Goodwill is what makes a business more than just a collection of assets.

Goodwill has a number of related meanings, including:

• the ability of the business to make a profit;

• the additional value a business has, beyond the individual property assets of the business;

• the reputation of the business or staff; and

• the likelihood of continuing customer support of the business.

Goodwill, in this context, is best defined as the value of a business, so far as that value exceeds the value of the independent assets. However, it is not an item of property in the usual sense of that term, as it does not exist and cannot be owned, bought or sold otherwise than as part of the other property that makes up the business.

A contract for sale of business always states that what is sold includes goodwill. However, as goodwill is not property in the usual sense of the term, when a contract says that it is selling goodwill, what it really means is that it is providing the purchaser with the means to use the collection of other assets being sold to make a profit.

This is achieved by transferring title to the assets of the business to the purchaser, along with contractual covenants not to interfere with the purchasers’ ability to use those assets to run the business.

These covenants are restraint provisions, which state that the vendor shall not directly or indirectly be involved in competing with the business. Restraint provisions typically prevent a purchaser from:

• providing competing goods or services to customers;

• poaching staff; and

• dealing with key suppliers.

A restraint clause which is an unreasonable restraint on the ability of the vendor to trade will be unenforceable. Accordingly, the clauses should be drafted so that they:

• are broad enough to protect the goodwill of the business;

• are not so broad as to be unenforceable;

• they are drafted so as to prevent the vendor from running a competing business through any other entity; and

• they are clear enough to be able to be enforced, without arguments as to precisely what conduct is prohibited, in what geographical location and for what period of time.

The courts will strike out any restraints that are too wide, but will leave the remaining provisions, if they still make sense and are not too wide. For this reason, it is common to have cascading restraints, whereby there are several alternative time periods and geographical areas. For example, a vendor of a business based in Sydney may be restrained from operating a competing business:

• In Australia;

• in NSW; and

• within 50km of the head office of the business.

If the first and second alternatives were too wide to be enforced, the third provision would still be binding.

Having cascading provisions for time, geographical area, and the types of business restrained can lead to multiple combinations of prohibitions. This is acceptable and enforceable, provided that the number of combinations is not so great as to make the provisions void for uncertainty.

See Goodwill and restraint clauses.

The fact that goodwill is not property as that term is generally used does not cause the taxation legislation any hesitation in taxing it. However, it is excluded from the depreciation provisions, which means that a business owner can claim no deduction in respect of depreciation of goodwill. There can be a difference of treatment of taxation of goodwill compared with tax on consideration for a restraint, especially if goodwill is pre-CGT. The relevant provisions are as follows:

Goodwill is included as a “CGT asset” under s 108-5 of the Income Tax Assessment Act 1997 (Cth).

Section 9-10 of A New Tax System (Goods and Services Tax) Act 1999 (Cth) defines “supply” so as to include goodwill.

Section 40-30 of the Income Tax Assessment Act 1997 (Cth) defines “depreciable asset” in such a way as to exclude goodwill.

See Tax considerations.