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Ruling

Subject: Income Tax: capital gains tax - active asset, residential property used in a business for the provision of employee accommodation.

Question 1

Would a residential property you propose to acquire and lease to X Co Pty Ltd (X Co) to be used in X Co's business by providing accommodation to their employees, an 'active asset' under section 152-40 of the Income Tax Assessment Act 1997?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 2012.

The scheme commences on:

1 July 2011.

Relevant facts and circumstances

You hold assets for lease to other entities, including entities that you are 'connected with'.

You are 'connected with' X Co within the meaning set out under section 328-125 of the ITAA 1997. X Co is a trading company that operates in Australia.

X Co provides accommodation to its employees. At this time X Co rent a number of residential properties from third parties in order to house its employees.

Arising from a need to secure additional accommodation for X Co's employees, it is proposed that you will purchase a residential property and lease that property to X Co. It is proposed that X Co will pay you rent on an arms-length commercial basis. No business activity would be conducted from the residential property.

The proposed residential property is in a remote location within Australia. The property consists of a 4 bedroom, 1 bathroom house with a carport. The proposed property does not possess any unique features.

X Co will use the proposed property to house employees who will be required to be sourced from other areas of Australia. The property will not be inhabited by non-employees.

It is proposed that the rights and obligations of the employees under any rental property agreement will be consistent with existing rental property agreements with employees. Those contracts require the employee to pay a bond, however the employee is not required to make payments of rent.

It is proposed that due to the expected longevity of carrying on a business in the area, you will hold the property for at least 5 years.

For the purpose of determining whether you satisfy the basic conditions for relief under section 152-10 of the ITAA 1997, at least one of the circumstances under paragraph 152-10(1)(c) of the ITAA 1997 applies to you.

The provision of the proposed property to X Co's employees constitutes an exempt housing benefit in terms of the Fringe Benefits Tax Assessment Act 1986 as the arrangement falls within the remote area housing guidelines.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Subsection 152-10(1)

Income Tax Assessment Act 1997 Paragraph 152-10(1)(c)

Income Tax Assessment Act 1997 Paragraph 152-10(1)(d)

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Subsection 152-40(1)

Income Tax Assessment Act 1997 Paragraph 152-40(1)(a)

Income Tax Assessment Act 1997 Subparagraph 152-10(1)(d)(ii)

Income Tax Assessment Act 1997 Paragraph 152-10(1)(b)

Income Tax Assessment Act 1997 Subparagraph 152-40(1)(a)(iii)

Income Tax Assessment Act 1997 Subsection 152-40(4)

Income Tax Assessment Act 1997 Paragraph 152-40(4)(e)

Income Tax Assessment Act 1997 Subsection 152-40(4A)

Income Tax Assessment Act 1997 Section 328-125.

Reasons for decision

These reasons for decision accompany the Notice of private ruling.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Detailed reasoning

General discussion of the law

Small business relief

Division 108 of the Income Tax Assessment Act 1997 (ITAA 1997) defines the various categories of assets relevant for capital gains tax (CGT) purposes. Section 108-5 of the ITAA 1997 provides that a 'CGT asset' includes any kind of property, examples of which include land and buildings.

In order to access small business relief available in Division 152 of the ITAA 1997 to reduce or disregard a capital gain, you must satisfy the basic conditions for relief under subsection 152-10(1) of the ITAA 1997, which include:

…(c) at least one of the following applies:

(i) you are a *small business entity for the income year;

(ii) you satisfy the maximum net asset value test (see section 152-15);

(iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership;

(iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year;

Note:

For determining whether an entity is a small business entity, see Subdivision 328-C (as affected by sections 152-48 and 152-78).

(d) the CGT asset satisfies the active asset test (see section 152-35)…

In addition, as the relevant CGT asset must satisfy the active asset test in section 152-35 of the ITAA 1997, it is necessary to determine that the CGT asset is an 'active asset'. Subsection 152-40(1) of the ITAA 1997 provides that a CGT asset is an active asset at a given time if, at that time, you own it and:

…(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 View history reference

(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, certain assets are excluded from being active assets under subsection 152-40(4) of the ITAA 1997.

Exclusion - main use to derive rent

Paragraph 152-40(4)(e) of the ITAA 1997 excludes, among other things, assets whose main use is to derive rent (unless such use was only temporary). Such assets are excluded even if they are used in the course of carrying on a business.

However, if the activities carried on do not amount to the carrying on of a business, it is unnecessary to consider whether the main use of the asset is to derive rent.

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 follows:

the amount payable by a tenant to a landlord 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, 86, 93, 99);

a tenant's periodical payment to an owner or landlord for the use of land or premises ( The Australian Oxford Dictionary , 1999, Oxford University Press, Melbourne); and

recompense paid by the tenant to the 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 4th Edition Reissue, Butterworths, London 1994, Vol 27(1) 'Landlord and Tenant', paragraph 212).

A key factor therefore 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, 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 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 unlikely to be rent.

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.

Ultimately, these are questions of fact depending on all the circumstances involved. Relevant factors to consider in determining these questions (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).

Use by a connected entity

Following amendments to the ITAA 1997 in June 2009, for CGT events happening after 23 June 2009, all uses of the asset are considered when working out an asset's main use.

For the purposes of paragraph 152-40(4)(e) of the ITAA 1997, in determining the main use of an asset subsection 152-40(4A) of the ITAA 1997 provides that you:

(a) disregard any personal use or enjoyment of the asset by you; and

(b) treat any use by your *affiliate, or an entity that is *connected with you, as your use.

Taxation Determination TD 2006/63 sets out the Commissioner's view regarding whether a CGT asset that is leased by a taxpayer to a connected entity for use in the connected entity's business was an active asset under section 152-40 of the ITAA 1997.

TD 2006/63 discusses that if a CGT asset is leased by a taxpayer to a connected entity for use in the connected entity's business, the question arises as to whether the main use of the asset by that connected entity is to derive rent.

For example, where an entity leases land to another entity that is a connected entity for use in that entity's business, the use of the land by the connected entity is examined. In this example, the land is considered to be used in the course of carrying on a business and will not be excluded by paragraph 152-40(4)(e) of the ITAA 1997.

Application of the law

At least one of the circumstances under paragraph 152-10(1)(c) of the ITAA 1997 applies to you such that, apart from paragraph 152-40(1)(d) of the ITAA 1997, you would otherwise satisfy the basic conditions for relief under section 152-10 of the ITAA 1997.

In the first instance, the residential property that it is proposed you will acquire and lease to X Co, would clearly be held for the purpose of deriving rent. Therefore that residential property would ordinarily be excluded under paragraph 152-40(4)(e) of the ITAA 1997.

However, in accordance with subparagraph 152-40(1)(a)(iii) of the ITAA 1997 and consistent with the Commissioner's view discussed in TD 2006/63, as you are connected with X Co and for a CGT event arising in respect of the proposed property that occurs after 23 June 2009, it is necessary to examine the use of that property by X Co.

It is proposed that X Co will lease the property for use in X Co's business. X Co provides accommodation to its employees. X Co's employees will sign a rental property agreement, which requires the payment of a bond but does not require payments of rent.

In consideration of the facts of the scheme, the main use of the proposed residential property by X Co is not to derive rent. Paragraph 152-40(4)(e) of the ITAA 1997 will not apply in respect of the proposed property.

Therefore, where you otherwise satisfy all relevant conditions for relief under division 152 of the ITAA 1997, the residential property you propose to acquire and lease to X Co to be used in X Co's business by providing accommodation to their employees, is an active asset under section 152-40 of the ITAA 1997.

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