Edited version of private advice

Authorisation Number: 1052106294159

Date of advice: 6 April 2023

Ruling

Subject: CGT - small business concessions

Question

Will the Trust satisfy the basic conditions to be eligible for the small business concessions under Division 152 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 commenced on:

1 July 2020

Relevant facts and circumstances

1.            The Trust purchased a commercial property via its corporate trustee after 20 September 1985.

2.            In 20XX, a sale contract was entered into to dispose of the Property which resulted in a capital gain being made.

3.            At the time of acquisition, the Property consisted of one shop which was leased. Subsequently, a major renovation took place, resulting in the Property having multiple shops located on the Property.

4.            The total area of the Property consists of a net lettable area of less than half of the total area and includes public parking spaces covering and public access thoroughfare.

5.            The sole beneficiary of the Trust directly managed all activities relating to the Property, such as repairs and maintenance, managerial duties, supervision of external contractors, cleaning toilets, carpark lane markings, waste management, landscaping, painting and roof repairs. The sole beneficiary was a director of the corporate trustee throughout the entire ownership period and was remunerated by way of an annual trust distribution.

6.            The sole employee of the Trust was the sole beneficiary of the Trust and managed day-to-day administration, campaign meetings and tax and legal paperwork.

7.            The Trust has no connected entities or affiliates.

8.            The Financial Statements provided showed the annual turnovers for the 20XX-20XX and 20XX-20XX to be below $2 million and comprising predominantly rental income.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Subsection 104-10(1)

Income Tax Assessment Act 1997 Subsection 104-10(2)

Income Tax Assessment Act 1997 Subsection 104-10(3)

Income Tax Assessment Act 1997 Subsection 104-10(4)

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)(a)

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

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

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

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

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

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Section 152-40

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

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

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

Income Tax Assessment Act 1997 Section 328-110(1)

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise indicated.

Question

Will the Trust satisfy the basic conditions to be eligible for the small business concessions under Division 152?

Summary

The Trust is not entitled to access the small business concessions in Division 152 to reduce or disregard any capital gain made from the disposal of the Property. This is due to the exception in paragraph 152-40(4)(e) applying, which excludes the Property from being active asset as its main use was to derive rent.

Detailed reasoning

1.             You make a capital gain or capital loss if a CGT event happens to a CGT asset.[1] The Property is considered to be a CGT asset.[2]

2.                CGT event A1 happens if you dispose of your ownership interest in a CGT asset.[3]

3.             As the Trust disposed of the Property, CGT event A1 happened at the time the contract was entered into.

4.             You make a capital gain if the capital proceeds from the disposal are more than the asset's cost base[4], which is the case with the disposal of the Property.

Basic conditions for relief

5.             Division 152 provides small business relief to allow eligible taxpayers to disregard or defer some or all of a capital gain arising from the disposal of an active asset used in a small business, provided certain conditions (the basic conditions) are met. Subsection 152-10(1) sets out the basic conditions to be satisfied before a taxpayer can access Division 152.

6.             Subsection 152-10(1) states:

A *capital gain (except a capital gain from *CGT event K7) you make may be reduced or disregarded under this Division if the following basic conditions are satisfied for the gain:

(a)          a *CGT event happens in relation to a *CGT asset of yours in an income year;

(b)          the event would (apart from this Division) have resulted in the gain;

(c)           at least one of the following applies:

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

(ii)           you satisfy the maximum net asset value test;

(iii)          you are a partner in a partnership that is a CGT 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;

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

7.             When the Trust sold the Property, CGT event A1 happened, resulting in the first condition in paragraph 152-10(1)(a) being satisfied.

8.             As a capital gain was made from disposing of the Property, the second condition in paragraph

9.             152-10(1)(b) will be satisfied.

10.          In determining if the Trust is a CGT small business entity, subsection 152-10(1AA) requires the Trust to be a small business entity. Subsection 328-110(1) sets out that you are a small business entity if:

(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.

11.          The Trust was carrying on the business of running the Property. As its aggregated turnover was below $2 million[5] in 20XX-20XX, the Trust will meet requirements to be a CGT small business entity under subsection 152-10(1AA). Consequently, the third condition in paragraph 152-10(1)(c)(i) will be satisfied.

12.          Therefore, it needs to be determined if the final condition in paragraph 152-10(1)(d) is met, that is, if the active asset test in section 152-35 is satisfied.

