Edited version of private advice

Authorisation Number: 1052264201063

Date of advice: 1 July 2024

Ruling

Subject: Land development

Issues

Question 1

Will the sale of the Property by the Taxpayers be subject only to the capital gains tax (CGT) provisions set out in Part 3-1 and Part 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Is the Property an active asset for the purposes of section 152-40 of the ITAA 1997?

Answer

Yes - to the extent the pattern of activities remain consistent with that for the period XXXX to date and continue for the relevant test period required for the active asset test in subsection 152-35(1) of the ITAA 1997, the Taxpayers would be able to satisfy the requirement that the Property has been used by them in carrying on a business for the purposes of section 152-40 of the ITAA 1997 (and thereby paragraph 152-10(1)(d)).

This ruling applies for the following periods:

1 July XXXX to 30 June XXXX

Relevant facts and circumstances

Individual A died on XXXX, and the two testamentary trusts were established from that date pursuant to the terms of their Will - Testamentary Trust A and Testamentary Trust B (collectively, the Testamentary Trusts).

Relevantly, in the late XXXX Individual A had purchased the Property.

Pursuant to the terms of their Will, on XXXX, the Property was transferred to Individual B as the Trustee for Testamentary Trust A and Individual C as the Trustee for Testamentary Trust B (collectively, the Trustees), with each owning 50% of the Property as tenants in common.

The Property

Living on the Property

Individual B and their spouse first moved to the Property in XXXX (whilst it was still owned by Individual A) as Individual B's spouse wished to work in the region. They had originally intended to live at the Property for X to X months. They lived in X house", being a building constructed by Individual A for their family's own use.

In early XXXX, having established themselves in the community and with employment in the region, Individual B and their spouse decided that they would stay for another X or X years. Consequently, Individual B and their spouse decided to renovate the X house at the Property, which until that time had been occupied by a series of farm managers. The renovation was completed, and they moved into the X house, on XXXX. Individual B and their family have lived in this house since XXXX, apart from the periods during XXXX and XXXX when they were in X renovating a house that Individual B inherited from Individual A.

Individual C and their family reside in X, and regularly stay at Y house on the Property and attend to maintenance work and other activities at the Property.

The use of the Property

Prior to XXXX

Individual A conducted primary production activities - which dwindled over time.

At the time Individual A died, they were in the process of intensifying primary production activities on the Property.

XXXX until XXXX

Following Individual A's death, the Taxpayers maintained the animal stock while deciding whether to restock by proceeding with the search and acquisition of a new animals or change to something else such as growing hay or grazing cattle.

Farming activities at the time were limited to moving the animals into a new paddock at least every two weeks, weekly fencing maintenance and feeding them hay throughout the drier months.

The Taxpayers spent some time researching the viability of carrying on the farming business and eventually decided it wouldn't be commercially viable to bring a new animal as there wasn't a suitable market to sell into.

After spending almost a year trying to sell the animals (and even trying to give them away) without success, the Taxpayers euthanised the surviving animals on XXXX.

XXXX to XXXX

On advice from farming members of their family, the Taxpayers made the decision to rest the paddocks for at least a year before moving to either growing hay or grazing cattle.

The Taxpayers decided to continue farming animals on the Property and decided to purchase animals.

As the Taxpayers were preparing to purchase animals, they were approached by a local farmer as he had been looking for land in the area to lease. It was a convenient solution for the Taxpayers as they both had young and growing families and the lease included maintenance of all fences, windmill/watering troughs, etc. The Taxpayers commenced leasing the Property on XXXX.

XXXX to XXXX

Land was leased to the local farmer until XXXX at the point when the Taxpayers decided they were in a position to again run animals on the Property themselves.

XXXX to date

The Taxpayers registered their own Property Identification Code (PIC) in XXXX and have been buying X-X animals (depending on the market at the time) each year since as the land starts greening and selling them as the paddocks dry out.

The buying and selling decisions are made in consultation with their agent to maximise the potential profit.

The first year the Taxpayers held the animals for too long during the summer months and needed to buy hay which turned out to be a very expensive exercise. Since then, the Taxpayers have sold the animals before they run out of natural feed.

Day to day farming activities include - moving the animals at least every two weeks, daily check of water troughs, weekly or as required fence maintenance, regular treatment of cattle (worming, etc) and seasonal weed management.

Zoning history

Until very recently, the Property was zoned Rural and Conservation (with an agricultural use exception recognised over the Conservation zoned land).

