August 1987.
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Relying on principles set down by the High Court in Legione v. Hateley,741 Waddell
CJ ruled that Reffell was entitled to rely upon that understanding and would suffer
considerable detriment without compensation. Thus he made an order for
compensation based on the value of the goodwill of the business.742
10.5 Conclusion
A major source of goodwill in the form of land plays the most significant part in most
of the cases as would be expected where compensation for loss of business is the
primary concern.While there is some consideration given to personal goodwill as
opposed to site goodwill in making the compensation assessments, the focus is usually
on site goodwill. The reason for this focus is that the value of goodwill attributable to
the business premises is the value added to the premises in making the assessment. As
the High Court recognized in Murry,743 compensation cases may constitute an
exception to the rule that goodwill is indivisible and inseparable from the business.
However, as noted in this chapter, this exception is more apparent than real, being
designed to serve the particular purposes of calculating compensation for the loss of
business. That is, in compensation cases a different approach is taken to goodwill and
its relationship to other property of the business, especially land, by deeming goodwill
to be part of land for the purposes of calculation. However, this approach does not
change the essential nature of the legal concept of goodwill. Thus, in compensation
cases the concept of goodwill may be seen as largely consistent with that of other
areas of law. Only the approach to it is different.
741 (1983) 152 CLR 406 at 430-2 (per Mason and Deane JJ). 742 As pointed out by Terry and Giugni,op. cit., the later High Court case of Waltons Stores (Interstate)
Ltd v. Maher (1988) 164 CLR 387 resolved any doubt about the application of promissory estoppel in situations where a party has relied on promises to its detriment. 743 See (1998) 98 ATC 4585 at 4593.
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Chapter 11: Goodwill and Taxation Issues
11.1 Introduction
Taxation raises a range of issues concerning the nature and treatment of goodwill. A
number of these have been taken up in other chapters as, for example, a range of CGT
issues concerning goodwill in the context of partnerships in chapter 5, the relationship
of goodwill and stamp duties in chapter 7, and tax issues involved in licensing, leasing
and franchising in chapter 8. In general, there has been an uneasy relationship between
taxation systems and goodwill; it has been seen already in earlier chapters that much
friction between the concept of goodwill and its treatment arises in taxation
contexts744. For example, what may be taken as the major ‘landmark’ goodwill
decisions dealt with tax matters: CIR v. Muller and Co’s Margarine Ltd745 concerned
UK stamp duties; and FCT v. Murry746 concerned Australian capital gains tax. Our
understanding of the nature of goodwill and its relationship with other property in a
business setting owes a considerable amount to these two cases which are referred to
repeatedly throughout this paper.
This chapter deals specifically with tax issues concerning goodwill not dealt with
elsewhere. In keeping with the general approach taken in this paper, the Australian
and UK jurisdictions are focussed on. It should be noted that the purpose of this
chapter is to consider the nature and value of goodwill in the context of taxation. The
purpose is not to analyse and critique the tax issues themselves; rather, these issues
constitute a tax context for the examination of the concept of goodwill. To this end,
this chapter takes the following form. Paragraph 11.2 deals with a Goods and Services
Tax exemption on the sale of a business as a going concern. Goodwill must
necessarily be supplied with the business to satisfy the requirement of this exemption.
Paragraph 11.3 deals with capital expenditure in relation to goodwill. Two issues are
examined – whether capital expenditure in relation to goodwill may be included in the
cost base for CGT and alternatively whether such expenditure may be deductible as
‘black hole’ expenditure. Paragraph 11.4 concerns the CGT small business
744 For an examination of goodwill and Australian taxation issues, see Walpole, M., ‘Goodwill and Taxation Issues’, (2008) 11(3) The Tax Specialist 201, and for further analysis and reform proposals see Walpole, M. 2009, Proposals for the reform of the taxation of goodwill in Australia, ATRF, Sydney. 745 [1901] AC 217. 746 (1998) 98 ATC 4585.
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concessions involving the disregarding or reducing of capital gains from the disposal
of what are termed active assets where certain conditions are met. Goodwill is defined
as an active asset for the purpose of these concessions and this definition is reconciled
with its general legal concept. Paragraph 11.5 similarly deals with goodwill as an
active asset, in this case in terms of being an active foreign business asset for certain
CGT exemption purposes. Paragraph 11.6 addresses the multiple concepts of goodwill
to be found in the consolidation regime in Part 3-90 of the Income Tax Assessment Act
1997 (Cth). Not only are the accounting and legal concepts of goodwill found in this
regime, but also forms of ‘goodwill’ which do not fit within either of these standard
concepts as, for example, so-called ‘synergistic’ goodwill. Finally, in paragraph 11.7,
the treatment of goodwill in the UK Stamp Duty Land Tax is examined as it provides
a useful comparison with another tax jurisdiction.
11.2 Goodwill and GST
The Goods and Services Tax (GST) is a broad-based consumption tax imposed on
final private consumption expenditure in Australia by A New Tax System (Goods and
Services Tax) Act 1999 (Cth) (GSTA). It operates as a value added tax. The rate of tax
is 10% and is charged on goods and services supplied in Australia and on goods
imported into Australia. GST does not apply to exports. Apart from goods and
services, it also includes transactions dealing with real estate and other kinds of
property. It came into effect on 1 July 2000.
Subdivision 38-J of the GSTA, comprising only s. 38-325, provides an exemption747
from GST for the supply of a going concern: s. 38-325(1). A supply of a going
concern is defined in s. 38-325(2) as a supply under an arrangement under which the
supplier supplies to the recipient all of the things that are necessary for the continued
operation of an enterprise: see s. 38-325(2)(a). Further, s. 38-325(2)(b) requires the
supplier to carry on the enterprise until the day of supply to satisfy the definition. An
enterprise, in turn, is defined in s. 9-20, where its essential meaning may be taken to
be an activity in the form of a business748 as in s. 9-20(1)(a). As one commentator has
747 While the general term ‘exemption’ has been used, the term actually used in the GSTA is GST-free which is defined in s. 9-30(1) and s. 38-1. If a supply is GST-free, then no GST is payable on the supply and any entitlement to input tax credits in respect of making the supply is not affected. 748 In keeping with tax legislation generally, business is not defined in any meaningful way in the GSTA, so that its meaning must be determined from case law; eg see Ferguson v. FCT (1979) 79 ATC 4261 (Full FC). An enterprise as defined in s. 9-20, however, may include activities other than those of
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described it,749 the exemption provided in s. 38-325 is intended for the case of a sale
of a business on a ‘walk in-walk out’ basis, thus relieving the recipient (purchaser) of
the need to obtain for a bridging period, until they could be recovered as a tax credit,
the additional funds to cover the GST that would otherwise be included in the price of
the business.750
The exemption requires that the supplier supplies to the recipient ‘all of the things that
are necessary’ for the continued operation of the business: s. 38-325(2)(a). This
requirement raises the question of what things are necessary to transfer a business as a
going concern. The Australian Taxation Office addresses this question in the Goods
and Services Tax Ruling GSTR 2002/5 entitled ‘Goods and services tax: when is a
“supply of a going concern” GST-free?’ (‘the Ruling’). The Ruling, at para. 111,
states that where the enterprise is a business, ‘goodwill is supplied as one of the things
that is necessary for the continued operation of that enterprise.’ Then, at para. 112, the
Ruling holds that ‘[g]oodwill which emanates from the personality, reputation, skills
or attributes of an individual is not transferable.’ That is, according to the Ruling,
personal goodwill cannot be supplied.751 However, the same paragraph goes on to
state that ‘goodwill emanating from other sources will continue to draw custom to the
enterprise and can be supplied.’ This statement represents and continues a
misunderstanding of the nature of goodwill.752 As discussed elsewhere in this paper,
goodwill is one indivisible item of property, regardless of its sources. The case law
authority753 is clear on this. Therefore, the sources of the goodwill are not relevant to
the ability at law to transfer the goodwill of a business. Quite simply, if the business is
transferred, then the goodwill is also transferred because it is attached to that business
a business as ordinarily understood. For example, leasing property may constitute an enterprise in accordance with s. 9-20(1)(c), but such activity would not normally constitute a business at common law. Goodwill can only exist in relation to a business, and not to other income-producing activities, so the analysis of the Subdiv. 38-J exemption in this paper is confined to business. For consideration of broader issues of an enterprise for GST, see Hill, P., ‘Commencing or Terminating an Activity – a Critical GST Analysis’, (2004) 7(4) The Tax Specialist 181. 749 Evans, M., ‘The Australian going concern concession: when is a “supply of a going concern” GST-free?’, (2001) 30 Australian Tax Review 100. 750 See also Goods and Services Tax Ruling GSTR 2002/5, para. 11. 751 See Tregoning, I., ‘Goodwill: Another View’, (2005) 9(1) The Tax Specialist 22 and Tregoning, I., ‘The meaning and nature of goodwill in the tax context’, (2010) 39(3) Australian Tax Review 123 for a discussion on the issue of so-called personal goodwill and its supposed non-transferability. These articles take issue with this view in the light of Murry and earlier authority. 752 A similar view is stated in Taxation Ruling TR 1999/16, para. 59. 753 For example, see CIR v. Muller & Co’s Margarine Limited [1901] AC 217, Geraghty v.Minter (1979) 142 CLR 177, and FCT v. Murry (1998) 98 ATC 4585.
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and inseparable from it.754 GSTR 2002/5, in fact, recognizes that goodwill attaches to
the business in para. 110, but that recognition has not prevented the Ruling from
perpetuating the misconception about the non-transferability of so-called personal
goodwill.755
As a consequence, the Ruling on this question is somewhat confusing and at variance
with the law. As noted above, para. 110 recognizes that goodwill is attached to the
business and then recognizes the High Court’s view of goodwill as the legal right or
privilege to conduct a business in the manner designed to attract custom to it.756 Then,
logically it seems, it goes on in para. 111 to state: ‘So, if the “identified enterprise” is
a business, goodwill is supplied as one of the things that is necessary for the continued
operation of that enterprise.’ If this paragraph is taken to mean that if a business is
supplied then the goodwill will necessarily be supplied with it, the Ruling to this point
may be taken as consistent with the law. However, it follows with the incorrect view
of ‘personal’ goodwill in para. 112. Then in paras. 113 and 114 an example of the
treatment of personal goodwill is provided. The example concerns a small business
with most of the goodwill emanating from the personal attributes of the proprietor.
The Ruling states that ‘this part of the goodwill’ is not transferable – an incorrect view
of the legal concept of goodwill, as noted above. However, the Ruling continues by
way of the example, goodwill from other sources may still be supplied (see the
qualification in para. 112), therefore apparently satisfying the ‘going concern’
requirements for exemption. But, as argued above, the transfer or supply of a business
as a going concern simply takes the goodwill (as one indivisible item of property) with
it. Reducing goodwill to constituent parts, emanating from different sources, serves no
purpose in determining the application of the exemption and is also, most
significantly, in conflict with the legal concept. There is nothing by way of a
754 The cases in footnote 753 also make it clear that goodwill is inseparable from the business to which it is attached. 755 It seems that some commentators also are not completely free of misconceptions about the nature of goodwill, eg see Sutton, J., ‘Going Concerns and the Transfer of Goodwill’, (2007) 7 Australian GST
Journal 25. The author considers the issue of transferring goodwill as part of a going concern for the purpose of the exemption under s. 38-325. In an article dealing with the exemption and GSTR 2002/5, she falls for the myth of goodwill as comprising separate elements or parts (eg personal goodwill and other elements). In this article, as with the Ruling, the essential nature of goodwill – as one indivisible item of property, separate from its sources but attached inseparably to the business – is largely overlooked. 756 Refer to FCT v. Murry (1998) 98 ATC 4585 at 4590-1 for the High Court’s view on goodwill as a property right and its inseparable attachment to the business.
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definition of goodwill in the GSTA (as is the case in tax legislation generally) to
indicate that anything other than its common law concept is applicable.757
In summary, whether a business is supplied as a going concern is a question of fact;758
but once it has been established that such a business has been supplied or
transferred,759 the goodwill, including ‘personal’ goodwill, is of necessity transferred
also.760 Thus there is no need to analyse the question of the supply of the business
from the viewpoint of asking whether the goodwill has been transferred. In fact, this is
757 However, as noted in para. 11.6, the concept of goodwill for the particular purposes of consolidation is broader and multi-faceted. Nonetheless, this broader concept arises from the requirements of consolidation, rather than from any specific definition. 758 In Kenmir Ltd v. Frizzell [1968] 1 All ER 414 at 418 it was stated that: ‘In deciding whether a transaction amounted to the transfer of a business, regard must be had to its substance rather than its form, and consideration must be given to the whole of the circumstances, weighing the factors which point in one direction against those which point in another. In the end, the vital consideration is whether the effect of the transaction was to put the transferee in possession of a going concern, the activities of which he could carry on without interruption.’ Moreover, it may be that what is necessary to transfer a business is contained in two or more contracts dealing with different assets of the business, with these separate contracts being treated as substantially the one contract of sale and accordingly the one supply. Thus in Debonne Holdings Pty Limited v. FCT 2006 ATC 2467, for example, the taxpayer entered into two contracts to purchase a hotel – one contract dealing with the land and improvements and the other contract relating to a range of necessary hotel assets including the goodwill. The company taxpayer argued that supply of the land was not GST-free under s. 38-325 as it did not constitute the supply of a going concern, that being effected by the other contract, and so it was entitled to an input tax credit on the purchase of the land. However, the AAT held that both contracts were required to supply all of the things that are necessary to continue the business and dismissed the taxpayer’s claim. On the other hand, an example of a situation which did not constitute a supply of a going concern may be found in Allen Yacht Charters Limited v. CIR (1994) 16 NZTC 11270 where the High Court of New Zealand,in considering a similar exemption in the NZ GST legislation, held that the sale of a charter boat did not entail the supply of a business as a going concern, even though the boat was the essential asset of the business. The Court explained: ‘There was no payment for goodwill, there was no transfer to the purchaser of forward bookings, there was no examination of the accounts of the business, there were no steps taken for [the purchasers] to take over [the vendor’s] customers, and there was little evidence that [the purchasers] had any detailed knowledge of the nature of the business’ (at 11276). See also Chiert, G., ‘Murry: Ending the Mysteries of Goodwill or Creating New Commercial Pitfalls’, (1999) 73 The
Australian Law Journal 659, Walpole, M., ‘The Fate of Goodwill after Ralph’, (2000) 3(5) Journal of
Australian Taxation 344 and Westpac Banking Corporation v. CSD(Qld) 2004 ATC 4135 for consideration of what constitutes the transfer of a business. 759 In cases where the vendor is not in a position supply all of the things necessary to constitute fully a business as a going concern, such as where licences and leases cannot be transferred but have to be issued anew to the purchaser, this should not detract from satisfying the exemption requirements of s. 38-325. Businesses are often sold on the condition that necessary licences and leases will be provided to the purchaser by third parties such as government agencies responsible for licensing and landlords for leases. Some of these matters are broached in chapter 8. 760 Small businesses which rely significantly for custom on the person of the owner/vendor are routinely sold. Of course, the personal characteristics of the vendor cannot be transferred, but those characteristics themselves do not constitute the goodwill; rather they are a source of the goodwill. As a practical matter, there are ways to effect the transfer of ‘personal’ goodwill such as, for example, having the vendor work in the business for a period to introduce and recommend the new owner to the customers in order to transfer their allegiance and also having the protection of a restrictive covenant where appropriate. To the extent that the transfer of a personal following may be difficult to effect, it would seem that the goodwill in the sale would be valued appropriately to reflect that difficulty.
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the wrong way of looking at it. The focus should not be on the goodwill; rather, the
focus should be on the business as a whole (as a going concern) and its supply.761
On a final note, a fundamental problem in this area appears to relate to the
identification of goodwill in terms of its major sources, ie personal goodwill, site
goodwill (arising from location), name goodwill (from brands and trademarks, etc),
and monopoly goodwill (from exclusive licences, etc). These are convenient labels for
various ‘types’ of goodwill, based on their major sources, and they provide a useful
framework for analysis, but care needs to be taken not to see them as separate items of
goodwill.762 Goodwill is one indivisible item of personal property and is attached to
the business, regardless of its sources. This is the important message from the High
Court in FCT v. Murry.
11.3 Capital expenditure and goodwill
Goodwill has featured, and continues to feature, in specific ways in the CGT system
where it is defined as an asset. Originally, for example, there was a concession by way
of a reduction of the capital gain made on the sale of goodwill in the sale of a small
business.763 This concession gave rise to the important CGT cases of FCT v. Krakos
Investments Pty Ltd764 and, most significantly, FCT v. Murry
765 which reminded us of
the meaning of legal goodwill and is referred to extensively throughout this paper.
This concession has been repealed in favour of a range of small business concessions
which is considered in para. 11.4 of this chapter.
Goodwill in the context of CGT has been considered in other chapters of this paper, as
noted in para. 11.1 above. Nevertheless, it will be useful to revisit some basic ideas
761 Subsection 9-10(1) of GSTA defines supply as ‘any form of supply whatsoever’. This broad definition would include the supply of a business which typically consists of a range of property (goods). Business itself is not property but rather a course of conduct: see FCT v. Murry (1998) 98 ATC 4585 at 4596. 762 This issue has been addressed earlier in this paper in chapter 3, para. 3.9, and in chapter 4. 763 Under the CGT provisions which applied at the time, a capital gain on disposal of goodwill might be subject to concessionary treatment in the form of a 50% reduction pursuant to s. 160ZZR(1) of the Income Tax Assessment Act 1936 (Cth). To qualify for this concession, it was required that the taxpayer dispose of a business, or an interest in a business, that included goodwill, or an interest in goodwill, and that the net value of the business, or the interest in the business, be less than a stipulated exemption threshold for the year in question. This threshold was calculated in accordance with s. 160ZZRAA which set the threshold at $2,000,000 before the 1993-94 income year and indexed it from that year. This treatment was continued in rewritten legislation in the Income Tax Assessment Act 1997 (Cth) until its repeal in 1999-2000 in favour of a broader range of small business concessions enacted in response to recommendations from the Ralph Review of Business Taxation. 764 (1996) 96 ATC 4063. 765 (1998) 98 ATC 4585.
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briefly where appropriate. The following CGT provisions under consideration are
contained in Part 3-1 of the Income Tax Assessment Act 1997 (Cth). Goodwill is
specifically included in the definition of a CGT asset in s. 108-5(2)(b), expressly to
avoid any doubt.766 However, given that the fundamental definition of a CGT asset is
‘any kind of property’ in s. 108-5(1)(a), and clearly goodwill is property, this specific
inclusion seems redundant. There can be no doubt goodwill is property for the
purposes of law, of which CGT and tax in general are part, and also is an asset for
accounting purposes: this has been discussed earlier in this paper.
As goodwill is a CGT asset, its disposal as part of the sale of a business will constitute
a CGT event A1, the disposal of a CGT asset, as set down in s. 104-10. In accordance
with s. 104-10(4), the capital gain or loss is calculated by deducting the relevant cost
base from the capital proceeds as worked out under Div. 116 (the details of which are
not relevant for this discussion). The cost base and reduced cost base are worked out
under the rules set down in Div. 110. The cost base is used to calculate a capital gain
and may consist of up to five elements: see s. 110-25(1). The reduced cost base, on the
other hand, is used to calculate a capital loss. For the purpose of this discussion, the
elements of both cost bases may be taken to be the same,767 with the fourth element
being the relevant one. The fourth element includes capital expenditure incurred for
the purpose of increasing or preserving the asset’s value: see s. 110-25(5).768
However, s. 110-25(5A) provides that subsection (5) does not apply to capital
expenditure incurred in relation to goodwill. Thus capital expenditure relating to both
increasing and preserving the value of goodwill specifically may not be included in its
cost base.
However, capital expenditure to preserve, but not enhance, the value of goodwill of a
business may be claimed under s. 40-880769 which allows business capital expenditure
766 In s. 100-25(3), also, goodwill is listed as a ‘not so well known’ CGT asset. 767 The rules for working out the reduced cost base are found in s. 110-55. As noted in s. 110-55(2), all the elements of the reduced cost base (except the third one) are the same as for the cost base. 768 Subsection 110-25(5) was amended, and s. 110-25(5A) inserted, by the Tax Laws Amendment (2006
Measures No 1) Act 2006 (Act No 32 of 2006), effective from 1 July 2005. Previously, there was no specific exclusion of expenditure on goodwill from the fourth element. However, such expenditure was effectively excluded because it had to be reflected in the state or nature of the asset – a requirement not possible in the case of an intangible asset such as goodwill. 769 Section 40-880 was also amended by Act No 32 of 2006, effective from 1 July 2005. The present version of s. 40-880 has broader application to business capital expenditure than its predecessor, which also excluded from deduction expenditure incurred in relation to a lease or other legal or equitable
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to be deducted on a straight line basis over five years: s. 40-880(2). This deduction is
made on the basis that the expenditure cannot be claimed under any other provision
(or be included in a cost base) as stipulated in s. 40-880(1). In other words, this
section provides deductions of last resort for what is commonly termed ‘blackhole’
expenditure. There are specific exclusions from deduction of expenditure in s. 40-
880(5) including paragraph (5)(d) which refers to capital expenditure in relation to a
lease or other legal or equitable right. This exclusion, however, does not apply to
expenditure incurred to preserve (but not enhance) the value of goodwill if the
expenditure is in relation to a legal or equitable right and the value of the right is
solely attributable to the effect that the right has on goodwill: see s. 40-880(6).770
Consequently, capital expenditure on rights to preserve the value of goodwill may be
deductible under s. 40-880,771 but not expenditure on those rights which increase or
enhance the value of goodwill. Given that s. 40-880 is a deduction provision of last
resort, this means that such expenditure which increases or enhances the value of
goodwill fails to be deductible and accordingly remains in a ‘black hole’. But why
should this be so? The Explanatory Memorandum to the Tax Laws Amendment (2006
Measures No 1) Act 2006 (Act No 32 of 2006) explains in paragraph 2.71 that
expenditure in relation to a right to enhance the value of goodwill, or has an inherent
value in itself, is not deductible because it ‘does not represent a loss to the taxpayer’.
This indicates that the type of capital business expenditure which is to be deductible
under s. 40-880 must be of a type that does not contribute to the creation or
right. However, the present s. 40-880 at least allows a deduction for such expenditure where it preserves the value of goodwill. 770 The previous version of s. 40-880, effective from 1 July 2001, was amended by the Taxation Laws
Amendment Act (No 5) 2002 to insert inter alia para. (3)(d) which excluded capital expenditure on leases and rights similarly to para. (5)(d) of the present s. 40-880. The reason for this exclusion provided in the Explanatory Memorandum to this Act at para. 3.67 was that the treatment of such expenditure was subject to Government review arising out of recommendations by the Review of Business Taxation and was to be determined as part of that review. Some details of that review and consideration of the treatment of leases or other legal or equitable rights may be found in ATO Interpretative Decisions ID 2007/93 and ID 2007/111. 771 An example of expenditure to preserve goodwill may be found in Broken Hill Theatres v. FCT (1952) 85 CLR 423. In this case, legal expenses incurred by a movie theatre in opposing an application by a competitor to show movies were held to be capital because the expenses were incurred to protect the theatre’s business. As these expenses were outlaid to defend the business from competition, they could therefore be taken to preserve its goodwill. Such capital expenditure should now be deductible under s. 40-880. However, another way of looking at this type of expenditure is that it should qualify as typical ‘blackhole’ expenditure deductible under s. 40-880, anyhow. The point to be made under this approach is that such expenditure, if deemed to relate to goodwill, would be taken to preserve that goodwill rather than enhance it. Thus the expenditure would not be precluded from deduction under s. 40-880.
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enhancement of an asset which itself has value.772 Normally, of course, this
expenditure on rights would be excluded from deduction under s. 40-880 by s. 40-
880(5) because it would be deductible elsewhere or be included in the asset’s cost
base, particularly in the fourth element in s. 110-25(5). These rights are property and
assets in themselves, while also being sources of the goodwill of the business.
However, other sources of goodwill may be expenditures which are revenue in nature,
rather than capital, and so may be deductible under s. 8-1. This situation has been
recognized by the High Court in Sun Newspapers Limited v. FCT 773 and FCT v.
Murry.774
Notwithstanding issues about the treatment of capital expenditures on rights which
affect goodwill, the essential matter for the purpose of this chapter is the nature of this
goodwill. In this respect, there is nothing to indicate that goodwill is understood to be
anything other than the legal concept as defined by the High Court in FCT v. Murry.
In fact, the important idea of goodwill as having sources comprising, inter alia, other
assets is found in the provisions of s. 40-880.
11.4 The CGT small business concessions
As noted in para. 11.3, there was originally a small business CGT concession in the
form of a 50% reduction in the capital gain arising from goodwill on the sale of the
business. This concession, however, was repealed from 21 September 1999 as part of
the reforms recommended in the Review of Business Taxation and in its place several
more generous small business concessions were introduced in Div. 152 of the Income
Tax Assessment Act 1997 (Cth). While these concessions involve goodwill, together
with other business assets, they do not relate specifically to it as did the original more
limited concession. It is not the purpose here to deal in depth with these concessions.
Rather, the purpose is to examine the place and nature of goodwill in the context of
these concessions.775 Nevertheless, a brief outline of the concessions is necessary to
provide this context. Div. 152 provides four concessions as listed in s. 152-1:
772 For an analysis of the law and policy relating to s. 40-880, see Augustinos, N., ‘Blackhole expenditures and the application of section 40-880’, (2009) 38 Australian Tax Review 100. 773 (1938) 61 CLR 337 at 360-1 (per Dixon J). 774 (1998) 98 ATC 4585 at 4591. 775 For a concise and useful explanation of these small business concessions, see Woellner, R. et al. 2009, Australian Taxation Law, 19th ed., CCH, Sydney, paras. 8-400 – 8-450.
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(1) The 15-year exemption (in Subdiv. 152-B). Broadly, this concession grants a full
exemption to the disposal of a business CGT asset which has been owned by the
taxpayer for at least 15 years and the owner has reached the age of 55 years and has
retired or is permanently incapacitated. The exemption is effected by disregarding the
any capital gain arising from the relevant CGT event, consistent with the method of
exemption throughout the CGT system.
(2) The 50% reduction (in Subdiv. 152-C). This reduction by 50% in a capital gain
arising from the disposal of a CGT asset may be applicable where the basic conditions
in s. 152-10(1) (below) have been satisfied. This reduction may be applied on top of
any general 50% discount available to individuals, thus reducing the capital gain to
25%. It should be noted that this concession is rendered redundant where the full
exemption in Subdiv. 152-B above is applied.
(3) The retirement concession (in Subdiv. 152-D). This concession is designed to
encourage a taxpayer to contribute funds to his or her retirement. It enables the
taxpayer to disregard any capital gains arising from business assets up to a limit of
$500,000. This concession would be expected to be applied after any available
reductions from Subdiv. 152-C have been taken into account.
(4) The roll-over (in Subdiv. 152-E). This concession enables a small business to defer
the recognition of a capital gain from the disposal of a CGT asset where a replacement
asset is acquired within stipulated time limits.
Before any of these concessions may be applied, however, the basic conditions set out
in s. 152-10(1) must be satisfied. The essence of the concessions is that a capital gain
from a CGT event may be reduced or disregarded if these conditions are satisfied,
subject also to satisfying specific requirements in the concessions themselves. These
conditions are: (a) a CGT event happens to a CGT asset of the taxpayer’s in an income
year; (b) the event would (apart from Div. 152) have resulted in a capital gain; (c) the
taxpayer is a small business entity or satisfies a maximum net asset value test; and (d)
the CGT asset is an active asset.
The important matters for the purpose of this discussion are the meaning of active
asset, the last of the basic conditions in s. 152-10(1), and whether goodwill qualifies
as such an asset. If goodwill qualifies, then it may be subject to the appropriate
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concessions, of course. The definition of an active asset is provided in s. 152-40 where
the relevant meaning is found in s. 152-40(1)(b) which deals with intangible assets –
an intangible asset will be an active asset where it is ‘inherently connected with a
business’ carried on by the taxpayer or an affiliate. Goodwill is in fact given as an
example of such an asset in that paragraph. In view of the very nature of goodwill as
an asset inseparable from the business and having no existence apart from it, it is clear
that it is inherently connected with that business.776 Accordingly, it may be concluded
that the concept of goodwill employed here is completely consistent with the concept
at common law. On a final note, the disposal of goodwill to gain a relevant concession
would require the sale of the business, involving all the necessary assets to transfer a
going concern, given the relationship of goodwill to the business. While many other
assets may be disposed of individually and separately from the business, this is not
possible with goodwill.
