Edited version of private advice

Authorisation Number: 1051965362933

Date of advice: 2 June 2022

Ruling

Subject: Capital gains tax

Question 1

Are you a small business entity under section 328-110 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Are you a small business entity under section 152-10(1AA) of the ITAA 1997 for the purpose of applying the small business capital gains tax (CGT) retirement exemption concession?

Answer

Yes.

Question 3

Does the commercial building on a residential block, built for the business and used continuously to run the business from construction to current date satisfy the active asset test under section 152-35 of the ITAA 1997?

Answer

Yes.

Question 4

Is goods and services tax (GST) payable on the sale of a shop and café which was purchased and can the margin scheme be applied on the sale?

Answer

Yes.

Question 5

Could you claim any other expenses in the cost base for GST purposes?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Person A (you) is a sole trader, carrying on a retail business.

You started your retailing business in October 19XX, where you leased a shopfront.

In 19XX, you purchased a residential vacant block of land (the Property).

The Property is a on a single title.

On 1 July 20XX, you registered for GST.

In 20XX, you constructed your private residence on the Property.

The envelope of land which your residential house is constructed represents approximately a quarter of the total land area.

You also constructed separate townhouses, representing less than a quarter of the total land area.

You receive rental income for the townhouses. The townhouses were finished being built in 20XX and the tenants moved in a few weeks later. The townhouses have been rented out for the entire period of ownership.

In 20XX, you constructed a standalone, purpose-built shop and café, representing over half of the total land area.

The shop area includes car parking spaces, retail space, office space, function room, servery, and amenities.

The café consists of a large dining area, commercial kitchen, and amenities. There are no showers, baths, or bedrooms in this building.

The whole property is on a single title and you are the owner of the townhouses, and they are not strata titled, nor has the title changed since the original purchase of the vacant land in 19XX.

In 20XX, you ceased the café business due to the impacts of COVID-19.

In the previous income year, your annual turnover was under a million dollars.

In the current income year, your annual turnover was under a million dollars.

In the previous income year, your aggregated turnover was under $2 million.

In the current income year, your aggregated turnover was under $2 million.

You intend to utilise the capital gains tax small business concessions when you sell the Property.

The total sale price is expected to be more than the purchase price.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 section 9-5

A New Tax System (Goods and Services Tax) Act 1999 section 9-40

A New Tax System (Goods and Services Tax) Act 1999 section 9-80

A New Tax System (Goods and Services Tax) Act 1999 section 75-5

Income Tax Assessment Act 1997 subsection 152-10(1AA)

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 328-110

Income Tax Assessment Act 1997 section 328-115

Income Tax Assessment Act 1997 section 328-120

Reasons for decision

Detailed reasoning

Questions 1 and 2

Subsection 328-110(1) of the ITAA 1997 states the requirements of a small business entity for an income year as:

(a) you carry on a business in the current year, and

(b) one or both of the following applies:

(i) you carried on a business in the income year (the previous year) before the current year and your aggregated turnover for the previous year was less than $10 million

(ii) your aggregated turnover for the current year is likely to be less than $10 million

Furthermore, section 152-10(AA) of the ITAA 1997 explains you will be a CGT small business entity to apply the small business concessions, if you are carrying on a business and have an aggregated turnover of less than $2 million.

Aggregated turnover

The term 'aggregated turnover' for an income year is defined in subsection 328-115(1) of the ITAA 1997 as the sum of the relevant annual turnovers listed in subsection 328-115(2), excluding any amounts covered by subsection 328-115(3).

Under subsection 328-115(2) of the ITAA 1997, the relevant annual turnovers are:

•         your annual turnover for the income year

•         the annual turnover for the income year of any entity (a relevant entity) that is connected with you at any time during the income year, and

•         the annual turnover for the income year of any entity (a relevant entity) that is an affiliate of yours at any time during the income year.

Under subsection 328-115(3) of the ITAA 1997, your aggregated turnover for an income year does not include the following amounts:

•         amounts derived in the income year by you or a relevant entity from dealings between you and the relevant entity while the relevant entity is connected with you or is your affiliate

•         amounts derived in the income year by a relevant entity from dealings between the relevant entity and another relevant entity while each relevant entity is connected with you or is your affiliate

•         amounts derived in the income year by a relevant entity while the relevant entity is not connected with you and is not your affiliate.

An entity's aggregated turnover is the same as its annual turnover if there are no other entities it is connected with or affiliated with.

Application to your circumstances

You carry on a business of retailing that you established in 19XX. In 20XX, you constructed a standalone purpose-built shop and café. In the 20XX year you ceased the café business due to the effects of COVID-19. Your aggregated turnover is not the same as your annual turnover as you receive rental income from property that you rent out. You have no other connected or affiliated entities. In applying Division 152 of the ITAA 1997 to your circumstances, through the ordinary course of carrying on a business, your aggregated turnover in the previous income year was under $2 million. Furthermore, you expect to derive similar amounts of income for the current income year and expect to remain under the $2 million threshold.

