Meaning of active asset
A capital gains tax (CGT) asset is an active asset if you own it and:
- you use it or hold it ready for use in the course of carrying on a business (whether alone or in partnership)
- it is an intangible asset (for example, goodwill) inherently connected with a business you carry on (whether alone or in partnership).
A CGT asset is also an active asset if you own it and it is used or held ready for use in the course of carrying on a business or it is an intangible asset inherently connected with a business carried on, (whether alone or in partnership) by any of the following:
- your affiliate
- your spouse or child under 18 years
- an entity connected with you.
However, certain CGT assets cannot be active assets, even if they are used or held ready for use in the course of carrying on a business – for example, assets whose main use is to derive rent (unless the asset was rented to an affiliate or connected entity for use in their business). Generally a rental property will not be an active asset.
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When an asset is ‘held ready for use’
For an asset to be held ready for use in the course of carrying on a business, it needs to be in a state of preparedness for use in the business and functionally operative. As such, premises still under construction, or land upon which it is intended to construct business premises, could not be said to be 'held ready for use' and would, therefore, not be active assets at that time.
Example 1: Asset is not held ready for use
Margaret carried on business at various customer on-site locations. She acquired some land with the intention of constructing premises in which to carry on her business. Soon after Margaret acquired the land she was approached by another party that was keen to acquire the land. Margaret sold the land and made a capital gain. She was only part way through the construction of the premises at that time.
In this situation, the land was not held ready for use by Margaret in the course of carrying on her business at any time. It was not in a state of preparedness in which Margaret could carry on her business. This means that the land was not an active asset at any time.
End of exampleAssets that cannot be active assets
The following CGT assets cannot be active assets (even if they are used, or held ready for use, in the course of carrying on a business):
- shares in companies or interests in trusts, unless they satisfy the 80% test (see The 80% test)
- financial instruments, such as bank accounts, loans, debentures, bonds, futures and other contracts and share options (if a financial instrument is inherently connected with the business, it can count towards the satisfaction of the 80% test)
- assets whose main use is to derive interest, an annuity, rent, royalties or foreign exchange gains, unless the main use for deriving rent was only temporary or the asset is an intangible asset that you have substantially developed or improved so that its market value has been substantially enhanced.
- shares and trust interests in widely-held entities, unless held by a CGT concession stakeholder in the widely-held entity.
Trade debtors are not considered to be financial instruments for the purposes of the active asset exclusions. Rather, they are a business facilitation mechanism that assists in the conduct of the business and are inherently connected with the business. Accordingly, trade debtors can be included in the value of active assets when calculating the 80% test.
The 80% test
At least 80% of the market value of all a company or a trust’s assets are made up of the market value of the company or the trust’s:
- active asset
- financial instruments and cash that are inherently connected with the business.
Inherent connection
Inherent connection requires more than just some form of connection between the cash or financial instrument and the business. Examples of things inherently connected to a business include:
- when it is a permanent or characteristic attribute of the business, for example, goodwill, or trade debtors
- excess funds the business has as a result of a temporary spike in trading activity or the sale of a business asset
- a financial instrument that is inherently connected with a business that the owner of the financial instrument carries on, rather than any business a related entity carries on.
Example 2: Loan to a related company
Archimedes Pty Ltd is a manufacturing business. It lends $300,000 to a related company, Galileo Pty Ltd, to acquire various assets for use in the businesses of both companies.
Although the loan is made between members of a corporate group as part of the overall financing of the group, it is not a permanent or characteristic attribute of the business (which is manufacturing, not the acquisition of assets).
The loan is included in the total market value of all the assets, but not included as an active asset.
The market value of Archimedes Pty Ltd.'s active assets is $700,000 (without the loan) and the market value of all its assets (including the loan) is $1 million. The relevant calculation is:
- $700,000 ÷ $1 million = 70%
This means that the 80% test is not satisfied.
End of exampleTemporary breaches of the 80% test
The 80% test will be taken to have been met where the total market value of the active assets falls below 80% of the total market value of the company or trust and:
- this is only temporary in nature
- it is reasonable to conclude that the 80% threshold has been passed.
Depreciating assets, such as plant, are CGT assets. They can be active assets and included in the 80% test.