11.5 Goodwill as an active foreign business asset
Division 768 of the Income Tax Assessment Act 1997 (Cth) provides CGT concessions
for capital gains or losses of resident companies arising from CGT events happening
in relation to specified interests, eg shares, in foreign companies.777 Thus the typical
situation would involve the sale of shares by a resident company in a foreign
company. The concession may take the form of a full exemption from capital gains
(and the disregarding of any capital losses where appropriate) or, alternatively, a
proportional reduction in capital gains or losses, depending on the circumstances. The
concession depends on several conditions, including the resident company’s holding a
direct voting percentage in the foreign company of at least 10%, the holding of the
specified interest for a continuous period of 12 months in the two years before the
CGT event, and the extent to which the business activities of the foreign company
may be classified as active. The last condition concerning active business of the
776 The nature of goodwill as inseparable from the business also means that it is not a ‘tainted asset’ for the purposes of Part X of the Income Tax Assessment Act 1936 (Cth) dealing with controlled foreign companies. Paragraph (c) of the definition of ‘tainted asset’ in s. 317(1) excludes assets ‘used solely in carrying on a business’. Given the nature of goodwill and its relationship to a business, this exclusion must apply to goodwill, a view stated in ATO Interpretative Decision ID 2006/181. Moreover, for similar reasons, goodwill is not a tainted asset for the purposes of s. 23AH(3) of the Income Tax
Assessment Act 1936 (Cth) which exempts capital gains of foreign branches: see ID 2006/17. 777 Division 768 was introduced by the New International Tax Arrangements (Participation Exemption
and Other Measures) Act 2004 with effect from 1 April 2004.
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foreign company, which determines the extent of the exemption, is the critical one for
the purposes of this topic.
The concession is based on an active foreign business asset percentage calculated
under s. 768-510. It is this percentage that is the basis of the amount of reduction in
the capital gain or loss accruing to the resident company. The active foreign business
asset percentage is, broadly, the value of the active foreign business assets of the
foreign company expressed as a percentage of the value of the total assets of the
company. An active foreign business asset is defined in s. 768-540, specifically
including goodwill in s. 768-540(1)(b)(ii). This inclusion is consistent with the
definition in s. 152-40 of an active asset as an asset which is used in the course of
carrying on a business and, in the case of an intangible asset such as goodwill, is
inherently connected with that business: see s. 152-40(1)(b). As noted in para. 11.4
where the same definition was considered, goodwill by its very nature is inherently
connected with the business in keeping with its common law concept.
11.6 Goodwill and the consolidation regime
The consolidation regime is contained in Part 3-90778 – Consolidated Groups – of the
Income Tax Assessment Act 1997 (Cth), with effect from 1 July 2002. This regime
comprises a long and complex set of provisions which enable wholly-owned
Australian resident subsidiaries of an Australian head company to consolidate into a
group for the purpose of being treated as a single entity779 for income tax.780 A
detailed examination of this regime is outside the scope of this paper, but an outline of
its operation is necessary to create the context for an examination of the concept, the
valuation, and the treatment of goodwill within it.
778 Part 3-90 comprises Divs. 700 – 721. 779 See the single entity rule in s. 701-1. 780 Not only is the regime complex, it is subject to constant review and change. For example, the 2009
Australian Master Tax Guide, 44th ed., CCH, Sydney, lists 25 modifications which the government intends to proceed with: see para. 14-000. In this regard, in December 2009 the Board of Taxation issued a discussion paper titled ‘Post-implementation Review into Certain Aspects of the Consolidation Regime’, dealing with key elements of the regime involving the single entity rule, the interaction between consolidation and other parts of the income tax law, and the inherited history rules. For a useful introduction to the consolidation regime, see the 2009 Australian Master Tax Guide, 44th ed., CCH, Sydney, ch. 14, Woellner, R. et al. 2009, Australian Taxation Law, 19th ed., CCH, Sydney, ch. 20, and Taxation Ruling TR 2004/11. For an examination of the treatment of the group as a single entity specifically, the so-called ‘single entity rule’, see Slater, A. and Murray, P., ‘Tax Consolidation and the Single Entity Rule’, (2004) 7(4) The Tax Specialist 206.
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The head company is treated as the single taxpayer on behalf of the consolidated
group and accordingly lodges the one tax return and pays the tax for the group
including consolidated tax instalments. Consolidation broadly involves: the attribution
of all income and deductions to the head company; the pooling of losses and franking
credits; the maintenance of the one franking account; and the disregarding of
transactions between group members. Further, the head company is taken to own
group members’ assets (and liabilities) and is liable to account for balancing
adjustments and capital gains and losses in relation to the disposal of these assets.781
The term asset is not defined in the Income Tax Assessment Act 1997 (Cth) for the
purposes of Part 3-90. However, in Taxation Ruling TR 2004/13 it is stated that the
meaning of asset is to be found in its commercial or business context (para. 4). This
meaning is not limited to assets that would be recognized under accounting standards
or statements of accounting concepts (para. 6). Consequently, internally generated
goodwill may be recognized for consolidation, although not recognized for
accounting.782 However, it is noted in para. 11 of this ruling that assets recognized for
purposes of the tax legislation will be assets for Part 3-90: these include CGT assets
which in turn include goodwill (see s. 108-5(2)(b)). Specifically, it is the treatment of
goodwill as a CGT asset which is relevant to this topic.
There are three basic situations which may be encountered in consolidations: (1) an
entity joining an established group; (2) the formation of a group; and (3) an entity
leaving a group.783
781 Consolidation involves a complex set of accounting transactions: for an explanation see Betkowski, F., ‘Accounting for the Consolidation System’, (2003) 7(1) The Tax Specialist 39. 782 See AASB 138 Intangible Assets, para. 48. However, in AASB 138 some recognition is given to assets not recognized for accounting in the financial reports but for which a purchaser is prepared make payment in a business combination (see para. 11). 783 The treatment of goodwill in these situations is dealt with in detail in Taxation Ruling TR 2005/17.
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11.6.1 An entity joining a group
Under the single entity rule in s. 701-1 assets of a joining entity are treated as the head
company’s assets for the purpose of determining their tax treatment in the
consolidated group. Subject to some exceptions, the assets of a joining group are
classed as reset cost base assets in terms of s. 705-35(1). In accordance with s. 701-
10(4), these assets are liable to have their costs reset at the time the entity joins the
established group as a subsidiary member. Consequently, an allocable cost amount
(ACA) is spread across the value of the joining entity’s assets to reset their costs in the
group. The ACA is calculated in accordance with s. 705-60 and consists of the cost of
the group’s membership interests in the joining entity plus the value of the joining
entity’s liabilities and several other amounts, the details of which are not relevant to
this analysis. The reset cost base assets will have their costs reset by a tax cost setting
amount (TCSA), determined under s. 705-35, which broadly involves having the ACA
allocated to these assets in proportion to their market values. The TCSA will
constitute the cost base or reduced cost base for general CGT purposes: s. 701-55(5).
Goodwill is classed as a reset cost base asset of a joining entity in terms of s. 705-
35(1) and accordingly the goodwill of this entity would be subject to cost resetting as
outlined above. This is the goodwill of joining entity’s business and which has its
value reset for tax purposes. However, beyond this relatively straightforward situation,
there are specific rules applicable to goodwill in s. 705-35(3) which relates to what is
generally called ‘synergistic’ goodwill. As explained in s. 705-35(3), this goodwill
results from the head company’s ownership and control of the joining entity and is
associated with synergies arising out of the assets and businesses of the joined group.
This is deemed to be a separate amount of goodwill of the joining entity and hence an
asset of the head company under the single entity rule of s. 701-1(1): see s. 705-
35(3)(b)(i). In accordance with s. 705-35(3)(a), this goodwill is taken into account for
head company core purposesin terms of s. 701-1(2), namely to work out the head
company’s income tax liability, and its tax cost is set at joining time at its TCSA.
A TCSA is calculated for this synergistic goodwill as a separate (deemed) asset by
allocation of an amount of ACA in proportion to its market value. This market value,
in accordance with Taxation Ruling TR 2005/17, should be determined using the
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‘commercial residual value approach’ (para. 12).784 This is the standard accounting
valuation approach of subtracting the value of identifiable assets of the business from
the total value of the business, leaving the value of goodwill as a residual amount.
11.6.2 The formation of a group
This situation involves the original formation of a consolidated group, rather than an
entity’s joining an already formed group as in the situation above. It is stated in TR
2005/17 that synergistic goodwill in terms of s. 705-35(3) ‘has no application to an
entity when it forms part of a consolidated group where the residual value method of
identifying goodwill is used and the businesses of the entity are valued using a
valuation method based on the cash flow of each business’ (para. 14). However, the
goodwill assets of the members of the group are reset at their appropriate TCSAs, as
described in 11.6.1.
11.6.3 An entity leaving a group
Where an entity leaves a group, that entity takes with it goodwill attached to its
business and also adjustments must be made to any synergistic goodwill of the head
company which has been recognized under s. 705-35(3). The cost base of this
synergistic goodwill is calculated in accordance with s. 711-25(2) to reflect any
reduction in its value resulting from the loss of economic benefit of the leaving
entity.785 In addition, the leaving entity will have its own goodwill associated with its
business and also may have had synergistic goodwill from the economic benefits from
being associated with the other group members. Details of these calculations,
however, are not necessary for this analysis which is focussed on the nature and
treatment of the goodwill in these settings. Furthermore, there may be specific capital
gains or losses arising from these events, but these also are not relevant to this
analysis.786
784 See also Taxation Determination TD 2007/1. 785
Taxation Determination TD 2007/27 explains the complementary relationship between s. 705-35(3) and s. 711-25(2). 786 Detailed consideration of the implications of leaving a group may be found in twin articles by Scott, H. and Spence, K., ‘Consolidation and Exits – the other end of the food chain, Part 1’, (2004) 8(1) The
Tax Specialist 30 and ‘Consolidation and Exits – the other end of the food chain, Part 2’, (2004) 8(2) The Tax Specialist 81.
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11.6.4 The nature of goodwill in consolidations
The particular requirements of the complex consolidation regime involving the
combining of separate entities, including their assets and liabilities, to constitute the
one economic entity for income tax purposes lead to several issues concerning
goodwill. While the fundamental legal concept of goodwill, as the attractive force
which brings in custom, is the one that would apply to the separate entities of a
consolidated group for legal purposes, it is arguably the accounting concept which
holds sway in consolidation. This is because it is the value of goodwill in determining
its cost in the consolidation process that is taken into account in this regime.
However, as noted by the High Court in FCT v. Murry the value of legal goodwill and
accounting goodwill may be identical in the case of a profitable business.787 The
situation may differ in the view of the High Court, however, where the business is
unprofitable and accordingly ‘there may be a marked difference between the value of
goodwill for legal purposes and its value for accounting or commercial purposes.’788
The High Court explained this difference thus:
That is because goodwill for legal purposes includes everything that adds value to
business – ‘every positive advantage’ as Wood V-C pointed out in Churton v. Douglas.
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. … Having regard to the likely future of the business, often it
may have only nominal value.789
While the accounting concept of goodwill is more applicable than the legal concept
for consolidation, this concept itself is not entirely applicable either. As noted above,
the concept of an asset goes beyond the accounting concept of goodwill to encompass
also assets not recognized under accounting standards, that is, assets found and
recognized in a commercial or business context. This view, expressed in Taxation
Ruling TR 2004/13, enables internally generated goodwill, for example, to be taken
into account, whereas it is not recognized for accounting purposes.790 Here the
situation therefore becomes a little more complex, because internally generated
787 See (1998) 98 ATC 4585 at 4595. 788 Ibid. 789 Ibid. 790 See AASB 138 Intangible Assets, para. 48. Accounting conservatism militates against the recognition of this form of goodwill because no cost can be reliably determined for it.
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goodwill may be recognized for legal purposes.791 Accordingly, goodwill in this
context is not encompassed entirely by either concept.
Furthermore, the so-called ‘synergistic’ goodwill, by its very nature a creature of
consolidation, is not an asset for either accounting or law. This view was endorsed by
the NTLG Consolidation Subcommittee which saw synergistic goodwill not as an
asset but as a value which is allocated to a joining entity’s goodwill, where that value
is a premium arising from the synergy generated by the group.792 Thus synergistic
goodwill is a value for allocation across assets of the group and not an asset in itself.
What this amounts to is that goodwill for the requirements of consolidation may be a
range of concepts to suit the process of valuing assets, and deemed assets, in the
joining or leaving of a group. Thus the consolidation regime takes multiple views of
goodwill, not all of which are consistent with the standard concepts for either
accounting or law. However, there is no need for consistency in a situation where
there these views represent specific statutory requirements. There is nothing in the
consolidation regime which should be taken to add anything new or different to the
general accounting or legal concepts of goodwill. Nonetheless, consolidation reveals
that there may be some consistency, and therefore a degree of synthesis, between the
accounting and legal concepts of goodwill, particularly in the area of value.
11.7 Goodwill and the Stamp Duty Land Tax (UK)
Finally, the UK Stamp Duty Land Tax is considered as a useful addition to, and
comparison with, the Australian tax systems considered in this chapter and elsewhere
in this paper. Moreover, as the law in this paper is based significantly on UK common
law (for example, the legal concept of goodwill itself), the inclusion of this tax is
apposite.
As discussed in chapter 7, goodwill had been recognized as property for UK stamp
duties purposes since the first half of the nineteenth century. However, in the UK,
stamp duty on goodwill was abolished pursuant to s. 116 of the Finance Act 2002. In
its place the Stamp Duty Land Tax (SDLT) legislation was enacted as Part 4 of the
Finance Act 2003 which now imposes duty on land transactions. As a consequence,
791 See discussion on internally generated goodwill in chapter 4, para. 4.7. 792 Per NTLG Consolidation Subcommittee meeting minutes of 8 June 2006, agenda item 3: Synergistic goodwill.
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HM Revenue & Customs (HMRC) have succumbed to the temptation of including
goodwill in the value of land for the purpose of imposing duty.793 The inclusion of the
value of goodwill in the value of land is set down in the HMRC’s Stamp Duty Land
Tax Manual.(The pages of this manual have the prefix SDLTM). Thus page
SDLTM04005 refers to goodwill inherent in the land as actually forming part of the
land. In support of this position, the HMRC have made a distinction between what
they call ‘inherent goodwill’, claiming that to be part of the land, and ‘free goodwill’,
being separate from the land. The value of the so-called inherent goodwill, therefore,
is claimed to be dutiable as part of the value of the land for the purposes of the SDLT.
However, case law in the UK (as in Australia) indicates that there is no basis in the
law to include goodwill in land.794
11.7.1 The HMRC position
The HMRC set out the definition of goodwill and the distinction between inherent
goodwill and free goodwill in the Capital Gains Manual at pages CG68000 –
CG68046, as referred to on SDLTM04005. On page CG68005 it is stated that
goodwill is regarded as ‘a single asset’ and further that it ‘is not a divisible asset’. But
then on CG68012 goodwill is divided into three categories: personal goodwill;
inherent goodwill; and free goodwill. And the manual proposes that at least inherent
goodwill and free goodwill may be transferred on the sale of a business. For a start,
this presents an inconsistency. If goodwill is a single, indivisible asset (or one item of
property), how then can it be divided into distinct categories? Moreover, as a basis for
these categories, the manual placed reliance on the zoological classifications of
goodwill relating to cats, dogs, rats and rabbits found in Whiteman Smith Motor
Company Limited v. Chaplin,795 a case considered in chapter 3. However, it should be
noted that these are simply colourful metaphors for certain classes of customers of a
business and do not constitute a sound basis for the approach to goodwill taken by the
HMRC. And, in fact, the HMRC dispensed with these zoological classifications in
early 2009, stating that they are ‘no longer considered helpful as they tend to cause
793 This was also the approach taken by the Commissioner of State Revenue in Victoria where stamp duty is not imposed on conveyances of property. However, as discussed in chapter 7, this approach has been laid to rest by the courts in the wake of Murry. See also Tregoning, I., ‘Goodwill and Stamp Duties: the Legacy of Murry’ (2006) 6(2) Oxford University Commonwealth Law Journal 183. 794 See Tregoning, I., ‘Goodwill and the Stamp Duty Land Tax’, [2007] (5) British Tax Review 648. 795 [1934] 2 KB 35.
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confusion’.796 Nonetheless, although they have dropped the animal metaphors, the
HMRC remain wedded to their position that the value of goodwill may be included in
the value of land.
11.7.2 The Australian situation
The legal nature of goodwill and its relationship to other property of a business was
given a detailed analysis by the High Court of Australia in FCT v. Murry,797 as
discussed elsewhere in this paper. The essence of the High Court’s view of goodwill
was that it is one indivisible item of property, attached to the business, but legally
distinct from other property of the business. The High Court saw goodwill as having
various sources, including other property or assets of the business, and also non-
proprietary qualities of the business such as the personalities of the staff, advertising
and good customer relations. However, it was made clear that goodwill was separate
from these sources. On this view, it is not possible to split goodwill into components
and to claim that part of it is to be included in other property, such as land.
Goodwill is treated as property for the imposition of ad valorem duty in all Australian
jurisdictions, except the state of Victoria.798 Thus there was a specific revenue
incentive in Victoria to include the value of goodwill in the value of land which is
subject to stamp duty on transfer, like the situation with the HMRC currently. While
the other Australian jurisdictions do not have this particular incentive, the anti-
avoidance ‘land rich’ provisions of all the jurisdictions make the relationship of
goodwill and land an important consideration. Before the High Court’s
pronouncements on the nature of goodwill in Murry, the revenue authorities and the
courts had been inclined to include goodwill in the value of the land for stamp duty
purposes. However, in the wake of Murry, the courts have declined to treat goodwill
as part of the land for stamp duty, on the understanding that they are separate items of
property, even where the land may have been seen as the major source of the
goodwill.
796 HMRC Practice Note ‘Apportioning the Price Paid for a Business Transferred as a Going Concern’ (issued 30 January 2009), para. 3.5. See also McLaughlin, M., ‘The Goodwill Trap’, (May/June 2009) Practice Update 2. 797 (1998) 98 ATC 4585. 798 For a detailed analysis of the Australian situation, see ch. 7.
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11.7.3 UK case law
It is well established that goodwill is property: see for example the House of Lords’
case of CIR v. Muller & Co’s Margarine Ltd.799 Furthermore, on the authority ofthis
case it is clear that goodwill is one whole item of property which is attached to the
business rather than to any other item of property in the business. In this regard, Lord
Macnaghten said ‘[t]he goodwill of a business is one whole … goodwill has no
independent existence. It cannot subsist by itself. It must be attached to a business’.800
While Muller was a stamp duty case, it did not deal directly with the question of the
connection of goodwill to land. But another UK case, The West London Syndicate
Limited v. CIR,801 did deal directly with this question. By majority, the Court of
Appeal held that goodwill was property separate from land for the purpose of the
Stamp Act, 1891. An earlier stamp duty case, Potter v. CIR,802 also indicated that
goodwill was property separate from the land in a business. As Collins CJ observed in
Danubian Sugar Factories v. CIR803 concerning both The West London Syndicate and
Potter, they ‘decided that the goodwill of premises, apart from the premises, was itself
property’.804 In the light of these cases, it may be seen that there is long-standing
authority to support the position that goodwill is one whole item of property in its own
right and separate from land.
11.7.4 The final word
Both the Australian and UK authorities make it clear that goodwill is one whole item
of property separate from its sources, including land. There can be no doubt that
goodwill may be generated by land and thus may be identified as so-called inherent
goodwill (or site goodwill). But that does not mean that the value of goodwill may be
included in the value of land for purposes of imposing duty.805 Of course, the land
may be made more valuable in itself by having a successful business conducted on it
(a situation recognized in Murry), but the value of that land should not also be
increased for duty by adding an amount of goodwill to it.
799 [1901] AC 217. 800 Id at 224. 801 [1898] 2 QB 507 (CA). 802 (1854) 10 Ex 147; 156 ER 392. 803 [1901] 1 QB 245. 804 Id at 251. 805 This has been noted by Smith, C. in ‘Any claim to stamp duty land tax on goodwill should be appealed’, (2009) The Law Gazette http://www.lawgazette.co.uk/print/53418.
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11.8 Conclusion
The conclusion to be drawn from the issues in this chapter is that the concept of
goodwill for a range of tax purposes is generally consistent with the settled
jurisprudence on its meaning and nature. Given that taxation is a body of law, there
should be no reason or basis for viewing goodwill in any other way. This is the case
notwithstanding the fact that tax offices such as the ATO, the state revenue offices and
the HMRC, have deviated from this settled jurisprudence in certain situations and still
maintain this unorthodoxy concerning personal goodwill. Moreover, they have tended
to deviate in the past in their endeavours to include site goodwill in the value of land
(as dealt with in chapter 7 specifically).
However, while it is the legal concept of goodwill which is generally applicable for
tax, the value of that goodwill is typically taken into account for calculation and
assessment purposes. Thus the concept may be taken to be close the accounting
concept which is essentially one of value. This position is especially evident in the
consolidations regime where it is the value of goodwill which is paramount.
Furthermore, the consolidations regime goes beyond the conventional concepts of
goodwill to encompass concepts outside both the general accounting and legal
concepts. However, as explained in para. 11.6, these concepts are designed to meet the
specific requirements of that regime and do not affect the general conception of
goodwill.
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Chapter 12: The Valuation of Goodwill
12.1 Introduction
Previous chapters have dealt largely with the composition and nature of goodwill and
its relationship with other property of the business. This chapter deals with the
valuation of goodwill, rather than questions of its existence and nature in the business
in particular. It is, however, impossible to separate the value of goodwill from its
origins as the value reflects the nature of the goodwill being valued. Principles of
goodwill valuation for legal purposes are thus derived from case law precedents, in
contrast with the value of accounting goodwill which is essentially a residual amount
after all identifiable assets of a business have been valued.
While this chapter focuses on legal goodwill, when it comes to matters of valuation
accounting concepts may also play a part. There may, in fact, be a reasonable degree
of congruence (if not synthesis) between the legal and accounting concepts of
goodwill in the area of its valuation in appropriate circumstances. This matter was
addressed by the High Court in FCT v. Murry where the majority said:
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. Admittedly this approach can cause problems in valuing
goodwill for legal purposes because the identifiable assets need to be valued with
precision.806 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.807
However, while the value of legal and accounting goodwill may be identical in
profitable businesses, the High Court considered there may be a marked difference in
values between the two concepts in the case of low-profit or non-profitable
businesses.808 Their opinion was based on the view that legal goodwill may have a
806 This last proposition is somewhat puzzling – why not precision for accounting also? It appears that it is a reference to unreliable historical costs in a balance sheet as suggested in the next sentence. 807 (1998) 98 ATC 4585 at 4595. This issue also arose in chapter 11, para 11.6, concerning consolidations and the value of goodwill. 808 Ibid.
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value to the business even where it has no value for accounting because, they
explained, ‘goodwill for legal purposes includes everything that adds value to the
business – “every positive advantage” as Wood V-C pointed out in Churton v.
Douglas’.809 It is reasonable to say that legal goodwill may be of some value to a
business regardless of its level of profitability because the legal concept may provide
an advantage to business apart from its actual monetary value. This can occur, for
example, where legal goodwill gives rise to legal rights that can give rise to monetary
damages where the goodwill is the subject of a passing-off action or a restrictive
covenant. However, such advantages are somewhat limited in scope and it is difficult
generally to conceive of legal goodwill as something independent of notions of
monetary value. The accounting treatment of goodwill may result in its being written
down to a low value or written off entirely from the business balance sheet, but this is
an accounting practice which need not reflect the value of the goodwill where, say, the
business is sold.
From a practical viewpoint, the valuation of goodwill may present a range of
difficulties for those undertaking the task which is generally considered to be within
the domain of valuation experts rather than the courts. As Pagone J said in Fagenblat
v. Feingold Partners Pty Ltd:
The task of valuation of the goodwill of a professional practice is complex and is
peculiarly within the domain of experts. The identification of the matters which will, or
may, bear upon so elusive a concept as the valuation of goodwill requires detailed
investigation by a person who knows how and what to investigate. It is imperative that
the expert called upon to determine the … value of a professional practice understands
the business fully. That necessarily presupposes a degree of expertise and experience on
the part of the valuer to know what to look for as well as how to evaluate what is found.
These are tasks which are dependant upon expertise based upon experience and
training; they are not suited to the mere intuition of a court.810
While the above passage refers specifically to professional businesses, it may equally
apply to other businesses also. The nature of goodwill, with its value varying with the
fortunes of the business, may present problems regardless of the nature of the
809 Ibid. Churton v. Douglas (1859) Johns 174; 70 ER 385 provided an early definition of goodwill: see chapter 2, para. 2.4. 810 (2001-2002) 49 ATR 18 at 22.
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business. The majority of the High Court in FCT v. Murry recognized the problem in
saying:
The value of the goodwill of a business 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.811
Certain general principles and approaches may be gleaned from cases, but the very
nature of valuation of goodwill, being dependant on the nature of the business, its
profitability and the reasons for the valuation, means that specific rules cannot be
determined. Cases as far back as the early nineteenth century may be seen to be
grappling with the valuation of goodwill, including methods of valuation and
contextual factors affecting its value.
With the above matters in mind, the rest of this chapter takes the following form. In
para. 12.2 the early case law on questions of the valuation of goodwill is examined.
Issues concerning approaches to valuing goodwill for various purposes are evident
from an early stage. Then, in para. 12.3, current methods of valuation of goodwill are
addressed, including the areas of partnerships, bankruptcy and divorce. Subparagraph
12.3.1 deals with a range of issues concerning partnership goodwill. Partnerships
present a range of interesting issues arising from the need to value goodwill where
there is not the direct sale of the business but where instead there are retirements or
deaths of partners or other changes in the composition of the partnership.
Subparagraph 12.3.2 deals with particular valuation issues relating to goodwill which
arise in bankruptcy and divorce settlements. These settlements produce some specific
issues, including the treatment of personal goodwill. As concluded in para. 12.4, a
significant degree of overlap between the legal and accounting concepts of goodwill
may be found in the area of valuations. In this sense, goodwill emerges as a multi-
faceted concept.
12.2 Early case law
In his decrees in Cook v. Collingridge812 in 1825, Lord Eldon LC put his mind to the
valuation of goodwill in a business partnership that had terminated with the effluxion
of time. The essence of his decree in this matter was that the value must be adversely
811 (1998) 98 ATC 4585 at 4595. 812 (1825) 27 Beav 456; 54 ER 180.
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affected by the absence of a restrictive covenant to protect its value, and that the
goodwill in this case, therefore, could not be valued on the same basis as for a
business which remained as a going concern and where a partner simply sold his share
and retired from the trade. Lord Eldon declared in his prolix and convoluted fashion:
… that the claim … to have any estimated value put upon any subject that can be
considered as described by the term goodwill cannot be supported upon the same
grounds or principles as those upon which a compensation or value was, in this
establishment, received from a partner buying the share of a partner going out of the
business of this establishment, and retiring from the trade and business altogether. …
that, in this case, if the property of the present establishment is sold, and the present
partners, or any of them, … engage in a new establishment carrying on the same trade
or business (which they are fully at liberty to do), it is obvious that if by goodwill is
meant the value of the chance that the customers of the partners retiring altogether will
deal with those who purchase from such retiring partners and succeed to their
establishment, a goodwill of that nature cannot be valued on the same principle, as
where the persons retiring, but not retiring altogether, from trade, have also a chance,
and a great chance, of carrying the old customers into their new establishment, which
must most materially affect, if it does not destroy, the chance of the persons purchasing
the old establishment will retain many of the customers of the old establishment.813
In this case it may be seen that Lord Eldon viewed goodwill as the chance that the old
customers would resort to the old establishment along the lines of his definition in
Cruttwell v. Lye814 and, in so viewing it, he held that ‘it was going on too far to hold
that chance is to be treated as of no speculative value’.815 He then advanced a
‘reasonable’ approach to valuing the goodwill on the part of the purchasers of the
business in the following terms:
… as reasonable good information as the present partners … and … in addition of the
articles which can be enumerated, they are informed of the last three or four years’
profits, and who are the persons that are the customers of the present concern, they may
then speculate (as far as the nature of the transaction can admit of them speculating)
prudently what they will give for the chance of retaining the old customers, or any of
them, having regard to the fact that the old partners are, some of them are, about to
813 Id at 458-9. 814 (1810) 17 Ves Jun 335; 34 ER 129. In this case, Lord Eldon defined goodwill as the probability that the old customers will resort to the old place: see ch. 2, para 2.3. 815
Cook v. Collingridge (1825) 27 Beav 456 at 459; 34 ER 180 at 181.
