Edited version of your written advice

Authorisation Number: 1051203884074

Date of Advice: 21 March 2017

Ruling

Subject: Income Tax - Small Business Concessions - Active Asset

Issue1

Will the land and buildings qualify as a pre-capital gains tax asset where any capital gain made can be disregarded?

Question 1

Is the company entitled to disregard the capital gain on the sale of its land and buildings?

Answer

No

Issue 2

Will the land and buildings be considered as an active asset?

Question 2

Are the land and buildings active assets as defined in section 152-40 Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 3

Is the asset excluded from being an active asset by paragraph 152-40(4)(e) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 4

Will the gain from the sale of the land be a disregarded capital gain under subsection 152-110(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 5

Will the proposed payments by the company to the Individuals be exempt income of those individuals under subsection 152-115(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following period:

Year ended 30 June 2017

The scheme commences on:

1 July 2016

Relevant facts and circumstances

The company was incorporated before 1985.

The land and buildings which are known as the property were purchased by the company.

The shareholder of the company is the trust. The beneficiaries of the trust are non-residents and include the individuals.

You signed a contract to purchase the property after September 1985.

The company applied to the Foreign Investment Review Board (FIRB) in order to receive approval for the purchase of the property.

Prior to 19 September 1985 the sale price was agreed to and you requested the Vendor to exchange contracts subject to FIRB approval, which was rejected by the Vendor.

In early September 1985 the sales price and other conditions were agreed to verbally through the real estate.

The FIRB granted approval for the purchase after 19 September 1985.

You provided documents to support the above facts.

The company sold the property and will have a capital gain.

The property contains more than 20 shops.

The shops cover an area of about half the size of the car park and there is a small portion of area used as a central mall. The car park is occupied by the company who provides free parking for a limited time, with fees charged after the free period.

The company which is also the Manager of the shopping centre has over the years secured the services of its directors, employees and external service providers to ensure efficient operation of the centre.

The company has employed a fulltime resident manager for the centre with an office on site together with a bookkeeper, administration assistant who is part time and various other employees when necessary. The day to day operation of the car park is also performed by an external service provider.

The company has acted as property manager over the years and it provides the following services to its tenants and the public:

Day to day operation of the centre, including opening and closing and regulating public access and supervision of all public areas,

Operation of commercial parking facility, including provision of customer parking for the whole of the centre,

Promotion and advertising within the centre,

Cleaning and maintenance of the property,

Public and occupational health and safety,

Rubbish removal and control,

Repairs and maintenance,

Capital works,

Arranging building insurance, including quotes, claim resolutions and public liability,

Provision and maintenance of public lighting and security,

Payment of outgoings including rates and taxes for centre,

Arranging for annual audit of outgoings and attending to recovery from tenants in accordance with provisions of leases,

Negotiation of leases when change of shop tenants,

Collection of rent and outgoings from tenants monthly,

Sourcing new tenants when shops become vacant,

Preparation and lodgement of quarterly BAS and payment of GST,

Fire regulations and compliance,

Calculation and payment of Superannuation Guarantee Levy on wages paid,

Graffiti removal,

Management of security issues within the centre, and

Engage lawyers for preparation of leases and various legal issues.

Another task of the company includes constantly reviewing the tenancy mix to ensure optimal mix to attract quality tenants and customers to the centre. The overall objective of the various tasks of the company is to manage the Centre to ensure a full a tenancy position as possible in a particular bad business environment such as;

The company has operated a business in the centre itself to prevent Australia Post from removing the existing local licence PO from the area.

The company obtained the licence to operate the Post Office in the Centre for a few years during the 1990s and during that time employed another manager and support staff.

The company also owned a restaurant through an associated company and operated that business for a few years during the 1990s.

The company holds the view that it was essential for the Centre to maintain the restaurant business as part of the services provided to the employees of the tenants and the public.

