Private ruling: Capital gains tax-active asset
Date of advice: 4 December 2015
Published: February 2016
Ruling period: Year ended 30 June 2013 | Year ended 30 June 20XX
Date scheme commenced: 1 July 2012.

Ruling: Q1: Is the property you disposed of considered to be an active asset under section 152-40 of the ITAA 1997 for the purposes of the CGT small business concessions? | A1: No.


Relevant legislative provisions: Income Tax Assessment Act 1997 Division 152 | Income Tax Assessment Act 1997 subsection 152-10(1) | Income Tax Assessment Act 1997 subsection 152-10(1A) | Income Tax Assessment Act 1997 section 152-15 | Income Tax Assessment Act 1997 section 152-35 | Income Tax Assessment Act 1997 subsection 152-40(1) | Income Tax Assessment Act 1997 subsection 152-40(4) | Income Tax Assessment Act 1997 paragraph 152-40(1)(a) | Income Tax Assessment Act 1997 paragraph 152-40(4)(e) | Income Tax Assessment Act 1997 Subdivision 152-E | Income Tax Assessment Act 1997 section 995-1

Reasons for decision: Summary: The conditions that must be met in order to obtain the small business rollover relief are set out in Subdivision 152-E of the ITAA 1997. However, before the small business rollover relief can be examined you must firstly satisfy the basic conditions for the small business CGT concessions found in Subdivision 152A of the ITAA 1997. The small business CGT concessions are dealt with in Division 152 of the ITAA 1997. Subsection 152-10(1) of the ITAA 1997 contains the following basic conditions to be satisfied: (a) a CGT event happens in relation to a CGT asset of yours in an income year. This condition does not apply in the case of CGT event D1. (b) the event would (apart from Division 152 of the ITAA 1997) have resulted in the gain (c) at least one of the following applies: (i) you are a small business entity for the income year (ii) you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997 (iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership (iv) the conditions in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year (d) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997. All of these basic conditions need to be satisfied for you to qualify for the small business CGT concessions. Some concessions also require that other conditions be satisfied. In your circumstances, it is necessary to examine if the property will satisfy the active asset test. | Detailed Reasoning - Definition of active asset: For a CGT asset of a business to be an active asset for the purposes of Division 152 of the ITAA 1997 it must firstly satisfy one of the 'positive tests' in subsection 152-40(1) of the ITAA 1997 and then also not be excluded by one of the exceptions in subsection 152-40(4) of the ITAA 1997. Under paragraph 152-40(1)(a) of the ITAA 1997, a CGT asset is an active asset 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. However, paragraph 152-40(4)(e) of the ITAA 1997 provides that an asset whose main use is to derive rent cannot be an active asset unless such use was only temporary. That is, even if the asset is used in a business it will not be an active asset if its main use is to derive rent. | Detailed Reasoning - Carrying on a business: Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'. Normally the receipt of income from the letting of property to a tenant(s) does not amount to the carrying on of a business ( Wertman v. Minister of National Revenue (1964) 64 DTC 5158; Federal Commissioner of Taxation v. McDonald (1987) 15 FCR 172; 87 ATC 4541; 18 ATR 957 ( McDonald's Case ); Cripps v. FC of T 99 ATC 2428 ( Cripps' Case ); Case X48 90 ATC 384; (1990) 21 ATR 3389). Whether the letting of property amounts to the carrying on of a business will depend on the circumstances of each case, ( Californian Copper Syndicate (Limited and Reduced) v. Harris (1904) 5 TC 159). Generally, it is easier for a company that derives income from the letting of property to show that it carries on a business than it is for an individual (paragraph 3 of Taxation Ruling IT 2423). A person who simply co-owns an investment property or several investment properties is usually regarded as an investor who is not carrying on a rental property business, either alone or with other co-owners. This is because of the limited scope of the rental property activities and the limited degree to which a co-owner actively participates in rental property activities. A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations. If rent was derived from a number of properties or from a block of apartments, that may indicate the existence of a business (paragraph 5 of Taxation Ruling IT 2423). In McDonald's case , the taxpayer and his wife purchased several income producing properties. In considering whether a business was being carried on, the Federal Court considered the level of active participation by the parties. It was considered that this was not a case of the active joint participation by the parties in a business activity, as the investment involved little, if any, active participation from either party. Rather, it was a case of renting out of premises without the provision of other services. In Case G10 75 ATC 33 ( Case G10 ), the taxpayer owned two properties of which six units were let as holiday flats for short term rental. The taxpayer, with assistance from his wife, managed and maintained the flats. Services included providing furniture, blankets, crockery, cutlery, pots and pans, hiring linen and laundering of blankets and bedspreads. The taxpayer also showed visiting inquirers over the premises, attended to the cleaning of the flats on a daily basis, mowing and