As your aggregated and expected aggregated turnover for the previous and current income years was and remains likely less than $2 million and you are carrying on a business, you satisfy the requirements under section 328-110 of the ITAA 1997 to be a small business entity and further satisfy the requirements under subsection 152-10(1AA) of the ITAA 1997 to be a small business entity for the purposes of applying the capital gains tax small business concessions.

Question 3

Active Asset Test

Subsection 152-35(1) of the ITAA 1997 states that a CGT asset satisfies the active asset test if:

•         you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the period owned; or

•         you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7.5 years.

Subsection 152-40(1) of the ITAA 1997 explains that a CGT asset is an active asset when you own the asset and it is used, ready to use in the course of carrying on a business that is carried on by you, your affiliate, or another connected entity.

Subsection 152-40(4) of the ITAA 1997 explains that not all CGT assets are active assets. In particular paragraph 152-40(4)(e) of the ITAA 1997 explains an asset whose main use by you is to derive rent is not an active asset as it is not used in the course of carrying on a business.

Application to your circumstances

In 20XX, you constructed a standalone purpose-built shop and café with car parking spaces representing more than half of the total land area in the course of carrying on your business. Due to the impacts of COVID-19, in the 20XX income year, you ceased the café business. You have continued to operate your business from the shop. Therefore, you have owned the asset, being the shop and café built in the envelope of land representing the majority of your total block, for more than 15 years. The shop and café have been an active asset of yours for a minimum of 7.5 years. Accordingly, as the asset was used in the course of carrying on your business, you satisfy the active asset test under section 152-35 of the ITAA 1997.

Question 4

Under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act), an entity makes a 'taxable supply' where the supply is:

a.    made for a consideration;

b.    made in the course or furtherance of an enterprise that you carry;

c.     connected with the indirect tax zone; and

d.    made by a supplier who is registered, or required to be registered, for GST.

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed.

The property consists of residential premises, townhouses and your business. The residential premises and townhouses will be input taxed under section 40-65 of the GST Act. As it is an input taxed supply it is excluded from analysis under section 9-5 and the focus is on the business and the land on which it is located.

All of the requirements in section 9-5 of the GST Act needs to be met to be a taxable supply.

Under section 9-40 of the GST Act, an entity is liable for GST on all taxable supplies that it makes.

In respect of the shop and the café business there is clearly a supply. You are registered for GST and the supply is connected with the indirect tax zone. Consideration is present as the property will be sold for an amount of approximately $X million.

In addition, there is no provision in the GST Act that will make the sale of the shop and café a GST-free or an input taxed supply.

The issues to be considered are whether the sale of shop and café is a mixed supply.

Where an entity is making a mixed supply that is a combination of separately identifiable taxable and non-taxable parts the GST liability is only calculated on the taxable portion of the supply.

Further, for a mixed supply, the consideration received for the supply must be apportioned and GST levied only on the consideration relating to the taxable portion of the supply.

The taxable portion of a mixed supply is calculated in accordance with the formula contained in section 9-80 of the GST Act.

Goods and Services Tax Ruling GSTR 2001/8 Goods and Services tax: apportioning the consideration for a supply that includes taxable and non-taxable parts provides the ATO view on identifying whether a supply includes taxable and non-taxable parts.

It may be necessary to characterise what is supplied to determine whether it wholly or partly meets the requirements of section 9-5 or a provision that makes it non-taxable.

Paragraphs 11, 12, 16 and 27 of GSTR 2001/8 states:

11. Where you make a supply that is identifiable as having more than one part and each part is taxable, you do not need to apportion the whole supply. This is because GST is payable on the whole supply. Similarly, if all the parts of a supply are identifiable as being non-taxable, GST is not payable on any part of the supply.

12. However where you make a supply that is a combination of separately identifiable taxable and non-taxable parts, you need to identify the taxable part of the supply.

...

16. the term 'mixed supply' is used to determine a supply that has to be separated or unbundled as it contains separately identifiable taxable and non-taxable parts that need to be individually recognised.

...

27. You should keep records that explain the basis used to apportion the consideration between the taxable and non-taxable parts of a supply.

GSTR 2001/8 explains that where there is no legislative provision specifying the basis for apportionment, you may use any reasonable method (direct or indirect) to apportion the consideration for a mixed supply. However, the apportionment must be fair and reasonable in the circumstances of the case and not just the method that gives the best result.

How this applies in your case

The residential premises, townhouses and the shop and cafe are clearly identifiable. The residential premises and townhouses are input taxed.

However, the shop and cafe will be treated as a taxable supply.

Apportionment

Section 9-40 of the GST Act provides that an entity is liable for GST on all taxable supplies that it makes. However, where an entity is making a mixed supply that is a combination of separately identifiable taxable and non-taxable parts the GST liability is only on the taxable part of the supply.

In respect to a mixed supply, the consideration received for the supply must be apportioned and GST levied only on the consideration relating to the taxable portion of the supply.

