Private ruling: CGT - Small business concessions - Active asset test
Published: June 2012
Ruling period: Year ended 30 June 2011
Date scheme commenced: 1 July 2010

Ruling: Q1: Are you eligible for the small business retirement exemption? | A1: No

Relevant facts and circumstances: After 1 January 2001 you purchased two strata properties and a block of land (which is also part of the strata). The two properties were purpose built for short term accommodation. After 1 January 2003 you built a third property, also purpose built for short term accommodation. You sold one of the original properties in the 2010-11 income year. The properties were available for short term rental all year round. Bookings were managed by an agency that was set up specifically for managing short term rentals. You pay the agent a commission for each booking, you also pay them an additional fee which covers their management of payments for the cleaning after each rental (plus an additional midweek clean for a booking of six days or more), gardening and wood delivery. The agent also receives a fee to undertake the marketing of the properties through their website and brochures. If minor repairs are needed, you authorise the agent to organise them. You organise any major repairs, furniture replacements or renovations personally. You travel to the location of the properties approximately two times a year, when you will meet with the agents and cleaner to discuss marketing, management, repairs and maintenance of the properties. While there, you may undertake some maintenance matters, gardening and cleaning as well as purchasing any items that require replacement. Each property may have different cleaners and gardeners, it is your responsibility to organise any changes in these contractors. There is a total of four properties in the strata group, each with surrounding land on each title and a shared driveway and parking areas. Guests have exclusive use of the property for the time they are there, apart from a mid week clean if they are there for a week or more. You intend to progressively sell the remaining properties to help fund your retirement. You are both retired from full time work.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 152-10(1) | Income Tax Assessment Act 1997 Section 152-35 | Income Tax Assessment Act 1997 Subsection 152-40(1) | Income Tax Assessment Act 1997 Section 995-1

Reasons for decision: Summary: In order to be eligible for the small business retirement exemption, a number of basic conditions must be satisfied. The basic conditions for the small business CGT concessions are outlined in subsection 152-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997). One of the basic conditions is that the asset must satisfy the active asset test. Under section 152-35 of the ITAA 1997, a CGT asset satisfies the active asset test 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 test period; 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 7½ years during the test period. The term 'active asset' is defined in subsection 152-40(1) of the ITAA 1997 as an asset you own and use (or hold ready for use) in the course of carrying on a business; or in the course of carrying on a business by a connected entity under paragraph 152-40(1)(c) of the ITAA 1997. | 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 ( Wertman's Case) ; 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 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. The issue of whether individuals are carrying on a business of letting property has been considered in a number of cases, some of which are discussed below. In 11 CTBR (OS) Case 24 (Case 24) , the taxpayer's income included rent from three properties. The taxpayer employed a manager and an accountant who was principally a letting clerk with authority to refuse tenants. He collected and banked rents, attended to repairs and supervised them, and controlled the caretaker and cleaners. He kept books in connection with rents and repairs, and rates and other outgoings. The taxpayer said he personally carried out the principal part of the management of his rent-producing properties and directed policy, attended to the financial arrangements and made decisions regarding repairs. The taxpayer claimed that he was carrying on a business. In holding that he was not carrying on a business, a majority of the members of the Board of Review said: It is obvious that some measure of supervision and management must ordinarily be exercised by a property owner who lets offices… and if that does not amount to the carrying on of a business, the fact that he employs others to assist him, either in the letting of the properties or in the preparation of the accounts relating to his rents and outgoings, will not make any difference. For the foregoing reasons we are unable to uphold the claim that the taxpayer is engaged in a 'business as property owner' ... . In 15 CTBR (OS) Case 26 , ( Case 26 ) the taxpayer derived income substantially from her joint ownership of a block of flats (containing 22 living units) with her sister-in-law. A swimming pool was shared with a neighbouring block of flats owned by the taxpayer's husband and his brother. A garden was maintained and a staff of one caretaker and one cleaner employed on both buildings with casual labour as required. The building was erected and financed by F & Co., the husbands of the joint owners, in the course of their business as building contractors. The general supervision of letting, rent collecting, servicing and maintenance was carried out by the owners or by F & Co. on their behalf. No charge was made by F & Co. for the extensive assistance given in the supervision of the flats. It was held that a business was not being carried on by the owners of the block of flats. On the other hand, 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. Taxation Ruling TR 97/11 incorporates the general factors that are considered important in determining the question of whether a business activity is being carried on: · 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. TR 97/11 states the indicators must be considered in combination and as a whole and whether a business is being carried on depends on the 'large or general impression gained' ( Martin v. FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551) from looking at all the indicators, and whether these factors provide the operations with a 'commercial flavour' ( Ferguson v. FC of T (1979) 37 FLR 310 at 325; 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884). However, the weighting to be given to each indicator may vary from case to case. 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 and the repetition and regularity of the activities. | Detailed Reasoning - Applying the relevant cases and indicators to your circumstances: In this situation, we consider that you are not carrying on a business of providing short term accommodation. While you personally perform some of the maintenance and repair work to the properties, the undertaking of managing and maintenance, level of involvement, scale of activity and volume of operation in the activity is not as significant as that noted in Case G10 . You have engaged an agent to effectively manage the properties for you and the services provided to guests are minimal. After considering all of the relative business indicators and objective facts surrounding the case it is considered that you are not carrying on a business of leasing short term residential properties. The income is not derived from the services you provide; it is derived from the letting of the properties and is considered to be passive income. Accordingly the asset can not be an active asset as it is not held in the course of carrying on a business for the purposes of paragraph 152-40(1)(a) of the ITAA 1997. As the property is not an active asset, it does not satisfy the basic conditions and you will not be entitled to the small business retirement exemption.

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