Active asset test
This information may not apply to the current year. Check the content carefully to ensure it is applicable to your circumstances.
End of attention
The active asset test requires the CGT asset that gave rise to the capital gain to be an active asset, both at a particular time and for half a particular period.
To satisfy the active asset test, a CGT asset must have been an active asset of yours just before the earlier of:
- the CGT event, and
- when your business ceased - if the CGT event happens within 12 months (or any longer period that the Commissioner allows) of your business ceasing.
Further, the CGT asset must have been an active asset for at least half of the period:
beginning at the later of:
- when you acquired the CGT asset, and
- 15 years before the CGT event or when your business ceased, whichever occurred earlier
and ending at the earlier of:
- the time of the CGT event, and
- when your business ceased.
Broadly, this means that if your business has not ceased and you have owned the asset for less than 15 years, the CGT asset must be an active asset just before the CGT event and for at least half of the period of ownership. If you have owned the asset for more than 15 years, it needs to be an active asset only for at least half of the 15-year period ending at the time of the CGT event (or when the business ceased, if earlier).
The words 'just before' as used in the active asset test mean 'immediately before'. For example, if a business has not ceased, the test requires the CGT asset to be an active asset immediately before the CGT event. If the asset stops being an active asset shortly before it is sold, it will not satisfy the active asset test.
Laura, a sole trader, carried on business from premises she owned. The premises had been used only for business purposes. Due to expansion of the business, Laura vacated the premises and moved into larger premises across the street. Shortly after moving, Laura entered into a contract to sell the original premises.
In this case, immediately before their sale, the premises were not used, or held ready for use, in Laura's business (because Laura had moved to other premises). Accordingly, the premises were not an active asset 'just before' the CGT event (sale of the premises) and therefore do not satisfy the active asset test. The small business CGT concessions are not available in this situation.
Cessation of a business
For the purposes of the active asset test, the cessation of a business includes the sale of a business. That is, it is not limited to a business that ends in the sense that no-one continues to carry it on but also includes a business that has ceased to be carried on by an entity because the entity has sold that business.
This aspect of the active asset test allows some flexibility in the situation where a business is sold, or has otherwise ceased, and an asset previously used in the business is sold after that time. As the asset would no longer be an active asset after the business ceases, it would fail the 'just before the CGT event' part of the test. The 'just before cessation of the business' alternative allows an asset that was used in the business up until the time of the sale of the business to satisfy the active asset test if the other aspects of the test are also satisfied.
For the cessation of the business alternative to apply, the CGT event must happen within 12 months of the business ceasing or any longer period the Commissioner allows. If the CGT event happens outside the 12-month period, you need to seek an extension of time from the Commissioner. Extension of time requests are considered on the merits of each case.
Jane carried on a business from premises she owned. In June 2003 she sold the business but retained ownership of the premises. In December 2003 Jane sold the premises and made a capital gain. As Jane sold the premises within 12 months of selling the business and the premises were an active asset just before the sale of the business, the premises can satisfy the active asset test if the other aspects of the test are also satisfied.
Asset devolved to legal personal representative
If a person carrying on a business dies and their assets devolve to their legal personal representative, the active asset test is applied to the legal personal representative in relation to any capital gain made on a sale of the assets by the legal personal representative.
Arthur carried on a business for many years from premises he owned. In 2002 he died and the business ceased at that time. Six months later, the legal personal representative of Arthur's estate sold the premises and made a capital gain.
As it was the legal personal representative who made the capital gain, the active asset test was applied to them. In this situation, the premises were not an active asset (that is, used in a business) of the legal personal representative just before their sale because the legal personal representative did not continue to carry on the deceased's business. As well, the premises were not an active asset of the legal personal representative just before the business ceased because at that time they were not an asset of the legal personal representative at all (but were still owned by Arthur).
Accordingly, the business premises did not satisfy the active asset test in relation to the capital gain made by the legal personal representative when they sold the premises.
Continuing time periods for active asset test for involuntary disposals
There are modified rules to determine if the active asset test is satisfied for CGT assets acquired or transferred under the rollover provisions relating to assets compulsorily acquired, lost or destroyed or to marriage breakdown (Subdivisions 124-B and 126-A of the ITAA 1997 respectively).
If you acquired a replacement asset to satisfy the rollover requirements for the compulsory acquisition, loss or destruction of a CGT asset, the replacement asset is treated as if:
- you acquired it when you acquired the original asset, and
- it was an active asset at all times when the original asset was an active asset.
If you have a CGT asset transferred to you because of a marriage breakdown, and the capital gain arising from that transfer was rolled over under the marriage breakdown rollover provisions, for purposes of the active asset test you can choose whether to:
- include the ownership and active asset periods of your former spouse, or
- commence the ownership and active asset periods from the time the asset was transferred to you.
If you choose to include your former spouse's ownership and active asset periods of the CGT asset, that asset is treated as if it had been:
- acquired by you when your former spouse acquired the asset, and
- an active asset of yours at all times when the asset was an active asset of your former spouse.
Modified active asset test for CGT event D1
A modified active asset test applies if you make a capital gain from CGT event D1 (about creating rights in another entity). The active asset test requires you to own the CGT asset before the CGT event happens. However, under CGT event D1, the relevant CGT asset (the rights) are created in the other entity without you owning them so it would not be possible to satisfy the active asset test.