Subsection 9-80(1) of the GST Act states that "the value of the part of the actual supply that is a taxable supply is the proportion of the value of the actual supply that the taxable supply represents".

Please note that 'value' is determined by reference to the consideration provided.

This means to determine the value of the taxable portion it is necessary to calculate the taxable proportion, that is, the proportion of the value of the actual supply that the taxable part represents.

You have indicated that the components that make up your supplies are clearly identifiable based on the land area and, as a result, it would be possible to separate the applicable GST either on the value or land area.

In conclusion

Your supplies are mixed supplies with the GST status of each individual component of the supply required to be assessed individually.

As the residential premises and the townhouses are an input taxed supply for GST purposes, GST is not payable on that portion of the sale.

The taxable part of the supply will be the shop and cafe and the land used in conjunction with that business.

You have identified two options to calculate the GST on the sale of the shopfront. You can either use the value or land area.

The basis for apportionment needs to be calculated on a reasonable basis and records must be kept to explain the method of apportionment used in particular the residential property and the townhouses and the shopfront.

Margin scheme

You can choose to apply the margin scheme pursuant to subsection 75-5(1) of the GST Act if:

• you and the recipient of the supply have agreed in writing that the margin scheme is to apply; and
• such an agreement is made on or before the making of the supply; and
• you did not acquire the freehold interest through a taxable supply on which the GST was worked out without applying the margin scheme.

Normally, GST is calculated as one eleventh of the consideration for a taxable supply in accordance with subdivision 9-C of the GST Act. However, if the GST is calculated under the margin scheme, the GST payable is one eleventh of the margin of the supply.

Under subsection 75-10(2), the margin for a supply is the amount by which the consideration for the supply exceeds the consideration for your acquisition of the interest unless subsection 75-10(3) applies.

Subsection 75-10(3) states that subject to section 75-11, if:

(a) the circumstances specified in an item in the second column of the table in this subsection apply to the supply; and

(b) an *approved valuation of the freehold interest, *stratum unit or *long-term lease, as at the day specified in the corresponding item in the third column of the table, has been made;

the margin for the supply is the amount by which the *consideration for the supply exceeds that valuation of the interest, unit or lease.

Goods and Services Tax Ruling GSTR 2006/7 Goods and services tax: how the margin scheme applies to a supply of real property made on or after 1 December 2005 that was acquired or held before 1 July 2000 deals with the margin scheme.

Paragraph 45A of GSTR 2006/7 provides information on when a taxpayer is taken to have held or acquired real property for the purposes of subsection 75-10(3). It states:

45A. The Commissioner considers that the Full Federal Court decision in Brady King v. Commissioner of Taxation (Brady King) is authority for the view that, for the purposes of subsection 75-10(3), an entity supplying real property is taken to have held or acquired a sufficient interest in that property at the time it entered into a contract for its acquisition. As such, if the entity entered into the contract before 1 July 2000, the entity may work out its GST liability under the margin scheme by reference to an approved valuation of the real property as at the day specified in subsection 75-10(3), even if settlement of the contract occurred on or after 1 July 2000 (assuming the requirements for application of the margin scheme are satisfied).

You entered into a contract for the purchase of the property in 19XX and before 1 July 2000. Therefore, you are taken to have held or acquired the property prior to 1 July 2000 for the purposes of subsection 75-10(3).

You are required to apply to the office (Commissioner) to exercise his discretion to extend the period for making written agreements to apply the margin scheme.

Further details on this are in section 75-5(1A) of the GST Act and Law Administration Practice Statement PS LA 2005/15 The Commissioner's discretion to extend the time in which the agreement in writing must be made to apply the margin scheme under Division 75 of the A New Tax System (Goods and Services Tax) Act 1999.

In addition, you will be required to obtain an approved valuation of the property as of 1 July 2000. Therefore, when you do obtain the valuation, the margin on the sale of the shop and café will be the amount by which the consideration for your sale of them exceeds the valuation.

If you choose to apply the margin scheme you must use the same apportionment methodology used to calculate the GST payable on the sale of the shop and café above either based on land size or value.

You cannot use the margin scheme if you are not registered or required to be registered for GST at the time of your sale.

Question 5

Section 75-14 makes it clear that in working out the consideration for the acquisition the following are disregarded:

a)    the cost or value of any other acquisitions that have been made by you, or any work that has been performed in relation to the real property; and

b)    the cost or value of any other acquisitions that are intended to be made by you, or any work that is intended to be performed after you have acquired the real property,

including acquisitions or work connected with bringing the real property into existence.

However, you are entitled to claim input tax credits on the creditable acquisitions you make in order to sell the shop and café (e.g. legal costs).

You should apportion the input tax credit claims on creditable acquisitions using the same apportionment methodology used to apportion the sale of the shop and café (e.g. land size or value) and claim the input tax credits accordingly.

Further issues for consideration

This ruling has not fully considered your eligibility for the small business CGT concessions. You should ensure that you satisfy the relevant basic conditions for the concessions. More information is available on our website www.ato.gov.au using keywords 'concessions for small business' to search.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).