Private ruling: Income tax – capital gains tax – small business concessions
Date of advice: 3 May 2019
Published: June 2019
Ruling period: Year ended 30 June 2019
Date scheme commenced: 1 July 2018

Ruling: Q1: Are the commercial properties considered to be active assets for the purposes of the small business capital gains tax (CGT) concessions? | A1: No.

Relevant facts and circumstances: You own commercial properties which have been held and marketed, managed and maintained since acquisition. The properties consist of warehouses and renovated office/retail space. There are several tenants that occupy these spaces. The tenants are granted the right of exclusive possession. There is a significant amount of administration and maintenance required for the properties given the number and variety of tenants. You are responsible for regularly maintaining and directly administering the properties, as no agent is used. Repairs and maintenance of the properties is required regularly. You keep business/financial records of the activity in dedicated bookkeeping software, including invoicing, debtor management, creditor management, and bank reconciliations. You carefully consider tenants prior to signing lease agreements. The rent charged is carefully considered and researched in relation to the prevailing market conditions. You spend approximately X hours per week respectively each week to manage the properties.

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 152-40(1) | Income Tax Assessment Act 1997 subsection 152-40(4) | Income Tax Assessment Act 1997 paragraph 152-40(4)(e) | Income Tax Assessment Act 1997 section 995-1

Reasons for decision: Summary: Subsection 152-40(1) of the Income Tax Assessment Act 1997 (ITAA 1997) details that a CGT asset is an active asset at a time if it is used, or held ready for use, in the course of carrying on a business that is carried on by you, or your affiliate, or another entity that is connected with you. | 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. Whether the letting of property amounts to the carrying on of a business will depend on the circumstances of each case. A person, who simply owns an investment property or several investment properties, either alone or with other co-owners, is usually regarded as an investor who is not carrying on a rental property business. This is because of the limited scope of the rental property activities and the limited degree to which an 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 Cripps v FC of T 99 ATC 2428; (1999) 43 ATR 1202 (Cripps case), the taxpayer and his wife purchased, as joint tenants, 14 townhouses which they rented out. They also purchased a property which was used initially as a holiday home but was later periodically rented out. A further property was purchased for residential purposes. After a failed attempt to sell it, it was also rented out. The Administrative Appeals Tribunal found that the taxpayer and his wife were mere passive investors and were not in the business of deriving income from rental properties. They rejected the taxpayer's argument that he had greater involvement with his 16 properties. In 11 CTBR (OS) Case 24 (Case 24) , the taxpayer's income included rents from three properties. The taxpayer employed a manager and an accountant - he 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, &c., 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’.... Taxation Ruling TR 97/11 Income Tax: am I carrying on a business of primary production? provides the Commissioners view of the factors used to determine if a taxpayer is in business for tax purposes. Its principles are not restricted to questions of whether a primary production business is being carried on. In the Commissioner's view, the factors that are considered important in determining the question of business activity are: ● 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. Based on the information and documentation provided, and weighing up the relative business indicators and objective factors to your case, it is the Commissioner’s view that your rental property activities are those of a mere passive investor. Therefore, your rental property activities are not those of a taxpayer carrying on a business of letting rental properties. While you have provided details of a number of activities you carry out in relation to earning rental income from your properties, these activities are all part of maintaining rental properties and do not constitute carrying of a business. | Detailed Reasoning - Main use to derive rent: Certain assets are excluded from being active assets under subsection 152-40(4) of the ITAA 1997. An asset whose main use is to derive rent (unless such use was only temporary) is excluded from being an active asset. Such assets are excluded even if they are used in the course of carrying on a business. 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 [1974] 1 All ER 1003 at 1010; United Scientific Holdings Ltd v Burnley Borough Council [1977] 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 4 th Edition Reissue, Butterworths, London 1994, Ch 27(1) ‘Landlord and tenant’, paragraph 212). Example 1 in Taxation Determination TD 2006/78 deals with commercial rental properties: Commercial Property Co owns 5 commercial rental properties. The properties have been leased for several years under formal lease agreements to various commercial tenants which have used them for office and warehouse purposes. The terms of the leases have ranged from 1 year to 3 years with a 3 year option and provide for exclusive possession. The company has not engaged a real estate agent to act on its behalf and manages the leasing of the properties itself. In this situation, the company has derived rental income from the leasing of a number of properties. Accordingly, the main (only) use of the properties is to derive rent and they are therefore excluded from being active assets under paragraph 152-40(4)(e) of the ITAA 1997 regardless of whether the activities constitute the carrying on of a business. 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 at 222). In the present case, the properties have been leased out to tenants and the tenants would be entitled to exclusive possession under that agreement. In this case, you rent the commercial properties to tenants who are granted exclusive possession. This situation is similar to the example provided in TD 2006/78. Therefore, regardless of whether or not the property is an asset used by you in the course of carrying on a business for the purposes of subsection 152-40(1), it cannot be regarded as an active asset as its main use is to derive rent. While a connected entity typically uses one of the tenancies in the properties, this use is considered to be incidental to their business activities. The properties are primarily used to derive rent and it is only in the event of a vacant tenancy that you use the property to store equipment and materials related to your building business. There is no dedicated area for the related business to operate from. It is considered that the properties are used primarily to derive rent and that the use by the connected entity is not substantial enough to prevent the main use of the properties from being the derivation of rent. Consequently, as the property is not an active asset, it does not satisfy the basic conditions for the small business CGT concessions.