Edited version of private ruling

Authorisation Number: 1011556185226

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Ruling

Subject: Capital gains Tax - Small Business Concessions

Question

Can you apply the Small Business Capital Gains Tax (CGT) concessions in Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of the disposal of your property?

Answer

No. Paragraph 152-40(4)(e) of the ITAA 1997 expressly excludes from the definition of an active asset an asset whose main use is to derive rent.

This ruling applies for the following period

1 July 2009 to 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

You registered a company. The company acquired land and constructed a facility consisting of a commercial factory, a commercial shopfront and storage units. For approximately five and a half years the company operated its own business from the commercial factory. Subsequently, the company's business ceased operating but the accommodation activities continued.

Both directors were involved in the administration, maintenance and cleaning of the facility. It is estimated that management activities required an average of thirty hours per week during that period.

Until recent years, the clients averaged six to eight months occupation. Thereafter, there was a change in direction. There was a greater focus on attracting long-term occupants. Over the two years prior to the sale of the facility there were a number of permanent occupants. The more stable user base reduced the management hours. The facility was subsequently sold.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-40

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part. If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Unless otherwise stated, all legislative references in the following Reasons for Decision are to the Income Tax Assessment Act 1997.

Summary

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 for the purposes of paragraph 152-40(4)(e). As the property is not an active asset, it does not satisfy the basic conditions for the small business CGT concessions.

Detailed reasoning

You have disposed of a property which you have used to derive income. You wish to know if such properties can be treated as active assets for the purpose of taking advantage of the small business CGT concessions. In order for you to choose to disregard all or part of a capital gain under the small business CGT concessions, certain conditions must be satisfied.

The first condition requires you to meet the basic conditions for the concessions in Sub-division 152-A. One of the basic conditions requires the relevant CGT asset to satisfy the active asset test in section 152-35. The meaning of an active asset is provided in section 152-40. Sub-section 152-40(1) states:

(1) 'A CGT asset is an active asset at a time if, at that time:

(a) you own the asset (whether the asset is tangible or intangible) 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) if the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

However, paragraph 152-40(4) (e) states that:

(4) the following CGT assets cannot be active assets:

an asset whose main use by you is to derive …rent, … unless:

(ii) its main use for deriving rent was only temporary.

Therefore, an asset whose main use in the course of carrying on a business is to derive rent is specifically excluded from being an active asset - unless deriving rent was only temporarily the main use of the asset. Whether an asset's main use is to derive rent will depend upon the particular circumstances of each case.

Therefore, two questions need to be considered before the property can be accepted as an active asset and eligible for the small business concessions under Sub-division 152-D:

· Is the predominant use of the property to derive rent?

· Is the property used by you in the course of carrying on a business?

There is no need to consider the second question above if the answer to the first is in the affirmative, as in that case the asset will not be considered to be active regardless of whether it is used in the course of carrying on a business or not.

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).

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, tenants are entitled, for all practical purposes, to exclusive possession under their agreement and the nature of the agreement entered into indicates that it constitutes a lease. In Radaich v Smith, in which an agreement was found to be a lease despite being described as a licence, it was found that the substance of an agreement would determine whether it constituted a lease rather than the terms in which it was described.

An examination of the facts in the present case indicates that a landlord/tenant arrangement existed between the company and the clients who occupied the asset. While there was a change in the permanency of the lettings, the nature of the relationship between the company and the occupants was unchanged in all relevant respects. Both before and after that time, the income earned would be considered to be rent.

The facts in this case can be distinguished from those in Example 2 of Taxation Determination TD 2006/78 in that the operator in that case provided goods and services which went beyond the mere provision of accommodation in that she, amongst other things, sold or let ancillary items and made available a regular cleaning service for a fee. In other words, the taxpayer was not merely providing accommodation and services necessarily or ordinarily provided in the course of a normal rental agreement.

During the initial period when the business was in operation, it is arguable that the facility may have constituted an active asset if the income earned from it came primarily from the business and not from the other activities. However, even in that case the facility would not pass the active asset test as the requirement in paragraph 152-35(1)(b) that an asset held for more than fifteen years be an active asset for at least seven and a half years would not be met.

Accordingly, the amounts received by you from the property constitute rent and, as the property was not used by you for other purposes for the majority of the period that it was held, the predominant use of the property was to derive rent. 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 for the purposes of paragraph 152-40(4)(e). As the property is not an active asset, it does not satisfy the basic conditions for the small business CGT concessions.

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