The lease between the company and the tenants includes detailed rules regarding the fit-out of the shops and the hours of opening. As part of the lease agreements the company may also receive additional rent from the largest tenant known as percentage rent, which is calculated in accordance with a formula specified in the lease and is payable when the lessee's gross sales exceed a certain amount each year. This is monitored by the lessee providing their monthly sales to the company.

The company also receives contributions from tenants for operating expenses on a monthly basis supported by an audit certificate arranged by a company at the end of each financial year.

In addition, during each year of the lease when activated the lessee must pay to the company a contribution to the advertising and promotion fund. The company must expend the moneys received in promoting the centre or the businesses carried on in the centre.

On occasions the company also moved tenants to other shops in the centre to attract different types of businesses. These were done in accordance with various leases at the time and the tenants moved were sometimes given rent free periods in new shops.

The sample lease states that the lessee's business cannot be required to be relocated unless the lessor has given the lessee at least 3 months' written notice of relocation, and that notice gives details of an alternative shop to be made available to the lessee within the centre.

You provided a specific example of when the company moved tenants to another shop to accommodate a new tenant.

The sample lease states that unless there is an emergency the lessor must give the lessee reasonable notice to enter the leased premises in order to carry out work such as repairs and maintenance.

The company will make payments to the individuals.

Immediately before the CGT event the individuals were CGT concessions stakeholders.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 109-5

Income Tax Assessment Act 1997 Section 152—35

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

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

Income Tax Assessment Act 1997 Subsection 152-110(1)

Income Tax Assessment Act 1997 Subsection 152-125(2)

Reasons for decision

Issue 1

Detailed reasoning

CGT event A1 has occurred when the company sold the property.

You make a capital gain if the capital proceeds from the disposal are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

A capital gain or capital loss you make is disregarded if you acquired the asset before 20 September 1985 (pre-CGT asset).

Generally, you acquire a CGT asset when you become its owner. You may acquire a CGT asset when someone else has a CGT event (for example, the transfer of land to you under a contract of sale). If you acquired an asset because of a CGT event, you are generally taken to have acquired the asset at the time of the CGT event. For example, if you enter into a contract to purchase a CGT asset, the time of acquisition is when you enter into the contract.

In your case, as the company entered into a contract to purchase the property, the time of acquisition is XX/XX/XXXX, when the company entered into the contract by exchanging contracts with the vendor. Although sale negotiations had started before 20 September 1985, there was no binding agreement before that date. This is supported by the letter from the vendor's solicitor dated 19 September 1985 which refers to a draft agreement that had not been seen or approved by the vendor. As the property was not acquired before 20 September 1985 it is not considered a pre-CGT asset and any capital gain or capital loss made on the disposal of the property will not be disregarded.

Issue 2

Summary

We consider that the main use of the shopping centre is to derive rent and therefore it is excluded from being an active asset under paragraph 152-40(4)(e) of the ITAA 1997.

Detailed reasoning

To qualify for the small business CGT concessions, the Company must satisfy several conditions that are common to all the concessions. These are called the basic conditions. Subdivision 152-C of the ITAA 1997 applies the small business 50% active asset reduction provided the basic conditions are satisfied.

A capital gain that you make may be reduced or disregarded under Division 152 of the ITAA 1997 if the following basic conditions are satisfied:

A CGT event happens in relation to a CGT asset of yours in an income year,

The event would have resulted in a gain,

The CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997, and

At least one of the following applies:

You are a small business entity for the income year,

You satisfy the maximum net asset value test in section 152-15 of the ITAA 1997,

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, or

You do not carry on a business, but your CGT asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you.

A CGT asset is an active asset if it is owned by you and is used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate or an entity connected with you (subsection 152-40(1) of the ITAA 1997).

Paragraph 152-40(4)(e) of the ITAA 1997 states, however, that an asset whose main use in the course of carrying on the business is to derive rent cannot be an active asset unless the main use for deriving rent was only temporary.

Taxation Determination TD 2006/78 discusses the circumstances in which premises used in the business of providing accommodation for reward can be active assets notwithstanding the exclusion in paragraph 152-40(4)(e) of the ITAA 1997.