Example 3: Temporary breach due to borrowing money
John sells an active asset that meets the basic conditions and makes a capital gain. He acquires shares in Fruit and Veg Co, which runs his family business, as replacement assets. The shares meet the 80% test and, as a result, are active assets.
Sometime later, Fruit and Veg Co borrows money to pay a dividend, and fails the 80% test. Two weeks later they pay the dividend and the shares pass the 80% test again. For the interim two weeks the shares are treated as active assets, even though they do not pass the 80% test.
End of exampleWhere an asset's main use is to derive rent
An asset whose main use is to derive rent (unless that main use is only temporary) cannot be an active asset. This is the case even if the asset is 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. A key factor in determining whether an occupant of premises is a lessee paying rent is whether the occupier has a right to exclusive possession.
For example, 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 are 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 not likely to be rent.
An asset that is leased to a connected entity or affiliate for use in its business may still be an active asset. It is the use of the asset in that entity’s business that will determine the active asset status of the asset.
All uses of an asset are considered in determining what the main use of the asset is and, therefore, whether it is an active asset. However, personal use of the asset by the asset owner, or by an individual who is their affiliate, is not considered in determining the main use of the asset.
Example 4: Asset's main use is to derive rent
Rachael owns five investment properties which she rents to tenants under lease agreements that grant exclusive possession. The lease terms vary from six months to two years. The properties are not active assets because they are mainly used by Rachael to derive rent. It is irrelevant whether Rachael’s activities constitute a business.
End of example
Example 5: Asset's main use is not to derive rent
Michael owns a motel (land and buildings) which he uses to carry on a motel business. The motel provides room cleaning, breakfast, in-house movies, laundry and other services as part of the business. Guests staying in the motel do not receive exclusive possession, but simply have a right to occupy a room on certain conditions. The usual length of stay by guests is between one and seven nights. The motel would be an active asset because its main use is not to derive rent.
End of exampleThe following is considered use of the asset to derive rent, where the rent is derived:
- from an entity that is not an affiliate or connected with the asset owner (third party), or
- by an entity that is an affiliate or connected with the asset owner (relevant entity).
The use of the asset to derive rent from a third party will be considered use to derive rent, even if that entity uses the asset in their business. This is because the use of the asset by the asset owner is to derive rent.
However, use of the asset by a relevant entity is treated as the use by the asset owner, even if the asset owner receives rent from the relevant entity for the use of that asset.
This means, if the relevant entity uses the asset:
- in its business, that use is treated as use by the asset owner to carry on business
- to derive interest, rent, royalties, or foreign exchange gains from an entity that is a third party, that use is treated as use by the asset owner to derive passive income.
Example 6: Asset used by a relevant entity
Kiki owns a property and rents out 90% of the floor area to Lost Dog Pty Ltd that is neither her affiliate nor connected with her (ie a non-related third party). Kiki earns 90% of the revenue derived from owning the property from renting it to Lost Dog Pty Ltd.
Beaglehole Pty Ltd, which carries on a dog-grooming business, uses the remaining 10% of the floor area of the property as its business premises and pays Kiki rent for using it – this rent forms 10% of the revenue Kiki earns from owning the property. As Kiki owns 60% of Beaglehole Pty Ltd, Beaglehole is connected with Kiki.
Beaglehole Pty Ltd.’s use of that 10% of the property is treated as Kiki’s use because Beaglehole Pty Ltd is connected with Kiki. Because Beaglehole uses that part of the property as its business premises, Kiki is treated as using that part as business premises. This means that the rent Beaglehole Pty Ltd pays to Kiki is not treated as rent for the purposes of determining Kiki’s main use of the property.
However, Kiki’s main use of the property is to derive rent, because 90% of the revenue she derives from the property is rent received from Lost Dog Pty Ltd, a non-related third party.
Kiki’s property is not an active asset in these circumstances.
End of example
Example 7: Mixed use
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's appropriate to consider a range of factors. In this case, a substantial (although 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.
In all the circumstances, we consider 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.
End of exampleSee also:
A capital gains tax (CGT) asset is an active asset if you own it and you use it or hold it ready for use in the course of carrying on a business, or it is an intangible asset inherently connected with a business.