Private ruling: Active asset test
Date of advice: 9 March 2017
Published: August 2017
Ruling period: Year ended 30 June 2016
Date scheme commenced: 1 July 2015

Ruling: Q1: Is unit A an active asset for the purpose of section 152-35 and section 152-40 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: You purchased Unit A (Unit A) in 20AA. At this time you also purchased Unit B. The cost of Unit A was approximately $XXXX. Unit A has a total floor area of XXX square metres. You have leased Unit A and Unit B to ABC Pty Ltd (ABC) from 20AA to 20BB. ABC carried on a business in both units until 20BB. ABC used all of Unit B and XX% of Unit A to carry on its business and the remainder of Unit A was used to carry on the other business. In 20BB ABC sold its business. At this time you continued to lease all of Unit B and it was no longer available for ABC to use in its business. During the 20BB financial year XYZ Pty Ltd as trustee for the BDE Trust (BDE) commenced carrying on the business that was formerly carried on by ABC. It continued to operate this business until it was sold in 20CC. BDE was established in 19AA and is a discretionary trust. You and your spouse are beneficiaries of BDE and you have received equal distributions of income and capital from BDE since BDE commenced carrying on the business of FGH except in the 20DD financial year where you received no distributions. The trustee of BDE has nominated you and your spouse as nominated beneficiaries for each that BDE has a loss or no net income. ABC has X million shares on issue and has paid up capital of $XX. All shares have been held by XYZ as trustee for BDE since the company was incorporated. You have been the director and secretary of ABC since 20FF. The business carried on by BDE was named FGH to distinguish it from the business formerly carried on by ABC. The business carried on by both ABC and FGH were providing services. The relevant practitioners were health specialists who provided a range of services that rented the professional offices in Unit A. ABC and FGH provided substantial services to the practitioners, in addition to providing those professionals with professional office space. To enable BDE to carry on their business it commenced leasing Unit A from you. They used approximately XX% of the space leaving the remaining empty. In the 20DD financial year the empty portion of Unit A was leased to a specific business to enable them to expand their business. During the time the business was operated by BDE you were engaged to provide professional healthcare services to its clients. Over the period that Unit A was used by BDE a number of income earning activities were undertaken, including both rental and business income. In 20LL a contract was signed for the sale of the Property and the business FGH for $XX million. Settlement occurred in late 20LL.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 152-35 | Income Tax Assessment Act 1997 paragraph 152-40(4)(e) | Income Tax Assessment Act 1997 section 152-40 | Income Tax Assessment Act 1997 section 152-78 | Income Tax Assessment Act 1997 section 328-125

Reasons for decision: Summary: The active asset test in section 152-35 of the ITAA 1997 is satisfied if: (a) you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the period detailed below or (b) you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7 ½ years during the period detailed below: The period: (a) begins when you acquired the asset and (b) ends at the earlier of: (i) the CGT event and (ii) if the relevant business ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows) when the business ceased. In your case, you owned the Unit A for approximately XX and half years. The property has been used by a discretionary trust for business purposes for a period of X years and X months, which is over half of your ownership period. Providing the trust is connected with you, the active asset test will be satisfied. Active Asset Section 152-40 of the ITAA 1997discusses the meaning of the term 'active asset', and at subsection 152-40(1) of the ITAA 1997 states, in part, that a CGT asset is an active asset at a time if, at that time, you own the asset and it is used, or held ready for use, in the course of carrying on a business that is carried on by you or your affiliate, or another entity that is connected with you. We need to establish if the discretionary trust that used the property for business purposes is connected to you. Connected with an entity An entity is connected with another entity if: (a) either entity controls the other entity in a way described in this section; or (b) both entities are controlled in a way described in this section by the same third entity. Direct control of a discretionary trust may be established via either of two paths. Subsection 328-125(3) of the ITAA 1997 or subsection 328-125(4) of the ITAA 1997. Subsection 328-125(3) of the ITAA 1997 provides that an individual controls a discretionary trust if the trustee of that trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the individual, his/her affiliates, or the individual together with his/her affiliates. Subsection 328-125(4) of the ITAA 1997 provides, in part, that an individual directly controls a discretionary trust for an income year if, for any of the preceding four income years, the discretionary trust distributed at least 40% of any income or capital paid for that year to either the individual, the individual's affiliates, or to the individual together with any of his/her affiliates. In addition, subsection 152-78(1) of the ITAA 1997 provides that the trustee of a discretionary trust may nominate at least four beneficiaries as being controllers of the trust for an income year in which no distribution of income or capital is made if the trust had a tax loss or no net income. Mixed use of a property Paragraph 152-40(4)(e) of the ITAA 1997 states that an asset whose main use in the course of carrying on the business is to derive rent cannot be an active asset unless the main use for deriving rent was only temporary. Taxation Determination TD 2006/78 considers the active asset test and the main use to derive rent concept. Paragraph 26 of TD 2006/78 states that: If an asset is used partly for business and partly to derive rent at any given time, it will be a question of fact depended on all the circumstances as to whether the main use of the asset at that time is to derive rent. No on single factor will necessarily be determinative, and resolving the matter is likely to involve a consideration of a range of factors such as: ● the comparative areas of use of the premises (between deriving rent and other uses); and ● the comparative levels of income derived from the different uses of the asset. Example 5 considers mixed use of a property: Mick owns land on which there are a number of industrial sheds. He uses one she (45% of the land by area) to conduct a motor cycle repair business. He leases the other sheds (55% of the land by area) to unrelated third parties. The income derived from the motor cycle repair business is 80% of the total income (business plus rentals) derives from the use of the land and buildings. In determining if the main use of the land is to derive rent, it is appropriate to consider a range of factors. In this case, a substantial (although nevertheless not a majority) proportion by area of the land is used for business purposes. As well, the business proportion of the land derives the vast majority (80%) of the total income. In all the circumstances, the Tax Office considers the main use of the land in this case is not to derive rent and accordingly the land is not excluded from being an active asset by paragraph 152-40(4)(e) of the ITAA 1997. | Detailed Reasoning - Application to your circumstances: As the property was used in a business by an entity connected with you for a period of X years and X months and the main use of the asset was to not to derive rent the active asset test is satisfied. Therefore, the property will meet the requirements of section 152-35 of the ITAA 1997 and section 152-40 of the ITAA 1997.