Private ruling: Active asset test
Date of advice: 24 May 2016
Published: July 2016
Ruling period: Year ending 30 June 2016
Date scheme commenced: 1 July 2015

Ruling: Q1: Does the property satisfy the active asset test? | A1: Yes.

Relevant facts and circumstances: Trust A purchased property. The property included a number of different suites. All but one of the suites was available for rent to unrelated parties, during the whole period held. The final suite was leased to a related party, Trust B, to conduct its business. The business later moved out of the property but it conducted its business there for more than half of Trust A's ownership period. Trust A and Trust B are considered to be connected entities. Trust B used a substantial proportion of the floor space of the property in carrying on its business (although not a majority of the floor space). The vast majority of the income derived from the property came from its business use. The property was later sold.

Relevant legislative provisions: Income Tax Assessment Act 1997 - Section 152-35, | Income Tax Assessment Act 1997 - Section 152-40 and | Income Tax Assessment Act 1997 - Subsection 328-125(1).

Reasons for decision: Detailed Reasoning - Active Asset Test: For the small business concessions in Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997) to apply to reduce or disregard a capital gain, the relevant CGT asset must satisfy the active asset test in section 152-35 of the ITAA 1997. The active asset test 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: • begins when you acquired the asset, and • ends at the earlier of • the CGT event, and • when the business ceased, if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows). The test period: • begins when you acquired the asset, and • ends at the earlier of • the CGT event, and • when the business ceased, if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows). The asset does not need to be an active asset just before the CGT event. The meaning of an active asset is set out in section 152-40 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. Under subsection 152-40(1) 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 by you or your small business CGT affiliate or another entity that is connected with you under paragraph 152-40(1)(c) of the ITAA 1997. The combined effect of sections 152-35 and 152-40 of the ITAA 1997 is that the asset will meet the active asset test if the asset was used, or held ready for use, in the course of carrying on a business for at least half of the time period it was owned, subject to the exclusions in subsection 152-40(4) of the ITAA 1997. | Detailed Reasoning - Connected entities: In this case, Trust A owned the property for less than 15 years. Trust A never used the property to carry on a business; however, Trust B used part of the property in the course of carrying on its business for more than half of Trust A's ownership period. For the purposes of the active asset test for the small business concessions, Trust A and Trust B are considered to be connected with each other because they are both controlled by the same entity (subsection 328-125(1) of the ITAA 1997). Accordingly, Trust A can include Trust B's business use of the property in considering whether the property meets the active asset test. As a result, the premises satisfies the active asset test subject to it not being excluded from being considered an active asset under subsection 152-40(4) of the ITAA 1997. | Detailed Reasoning - Use of property to derive rent: Even though the basic conditions of the active asset test are met, subsection 152-40(4) of the ITAA 1997 provides a list of exceptions and outlines which CGT assets cannot be active assets. 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. Whether an asset's main use is to derive rent will depend on the particular circumstances of each case. If an asset is used partly for business and partly to derive rent at any given time, it will be a question of fact dependent on all the circumstances as to whether the main use of the asset at that time 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 the comparative areas of use of the premises (between deriving rent and other uses), and the comparative levels of income derived from the different uses of the asset. Taxation Determination TD 2006/78 Income tax: capital gains: are there any circumstances in which the premises used in a business or 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(e) of the Income Tax Assessment Act 1997 for assets whose main use is to derive rent? , provides the following example: Mick owns land on which there are a number of industrial sheds. He uses one shed (45% of the land by area) to conduct a motor cycle repair business. He leases the other sheds (55% of the land by area) to unrelated third parties. The income derived from the motor cycle repair business is 80% of the total income (business plus rentals) derived from the use of the land and buildings. In determining if the main use of the land is to derive rent, it is appropriate to consider a range of factors. In this case, a substantial (although nevertheless not a majority) proportion by area of the land is used for business purposes. As well, the business proportion of the land derives the vast majority (80%) of the total income. The Tax office considers the main use of the land in this case is not to derive rent and accordingly the land is not excluded from being an active asset by paragraph 152-40(4)(e) of the ITAA 1997. Your case is similar to the example listed above. In your case, a substantial proportion of the floor space of the property was used in carrying on Trust B's business (although not a majority of the floor space). Moreover, the vast majority of the income derived from the property came from its business use. Accordingly, it is considered that the main use of the property was not to derive rent. As a result, the property meets the conditions for the active asset test in section 152-35 of the ITAA 1997.