Private ruling: CGT - Small business concessions - active asset test
Published: October 2014
Ruling period: Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Are your rental properties able to be considered active assets for the purposes of the small business capital gains tax (CGT) concessions? | A1: 

Relevant facts and circumstances: You refurbished and sold rental property in 20XX. The proceeds from the sale of this property, was used to purchase another property a few months later. You started your business by buying a property, and gradually adding more properties to your portfolio over time, in order to grow your business and increase its asset base. You have gradually sold and purchased more properties over the years. You have been working to grow your real estate business by increasing your asset holdings. You do this by selling for profit when the market dictates, and then reinvesting the funds in the business. You employed a number of estate agents in different localities this year to collect your rents, this is the only part of the business function that you aren't involved in. You manage your own properties, employ trades when necessary and take a, hands on approach, attending to most of the maintenance yourself. You play an active role in refurbishing the properties and running your business.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 152-35 , | Income Tax Assessment Act 1997 Subsection 152-40 , | Income Tax Assessment Act 1997 Subsection 152-40(1) and | Income Tax Assessment Act 1997 Paragraph 152-40(4)(e) .

Reasons for decision: Summary: To access the small business capital gains tax (CGT) concessions in Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997), an entity must first satisfy the basic conditions in section 152-10 of the ITAA 1997. One of the basic conditions requires the relevant CGT asset to satisfy the active asset test in section 152-35 of the ITAA 1997. The meaning of an active asset is provided in subsection 152-40(1) of the ITAA 1997, which states: (1) A CGT asset is an active asset at a time if, at that time: (a) you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a business that is carried on (whether alone or in partnership) by: (i) you; or (ii) your affiliate; or (iii) another entity that is connected with you; or (b) if the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you. Certain assets are, however, excluded from being active assets under subsection 152-40(4) of the ITAA 1997. An asset whose main use is to derive rent (unless such use was only temporary) is excluded from being an active asset. Such assets are excluded even if they are used in the course of carrying on a business. Example 1 in Taxation Determination TD 2006/78 deals with commercial rental properties: Commercial Property Co owns 5 commercial rental properties. The properties have been leased for several years under formal lease agreements to various commercial tenants which have used them for office and warehouse purposes. The terms of the leases have ranged from 1 year to 3 years with a 3 year option and provide for exclusive possession. The company has not engaged a real estate agent to act on its behalf and manages the leasing of the properties itself. In this situation, the company has derived rental income from the leasing of a number of properties. Accordingly, the main (only) use of the properties is to derive rent and they are therefore excluded from being active assets under paragraph 152-40(4)(e) of the ITAA 1997 regardless of whether the activities constitute the carrying on of a business. The Advanced guide to capital gains tax concessions for small business 2012-13 (NAT 3359) states that the term 'rent' has been described as referring to the payments made by a tenant or lessee to a landlord or lessor for exclusive possession of the leased premises. As such, a key factor in determining whether an occupant of premises is a lessee paying rent is whether the occupier has a right to exclusive possession. If, for example, premises are leased to a tenant under a lease agreement granting exclusive possession, the payments involved are likely to be rent and the premises are not an active asset. On the other hand, if the arrangement allows the person only to enter and use the premises for certain purposes and does not amount to a lease granting exclusive possession, the payments involved are not likely to be rent. The Advanced Guide gives the following example: Rachael owns five investment properties which she rents to tenants under lease agreements that grant exclusive possession. The lease terms vary from six months to two years. The properties are not active assets because they are mainly (only) used by Rachael to derive rent. It is irrelevant whether Rachael's activities constitute a business. In your case, you are carrying on a business of residential property investment, investing, refurbishing, maintaining and renting out your properties. This situation is similar to the above examples. Whilst it is appreciated that you have made considered and educated decisions in the investments and maintenance of the properties, the fact remains that your tenants have right to exclusive possession for the term of their lease, therefore it is considered that the main or only use of the properties is to derive rent. Therefore, the properties are excluded from being active assets under paragraph 152-40(4)(e). This is regardless of the fact that your activities amount to the carrying on of a business. Accordingly, as the properties cannot pass the active asset test under section 152-35 of the ITAA 1997, you will not be able to access any of the small business CGT concessions in relation to the sale of your properties.