Private ruling: Small business concessions
Date of advice: 16 April 2018
Published: July 2018
Ruling period: Year ending 30 June 2018 | Year ending 30 June 2019
Date scheme commenced: 1 July 2017

Ruling: Q1: Are you carrying on a business of providing short term accommodation? | A1: No | Q2: Will you be entitled to claim the small business capital gains tax (CGT) 15 year exemption under Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997) on the disposal of your villa? | A2: No

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. You, being M and N own a villa (villa 1). You purchased villa 1 in XXXX for approximately $XXX,XXX. Your self managed superannuation (SMSF) fund purchased other villas. You are directors, trustees and beneficiaries of this SMSF. This private ruling only relates to activities conducted in relation to villa 1. You provide short term accommodation to local and international guests. Average stay periods are for X-X days. The management and marketing of all villas is undertaken by M and N as part of a partnership, although no formal partnership agreement exists. You have stated that the additional acquisitions of the other villas increased your work load by X%, as you were able to efficiently service and market the additional villas based on your existing business model and operating systems you had established. You visit the villas regularly to monitor your operations, supervise existing contractors and carry out small maintenance and landscaping works. You reside X hours from villa 1 and a contract manager you engage is located X minutes from villa 1. The duration of your visits to the villas tend to be around X days and during this time, you will accompany and supervise contractors, monitoring their work and interaction with customers. When visiting villa 1, you will stay in a flat (flat) that adjoins villa 1. The flat is booked on occasions by you to families that require additional rooms. Booking agents you have engaged to take bookings for the villas don’t have authority to book the flat. You take bookings on your mobile phone 24 hours/7 days per week for international guests and provide XX hours of contact time daily to take local bookings. You have quantified the time that you both allocate to your activities as being around XXX hours per week. That would equate to around XX hours per week that you each allocate to operating villa 1. You take approximately X bookings each month for villa 1, but receive many more enquiries in relation to villa 1. Accommodation bookings are also done through agents and web based accommodation sites, including a website you have created. You engage contract staff via entering into contractual arrangements. You provide training to contractors and detailed written procedures. You have engaged around XX contractors. You supervise these contract positions when present and conduct training on a monthly basis for your new contractors. You have entered into arrangements with businesses that provide services to your villas. You are both nearing retirement and have scaled back your operations, but will continue to operate another business (the business) which involve around XX hours per week commitment each. You operate this business with another partner (other partner). You undertake a passive role in this business. Operations that are either performed by you when you schedule visits to villa 1 or duties performed by your contractors include: ● offering valet services to guests; ● showing guests how to operate equipment within their villa; ● assisting guests with a sightseeing itinerary and liaising with tourist operators to make bookings on behalf of clients; ● cleaning, changing linen, replenishing bathroom and kitchen supplies; ● checking for broken and missing utensils, crockery and other supplies for each villa. ● performing small maintenance jobs when tending to your villas such as painting and rehanging doors. ● While a gardening contractor looks after the pool and garden X times a week, you will do planting and landscaping work when onsite. You have chosen a model that involves your active involvement in taking bookings and visiting villa 1 to carry out the above duties as opposed to having a body corporate manager perform the above tasks on behalf of you. As you don’t have to pay a percentage of the income you receive to a body corporate manager, you have channelled these savings into improvements to your villas. You don’t have a formal business plan, but have a marketing strategy that consists of: ● Entering into agreements with agents (booking agents) that specialise in marketing short term accommodation. You have engaged agents overseas and throughout Australia and pay them a commission based on the value of the booking taken. Approximately XX% of the income derived from the hire of villa 1 is generated from agents taking bookings and the remaining XX% of income is derived from bookings on your website and phone call enquires you take. ● You advertise your villas on a number of websites. ● You utilise a booking platform which allows you and booking agents that you engage as contractors to make bookings in a central calendar. Approximately half of the income you derive from villa 1 is from bookings taken by contract booking agents. Approximately, XX% of the bookings taken for villa 1 occurs through your website. Around XX% of all bookings taken, result in return bookings. You prepare financial projections of income and expenditure for each villa annually and monitor this budget and document your income and expenses half yearly against the current budget. You have developed a budget projection for a future income year. In relation to your budget: ● You provide vehicles that can be hired