Sometime during X, neighbours of the Property applied to rezone their small parcel of land to Urban. The City council rejected their proposal and indicated that any development in the area would also need to consider the surrounding landholdings (including the Property).

Individual A had no intentions of developing the Property, and their involvement at the time was limited to a letter of support for the neighbours. In the ensuing years, the neighbours made several further attempts to progress their re-zoning application.

The Trustees' involvement didn't change until XXXX, when Individuals B and C (as trustees of their respective Testamentary Trusts) engaged a planning consultant to prepare a submission on their behalf regarding the City's proposal to update the local planning strategy document, to ensure that their interests weren't assumed to be the same as their developer­ neighbours' interests.

This was followed by a further submission in XXXX to the Planning Commission regarding a review of the relevant regional planning document. The outcome of this planning strategy review process was that the Property and the surrounding smaller landholdings were included in the updated strategy document as a Planning Investigation Area named X.

With the onset of COVID, the shortage of land in the area became acute and a meeting was arranged by the neighbours with the Planning Commission and their planning consultant in late XXXX in an effort to progress the development of their land.

As the Taxpayers have the largest landholding in the immediate area and any development would be contingent on their involvement, they were also invited to attend the discussion. The outcome of this meeting was that the Planning Commission authorised the Taxpayers and their neighbours (as the X landowner group) to commence preliminary investigations into the suitability of the land, including the Property, for more intensive land uses.

The Taxpayers agreed to join with their neighbours and contribute financially to the analysis and reporting from the neighbours' consultants.

A preliminary report was submitted in XXXX, and in XXXX the Planning Commission resolved to designate the area future urban and invited the landowner group to prepare a structure plan for the designated area (of which the Property comprises more than X%).

The structure plan and rezoning application/ scheme amendment was submitted to the Local Government in XXXX and was referred (with some minor recommendations) to the relevant government department in XXXX.

The re-zoning was executed by the Minister on XXXX, and the structure plan is in the final stages of assessment by the Department. The Property is now zoned Urban Development.

The Taxpayers are proposing to sell the Property on an arm's length basis, either to a related or unrelated party, in its entirety on an 'as is' basis (sale of the Property).

Taxpayers' contentions

Taxation Ruling TR 97/11Income tax: am I carrying on a business of primary production? provides guidance as to whether a taxpayer is carrying on business of primary production. Paragraph 13 of the ruling provides a list of indicators that are relevant in determining whether a taxpayer is carrying on a primary production business. Broadly, these indicators are as follows:

•         Whether the activity has a significant commercial purpose or character.

o   The commercial purpose for the Taxpayers' farming business is to farm the Property at its capacity. This is based on advice from the agent, but it can vary depending on factors such as weather and amount of feed on the property, size of the animals, holding period.

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

o   The farming business is operational and has been running since XXXX.

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

o   Before purchasing animals (and ending the lease with the local farmer), meetings were held with the agent to determine the viability of various options for the Taxpayers' use of the Property for their own farming business. It was determined that the most suitable use of the land would be either cutting hay and/or buying and selling animals each year (holding them for only the wetter/greener months). There is a profit projection.

•         Whether there is repetition and regularity of the activity.

o   The Taxpayers have purchased and sold X to X steers annually, in consultation with their agent.

o   Day to day activities are regularly required at the Property to support its farming operation. Each morning while animals are on the Property.

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

o   The Taxpayers understand that many small farm owners in the area use a similar strategy for farming their land.

•         Whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit.

o   The timing of each purchase and sale of animals is decided in consultation with the agent in order to maximise profit (or in recent years, to minimize loss).

•         The size, scale and permanency of the activity.

o   The Taxpayers have been informed by their agent, that the carrying capacity of the Property is normally in the order of X to X animals. The Taxpayers have followed this advice.

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

o   The work required to undertake the farming operation is not a form of recreation, sport or hobby.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

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

Income Tax Assessment Act 1997 Division 152-35

Income Tax Assessment Act 1997 Division 152-40

Reasons for decision

Question 1

Summary

The sale of the Property would be a 'mere realisation' of a capital asset that is subject to capital gains tax only.

Detailed reasoning

Income tax treatment of the sale of land

Broadly, profits from a land subdivision can be treated for taxation purposes in the following manner:

a)    As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock.

b)    As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of an isolated commercial transaction entered into by a non-business taxpayer or outside the ordinary course of business of a taxpayer carrying on a business, which is the commercial exploitation of an asset acquired for a profit-making purpose.

c)    As statutory income under the capital gains tax (CGT) regime (sections 10-5 and 102-5 of the ITAA 1997) on the basis that a mere realisation of a capital asset has occurred.

d)    As statutory income under section 15-15 of the ITAA 1997, where pre-CGT land is ventured into a profit-making scheme.

