Private ruling: CGT - small business concessions

Ruling: Q1: Do the units used in the business of providing short term holiday unit accommodation satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Do the units continue to be an active asset if they are converted to strata title? | A2: Yes | Q3: Will any gain from the sale of the individual units be capital in nature? | A3: Yes | Q4: Can you apply the small business 15-year exemption to the capital gain on disposal of each individual unit? | A4: Yes

Relevant facts and circumstances: The company is a registered company limited by shares. The directors are a couple. They are also the sole shareholders. The company purchased land post September 1985 and constructed a number of holiday units on the site. Construction was completed and the units have been available since that time for holiday/motel accommodation. The units are self contained. The cost of linen is included in the nightly rate. On arrival, guests are provided with linen and 'basic supplies' - soap, toilet paper and tea and coffee items. Meals are not included as the units are all self-contained. Accommodation is short stay, generally for periods of 1 to 7 days. The majority of bookings are for 1-3 nights. At Christmas time, bookings are generally weekly. The directors of the company actively manage all aspects of the business operation. They make all bookings, accept payment, manage the guests, and undertake all cleaning and maintenance of the units, pool and complex. Guests at no time have exclusive possession but a right to occupy for the number of nights they have paid for, subject to their behaviour. The directors/shareholders of the company are over 55 years of age. They have been trying to sell the unit complex for a number of years but have been unable find a buyer who will purchase the complex in its entirety. Approximately xx months ago the directors engaged professionals to commence the process of strata titling the property, enabling the sale of the individual units. There were no physical changes to the units required. Costs of the conversion included costs for professional services - engineer, surveyor, town planner and solicitor. A real estate agent is handling the sale of the units. As each of the units is sold, the business will be wound down. At the time of the ruling request, a number of units were under contract of sale. The remaining units are still being used for holiday/motel accommodation.

Relevant legislative provisions: Income Tax Assessment Act 1997, section 6-5 | Income Tax Assessment Act 1997, section 6-10 | Income Tax Assessment Act 1997, Division 40 | Income Tax Assessment Act 1997, Part 3-1 | Income Tax Assessment Act 1997, section 102-5 | Income Tax Assessment Act 1997, section 102-20 | Income Tax Assessment Act 1997, section 104-10(4) | Income Tax Assessment Act 1997, subdivision 108-D | Income Tax Assessment Act 1997, section 108-55 | Income Tax Assessment Act 1997, section 118-20 | Income Tax Assessment Act 1997, section 118-42 | Income Tax Assessment Act 1997, Division 40 | Income Tax Assessment Act 1997, Division 152 | Income Tax Assessment Act 1997, section 152-10 | Income Tax Assessment Act 1997, section 152-40 | Income Tax Assessment Act 1997, section 152-40(1) | Income Tax Assessment Act 1997, section 152-40(1)(a) | Income Tax Assessment Act 1997, section 152-40(4) | Income Tax Assessment Act 1997, section 152-40(4)(e) | Income Tax Assessment Act 1997, section 152-10 | Income Tax Assessment Act 1997, Division 152-B | Income Tax Assessment Act 1997, section 152-55 | Income Tax Assessment Act 1997, section 152-60 | Income Tax Assessment Act 1997, section 152-65 | Income Tax Assessment Act 1997, section 152-100 | Income Tax Assessment Act 1997, section 152-125 | Income Tax Assessment Act 1997, subsection 152-125(3)

Reasons for decision: Summary: The income derived is not 'rent' and therefore the paragraph 152-40(4)(e) exclusion does not apply. The apartment is an active asset under section 152-40 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: For a CGT asset of a business to be an active asset for the purposes of Division 152 of the ITAA 1997, it must firstly satisfy one of the 'positive tests' in subsection 152-40(1) of the ITAA 1997, and then also not be excluded by one of the exceptions in subsection 152-40(4) of the ITAA 1997. Section 152-40 of the ITAA 1997 provides a CGT asset is an active asset at a time if, at that time you own the asset 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: · you; or · your affiliate; or · another entity that is connected with you. Under section 152-35 of the ITAA 1997 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 7½ years during the ownership period. The asset does not need to be an active asset just before the CGT event. Under paragraph 152-40(1)(a) of the ITAA 1997 a CGT asset is an active asset (subject to the exclusions) if it is owned and used or held ready for use in the course of carrying on a business. However, paragraph 152-40(4)(e) of the ITAA 1997 provides that an asset whose main