trimming of lawns, and various other repairs and maintenance. The taxpayer's task in managing the flats was a seven day a week activity. The Board of Review held that the activity constituted the carrying on of a business. The general indicators of a business, as used by the Courts, are described in Taxation Ruling TR 97/11 which summarises these indicators. The question of whether a business is being carried on is a question of fact and degree. In the Commissioner's view, the factors that are considered important in determining the question of business activity are: • whether the activity has a significant commercial purpose or character • whether the taxpayer has more than just an intention to engage in business • whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity • whether there is regularity and repetition of the activity • whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business • whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit • the size, scale and permanency of the activity, and • whether the activity is better described as a hobby, a form of recreation or sporting activity. Whether a business is being carried on depends on the large or general impression gained ( Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548) from looking at all the indicators of carrying on a business, and no one indicator will be decisive ( Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). | Detailed Reasoning - Holiday letting activity: As shown in the legal cases and the views of the Commissioner listed above, the indicators with the greatest weighting are the scale or volume of operations, repetition and regularity of the activities and the level of services provided in addition to the letting of the unit and the other indicator noted above. Significant commercial purpose The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators. You purchased a unit for short term holiday accommodation which was sold in July 20XX. The guests stayed for periods ranging from four nights to three weeks. In some aspects, your activity is similar to that of a commercial operator such as: advertising, booking, cleaning, paying accounts. However, you only have one unit as opposed to the taxpayer in Case G10 who operated 2 properties with a total of six units. Intention of the taxpayer You purchased the property and renovated the property with the intention to let the unit as a holiday rental. You had sought advice in relation to undertaking the activity. You have invested capital into the activity. Prospect of profits The taxpayer's involvement in the business activity should be motivated by wanting to make a tax profit and the taxpayer's activities should be conducted in a way that facilitates this. This will require examining whether objectively there is a real prospect of making such a profit from participating in the business of the taxpayer. You had undertaking research into the profitability of the activity. You have stated that you have a high occupancy rate. However, your analysis had not taken into account the effects of other holiday accommodation operator's lower off-season pricing strategies. While your intention was to make a profit, the activity ceased when it was apparent the activity was making a loss. Repetition and regularity Frequent and regular transactions are the usual feature of business operations. Turnover is maximised if the processes are repeated over a long period. Frequent activity does not necessarily mean a business is carried on but it will support this argument ( FC of T v. Radnor 91 ATC 4689; 22 ATR 344). Regularity, frequency and duration of the activity are considered to be important factors in determining if a business is being carried on. In Inglis v. FC of T 80 ATC 4001 Brennan J, at 4005, said that 'At the end of the day the extent of activity determines whether the business is being carried on'. The daily management of the properties is undertaken by you. Your current level of activity is limited to the bookings, enquiries, paying bills and engaging a cleaner and engaged a person to pick-up guests. You spend on average one to two hours a day on this activity Activities of the same kind and carried on in a similar manner to those of the ordinary trade in that line of business If a taxpayer carries out their activity in a manner similar to other taxpayers in the industry, it is more likely that their activity amounts to the carrying on of a business. That is, the taxpayer's operations are of the same kind and carried on in the same way as those characteristic of ordinary trading in that particular line of business ( IR Commissioners v. Livingston 11 TC 538). This indicator requires a comparison between the activities of the taxpayer in question and those undertaken by a person in business in the same type of industry. Where the taxpayer's activities are similar in nature to the business, further support is given to the fact that a business exists. Your unit is not rented out on a long term residential basis but was used for short term accommodation generally for a few days to few weeks. The services provided are similar to those noted in Case G10 . However, your level of active involvement in relation the unit is significantly less than those noted in G10 when compared to the taxpayer's in Case G10 as their activity involved a significant amount of their time devoted to the holiday letting activity of two properties with six units. For example the cleaning of each flat on the average required two people each working for two hours. Other work the taxpayer had undertaken was the cleaning and maintenance of the garages