Active asset test

13.          The meaning of active asset is set out in section 152-40. Paragraph 152-40(1)(a) provides that a tangible or intangible CGT asset is an active asset if you own the asset and it is used, or held ready for use, in a business carried on (whether alone or in partnership) by you, your affiliate or another entity that is connected with you.

14.          Based on the information provided, the Trust is considering to be carrying on a business and is using the Property in carrying on that business. However, subsection 152-40(4) sets out exceptions to certain CGT assets that cannot be active assets. In particular, paragraph 152-40(4)(e) states:

However, the following *CGT assets cannot be active assets:

...

(e)          an asset whose main use by you is to *derive interest, an annuity, rent, royalties or foreign exchange gains unless:

(i)            the asset is an intangible asset and has been substantially developed, altered or improved by you so that its *market value has been substantially enhanced; or

(ii)           its main use for deriving rent was only temporary.

15.          Since owning the Property, the Trust has leased shops within the Property to various businesses. The Trust has not used the Property for any other income producing purpose.

16.          Taxation Determination TD 2006/78 examines the circumstances where premises used in a business of providing accommodation for reward satisfy the active asset test. 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

•                     a tenant's periodical payment to an owner or landlord for the use of land or premises, and

•                     recompense paid by the tenant to the landlord for the exclusive possession of corporeal hereditaments.

17.          A key factor, therefore, in determining whether an occupant of premises is a lessee is whether the occupier has a right of exclusive possession. 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.

18.          Whilst TD 2006/78 focusses on the provision of accommodation services, example 1 relates to commercial rental properties:

2. Commercial Property Co owns 5 commercial rental properties. The properties have been leased for several years under formal lease agreements to various commercial tenants which have used them for office and warehouse purposes. The terms of the leases have ranged from 1 year to 3 years with a 3 year option and provide for exclusive possession. The company has not engaged a real estate agent to act on its behalf and manages the leasing of the properties itself.

3. In this situation, the company has derived rental income from the leasing of a number of properties. Accordingly, the main (only) use of the properties is to derive rent and they are therefore excluded from being active assets under paragraph 152-40(4)(e) of the ITAA 1997 regardless of whether the activities constitute the carrying on of a business.

19.          From the information provided, the Trust has used the Property solely to derive rent and can be likened to example 1 in TD 2006/78. The shops within the Property have been leased for several years under formal lease agreements to various commercial tenants which have used them for carrying on their own businesses. Although the public has access to the shops during business hours of 8am to 6pm daily, this does not indicate that the lessees do not have exclusive possession. Rather, it is a normal consequence of conducting retail trade.

20.          Although the Trust's business was aligned in helping and supporting each of the tenant businesses, the purpose was to derive rent from them. That is, the Trust's activities, promotional activities and support of the tenant's businesses were ultimately in the pursuit of deriving rental income.

21.          Paragraph 26 of TD 2006/78 explains that if an asset is used partly for business and partly to derive rent at any given time, it will be a question of fact dependent on all the circumstances as to whether the main use of the asset at that time is to derive rent. No one single factor will necessarily be determinative, and resolving the matter is likely to involve a consideration of a range of factors such as the comparative areas of use of the premises (between deriving rent and other uses) and the comparative levels of income derived from the different uses of the asset.

22.          Although less than a majority of the surface area of the Property is leased to the tenants, with other areas comprising parking space, delivery, storage and workshop areas and public thoroughfare, it is nonetheless evident that the Property is used solely by the Trust to carry on its business of running the Property and by extension solely to derive rent. There is no other business use of the Property by the Trust.

23.          Further, it is apparent from the annual turnovers provided by the Trust that the main use of the Property is to derive rent. Therefore, the Property falls within the exception in paragraph 152-40(4)(e) and the Property cannot be an active asset.

Conclusion

24.          The main use of the Property by the Trust was to derive rent. The exception at paragraph 152-40(4)(e) will apply to exclude the Property from being regarded as an active asset.

25.          Since the Property is not an active asset, the requirement at paragraph 152-10(1)(d) has not been met. The Trust therefore will not satisfy the basic conditions for relief in subsection 152-10(1). This means the Trust is not entitled to access the small business concessions in Division 152 in relation to the capital gain made from selling the Property.

[1] Section 102-20.

[2] Section 108-5.

[3] Subsection 104-10(1).

[4] Subsection 104-10(2) to (4).

[5] Paragraph 152-10(1AA)(b) reduces the $10m to $2m.

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