use in the course of carrying on the business is to derive rent cannot be an active asset (unless that main use was only temporary). That is, even if the asset is used in a business it will not be an active asset if its main use is to derive rent. Given the personal involvement in the day to day running of the enterprise, it appears that you have treated the activity as a business and the nature of the activities show that you are actively involved in the derivation of the income. It is therefore concluded that your activities in relation to the management and running of the accommodation constitute the carrying on of a business for the purposes of paragraph 152-40(1)(a) of the ITAA 1997. Having satisfied paragraph 152-40(1)(a) of the ITAA 1997 with regard to carrying on a business it is necessary to consider if the business falls within the exclusions contained in paragraph 152-40(4)(e) of the ITAA 1997. Where premises offer short-term accommodation, the issue arises as to whether an occupant of part of the premises is a tenant or a lodger/boarder with a licence to occupy. In Taxation Determination TD 2006/78, the Commissioner has considered whether there are any circumstances in which the premises used in a business of providing accommodation for reward may satisfy the active asset test. The determination states that whether an asset's main use is to derive rent will depend on the particular circumstances of each case. It does, however, set out the factors to which the Commissioner will have regard in arriving at a decision. Those considerations include whether: · no notice is required to quit the rooms. · there are rules requiring visitors to leave the premises by a certain time · the owner/manager retains the right to enter the accommodation · the owner pays for all utilities (gas, electricity, water) · the owner provides services and facilities to guests such as room cleaning and general maintenance, linen and towels and common areas such as a TV/lounge room, kitchen, bathrooms, laundry and a recreation area . · the average length of stay is relatively short. · the owner/manager retains a significant degree of control over the premises through being on the premises most of the time. · the arrangements entered into indicate that those staying in the accommodation do not have the right to exclusive possession of a room but rather only a right to occupy the room. Typically, accommodation catering primarily to tourists seeking short-term accommodation would fulfil most or all of the above requirements. In such cases, the circumstances would indicate that the relationship between the owner and those staying at the premises is not that of landlord/tenant under a lease agreement. In the present case, · the owner/manager retains the right to enter the accommodation and retains a key for this purpose · the owner pays for all utilities - guests are charged a nightly rate for the right to occupy the room and for the supply of clean linen · you provide cleaning and general maintenance of the units, the pool and spa, and the common areas · you provide a 'starter pack' on arrival consisting of tea, coffee, milk, toilet paper etc · the average length of stay is relatively short - between 1 and 7 days · you retain a significant degree of control over the premises through being on the premises most of the time, residing next door | Detailed Reasoning - The amount payable is calculated on a daily basis: The arrangements entered into indicate that those staying in the accommodation do not have the right to exclusive possession of a room but rather only a right to occupy the room. The terms on which the clients are able to stay in the premises are at the discretion of the owner. You may terminate the stay at any time for a breach of the rules. You maintain exclusive control of the premises and the rooms occupied at all times. These facts indicate that the relationship between the taxpayer and those staying at the units is not that of landlord/tenant under a lease agreement. Accordingly, the income derived is not 'rent' and therefore the paragraph 152-40(4)(e) exclusion does not apply. The apartment is an active asset under section 152-40 of the ITAA 1997. Therefore the provisions of section 152-40(1) of the ITAA 1997 are satisfied. | Summary: On conversion to strata title the individual units retain their status as active assets. No capital gain or loss is assessable on the conversion. | Detailed Reasoning - Detailed reasoning: Section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a capital gain or loss is made as a result of a CGT event. Land and buildings acquired on or after 20 September 1985 are CGT assets. Any net capital gain which results from a CGT event is included in a taxpayer's assessable income by section 102-5 of the ITAA 1997. | Detailed Reasoning - Strata title conversions: If a taxpayer owns land on which there is a building, the building is subdivided into stratum units and each unit is transferred to the entity having the right to occupy it just before the subdivision, a capital gain or loss made