Private ruling: Small Business Concession - Am I in business - boarding house
Published: September 2017
Ruling period: Year ending 30 June 2016
Date scheme commenced: 1 July 2015



Relevant legislative provisions: Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Section 152-35 | Income Tax Assessment Act 1997 Paragraph 152-40(4)(e) | Income Tax Assessment Act 1997 Section 152-55 | Income Tax Assessment Act 1997 Section 152-110 | Income Tax Assessment Act 1997 Section 995-1

Reasons for decision: Detailed Reasoning - Small business CGT concessions - basic conditions: A small business entity may be eligible to apply up to four CGT concessions to reduce or disregard a capital gain which results from a CGT event where the small business entity satisfies certain conditions. The four concessions are: a) the small business 15-year exemption b) the small business 50% active asset reduction c) the small business retirement exemption, and d) the small business rollover. To qualify for the small business CGT concessions, you must satisfy several conditions that are common to all the concessions. These are called the basic conditions. The basic conditions for the small business CGT concessions in Subdivision 152-A of the Income Tax Assessment Act 1997 (ITAA 1997) (as relevant to this case) are: a) the small business entity test and b) the active asset test. | Detailed Reasoning - Small business entity test: You will be a small business entity if you are an individual, partnership, company or trust that is carrying on a business and have an aggregated turnover of less than $2 million. We need to determine if your boarding house rental activities are considered to be a business for tax purposes. Taxation Ruling TR 97/11 outlines the important factors that are considered in determining if your activity is a business for tax purposes. The factors are: i. whether the activity has a significant commercial purpose or character ii. whether there is more than just an intention to engage in business iii. whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity iv. whether there is regularity and repetition of the activity v. 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 vi. whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit vii. the size and scale and permanency of the activity, and viii. whether the activity is better described as a hobby, a form of recreation or a sporting activity. Paragraph 15 of TR 97/11 states that no one indicator is decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). In addition, paragraph 16 of TR 97/11 states that the indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the general impression gained from looking at all the indicators (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470 at 474; 5 AITR 548 at 551), and whether these factors provide the operations with a 'commercial flavour' (Ferguson v. Commissioner of Taxation (1979) 37 FLR 310 at 325; 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884). Taxation Ruling IT 2423 Withholding tax: whether rental income constitutes proceeds of business - permanent establishment- deduction for interest, states at paragraph 5 ● A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations. An individual who derives income from the rent of one or two residential properties would not normally be thought of as carrying on a business. On the other hand if rent was derived from a number of properties or from a block of apartments, that may indicate the existence of a business. The issue of whether the owner of one or several properties, in providing accommodation, is carrying on a business has arisen in a number of cases. Taxation Ruling TR 93/32 Income tax: rental property- division of net income or loss between co-owners, states at paragraph 22 and 23: 22. As a general proposition, it is more accurate to describe the owners of rental property in the words of Beaumont J in McDonald's case at ATR p.969; ATC p 4552 'as co-owners in investment rather than as partners in a business operation.' 23. That is not to say that co-owners cannot carry on a business of property rental and therefore be partners at general law. As already noted, whether an activity constitutes the carrying on of a business is a question of fact to be decided on a case by case basis. In Commissioner v. McDonald (1987) 15 FCR 172; 18 ATR 957; 87 ATC 4541 (McDonald's case), the taxpayer owned two properties, one of which was let on a short term basis to holiday makers, which were subsequently let through letting agents. The Federal Court considered that for a business to be carried on by owners of property, one would expect that they would be involved in providing services in addition to the process of letting property (as with a boarding house), not merely receiving payments for the tenants occupation of the property. In Carson and Anor v. FC of T AAT 156 (Carson's case) the taxpayers owned one property jointly which was used to provide short term tourist accommodation, usually for stays of about a week to two weeks. Senior Member BH Pascoe stated that whether a business is being carried on, is a question of fact and an objective consideration of the extent of the applicant's activities relating to the property. He pointed out that appointing a real estate agent to arrange rentals and minor repairs, spending one week every six months servicing the property and providing brochures relating to the property as required activities with all the earmarks of maintaining and deriving income from an investment rather than the carrying on of a business. Similarly, activities such as financing the property, dealing with rating authorities and body corporate are no more than any investor in real estate would do. In accordance with the judicial comments above and guidelines set down in Taxation Rulings IT 2423 and TR 97/11, although there is regularity to your activities and you have a profit making intention, your activities are not of a size or scale necessary to be characterised as carrying on a business of short stay accommodation. Therefore, the income that you received from the property is not from the carrying on of a business; rather it was received from an investment in property. | Detailed Reasoning - Active Asset Test: The active asset test contained in section 152-35 of the ITAA 1997 and is satisfied if: ● 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 detailed below; or ● 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 7.5 years during the test period. The test period is from when the asset is acquired until the CGT event. If the business ceases within the 12 months before the CGT event (or such longer time as the Commissioner allows) the relevant period is from acquisition until the business ceases. A CGT asset is an active asset if it is owned by you and is used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child or an entity connected with you. Paragraph 152-40(4)(e) of the ITAA 1997 states, however, that an asset whose main use in the course of carrying on the business is to derive rent cannot be an active asset unless the main use for deriving rent was only temporary. Taxation Determination TD 2006/78 discusses the circumstances in which premises used in the business of providing accommodation for reward can be active assets notwithstanding the exclusion in paragraph 152-40(4)(e) of the ITAA 1997. Whether an asset's main use is to derive rent will depend upon the particular circumstances of each case. In accordance with paragraph 22 of TD 2006/78, the term 'rent' has been described as follows: ● the amount payable by a tenant to a landlord for the use of the leased premises (C.H. Bailey Ltd v. Memorial Enterprises Ltd [1974] 1 All ER 1003 at 1010, United Scientific Holdings Ltd v. Burley Borough Council [1977] 2 All ER 62 at 78, 86, 93, 99); ● a tenant's periodical payment to an owner or landlord for the use of land or premises (The Australian Oxford Dictionary, 1999, Oxford University Press, Melbourne); and ● recompense paid by the tenant to the landlord for the exclusive possession of corporeal hereditaments ...... The modern conception of rent is a payment which a tenant is bound by contract to make to his landlord for the use of the property let A key factor therefore in determining whether an occupant of premises is a lessee is whether the occupier has a right to exclusive possession (Radaich v. Smith (1959) 101 CLR 209). If 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 less likely to be rent. For example, if residential units are operated as holiday apartments, the issue arises as to whether the occupants of the apartments are tenants/lessees or only have licences to occupy. This will be questions of fact depending on all the circumstances involved. Relevant factors to consider in determining this question include: ● whether the occupier has a right to exclusive possession ● 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 (Allen v. Allen (1966) 1 NSWR 572; Appah v. Parncliffe Investments Ltd [1964] 1 All ER 838 and Marchant v. Charters [1977] 3 All ER 918). Example 4 of TD 2006/78 states: 11. Linda owns a complex of 6 holiday apartments. The apartments are advertised collectively as a motel and are booked for periods ranging from 1 night to 1 month. The majority of bookings are from 1 to 7 nights. 12. Linda is responsible for bookings, checking guests in and out and cleaning the apartments. She also provides clean linen and meal facilities to guests. Linda does not enter into any lease agreement with guests staying at the apartments. 13. In this example, the apartments are operated similar to a motel. The guests do not have exclusive possession of the apartment they are staying in but rather only a right to occupy the apartment on certain conditions. The usual length of stay by guests is very short term and room cleaning, linen and meals are also provided to guests. 14. These facts indicate that the relationship between Linda and the guests is not that of landlord/tenant under a lease agreement. Accordingly, the income derived is not 'rent'. If Linda's activities amount to the carrying on of a business, the paragraph 152-40(4)(e) of the ITAA 1997 exclusion would not apply and the apartments would be active assets under section 152-40 of the ITAA 1997. However, many arrangements involving holiday apartments are unlikely to be active assets because no business is being carried on or, even if a business is being carried on, it amounts to the derivation of rent. This is because in many cases the services provided are not sufficient to change the nature of the income from passive to active. For example if meals or daily cleaning are not provided. In Carson's case, the taxpayers provided short-term tourist accommodation to the public. The subject asset was one unit, presumably within a group of residential units. Occupants generally stayed for one or two weeks. Crockery, cutlery and linen were included but cleaning was done only after each stay. The taxpayers relied on TD 2006/78 and contended that the unit was an active asset for the purposes of the small business CGT concessions. The AAT held that the main use of the property was to derive rent and therefore it was excluded from being an active asset. Although no formal agreement was signed, there was a landlord/tenant relationship in that the occupants of the unit would no doubt regard themselves as having rented the unit and having exclusive possession thereof. The same reasoning can be applied to your case as the facts are similar. In your case, you do not provide additional services such as meals and the common areas are cleaned. You have provided details of the time you spend cleaning and maintaining the property, we do not consider they provide a significant value adding service to the boarders. Having regard to all the facts, we consider that the relationship between you and the boarders is more properly characterised as that of landlord/tenant. A formal agreement was signed and accordingly we consider the boarders who stayed at the property would believe they had exclusive possession of the particular room for the duration of their stay. Accordingly, the main use of the property was used to derive rent. As the main use of the property was to derive rent, the property will not satisfy the active asset test under section 152-35 of the ITAA 1997. Consequently you will not be able to access the small business CGT concessions under Division 152 of the ITAA 1997 in relation to the capital gain relating to the property.