with your villas. You originally owned X vehicles but sold them and purchased a new one and lease the other vehicles. While the vehicle lease costs have increased in the 20XX-XX income year, other vehicle costs have declined. ● The net loss recorded prior to and during the 20XX-XX income year was due to meeting your loan repayment. Your loan repayments totalled $XX,XXX in the 20XX-XX income year. ● You apportion your travel expenses to visit the villas equally across all villas. ● Income received for the first 6 months of the 20XX-XX income year is above your forecast budget. You have recorded in your income tax returns from 20XX-XX to the 20XX-XX, income derived from villa 1 as rental income and not business income. You both have recorded net rental losses for villa 1 in the income years 20XX-XX to 20XX-XX. Your net rental losses are attributable to such expenses as commissions paid to agents who take bookings, your travel expenses, interest and loan repayment expenses, contractor expenses (valet, cleaning contractors) and maintenance and capital improvements expenses. You keep separate accounts relating to each villa, recording income and expenses. You also record usage and expenses relating to supplying utility services to villa 1 and the other villas. Administration, financial and other duties undertaken by you include: ● Processing invoices; ● Paying commissions to booking agents; ● Paying contractors and businesses you have engaged; ● Developing instruction sheets for taking bookings, procedures for cleaning; and checklists that summarise cleaning performance; ● Organising tours and activities for guests once they have booked. This involves liaising with leisure business operators and arranging transport for guests to visit attractions. You currently have your villas, including villa 1 listed for sale. You expect to sell villa 1 for approximately $X,XXX,XXX.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subdivision 152-A | Income Tax Assessment Act 1997 section 152-105

Reasons for decision: Summary: You are not carrying on a business of providing short term accommodation. | Detailed Reasoning - Detailed reasoning: The determination of whether or not a business is being carried on is generally a process of weighing up all of the relevant indicators within the context of a given situation. No one indicator determines whether or not a business is being carried on. Taxation Ruling TR 97/11 ( Income Tax: am I carrying on a business of primary production?) provides a guide to the indicators that the courts have held to be relevant as to whether or not a person is carrying on a business. The indicators are: ● Whether the activity has a significant commercial purpose or character, ● Whether the taxpayer has more than 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 repetition and regularity of the activity, ● Whether the activity is of the same kind that is carried on in a similar manner to that of the ordinary trade in that line of business, ● Whether the activity is planned, organised and carried out in a business-like manner, ● The size, scale and permanency of the activity, ● Whether the activity is better described as a hobby, a form of recreation or a sporting activity. We have considered the following indicators in Taxation Ruling 97/11 and applied them to your facts to determine whether you are carrying on a business: ● Whether the activity has a significant commercial purpose or character A business is generally carried out on such a scale and in such a way as to show it is being operated on a commercial basis and in a commercially viable manner with an intention of producing an overall profit over the term of the activity. For this indicator to be satisfied, it is not sufficient that the taxpayer only expects a token profit. In the case Cecil Crees v Commissioner of Taxation 2001 ATC 2012 (2001) 46 ATR 1091 it was stated: “ It would be most unusual that a business operator who would expend large amount of money and labour, for more than 10 years, on a business which was unlikely to ever cover the expenditure and even if it did, was not likely to give a reasonable return for effort”. Up until 20XX-XX, villa 1 was generating a net loss, largely due to repayment of the loan and other operating expenses and capital improvements. You both derived a net profit of $XX,XXX in the 20XX-XX income year, which is a low return given that you both committed XX hours each week to this activity. It is acknowledged that you have implemented efficiencies from the 20XX-XX income year in the form of leasing vehicles to reduce maintenance and purchase costs. It is also acknowledged that you have budgeted for increased improvements since the 20XX-XX income year, so you can compete with existing accommodation facilities that are being rebuilt and to command a higher sale price when you sell all villas. You engaged in activities to increase the value of villa 1 so it can be sold and the proceeds used to meet your retirement needs. ● Prospect of profit The taxpayer’s involvement in the business activity should be motivated by wanting to make a profit and the taxpayer’s activities should be conducted in a way that facilitates this. Where an objective analysis demonstrates that the activities are likely to generate a commercially realistic profit on a continuous and repetitive basis, this indicator will be satisfied. A net profit of $XX,XXX was generated in 20XX-XX income year and represents a net profit margin of XX%. The net profit is expected to increase during the 20XX-XX income year due to you receiving increased bookings as a result of the closure of competitive accommodation facilities. Given that your overall expenses have exceeded the income derived