Land sold as part of carrying on a business of property development

Whether the sale of land is a disposal in the course of carrying on a business is determined by examining and weighing all the relevant facts and circumstances taken as a whole.

The principles in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? (TR 97/11) provide guidance on whether a taxpayer is carrying on a business and can be applied in various contexts. Specifically, paragraph 13 of TR 97/11 provides a list of indicators that are relevant in determining whether a taxpayer is carrying on a business. In general, the indicators are:

•         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 repetition and regularity of the activity;

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

•         whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at 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 a sporting activity.

Relevantly, activities etc. do not need to be conducted by the taxpayer for the taxpayer to be considered to be carrying on a business - it can be by the taxpayer, on behalf of the taxpayer or in conjunction with others: see for example, Hance & Anor v Federal Commissioner of Taxation 2008 ATC 20-085 where the court confirmed that businesses can take many forms, and can include a silent partner who delegates all responsibility for the business to another individual and consequently individual investors would be considered to be carrying on a business.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the 'large or general impressions gained' from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

Land is sold as part of an isolated transaction entered into by a non-business taxpayer, or outside the ordinary course of business of a taxpayer carrying on a business for the purpose of making a profit

Profits arising from an isolated transaction as a result of entering into a profit-making undertaking or scheme will be ordinary income under section 6-5 of the ITAA 1997, on revenue account (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693 (Myer Emporium)

Taxation Ruling TR 92/3 - Income tax: whether profits on isolated transactions (TR 92/3) discusses the application of the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are ordinary income and therefore assessable under section 6-5 of the ITAA 1997. It refers to isolated transactions as:

•         those transactions outside the ordinary course of business of a taxpayer carrying on a business, and

•         those transactions entered into by non-business taxpayers.

TR 92/3 also provides that profits from an isolated transaction will be income when:

•         the intention or purpose in entering into the transaction was to make a profit or gain, and

•         the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

For an isolated transaction to be considered to be of a business or commercial nature, it is usually necessary that a taxpayer has the purpose of profit-making at the time of acquiring the property. In Myer Emporium, the Full High Court said the following about the nature of profits from isolated transactions and the purpose of profit-making at the time of acquisition:

It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of acquisition of acquiring for the purpose of profit-making by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realisation. But it is quite another thing if the decision to sell is taken by way of implementation of an intention or purpose, existing at the time of acquisition, of profit-making by sale, at least in the context of carrying on a business or carrying out a business operation or commercial transaction.

In general, whether a profit from an isolated transaction is income according to ordinary concepts depends very much on the individual circumstances of the case. Matters listed in TR 92/3, which are relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction include:

• the nature of the entity undertaking the operation or transaction
• the nature and scale of other activities undertaken by the taxpayer
• the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained
• the nature, scale and complexity of the operation or transaction
• the manner in which the operation or transaction was entered into or carried out
• the nature of any connection between the relevant taxpayer and any other party to the operation or transaction
• if the transaction involves the acquisition and disposal of property, the nature of that property, and
• the timing of the transaction or the various steps in the transaction.

In determining whether activities relating to isolated transactions result from a profit-making undertaking or are the realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. This may require a consideration of the factors outlined above; however there may also be other relevant factors that need to be weighed up as part of the process of reaching an overall conclusion. No single factor will be determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

Land is sold as part of a profit-making undertaking or scheme

Where pre-CGT land has been ventured into a profit making undertaking or scheme that is more than a mere realisation of the asset but less than carrying on a business or an isolated business or commercial transaction with a profit making purpose with - the land is treated as a revenue asset and the profit from the disposal of land is statutory income under section 15-15 of the ITAA 1997 and the loss is deductible under section 25-40 of the ITAA 1997.

Section 15-15 of the ITAA 1997 cannot apply if the profit is ordinary income under section 6-5 of the ITAA income or the property was acquired on or after 20 September 1985.

Mere Realisation

The expression 'mere realisation' is used to distinguish a mere realisation from a business operation or a commercial transaction carrying out a profit-making scheme, where the sale of the CGT is on capital account to which the CGT rules will generally apply. These proceeds are not ordinary income.

Profits made on the realisation of capital assets can still be ordinary income if the activities go beyond a mere realisation and instead become a separate business operation or commercial transaction even though the taxpayer did not have a purpose of profit-making at the time of acquiring the asset.