Question 1: Are you carrying on a business of providing short term accommodation? | Question 2: Will the property satisfy the active asset test set out in section 152-35 and 152-40 of the Income Tax Assessment Act 1997 (ITAA 1997)? | Relevant facts: You acquired a dwelling (the property) | The dwelling has been used as a registered boarding house for your entire ownership period. | The property provides low cost accommodation. | The property has been serviced and maintained by you during your ownership period. | The property has been your main source of income during your ownership period. | You entered into a contract to sell the dwelling in 20XX. | You have provided a number of documents that forms part of and should be read in conjunction with this private ruling. | The property has a number of rooms available for rent. Some of the rooms are self-contained with a kitchen and bathroom and the remaining rooms share a common kitchen bathroom and living space. | The property also has a designated room available as an office. | The property also has as a room which is available to you. | You do not reside at the premises, however you live locally. | You provide linen and towels. | You do not provide meals. | The premises are registered as a boarding house. | You have previously insured the premises under a combined business insurance policy. | You advertise for prospective boarders in local newspapers and low cost advertising methods. | The property has a number of electricity meters. A number of the available rooms are connected to one electricity meter which you are responsible for. A number of the rooms have separate meters which the occupants of those rooms are responsible for. | You are not registered for GST as you have not exceeded the GST turnover threshold. | The boarders are generally charged a weekly rate and payment is made in advance by either cash or electronically. | The boarders enter into a formal agreement and are required to pay a bond. You are able to increase the rent during the period of the agreement provided thirty days' notice is provided. | You attend on site daily to undertake various tasks including cleaning, rent collection, inspections and maintenance. | You estimate that you spend approximately X hours per week at the property. | The following information has been extracted from the boarder register. | You have been required to enter the boarder's rooms on a number of occasions without their permission during a specified period. | The boarder's generally stay at the property for medium to long periods, ranging from 1 month to several years. You also have long term boarder's.