since acquiring villa 1 to the 20XX-XX income year, it is not credible to conclude that your activity has been undertaken with the requisite intention of making a profit. ● Whether the taxpayer has more than an intention to engage in business As you have engaged in losses for extensive periods of time over the period you have owned villa 1, rather than making a profit, it is unlikely that those activities would amount to carrying on a business. ● Repetition and Regularity Repetition and regularity are considered to be important indicators on whether or not a business is being carried on, with the size and scale of the activity being supporting factors. In your case, you spend considerable periods of time supervising contractors you engage and have entered into agreements with businesses who provide maintenance services to villa 1. You have elected to travel to and from your home to villa 1 regularly and are responsible for taking all bookings via the phone and responding to web based enquiries on your website. This operating model that you have adopted demonstrates active participation by you in the letting of short term accommodation, but not regular and repetitive activity aimed at generating a profit. The excessive responsibilities you undertake in operating villa 1 does not strengthen your argument that you are carrying on a business as you have not been able to demonstrate a profit making purpose. ● Scale and Permanency of your activities When considering this factor we look at the scale in terms of the number of short term properties you have and what management input is required to conduct the activity. The greater the number of accommodation facilities a taxpayer has, the more likely that a taxpayer will be considered to be carrying on a business. The business should be large enough to make it commercially viable. You expect to sell villa 1 for $X,XXX,XXX. In the 20XX-XX income year you received a gross income of $XX,XXX and you made a net profit of $XX,XXX. Your activities demonstrate limited scale and permanency evident by the net losses that occurred prior to and during the 20XX-XX income years and small positive return you have achieved in the 20XX-XX income year compared to the labour and capital you devoted to your activity. ● Activities of the same kind and carried on in a similar manner to those of the ordinary trade in that line of business If a taxpayer carries out their activity in a manner similar to other taxpayer in the industry, it is more likely that their activity amounts to the carrying on of a business. That is, the taxpayer’s operations are of the same kind and carried on in the same way as those characteristic of ordinary trading in that particular line of business (IR Commissioners v Livingston 11 TC 538). A feature indicating that your activity is not carried out in a similar manner to other businesses in the industry is that the ground floor flat that connects with villa 1 is utilised by you when visiting your villas, therefore reducing your income earning capacity. The use of villa 1 is essential to the efficient conduct of a business. You have indicated that booking agents don’t accept bookings in relation to the ground floor flat and during the period in which you reside in the flat it is not available for commercial hire. ● Planned, organised and carried out in a business-like manner Activities are more likely to amount to the carrying on a business where they are carried out in a systematic and organised manner. This involves such matters as advertising for customers in a consistent and systematic manner, maintaining operations on a consistent basis, retaining and pursuing profitable activities, discontinuing unprofitable activities and keeping appropriate business records. You devote around XX hours per week to your activities. You don’t have a business plan, but have procedures and financial data that allows you to compare income and expenses with your forecasted budget. Some of your activities demonstrate a business- like approach such as engaging agents to take bookings using a shared booking platform; engaging, training and supervising contractors who provide valet, cleaning and other services to your villas; and accepting bookings directly and on your website and other websites you are affiliated with. However, there is not the repetition and regularity in undertaking activities aimed at generating a profit due to: ● Loan repayments you made in relation to villa 1 from the 20XX-XX to and including the 20XX-XX income years resulted in a net loss. ● Your income earning capacity is restricted by the expenses you incur in travelling to villa 1, engaging contractors on your behalf to operate various aspects of the operation and the restrictions placed on the ability to derive income from the hire of the downstairs flat that adjoins villa 1. Overall, you have not demonstrated systematic trading pattern aimed at generating a profit, nor were your operations carried out in a business like or sophisticated manner to be considered a business. | Summary: You are not using villa 1 in the course of carrying on a business of providing short term accommodation and you do not satisfy the active asset test. | Detailed Reasoning - Small Business capital gain tax concessions: The basic conditions for the small business capital gains tax concessions in Subdivision 152-A of the ITAA 1997 are: ● A CGT event happens in relation to a CGT asset of yours in an income year; and ● The event will result in a capital gain; and ● You are either a small business entity for the income year or you satisfy the maximum net asset value test; and ● The CGT asset satisfies the active asset test. | Detailed Reasoning - 15 Year small business concession: Section 152-105 of the ITAA 1997 states that you can disregard a capital gain from a CGT event happening to a CGT asset you have owned for at least 15 years if you: ● Satisfy the basic conditions Subdivision 152-A of the ITAA 1997 ● Continuously owned the CGT asset for the 15 year period ending just before the CGT event happened; and ● If you are an individual – you are at least 55 years old at the time of the CGT event and the event happens in connection with your retirement, or – you were permanently incapacitated at the time of the CGT event. | Detailed Reasoning - Active asset test: A CGT asset is an active asset at a time if: a. 