Private ruling: Small business capital gains tax concessions
Date of advice: 11 December 2018
Published: April 2019
Ruling period: Year ended 30 June 2016
Date scheme commenced: 1 July 2015

Ruling: Q1: Does the Property satisfy the active asset test? | A1: No.

Relevant facts and circumstances: 1. The Entity Pty Limited is trustee for the Entity Family Trust (the Entity). The beneficiaries of the Entity are A and B. 2. It is your position the Entity runs a business of commercial property ownership and development or similarly the management and development of real property. Property purchases 3. The Entity purchased a number of properties: a. A vacant block of land for development. This was sold after eight years. b. A set of three shops. These were sold after four years. c. The Property, on which a business was located. 4. A related party purchased several parcels of land which it held for several years. Several lots were developed before being sold. 5. Several other properties were bought and sold through entities controlled by A and B The Property 6. After purchasing the Property, you ran the business for six months. You then leased the Property to an independent third party. From this time, you were not involved in running the motel. The lease continued to be managed in house. 7. You have provided copies of two leases in relation to the Property. a. A lease over the land and improvements (The Main Lease); and b. A lease over part of car parking area (The Carpark Lease). 8. The Main Lease had an initial period of 25 years. 9. Relevant clauses of the Main Lease include: ● The set annual rent in the first year. This will be increased in line with indexation every five years. ● The Landlord is the Entity. ● The rent includes the tenant’s proportion of rates and taxes. ● The Landlord grants the tenant the right to use and possess the property. ● The Tenant cannot sublet assign or part with possession without written consent of the Landlord. ● The Tenant is responsible for keeping the property in good repair. ● The Tenant is responsible for paying water, gas, electricity, and other utilities. ● The Landlord must give seven days’ notice to enter and inspect the Property. ● The Tenant is to keep insurance. ● The Landlord can enter to carry out structural or other required repairs. 10. The Second Lease had an initial period of five years. It contains a list of defined terms. 11. Relevant clauses of the Second Lease include: ● The Lessor is the Entity. ● ‘Base Rent’ is defined as the yearly amount being the same rate as in the Main Lease. ● The Lessee to carry out relevant repairs. ● The Lessee is entitled to quiet enjoyment and they may occupy the leased area without interruption by the Lessor. ● If someone else becomes entitled to receive the Rent, the Lessor must notify the Lessee. ● The Lessor may enter and carry out any works within the leased area. ● The Lessee cannot assign without the Lessor’s consent. Sale and access to concessions 12. A contract for the sale of the Property was entered into. 13. It is your position that the Property was an active asset, as it was used in the operations of a commercial property ownership and development business of the Entity. You believe that you are eligible to apply the small business CGT concessions in Division 152 of the ITAA 1997. 14. You say that the Property was not used to derive passive income as the asset was actively managed by the owners and provided the sole source of income for the owners. 15. Your business activity did not cease, there was simply a reduction in the number of properties being held within the group due to financial difficulty.

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

Reasons for decision: Summary: For the small business CGT concessions in Division 152 of the ITAA 1997 to apply to reduce or disregard a capital gain on the disposal of a CGT asset, the relevant CGT asset must, among other requirements, satisfy the active asset test in section 152-35 of the ITAA 1997. The active asset test requires the relevant CGT asset to be an active asset: ● for a total of at least half of the period specified in subsection 152-35(2) of the ITAA 1997 if you have owned the asset for 15 years or less; or ● for a total of at least 7.5 years during the period specified in subsection 152-35(2) of the ITAA 1997 if you have owned the asset for more than 15 years. Subsection 152-40(1) of the ITAA 1997 provides that a CGT asset is an active asset at a given time if, at that time, you own it and: ● it is used (or held ready for use) in the course of carrying on a business by you, your affiliate or an entity connected with you (paragraph 152-40(1)(a) of the ITAA 1997); or ● it is an intangible asset that is inherently connected with a business that is carried on by you, your affiliate, or an entity connected with you (paragraph 152-40(1)(b) of the ITAA 1997). However, even where an asset satisfies these requirements, an asset may still be excluded from being an active asset by operation of subsection 152-40(4) of the ITAA 1997. Paragraph 152-40(4)(e) of the ITAA 1997 excludes, among other things, assets whose main use is to derive rent (unless such use was only temporary). Such assets are excluded even if they are used in the course of carrying on a business. If the activities carried on do not amount to the carrying on of a business, it is unnecessary to consider whether the main use of the asset is to derive rent. In your case, we have agreed not to consider whether a business is being carried on unless the main use of the Property was not to derive rent. Whether an asset's main use is to derive rent will depend on the particular circumstances of each case. In Tax Determination TD 2006/78 ‘Income tax: capital gains: are there any circumstances in which the premises used in a business of providing accommodation for reward may satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 1997 notwithstanding the exclusion in paragraph 152-40(4)(e) of the Income Tax Assessment Act 1997 for assets whose main use is to derive rent?’ the Commissioner stated that a key factor in determining whether an occupant of premises is a lessee 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 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 unlikely to be rent. Other factors to consider include the degree of control retained by the owner and the extent of any services provided by the owner such as room cleaning, provision of meals, supply of linen and shared amenities. Example 1 in TD 2006/78 contains the following example of a company deriving rent from a property, thereby preventing the property from being an active asset. 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 . It is your position that the money obtained from the leasing of the Property to a third party is not rent, but business income. While we have not considered the question of whether you are in business, it is our position that an entity’s business income can include rental income. You have provided information about a number of development opportunities carried out by the controlling individuals either individually, or through entities that they control. These developments are not relevant to our decision on whether the Property was an active asset. The critical issue is whether the main use of the Property was to derive rent. If the main use of the Property was to derive rent, the Property is not an active asset irrespective of the rent being your business income. You purchased the Property and operated a business for a period of six months, before leasing the Property to a third party. You have provided two leases relating to the Property, the Main Lease and the Second Lease. The Main Lease was entered for a period of 25 years. The initial annual rent was set at a specific amount, to be increased in line with indexation every five years. You are the landlord. You grant the tenant the right to use and possess the property and the tenant cannot sublet, assign or part with possession without your written consent. The tenant is responsible for keeping the property in good repair and must hold insurance. You, as Landlord, can enter the Property only to carry out structural or other required repairs or by giving seven days’ notice of an inspection. The Second Lease was entered into for an initial period of five years. The rent is defined as that payable under the Main Lease and for all relevant purposes contains similar terms as the Main Lease. The conclusion to be drawn from the two leases and your actions during your period of ownership is that the main use of the Property was to derive rent. The Property’s use to derive rent during your ownership period was 96% of the time that you owned the Property. The Property is not an active asset and you are not entitled to apply the small business CGT concessions.