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engage in the same business, and may attract to their new establishment those
customers, many or some of them. … in this case, as it appears to this Court to be
circumstanced, the valuation and estimate is and can only be that which every bidder,
according to his own speculations, can fancy to be the worth of his chance of retaining
old customers, and their not following the old partners, or any of them, into a new
establishment.816
A more concise translation of the above passage is that the value of the goodwill
should be based on the chance of retaining the old customers, and on an estimate of
the profits they would generate, in the face of competition from the vendors in the
absence of a restrictive covenant. Notwithstanding Lord Eldon’s painful prolixity,
however, these decrees from this early case clearly indicate the importance of valuing
goodwill in the view of the courts. And indeed the value of goodwill is of fundamental
importance by its very nature; the essence of goodwill is the value of the business as a
going concern.
In 1858 in Davies v. Hodgson817 Sir John Romilly MR followed Lord Eldon’s decree
in Cook v. Collingridge in holding that the goodwill of the business in this particular
case was worth nothing because it was not protected by a restrictive covenant. The
business was that of a tobacco broker which was found to depend mainly on the
personal knowledge and endeavours of the person carrying on the business. Without
the protection of a covenant removing the vendor from potential competition, there
was effectively nothing to sell. In similar vein, Lord Westbury LC held in Hall v.
Barrows818 in 1863 that partnership goodwill should be valued on the footing that the
surviving partner would be at liberty to compete with a purchaser. On the other hand,
in the early 1817 case of Harrison v. Gardner819 Plumer V-C was prepared to grant an
injunction to protect goodwill on finding that there existed, in effect, a restrictive
covenant which bound the defendant from competing with the plaintiff. There is
clearly no doubt that restrictive covenants have always been an effective way of
protecting the value of goodwill from its vendors. What is not so clear, however, is
why these valuations were made on the assumption of no restrictive covenant to
protect the goodwill in the nineteenth century. Perhaps it may be inferred that the
816 Ibid. 817 (1858) 25 Beav 177. 818 (1863) 4 De G J & S 150. 819 (1817) 2 Madd 198; 56 ER 308. Details of this case may be found in chapter 6.
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general lack of restrictive covenants in actual sales of businesses in that period led to
the view that they should not be implied in other cases necessitating the valuation of
goodwill. This general lack of restrictive covenants in that period has also been
referred to in chapter 6.
The cases noted above make the fundamental point that the value of goodwill is
affected by the possibility of competition, as recognized early by Lord Eldon. But this
point does not offer any formula or methodology for calculating a value for goodwill.
Obviously, something as elusive and multi-faceted as goodwill will not afford any
straightforward formula for its calculation, as was recognized back in the nineteenth
century by Allan who said:
The value of the goodwill of a business is not an easy matter to determine. It should be
ascertained in each case by persons acquainted with the particular class of business in
question, and attention should be paid as to what is really to be conveyed and what is
not.820
In Hall v. Hall821 in 1855 a retiring partner claimed that the compensation for his share
of the partnership goodwill should be calculated as an amount equalling an estimate of
two years’ profits of the partnership business. In this particular case, this claim was
not accepted by the court because it determined that the retiring partner was not
entitled to any compensation for goodwill. However, it does indicate an approach to
valuation using a calculation based on profit estimates. Indeed, in Austen v. Boys it
was stated obiter by the Lord Chancellor as a general proposition that ‘in determining
[goodwill’s] value the profits are necessarily taken into account, and it is usually
estimated at so many years’ purchase upon the amount of those profits’.822 This
approach was noted by Allan who stated that ‘[t]he usual basis of valuation is the
average net profits made during the few years preceding the sale.’823
As discussed elsewhere in this paper, however, there was also in the nineteenth
century a more fundamental issue found in cases involving professional businesses,
namely whether goodwill existed at all in such businesses. Thus in a case such as
820 Allan, C. E. 1889, The Law relating to Goodwill, Stevens and Sons Ltd, London, 84. 821 (1855) 20 Beav 139; 52 ER 555. 822 (1858) 27 LJ Ch 714 at 718. 823 Allan, C. E. 1889, op. cit. 85.
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Arundell v. Bell,824 concerning the dissolution of a partnership of solicitors, counsel
for the plaintiff argued that the goodwill should be valued at 10,000 pounds on the
basis of five years’ purchase of an estimated profit of 2,000 pounds per year. But the
Court of Appeal held that no goodwill existed, rendering the calculation redundant.
However, as also noted elsewhere, this issue had been laid to rest by the end of that
century by which time goodwill had been accepted generally in professional
businesses.
The elusive character of goodwill and the consequent difficulty of valuing it was
nicely put by Romilly MR in Mellersh v. Keen in 1860 where he said that ‘[t]he
difficulty of ascertaining the value of the goodwill of a business is very great; it is of a
shadowy character, and a very slight thing will increase or diminish its value’.825 An
example of this difficulty had been addressed earlier by Romilly in Smith v. Everett826
in 1859 where he was required to determine whether the estate of a deceased partner
was entitled to a share of goodwill on the subsequent sale of the business of banking
by the surviving partner, the defendant. There was no clear evidence that an amount
for goodwill from the sale was included in the settlement paid to the deceased estate
and consequently Romilly placed the onus on the defendant to show that such an
amount was included and directed enquiries to be made. In doing so, he directed that
any amount of goodwill should be calculated having regard to certain facts that would
tend to reduce the value of goodwill due to the estate of the deceased partner. These
facts were:
1. That the premises in which the partnership business was carried on belonged
to the defendant Mr Everett.
2. That the defendant Mr Everett was entitled to carry on the business of a
banker … in the same premises after the goodwill had been sold.
3. That there survived to Mr Everett the sole and exclusive right of issuing
[bank] notes.827
824 (1883) 52 LJ Ch 537. 825 (1860) 28 Beav 453 at 454-5; 54 ER 440 at 441. 826 (1859) 27 Beav 446; 54 ER 175. 827 Id at 456.
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While the above facts do not constitute a formula for the calculation of goodwill, they
represent matters which together both affected the value of the goodwill itself and the
share of it to which the deceased estate was entitled.
These early cases reveal certain approaches to the valuation of goodwill which may be
found today, particularly the reasonably straightforward methods based on several
years’ profits. However, some of the more sophisticated methods involving, for
example, capitalizations of future profit projections were apparently not used in the
nineteenth century. A notable issue affecting valuations in this early period was the
question of the presence of a restrictive covenant to protect the goodwill on sale of the
business. This is not an issue which would be expected to apply in modern times with
the inclusion of appropriate restrictive covenants being standard practice. But
notwithstanding these earlier issues, the problems arising from the elusive nature of
goodwill may be found in these cases, as is the situation today.
12.3 Current issues in the valuation of goodwill
In the modern day a range of issues and problems concerning goodwill are found to
exist still. In determining the value of goodwill on the purchase of a business, Gole
has stated:
Because of the very nature of goodwill the valuation of it presents some problems. It is
far more convenient and much more logical to regard goodwill as incidental to
valuation rather than fundamental to it. In this sense the value of goodwill is a residual
figure resulting from applying value to tangible things and setting this against the total
price paid to determine how much has been paid for goodwill.828
This is a straightforward reference to the residual method of valuing goodwill used in
accounting on the purchase of a business.829Then Gole goes on to survey a range of
valuation methods which have been advocated and used in valuing goodwill
separately for specific purposes outside the sale of the business.830Some of these
828 Gole, V. L. 1980, Valuation of Business Shares and Property, Butterworths, Sydney, ch. 6. 829 For discussion and explanation of the valuation of businesses as a whole, see Lonergan, W. 2003, The Valuation of Businesses, Shares and Other Equity, 4th ed., Allen & Unwin, Crows Nest, NSW. (However, chapter 17, specifically on the valuation of goodwill, is unfortunately inadequate and should be avoided.) 830 Useful detail and concise explanations of these valuation methods may be found in Reed, R., ‘Valuing the Elusive Business Goodwill’, (Aug. 1997) The Valuer & Land Economist 604. (The authormakes some comments about the nature of goodwill which do not accord with the law, but the
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methods, dating from earlier times, have been referred to already in this chapter.
Typically these methods are used in cases where a partner is leaving a partnership
business and his share of the goodwill needs to be calculated to determine his pay-out
and in cases concerning bankruptcy and divorce where amounts of goodwill need to
be valued for purposes of settlement.
However, the specific details of the methods of valuing goodwill are not important for
this paper, only what they may contribute to an understanding of the concept of
goodwill. The methods typically used to value goodwill do not of themselves reveal
much about the nature of goodwill in either its accounting or legal concepts. Looked
at purely from a mathematical viewpoint, little may be learnt about the nature of
goodwill. Nevertheless, aside from the specifics of the valuation methods themselves,
modern valuations in the context of partnerships, bankruptcy and divorce raise issues
which shed light on the nature and treatment of goodwill in these particular
circumstances.
In addition to calculations of value, issues going right to the nature of goodwill may
also arise. A ready example is the issue of so-called personal goodwill and the
tendency in certain situations to treat it as a separate item of goodwill apart from any
other goodwill, as has been discussed in other parts of this paper. This approach is
clearly contrary to the settled jurisprudence on goodwill as, inter alia, one whole
indivisible item of property. Nonetheless, there may be certain types of situation
where a notional separation of the elements of goodwill, according to its sources, is
justifiable to suit specific requirements. A prime example of this type of situation was
discussed in chapter 10 concerning the practice of including the value of site goodwill
in the value of land for the particular purpose of calculating compensation to be paid
on the loss of a business. This approach represents a notional splitting of goodwill for
the specific purpose of calculation and therefore need not be taken to represent a
departure from the legal concept of goodwill. In other words, this approach is taken to
suit the purposes of valuation rather than being a statement about the nature of
goodwill. This is a view supported by the High Court in Murry.831
valuation methods are the important part of this article.) See also Callard, L. M. and Pallot, W. J. 1994, Business Valuation Practice, LBC, Sydney, ch. 4. 831 (1998) 98 ATC 4585 at 4594.
227
As is discussed below, a somewhat similar approach may also be discerned in
bankruptcy and divorce cases where particular views and valuations of goodwill may
be required.832 In bankruptcy, it needs to be determined what goodwill should be
vested in the trustee in bankruptcy. In divorce, the focus is on the value of goodwill
which may be taken into account in a settlement.833 In both of these areas, there is a
tendency to view personal goodwill as an item of property separate from other
goodwill in considering the nature and treatment of goodwill.
12.3.1 Valuation of partnership goodwill
The valuation of goodwill in partnership businesses presents interesting issues because
of the need to value the goodwill in cases of partnership dissolution or on the addition
or departure of partners. This presents a different case from that of the sale of a
business as a going concern where the value of the goodwill will be settled as part of
the business assets subject to sale. A change in the composition of a partnership
without sale does not provide the opportunity for testing the value in the market place,
so alternative methods of valuation have to be determined. A number of the cases
already referred to in this chapter concern partnerships: not a surprising situation in
view of the problems just alluded to.
In Re David and Matthews Romer J laid down the following basis for valuing the
goodwill of a two-man partnership on the death of one of them for the purpose of
determining how much was due to his estate:
I think that goodwill ought to be valued on the footing of the consideration of what its
value would have been to the partnership if there had been no contract between the
partners that the surviving partner should purchase the share of the deceased partner in
the partnership effects and securities, and therefore on the footing that if it were sold the
832 There may be interactions between the areas of bankruptcy and divorce where, for example, a party is bankrupt already or is driven to bankruptcy resulting from a divorce settlement. Questions of priority of debtors over parties to the divorce may arise in these circumstances. See Watts, G., ‘Interaction of Family Law and Bankruptcy Law’ (ch. 6) in Cooper P. K. (ed.) 1993, Family Property Law, Blackstone Press, NSW. 833 In the USA, in both bankruptcy and divorce, the courts make a distinction between ‘professional’ (personal) goodwill and ‘enterprise’ goodwill (arising from all other sources). Professional goodwill is not included in a bankrupt’s estate and is not counted as property in a divorce settlement. The fundamental view taken is that professional goodwill is not transferable. See Epstein, P. H., ‘The Transfer of Professional Goodwill’, (2006) 8(3) Corporate Business Taxation Monthly 45 for a survey of both areas of law, and Kelly, A. B., ‘Sharing a Piece of the Future Post-Divorce: Toward a More Equitable Distribution of Professional Goodwill’, (1999) 51 Rutgers Law Review 569 for a detailed examination of professional goodwill in divorce.
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surviving partner would be at liberty to carry on a rival business, but also, I think, on
the footing that he could not use the name of the partnership firm … , and would not
have the right to solicit the old customers of the firm.834
This basis assumes that there is no restrictive covenant protecting the goodwill on the
notional sale, a situation which is unlikely to be the case today in the event of an
actual sale. Thus this seems to be an unreasonable constraint on determining the value,
with the likelihood of an undervaluation in comparison with an actual sale. It is
arguable that this is not an equitable situation for a retiring partner. The second
assumption or footing concerning not soliciting the old customers of the firm is
reasonable and based on the equitable principle that the seller of goodwill should not
depreciate the value of that goodwill, as discussed in chapter 6. However, a suitable
restrictive covenant would remove the need for such a principle in the first place, of
course. The use of the firm’s name also would be expected to be settled in such a
covenant.
In McFadden v. CSD(NSW)835both Hutley and Samuels JJA applied the above
principles from Re David and Matthews in deciding the appropriateness of the
valuation method used to determine the amount of goodwill to be included in a
deceased partner’s estate for death duty purposes. The valuation method itself,
undertaken by a chartered accountant on the basis of these principles, was based on
three years’ profits after allowing notional salaries for partners and deducting income
tax from these profits. Both judges accepted the appropriateness of the calculation,
with the exception of the deductions for income tax which they held were contrary to
High Court authority.836 While it was not made explicit in the judgments in this case,
the estimated amounts of income would have been discounted by a suitable
capitalization rate to obtain the value of the goodwill. The third judge in McFadden,
Mahoney JA, made mention of two basic approaches to the calculation of goodwill:
the ‘comparable sale’ approach; and the ‘summation’ or ‘capitalisation’ approach, as
used in this case. In reference to the former approach, Mahoney JA said that ‘[t]he
value of … goodwill is affected by what, given the sale of it, a willing but not anxious
834 [1895-9] All ER 817 at 819. 835 (1980) 80 ATC 4343. 836
Eastaway v. Commonwealth (1950) 84 CLR 328 and Dangerfield v. Town of St. Peters (1972) 129 CLR 586 were cited. However, the difference in value made by omitting tax was found to be immaterial and thus was not contested by the Commissioner of Stamp Duties.
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purchaser would pay for it.’837 The ‘comparable sale’ approach seems not to be
favoured, with the more mathematical capitalisation approach being favoured in most
cases.
Capitalisation was the method accepted in valuing the goodwill of a law firm in
Fagenblat v. Feingold Partners Pty Ltd.838 This case, in fact, illustrates some of the
typical difficulties which may be encountered in valuing a business and its goodwill.
At issue was the proper valuation of the goodwill on the plaintiff’s retirement from the
firm. The defendant contested the valuation made by an expert valuer on several
grounds, including the calculation of projected future earnings of the firm, the
determination of the capitalisation rate, and that the valuer failed to take into account
the possibility that the retiring plaintiff would not remain with the firm in an employed
capacity as originally planned. In fact, the valuer had calculated both the earnings and
the capitalisation rate on the basis that the plaintiff would be remaining in the firm as
an employee.
The basis for the valuation was the calculation of the future maintainable earnings of
the firm, which in turn were based on the preceding three years’ profits, adjusted for
non-recurring items to include therefore only the operating results of current activities.
One of the adjustments specifically mentioned in the judgment was a deduction for
notional interest on the partners’ working capital. Pagone J saw no reason to doubt the
appropriateness of this approach, nor to doubt the choice of the capitalization rate of
30% which was chosen by the valuer simply because it had been used in the past by
the firm for other calculations.
One interesting issue of dispute between the parties ‘concerned the extent to which it
was either permissible or proper to take into account facts subsequent to the valuation
date in order to determine the value as at the date of valuation.’839 The date of
valuation when the plaintiff was to retire from the firm as a principal was 30 June
837 (1980) 80 ATC 4343 at 4349. 838 (2001-2002) 49 ATR 18. This practice was a partnership of family practice trusts where one company, Feingold Partners Pty Ltd, was the trustee of all five of these trust members. The legal practitioners themselves were directors of the trustee company and each was connected with his particular practice family trust. This ‘less than usual arrangement’, in Pagone J’s words, was apparently approved by the Legal Practice Board in Victoria. Regardless, this arrangement was not considered to be an issue in this case; for the purposes of valuation of the goodwill, it was considered immaterial whether the retiring partner was the plaintiff himself or his family trust. 839 (2001-2002) 49 ATR 18 at 22.
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2000, but he indicated his willingness to continue from that time as an employee of
the firm in a full-time capacity. As noted above, this was taken into account in the
valuation. However, as relations between the plaintiff and one of the other principals
were very poor, it was argued for the defendant that the consequent likelihood of the
plaintiff’s not remaining with the firm should have been taken into account. His
departure, it was argued, would have an adverse effect on earnings and therefore
reduce the value of the goodwill of the practice. Concerning the law on this issue,
Pagone J stated:
The law has long been that regard may be had to events after the date for valuation
‘insofar as they illuminate the value of the thing as at’ the date for valuation. It is
equally plain … that not every event subsequent to the valuation date may be taken into
account in the valuation. In each case the court has to consider ‘whether a subsequent
event truly indicates or reflects’ the value at the date for valuation.840
In the circumstances of this case, Pagone J was not persuaded that account should
have been taken of the plaintiff’s subsequent departure. He held that there was much
evidence that as at the time of valuation on 30 June 2000 it was probable that the
plaintiff would remain with the firm at least long enough to enable an orderly
departure in such a way that would preserve the firm’s earnings.
These cases illustrate issues which may apply in the specific situation of partnership
dissolutions as opposed to the straight out sale of the business of the partnership. The
need to value goodwill to settle a payout to a retiring partner or to pay a share to a
deceased partner’s estate require valuations of the goodwill in the business as a
continuing business, as opposed to a value that is determined on sale to an external
purchaser. This need is based on the partnership law that a share of goodwill is due to
a partner on retirement or to his estate on death, as discussed in chapter 5.
12.3.2 Valuation issues in bankruptcy
For the purposes of the Bankruptcy Act 1966 (Cth) goodwill of the bankrupt’s
business will constitute property which is defined in broad terms in s. 5(1) to mean
principally ‘real or personal property of every description’. Consequently, goodwill
should form part of the property vested in the trustee in bankruptcy and be divisible
840 Ibid. Pagone J cited and quoted from Kizbeau Pty Ltd v. W G & B Pty Ltd (1995) 184 CLR 281 in support of this view.
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among creditors in accordance with s. 116(1), given that it is not exempted by any of
the limiting provisions of s. 116(2).841 However, to the extent that the goodwill is
personal goodwill sourced to the person of the bankrupt, it seems it may be excluded
from the value of the goodwill vested in the trustee for the creditors’ benefit. In Re
Hunter,842 for example, Clyne J said: ‘So far as goodwill is local it can pass to a
bankrupt’s trustee but so far as it is personal it remains with the bankrupt’.843 This
case concerned a medical practice and the judge found that the facts revealed that the
goodwill was solely sourced in the premises,844 as local (site) goodwill, and therefore
it fully vested in the trustee in bankruptcy. However, the principle expressed by Clyne
J may be interpreted as reasonable in the circumstances where there is a component of
personal goodwill which is not possible to transfer in a practical sense, such as where
the custom cannot be effectively transferred.845 What this should mean is that the
value of the goodwill should be decreased to reflect this limitation. In accordance with
the current understanding of goodwill, however, it is not strictly correct to hold that
personal goodwill cannot be transferred, remembering that goodwill is one whole item
of property separate from its sources whatever they might be.
On the other hand, in Re Lazarus,846 concerning a solicitor’s practice, no reference
was made to any personal component of the goodwill, with a valuation of the goodwill
as a whole made in determining the amount to be paid to the trustee for that goodwill.
Nonetheless, it seems that there is some authority for reducing the value of goodwill
to reflect, where appropriate, practical difficulties or limitations in transferring
customer allegiance in the transfer of a business. This is a reasonable approach to a
particular type of situation turning essentially on issues of value; it does not affect or
run counter to the settled jurisprudence on the nature of goodwill.
841 An explanation of what comprises a bankrupt estate may be found in Symes, C. and Duns, J. 2009, Australian Insolvency Law, LexisNexis Butterworths, Chatswood NSW, ch. 3., and Rose, D. 1999, Australian Bankruptcy Law, 11th ed., LBC, Sydney. 842 (1953) 16 ABC 129. 843 Id at 131. 844 The practice had been the subject of sale and the bankrupt had not undertaken to introduce the purchaser to any of the patients, indicating that personal goodwill could not be present. 845 It is most probable that Clyne J actually perceived goodwill as having separate components such as local goodwill and personal goodwill, counter to the settled jurisprudence, but this is would not affect the practical principle. 846 (1940) 11 ABC 249.
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12.3.3 Valuation issues in divorce
Settlements of property upon divorce are governed by the Family Law Act 1975 (Cth)
in which property is defined in s. 4(1) to mean in relation to the marriage partners,
jointly or individually, ‘property to which those parties are … entitled, whether in
possession or reversion’. This is a circular definition which defines property simply as
property owned or possessed jointly or individually by the parties to the divorce.
Hence it would be expected that property would be given a broad general meaning,
which is supported by the following statement from the Full Family Court:
It seems unnecessary to attempt to set out a catalogue of what ‘property’ may include in
the context of s. 79. It is sufficient for the purposes of this case to say that ‘property’
means property both real and personal and includes choses in action.847
Court orders concerning the division of this property are made under the provisions of
s. 79, including the appropriate valuation of the property for this purpose. The relevant
issues for this topic are the concept, the valuation, and the treatment of goodwill as
property which it clearly is in this context.
As with bankruptcy, the critical issue concerning goodwill is one of valuation for the
purpose of determining the settlement. In the case of a company-owned business, the
value of goodwill would affect the value of the shares held by the party or parties.
Conceptually this is straightforward, but of course there may be practical issues and
problems of making an appropriate valuation. While in the normal course the
valuation methods alluded to in this chapter may be applied, there may be particular
problems in valuation in determining an equitable settlement. Such a problem
confronted the court in Aroney v. Aroney848 where the husband controlled a group of
private companies as governing life director. The court was of the view that, because
of this control, he had a financial resource which went ‘far beyond the value of his
shareholding calculated as a proportion of the goodwill and assets of the several
companies’.849 However, on the available evidence and valuations, it was not clear
just what the true value of the goodwill in each company was worth. Nonetheless, the
847
Duff v. Duff (1977) FLC ¶90-217 at 76,132. See Alexander, R. et al. 2007, Australian Master Family
Law Guide, 1st ed., CCH, Sydney, ch. 12, for an explanation of the meaning of property and its valuation. 848 (1979) FLC 78780. 849 Id at 78786.
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court made a ‘speculative’ assessment of the total value of goodwill in the group on
the limited evidence available.
In the case of non-corporate businesses, typically sole traders and partnerships, the
issue of valuing goodwill presents basically the same difficulties as for privately held
companies. However, as with businesses more generally, the valuation of personal
goodwill may be an issue. Where the goodwill is mainly generated by one of the
parties to the divorce, that goodwill may well have little or no value if the business has
to be sold. In effect, for divorce purposes, personal goodwill (sometimes referred to as
professional goodwill) is not treated as an asset, but rather as a financial resource held
by one of the parties to the divorce. While such a resource is not treated as property
and an asset, it may still be taken into account in the settlement.850 This may be
reasonable for these purposes, but to say that personal goodwill is not property is not
correct at law. So-called personal goodwill is simply, of course, goodwill which
emanates largely from a person in the business. The attributes and qualifications of
that person are not themselves property but are the sources of the property, the
goodwill.
The difficulties which may be encountered in determining divorce settlements
concerning businesses are well demonstrated in the case of Dunbar v. Dunbar851 heard
on appeal by the Full Court of the Family Court. Husband and wife presented different
valuations, based on different methods, of their partnership business. At trial the judge
had been confronted with these conflicting valuations and had decided on a
compromise in taking the mean of the two valuations, an approach rejected by the Full
Court which remitted the case for retrial. The husband’s valuer reached his figure by a
‘summation method’ which involved individually valuing the assets of the business,
apparently by unclear means, and then summing them. He attributed no value to
goodwill in this calculation. The wife’s valuer, on the other hand, indicated that the
more conventional method involving the capitalisation of business profits should be
the appropriate one. However, as there were effectively no profits and in the view of
the valuer the business could not be sold as going concern, this method could not be
used. A business which could not be sold as a going concern could be said effectively
850 See s. 75(2)(b) of the Family Law Act 1975 (Cth). 851 (1987) FLC 76389.
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to have no goodwill,852 consistent with the other valuer’s approach to the calculation.
Nonetheless, the widely differing results illustrated the difficulties which may be
found in this area.
12.4 Conclusion
The valuation of goodwill and of businesses more broadly in the context of
partnerships, bankruptcy and divorce presents a range of valuation problems. These
problems are not limited to issues with selecting appropriate valuation methods and
dealing with speculative values of various assets and estimates of profit, although
these are challenging enough in themselves. Rather, there are additional practical
problems stemming from the particular demands placed on the relevant parties to
relinquish their businesses or interests on those businesses in what may often be less
than ideal circumstances. In divorce, in particular, it is arguable that the conflict
between the divorcing parties adds to the problems of a sale in the best circumstances.
This assumes, of course, that a sale to a third party is necessary or possible for the
purpose of the divorce settlement. In the case of sale from one divorcing party to the
other, on the other hand, there is the obvious potential for problems of valuation to
remain in the face of conflicting interests.853 Notwithstanding these types of issues,
however, the essential nature of goodwill as a business asset remains. Various issues
of valuation in these settings may present particular practical problems, but these do
not affect the concept of goodwill in either law or accounting.
The valuation of goodwill for legal purposes has been an issue since early in the
nineteenth century. However, its valuation for accounting purposes (to determine its
value in the balance sheet) is also important and has been a vital topic in accounting
since its recognition as a business asset in the latter part of the nineteenth century.854
The valuation of goodwill would seem, on the face of it, to accord more with the
accounting concept of goodwill than the legal concept because the accounting concept
is one very much of monetary value. Nonetheless, the legal concept, as always,
provides the fundamental idea of goodwill as property of a business. Elements of a
852 Goodwill has no existence independent of the business to which it is attached: see chapter 4, para. 4.4. 853 For a discussion of valuation issues in family law, particularly in the absence of market values available from comparable sales, see Coleman J (of the Family Court of Australia), ‘Valuation Issues in Family Law’ (ch. 1) in Cooper P. K. (ed.) 1993, Family Property Law, Blackstone Press, NSW. 854 See chapter 13.
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multi-faceted goodwill are clearly evident in this environment which requires the
identification of goodwill in a legal sense and its valuation in an accounting sense.
Given the essential nature of goodwill as ‘the very sap and life of the business’,855 the
type of goodwill under consideration in any context must in the end be the same; what
differs is the facet of the goodwill being considered for the particular requirements of
the case.
855 In Trego v. Hunt [1896] AC 7 at 24, Lord Macnaghten referred to goodwill as ‘the very sap and life of the business, without which the business would yield little or no fruit. It is the whole advantage, whatever it may be, of the reputation and connection of the firm, which may have been built up by years of honest work or gained by lavish expenditure of money.’
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Chapter 13: The Origins and Development of Accounting
Goodwill
13.1 Introduction
This chapter introduces the accounting concept of goodwill as the second major part
of this paper after the legal concept. It takes an historical approach to the accounting
concept of goodwill in examining its origins, development, valuation and treatment
during its early period. In doing so, the chapter plots the evolution of accounting
goodwill from its recognizable beginnings in the 1880s to WWII. The period beyond
this point is treated as the modern era which is the subject of chapter 14.
Accounting goodwill has a significantly shorter history than legal goodwill in that its
recognition as an accounting issue may be traced back to only the latter part of the
nineteenth century. The reason for this late recognition may be found in the
development of accounting itself. The development of more sophisticated accounting
practice was a slow process, beginning largely in the late sixteenth century in England
in response to the need to account for capital and profits of the emerging commercial
enterprises in the form of partnerships and joint stock companies. The separation of
ownership and management of these larger business structures required a much better
accounting system than the earlier feudal collections of receipts and expenditures for
the benefit of a sole business proprietor or land owner.856 However, it was not until the
nineteenth century that what might be understood as modern accounting finally
became common practice.857 Consequently, it is not surprising that the recognition of
the rather abstract notion of goodwill as an asset which needed to be recognized in the
accounts did not take root until later in that century.