by the taxpayer from transferring the units is ignored for CGT purposes (section 118-42 ITAA 1997). In your case, the unit complex was wholly owned by the company. After the strata conversion, the individual units continued to be held by the company. No capital gain or loss is assessable on the conversion. As the units continue to be let for holiday tenancies, and there has been no change to occupation rights as a result of the conversion, the active asset status is retained. | Summary: The sale of the individual units are the realisation of a capital asset and any realised gain on the transaction will be a capital gain for the purposes of subsection 102-5 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Before ruling on the availability of the capital gains tax small business concessions, it is first necessary to determine whether the proceeds from the sale of the individual units will be income or capital in nature. The disposal of real estate property may fall under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as ordinary income, or Part 3-1 of the ITAA 1997 as capital gains, or both. To determine the nature of a receipt, it is necessary to identify the nature and scope of the taxpayer's business, and the intention or purpose of the taxpayer in entering into the transaction. Profits derived in the ordinary course of the taxpayer's business are income. Additionally the proceeds derived from an isolated transaction may also have the character of income. Taxation Ruling 92/3 provides guidance in determining whether profits from isolated transactions are income. Generally speaking, such profit is income when both of the following elements are present: (a) there was a profit-making intention or purpose for the taxpayer in entering into the transaction; and (b) the transaction was entered into, and the profit was made, in the course of carrying on a business operation or commercial transaction. Some matters which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are the following: (a) the nature of the entity undertaking the operation or transaction; (b) the nature and scale of other activities undertaken by the taxpayer; (c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained; (d) the nature, scale and complexity of the operation or transaction; (e) the manner in which the operation or transaction was entered into or carried out; (f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction; (g) if the transaction involves the acquisition and disposal of property, the nature of that property; and (h) the timing of the transaction or the various steps in the transaction. Where profit is capital in nature, for example a mere realisation or an enhancement of value, it will not be assessable under section 6-5 as ordinary income but under capital gains tax (CGT) provisions, Part 3-1 of the ITAA 1997. If the receipt gives rise to both ordinary income and a capital gain, the operation of section 118-20 reduces the capital gain to the extent that the amount is already included in the taxpayer's assessable income. In your case; The stakeholders/shareholders of the company purchased the company after September 1985 with the intention of building holiday units on the land and running a business providing short-term holiday accommodation. A number of self contained units were constructed on the property. The business of providing holiday accommodation commenced when construction was completed. You are still in the business of providing holiday units/motel style accommodation from the strata titled units. As the individual units are sold, the business is being wound down. Your stakeholders/business operators are aged over 55. They wish to sell the units, cease the business, and access the small business CGT retirement concessions. Attempts over a number of years to sell the property in one parcel were not successful. You elected to convert the property to strata titled units as you considered this provided a better prospect of a successful sale(s). You state the decision to sub-divide was a 'last resort' taken solely due to the failure to sell as one parcel. You had limited involvement in the actual conversion to strata title, and relied on professionals to undertake the conversion as well as the sale of the units. The conversion did not require structural/building alterations. Based on the information provided, the company has been in the business of providing short term holiday accommodation for many years and is continuing in this activity while attempting to sell the units. The decision to strata title and sell was taken to enable the capital of the company to be realised and the business to cease. The sale proceeds are capital in nature as they flow from the realisation of a capital asset acquired without any subjective intention to make a profit by resale. Sale proceeds are received on capital account and assessed to capital gains tax if the capital proceeds exceed the cost base of the asset. | Summary: As you are a small business entity and you meet the qualifications for the small business 15-year