Private ruling: CGT connected entity and the active asset test
Date of advice: 25 February 2016
Published: April 2016
Ruling period: Year ending 30 June 2016 | Year ending 30 June 2017 | Year ending 30 June 2018
Date scheme commenced: 1 July 2015

Ruling: Q1: Is the trust connected with you under section 328-125 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Is the building an active asset as defined under section 152-40 of the ITAA 1997? | A2: Yes | Q3: Does the building meet the active asset test under section 152-35 of the ITAA 1997? | A3: Yes


Relevant legislative provisions: Income Tax Assessment Act 1997 Section 152-35 | Income Tax Assessment Act 1997 Section 152-40 | Income Tax Assessment Act 1997 Section 328-125

Reasons for decision: Summary: Subsection 328-125(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states an entity is connected with another entity if: • either entity controls the other entity, or • both entities are controlled by the same third entity. | Detailed Reasoning - Direct control of a discretionary trust: Subsection 328-125(3) of the ITAA 1997 states an entity (the first entity) controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its affiliates, or the first entity together with its affiliates. In this case the corporate trustee of the trust is owned by two shareholders. They are also the directors of the corporate trustee. The corporate trustee could reasonably be expected to act in accordance with the directions or wishes of both the shareholders. It therefore follows that the shareholders control the trust through the corporate trustee. As both the shareholders control the trust, via the corporate trustee, the trust is connected to both shareholders. | Detailed Reasoning - Question 2: Section 152-40 of the ITAA 1997 discusses the meaning of "active asset". Subsection 152-40(1) of the ITAA 1997 in part states a CGT asset is an active asset at a time, if at that time 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 another entity that is connected with you. Subsection 152-40(4) of the ITAA 1997 discusses the situation where CGT assets cannot be active assets. Subparagraph 152-40(4)(e)(ii) of the ITAA 1997 outlines one of those situations where an asset whose main use by you is to derive interest, an annuity, rent, royalties or foreign exchange gains unless its main use for deriving rent was only temporary. Where an asset is used partly for business and partly to derive rent, it will be a question of fact dependent on all the circumstances of the case as to whether the main use of the premises is to derive rent. No one single factor will necessarily be determinative and resolving the matter is likely to involve a consideration of a range of factors such as: (a) The comparative areas of use of the premises (between rent and business) (b) The comparative times of use of the premises (between rent and business) (c) The comparative levels of income derived from the different uses of the asset. In your case the area of the building was used almost half for business use and just over half for rental purposes. A vast majority of the total income was derived from the business and a small minority was derived from renting part of the property out. Even though a larger area has been let than was used for business purposes the vast majority of total income derived was from the business activities and not from renting out areas. As a significant area of the building has been used in carrying on the business and the majority of income has been derived from the business it is considered that the main use of the building was not to derive rent but for business purposes and accordingly the building is not excluded from being an active asset. As you own the building and it is used in the course of carrying on a business that is carried on by the trust which is connected with you the building is considered an active asset. | Detailed Reasoning - Question 3: Section 152-35 of the ITAA 1997 discusses the active asset test. Paragraph 152-35(1)(b) of the ITAA 1997 states a CGT asset satisfies the active asset test if 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 71/2 years during the period specified in subsection (2). Subsection 152-35(2) of the ITAA 1997 states 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 to be carried on in the 12 months before that time or any longer period that the Commissioner allows - the cessation of the business. In this case you constructed a new building. The business run by the trust has operated from that building for many years. As you both have owned the building for more than 15 years and it has been an active asset for more than 71/2 years during that period the building has passed the active asset test.

Relevant facts: You purchased a property. | At that time the property consisted of land and a building. | The property was let at arms-length. | The tenant vacated the premises at which time the trust moved in and began to operate the business. | You obtained financing from a financial institution in order to build a new, separate building on the block. With the loan from the financial institution you constructed a new building. | The construction of the building created a separate CGT asset from the land, which was acquired prior to the introduction of CGT. Once the construction of the new building was completed, the old building was demolished and the business moved in to the new building. | The trustee of the trust is a company in which you and your spouse own all the shares and are the directors. | Since the completion of the new building its main use has been to the business. Any lettable area surplus to the business needs has been let on a commercial arms-length basis to other tenants. | Since the completion of the area of the building it has been used less for business use and more for rental purposes. However, the vast majority of the total income has been derived as part of the business and a small minority was derived from renting part of the property out.