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: (i) you; or (ii) your affiliate; or (iii) another entity that is connected with you; or b. ……….. 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 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. Subsection 152-40(4)( e) of the ITAA 1997 excludes certain assets from being active assets, such as assets whose main use is to derive rent. | Detailed Reasoning - Is the renting of short term accommodation considered an active asset?: Paragraph 152-40(4)(e) of the ITAA 1997 provides that an asset whose main use is to derive rent cannot be an active asset, unless that main use is 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. Taxation Determination TD 2006/78 (TD 2006/78) discusses the circumstances in which a premises used in a business of providing accommodation for reward may satisfy the active asset test, notwithstanding the exclusion mentioned above. 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 lessee to a lessor for the use of the leased premises (C.H. Bailey Ltd v. Memorial Enterprises Ltd 1 All ER 1003 at 1010; United Scientific Holdings Ltd v. Burnley Borough Council 2 All ER 62 at 76, 80, 86, 93, 99); ● a tenant's periodical payment to an owner or landlord for the use of land or premises (Australian Oxford Dictionary, 1999, Oxford University Press, Melbourne); ● recompense paid by a tenant to a 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 (Halsbury's Laws of England 4th Edition Reissue, Butterworths, London 1994, Ch 27(1) 'Landlord and tenant', paragraph 212). A key factor 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 will not be 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. 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 (Radaich v. Smith (1959) 101 CLR 209), ● 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. Aller (1966) 1 NSWR 572, Appah v. Parncliffe Investments Ltd [1964] 1 All ER 838 and Marchant v. Chaters [1977] 3 All ER 918). In Carson v FCT (2008) AATA 156 (Carson’s Case), the taxpayers provide short-term tourist accommodation to the public. The subject asset was one unit, presumably within a group of residential units. Occupants generally stay for one or two weeks. Crockery, cutlery and linen are included but cleaning is 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. 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, the activity is likely to be viewed as a passive investment activity . | Detailed Reasoning - Application to your circumstances: Applying the basic small business concessions under section 152A of the ITAA 1997 to your circumstances, you meet two of the four conditions of this section, as you are the owner of the CGT asset (villa 1) and when you dispose of villa 1, CGT event A1 will occur. You do not meet the other two basic conditions of section 142A of the ITAA 1991: 1. You do not meet the small business entity or maximum net asset value test as villa 1 is not being used or held ready for use in a business carried on by you. 2. You are not holding or using villa 1 to conduct a business under the active asset test. Your circumstances are similar to Carson case, in that additional services are not provided to guests, such as providing meals, changing linen and cleaning villa 1.In most cases you undertake cleaning or provide clean linen or other supplies when the guests have left, unless the guests have made a request. While some services are provided for the guests, the majority of the activities undertaken are in relation to the ensuring that the villas are in readiness for the arrival and stay of the guests. Given that you and a contract manager you engage are not physically located onsite, the guests have exclusive occupation of villa 1 during their stay. Having regard to all the facts of this situation, we consider that the relationship between you and the guests is more properly characterized as that of landlord/tenant. We consider guests would believe they have exclusive possession of villa 1 for the duration of their stay. Accordingly the main use of villa 1 is to derive rent. It is therefore not considered an active asset for the purposes of the small business concessions. | Detailed Reasoning - Conclusion: You are not considered to be carrying on a business of providing short term accommodation for the time that you have owned villa 1. A lack of significant commercial purpose and a prospect of profit largely indicate that a business is not being carried on. Additionally, the value adding services that you offer are not extensive or sufficient enough to change the character of the relationship between you and guests staying at villa 1from that of landlord/tenant. You would be considered as deriving rent and villa 1 would not be considered to be an active asset. Accordingly, you are not able to apply the 15 years small business exemption and disregard the capital gain made on the sale of villa 1. However, any capital gain derived on the sale of villas 1 can be reduced by the 50% individual CGT discount as you have owned the villa 1for longer than 12 months.