asset exemption, any capital gain is entirely disregarded and it is unnecessary to apply any further concessions. | Detailed Reasoning - Small business concessions: A taxpayer may be entitled to four CGT concessions which apply to CGT events happening after 11.45 am EST on 21 September 1999. These are: · the 15-year asset exemption; · the 50% active assets concession; · the retirement exemption; and · the business asset rollover concession. To qualify for the concessions, the taxpayer must satisfy the basic conditions, as well as any specific conditions that may be relevant for the particular concession or CGT asset | Detailed Reasoning - Basic conditions: The basic conditions under section 152-10 of the ITAA 1997 are as follows. A CGT event happens When you sold the individual units a change of ownership occurred and a CGT event resulted. This condition is satisfied The event would have resulted in a gain You expect to realise a capital gain (CGT event A1) on the sale. This condition is satisfied. You are a small business entity for the income year or you satisfy the maximum net asset value test You state that you satisfy the requirements and are a small business entity. The CGT asset meets the active asset test This condition was considered in Question 1 where it was concluded you satisfy the active asset test. The basic conditions are therefore satisfied. 15-year asset exemption The small business 15-year exemption is set out in subdivision 152-B of the ITAA 1997. A small business entity that is a company can disregard a capital gain under section 152-100 of the ITAA 1997 if certain conditions are satisfied; the basic conditions set out under section 152-10 of the ITAA 1997, and you continuously owned the asset for at least 15 years ending just before the CGT event, and you had a significant individual for a total of at least 15 years during which the entity owned the asset the individual who was the significant individual just before the CGT event either: was 55 or over at that time and the event happened in connection with the individuals retirement; or was permanently incapacitated at that time. In your case: 1. As discussed above, you satisfy the basic conditions for the CGT small business concessions 2. You advise the land was purchased post September 1985 and the construction of the units completed in xxxx. Exceptions to the common law principle that anything attached to land becomes part of the land are set out in Subdivision 108-D of the ITAA 1997. A building on land acquired on or after 20 September 1985 is treated as a separate CGT asset from the land if a balancing adjustment can apply to the building under the provisions for depreciating assets (section 108-55 ITAA 1997). Buildings and structures for which only a capital works deduction is available are not treated as separate assets from post-CGT land. As the units constructed on the land are not a depreciating asset under Division 40 of the ITAA 1997, they are not considered to be an asset separate to the land. You have therefore held the asset (the land and subsequent capital works) continuously for a period in excess of 15 years immediately prior to the CGT event. 3. Section 152-55 of the ITAA 1997 provides that an individual is a significant individual in a company at a particular time if the individual has a small business participation percentage of at least 20%. Section 152-65 states the small business participation percentage is the sum of the entity's direct and indirect small business percentage in the other entity. An entity's direct small business participation percentage is determined by reference to the percentage of voting power, dividends or capital gains distribution entitlement accorded because of the entity's share holdings in the company (section 152-70 ITAA 1997). The two shareholders have each held 50% of the shares in the company, and have therefore been 'significant individuals' of the company, for a period in excess of 15 years. 4. The 'significant individuals' of the company are over 55 years of age and the sale of the units is in relation to their retirement. You therefore satisfy the conditions to apply the small business 15-year exemption. A capital gain that qualifies for the 15-year asset exemption is disregarded entirely and is not taken into account in working out a taxpayer's net capital gain. | Detailed Reasoning - Effect on shareholders: Section 152-125 of the ITAA 1997 applies when a company or trust makes payments that are attributable to the exempt amount (from applying the 15-year exemption), to its CGT concession stakeholders within 2 years after the relevant CGT event. These payments are also exempt up to the proportion of the shareholder's participation percentage in the company just before the relevant CGT event. Subsection 152-125(3) provides that such payments would not be considered to be either dividends or frankable distributions. A significant individual is also a CGT concession stakeholder of a company (section 152-60 of the ITAA 1997).

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