The early accounting literature on goodwill reveals a concept based closely on the
legal concept,858 as one might expect. Therefore, prima facie, it might be postulated
856 See Bryer, R. A., ‘The history of accounting and the transition to capitalism in England. Part one: theory’, (2000) 25 Accounting, Organizations and Society 131 and ‘The history of accounting and the transition to capitalism in England. Part two: evidence’, (2000) 25 Accounting, Organizations and
Society 327. 857 See Lee, G. A., ‘The Concept of Profit in British Accounting, 1760-1900’, (1975) 49(1) Business
History Review 6 for a study of the development of accounting to the end of the nineteenth century. 858 As noted by Brief, R. P., ‘The Origin and Evolution of Nineteenth Century Asset Accounting’, (1966) 40(1) Business History Review 1, at 10-11, and generally by Bryer, R. A., ‘The laws of accounting in late nineteenth century Britain’, (1998) 3(1) Accounting History 56, accounting in general in the nineteenth century was significantly influenced by the law. Issues concerning accounting for assets were particularly influenced by decisions of the courts. See also Edey, H. C. and Panitpakdi, P.,
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that there should not be a great difference between the legal and accounting concepts,
given their common origins. Nonetheless, the traditional view espoused in the case
law and the literature suggests that they are separate concepts which, what is more,
cannot be synthesized.859 This view, however, appears to be of a more recent origin. In
the early accounting classic, Goodwill and its Treatment in Accounts,860 Lawrence
Dicksee stated in the preface to the third edition of 1906 that the treatment of the legal
aspects of goodwill had been so fully dealt with that the work would be entitled to
take its place as a legal text book. In fact, the first seven chapters of this book dealt
with legal aspects of goodwill before its accounting treatment was broached.861 Yet by
1930 it was stated in the preface to another classic text, by P D Leake, that:
It is clear that the word ‘goodwill’ covers a more restricted area in its ordinary legal
meaning than in its commercial meaning, because some of the rights having this
common characteristic of growing out of past effort in profit-seeking are protected in
law by separate statutes under names other than goodwill. For this reason the area
covered by goodwill in law appears not to extend to those rights which are protected by
separate statutes. Legal goodwill is confined to the connection of an established
undertaking associated with names, person and places of business, and also to
unregistered marks. It is equally clear that the area covered by commercial goodwill is
much wider, including, by custom, and in fact, all rights growing out of past effort in
profit-seeking.862
‘British Company Accounting and the Law 1844-1900’ in Littleton, A. C. and Yamey, B. S. (eds) 1956, Studies in the History of Accounting, Sweet and Maxwell, London, 356, where the writers examine the influence the various Companies Acts enacted in the period of 1844-1900 had on the development of company accounting in particular. For an examination of the influence of company law on accounting in the twentieth century, see Napier, C. and Noke, C., ‘Premiums and Pre-Acquisition Profits: The Legal and Accountancy Professions and Business Combinations’, (1991) 54 Modern Law Review 810. 859 The proposition that the legal and accounting concepts of goodwill cannot be synthesized was put forward by the majority of the High Court in FCT v. Murry (1998) 98 ATC 4585 and forms part of the basis of this paper: see chapter 1, para. 1.1. 860 Dicksee, L. R. and Tillyard, F. 1906, Goodwill and its Treatment in Accounts, 3rd ed., Gee & Co., London, vii. (Reprint edition by Arno Press Inc. 1976.) The first edition of this book was published in 1897. The lead author, Lawrence Dicksee, 1864-1932, was a most prominent accountancy pioneer: in the profession, in writing and in academia. His first book, Auditing, was published in 1892 and ran for 15 editions, with also an American edition published in 1905. He was appointed to the first chair in accounting at any British university, at the University of Birmingham in 1902. He later occupied a similar chair at the University of London. See Kitchen, J. and Parker, R. H. 1980, Accounting Thought
and Education: Six English Pioneers, ICAEW, London, ch. 5. 861 In the view of a contemporary, this work was to be recommended as of ‘the greatest value’ to advanced accountancy students, although ‘its treatment of the legal section [was] more detailed and comprehensive than that dealing with the entries required in the books of account’: Bartle, C., ‘Goodwill, its Treatment in Accounts’, (15 Mar 1919) The Accountant 213 at 213. 862 Leake, P. D. 1930, Commercial Goodwill: Its History, Value, and Treatment in Accounts, 2nd ed., Pitman and Sons, London, vi-vii.
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So, it is apparent that by 1930 a general view had emerged that accounting goodwill
had diverged significantly from its legal parent. Nonetheless, this parentage remained
important as is made clear by the fact that chapter one of Leake’s book on the history
and nature of goodwill deals with the legal development of the concept. However,
from that legal basis in the first chapter Leake moved straight on to issues of the
valuation of goodwill and its accounting treatment, in keeping with its commercial
orientation.
As noted at the beginning, this chapter takes an historical perspective on the
development of accounting goodwill. First, in para. 13.2, the early literature on
goodwill is examined in the period up to World War I. This examination includes a
range of emerging issues such as the definition and nature of goodwill, its value, and
its treatment in accounts. It reveals from the outset that the legal concept of goodwill
had a distinct influence on the accounting concept, even though this concept was
concerned with notions of value rather than the inherent nature of goodwill. Then, in
para. 13.3, similar issues are revealed and plotted in the between-the-wars period to
WWII. Finally, in para. 13.4, it is concluded that there had evolved a hybrid concept
of goodwill based on both legal notions and accounting requirements.
13.2 The early period to WWI
While World War I may be seen as an arbitrary ending point of the first period, it may
also be seen as a suitable point because the upheaval of this war marked the end of a
period in many respects. The appropriateness of using WWI to mark the end of a
period is supported by Kitchen and Parker who stated that this war ‘had a great impact
upon the accountancy profession as … it had upon almost all aspects of British
life’.863 There is no evidence to show, or reason to believe, that the situation was any
different in Australia. Kitchen and Parker continued:
The War had another effect on the [accountancy] profession, which has perhaps gone
unrecognised. It exaggerated the predominance in accounting education and ideas of the
work of Dicksee, Cutforth, de Paula, and, to a lesser extent, Pixley [all prominent
accounting pioneers discussed in their book]. The issue is simply that the First World
War was effective in eliminating, if not a whole generation of young men, at least an
important proportion of the generation of young accountants which might have
863 Kitchen and Parker, op. cit.,5.
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provided replacements in the 1920s and 1930s for men like the pioneers we deal with in
this book. … There were heavy losses of young qualified men and articled clerks as
well as other potential entrants to the profession, and the exhausting war years levied a
heavy toll on the minds and energies of serving practitioners. The consequence was that
successive editions of pre-War works continued to appear with only limited revision
into the 1930s, despite the major changes that were taking place in the economic and
social context of business and in the demands falling on the profession.864
Thus it may be said that the pre-War pioneers of the accountancy profession had an
important influence on accounting theory and practice which went significantly
beyond that period. This may be especially borne out in relation to goodwill where the
issues concerning accountants in the late nineteenth century and up the WWI have
persisted to present times in many respects.865 Significant development in accounting
goodwill took place in that first period, which justifies its recognition.
13.2.1 Early accounting definitions of goodwill
The legal concept of goodwill has tended to focus on the connection customers have
with the business, thus legal definitions reflect that connection.866 The accounting
concept, on the other hand, has tended to focus more on profits and economic
benefits,867 and accounting definitions from the beginning have tended to reflect this
focus. Nonetheless, as illustrated in some of the following definitions, accounting
definitions have also recognized the legal concept of customer connection, and thus
there is not a clear-cut distinction to be made. In view of the legal parentage of the
accounting concept, this would be expected. Arguably, the earliest accounting
definition comes from 1882:
The advantage connected with an established business of good repute. A well-
established business presents an expectation of profits to anyone entering upon it, and is
worth paying for. Anyone having such a business and who is willing to relinquish the
864 Id at 6. 865 A range of these issues is addressed in chapter 14. 866 As noted throughout this paper, the essence of the legal definition of goodwill is ‘the attractive force which brings in custom’ from CIR v. Muller and Co’s Margarine Ltd [1901] AC 217. 867 For example, Accounting Standard AASB 3 currently defines goodwill as ‘[an] asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised.’ This definition will be considered in chapter 14.
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expectation of the business by transferring it for consideration to someone else can do
so by what is technically called ‘selling the goodwill of that business’.868
While this definition emphasizes profits and value, there is a reference to ‘good
repute’ at the beginning, implying the legal concept also.
As noted below, the article that is generally recognized as the first on accounting
goodwill is attributed to William Harris in 1884. While his article was very much a
legal one with a case law orientation, it is notable that the definition of goodwill which
he provided was accounting oriented with its emphasis on value:
Goodwill may be defined as being the money value over and above the value of the
actual assets of a concern (such as book debts, stock-in-trade, machinery etc) which can
be realised in cases of death, dissolution, retirement, or liquidation.869
This definition in fact reflects the residual valuation of goodwill approach which is
taken by accountants in determining the value of goodwill to be included in a balance
sheet on the purchase of a business.
In 1888, in what is claimed to be the first article specifically on accounting goodwill, J
H Bourne defined goodwill as ‘the benefit and advantage accruing to an existing
business from the regard that its customers entertain towards it, and from the
likelihood of continued patronage and support’.870 Ironically perhaps, this accounting
article adopted a more legal form of the definition. However, this approach again
demonstrates the interplay between the two forms of definition, arising from their
common heritage.
The following non-attributed definition from A G Roby, barrister-at-law, in a
published lecture from 1892 again provided a combination of the legal and accounting
concepts, and it was described by the author as the best he could find:
Goodwill is the advantage or benefit which is acquired by an establishment or a man
beyond the mere value of the capital stock, funds, or property employed therein, or by
868 Bithell R. A. 1882, Counting House Dictionary,George Routledge & Sons, London, 142, cited in Courtis, J. K., ‘Business Goodwill: Conceptual Clarification via Accounting, Legal and Etymological Perspectives’, (1983) 10(2) Accounting Historians Journal 1, Appendix 1. This appendix contains a range of goodwill definitions, both accounting and legal, from the period 1882 to 1981. 869 Harris, W., ‘Goodwill’, (29 Mar 1884) 486 The Accountant 9 at 9. 870 Bourne, J. H., ‘Goodwill – No. 1’, (22 Sep 1888) The Accountant 604 at 604.
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him, in consequence of the general public patronage and encouragement which it or he
receives from constant or habitual customers, clients, or patients, on account of its or
his local position, or common celebrity, or reputation for skill, or affluence, or
punctuality, or from other accidental circumstances, or even from partialities or
prejudices.871
The last word on definitions in this period may be given to the prominent pioneering
accounting academic and professional accountant, L R Dicksee, who stated in 1897:
Many definitions have been given of goodwill, most of which are more or less
satisfactory, but which, to my mind, are all more or less incomplete. The definition is
‘the benefit arising from connection and reputation, the probability of the old customers
going to the new firm which has acquired the business’; but one of the best which I
have been able to discover is ‘the value of that reputation which has acquired during its
continuance, which induces the confidence or expectation that the same, or an
increasing, patronage will continue to be extended so long as the business is conducted
in the same place upon the same principles’.872
Both of these definitions focus on the legal concept of goodwill, and coming from an
accountant this demonstrates the influence of that concept on accounting.
Nonetheless, an oscillation between the legal and accounting concepts may be
discerned in these late nineteenth century definitions. And this situation continued
well into the next century according to Courtis who, looking forward from the year
1898, stated that ‘[d]uring the next fifteen years writers continued to oscillate between
the theme of reiterating patronage and arguing for refinements to rule-of-thumb
measurement approaches’.873
As already noted, apart from the legal concept, the early accounting literature also
focused on the valuation and treatment of goodwill in accounts, a natural concern of
accounting which persists to the present. Concerns with valuation and treatment,
particularly in this early period, are examined in the following paragraphs on the early
literature and emerging issues.
871 Roby, A. G., ‘Goodwill’, (2 Apr 1892) The Accountant 288 at 289. 872 Dicksee, L. R., ‘Goodwill and its Treatment in Accounts’, (9 Jan 1897) The Accountant 40 at 40. 873 Courtis, J. K., ‘Business Goodwill: Conceptual Clarification via Accounting, Legal and Etymological Perspectives’, (1983) 10(2) Accounting Historians Journal 1 at 4.
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13.2.2 The beginnings of the literature
Hughes in Goodwill in Accounting: A History of the Issues and Problems cited the
following passage dating back to 1916:
No one can afford to be dogmatic about the treatment of goodwill. So many excellent
authorities disagree absolutely as to the treatment of goodwill that it would seem as if
almost any of the methods discussed would be justifiable.874
Thus it seems that even early in the twentieth century accounting goodwill had
evolved into a difficult concept about which there was little agreement as to its
treatment. But by 1916, Hughes claimed, accounting for goodwill was already a
relatively old topic, having been discussed in the literature for over thirty years. So
when did the accounting literature on goodwill begin? Hughes placed its origin in
1884 in the form of an article by William Harris875 entitled ‘Goodwill’ published on
29 March of that year in The Accountant, the then journal of the Institute of Chartered
Accountants in England and Wales (ICAEW). This article was the publication of a
speech entitled ‘The Law and Practice in relation to Goodwill’ made by Harris to a
meeting of the Manchester Accountants’ Students’ Society on 4 February 1884876 and,
as the title indicates, it had a firm basis in law. In fact, apart from an accounting
definition of goodwill, the article is entirely concerned with the legal concept of
goodwill, involving issues arising from important case law of the nineteenth century
up to that time. Hence, as a clear pointer to the legal parentage of the accounting
concept, it may be seen that the first ‘accounting’ article on goodwill was really a
legal one. It may be more correct, therefore, to say that it was the first article on
goodwill to feature in an accounting journal, notwithstanding its legal nature.
However, a little later, in 1888, The Accountant published two short papers on
goodwill wherein issues of the treatment of goodwill in the accounts were raised. Thus
it may well be proposed that these papers represent the first real accounting articles on
the subject of goodwill. It is notable that these papers were the prize-winning products
874 Hughes H. P. 1982, Goodwill in Accounting: A History of the Issues and Problems, Georgia State University, Atlanta, 1. The passage cited is taken from Gilman, P. 1916, Principles of Accounting, La Salle Extension University, Chicago, 195. 875 Harris, W., ‘Goodwill’, (29 Mar 1884) 486 The Accountant 9. 876 This is generally cited as the first article on goodwill: for further support see Cooper, J., ‘Debating Accounting Principles and Policies: the Case of Goodwill, 1880-1921’, (2007) 17(2) Accounting,
Business & Financial History 241 at 242 who cites as authority the original Accountants Index published in the USA by the AICPA in 1921.
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of a student essay competition conducted by the Liverpool Chartered Accountants
Students’ Association.877 But perhaps it is appropriate that students new to the
accounting profession should have been the pioneers in publishing in this new field.
The senior winner, J H Bourne, whose definition of goodwill has been noted above,
canvassed a range of issues, including legal ones, but addressed valuation and
accounting questions also. In particular, he had the following to say about the
accounting treatment of purchased goodwill:
How ought the purchase money to be treated by the purchaser? We think it should be
gradually written off, so that in a few years the account may be closed. It has been
objected that if the business is increasing in prosperity, the value of the goodwill will
correspondingly increase, and therefore it can safely stand at the original figure. On the
other hand, if the business is declining, the revenue account will be unable to stand the
further charge against it. To this it may be replied that a successful business will be able
comfortably to depreciate the amount, and it is the prudent course to adopt, not
knowing what may happen in futurity; while a declining business is itself the warrant to
extinguish as early as possible all intangible and fictitious assets.878
It is interesting to note that Bourne addressed some of the issues still concerning the
accounting profession in regard to amortizing goodwill. Apart from a traditional
accounting conservatism, it appears that his view that goodwill should be written off
as early as possible was also influenced by a perception of goodwill as a ‘fictitious’
asset. This suggests that he saw goodwill as not really having a legitimate right to be
in the balance sheet in the first place. (Perhaps he could have recommended a direct
write-off of goodwill, consistent with some later views and practices.)
The junior winner, W E Stacey, also addressed issues of valuing and accounting for
goodwill. On the latter issue, he concluded that ‘with regard to an item for goodwill
appearing in a balance sheet, it is necessary to see that a certain sum is periodically
written off the same’.879 Furthermore, he went on to address the issue of internally
generated goodwill, as noted later.
877 There was a senior and a junior division of the competition. J. H. Bourne won the senior division and W. E. Stacey the junior division. The papers were published under the titles ‘Goodwill – No. 1’ and ‘Goodwill – No. 2’ respectively. 878 Bourne, J. H., ‘Goodwill – No. 1’, (22 Sep 1888) The Accountant 604. 879 Stacey, W. E., ‘Goodwill – No. 2’, (22 Sep 1888) The Accountant 605.
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Already from these two articles from 1888 may be seen the emergence of important
accounting issues concerning the recognition of goodwill as an asset in the balance
sheet, the amortization of that asset, and the position of not recognizing internally
generated goodwill. These will be taken up, amongst other issues, in the following
paragraph on emerging issues.
13.2.3 Emerging issues
From the tentative beginnings represented by the above three articles, with one being
essentially a law article, it did not take long for a significant body of literature to
develop. This early literature on goodwill in the accounting context is largely found in
articles published by The Accountant, the journal of the ICAEW, as would be
expected for the journal of the major accountancy body in the UK.880 It was not until
1897 that Lawrence Dicksee published the first book on goodwill for accountants
entitled Goodwill and its Treatment in Accounts.881 Within this literature may be
discerned a range of issues which have resonated right up to modern times in
accounting theory and practice.
13.2.3.1 The nature of accounting goodwill
It had been firmly established before the 1880s that goodwill was property for the
purposes of law882 but what was still to be finally settled was whether it should also be
treated as an asset for accounting purposes. In his article of 1884, Harris defined
goodwill as ‘the money value over and above the value of the actual assets of a
concern’,883 an indication that goodwill itself was an asset, albeit an asset apart from
the ‘actual’ assets. Both the 1888 accounting articles indicate that goodwill was a
balance sheet asset, even though Bourne saw it as a ‘fictitious’ asset. To this point it
seems that goodwill was only begrudgingly recognized and treated as an asset, being
of ‘such a vague character’ in the words of Stacey.884 What begins to emerge from this
point is an accounting concept of goodwill which had started out as basically a legal
one, as the earlier definitions indicate, but was changing in focus to one constituted by
matters of value, particularly as a residual value as noted by Harris above.
880 The ICAEW was formed in 1880, incorporating several earlier accountancy bodies. 881 Dicksee, L. R. 1897, Goodwill and its Treatment in Accounts, Gee & Co, London. 882 See chapter 4. 883 Harris, W., op. cit., at 9. 884 See Stacey, W. E., op. cit.,at 606.
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An anonymous writer in The Accountant in 1889 stated that it was undisputed that
goodwill was property (and therefore an asset) in agreement with the views of lawyers
and certainly with the practice of mercantile men including accountants.885 This article
considered the nature of goodwill for the purpose of stamp duty in the wake of the
Court of Appeal’s decision in CIR v. Angus & Co.886 In a detailed article in 1891
Francis More clearly recognized goodwill as an asset, but one which should be written
out of the balance sheet as soon as prudently possible. It appears from his article that
More viewed goodwill as encompassing the value of intangibles which apparently
were not likely to be recognized as assets at that time. As examples, he cited
monopolies, patents and leases and their values as effectively no more than goodwill.
This approach is reflected in the modern view of accounting goodwill as an ‘asset
representing the future economic benefits arising from other assets acquired in a
business combination that are not individually identified and separately recognised’
per Accounting Standard AASB 3. The only difference would appear to be that
modern accounting recognizes assets, such as the above examples, which would not
have been recognized as assets in the nineteenth century.
Subsequent writers in the 1890s indicate that the accounting profession had
recognized goodwill as an asset, intangible in nature and also a fixed (non-current)
asset in terms of balance sheet classification.887 This view accords with the modern
accounting concept of goodwill, except for the modern technical classification of
goodwill as an unidentifiable asset apart from the intangible assets.888
In view of the foregoing, one might have expected that recognition of goodwill as an
asset would have been well-settled by 1902, but it would seem not necessarily to be so
if an article by W H Gundry889 is to be taken at face value. The author seemed to feel
constrained to argue that goodwill was an asset, stating that ‘there appears to be a
885 Anonymous, ‘Goodwill and the Stamp Act 1870’, (10 Aug 1889) The Accountant 419. 886 (1889) 23 QBD 579. This case is considered in ch. 7 on Stamp Duties. 887 For example, see: Payne, A., ‘The principles upon which the assets of a joint stock company should be valued for balance sheets’, (13 Feb 1892) The Accountant 141; Dicksee, L R., ‘Goodwill and its Treatment in Accounts’, (9 Jan 1897) The Accountant 40; and Guthrie, E., ‘Goodwill’, (23 Apr 1898) The Accountant 425. See also Matheson, E. 1893, The Depreciation of Factories Mines and Industrial
Undertakings and their Valuation, 2nd ed., E & F N Spon, London (Reprint 1976, Arno Press, New York.) 888 See AASB 138 Intangible Assets. The classification of goodwill for accounting is dealt with in ch. 14. 889 Gundry, W. H., ‘Goodwill’, (28 Jun 1902) The Accountant 662.
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prejudice against the term “goodwill” as an asset.’890 However, he provided no
evidence for this ‘prejudice’ and, moreover, was in no doubt himself that goodwill
was a valuable asset. He also suggested that goodwill was a ‘tangible’ asset, which
might have been a cause for some concern except that he appeared to mean that it was
an asset of significance rather than of physical substance. This view as one applicable
in this period is supported in an article by an anonymous writer who opined in respect
of the term ‘tangible’ that ‘metaphorically it may be applied to perception through any
of the senses.’891 The writer went on to explain that ‘when accountants speak of
tangible assets, they ordinarily mean realisable values (real in our perception) …’.892
Notwithstanding any suggestions of doubt, it is made clear in subsequent articles in
this early period to WWI that goodwill was accepted fully as an asset. For example, C
Cleminson893 in 1907 identified goodwill as an asset in the form of personal property,
D B Hargreaves894 in 1913 indicated that it was an intangible asset,895 and P D
Leake896 in 1914 recognized purchased goodwill only as an asset to be recorded in the
accounts in accord with modern practice. (Goodwill as an asset is still ignored today if
it has no value. Accounting conservatism militates against recognizing goodwill in the
balance sheet if it has not been purchased.)
Moreover, early recognition of other assets and characteristics of the business as
effectively the sources of the goodwill, in terms of Murray, may also be found.
Browne, for example, stated: ‘Goodwill is … dependent for existence upon the
tangible assets of a concern, as well as upon numerous conditions such as personality,
locality, connection, past results, future prospects, etc.’897 Similarly, Kirkland898
identified the nature of goodwill as depending on particular parts of the business,
including other assets and elements such as location, personnel and the firm’s name.
These views reflect conceptions of goodwill as local, personal or name goodwill, in
890 Id at 663. 891 Anonymous, ‘Goodwill: its Nature, Value, and Treatment in the Accounts’, (6 Dec 1913) The
Accountant 816 at 818. 892 Ibid. 893 Cleminson, C., ‘Goodwill’, (8 Jun 1907) The Accountant 784. 894 Hargreaves, D. B., ‘A Few Notes on Goodwill’, (22 Mar 1913) The Accountant 441. 895 See also Guthrie, E., ‘Goodwill’, (23 Apr 1898) The Accountant 425 who notes goodwill as an ‘intangible thing’ (at 425). 896 Leake, P. D., ‘Goodwill, its nature and how to value it’, (17 Jan 1914) The Accountant 81. 897 Browne, E. A., ‘Goodwill: Its Ascertainment and Treatment in Accounts’, (20 Dec 1902) The
Accountant 1339 at 1340. 898 Kirkland, W. H., ‘The Law Applicable to Goodwill’, (5 Mar 1910) The Accountant 343.
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line with the elements of goodwill, as major sources of the goodwill, discussed in
chapter 3. However, contrary to the modern legal concept, accounting goodwill was
not seen as necessarily separate from these sources. Rather, such goodwill was often
seen as being attached to various other assets or characteristics of the business: for
example, being attached to the premises as site (local) goodwill.899 This is a view that
existed at law also, as discussed elsewhere in this paper, and it is not surprising that
such a view percolated through to the accounting concept, given the influence the
legal concept had on early accounting.
Consequently, the nature of goodwill as understood in this period may be seen as
largely consistent with its modern concept, from both the accounting and legal
viewpoints. From the accounting viewpoint, there is clearly a significant amount of
similarity with the modern concept. From the legal viewpoint, there is also a degree of
similarity, but with a significant difference being that goodwill was not usually seen as
separate from its sources in this earlier period.
13.2.3.2 Internally generated goodwill
The above observation by Leake that only purchased goodwill, as opposed to
internally generated goodwill, should be recorded in the accounts was recognized
early by Stacey in his article in 1888, as already noted. Stacey recommended, in
effect, that internally generated goodwill not be recognized in the balance sheet,
stating:
It is scarcely possible for a firm that has built up its own business to include goodwill as
an asset in its balance sheet, as the value of a goodwill is only what can be obtained for
it when put up for sale; hence the danger of over-estimating this value, and on the
whole, the item had, perhaps, better be omitted.900
Apart from the above reference, specific references to the issue of internally generated
goodwill are not evident in the early literature. Rather, its non-recognition is implied
899 For example, see: Anonymous, ‘Goodwill and the Stamp Act, 1870’, (10 Aug 1889) The Accountant 419; More F., ‘Goodwill’, (11 Apr 1891) The Accountant 282; and Warren, W. R., ‘Goodwill’, (Apr 1894) The Incorporated Accountants’ Journal 97. 900 Stacey, W. E., ‘Goodwill – No. 2’, (22 Sep 1888) The Accountant 605.
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by the fact that articles generally refer to purchased goodwill as the type to be
recognized in the balance sheet.901
13.2.3.3 The value of goodwill
The valuation of goodwill has been dealt with in chapter 12, but with more of a legal
focus than strictly an accounting one. The value of goodwill constitutes that asset
which is included in the balance sheet, the essence of accounting goodwill being an
amount of residual value. The value of goodwill and the methods of calculating it
have occupied the minds of accountants from the outset, and it is clearly evident that
the value of goodwill was largely seen as defining the nature of goodwill.902 For
example,in the first article of 1884, Harris defined goodwill ‘as being the money value
over and above the value of actual assets of a concern’.903 Leading authors like
Dicksee and Leake also perceived goodwill as essentially a matter of value. Dicksee
saw goodwill as the value of the reputation of a business (as noted in the early
definitions section) and Leake saw ‘[g]oodwill in its commercial sense as the present
value of the right to receive expected future super-profits’.904 However, there is also
evidence that a distinction between the nature of goodwill and its value was
understood to exist at an early stage, as the following passage from 1889 indicates:
Really [goodwill] is nothing more than a probability that those who have had dealings
with the old firm will have dealings with the new, and this … is often measured by the
amount of the profit in a given series of years.905
This article had a legal orientation concerning goodwill as property for stamp duty
purposes, which might have explained the focus on the nature of goodwill as well as
its value.
A range of methods for valuing goodwill may be found in the early literature. In the
earliest in 1888, the summing of up to three years’ profits was proposed as the basic
method. However, some more subtle methods of valuation and payment as
901 For example, see Browne, E. A., ‘Goodwill: its ascertainment and treatment in accounts’, (20 Dec 1902) The Accountant 1339 and Leake, op. cit. See also Bartle, C., ‘Goodwill with special reference to its treatment in partnership accounts’, (13 Jun 1914) The Accountant 863 for a detailed illustration of the treatment of goodwill as an asset in partnership accounts. 902 This is a matter taken issue with by later writers and is noted in this chapter. 903 Harris, W., ‘Goodwill’, (29 Mar 1884) 486 The Accountant 9 at 9. 904 Leake, P. D., ‘Goodwill, its nature and how to value it’, (17 Jan 1914) The Accountant 81 at 82. 905 Anonymous, ‘Goodwill and the Stamp Act, 1870’, (10 Aug 1889) The Accountant 419 at 419.
