Edited version of private ruling

Authorisation Number: 1011577102601

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Ruling

Subject: Capital Gains Tax - Small Business Concessions

Question

Can a single hotel room, which forms part of a larger hotel complex, be considered an active asset for the purposes of the Small Business Capital Gains Tax (CGT) concessions in Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following period

1 July 2009 to 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

You purchased a unit in a hotel. It was operated as a hotel room providing short-term accommodation. Whilst you owned the unit, the hotel management managed the leasing of the room for which they charged a percentage of the accommodation fees which were received. Management then forwarded to you the fees received less their commission.

Income received was dependent upon the occupancy of the unit; no income was received for those periods when it was unoccupied. The unit was sold and a capital gain realised.

Relevant legislative provisions

Section 152-40 of the Income Tax Assessment Act 1997

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 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 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

Paragraph 152-40(4)(e) expressly excludes from the definition of an active asset an asset whose main use is to derive rent. 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 hotel room 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:

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

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:

· you; or

· your affiliate; or

· another entity that is connected with you; or

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:

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).

According to the generally accepted views of what constitutes rent, the amounts received by you from leasing the property were rent and, as the property was not used by you for any other purposes during the period that it was held, the predominant use of the property during that time was to derive rent. As a result, the asset is excluded from the small business concessions as a consequence of the operation of paragraph 152-40(4)(e).

Note:

It should be noted that even if the income derived from the property were not characterised as rent it would still be necessary for the income to be earned in the course of carrying on a business in order for the asset to qualify as an active asset.

The enterprise is a business to the entity which operates the hotel as an entirety and it would likely be an active asset to them as suggested by Example Four in Taxation Determination TD 2006/78. In your case, your unit would not amount to carrying on a hotel business when viewed in isolation from the scale of activity afforded by the large number of units made available by other owners.

In this case, the facts from your perspective can be distinguished from those in Example Four of TD 2006/78 in that, amongst other things, the operator in that case undertook a range of activities related to the running of the premises which extended beyond simple ownership of the let premises. In other words, the taxpayer was not merely providing accommodation and services necessarily or ordinarily provided in the course of a normal rental agreement.

A person who simply owns an investment property or several investment properties is usually regarded as an investor who is not carrying on a rental property business. That is because of the limited scope of the rental property activities and the limited degree to which an owner actively participates in such activities.

The issue has been considered in a number of cases. In Cripps v. FC of T 99 ATC 2428; (1999) 43 ATR 1202, 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.

In 11 CTBR (OS) Case 24, the taxpayer's income included rents from three properties. The taxpayer employed a manager and accountant. 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'

Income tax ruling IT 2423 considers whether rental income constitutes proceeds of a business. IT 2423 states:

A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations. An individual who derives income from the rent of one or two residential properties would not normally be thought of as carrying on a business. On the other hand if rent was derived from a number of properties or from a block of apartments, that may indicate the existence of a business.

Taxation Ruling TR 93/32 is about rental property and division of net income or loss between co-owners. TR 93/32 quotes from the judgement in Federal Commissioner of Taxation v McDonald (1987) 18 ATR 957; 87 ATC 4541, were Beaumont J said at ATR p 968; ATC p 4550:

The reference to "business" . . . indicates a "commercial enterprise as a going concern": see Hope v Bathurst City Council (1980) 144 CLR 1 at 8; 12 ATR 231 at 236 per Mason J. Purely domestic transactions are thus excluded from the definition: see Fletcher, op cit p 28. The "business" must be "carried on". This suggests some active occupation or profession: see IRC v The Marine Steam Turbine Co Ltd (1919) 12 TC 174 per Rowlatt J at 179.' . . . 'On the other hand, in the case of a private individual as distinct from a company, "it may well be that the mere receipt of rents from properties that he owns raises no presumption that he is carrying on a business."

and at ATR page 969; ATC page 4552, where Beaumont J continued:

Their investment involved little, if any, active participation from either party ... This was not a case of the active joint participation by the parties in a business activity. Rather, it was a case of a renting out of premises without the provision of other services of the kind discussed in Wertman, supra. In my view, there was here a mere investment in property rather than a partnership in the properties or their profits.

The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the particular facts.

Taxation Ruling TR 97/11 outlines some factors that indicate whether or not a business of primary production is being carried on. These factors equally apply to other types of businesses. No individual factor is determinative, but should be weighed up in conjunction with the other factors. These factors are outlined as follows:

· the nature of the activities, particularly whether they have the potential of profit making,

· the repetition and regularity of the activities,

· organisation in a business-like manner and the keeping of records,

· the size and scale of the activity, and

· the amount of capital employed.

As shown in the legal cases and the views of the Commissioner above, the indicators with the greatest weighting are the scale or volume of operations and the repetition and regularity of activities performed. An individual who derives income from the rent of one or two properties would not normally be thought of as carrying on a business. An ordinary business of properties involves more than mere ownership of a unit. Also, the quantum of rental income derived does not affect the characterisation of the activity.

After considering your specific circumstances, it is considered that your activities are not carried on as a business for taxation purposes. We acknowledge that the hotel offers short tem traveller accommodation. However your activities are not conducted on a sufficient scale to be considered to be a business. You own one unit in the complex. That is not considered to be of a scale to take the activity beyond a passive income-producing property particularly given that you are not actively involved in the management of the unit at the resort, responsibility for which has been delegated to hotel management.

Even if it were not excluded by the operation of paragraph 152-40(4)(e), the asset is not held in the course of carrying on a business for the purposes of paragraph 152-40(1)(a). As the property is not an active asset, it does not satisfy the basic conditions for access to the small business CGT concessions.

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