Edited version of private ruling

Authorisation Number: 1011821758724

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Ruling

Subject: Active asset test

Question

Does the sale of your property satisfy the active asset test under section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following period

Year ending 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

You own a few residential properties which are used in your business for short term rentals. The properties are situated close by to each other and contain living and sleeping accommodation much in the manner of a standard house.

You have sold one of the properties used in your business.

Your business has its own:

• ABN

• business premises (centrally located)

• logo, letterhead, stationery

• bank account

• business records, and

• website

Once a customer advises that they wish to take up accommodation, rather than a lease agreement being entered into, you dispatch an invoice to the customer which states the duration of the stay, the amount to be paid (including a security deposit), and that the amount is due seven days before the stay commences. You have operated these properties in this way ever since they were acquired.

The average length of stay in the properties is seven nights. Some stays are as long as three months, but on the other hand some are as short as one night.

You run the enterprise as a business and take a totally hands-on role including:

• personally taking the bookings of the customers

• personally meeting the customers at the property and showing them around when they first check-in (like a porter at a motel), and

• personally checking the customers in and out of their accommodation, including conducting a final departure check.

You also provide many ongoing services throughout the stays including:

• changing linen as and when required

• constantly interacting with customers during their stay with advice on local amenities, sights, etc. (much like a concierge in a hotel), and

• paying all utility expenses such as gas, electricity and water.

You advertise that a weekly clean is available at an additional cost should the guest desire this service.

As well as changing the linen as and when required (entering the premises with your own key, with no notice when undertaking this task). You have stated you retain a significant degree of control over the premises for example:

• you have a copy of the keys to all premises

• you claim that you are not required to give the customer any advance notice whatsoever before entering any of the premises, and

• you claim that you let yourself into the premises (giving no advance notice) to brief tradespeople undertaking maintenance on any of the premises.

While no meals are provided to clients, you pay for all utilities (e.g. water and electricity).

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 152-10

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

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 capital gains tax (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 Subdivision 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. Subsection 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. 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 Subdivision 152-D:

1. Is the predominant use of the property to derive rent?

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

We will not address question two as you have advised that your activity constitutes a business and that the property was used in your 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).

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). 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 will not be 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 unlikely to be rent.

For example, if premises are operated as a boarding house, the issue arises as to whether an occupant of part of the premises is a tenant or alternatively only a lodger/boarder with a licence to occupy. Similarly, if residential units are operated as holiday apartments, the issue arises as to whether the occupants of the apartments are tenants/lessees or only have licences to occupy. These will be questions of fact. Relevant factors to consider (in addition to whether the occupier has a right to exclusive possession) include the degree of control retained by the owner and the extent of any services provided by the owner such as room cleaning, provision of meals, supply of linen and shared amenities ( Allen v Aller (1966) 1 NSWR 572), Appah v Parncliffe Investments Ltd [1964] 1 All ER 838 and Marchant v Charters [1977] 3 All ER 918).

Many arrangements involving holiday apartments are unlikely to be active assets because no business is being carried on or, even if a business is being carried on, it amounts to the derivation of rent. In Carson & Anor v FC of T [2008] AATA 156, the taxpayers contended that the use of a unit to provide short-term tourist accommodation was the carrying on of a business and therefore that it was an active asset. The AAT did not agree and concluded that the unit was mainly used to derive rent. The AAT observed that the taxpayers' activities had all the earmarks of maintaining and deriving an investment rather than the carrying on of a business; activities such as financing the property, dealing with rating authorities and the body corporate were no more than any investor in real estate would do.

In Tingari Village North Pty Ltd v FC of T [2010] AATA 233, the AAT held that the amounts paid by residents of a mobile home park in return for the right to occupy residential sites were payments of rent and, therefore, the mobile home park was not an active asset. The AAT held that there were compelling reasons for concluding that the payments were rent including the nature of the prescribed agreement between the mobile home park owner and resident, the relevant governing Act, the mobile home park owner's agreement to give vacant possession to a resident on a certain date, the grant of exclusive possession to the resident, the resident's right of quiet enjoyment, and the use of the residential site as the resident's "principal place of residence".

In your case, the property was used in your business. You provided some services including changing of linen, giving advice on local amenities and paying utility expenses.

You have advised that no lease agreement was entered into prior to taking up the accommodation and that you issue invoices to customers which states the duration of the stay. You have stated that you are able to enter the property without giving notice to undertake tasks such as changing linen, briefing tradespeople etc. Although there is no evidence to suggest this is the case.

The AAT found in Carson & Anor v FC of T [2008] AATA 156 in relation to whether the occupier had the right to exclusive possession or only a license to occupy (ie whether there was a landlord/tenant relationship). In this instance, although no formal agreement was signed, there was a landlord/tenant relationship in that the occupants of the unit would no doubt regard themselves as having rented the unit and having exclusive possession thereof.

The property is a residential home in a suburban area. You provide minimal services through your business which is not located on site. We consider guests who stayed at the property would believe, although no formal agreement was signed, that they had exclusive possession of the property for the duration of their stay. We consider the income derived from the property to be rent.

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. The property will not satisfy the active asset test under section 152-35.

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