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alternatives were also proposed in the same article, involving either the payment by
the purchaser of the business of an annuity to the vendor for a short period or a
payment of a percentage the net profits of the business by the purchaser for a limited
period.906 The use of average profits over a number of years, typically three to five
years, as a basis for valuing goodwill was a standard approach907 (and one which has
persisted to the present day). However, it is evident that appropriate adjustments to the
sum of several years’ profits were also commonly advocated, for example, allowances
for the capital invested in the business and for management costs.908
As early as 1897 the influential Dicksee was advocating a ‘super profits’ approach to
valuation of goodwill. He recognized that the practice in most businesses was ‘to base
the value of the goodwill upon so many months’ or years’ purchase of the average net
profits of the business’.909 However, he went on to say that this was not the most
reliable method and that it was becoming ‘more and more usual to take into
consideration not only the amount of profits that have been earned in the past, but also
the amount of capital which has had to be invested in order to earn those profits’.910
The method he explained as basing the value on ‘not only the profits actually earned,
but on the profits less interest on capital and less a provision estimated to represent the
value of the management which has not already been charged against profits’.911 This
approach was strongly supported by Guthrie who considered that it was a mistake not
to value goodwill in this manner.912
Dicksee’s approach was taken a step further in detail by Leake, who proposed that the
real value of goodwill should be the present value of an annuity equal to future years’
super profits.913 Support for this ‘scientific’ approach to valuation was immediately
906 See Bourne, J. H., ‘Goodwill – No. 1’, (22 Sep 1888) The Accountant 604. The author described the latter alternative as the fairest method, proposing: ‘If the business be more profitable than anticipated, it is only right that the vendor should receive a proportionate advance in the price; if, on the contrary, it does not come up to the expectations that were formed of it, the price should be correspondingly reduced’ (at 604). 907 See Anonymous, ‘Goodwill, from the vendor’s point of view’, (28 Sep. 1907) The Accountant 381. 908 See, for example, references to these methods in Cleminson, C. L. O., ‘Goodwill’, (8 Jun 1907) The
Accountant 784. 909 Dicksee, L R., ‘Goodwill and its Treatment in Accounts’, (9 Jan 1897) The Accountant 40 at 42. 910 Ibid. 911 Ibid. 912 Guthrie, E., ‘Goodwill’, (23 Apr 1898) The Accountant 425 at 426. See also Browne, E. A., ‘Goodwill: its ascertainment and treatment in accounts’, (20 Dec 1902) The Accountant 1339 for a similar approach contained in a summary of valuation methods for both the corporate and non-corporate sectors. 913 See Leake, P. D., ‘Goodwill, its nature and how to value it’, (17 Jan 1914) The Accountant 81 at 83.
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provided by another author, W. R. Hamilton.914 Dicksee’s method was also supported
by Bartle who described it as the standard one, but still as a guide rather than a hard
and fast rule.915
13.2.3.4 The treatment of goodwill in the accounts
The treatment of goodwill in the accounts casts light on its perceived nature for
accounting. The various treatments recommended in this period reflect the various
views of the nature of goodwill and its place and worth in the business. These
treatments may be found in later periods until accounting standards first produced in
the 1980s tended to standardize practice with their direction to amortize goodwill
against revenue. Currently, under the new international standards, amortization is
undertaken on an impairment basis, but previously the standards recommended a
straight line amortization over a period up to 20 years.916
As already noted, the two early writers on accounting goodwill – Bourne and Stacey –
both advocated the depreciation of goodwill. Subsequent writers revealed a range of
views on the treatment of goodwill,917 including mainly: (1) writing it off against
profits; (2) writing it off against capital; (3) creating a goodwill reserve by
appropriations from profits while retaining it at value in the balance sheet; and (4)
simply leaving it remain at value in the balance sheet.
(1) Writing off against profits. At the outset Bourne advocated that goodwill ‘should
be gradually written off [to profits], so that in a few years the account may be
closed.’918 Even at this early stage, this was a reasonably prevalent view. Thus in 1891
Francis More, a chartered accountant in Edinburgh, presented a paper dealing with a
914 Hamilton, W. R., ‘Goodwill’, (14 Feb 1914) The Accountant 216. 915 Bartle, C., ‘Goodwill: with Special Reference to its Treatment in Partnership Accounts’, (13 June 1914) The Accountant 863 at 866. Bartle also provided a useful explanation of the ‘super-profits’ approach in a later publication: ‘Goodwill cannot be worth anything unless the purchaser of a business is able to earn more money than would be possible by his own unaided efforts. It therefore follows that there can be no profit worth paying for until an adequate charge has been made for services and provisions made for interest on capital, because a salary could be earned without purchasing a business and interest obtained by investing capital in securities. The profits worth paying for will, therefore, be the balance remaining after making provisions for these two charges.’ (Bartle, C., ‘Goodwill, its Treatment in Accounts’, (15 Mar 1919) The Accountant 213 at 214.) 916 Para. 5.2 of both AAS 18 and AASB 1013. 917 For an examination of these views, see Cooper, J., ‘Debating Accounting Principles and Policies: the Case of Goodwill, 1880-1921’, (2007) 17(2) Accounting, Business & Financial History 241. See also Bryer, R. A., ‘A Political Economy of SSAP22: Accounting for Goodwill’, (1995) 27 British
Accounting Review 283 at 291 for a concise survey of early accounting treatments of goodwill. 918 Bourne, op. cit., 604.
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range of issues concerning goodwill to The Chartered Accountants Students’ Society
of Edinburgh.919 He also recommended the amortization of goodwill, as a charge
against revenue. By way of justification, he professed a clear aversion, perhaps
reflecting a Scottish conservatism, to an amount for goodwill being carried in the
balance sheet for any longer than necessary to prudently write it off. He stated that he
could not see how companies could be stable ‘so long as any considerable portion of
their capital is represented by nothing more tangible than goodwill.’920 Support for
More’s approach is found in a paper by another writer of the time, Alex Payne.921
Next we find a paper by A G Roby presented to the Manchester Society of Chartered
Accountants in 1892.922 The text of the paper dealt with the nature of goodwill from
the legal viewpoint, as might be expected from a barrister, and in that respect it is
unexceptional. However, the recorded discussion following the vote of thanks is
interesting. It reflects a division of views between depreciating goodwill and not
depreciating it, but with those for depreciation in the majority.923 One of the
discussants, recorded as Mr Mather Jr, was reported as having made the following
pithy observation of the issue:
As regarded depreciation, the rule seemed to him to be, if you were making money and
could afford to depreciate the goodwill, then you need not, but if the business was
declining, and you could not afford to depreciate, then you must.924
This observation, while no doubt with tongue in cheek, reflects the conservative
nature of accounting with its concern for not overstating profits.
Lawrence Dicksee925 in 1897 took a more discerning approach in advocating that
companies should write goodwill off against profits, because to write it off against
capital would be to reduce capital and it would be extremely doubtful that the courts
919 More, F., ‘Goodwill’, (11 Apr 1891) The Accountant 282. 920 Id at 287. 921 Payne, A. W., ‘The Principles upon which the Assets of a Joint Stock Company should be valued for Balance Sheets’, (13 Feb 1892) The Accountant 141. 922 Roby, A. G., ‘Goodwill’, (2 Apr 1892) The Accountant 288. A definition of goodwill in this article by Roby is noted in para. 13.2.1. 923 As noted by Kitchen and Parker, op. cit., 5, much attention was paid to depreciation in general in this early period. 924 Id at 293. 925 See Dicksee, L. R., ‘Goodwill and its Treatment in Accounts’, (9 Jan 1897) The Accountant 40 at 46.
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would sanction such a reduction. However, as noted below, he took a different view of
non-corporate businesses.
The record of the debate continues in The Accountant with E Guthrie’s paper of 1898
which detailed a range of valuation methods for goodwill and then addressed the, by
now, perennial issue of its treatment in the accounts.926 As a strong advocate for
depreciation, Guthrie proposed that goodwill would not last forever, even in the most
profitable businesses, and therefore that fact should be recognized by writing it down.
He noted that ‘sooner or later it may suffer impairment, and … it is well to make some
provision in the days of prosperity for the probable or inevitable contingency of
deterioration or eventual extinction.’927 While Guthrie conceded that it was impossible
to provide a rule that would serve for all cases, he did suggest some alternative
approaches, including the following formula for writing it down:
Given as the purchase price of a goodwill a certain number of years’ purchase over and
above (1) interest on capital, (2) personal services, set aside annually, as a charge
against revenue, out of the profits, in excess of interest and personal services, a sum
equal to half the amount of the years’ purchase of the goodwill as originally paid so far
as the excess profits will suffice. By this rule, should the profits in the future be
identical with the profits in the past the goodwill will be extinguished in account in
double the number of years at which the purchase was made.928
An alternative proposal involved the setting up of a ‘Goodwill Reserve Fund’ as a
provision for the ultimate extinction of the goodwill. Guthrie held this to be a
perfectly legitimate mode of treatment, but cautioned against the ‘temptation to write
it back to profit and loss in bad years for distribution as dividend’.929 As a
consequence of this, he recommended actually writing the goodwill down with a
charge against profits.
926 Guthrie, E., ‘Goodwill’, (23 Apr 1898) The Accountant 425. As an indication of the interest in accounting for goodwill at this time, Guthrie commented in this paper that when he had delivered the same paper two months earlier in Manchester it had been followed by ‘one of the most active, lively, and best debates’ that he had ever heard on such an occasion. At this time, Guthrie was President of the Manchester Society of Chartered Accountants. Kitchen and Parker, op. cit., 21, claimed that Guthrie wrote at some length on goodwill but contributed nothing original. 927 Id at 428. The notion of ‘impairment’ is raised in this passage as a reason to depreciate goodwill. Impairment under current accounting standards is dealt with in chapter 14. 928 Id at 429. 929 Ibid.
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In 1902 Browne930 referred specifically to companies in reminding readers that the
Companies Act precluded writing off goodwill against capital, thus leaving it to be
written off against profits. However, in a report of a discussion after the reading of
this paper the chairman opined that the author maintained ‘that there is neither a legal
obligation nor a moral necessity to extinguish goodwill out of the earnings of a
business’.931 Nonetheless, there appears to be a general view in this period that
goodwill should be written off, if only because it was undesirable to keep such an
asset in the balance sheet of a business. Evidence of this view, inter alia, may be
found in another discussion reported following a paper delivered by S. Smith932 in
1904.
In 1914 Leake was an advocate for writing off goodwill, but with the suggestion that
there was case to be made for write-offs only in years when super profits were earned.
But in the end he thought that the time had come for directors of public companies at
least ‘in all cases to settle and adopt the use of a scheme or definite policy on
reasonable lines for dealing with capital expenditure on goodwill’.933 Another writer
of the same period, Bartle,934 was also an advocate for writing goodwill off against
profits, taking his cue from Dicksee’s abovementioned recommendations for
companies.
(2) Writing off against capital. As has been noted above, writing goodwill off against
capital was precluded for companies: see Dicksee and Browne. However, Dicksee
took a different view in the case of non-corporate businesses. In the case of such
businesses, he saw goodwill as an asset which was embarrassing to disclose to
potential purchasers at a later date when negotiating a sale of the business and thus
proposed that it be written off against capital at the earliest possible stage.935
Nonetheless, there is little real evidence in the early literature that writing goodwill off
against capital was a common practice. However, in line with Dicksee’s view, Bryer
930 Browne, E. A., ‘Goodwill: Its Ascertainment and Treatment in Accounts’, (20 Dec 1902) The
Accountant 1339 at 1342. 931 Id at 1343. 932 Smith, S., ‘Depreciation of Assets and Goodwill of Limited Companies’, (9 Jan 1904) The
Accountant 44. 933 Leake, P. D., ‘Goodwill: Its Nature and How to Value It’, (17 Jan 1914) The Accountant 81 at 87. 934 Bartle, C., ‘Goodwill: With Special Reference to its Treatment in Partnership Accounts’, (13 Jun 1914) The Accountant 863. 935 See Dicksee, L. R., ‘Goodwill and its Treatment in Accounts’, (9 Jan 1897) The Accountant 40 at 46.
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has proposed that this practice, where advocated, was often for the purpose of
enabling the owners of these businesses to avoid disclosing the purchase price, rather
than on accounting grounds.936
(3) Creation of a goodwill reserve. This practice involved maintaining the goodwill in
the balance sheet as an asset at cost, but against that creating a goodwill reserve on the
liabilities side by making appropriations to it from profits. The policy behind this
practice was explained by Cooper thus:
This maintained the legal and conceptual premise of the permanency of goodwill while
allowing for a retention of distributable profits to provide for any possible future
permanent decline in value. This policy could be taken further and the reserve be used
to reduce or eliminate goodwill from the balance sheet even when there was no
permanent decline in value …’.937
In 1901 a short article by W J Dawson addressed superficially the accounting
treatment of goodwill, noting that such treatment was ‘a matter upon which opinions
seem to differ considerably.’938 He opined that goodwill does not depreciate, but
rather improves with age so long as profits are maintained and therefore should be
allowed to stand in the balance sheet in conjunction with the setting aside of a reserve
out of profits until that reserve equalled the cost of the goodwill.939
(4) Permanently retain goodwill in the balance sheet. While apparently a minority
view amongst the accounting profession, there was some early support for the practice
of permanent retaining goodwill at cost in the balance sheet. Densham, for example,
took a pragmatic view, expressing support in the following manner:
936 Bryer, R. A., op. cit., 283 at 293. 937 Cooper, J., ‘Debating Accounting Principles and Policies: the Case of Goodwill, 1880-1921’, (2007) 17(2) Accounting, Business & Financial History 241 at 253. 938 Dawson, W. J., ‘Goodwill’, (12 Jan 1901) The Accountant 50. The article also has some minor historical interest in that the author provided some ways in which profits may be overstated to boost the value of goodwill where based on so many years’ profits. It seems that this was directed as a warning to purchasers who might pay too much for goodwill in such circumstances. 939 Dawson also appeared to make a vague reference to internally generated goodwill in saying that: ‘Goodwill should not, as a rule, be treated as an asset in the accounts of a firm, though, of course, its omission from a balance sheet does not preclude a retiring partner from receiving payment for his share if it actually exists.’ (Dawson, op. cit., 50.) If interpreted as a reference to internal goodwill, this view is consistent with the present-day view of such goodwill and also its valuation in the case of a partner departing from a partnership. This issue is dealt with in chapter 5
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… the amount at which goodwill is stated in the balance sheet is never supposed to
represent either its maximum or its minimum value; … the account is absolutely
meaningless except as an indication of what the goodwill may have cost in the first
instance. Inasmuch, therefore, as nobody can be deceived by its retention, there is no
practical necessity for the amount of goodwill account to be written down.940
Some support for retention was also forthcoming from the legal side in cases such as
Wilmer v. McNamara & Co Ltd,941 which held that goodwill was fixed capital which
there was no need to depreciate to determine the profit available for distribution.
Further support for this approach may be found in Lee v. Neuchatel Asphalte Co942
and Verner v.General and Commercial Investments Trust Ltd.943 As noted by
Dawson,944 taking an auditor’s perspective, in this period there was no legal necessity
to write down goodwill and it could therefore remain at cost in the balance sheet so
long as it was plainly identified.
An example of the difference in views concerning this issue may be found in a piece
in The Accountant945 of 15 June 1907 reporting a debate at a company’s ordinary
general meeting between two shareholders and the chairman. This debate provides
some interesting insights into the nature and treatment of goodwill at this time. The
first shareholder opined that the historical amount of goodwill in the balance sheet
was much less than the amount that would represent the current value and therefore
argued, not for a revaluation upward, but for a complete writing off of this amount
against the profit of the current year. Then, rather than presumably being misled, the
public would be free to ‘put their own estimation on the value of the goodwill’.946 The
second shareholder also argued for writing off the goodwill because it was an
‘unworkable’ asset and the balance sheet ‘should only have items out of which they
could make money, so to speak.’947 The chairman, on the other hand, was firmly of
940 Densham, F. W., ‘Depreciation of assets and goodwill of limited companies’, (28 May 1898) The
Accountant 567 at 570. 941 [1895] 2 Ch 245. See Smith, S., ‘Depreciation of Assets and Goodwill of Limited Companies’, (9 Jan 1904) The Accountant 44 at 48. 942 (1889) 41 Ch D 1; 58 LJ Ch 408. See Byer, R. A., ‘The laws of accounting in late nineteenth century Britain’, (1998) 3(1) Accounting History 56 for an analysis of this case and its implications for the treatment of goodwill during this early period. 943 [1894] 2 Ch 239; 63 LJ Ch 456. See Bryer, op. cit., for consideration of this case. 944 Dawson, S. S., ‘Goodwill’, in Lisle, G. (ed.) 1903, Encyclopaedia of Accounting (vol. 3), William Green & Sons, Edinburgh and London, 207. 945 ‘The Treatment of Goodwill in Accounts’, (15 Jun 1907) The Accountant 801. 946 Ibid. 947 Ibid.
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the view that the goodwill should remain in the balance sheet, stating that ‘the
directors were very proud to be able to show that, with the colossal trade they did,
their goodwill was such a small item upon the balance sheet.’948 In what appears to be
an editorial stance taken by the journal, it supported the chairman in pronouncing that:
… it seems absurd to suppose that anyone professing to have the least acquaintance
with accounts would be so foolish as to think that the amount at which the goodwill of a
company is stated in its balance sheet represents its then realizable value. It would
obviously be most improper to write up the goodwill of the company as it increasingly
prospered, and many accountants regard it as equally incorrect to write it down if the
fortunes of the company are declining. When, however, it is admitted that a particular
asset is in point of fact worth enormously more than its book value, the only possible
result of writing the item out of the books altogether would be to create pro tanto a
secret reserve.949
The notion of denying the writing off of goodwill against profit because it would
create secret reserves, and also misstate profits, was one that obviously concerned the
editorial mind of this journal at least.
13.2.3.5 The acceptance of secret reserves
The above concern about secret reserves had been evident since at least the 1890s. In
1897 Dicksee had the following to say about the matter:
… it would be incorrect to write down the amount of goodwill out of profits; I am
aware that in many of the soundest undertakings this process is adhered to, but I think
on reflection that you will all agree with me that it is radically wrong, and that what is
really effected by the process is to create a reserve fund without stating it as such. There
may be circumstances under which it is desirable that there should be a secret reserve in
existence, but such cases are rare, and in the vast majority of instances the chief object
of a reserve fund is to parade it before the world as a proof of the financial stability of
the company.950
However, the creation of secret reserves did not concern everyone. For example, as
reported by Kitchen and Parker,951 strong approval was given to such reserves by
948 Ibid. 949 Id at 802. 950 Dicksee, L. R., ‘Goodwill and its Treatment in Accounts’, (9 Jan 1897) The Accountant 40 at 47. 951 Kitchen and Parker, op. cit., 31.
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Francis Pixley,952 another prominent pioneer of the accountancy profession. Pixley’s
approval of secret reserves was based on a strong concern for financial prudence and
the continuity of the business as a going concern. Creating these reserves, resulting
from writing goodwill off against profits, meant that the profits available to be
distributed to shareholders were reduced, thereby helping to maintain the financial
viability of the company business. Pixley, it is claimed by Kitchen and Parker, placed
the financial health of the company above the interests of the shareholders and thus
saw no problem with secretly retaining profits in this way.953 These authors state that
this type of view was commonly held by accountants and auditors until the case of R
v. Kylsant954 in 1932.
R v. Kylsant concerned an appeal by the appellant to the Criminal Court of Appeal
against a conviction under criminal law955 for issuing a company prospectus for the
issue of debenture stock, knowing it to be false in a material particular. At trial, the
prospectus had been held to be false in that it failed to disclose that for a number of
years dividends had been paid effectively out of secret reserves rather than out of
current profits. The Court dismissed the appeal, thus applying a brake to this type of
practice.
13.2.4 Summary of the period to WW1
The evidence reveals that from the beginning goodwill was perceived as property and
an asset in line with the view adopted from the legal concept of goodwill. The
valuation of goodwill for accounting and commercial purposes appears to have been
originally based on approaches found in the courts based on average earnings of the
business over a period of three to five years. However, more sophisticated approaches
involving discounting and the notion of super-profits emerged, consistent with the
quantitative approach which arguably suited the purposes of accounting where
952 Francis William Pixley, 1852-1933, was the author of many accounting books including the first British text on auditing which was published in 1881. 953 However, it seems that Pixley was more indifferent to shareholders who were interested in short-term profits than to long-term investors in the company whom he saw as protected by the financial strength gained by the company from secret reserves. For example, he said: ‘Secret reserves are not only legitimate, but desirable. … Secret reserves, when made honestly by a board of directors for the purpose of maintaining a company as a permanent institution, are of the greatest possible protection to shareholders.’ (Pixley, F. W. 1911, How to Read the Balance Sheet of a Commercial Concern, Gee & Co., London, 27.) 954 [1932] 1 KB 442 (CCA). The company involved in this case was the Royal Mail Steam Packet Company and accordingly it is sometimes referred to as the ‘Royal Mail’ case. 955 The Larceny Act, 1861, s. 84.
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valuation is of primary importance. In fact, the value of goodwill was taken to
constitute its essential meaning in many cases, as noted in the paragraph on early
definitions.
The treatment of goodwill in the accounts revealed a range of differing views on its
value and worth to a business. Regardless of the differing views of this period,
however, the evidence points to a distinct leaning towards amortizing goodwill, a
position recognized by Bryer who opined that a ‘substantial majority of leading
authorities favoured amortization’956 (Bryer’s italics). Furthermore, to a significant
extent this would have meant writing the goodwill off against profits, as companies
were legally precluded from writing it off against capital.
13.3 Between the wars
13.3.1 Continuing themes
Following WWI the pre-war accounting issues concerning the valuation and treatment
of goodwill persisted. In fact, it may be proposed that nothing really changed in what
might be seen as a new period between the wars. This is not surprising when it is
considered that the leading authorities pre-war continued to be influential in this later
period. It is notable that P D Leake continued to be a significant contributor to the
debate.957 His views on the use of super profits to value goodwill, his advocacy of
writing off goodwill against profits and his broader views on the meaning and concept
of goodwill in the accounting context were influential in this period.958
The use of super profits had taken a firm hold as the generally accepted valuation
method by this time, championed by Leake with support from others such as Bartle959
in 1919 and Jones960 who asserted in 1931 that in recent years this method had
replaced the old customary method of taking so many years’ purchase of the profits.
Views varied significantly concerning the period over which the super profits should
956 Bryer, R. A., ‘A Political Economy of SSAP22: Accounting for Goodwill’, (1995) 27 British
Accounting Review 283 at 293. 957 See, for example, Leake, P. D., ‘Commercial Goodwill’, (11 Nov 1922) The Accountant 698, ‘Commercial Goodwill; Some New factors’, (23 Jun 1928) The Accountant 901, ‘Commercial Goodwill and Company Shares’, (3 Nov 1928) The Accountant 581, and ‘Commercial Goodwill’, (14 Apr 1934) The Accountant 513. 958 For an assessment of Leake’s contribution the theory and valuation of goodwill, see Carsberg, B. V., ‘The Contribution of P D Leake to the Theory of Goodwill Valuation’, (1966) 4(1) Journal of
Accounting Research 1. 959 Bartle, C., ‘Goodwill, its Treatment in Accounts’, (15 Mar 1919) The Accountant 213. 960 Jones, E. F., ‘Goodwill’, (30 May 1931) The Accountant 715 at 720.
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be projected for the purpose of discounting to obtain a present value of these profits as
the value of the goodwill. Suggestions ranging from five years to 20 years may be
found.961
The valuation of goodwill naturally occupied the minds of the accountancy profession
and, as was the case earlier, its practitioners and theorists tended to perceive the
concept of goodwill as being defined by its value. Nonetheless, it was common also to
recognize the legal concept of goodwill, often for the purpose of distinguishing such
goodwill from accounting or commercial goodwill. This was an approach taken by the
ubiquitous Leake in his lectures and articles of this period. For example in a 1922
article,962 Leake defined commercial goodwill as a form of legal property and a ‘non-
material’ wasting asset. He identified these assets as including trade marks, patents
and designs, copyright, the right to exercise monopolies, and also ‘legal’ goodwill. All
of these assets, he asserted, ‘fall properly under the head of commercial goodwill’.963
These assets today would be separately recognized as assets, it should be noted, but
otherwise the approach taken by Leake to define goodwill as the value of what may be
taken as unidentifiable assets is similar to the current definition of accounting
goodwill (as already noted). He went on to explain:
In its true economic meaning, the term ‘commercial goodwill’ … covers a vast field of
rights growing out of all kinds of past effort in seeking profit, increase of value, or other
advantage, and which may be capable of future profitable development.964
Legal goodwill, according to Leake, covered a more restricted area than commercial
goodwill, being confined to the connection of an established undertaking associated
with names, persons, and places of business, and also unregistered trade marks.
Whether this means that legal goodwill is a more restricted concept than commercial
or accounting goodwill is a moot point, but he clearly based his legal view of goodwill
on the legal authorities of the time while effectively defining commercial goodwill in
961 For example, see Anonymous, ‘Valuation of Goodwill’, (18Sep 1926) The Accountant 406 which advised five years and Leake, P. D., ‘Commercial Goodwill and Company Shares’, (3 Nov 1928) The
Accountant 581 who advised a maximum of 20 years. 962 Leake, P. D., ‘Commercial Goodwill’, (11 Nov 1922) The Accountant 698. See also by Leake: ‘Commercial Goodwill; Some New factors’, (23 Jun 1928) The Accountant 901; and ‘Commercial Goodwill and Company Shares’, (3 Nov 1928) The Accountant 581 963 Ibid. 964 Ibid.
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terms of value arising from a range of business assets. This mirrors the essential
distinction between the two concepts which is found today.
Furthermore, consistent with the approach which had tended to emerge before WWI,
the general view was that goodwill should be written off against profits. Only
purchased goodwill was, of course, the subject of amortization in this manner, with
internally generated goodwill not being recognized.
13.3.2 New views
In 1937 Kaner in his A New Theory of Goodwill held that there were at least four quite
different views of goodwill, including the accounting conception and the legal
definition.965 He then asked whether these views could be reconciled. In answering
this question, Kaner discerned the legal definition to be one derived from the notions
of the Lords in CIR v. Muller and Co’s Margarine Ltd:966 ‘The benefit and advantage
of the good name, reputation and connection of a business. The attractive force which
brings in custom.’967 While the accountants’ definition, based a survey of several early
authorities including Dicksee and Leake, he stated as simply being ‘[t]he present value
of the expected future super profits.’968 This definition he promptly demolished as not
being a definition at all but merely ‘an arbitrary and entirely empirical method of
valuing goodwill.’969 And he added, to complete the demolition, that it was an
incorrect method, thus clearing the way for his ‘scientific’ method of valuation
proposed in this book. To fill the definitional void he had supposedly created, Kaner
proposed the following ‘composite’ definition:
Goodwill is that asset possessed by a commercial undertaking which, by enhancing that
undertaking’s reputation, attracts from a portion of the public special preferences, and
results in an added value in excess of the surplus tangible assets of the undertaking.970
965 Kaner, H. 1937, A New Theory of Goodwill, Pitman and Sons, London, 9-10. Kaner identified ‘the ordinary intelligent man’s idea of it, the legal definition, the Accountants’ conception, and the Inland Revenue’s notion’ (at 10). 966 [1901] AC 217. This case and the definitions of goodwill arising from it are discussed in chapter 2. 967 Kaner, op. cit., 16. 968 Ibid. 969 Id at 17. Previously, Kaner had explained that ‘where … accountants generally have erred is in confusing a formula for valuing goodwill with goodwill itself’ (at 15). Much later, in Gynther, R. S., ‘Some “Conceptualizing” on Goodwill’, (1969) 44(2) The Accounting Review 247, the author made a similar point in a critical reference to the understanding of goodwill as the discounted value of estimated excess earning power. He stated (at 247): ‘This is not what goodwill is. This is merely a rationalization of the method commonly used to calculate the value of goodwill, and it is this rationalization that has come to be accepted by many as being the nature of goodwill.’ 970 Id at 17.
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This definition, however, reflected the typical definitions from the pre-WWI period
which contained aspects of the legal and accounting concepts. Thus it cannot be said
to constitute a new definition; rather it was a reiteration of the earlier idea that the
accounting definition should incorporate recognition of its legal parentage.
Kaner’s tilt at a more scientific approach to calculating goodwill was a mathematical
approach and based on financial data obtained from various sources, including the
stock exchange, and across a range of different types of business. However, he did
admit that a simple and efficient system of valuing goodwill, to suit all circumstances,
was impossible to attain. But what comes through clearly is that he did not consider
the common approaches involving a number of years of profit and super profits to be
adequate. At the basis of his analytical scientific approach was a view of goodwill as
consisting of ‘at least seven different varieties’.971 This meant, he argued, that it was
impossible to construct a single formula to calculate the value for a ‘composite’
goodwill comprising a number of these different varieties. However, the fundamental
problem with Kaner’s ‘scientific’ approach is that he tended to over-analyse what is
such an elusive concept. This is readily illustrated by his identification of these
varieties. What these really are, in modern (legal) terms, are various sources of
goodwill, not goodwill itself. This represents an approach to reducing goodwill to
constituent elements, based on sources; this was a common approach at this time, at
least in the legal sphere.972
In the same year, 1937, another accounting study of goodwill, Goodwill as a Business
Asset was published by H E Seed.973 This was a more conventional book than Kaner’s,
dealing with a range of both legal and accounting matters. Similarly to Dicksee’s
earlier book, the first five chapters dealt largely with legal matters. In this regard, it
supported the view of legal goodwill as the parent of accounting goodwill. In later
chapters he detailed a range of accounting issues including recognition as an asset in
the accounts, valuation methods and the issue of whether it should be written down.