TD 2006/78 states:

22. 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 lessee to a lessor for the use of the leased premises (C.H. Bailey Ltd v. Memorial Enterprises Ltd [1974] 1 All ER 1003; United Scientific Holdings Ltd v. Burnley Borough Council [1977] 2 All ER 62),

A tenants 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 (Halsburys Laws of England 4^th Edition Reissue, Butterworths, London 1994, Ch 27(1) Landlord and tenant, paragraph 212).

23. 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.

Additionally, at paragraph 25, TD 2006/78 states:

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).

TD 2006/78 provides the following example:

Example 3: boarding house

8. David owns an 8 bedroom property which he operates as a boarding house. He resides on the premises. Boarders enter into arrangements to occupy single rooms with the average length of stay being 4-6 weeks. No notice is required to quit the rooms. There are rules requiring visitors to leave the premises by a certain time and David retains the right to enter the rooms. David pays for all utilities (gas, electricity, water) and provides the following services and facilities to boarders:

Room cleaning and general maintenance;

Linen and towels; and

Common areas such as a TV/lounge room, kitchen, bathrooms, laundry and a recreation area.

9. In this example, the services and facilities provided to boarders are relatively significant and the average length of stay is relatively short. David retains a significant degree of control over the premises through being on the premises most of the time. The arrangements entered into indicate that those staying in the boarding house do not have the right to exclusive possession of a room but rather only a right to occupy the room.

10. These circumstances indicate that the relationship between David and those staying at the boarding house is not that of landlord/tenant under a lease agreement. Accordingly, the income derived is not 'rent' and therefore the paragraph 152-40(4)(e) exclusion does not apply. If David's activities amount to the carrying on of a business, the boarding house will be an active asset under section 152-40 of the ITAA 1997. [emphasis added]

In this case, while it is accepted that the company does provide some services to the occupants of the shops and manages the car park, these services and the control the company retains over the shopping centre is not considered to be on the same scale as provided in the above example. A number of activities the company carries out are all activities that are generally associated with the ownership of any rental property. In any case in the above example 'the relationship… is not that of a landlord/tenant under a lease agreement' whereas in your case there is such a relationship and therefore it is considered that the company's situation can be distinguished from that in the example.

Although the leases provided do not explicitly say whether the tenants have exclusive possession, we consider that the terms of the lease amount to the granting of exclusive possession. It is noted that tenants have been moved but these have been isolated instances and the terms of the lease required reasonable notice to have been given. The leases are long term arrangements and it would be reasonable to assume that the tenants view the payments as rent and would not expect their business to be moved into a different shop at any time. In fact, the sample lease you provided refers to rent and the parties as being 'lessor' and 'lessee' which confirms that what is being granted by the company is a lease rather than some other right and what is being received is rent.

In your private ruling application you referred to Examples 2, 3, and 4 in TD 2006/78 for support. You contend that in each of these examples the income is 'rent' but despite this the paragraph 152-40(4)(e) exclusion was not considered to apply and therefore it is not fatal to in the present circumstances that your income is 'rent'.

However, in these examples it was concluded that the paragraph 152-40(4)(e) exclusion did not apply because there was no tenant/landlord relationship under a lease and consequently the income was not rent. In the company's situation there is a tenant/landlord relationship under a lease and therefore the income is rent.

Accordingly, we consider the main use of the shopping centre is to derive rent. Therefore, the shopping centre will be excluded from being an active asset under paragraph 152-40(4)(e) of the ITAA 1997.

Under subsection 152-110(1) of the ITAA 1997 a company or trust can disregard a capital gain if particular conditions are met. In this case as the asset is not considered an active asset the company does not meet the conditions to disregard the capital gain.

In addition the company and the individuals will not be able to disregard the payments made to the individuals under subsection 152-125(2) of the ITAA 1997 as the payment would not be considered an exempt amount.

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