and laundry and storage room. The taxpayer task in managing and maintaining the flats was, as he said, a "seven day a week job". In your case, you spent a few hours a day on this activity. Some aspects your holiday letting activity are similar to that of a commercial operator for example providing a number of services such as booking service, fielding enquiries from customers and providing other amenities such as pay TV, linen, a cleaner and a service for picking up the guests. Organisation in a business-like manner, the keeping of books, records and the use of a system The activities conducted by, or on behalf of the taxpayer, should be carried out in a systematic and organised manner. This will usually involve matters such as the keeping of appropriate business records by the taxpayer. If the activities are carried out on the taxpayer's behalf by someone else, there should be regular reports provided to the taxpayer on the results of those activities. You keep records for this activity. The size and scale of the activity The larger the scale of the activity the more likely it is that the taxpayer is carrying on a business. This is not conclusive and a person may carry on a business in a small way ( Thomas v. FC of T 72 ATC 4094; 3 ATR 165). In contrast to Case G10 the scale and the size of your activity is small as you have one holiday unit available for letting. Another occupation You commenced employment with your employer in January 20XX. Hobby or recreation The activity does not have the nature of a hobby or recreational pursuit. The nature of your activity is similar to other property owner who are involved holiday letting. Conclusion In your case, you jointly own one short term holiday rental. You undertook research into the activity before the purchasing the property. Your intention was to make a profit from letting the unit. However, the activity has ceased due to the activity continuing to run at a loss. Some aspects of your holiday letting activity are similar to that of a commercial operator for example providing a number of services such as bookings, fielding enquiries from customers and providing other amenities such as TV, linen, a cleaner and a service for picking up the guests. From the information provided you generally only service the property when clients leave and as most clients stay for several days to a number of weeks and as a result you are not servicing the unit daily as you only the one unit. Your level of personal involvement in providing some services is significantly less than that noted in Case G10. The size and scale of activity and volume of operation in the activity is not as great as that noted in Case G10. Based on the information you have provided your activity is similar to other property owners who let a property for income; however, your activity is not conducted on a sufficient scale to be considered a business. The finding that your activity is not a business does not change whether or not income from this activity is assessable or the expenses are deductible. As a business is not being carried on the property does not qualify as an active asset and you do not qualify for the small business CGT rollover concessions.

Relevant facts: You and your spouse resided in an overseas country prior to moving to Australia. | You and your spouse jointly purchased a unit. | Your finance for the purchase of the unit was through a financial institution. | Your intention was to offer the unit for short term holiday rental and to make a profit from the activity. | You renovated the unit shortly after purchasing it. | You conducted research into the letting of holiday properties by seeking advice from another operator of a holiday unit. | You conducted research into the profitability of the activity; however, your analysis did not take into account the effects of the lower letting prices offered in the off-season by other holiday unit and apartment operators. | The unit was let for a few nights minimum booking period with a maximum booking period of a few weeks. The guests did not have exclusive possession of the unit only a right to occupy the unit on certain conditions. | All guests stayed short term during the period of ownership. | You did not enter into any lease agreements with the guests. | You believe the relationship was not that of a landlord/tenant under a leasing arrangement. | Bookings were made throughout the year. The rate charge was largely dependent on the periods | throughout the year (such as school holidays, public holidays, etc.) | The occupancy rate was high over the period of ownership. | You returned net rent losses from holiday accommodation activity in your tax returns. | You undertook the following activities in relation to letting the property: | • managed all the bookings | • fielded enquiries from customers | • receiving deposits, final payments and issued refunds | • paid the bill such as body corporate fees, rates , insurance and other utilities bills | • engaged a person to meet the guests upon arrival | • arranged for a cleaner to clean the unit when the guests departed | • engaged contractors to complete repairs | You provided the following amenities: | • telephone and internet services. | The property is advertised on a number of websites. | You spent a few hours a day on the activity. | You used a section of your residence as a home office to carrying out the letting activity. | You kept bank statements and a record of the guests who stayed in the unit. | You sold the unit when it was apparent the activity was continuing to run at a loss. | You made a capital gain on the sale of the unit.