971 Id at 58. Kaner identified these varieties or kinds of goodwill as: (1) locality goodwill; (2) efficiency goodwill; (3) organization goodwill; (4) advertisement goodwill; (5) personal goodwill; (6) established goodwill; and (7) monopoly goodwill. 972 This matter is addressed in chapter 4. 973 Seed H. E. 1937, Goodwill as a Business Asset, Gee & Co Limited, London.
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The primary point about the recognition of goodwill was that it should be separately
recognized in the balance sheet974 as a fixed asset, apart from other intangibles such as
patents and trade marks which, Seed indicated, might at times have been purchased as
a composite item. This, of course, is consistent with modern accounting practice and
with the legal concept of goodwill as separate from other property of a business.
In respect of valuation Seed gave little regard to the worth of calculating the present
value of super profits method by broaching it only late in the piece and then in a
critical manner. His recommended method, out of many he canvassed, was based on
calculating a rate of return on an estimate of future ‘maintainable profits’. The details
of this and other methods are not specifically relevant to this paper, but it is notable
that he did recognize that the business should be valued as a whole in valuing
goodwill where a sale was intended, based on the well-established position that
goodwill was inseparable from the business. When it came to the treatment of
goodwill in the accounts, Seed was against writing it off as an expense against
revenue, holding that there was much to be said for retaining it at cost in the balance
sheet.
The final word from this period may be given to Young975 who reviewed a number of
these earlier writers and their views. While this paper was published just after WWII
in 1946, it may be taken to be a product of the between-the-wars period with its focus
on the writings of that period. In keeping with the key preoccupations of the
accounting profession to this time (and indeed to the present, it must be said), Young
addressed inter alia the issues of the meaning of goodwill, methods of its valuation,
and its treatment in accounts. In surveying a number of definitions, most of which
have been considered in this chapter, he observed that there had been a change in
emphasis over the years, with a movement from essentially the legal concept to a
more commercial concept involving also notions of earnings power and value. In
assessing the typical valuation methods to this time he favoured a method based on the
approach advocated by Leake, rather that the approach recommended by Seed.
974 In the case of companies, the treatment of goodwill was driven by the Companies Acts. In this particular case, Seed cited s. 124(2) of the Companies Act, 1929 (UK) which required the amount of purchased goodwill to be shown as a separate item in the balance sheet. 975 Young, N. S., ‘Valuation of Goodwill and its Treatment in Accounts’, reprint published by Canberra University College from (Nov 1946) The Australian Accountant 473 and (Dec 1946) The Australian
Accountant 530.
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Finally, concerning the perpetual problem of the treatment of goodwill in the
accounts, he recognized that the authorities were far from being in agreement.
Nonetheless, he opined that generally purchased goodwill should be written off as a
matter of practical policy.
13.4 Conclusion
This chapter has revealed the accounting concept of goodwill as emerging from its
legal parent in the latter part of the nineteenth century. With the greater emphasis
being placed on practical accounting, particularly in the case of companies driven by
the requirements of companies’ legislation, concern for the accounting recognition
and treatment of goodwill grew as part of this trend. What clearly emerges from the
early period is a concept of goodwill which has an emphasis on value for the purpose
of accounting. Thus there evolved a hybrid or compound concept based on the legal
notion of business reputation and customer connection coupled with the need to value
the goodwill based on its generation of profits for the business. The early definitions
canvassed in this chapter demonstrate a synthesis of sorts between the two concepts,
with the emphasis on profits and value for accounting purposes. However, this
‘synthesis’ arises out of the compound nature of goodwill, containing various facets
which are focussed on depending on the context in which the goodwill is examined.
This view is taken up in chapter 15.
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Chapter 14: Modern Accounting Goodwill
14.1 Introduction
As noted in chapter 13, contentious questions regarding the appropriate accounting
rules for goodwill date back to at least the 1880s when goodwill first appeared in the
literature. Such questions include: What constitutes goodwill? Should purchased
goodwill be written off immediately, be amortised,976 be written down periodically to
reflect fair value, or tested for impairment? Should internally generated goodwill be
recognized?977 Today, accounting standards provide rules specifically tailored for
goodwill. Prior to 1 January 2005 in Australia these standards were AAS 18
Accounting for Goodwill for the non-corporate sector and AASB 1013 Accounting for
Goodwill for companies. From 1 January 2005, new standards dealing with goodwill,
but not exclusively about goodwill, were issued. These new standards have been based
on international accounting standards, but they retain essentially the same definition of
goodwill contained in the earlier standards. The major difference from the previous
standards concerns the treatment of goodwill in the accounts.978 Before these changes,
goodwill had been the subject of extensive discussion and had been on the agenda of
the International Accounting Standards Committee for quite some time. Accordingly,
accounting goodwill has remained a very important issue in Australia and
internationally. It has been a constant concern of the professional accounting bodies
including both practitioners and academics, standard setting bodies, and other
interested parties such as governments and stock exchanges.
This chapter examines the modern concept of accounting goodwill with an emphasis
on the period from the early 1980s when accounting standards were introduced. First,
in para. 14.2 theoretical and practical issues concerning the concept, recognition and
treatment of accounting goodwill are discussed as a basis for consideration of
goodwill in the context of the various accounting standards. In para. 14.3 the
background to standard setting in Australia is addressed before a discussion of
976 The terms ‘amortise’ and ‘amortisation’ are generally used in respect of goodwill, but they are treated as synonymous with ‘depreciate’ and ‘depreciation’ and the terms may used interchangeably. However, ‘amortise’ and ‘amortisation’ are the terms normally used in respect of intangible assets including goodwill: see AASB 136, Impairment of Assets, para. 6 for recognition of this usage. 977 A range of similar questions were considered from a public policy perspective in Chauvin, K. and Hirschey, M., ‘Goodwill, Profitability, and the Market Value of the Firm’, (1994) 13 Journal of
Accounting and Public Policy 159 at 161. 978 Accounting standards have the force of law in respect of drawing up company accounts pursuant to s. 296 of the Corporations Act 2001 (Cth).
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goodwill under the old standards in para. 14.4. Then the adoption of the international
accounting standards is briefly addressed in para. 14.5 before, in para. 14.6, a more
detailed examination of goodwill under the new accounting standards adopted in
Australia. Finally, in para. 14.7 consideration is given to the nature of accounting
goodwill found in the standards, with particular reference to the accounting
profession’s statement of accounting concepts concerning the meaning of an asset.
The concluding para. 14.8 finds that little concerning the definition, valuation and
treatment goodwill has changed in essence from the earlier periods covered in chapter
13. Moreover, the inherent nature of goodwill remains as elusive as ever, with
accounting being more concerned with practical matters of measurement and
treatment in accounts.
14.2 Theoretical and practical issues
In chapter 13, early issues concerning the nature and definition of goodwill, its
valuation, and its treatment in accounts were considered. As indicated above, these
issues have persisted throughout the post-WWII period to the present. For example, in
1969 Gynther979 endeavoured to make a distinction between the nature of goodwill
and the measurement and treatment of its value. He asserted that much of the
disagreement about goodwill was caused by the submerging of its real nature in
methods of calculation. While goodwill usually ends up as a residual amount in a
balance sheet (to be dealt with in accordance with the practices or standards of the
time), accounting standards define it in terms of the economic benefits which it
represents. This approach to defining goodwill may be seen as an attempt to identify it
as a concept, apart from the basic understanding of it as a residual value, with the
result that it can be recognized and treated as an asset.980 However, as an asset
goodwill is perceived as being in a category of its own. As Leo has said, ‘goodwill is
very different from tangible and intangible assets in that goodwill is unidentifiable and
979 Gynther, G. S., ‘Some “Conceptualizing” on Goodwill’, (1969) 44(2) The Accounting Review 247. 980 In discussing goodwill as a residual asset, one author takes a dim view of its usefulness as ‘the most intangible of all intangibles’ and adding: ‘Goodwill presents the opportunity for accounting nonsense (ie the figures add up but do not make sense) instead of reporting vital resources or assets’: Grojer, J., ‘Intangibles and accounting classifications: in search of a classification strategy’, (2001) 26 Accounting,
Organizations and Society 695 at 706.
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measured as a residual by reference to the worth of the business as a whole.’981 The
definition of goodwill in the accounting standards is dealt with later in this chapter.
When it comes to the treatment of modern goodwill, surveys have revealed views and
practices as least as varied as in the period before WWII. These treatments are
considered in para. 14.2.2 below.
Apart from the definition and treatment of purchased goodwill, two other issues have
arisen for consideration over the years: the issues of internally generated goodwill and
of ‘negative goodwill’. Some consideration is also given to these issues.
14.2.1 Is goodwill an asset?
Given the apparent resolution of the question of goodwill as an asset in the earlier
periods dealt with in chapter 13, it may be surprising that it has persisted as an issue
into the modern period. However, some modern writers and theorists, together with
accounting practitioners, have continued to question whether goodwill is an asset
conceptually and whether it should be treated as an asset in the accounts of a business.
Theorists have questioned the acceptance of goodwill as an asset on a number of
bases. Some of this questioning has arguably stemmed from a fundamental lack of
conceptual clarity concerning the meaning of an asset itself. As reported by
Schuetze982 on attending a World Congress of Accountants in the early 1990s, there
was a discernible lack of agreement on the meaning of an asset. He went to note that
in the USA the Financial Accounting Standards Board (FASB) in Concepts Statement
6 proposed the following three essential characteristics of an asset: ‘(a) it embodies a
probable future benefit that involves a capacity, singly or in combination with other
assets, to contribute directly or indirectly to future net cash inflows; (b) a particular
entity can obtain the benefit and control others’ access to it; and (c) the transaction or
other event giving rise to the entity’s right to or control of the benefit has already
occurred.’983 By way of elaboration, the same paragraph of Concepts Statement 6
stated:
981 Leo, K., ‘Implications for Australia: think again’, (1996) 66(11) Australian Accountant 24 at 24. 982 Schuetze, W. P., ‘What is an Asset?’, (1993) 7(3) Accounting Horizons 66 at 67. 983 Ibid.
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Assets commonly have other features that help identify them – for example, assets may
be acquired at a cost and they may be tangible, exchangeable, or legally enforceable.
However, these features are not essential characteristics of assets. Their absence, by
itself, is not sufficient to preclude an item’s qualifying as an asset. That is, assets may
be acquired without cost, they may be intangible, and although not exchangeable they
may be usable by the entity in producing or distributing other goods or services … .984
Taking the three essential characteristics from the above statement, (a) reflects the
general accounting concern with an asset’s generating future economic benefits, (b)
reflects a legal conception involving an exclusive property right to the asset, and (c)
simply recognizes that control of the asset arises from past events.985 As will be
discussed later, (a) is the focus of the formal definition of an asset in the International
and Australian accounting standards, as well as forming the basis for defining
goodwill as an asset. In terms of the elaboration above, purchased goodwill is
obviously acquired at a cost but is not separately exchangeable, being inseparable
from the business (consistent with its legal concept). Nonetheless, this is not a barrier
to its being found an asset on this view.
What may be a barrier, strictly speaking, is whether goodwill as an asset really
generates a future economic benefit. For example, if goodwill were completely written
off, that is removed completely from the balance sheet, it would make no difference to
the income generating ability of the business. Goodwill, either alone or in combination
with other assets, cannot produce economic benefits. Rather, goodwill is a reflection
of the operation and profitability of the business – a valuable component of the
business but not of itself a generator of income.986 The reality of (purchased) goodwill
in an accounting or commercial context is one of a cost included in the balance sheet
as a premium on purchase of the business. Its cost represents the value of the business
beyond the net value of its other assets. As noted by Arnold: ‘Determining whether
984 Ibid. 985 In AASB 138, an asset is defined as ‘a resource (a) controlled by an entity as a result of past events and (b) from which future economic benefits are expected to flow to the entity’ (para. 8). 986 Some recognition of the lack of ability of goodwill to generate income is found in AASB 136 in para. 8, but it is still indicated that goodwill may generate income in association with other assets, namely cash-generating units as the basis of impairment testing. However, the view in this paper is that goodwill of itself cannot generate income, either alone or in association with other assets.
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goodwill meets the definition of an asset is not a straightforward matter, given that
goodwill is a residual from disaggregating a larger outlay into its constituent parts.’987
From a practical viewpoint, Goodwin988 surveyed the accounting treatment of
goodwill on consolidation by Australian companies for the years 1980 – 1983 and
found that no more than one-third of these companies recorded goodwill as an asset.
The major approach, for about 50% of the companies, involved treating the goodwill
as a negative component of capital and reserves. In the UK there have been differing
views and practices. In 1990 Grinyer989 reported that a number of accounting thinkers
supported the direct write-off of goodwill to reserves, which at the time was also
advocated by the UK’s Accounting Standards Board in SSAP 22 Accounting for
Goodwill (later superseded by Financial Reporting Standard No. 10). In the USA the
accounting profession also has presented different views on goodwill, but with general
acceptance of goodwill as an asset.990 Nonetheless, the FASB still felt constrained to
define it as an asset in 1997 in its Concepts Statement 6.991 What is evident from these
views was the lack of consistency in the recognition of goodwill as an asset. However,
there was a discernible tendency to write off purchased goodwill directly to capital
reserves, thus overcoming the need to recognize and retain it in the balance sheet as an
asset.
Regardless of these issues, from 1984 Australian accounting standards have defined
purchased goodwill as an asset to be included in the balance sheet, originally to be
amortised and currently to be written down on an impairment basis, as will be
addressed later in this chapter. Likewise, in the UK the Accounting Standards
Committee issued Exposure Draft ED 47 in 1990 defining goodwill as an asset, thus
overturning its previous view in ED 30 in 1982.992 Consequently, there was a definite
push by accounting standard setters to define goodwill as an asset from the period of
the 1980s into the 1990s.
987 Arnold, J., ‘Goodwill: A problem that will not go away’, (Jun 1992) Accountancy 35. 988 Goodwin, J., Goodwill on Consolidation – an Empirical Study’, (1986) 10(2) Accounting Forum 15. 989 Grinyer, J. R. et al., ‘The Rationale for Accounting for Goodwill’, (1990) 22 British Accounting
Review 223. 990 See Davis, M., ‘Goodwill Accounting: Time for an Overhaul’, (1992) 173(6) Journal of
Accountancy 175. The author suggested that the real diversity of opinion by this time was on the treatment of goodwill in the accounts. 991 See Johnson L. T. and Petrone, K R., ‘Is Goodwill an Asset?’, (1998) 12(3) Accounting Horizons 293. 992 See Nobes, C., ‘A Political History of Goodwill in the UK: An Illustration of Cyclical Standard Setting’, (1992) 28(2) Abacus 142.
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14.2.2 The treatment of goodwill
In situations where goodwill is recognized as an asset and not written off immediately
on acquisition, how is it to be treated in the accounts of a business? Goodwin993 found
that there was an increase in the number of surveyed companies which systematically
amortised goodwill over the period of 1980 to 1983 with the number in 1983 almost
doubling that of 1980. She opined, reasonably it seems, that the increase in
amortisation of goodwill was in anticipation of an impending standard recommending
such treatment, based on the Exposure Draft Accounting for Goodwill issued in May
1983. (The ensuing standard was AAS 18 Accounting for Goodwill introduced in
1984.) The majority of these companies treated the amortised amounts as operating
expenses charged against revenue, while a few wrote the goodwill off against
reserves. In a similar study of a selection of companies listed on the Sydney Stock
Exchange over the period of 1980-1985, Kirkness994 identified five methods of
dealing with goodwill.995 Before the introduction of AAS 18 Kirkness found the most
common method was an immediate write-off of goodwill to reserves, with the
systematic amortisation soon to be prescribed by the standard being the least used
method. Following AAS 18 he found the most common method was the prescribed
method of systematic amortisation, but with the immediate write-off approach still be
the next most common (notwithstanding any non-compliance with the standard).
Since the introduction of the first standard on goodwill, AAS 18 in 1984 followed by
AASB 1013 in 1988, the recommended treatment of goodwill was to amortise it
systematically over its useful life, as a charge against revenue, but without prescribing
the specific method to be used. However, as a result of revisions to both standards in
1996, the straight line method of amortisation over a period not exceeding 20 years
was prescribed. These standards are considered in the following para. 14.3.
Nonetheless, as noted by Powell,996 the amortisation of acquired goodwill was a
controversial issue in accounting, and often resisted, because of its impact on
993 Goodwin, op. cit., 19. 994 Kirkness, J. J., ‘The Impact of AAS 18’, (Dec 1987) The Chartered Accountant in Australia 49 discussed in Whittred, G. and Zimmer, I. 1990, Financial Accounting, 3rd ed., Holt, Rinehart and Winston, Sydney, 238-240. 995 These methods were: (1) Capitalisation with no amortisation; (2) Capitalisation with unsystematic amortisation; (3) Capitalisation with systematic amortisation (as prescribed in AAS 18); (4) Goodwill deducted cumulatively from shareholders’ funds; and (5) Goodwill written off immediately to reserves. 996 Powell, S., ‘Accounting for intangible assets: current requirements, key players and future directions’, (2003) 12(4) European Accounting Review 797.
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profitability. The alternative approach of writing goodwill down on an impairment
basis was either already installed, as for example in the USA and Canada, or destined
to be taken up as a result of adopting International Accounting Standards as Australia
did in 2005.
In the UK in 1990 Grinyer reported a range of accounting treatments of goodwill,
summarizing them thus:
(i) Capitalize it as an asset, but retain it in the balance sheet and only write
it off if a permanent diminution in value occurs.
(ii) Capitalize it as an asset and write it off through the profit and loss
account over a suitable period.
(iii) Write it off immediately to reserves, without passing it through the profit
and loss account.997
Taken together, options (i) and (ii) effectively represent the current impairment basis
of amortising goodwill (without the need for a stipulated period). Grinyer noted that
this method was not permitted at the time in the UK, USA and Australia, but was in
fact the method favoured by a number of UK companies before it was prohibited by
SSAP 22 in 1984.998 As noted above, the Accounting Standards Board advocated the
direct write-off of goodwill to reserves in SSAP 22. Currently, however, impairment
is the recommended method resulting from the UK Accounting Standard Board’s
Financial Reporting Standard No. 10 (FRS 10) Goodwill and Intangible Assets issued
in 1997.999 In the USA the Financial Accounting Standards Board (FASB) Statement
no. 142 Goodwill and Other Intangible Assets (issued June 2001) directs that goodwill
997 Grinyer, J. R. et al., ‘The Rationale for Accounting for Goodwill’, (1990) 22 British Accounting
Review 223 at 228. The authors summarised these treatments from a range identified by McKinnon, S. M. 1983, Consolidated Accounts – The Seventh EEC Directive, Arthur Young McClelland Moores and Co. 998 For an early 1990s comparison of the US, UK and Japanese treatments, see Dunne, K. and Rollins, T., ‘Accounting for Goodwill: A Case Analysis of the US, UK and Japan’, (1992) 1(2) Journal of
International Accounting, Auditing & Taxation 191. See also Bryer, R. A., ‘A Political Economy of SSAP 22: Accounting for Goodwill’, (1995) 27 British Accounting Review 283 for background to SSAP 22. 999 For a discussion of the development and implementation of FRS 10, see Tollington, T., ‘UK goodwill and intangible asset structuration: the FRS 10 rule creation cycle’, (2006) 17 Critical
Perspectives on Accounting 799.
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be tested for impairment at least annually and any impairment loss be charged against
revenue.1000
14.2.3 Internally generated goodwill
As noted in ch. 13, internally generated goodwill, as opposed to purchased goodwill,
has lacked recognition from the outset. Notwithstanding the obvious importance of
such goodwill, generated by the activities of a successful business, accounting has
displayed a firm resolve not to include it in the balance sheet. The fundamental reason
for this omission is the lack of a cost, or the reliable measurement of one, to be taken
up in the accounts. From the beginning, accounting conservatism or prudence has
required a cost to be incurred before recognition, and this applies to this day in
accounting standards.1001 As Leo has observed: ‘There seems to be universal
agreement among standard setters that internally generated should not be
recognised’.1002 The issue of internally generated goodwill will be revisited later in
this chapter when the accounting standards are specifically considered.
14.2.4 Negative goodwill
Negative goodwill arises where the sum of the fair values of the identifiable assets of
a business exceeds the purchase price paid for that business. The amount of negative
goodwill is the amount of that excess. Conceptually, the idea of a ‘negative’ asset
makes no sense and more correctly this amount should be referred to as a ‘discount on
acquisition’, the term used in AAS 18 and AASB 1013. In fact, the latest version of
AASB 3 Business Combinations uses the term ‘gain on a bargain purchase’.1003
However, the term ‘negative goodwill’ is often used in this sense and is used here also
for the purpose of discussion.
In her survey of the treatment of goodwill on company consolidation, Goodwin found
that 74% of the companies which recorded negative goodwill treated it as part of
shareholders equity, mostly as a capital amount rather than an amount of
1000 See Hirschey, M. and Richardson V., ‘Information content of accounting goodwill numbers’, (2002) 21(3) Journal of Accounting and Public Policy 173 for a discussion of the US treatment of goodwill. 1001 For an examination and explanation of accounting prudence, see Maltby, J., ‘The Origins of Prudence in Accounting’, (2000) 11(1) Critical Perspectives on Accounting 51. 1002 Leo, K. et al. (eds) 1996, Financial Accounting Issues, John Wiley & Sons, Brisbane, 342. Other authors have made similar observations: for example, see Nobes, C. and Norton, J., ‘International Variations in the Accounting and Tax Treatments of Goodwill and the Implications for Research’, (1996) 5(2) Journal of International Accounting, Auditing & Taxation 179 at 181. 1003 See AASB 3, paras. 34-36.
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unappropriated profits. However, where companies had both positive and negative
goodwill the great majority offset the negative amount against the positive amount.1004
Goodwin also noted that this practice of offsetting was not permitted in the 1983
Exposure Draft on Accounting for Goodwill but was obviously ignored by these
companies. The ensuing accounting standards on goodwill – AAS 18 issued in 1984
and AASB 1013 issued in 1988 – did not recognize negative goodwill as such and
directed that the fair values of non-monetary assets be reduced proportionately to
eliminate the discount on acquisition.1005 The current AASB 3 directs that the acquirer
of the business reassess the appropriate identification and valuation of assets and
liabilities before recognizing a ‘gain on a bargain purchase’: para. 36. If such a gain is
found still to exist after this reassessment, that gain shall be recognized in the profit
and loss account on the acquisition date: para. 34.
Given the nature of so-called negative goodwill, one might have expected it not to be
very prevalent. However, in her 1980-83 study of 133 companies Goodwin found 58
to 63 companies in those years with negative goodwill. In contrast, but in a study over
a longer period, Higson found that negative goodwill was common in the UK in 1970s
but declined to the point of being rarely seen in the period 1986-1991.1006 Regardless
of its prevalence, the treatment of negative goodwill has varied somewhat
internationally: see Nobes and Norton1007 for a survey of its treatment across a number
of countries in the mid-1990s.
14.3 Standard setting in Australia
Accounting standards were first issued by Australian Accounting Research
Foundation (AARF), a body jointly sponsored by the Institute of Chartered
Accountants in Australia and the Australian Society of Accountants (now CPA
Australia) and instituted in 1966. In 1984 the Accounting Standards Review Board
(ASRB) was established by the Australian Government, on the recommendation of the
then National Companies and Securities Commission, to review the standards issued
by the professional accounting bodies. Where approved by the ASRB, these standards
were given the force of law under the Companies Act 1981 (Cth) and corresponding
1004 See Goodwin, op. cit., 18. 1005 See para. 8.1 of AAS and AASB 1013 (both standards revised as at June 1996). 1006 Higson, C., ‘Goodwill’, (1998) 30 British Accounting Review 141 at 149-150. 1007 Nobes, C. and Norton, J., op. cit., 187 (Table 5).
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states’ legislation.1008 In 1991 the ASRB was renamed the Australian Accounting
Standards Board (AASB), operating as an Australian Government agency under the
Australian Securities Commission Act1989 and with its standards having application
under the Corporations Law. Currently, the AASB operates under the provisions of
the Australian Securities and Investments Commission Act 2001 (ASIC Act) as a
result of the Australian Government’s corporate law economic reform program
(CLERP), which was enacted in the Corporate Law Economic Reform Program Act
1999 with effect from 1 January 2000. This Act introduced a range of amendments to
the Corporations Law and the ASIC Act.1009
Overseeing the work of the AASB is the Financial Reporting Council (FRC) which is
a statutory body set up under s. 225(1) of the Australian Securities and Investments
Commission Act 1989, since re-enacted as the Australian Securities and Investments
Commission Act 2001. The FRC has broad powers to oversee the standard-setting
activities of the AASB and to advise the relevant minister on these activities: see s.
225(2). It does not, however, have the power to intrude into technical matters
concerning standard-setting, thus ensuring the independence of the AASB. The
members of the FRC are appointed by the Federal Treasurer and represent a range of
stakeholders in the setting and application of accounting standards.
At the direction of the FRC in 2002, the AASB sought to harmonize Australian
standards with international standards by adopting the standards issued by the
International Accounting Standards Board (IASB). This has resulted in the AASB
issuing new standards with effect from 1 January 2005. These new ‘international’
standards, where relevant, will be considered later.
1008 Currently, compliance with accounting standards in their financial reports is required for most companies, excluding some small proprietary companies, under s. 296(1) of the Corporations Act 2001 (Cth). 1009 For an explanation of the amendments to relevant legislation, including those affecting the AASB and standard setting, see Ford, H. A. J. et al. 2000, An Introduction to the CLERP Act 1999, Butterworths, Sydney.
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14.4 The Australian position under the old standards
In Australia, as already noted, the definition and treatment of goodwill for accounting
purposes were set down in two accounting standards: AAS 18 and AASB 1013.1010
However, as discussed below, both of these standards ceased to apply from 1 January
2005 when the new standards took effect.
14.4.1 Accounting definitions of goodwill
AAS 18 and AASB 1013 contained identical definitions of goodwill and related
terms. In the definitions paragraph 13.1 of AASB 1013 goodwill was defined as ‘the
future benefits from unidentifiable assets’. Unidentifiable assets in turn were defined
as ‘those assets which are not capable of being both individually identified and
specifically recognised’. To complete the picture, identifiable assets as opposed to
unidentifiable ones, were defined as ‘those assets which are capable of being both
individually identified and specifically recorded in the books of account’.
14.4.2 Internally generated goodwill
Both AAS 18 and AASB 1013 directed that internally generated goodwill should not
be recognized, consistent with traditional practice: see para. 4.1 of both standards.
This lack of recognition, however, was one which precluded recognition in the
balance sheet and subsequent amortisation, rather than one based on any conceptual
difference in accordance with views expressed in the old accounting standards: see
AAS 18, para. 5.1.6 and AASB 1013, para. 5.1.2. That is, these standards took the
view that there was no difference between the concepts of purchased and internally
generated goodwill; the difference lay in their accounting treatment with only
purchased goodwill being recognized and subjected to amortisation. The reason for
this difference in treatment was that only purchased goodwill could be measured
reliably, based on the amount actually paid for it.
1010 AASB 1013 applied to those entities required to prepare financial statements in accordance with the Corporations Law (see para. 1), while AAS 18 applied to those entities, in both the private and public sectors, which were not so required. AAS 18 was first issued in 1984, and revised in 1996. AASB 1013 was first issued in 1988 and also revised in 1996. The main revision to both standards involved the prescription of the straight-line method of amortisation for goodwill, where no method had been prescribed before. Under the new standards, however, amortisation has been replaced by impairment write-downs.
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14.4.3 The treatment of goodwill
After the 1996 revisions, para. 5.2 of both AASB 1013 and AAS 18 directed that:
Purchased goodwill must be amortised so that it is recognized as an expense in the
profit and loss account on a straight-line basis, over the period from the date of
acquisition to the end of the period of time during which the benefits are expected to
arise. This period must not exceed twenty years from the date of acquisition.
In conjunction with this direction, para. 5.3 of both standards required the period over
which goodwill was to be amortised to be reviewed as at each reporting date and
adjusted if necessary to reflect the amount and timing of expected future benefits.
Furthermore, both standards required the unamortised balance of goodwill to be
reviewed at each reporting date and any excess of this amount above the actual value
of the goodwill to be expensed through the profit and loss account: see AASB 1013,
para. 5.4 and AAS 18, para. 5.6.1011
14.5 Adoption of International Accounting Standards
The AASB has implemented the Financial Reporting Council’s policy of adopting
international accounting standards (IASs) issued by the International Accounting
Standards Board (IASB) by ensuring that relevant Australian standards are consistent
with international standards. The relevant standards have been re-issued by the AASB
as new standards effective from 1 January 2005. There is no IAS which deals
specifically with goodwill, such as did AAS 18 and AASB 1013 previously. Rather,
goodwill and its treatment feature in two international standards, viz. IAS 22 on
business combinations, and IAS 36 on asset impairment (which represents the main
change to Australian practice). Goodwill, consistent with a range of other assets,1012 is
now to be written down to reflect impairment in value in each period rather than be
amortised straight-line over a fixed period. IAS 22 has been implemented in Australia
as AASB 3 Business Combinations and IAS 36 as AASB 136 Impairment of Assets. In
addition, the AASB has implemented IAS 38, dealing with intangible assets, as AASB
138 Intangible Assets. AASB 138 has only peripheral application to accounting for
goodwill in that it directs that, consistent with long-standing practice, internally
1011 Finch reports that in practice such write downs rarely occurred: Finch, N., ‘A Case Based Analysis of Impairment Decision Making’, (2008) 7(2) Journal of Law and Financial Management 36 at 36. 1012 AASB 136, para. 2, sets out the scope of its application concerning the impairment of assets. In short, all assets are to be written down on an impairment basis, but with the exclusion of specific assets designated in this paragraph.
