Edited version of private advice

Authorisation Number: 1051976712594

Date of advice: 21 June 2022

Ruling

Subject: Active asset

Question 1

Are you carrying on a business of leasing property?

Answer

Yes.

Question 2

Does the Property satisfy the meaning of active asset test under section 152-40 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following period:

year ended 30 June 20XX

The scheme commences on:

1 May 20XX

Relevant facts and circumstances

Person A (A) and Person B (B) are spouses.

A and B are partners in A & B partnership (the Partnership).

A and B are both over 55 years old.

In May, A and B acquired a half interest in property (the Property).

The other half interest is owned by your business partner.

A and B have multiple years of experience in the industry.

A and B purchased the property as a going concern which had tenancies.

A and B overtook the day-to-day management of the property including:

•         Advertising for tenants,

•         Preparation of leases,

•         Repairs and maintenance,

•         Lawn mowing and gardening,

•         Garbage and,

•         Cleaning of property after tenants vacated.

A and B rented space in the building to use the property management business.

During this period, the partnership employed a full time staff member, Person C (C).

After losing a major contract, A and B used your home office.

C remained an employee for approximately another year.

A and B spend a couple of hours per day at the Property and the main contracts for the property.

The Property has consistently had tenancies, most tenancies are let on a month to month basis although you currently have one lease of one year.

A and B have retired from full time employment and have put in managers for another property you own from 20XX.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 995-1

Summary

Yes, you are carrying on a business of leasing property however the property does not satisfy the meaning of active asset under paragraph 152-40(4)(e) of the ITAA 1997.

Detailed reasoning

Question 1

Carrying on a business

The term 'business' is defined to include any profession, trade employment, vocation or calling, but does not include occupation as an employee under subsection 995-1(1) of the ITAA 1997. 'Carrying on a business' is not defined in the ITAA 1997 and, therefore, takes its ordinary meaning, however Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? outlines general factors that indicate whether a business is being carried on.

Indicators of carrying on a business

Taxation Ruling TR 97/11 lists the relevant indicators as:

•         whether the activity has a significant commercial purpose or character

•         whether the taxpayer has more than just an intention to engage in business

•         whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

•         whether there is regularity and repetition of the activity

•         whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business

•         whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

•         the size, scale and permanency of the activity, and

•         whether the activity is better described as a hobby, a form of recreation or sporting activity.

TR 97/11 states the indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impression gained from looking at all the indicators, and whether these factors provide the operations with a commercial flavour. However, the weighting to be given to each indicator may vary from case to case.

Generally, the receipt of income from the letting of property to a tenant does not amount to the carrying on of a business (Wertman v. Minister of National Revenue (1964) 64 DTC 5158; Federal Commissioner of Taxation v. McDonald (1987) 15 FCR 172; 87 ATC 4541; 18 ATR 957; Cripps v. FC of T 99 ATC 2428; Case X48 90 ATC 384; (1990) 21 ATR 3389).

A person who simply owns an investment property or several investment properties, either alone or with other co-owners, is usually regarded as an investor who is not carrying on a rental property business. This is because of the limited scope of the rental property activities and the limited degree to which a co-owner actively participates in property activities. A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations.

In your case, in May 20XX together A and B as partners in the partnership purchased a half interest in a property that contained multiple tenancies. The partnership overtook the day-to-day management of the property including advertising for tenants, preparation of leases, repairs and maintenance, lawn mowing and gardening, garbage and, cleaning of property after tenants vacated. The partnership had an employee. Most tenancies are let on a month to month basis although the partnership currently has one lease of one year. A and B have been in the business of property management for many years however the scale of this operation is small. A and B have both retired from full time employment and have a prospect of profit from the activity. The leasing property is carried out similar manner to that of leasing properties. A and B consider the partnership is in the business of property management and carry on in a businesslike manner. The activity has regulation and repetition as the leases are on a monthly basis (apart from one on a yearly agreement).

By applying the business indicators listed in TR 97/11 to your circumstances, we do consider that the partnership was carrying on a leasing business. A and B act as the landlord and arrange the lease agreements for the tenants. The business is run similarly to other people in the same industry of leasing commercial property. Subsequently, A and B have demonstrated that the partnership is carrying on a business of leasing property.

Question 2

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 the meaning of an active asset is when you own the asset and it is used or ready to use in the course of carrying on a business that is carried on by you, your affiliate, or another connected entity.

Active Asset's main use is to derive rent

An asset whose main use is to derive rent cannot be an active asset. This is the case even if the asset is used in the course of carrying on a business.

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 referring to the payments made by a tenant or lessee to a landlord or lessor for exclusive possession of the leased premises. As such, a key factor in determining whether an occupant of premises is a lessee paying rent is whether the occupier has a right to exclusive possession.

The following is considered use of the asset to derive rent, where the rent is derived from an entity that is not an affiliate or connected with the asset owner (third party) or by an entity that is an affiliated or connected with the asset owner (relevant entity).

The use of an asset to derive rent from a third party, will be considered to be used to derive rent, even if that entity uses the asset in their business. This is because the use of the asset by the asset owner is to derive rent. However, use of the asset by a relevant entity (that is, affiliated or connected with the asset owner) is treated as the use by the asset owner, even if the asset owner receives rent from the relevant entity for the use of that asset.

This means that if the relevant entity uses the asset in its business, that use is treated as use by the asset owner to carry on a business and to derive interest, rent or royalties from an entity that is a third party; therefore, that use is considered to be use by the asset owner to derive passive income.

Application to your circumstances

In May 20XX, A and B both acquired a half share in the property as a going concern which had leasing tenancies that are not affiliates or connected with you. In line with subsection 152-40(4) of the ITAA 1997, because the property's main use is to derive rent, the property cannot be an active asset. This is the case even if the asset is used in the course of carrying on a business.

Further issues for consideration

This ruling has not fully considered your eligibility for the small business capital gains tax (CGT) concessions. You should ensure that XXX and XXX satisfy the relevant basic conditions for the concessions.

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