Accordingly, the test is modified to require the right you create that triggers the CGT event to be inherently connected with another CGT asset of yours that satisfies the active asset test.
Meaning of active asset
A CGT asset is an active asset if it is owned by you and is:
- used or held ready for use by you, your small business CGT affiliate, or an entity connected with you, in the course of carrying on a business, or
- an intangible asset that is inherently connected with a business you carry on, for example, goodwill.
An intangible asset you own that is used, or held ready for use, in the course of carrying on a business by your small business CGT affiliate or an entity connected with you may also be an active asset.
Hagar carries on an ocean cruise business called North Sea Adventures. He purchased waterfront land on 1 January 1990 but initially used it for family holidays and not in the business. On 1 January 1994 Hagar started using the land in the business for launching his boats and carrying out necessary repairs and maintenance. He continued to do so until 1 January 2000, when he sold the land and made a capital gain.
The land satisfies the active asset test as it was used in Hagar's business just before he disposed of it and for at least half the period he owned it, that is, for six out of the 10 years he owned it.
Shares and trust interests may also be active assets
A CGT asset is also an active asset at a given time if you own it and:
- it is either a share in a company that is an Australian resident at that time or an interest in a trust that is a resident trust for CGT purposes for the income year in which that time occurs, and
- the total of
- the market values of the active assets of the company or trust, and
- any capital proceeds the company or trust received during the two years before that time from CGT events happening to active assets the company or trust holds in the form of cash or debt pending the acquisition of new active assets
is 80% or more of the market value of all the assets of the company or trust.
This means a share in a company or an interest in a trust is an active asset if the company or trust itself has active assets with a market value of at least 80% of the market value of all its assets. Including capital proceeds from any recent sale of active assets in the 80% test provides some flexibility where the total market value of the active assets of the company or trust temporarily drops below 80% between the time active assets are sold and new active assets acquired.
The active asset test requires a CGT asset to have been an active asset for at least half of a particular period, as outlined earlier. For example, for a share in an Australian resident company to meet this requirement, the company must satisfy the 80% test for that same period.
Jack and Jill are the only shareholders of Hill Water Supplies Pty Ltd, an Australian resident company that carries on a water supply business. The market values of the company's CGT assets are as follows:
Rental property (not an active asset)
The total market value of the company's active assets is $900,000 which is more than 80% of the total market value of all the company's assets. Jack and Jill's shares in the company are therefore active assets.
The company sells its water filtration plant (for its market value of $200,000) and then immediately contracts to purchase new plant, which is delivered and installed two months later. The funds from the sale are held in the company's bank account before being used to pay for the new plant.
In this situation, although the market value of the company's active assets may drop below the 80% mark, the $200,000 capital proceeds held in the form of debt pending the acquisition of the new plant are included in the calculation. This means the 80% test is satisfied.
Although gains from depreciating assets may be treated as income rather than capital gains, depreciating assets such as plant are still CGT assets and may therefore be active assets and included in the 80% test.
End of attention
Interests in holding entities
An interest in an entity that itself holds interests in another entity that operates a business may be an active asset depending on the successive application of the 80% test at each level.
Ben owns 100% of the shares in Holding Co which, in turn, owns 100% of the shares in Operating Co (both are resident companies). The only assets of Holding Co are the shares in Operating Co and all of Operating Co's assets are active assets.
As Operating Co satisfies the 80% test, the shares owned by Holding Co in Operating Co are active assets. As those shares are the only assets owned by Holding Co, Holding Co also satisfies the 80% test and therefore the shares owned by Ben in Holding Co are also active assets.
If Ben sold the shares in Holding Co, all the small business concessions may potentially apply to any gains made. However, if Holding Co sold its shares in Operating Co, none of the concessions can apply because Operating Co does not have a controlling individual. Also, if Operating Co sold its active assets, only the 50% active asset reduction and the small business rollover can apply, again because Operating Co does not have a controlling individual. For more information see the controlling individual requirements.
End of attention
Certain assets 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, other than those that satisfy the 80% test outlined above
- financial instruments, such as loans, debentures, bonds, futures and other contracts and share rights and options, or
- 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).
Financial instruments exception
Other examples of financial instruments include bank accounts and Australian currency.
The main effect of these items not being active assets is that, generally, they can not be included in the 80% test when determining whether shares in companies or interests in trusts are active assets. However, as noted earlier, there is an exception if the funds in a bank account or Australian currency on hand (that is, debt or cash):
- represent capital proceeds received in the previous two years from CGT events happening to active assets, and
- are held pending the acquisition of new active assets.
Main use to derive rent exception
As already noted, an asset whose main use is to derive rent (unless that main use is only temporary) cannot be an active asset. This is so even if the asset is used in the course of carrying on a business. Of course, if the activities carried on do not amount to carrying on a business, you do not need to even consider whether the main use of the asset is to derive rent. You therefore must firstly determine whether a business is being carried on.
Whether an asset's main use is to derive rent will depend on the particular circumstances of each case. The term 'rent' has been described as referring to the payments made by a tenant/lessee to a landlord/lessor for exclusive possession of the leased premises. As such, 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. If, for example, 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.
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 (only) used by Rachael to derive rent. It is irrelevant whether Rachael's activities constitute a business.
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.
Last modified: 10 Sep 2007QC 27357