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generated goodwill shall not be recognized as an asset (para. 48). These standards
have been subjected to some revisions since their adoption and, where relevant, these
revisions will be considered in the following paragraphs.
14.6 Goodwill under the new standards
AASB 3 Business Combinations (as revised in 2008) currently defines goodwill as
‘[a]n asset representing the future economic benefits arising from other assets
acquired in a business combination that are not individually identified and separately
recognised.’1013 Hence, there is no significant difference from the old ‘pre-
international’ standards in the definition. Paragraph 32 of AASB 3 directs that
goodwill shall be recognized on acquisition and measured as, effectively, the excess of
the consideration paid over the net of the fair values of identifiable assets and
liabilities assumed on the acquisition. This standard, as its title indicates, deals with
assets, including goodwill, acquired in a ‘business combination’ which is defined as
‘[a] transaction or other event in which an acquirer obtains control of one or more
businesses’.1014 Thus the standard applies to the simple purchase of single business
and to more complex arrangements. The definition of ‘business’ in turn is ‘[a]n
integrated set of activities and assets that is capable of being conducted and managed
for the purpose of providing a return in the form of dividends, lower costs or other
economic benefits directly to investors or other owners, members or participants.’1015
While dressed up in more complex terminology, the directions concerning goodwill
under AASB 3 still reflect the traditional approach of recognizing goodwill as an asset
valued as a residual amount arising from the cost of the business less the value of the
other (net) assets.1016
1013 AASB 3, Appendix A, ‘Defined Terms’. The original definition of goodwill in this standard was the ‘[f]uture economic benefits arising from assets that are not capable of being individually identified and separately recognised.’ 1014 AASB 3, Appendix A, ‘Defined Terms’. 1015 Ibid. 1016 Under the original AASB 3, para. 51(a) directed that goodwill was to be recognized as an asset, which was therefore to be included in the accounts, on its acquisition under a ‘business combination’ which was defined as ‘[t]he bringing together of separate entities businesses into one reporting entity’. That goodwill is ultimately and essentially a residual amount or a premium paid was made clear in para. 51(b) which directed that the amount of goodwill to be recognized should be its cost, ‘being 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’. By way of explanation, para. 53 stated that ‘goodwill is measured as the residual cost of the business combination after recognising the acquiree’s identifiable assets, liabilities and contingent liabilities’ (emphasis added).
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In accordance with its legal concept, goodwill is viewed as an intangible asset on the
straightforward basis that it does not have physical substance (that is, it is not a
tangible asset), but the accounting concept is different in this respect.1017 AASB 138
makes it clear that goodwill is not classed as an intangible asset for accounting. This
standard defines an intangible asset as ‘an identifiable non-monetary asset without
physical substance’ (para. 8). The fact that an intangible asset must be identifiable
under this definition excludes goodwill from the class of intangible assets. By way of
explanation, it is stated in para. 11 that ‘[t]he definition of an intangible asset requires
an intangible asset to be identifiable to distinguish it from goodwill’. Then, consistent
with what has been noted elsewhere, it goes on in the same paragraph to say that
‘[g]oodwill … is an asset representing the future economic benefits arising from assets
acquired in a business combination that are not individually identified and separately
recognised’. So, where does this leave goodwill? According to the literal meaning of
‘tangible’ (something that can be touched), a tangible asset should have physical
substance, as distinct from an intangible asset. Consequently, goodwill cannot be
classified as a tangible, leaving it to occupy a special class of its own, that of an
unidentifiable intangible asset. Leo1018 dedicated the major part of a chapter to
surveying the question of the accounting profession’s views of the distinction between
tangible and intangible assets. The impression gained from this survey is that the
distinction between tangibles and intangibles has not necessarily depended entirely on
whether the assets have physical substance or not,1019 which tends to make
classification somewhat arbitrary and meaningless. In fact, Leo recommended
eliminating the term ‘intangible’ from accounting standards and statements of
accounting concepts. Instead of the tangible/intangible classification he recommended
that assets (and liabilities) should be classified as identifiable or unidentifiable.
However, this recommendation has not been taken up with the release of AASB 138
on Intangible Assets whose objective is ‘to prescribe the accounting treatment for
intangible assets that are not dealt with specifically in another Standard’ (para. 1).
1017 However, the majority of the High Court in FCT v. Hepples (1998) 98 ATC 4585 gave some recognition to the identifiable/unidentifiable assets question in their joint judgment. Nonetheless, they still made it clear that ‘the accounting and commercial view of goodwill … should not be regarded as an accurate statement of the legal definition of goodwill’ (at 4950). 1018 Leo, K. J. et al. 1995, Accounting for Identifiable Intangibles and Goodwill, Australian Society of CPAs, Melbourne, 23. 1019 This issue of tangible v. intangible assets had come under consideration in earlier times: see chapter 13, para. 13.2.3.1.
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14.6.1 Internally generated goodwill
Internally generated goodwill, as opposed to purchased goodwill, is not to be
recognized as an asset in accordance with para. 48 of AASB 138. In the following
para. 49 the situation with internal goodwill is explained thus:
In some cases, expenditure is incurred to generate future economic benefits, but it does
not result in the creation of an intangible asset that meets the recognition criteria of this
Standard. Such expenditure is often described as contributing to internally generated
goodwill. Internally generated goodwill is not recognised as an asset because it is not an
identifiable resource (ie it is not separable nor does it arise from contractual or other
legal rights) controlled by the entity that can be measured reliably at cost.
The recognition criteria are found in para. 21 of AASB 138 where it is emphasized
that, inter alia, the cost of the asset must be able to be measured reliably. While
purchased goodwill has a cost attached to it, internally generated goodwill does not, of
course, and therefore should not appear in the balance sheet in accordance with this
standard. It may readily be argued that internally generated goodwill is as important to
a business as acquired goodwill, perhaps even more so after a reasonable period; it has
an inherent presence in a business and in this sense may be seen in a similar light to
legal goodwill which is attached inseparably to the business. Nonetheless, well-
entrenched accounting conservatism militates against its recognition. And in keeping
with this approach, there is no provision for adding internally generated goodwill to
the value of acquired goodwill where it exists. In other words, there is no provision for
an upward revaluation of goodwill. Moreover, AASB 136 prohibits the reversal of an
impairment loss for goodwill: see para. 124. Thus the only way for internally
generated goodwill to surface in the accounts is by sale of the business, when it will
be recognized by the purchaser as purchased goodwill.1020
14.6.2 Treatment of goodwill
In the original 2004 version of AAS 3, para. 54 directed that after initial recognition
the acquirer should measure and carry goodwill at cost less any accumulated
impairment losses. Para. 55 made it clear that goodwill should not be amortised,
1020 While internally generated goodwill is not actually recognized in the balance sheet, it may still have an effect on the carrying amount of purchased goodwill in that internally generated goodwill may be used to cushion any impairment losses. That is, the goodwill generated internally by a business entity may counter the impairment of the purchased goodwill: see, for example, Picker, R. et al. 2009, Australian Accounting Standards, 2nd ed., John Wiley & Sons, Milton Qld, 508.
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departing from the approach set down in the old ‘pre-international’ standards, AAS 18
and AASB 1013. Instead, para. 55 went on to direct the acquirer to test the goodwill
for impairment annually, or more frequently if circumstances dictate, in accordance
with AASB 136 Impairment of Assets.1021 Both AAS 3 and AAS 136 have been
revised, but the treatment of goodwill as set down in the earlier versions of these
standards remains. In particular, the rules concerning impairment1022 testing for
goodwill have remained the same in the revised AAS 136 in paras. 80-99. Any
impairment loss incurred by an asset is to be immediately expensed through the profit
and loss account: para. 60.
Because goodwill itself cannot generate cash flows,1023 for the purpose of impairment
testing it must be allocated to what are called cash-generating units (CGU) in
accordance with para. 80, AASB 136. A CGU is defined in AASB 136, para. 6, as ‘the
smallest identifiable group of assets that generates cash inflows that are largely
independent of the cash inflows from other assets or groups of assets’. Para. 80
elaborates that each unit or group of units to which goodwill is allocated shall
represent the lowest level at which goodwill is internally monitored and not be larger
than a segment determined in accordance with AASB 8 Operating Segments. In
addition, para. 86 deals with the situation where the business entity disposes of an
operation within a CGU to which goodwill has been allocated; in this type of situation
the portion of goodwill associated with the operation should be included in
calculations to determine the gain or loss on disposal. It is beyond the scope of this
paper to consider just how such allocations of goodwill might be made. However, it
seems that the standard views goodwill as able to be divided or segmented to order for
purposes of calculating gains or losses.1024
How does this approach square with the accounting concept of income? Goodwill is
defined in AASB 3 in terms of an asset acquired in a business combination, which
1021 See paras. 80-99. For an explanation of the (two) methods of testing for impairment, see Finch, N., ‘A Case Analysis of Impairment Decision Making’, (2008) 7(2) Journal of Law and Financial
Management 36. 1022 The objective of AASB 136 concerning impairment is stated thus (in para. 1): ‘The objective of this Standard is to prescribe the procedures that an entity applies to ensure that its assets are carried at no more than their recoverable amount. An asset is carried at more than its recoverable amount if its carrying amount exceeds the amount to be recovered through use or sale of the asset. If this is the case, the asset is described as impaired and the Standard requires the entity to recognise an impairment loss.’ 1023 See AASB 136, para. 81, for recognition of this point. 1024 For an examination of issues concerning the impairment of goodwill, including methods for allocating costs, see Olde, M., ‘Impairment of assets’, (Mar 2007) Charter 72.
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means effectively that goodwill is attached to a business, consistent with the legal
concept of goodwill also. A CGU of a business, while a part of the business, may
reasonably be seen as a unit or division which could stand as a business in its own
right, and could be sold as such. However, whether an ‘operation’ within a CGU could
qualify as a business would be a question of fact in any particular case. Nonetheless,
for the purposes of calculation, goodwill is also allocated to such an operation. It must
be taken that this approach is specifically for this purpose and need not run counter to
the general accounting concept of goodwill. Moreover, at least at the CGU level, this
approach is not necessarily at odds with the legal concept of goodwill because
recognition has been given to the notion of divisional goodwill at law: see Geraghty v.
Minter per Stephen J.1025
14.7 The nature of accounting goodwill
Goodwill has been defined as an asset in a similar manner under both the old and the
current accounting standards, and indeed has been recognized as an asset from earlier
times as discussed in ch. 13. Accounting goodwill is specifically defined in AASB 3
as representing future benefits from assets which are not individually identified and
separately recognized. But how one can conceive of an asset that is unidentifiable is
difficult to say; the very term ‘asset’ would seem to mean something which can be
identified. Rather, in this regard it might be more meaningful to refer to goodwill as
representing qualities of a business other than assets, a matter somewhat similar to that
raised in chapter 4, para. 4.2 in the legal context. However, this approach still does not
completely address the issue of the production and nature of goodwill. Goodwill is
surely the product of both assets in general and other qualities of a business which
make it successful and more valuable than the individual values of its other assets. In
other words, goodwill may be seen as the outcome of a synergy between the other
assets, and qualities, and be represented by a premium paid on the purchase of those
assets as part of a business. The restricting of the concept of goodwill only to benefits
arising from ‘unidentifiable assets’ seems particularly unrealistic, unnecessary and
ultimately meaningless as a concept of any substance.
The reason for this approach to defining goodwill seems to relate to the general
approach of defining an asset in terms of its future benefits as originally set down in
1025 (1979) 142 CLR 177 at 193. Divisional goodwill is discussed in chapter 4, para. 4.8.
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Statement of Accounting Concepts, number 4, on the Definition and Recognition of
the Elements of Financial Statements (SAC 4)1026 and reproduced in similar form in
the accounting standards. SAC 4 has been superseded by the Framework for the
Preparation and Presentation of Financial Statements issued by the AASB in July
2004.1027 This framework defines an asset as ‘a resource controlled by the entity as a
result of past events and from which future economic benefits are expected to flow to
the entity’ (para. 49(a)). Further, in para. 89, it holds that: ‘An asset is recognised in
the balance sheet when it is probable that the future economic benefits will flow to the
entity and the asset has a cost or value that can be measured reliably.’ Thus an asset is
a resource which generates future economic benefits and is recognized for accounting
purposes where it has a reliably measured cost or value.
Consequently, as a product of this framework, it would be expected that goodwill as
an asset would be defined in terms of future benefits flowing from it to the entity.
However, in the particular case of goodwill it is defined differently in the standards as
‘representing’ the future economic benefits from assets which have not been identified
and separately recognized: see AAS 3, Appendix A. Thus it may be seen that there is a
fundamental difference in the definition of goodwill from that of other assets: other
assets are defined in terms of economic benefits flowing from them, but goodwill is
defined as representing economic benefits flowing from unidentifiable assets. But why
should goodwill be limited to economic benefits flowing from ‘unidentifiable’ assets?
There should be no need for standard setters to limit themselves to defining goodwill
in such an unrealistic and unnecessary manner. Rather, it should be relatively easy to
see goodwill as an over-arching asset arising from a mix of assets (identifiable) and
other qualities (including the so-called unidentifiable assets). Then it would be the
cost of the goodwill recorded as an asset, which is what happens in practice (and in
accordance with the standards) anyhow.
1026 In SAC 4 , ‘assets’ were defined as ‘future economic benefits controlled by the entity as a result of past transactions or other events’ (para. 14). 1027 This Framework is not an accounting standard but a formal expression of the conceptual framework supporting those standards. As stated in para. 1, it ‘sets out the concepts that underlie the preparation and presentation of financial reports for external users’. It is equivalent to the Framework for the
Preparation and Presentation of Financial Statements issued by the IASB and has application from 1 January 2005. For discussion of the international framework, see Alexander, A. et al. 2009, International Financial Reporting and Analysis, 4th ed., Cengage Learning EMEA, UK, 137.
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It has been noted that goodwill is defined in the current Australian standards as
representing future benefits from unidentifiable assets. And it is identified and
recognized as an asset. Thus here we have, it seems, the asset goodwill distinguished
from its sources, those nebulous unidentifiable assets. In this sense at least, accounting
goodwill resembles legal goodwill which is separate from its sources. Of course, if
accounting goodwill is to be identified and recognized as an asset, then it has to be
distinguished from those ‘unidentifiable’ assets which it is taken to represent.
Therefore goodwill as a particular form of intangible asset must of necessity be seen
as separate from those things (assets and other qualities of a business) which generate
it.1028 But, in the end, goodwill is no more than the value a purchaser is prepared to
pay for a business as a going concern above the value of identifiable assets. It is a
premium paid on acquisition. As a consequence, accounting goodwill may be seen as
a value or economic benefit, rather than a resource or thing which may generate it.
14.8 Conclusion
The most obvious thing to note about the definition, valuation, and treatment of
accounting goodwill in the modern period is how little in substance has changed from
the earlier periods covered in chapter 13. The most significant change, as a result of
the recent international standards, is the writing down of goodwill on an impairment
basis rather than amortising it. Notwithstanding different views and treatments,
amortisation of goodwill became the reasonably standard treatment of goodwill in the
period before WWII. After that period, a range of different treatments was commonly
practised until the standard setting bodies in the 1980s chose to recommend the
amortising of goodwill (over stipulated maximum periods). This was subsequently
replaced by the current impairment approach.
However, leaving aside matters of its accounting treatment, the inherent nature of
accounting goodwill remains as elusive as ever. The attempts at definition and
1028 The old standard AASB 1013, at para. 5.1.1, had the following to say about goodwill and its composition:
‘Consistent with the definition of assets as service potential or future economic benefits controlled by the entity as a result of past transactions or other past events, this Standard specifies that goodwill is an asset. In particular, goodwill comprises the future benefits from unidentifiableassets which, because of their nature, are not normally individually recognised. Examples of unidentifiable assets include market penetration, effective advertising, good labour relations and a superior operating team. Unidentifiable assets do not include assets of an intangible nature which are capable of being both individually identified and separately recognised, as may be the case with patents, licences, rights and copyrights.’
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explanation evident in the standards, and in the conceptual framework, are of doubtful
value and shed little light on the nature of accounting goodwill. In fact, it may be
argued that the accounting definition is misleading, involving a needlessly narrow
conception of goodwill at odds with the real circumstances of its production in a
business. But, as has always been the case, the ‘out’ for accounting is the firmly
entrenched practice of recognizing only the cost of purchased goodwill in the
accounts. Thus questions of the inherent nature of goodwill are avoided in a practical
sense.
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Chapter 15: Final Analysis and Conclusions
15.1 Introduction
The topic and research question introduced in chapter 1 concerned an examination of
the development and nature of goodwill and the possibility of achieving a synthesis
between its legal and accounting concepts. As explained in chapter 1, the genesis for
this topic was the pronouncement by the majority of the High Court in FCT v.
Murry1029 that it was impossible to achieve a synthesis of the legal and accounting
concepts of goodwill, based on their opinion that lawyers and accountants have
different views of the meaning of goodwill. In order to examine this position, the
historical development of both concepts was researched, together with their modern
conceptions. From the legal viewpoint, the focus was on the English and Australian
jurisdictions because the pronouncement was made by the High Court in the
Australian jurisdiction, based to significant extent on English authorities. From the
accounting viewpoint, a similar approach was used in that the focus was on the
development of the accounting concept in the UK and later in Australia which based
its concept on UK theory and practice. This approach to the concepts, effectively in
parallel, also facilitated the examination of any possibility of a synthesis of the
concepts.
Much of the research concerning the legal concept of goodwill necessarily involved an
examination of case law to distil the development of the concept, given that it is very
much a creature of common law rather than statute. Legislatures have steered clear of
attempting any statutory definitions of goodwill. At the outset this reveals a
fundamental problem with coming to grips with the legal concept; it reveals a difficult
concept eluding easy definition, as noted by judges in a number of cases.1030 The
English case law from the earliest was examined to plot the passage of the judicial
development of the legal concept and to gain an understanding of it by way of this
development. As was revealed in early chapters, the major development of the concept
occurred in the nineteenth century, culminating in the largely finished form delivered
1029 (1998) 98 ATC 4585. 1030 For example, see the early comments of Cotton LJ in Cooper v. Metropolitan Board of Works (1883) 25 Ch D 472 and of Lord Macnaghten in CIR v. Muller and Co’s Margarine Ltd [1901] AC 217. Both of these comments were referred to in chapter 1.
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by the House of Lords in 1901 in CIR v. Muller and Co’s Margarine Ltd.1031 Beyond
that point, as also noted in various parts of this paper, the major development of the
legal concept of goodwill may be found in FCT v. Murry1032where the High Court
posited goodwill as having sources, while being separate from those sources.
There is a greater emphasis on the legal concept of goodwill than on the accounting
concept in this paper. This is warranted and justified by the fact that there is a great
body of case law constituting the primary sources of the legal concept. Moreover, the
legal concept is older than the accounting concept – by at least one hundred years it is
reasonable to say. Nonetheless, the history, development and current concept of
accounting goodwill have been examined to the extent necessary to address the
question of a synthesis between the legal and accounting concepts. The accounting
concept evolved from the legal concept in the latter part of the nineteenth century,
meaning that the two modern concepts have a common ancestor, both having evolved
from the nineteenth legal concept of goodwill. The meaning and development of the
accounting concept of goodwill are derived from early literature in the form of journal
articles and accounting texts. Much more recently, from the 1980s, standards
promulgated by accounting bodies have taken the concept into its modern form. These
accounting standards have the force of law under s. 296(1) of the Corporations Act
2001 (Cth) in that all companies, with the exception of some small proprietary
companies, are required to comply with them in the production of their financial
reports. Thus these standards are of legal significance to the modern concept of
accounting goodwill.
However, to return to the original question, can a synthesis be achieved between the
two concepts? Or, viewed another way, is there sufficient similarity or overlap
between them to accept them as essentially the one concept, although a concept which
may be viewed from different angles, thereby presenting different facets? That is, can
goodwill be viewed as a multi-faceted concept? Viewed this way, goodwill may be
seen as a compound concept displaying various facets or aspects, depending on the
relevant viewpoint. It may be argued that even within the legal concept goodwill has
different facets, meaning different things in different legal contexts. So why not
simply see accounting goodwill as another facet of the one concept? While this may
1031
CIR v. Muller and Co’s Margarine Ltd [1901] AC 217. 1032 (1998) 98 ATC 4585.
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seem a reasonable proposition on the face of it, does it hold up against the evidence
adduced in this paper?
15.2 Summary of the topics
At this point, a summary of the topics addressed in the chapters of this paper is
provided as a reminder of the important issues and as a basis for further analysis.
Chapter 1 introduces the topic and addresses a range of definitions of goodwill, both
legal and accounting definitions. Whereas accounting goodwill is defined in
accounting standards, legal goodwill is defined in case law rather than in statutes.
Moreover, there are also many definitions in the literature derived from both
accounting and legal conceptions of goodwill. Chapters 2-12 deal largely with the
legal concept of goodwill, while chapters 13-14 deal with the accounting concept.
Chapter 2 examines the evolution of goodwill as a commercial legal concept dating
back to early references in the sixteenth century. The earliest reference to the idea of
goodwill in the case law dates from 16201033 where the term ‘custom’ was used as a
synonym for goodwill. The first reference to goodwill by name is found in a case from
17431034 with two more references to it in cases up to 1800.1035 However, it is the
nineteenth century which emerges as the critical period for the development of the
legal concept of goodwill. This century produced a significant body of case law on
goodwill, in contrast to the very few cases of the previous century. In fact, it was in
the nineteenth century that the legal concept of goodwill evolved into its modern form.
Chapter 3 carries on the examination of the legal concept from the point of view of it
major elements and sources. Chapter 4 deals with important issues which go to the
heart of our understanding of legal goodwill. The essential issues concern the concept
of goodwill as one whole item of property, inseparably attached to a business but
separate from its sources.
While chapters 2-4 deal with the evolution of goodwill and its inherent nature,
chapters 5-12 examine the concept in a range of specific legal contexts in order to
determine what they add to our understanding and also to determine how the essential
nature of legal goodwill holds up in the various contexts. Chapter 5 deals with
1033
Broad v. Jollyfe (1620) Cro Jac 596; 79 ER 509. 1034
Gibblett v. Read (1743) 9 Mod 459; 88 ER 573. 1035
Worral v. Hand (1791) Peake NP 105; 170 ER 95 and Hammond v. Douglas (1800) 5 Ves Jun 539; 31 ER 726.
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goodwill in the context of partnerships. Much of the case law involving goodwill in
this context arose in the nineteenth century in relation to the termination of
partnerships. The major question concerned whether goodwill of the partnership
business survived to the remaining partners in the absence of an agreement to that
effect. However, what emerges from the case law in this area is that the concept of
goodwill under consideration was clearly consistent with the general concept as an
item of property attached to the business. Chapter 6 provides an interesting take on
goodwill in relation to restrictive covenants designed to protect the goodwill of a
business. The history of this area of law can be traced back to the fifteenth century,
where an incipient notion of goodwill may be seen to be emerging. While it was not
until the eighteenth century that goodwill was formally recognized by name, this early
law reveals an awareness of goodwill as the essence of a business and something
worthy of protection.
Chapter 7 examines goodwill in the context of stamp duties, a tax with a long pedigree
stretching back to the late seventeenth century. However, for stamp duty purposes,
goodwill was not recognized as property until the nineteenth century. The major issue
found in the case law of that century was the approach of courts in including goodwill
in other assets, such as land as its source, for the purpose of valuation for duty. And
this approach persisted in Australia until Murry when the High Court reminded us that
goodwill is an item of property in its own right and separate from its sources. Chapter
8 examines the authorities concerning the nature and treatment of goodwill in the
contexts of licensing, leasing and franchising. A range of complex issues involving the
nature of goodwill arises in these contexts, but the conclusion reached is that goodwill
remains the concept as propounded by the High Court in Murry: an item of personal
property separate from its sources but inseparable from the business.
In chapter 9 the legal concept of goodwill is examined in the broad-ranging context of
the tort of passing-off. Goodwill plays a central part in the modern tort as the element
of business to be protected from damage by the act of passing-off. In this type of
situation the essential nature of goodwill is not of paramount importance; rather,
goodwill may be seen as a cipher for the business suffering damage. Nonetheless, a
number of significant issues surrounding the concept of goodwill are to be found in
this area of the law. These issues involve questions such as the location of goodwill
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for jurisdictional purposes, whether goodwill may continue to exist after the cessation
of business, and whether ‘future goodwill’ should be recognized. However, in the
final analysis there is nothing of substance in passing-off which leads to a different
conclusion about the legal nature of goodwill. These questions may be confined to the
particular requirements of passing-off and need not be viewed as representing a
deviation from the essential concept of goodwill as enunciated in Murry, for example.
Then, as discussed in chapter 10, the field of compensation law, somewhat similarly to
the requirements of passing-off, presents certain treatments of goodwill which strictly
run counter to its legal nature, particularly in respect of counting goodwill as part of
land in calculating an amount of compensation. However, this is no more than a
deeming device for the specific purposes of calculating compensation and thus should
not be taken as a deviation from the normal concept of goodwill.
Chapter 11 deals with goodwill in a number of tax contexts not covered elsewhere in
this paper. The relationship between tax and goodwill has been an uneasy one with a
degree of friction between the concept of goodwill and its treatment. In particular, tax
offices and courts have tended to treat personal goodwill as a separate non-
transferable item of property and have endeavoured to treat site goodwill as part of the
land for assessment purposes. The flaws in these approaches have been addressed in
this paper. Furthermore, the tax consolidation regime encompasses goodwill outside
the normal legal and accounting concepts, but for the specific requirements of the
regime. Typically, tax regimes focus on the value of goodwill for calculation and
assessment purposes and in this sense the concept may be seen as closer to the
accounting concept which is essentially one of value. Nonetheless, accepting that they
have specific requirements, there is nothing in these various tax regimes which should
be taken to affect the general concepts of goodwill for both law and accounting.
The last of the chapters focussing on legal goodwill, chapter 12, addresses issues
concerning valuation – more for legal purposes than for accounting. However, the
valuation of goodwill accords more with the accounting concept because the essential
identity of accounting goodwill is one of value. Nonetheless, the legal concept is
fundamentally important in its character as property of a business.
Finally, chapters 13 and 14 deal with the accounting concept of goodwill. Chapter 13
examines the origin and development of goodwill. It plots the evolution of accounting
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goodwill from its recognizable beginnings in the 1880s to WWII. It is clear from the
literature of the late nineteenth century that accounting goodwill evolved from the
legal concept, with early accounting definitions paying regard to the relationship of
customers to the business, the essence of the legal definition. At least up to WWI the
definitions employed in the accounting literature oscillated between the legal concept
and an accounting concept emphasising valuation. But, as proposed by Leake1036 in
1930, there was by that time a difference between the two definitions, with the legal
definition being narrower than the commercial or accounting one. This is a view with
which issue is taken in this final chapter. However, as observed by Young1037 who
surveyed the writings on goodwill in the period between WWI and WWII, there was a
movement from an essentially legal concept of goodwill to a more commercial
concept with an emphasis on earnings power and value.
Nonetheless, from the outset, more specific accounting issues of valuation methods
and of treatment in the accounts were of major concern to the profession and business.
Thus various methods of valuation were to be found in the early literature, together
with an emphasis on amortisation of the goodwill as the preferred treatment in the
accounts. This concern with valuation and methods of treatment continued to WWII
without any significant changes in approach. And throughout this period goodwill
continued to be treated as property and therefore recognized as an asset for
accounting, consistent with the legal concept. One area where such recognition was
not forthcoming, however, was in respect of internally generated goodwill which from
the beginning has not been recognized for accounting purposes.
Chapter 14 carries on with the examination of accounting goodwill in the modern
period, identified as the period after WWII with an emphasis on the time from the
early 1980s. As noted in the conclusion to that chapter, the definition, valuation and
treatment of accounting goodwill have changed little in substance from the earlier
periods examined in chapter 13. The major change may be seen in the formalization of
accounting for goodwill arising out of the establishment of standard setting bodies and
the issuing of accounting standards defining accounting concepts, including goodwill,
1036 Leake, P. D. 1930, Commercial Goodwill: Its History, Value, and Treatment in Accounts, 2nd ed., Pitman and Sons, London. 1037 Young, N. S., ‘Valuation of Goodwill and its Treatment in Accounts’, reprint published by Canberra University College from (Nov 1946) The Australian Accountant 473 and (Dec 1946) The
Australian Accountant 530.
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and governing accounting practice across a wide range of accounting activity. After
the issuing of home-grown accounting standards in the 1980s, including two
specifically on goodwill, the Australian Accounting Standards Board has adopted
international accounting standards, issuing new international standards effective from
1 January 2005. There is no new standard dealing specifically with goodwill, but
goodwill is instead dealt with across three standards: AASB 3; AASB 136; and AASB
138.
AASB 3 provides the accounting definition of goodwill as an ‘asset representing the
future economic benefits arising from other assets acquired in a business combination
that are not individually identified and separately recognised’. This standard also
prescribes effectively that only purchased goodwill should be recognised and that it
should be valued as a residual amount after subtracting the cost of all identifiable
assets from the purchase price of the business. Consistent with only purchased
goodwill being recognised for accounting, AASB 138 specifically directs that
internally generated goodwill should not be recognised. AASB 136 deals with the
treatment of goodwill in the accounts, with the current prescription being impairment
write-downs.
It is argued in chapter 14 that the definition of accounting goodwill seems
unrealistically and unnecessarily limited in that it is deemed to represent economic
benefits from so-called unidentifiable assets. In reality, accounting goodwill is the
product of a range of (identifiable) assets and other qualities of a business (such
qualities capturing those unidentifiable assts). As such, accounting goodwill can be
seen in a similar light to legal goodwill in that both may be perceived as separate from
their sources.
15.3 The recognition and nature of goodwill
As discussed in chapter 4, legal goodwill has been recognized as property from at
least the mid-nineteenth century,1038 a recognition authoritatively confirmed by the
House of Lords in Muller. For the purposes of accounting, goodwill is recognized as
an asset as discussed in chapters 13 and 14. Legal goodwill as property is also an
asset, of course, and is recognized as such where appropriate. In Murry the High Court
1038 For example, see Potter v. CIR (1854) 10 Ex 147; 156 ER 392. The character of goodwill as property is discussed in para. 4.2 of chapter 4.
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stated that ‘[g]oodwill is an item of property and an asset in its own right.’1039 This is
specifically the case in the field of taxation where, for example, goodwill is defined as
a CGT asset for the purposes of capital gains tax.1040
From the legal viewpoint, any business will have goodwill, whether that business is
profitable or not. That is, legal goodwill is recognized regardless of its value. As the
majority of the High Court said in Murry, ‘[i]t is clear as a matter of legal principle
that a business may have goodwill although it is not shown in the accounts of the
business.’1041 However, accounting goodwill, on the other hand, is recognized in the
accounts of a business only so long as it has value. In fact, it is very much a matter of
value as an asset. As such, accounting goodwill is subject to write-down, currently on
an impairment basis, and may be removed from the balance sheet as an asset as a
result of being written down to nil.
Another significant difference between the concepts concerns the issue of internally
generated goodwill. Goodwill is only recognized for accounting where it is purchased;
goodwill generated internally by a business is not recognized as an asset in accordance
with established practice and accounting standards.1042 However, at law goodwill does
not have to be purchased to be recognized; internally generated goodwill may be
recognized and valued according to legal requirements. For example, such goodwill
may be recognized as property to be protected in passing-off actions and may need to
be valued in cases of partnership dissolution.
The various definitions of goodwill in law and accounting over the years reveal both
similarities and differences. Similarities have arisen as a result of the accounting
concept being originally based on the legal concept, with an accommodation between
legal and accounting concepts found in some of the earlier definitions. The major
difference found in formal definitions amounts to one of focus and emphasis. The
legal definitions tend to focus on the attractive force which brings in custom while
accounting definitions focus on goodwill as an asset which has value to the business.
1039 (1998) 98 ATC 4585 at 4592. 1040 For capital gains tax, goodwill is defined as a CGT asset in s. 108-5(2)(b), Income Tax Assessment
Act 1997 (Cth). 1041 (1998) 98 ATC 4585 at 4595. 1042 See AASB 138, para. 48. Internally generated goodwill in accounting is discussed in chapters 13 and 14.
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For example, in accounting standards, goodwill is defined as an asset representing
certain economic benefits to the business.
Consequently, on the face of it, a synthesis may seem difficult to achieve between the
two concepts on the basis of differences relating to recognition, definition and
treatment. Nevertheless, at its core, goodwill remains an item of property and an asset
recognized by both law and accounting.
15.4 Goodwill and its sources
At law, all sources of goodwill, whether they be identifiable assets or not, are separate
from the goodwill. As the majority of the High Court in Murry said:
[Goodwill] may derive from identifiable assets of a business, but it is an indivisible
item of property, and it is an asset that is legally distinct from the sources – including
other assets of the business – that have created the goodwill. Because that is so,
goodwill does not inhere in the identifiable assets of a business, and the sale of an asset
which is a source of goodwill, separate from the business itself, does not involve any
disposition of the goodwill of the business.1043
For accounting, however, goodwill is defined as representing future economic benefits
arising from assets that are not capable of being individually identified and separately
recognized.1044 Thus prima facie this indicates a difference from the legal concept in
that, for accounting, unidentifiable assets only are seen as the source of goodwill,
whereas at law identifiable assets, inter alia, may also be the source of goodwill. This
is a matter of perception and arbitrary definition in law, but nonetheless a reflection of
the reality of goodwill as a legal concept. For accounting, on the other hand, the
definition specifically focuses on economic value from unidentifiable assets. But, as
argued in this paper, this restriction of sources to unidentifiable assets is unrealistic
and unnecessary. Thus this difference may be seen as more apparent than real.
Furthermore, in accordance with Murry, the law is clear that goodwill is separate from
its sources, while the accounting definition is less clear on this matter. However, the
accounting definition may be interpreted as meaning that goodwill, as the future
economic benefits from unidentifiable assets, is intended to be seen as separate from
1043 (1998) 98 ATC 4585 at 4587. 1044 AASB 3, Appendix A, Defined Terms.
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those ‘assets’. Regardless, it would seem that this is not an issue for accounting
because, once identifiable assets have been included in the balance sheet, goodwill
covers any other sources of economic benefit. Thus, for accounting purposes,
goodwill is recorded as an asset separate from the other (identifiable) assets and so
there is no conflict between goodwill and its sources, whatever they may be. In Murry
the majority saw no fundamental difference between law and accounting in regard to
the separation of goodwill from its sources, stating:
Goodwill is an item of property and an asset in its own right. For 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.1045
Under the new international accounting standards there is a range of items which now
must be recognized as intangible assets, whereas they were not so required under the
old standards. This change may intrude into the old domain of goodwill, limiting its
coverage. However, as accounting goodwill in the end is the difference between the
purchase price of the business and the fair values of the identifiable assets, all other
things being equal it would be reduced in value in a sale agreement (or later in the
purchaser’s balance sheet) to account for values attached to these additional assets
now recognized. But the concept itself for accounting is not changed by these changes
in asset recognition: accounting goodwill remains effectively the value of future
economic benefits from unidentifiable assets.
Accordingly, when it comes to the sources of goodwill the differences between law
and accounting are not of great significance. In this regard, at least, there is nothing
that specifically or substantially prevents a synthesis of the concepts.
15.5 The co-incidence (overlap) of the two concepts
The two concepts should not be seen as totally separate in all cases; there may be a
place for the accounting concept in, for example, capital gains tax and stamp duties
law where, arguably, the accounting or commercial concept, based on value, is the one
under consideration. It is in a commercial setting, as in the sale of a business, that
these revenue laws apply. Consequently, it is reasonable to argue that it is the
commercial concept which applies. Moreover, there may be an argument to hold in
1045 (1998) 98 ATC 4585 at 4592.
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the case of conflict that the accounting concept should apply because, after all,
goodwill is always found in a commercial setting; it is a creature of commerce.
However, the legal concept may be more appropriate in some cases, for instance in
passing-off; goodwill might not, or need not, even exist in accounting terms in such a
case.
It appears that McHugh J in Hepples v. FCT1046 went some way to conceding a place
for the accounting concept in law. He referred to Muller where Lord Macnaghten
stated that goodwill is ‘the attractive force which brings in custom’. Further, McHugh
J quoted a passage by Lord Lindley from the same case in which he said:
… I understand the word [goodwill] to include whatever adds value to a business by
reason of situation, name and reputation, connection, introduction to old customers, and
agreed absence from competition, any of these things, and there may be others which
do not occur to me.1047
Following this quote, McHugh J noted:
It will be seen from the statements in IRC v. Muller that goodwill is the collective name
for various intangible sources of the earnings of a business which are not able to be
individually quantified and recorded in the accounts as assets of the business. The
goodwill may be constituted by sources internally generated by the business entity or
‘from the combination or inter-relationship of entities or groups of assets (synergistic
benefits)’ or both: see the Statement of Accounting Standards AAS 18: Accounting for
Goodwill (March 1984), para. 7.1048
Thus McHugh J interpreted the statements on goodwill in Muller to support a concept
more in accord with the accounting one in that he saw goodwill as ‘the collective
name for various intangible sources … not able to be … recorded in the accounts as
assets of the business.’1049 However, McHugh J also invoked Lord Macnaghten’s
classic statement that goodwill is ‘the attractive force which brings in custom’ from
the same case. This statement has assumed iconic status as the essence of the legal
concept of goodwill, but it seems to sit at odds with the accounting concept also
1046 (1991) 91 ATC 4808. 1047 Id at 4837. (This passage is found in CIR v. Muller and Co’s Margarine Ltd [1901] AC 217 at 235.) 1048 Ibid. (As noted in chapter 14, AAS 18 (and AASB 1013) have been replaced by new accounting standards, where AASB 3 provides the definition of goodwill in similar terms to those in the earlier standards.) 1049 Ibid.
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divined from the same case. So, while there is scope for some overlap between the
two concepts, it appears that it is not total when looked at from the legal viewpoint.
This issue is considered further in the next paragraph.
15.6 Opposite viewpoints?
As noted above, for the purposes of law, goodwill is viewed as essentially the
attractive force which brings in custom. But, for the purposes of accounting, it is
effectively custom (that is, the level of business and profitability) which determines
the existence, and value, of goodwill. Thus it may be proposed that goodwill is viewed
from opposite ends by the two disciplines.1050 However, this proposal is not
necessarily indicative of separate concepts; rather, it only suggests that the one
concept may be seen from different viewpoints, as discussed elsewhere in this paper.
15.7 The breadth of the concepts
There may be found intimations in the literature that the accounting concept is broader
than the legal concept. For example, Grace and Lim1051 proposed this idea, as also did
Leake1052 in an earlier period as noted in chapter 13. However, issue must be taken
with any suggestion that accounting goodwill is a broader concept than legal goodwill.
Rather, the evidence points the other way.
Legal goodwill arises in a range of different contexts which are the subject of earlier
chapters in this paper. For example, goodwill arises for consideration in various fields
of taxation, it may be an issue in the dissolution of partnerships, and is the subject of
protection in passing-off actions. As the High Court noted in Murry, ‘goodwill has
1050 Something of this nature was proposed by Grace, T. and Lim J. in ‘EIE Ocean and goodwill – some stamp duty issues for consideration’, (1997) 19 Weekly Tax Bulletin, 414 at 414-5. They said:
The revenue law cases dealing with goodwill have indicated that goodwill is that which attracts custom (‘the attractive force of the business’). A moment’s reflection would suggest that the attractive force of a business relates only to the power to draw customers and the customers’ perception of the business. It therefore relates only to matters affecting the generation of revenue by a business. If this is correct, the benefits to a business created by sound expenditure controls could not form part of the legal goodwill – although such benefits would add value to the business and therefore be reflected in accounting goodwill.
1051 Grace and Lim, op, cit., at 415 stated: It would therefore appear that the legal concept of goodwill, as described by the cases, is less extensive than the accounting concept of goodwill (as defined in AASB 1013 as being all future benefits derived from unidentifiable assets). This is because some of the advantages recognized for accounting purposes relate to matters unrelated to the generation of revenue or the customers’ perception of a business.
1052 Leake, P. D. 1930, Commercial Goodwill: Its History, Value, and Treatment in Accounts, 2nd ed., Pitman and Sons, London.
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three different aspects – property, sources and value’.1053 These different aspects of
goodwill may apply in different contexts. When it comes to the sources of goodwill in
particular, a wide range of business activities and characteristics may generate custom
and revenue. Many of the advantages recognized for accounting purposes may
constitute sources of legal goodwill. Thus, in surveying the typical sources of
goodwill, the High Court stated:
… manufacturing and distribution techniques, the efficient use of the assets of a
business, superior management practices and good industrial relations with employees,
may be sources of the goodwill of a business because they motivate service or provide
competitive prices that attract customers.
…
Goodwill may also be the product of expenditures rather than the use of assets. Thus,
money spent on advertising and promotions, although charged against annual earnings
rather than capitalised, may generate brand, product or business name recognition that
helps to generate revenue. And part at least of the moneys expended on wages, labour
relations and customer services may result in creating goodwill for a business.1054
Furthermore, the majority of the High Court divorced the existence of goodwill from
its value, with the result that a non-profitable business could still have legal goodwill.
The majority explained its view thus:
… 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.1055
Consequently, legal goodwill, as the attractive force which brings in custom, is not
even confined to the generation of income. Regardless of the accounting definition of
goodwill as representing future benefits from unidentifiable assets and its numerous
valuation methods, in the end accounting goodwill is an amount of residual value. On
the other hand, legal goodwill includes value together with other aspects which have
1053 (1998) 98 ATC 4585 at 4590. 1054 Id at 4591. 1055 Id at 4590.
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been canvassed in this paper. Thus the evidence from the case law strongly supports
the view that the legal concept of goodwill is broader than the accounting concept.
15.8 A property of a business or property of a business?
As discussed in chapter 4, it has been proposed by Slater1056 that goodwill is a
property of a business, in the sense of an attribute or a characteristic of the business,
rather than property of that business. Nonetheless, it has been firmly established that
goodwill is property,1057 therefore arguments which suggest that goodwill may be seen
as something different, to the exclusion of property, must be dismissed in the face of
overwhelming authority to the contrary. However, these concepts need not be seen as
mutually exclusive; instead, goodwill may be seen as both a property of the business
and property of the business. It may be seen as a property in the form of that attractive
force which brings in custom, and as property in that it is traditionally bought and sold
with the business. In Muller, Lord Macnaghten suggested both of these concepts of
goodwill in stating that goodwill is property because it is bought and sold every day
and that it is the benefit and advantage of the good name, reputation and connection of
a business, amounting to the attractive force which brings in custom.1058 Moreover,
the majority of the High Court in Murry supported this view, proffering it as a reason
for the difficulty of defining goodwill notwithstanding its clear acceptance as
property. With a specific reference to Slater’s article, the majority said: ‘One reason
for this difficulty is that goodwill is really a quality or attribute [that is, a property]
derived from other assets of the business.’1059 Consequently, there is nothing in this
issue which need change our view of goodwill in either the legal or accounting
context. Goodwill remains an item of property and an asset.
15.9 A fallacious approach?
Neil Brooks has presented an interesting take on the interpretation of legislative and
other legal terms in proposing that courts commit, apparently frequently, the ‘fallacy
of the transplanted category’ in their interpretation of terms and provisions.1060 This
appears to be a fallacy of ambiguity arising where it is not recognized that terms may
1056 Slater, A. H., ‘The Nature of Goodwill’, (1995) 24 Australian Tax Review 31. 1057 See chapter 4, para. 4.2. 1058 See [1901] AC 217 at 223-4 for Lord Macnaghten’s views. 1059 (1998) 98 ATC 4585 at 4589. Slater’s article is referred to by way of endnote #15. 1060 Brooks, N., ‘The Responsibility of Judges in Interpreting Tax Legislation’, in Cooper G. S. (ed.) 1997, Tax Avoidance and the Rule of Law, IBFD Publications, Amsterdam.
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have different meanings in different contexts, and consequently terms are transplanted
from one context to another without regard to the need to appropriately change their
meanings. In tax law in particular, Brooks avers that courts ‘routinely commit the one-
word, one-meaning fallacy.’1061
The question arises whether the same fallacious reasoning may be detected in the
courts (and in respect of other parties such as taxation offices and commentators)
concerning the meaning of goodwill in different contexts, including different areas of
law and in accounting as opposed to law. It may be proposed, for example, that the
meaning of goodwill in a passing-off case is different from that in a taxation case
because different issues concerning the concept of goodwill are in question. In
Conagra Inc v. McCain Foods (Aust) Pty Ltd,1062 a case considered in chapter 9,
Lockhart J alluded to this issue in advocating for the purposes of passing-off that the
notion of business reputation should be used rather than goodwill, so that ‘the law of
passing off is not trammelled by definitions of goodwill developed in the field of
revenue law’.1063 Similarly, in the same case, Gummow J said ‘caution is necessary
against importing into this field observations made elsewhere as to the nature of
“goodwill”’.1064 Thus, in passing-off, goodwill may be viewed as a cipher for the
business damaged – this is, goodwill may be considered the essential notion of that
attractive force which brings in custom. In contrast, in a taxation case, it will normally
be the value of the goodwill that is of importance, rather than its essential nature.
Nonetheless, these different views of goodwill do not necessarily mean that distinctly
different concepts are at play; in each case it may be argued that it is the same
essential concept of goodwill involved, but looked at from different angles for
different purposes. This argument invokes the multi-faceted idea of goodwill
discussed above.
1061 Id at 123. This view may arguably be taken to support a case for a specialist taxation court to ensure consistency of interpretation of the taxation statutes. Kirby J reported that he was lobbied on this point at a tax conference he attended: see Kirby, M., ‘Hubris contained: why a separate Australian Tax Court should be rejected’, (2007) 42(3) Taxation in Australia 161. Kirby J rejected this proposal, being of the opinion that tax statutes should be interpreted like any other statute, with reference to other areas of the law where necessary, to ascertain the intention of parliament. See also his comments in FCT v. Ryan (2000) 201 CLR 109 at 146 (which were referred to in the above article). 1062 (1992) 23 IPR 193. 1063 Id at 232. 1064 Id at 258.
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In Murry the majority recognized this issue of different contexts in discussing reasons
for the difficulty of defining goodwill. They stated:
… courts have been called on to define and identify goodwill in greatly differing
contexts. In some cases, the nature of goodwill as property may be the focus of the legal
enquiry. In other cases, the value of the goodwill of a business may be the focus of the
enquiry. And in still other cases, identifying the sources or elements of goodwill may be
the focus of the enquiry. It is unsurprising that in these varied situations courts have
defined goodwill in ways that, although appropriate enough in one situation, are
inadequate in other situations.1065
These issues tend to support the concept of goodwill as multi-faceted, with different
facets or meanings to be applied in different contexts as appropriate. Thus the
fallacious approach argued by Brooks could have the potential to apply in contexts
where different concepts of goodwill may be relevant and, moreover, it offers an
interesting point of view. But evidence for this fallacy having been committed in the
broad field of goodwill is not readily apparent. Generally, errors, particularly in law,
have resulted from not understanding the essential concept of goodwill as one whole
item of personal property, separate from its sources within the business but
inseparable from the business itself. At its core, this essential legal concept is also the
essential accounting concept – there is nothing in their understanding or treatment
which disturbs this core similarity.
15.10 The final word
It must be concluded that the legal and accounting concepts of goodwill are essentially
the one concept. Fundamentally, both law and accounting recognize goodwill as an
item of property and an asset, a commercial concept connected with a business.
Moreover, the early accounting definitions of goodwill, as discussed in chapter 13,
reveal a close affinity with the legal concept as the parent of the accounting concept.
This affinity may be taken to exist to this day. While law may perceive goodwill more
as an attraction for custom of the business and accounting may be more concerned
with its value and treatment in the accounts, these are no more than different aspects
of the same thing. However, in different contexts, the various legal contexts and the
1065 (1998) 98 ATC 4585 at 4589.
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accounting context, different aspects or facets of goodwill may be focused on or
emphasized.
Certain differences between the concepts, constituting different facets, do not make a
cogent case for different concepts which necessarily defy synthesis as proposed by the
High Court. For example, the fact that internally generated goodwill is not specifically
recognized in accounts does not mean that it does not exist for accounting – it only
means that its formal recognition will arise on sale of the business when an objective
cost can be assigned to it by the purchaser. Internally generated goodwill, while not
specifically recognized for accounting, may of course influence the impairment write-
downs of goodwill in the balance sheet as noted in chapter 14. Thus it may reasonably
be argued that internally generated goodwill is also a part of accounting as it is of law.
Furthermore, the other differences in focus and emphasis discussed in various parts of
this paper do not, it is submitted, support a conclusion that these are concepts so
different that they cannot be synthesised if required. Regardless of these differences,
the essential feature of goodwill as a business asset remains at the core of the concept
in both disciplines.
What emerges from an examination of goodwill in its various contexts is a compound
concept wherein a particular aspect or facet may be focused on according to specific
requirements of the relevant context. Focusing on different aspects in this way does
not mean that there are fundamentally different concepts at play. Goodwill may be
perceived as the one whole regardless of context, thereby rendering the need to
achieve a synthesis redundant.
15.11 Areas for further research
The scope of this paper has been confined to Australia and England, with occasional
references to the USA for comparative purposes. The reason is that the aim of the
paper was to examine the evolution of goodwill from the Australian viewpoint, based
necessarily on English authorities.
As a consequence, there is scope for further research into goodwill, particularly as a
legal concept, in other common law jurisdictions (or civil law jurisdictions for that
matter). Of particular interest would be an examination of goodwill in the USA and a
301
comparison made with Australia, and England. There is evidence of similar issues in
the USA to those in Australia and England.
302
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307
Tallerman v. Dowsing Radiant Heat Company [1900] Ch 1 (CA). Taylor v. Neate (1888) 39 Ch D 538. The Collins Company v. Brown (1857) 3 K & J 423; 69 ER 1174. The Singer Manufacturing Company v. Loong (1882) 8 App Cas 15 (HL). The West London Syndicate Limited v. CIR [1897] 1 QB 226. The West London Syndicate Limited v. CIR [1898] 2 QB 507 (CA). Thornbury v. Bevill (1842) 1 Y & CCC 554; 62 ER 1014. Thorneloe v. Hill [1892] 1 Ch 569. Thornton v. Dixon (1791) 3 Bro CC 199; 29 ER 488. Thynne v. Shove (1890) 45 Ch D 577. Tooth & Co Ltd v. CSD (1909) 9 NSWSR 652. Townsend v. Jarman [1900] 2 Ch 698. Trego v. Hunt [1895] AC 7. Truax v. Corrigan, 257 US 312 (1921). Turner v. Evans (1852) 2 De G M & G 740; 42 ER 1061. Turner v. General Motors (Australia) Pty Ltd (1929) 42 CLR 352. Turner v. Major (1862) 3 Giff 442; 66 ER 483. Typing Centre of NSW Pty Ltd v. Northern Business College Ltd (1989) ATPR 40-943. United Builders Pty Ltd v. Mutual Acceptance Ltd (1980) 144 CLR 673. Verner v.General and Commercial Investments Trust Ltd [1894] 2 Ch 239; 63 LJ Ch 456. Wade v. Jenkins (1860) 2 Giff 509; 66 ER 214. Walker & Co v. Appleton & Co (1838) (reported in the Sydney Herald of 17 September 1838). Walker v. Mottram (1881) 19 Ch D 355. Webster v. Webster (1791) 3 Swans 493; 36 ER 949. Westpac Banking Corporation v. CSD(Qld) 2004 ATC 4135; [2003] QSC 483. Wedderburn v. Wedderburn (1856) 22 Beav 84; 52 ER 1039. Whiteman Smith Motor Company Limited v. Chaplin [1934] 2 KB 35. Williams v. Williams (1818) 2 Swans 253; 36 ER 612. Wilmer v. McNamara & Co Limited [1895] 2 Ch 245. Wood v. Griffith (1818) 1 Wils Ch 35; 37 ER 16. Worral v. Hand (1791) Peak NP 105; 170 ER 95. Zeekap (No 56) Pty Ltd v. CSD(Tas) (1999) 99 ATC 4745; 42 ATR 295.
308
TABLE OF STATUTES A New Tax System (Goods and Services Tax) Act 1999 (Cth). Australian Securities Commission Act 1989 (Cth). Australian Securities and Investments Commission Act 1989 (Cth). Australian Securities and Investments Commission Act 2001 (Cth). Bankruptcy Act 1966 (Cth). Companies Act 1981(Cth). Corporate Law Economic Reform Program Act 1999 (Cth). Corporations Act 2001 (Cth). Family Law Act 1975 (Cth). Income Tax Assessment Act 1936 (Cth). Income Tax Assessment Act 1997 (Cth). Lands Acquisition Act 1906 (Cth). New International Tax Arrangements (Participation Exemption and Other Measures)
Act 2004 (Cth). Taxation Laws Amendment Act (No 5) 2002 (Cth). Tax Laws Amendment (2006 Measures No 1) Act 2006 (Cth). Petroleum Retail Marketing Franchise Act 1980 (Cth). Seat of Government Act 1909 (Cth). Partnership Act 1892 (NSW). Stamp Duties Act 1898 (NSW). Stamp Duties Act 1920 (NSW). Duties Act 1997 (NSW). Partnership Act 1958 (Vic). Stamps Act 1958 (Vic). Duties Act 2000 (Vic). Partnership Act 1891 (Qld). Stamp Act 1894 (Qld). Duties Act 2001 (Qld). Duties Act 2001 (Tas). Partnership Act 1891 (Tas). Duties Act 2008 (WA). Partnership Act 1895 (WA). Liquor Licensing Act 1985 (SA). Partnership Act1891 (SA). Stamp Duties Act 1923 (SA). Partnership Act 1997 (NT). Stamp Duty Act 1978 (NT). Partnership Act 1963 (ACT). Duties Act 1999 (ACT). Companies Act, 1929 (UK). Land Clauses Act, 1845 (UK). Landlord and Tenant Act, 1927 (UK). Larceny Act, 1861 (UK). Partnership Act, 1890 (UK). Railways Clauses Consolidation Act, 1845 (UK). Stamp Act, 1765. Stamp Act, 1870 (UK).
309
Stamp Act, 1891(UK). Trade Marks Registration Act, 1875 (UK). 22 and 23 Charles II, c 9 (1671). 5 and 5 William and Mary, c 21 (1694). 22 Geo II, c 46. 41 Geo III, c 76. 48 Geo III, c 149 (1808). Uniform Partnership Act (US).
310
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Accounting Standards and Statements
AAS 18 Accounting for Goodwill. AASB 1010 Recoverable Amount of Non-Current Assets. AASB 1013 Accounting for Goodwill. AASB 3 Business Combinations. AASB 8 Operating Segments. AASB 136 Impairment of Assets. AASB 138 Intangible Assets. Statement of Accounting Concepts (Number 4) Definition and Recognition of the
Elements of Financial Statements (‘SAC 4’). Framework for the Preparation and Presentation of Financial Statements issued by the AASB in July 2004. ATO Taxation Rulings
Goods and Services Tax Ruling GSTR 2002/5. Taxation Determination TD 93/86. Taxation Determination TD 2007/1. Taxation Determination TD 2007/27. Taxation Ruling IT 2328. Taxation Ruling TR 1999/9. Taxation Ruling TR 1999/16. Taxation Ruling TR 1999/16A – Addendum. Taxation Ruling TR 2004/11. Taxation Ruling TR 2004/13. Taxation Ruling TR 2005/17.
322
ATO Interpretative Decisions ID 2002/248. ID 2006/17. ID 2006/181. ID 2007/93. ID 2007/111.
ATO Decision Impact Statement Debonne Holdings Pty Ltd v. FCT 2006 ATC 2467; [2006] AATA 886 re GSTR 2002/5.
ATO Consultative Document
Pre-Ruling Consultative Document PCD 8 Capital Gains: Goodwill.
Manuals
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Franchising Task Force Final Report, Better Printing Service, Queanbeyan NSW, December 1991.
Franchising – Australia and Abroad, Supplement to the Franchising Task Force Final
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Review of Business Taxation, A Tax System Redesigned, Report, July 1999.
Miscellaneous
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HMRC: Practice Note ‘Apportioning the Price Paid for a Business Transferred as a Going Concern’, 30 January 2009.
Discussion Paper: ‘Post-implementation Review into Certain Aspects of the Consolidation Regime’, Board of Taxation, December 2009.
The Lounger, No. 79, Sat 5 Aug 1786 (periodical article).
International Valuation Standards Council, ‘Valuation of Intangible Assets,’ Guidance Note 4, Feb 2010.