In McClelland v FC of T [1970] HCA 39, for example, the Privy Council held that the question to be answered was whether the facts revealed a mere realisation of capital, albeit in an enterprising way, or whether they justify a finding that the taxpayer went beyond this and engaged in a trade of dealing in the asset, albeit on one occasion only.

Lord Justice Clark, in distinguishing between proceeds that are mere realisation of capital and ordinary income, stated in California Copper Syndicate v Harris (1904) 5 TC 159 at pp 165-166 that:

...What is the line which separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be determined being - is the sum of the gain that has been made a mere enhancement of value by realising a security, or is it a gain made in an operation of business in carrying out of a scheme of profit-making?

In FC of T v Whitfords Beach Pty Ltd 82 ATC 4031, Gibbs CJ similarly said (at 4034), that:

When the owner of an investment chooses to realize it, and obtains a greater price for it than he paid to acquire it, the enhanced price will not be income within ordinary usages and concepts, unless, to use the words of the Lord Justice Clerk in California Copper...'what is done is not merely a realisation or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business'.

Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number (MT 2006/1) explains the circumstances in which transactions involving the sale of land are considered to be a profit-making undertaking or scheme, as opposed to the mere realisation of a capital asset:

Isolated transactions and sales of real property

262. The question of whether an entity is carrying on an enterprise often arises where there are 'one-offs' or isolated real property transactions.

263. The issue to be decided is whether the activities are an enterprise in that they are of a revenue nature as they are considered to be activities of carrying on a business or an adventure or concern in the nature of trade (profit making undertaking or scheme) as opposed to the mere realisation of a capital asset. (In an income tax context a number of public rulings have issued outlining relevant factors and principles from judicial decisions. See, for example, TR 92/3, TD 92/124, TD 92/125, TD 92/126, TD 92/127 and TD 92/128.)

264. The cases of Statham & Anor v. Federal Commissioner of Taxation ( Statham ) and Casimaty v. FC of T ( Casimaty ) provide some guidance on when activities to subdivide land amount to a business or a profit-making undertaking or scheme. In these cases, farmland was subdivided and sold. Minimal development work was undertaken to meet council requirements and to improve the presentation of certain allotments. On the particular facts of these cases the courts held that the sales were a mere realisation of a capital asset.

265. From the Statham and Casimaty cases a list of factors can be ascertained that provide assistance in determining whether activities are a business or an adventure or concern in the nature of trade (a profit-making undertaking or scheme being the Australian equivalent, see paragraphs 233 to 242 of this Ruling). If several of these factors are present it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows:

•         there is a change of purpose for which the land is held;

•         additional land is acquired to be added to the original parcel of land;

•         the parcel of land is brought into account as a business asset;

•         there is a coherent plan for the subdivision of the land;

•         there is a business organisation - for example a manager, office and letterhead;

•         borrowed funds financed the acquisition or subdivision;

•         interest on money borrowed to defray subdivisional costs was claimed as a business expense;

•         there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and

•         buildings have been erected on the land.

266. In determining whether activities relating to isolated transactions are an enterprise or are the mere realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. This may require a consideration of the factors outlined above, however there may also be other relevant factors that need to be weighed up as part of the process of reaching an overall conclusion. No single factor will be determinative rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

...

Land bought with the intention of resale

270. In isolated transactions, where land is sold that was purchased with the intention of resale at a profit (which would be ordinary income) the Commissioner considers these activities to be an enterprise. This would be so whether the land was sold as it was when it was purchased or whether it was subdivided before sale. An enterprise would be carried on in this situation because the activities are business activities or activities in the conduct of a profit-making undertaking or scheme and therefore an adventure or concern in the nature of trade.

CGT Event A1

Relevantly, under subsection 104-10(1) of the ITAA 1997, CGT event A1 happens if you dispose of a CGT asset.

Under subsection 104-10(2) of the ITAA 1997, you dispose of a CGT asset when a change of ownership occurs from you to another entity.

The effect of CGT Event A1 happening is that you make a capital gain if the capital proceeds from the disposal are more than the asset's costs base, or a capital loss if those capital proceeds are less than the asset's reduced cost base (subsection 104-10(5) of the ITAA 1997).

The time of the event is when you enter into the contract for the disposal, or, if there is no contract, when the change occurs (subsection 104-10(3) of the ITAA 1997).

The time when a contract is entered into is the time when it comes into existence for general law purposes.

If a contract is subject to a condition, an issue arises whether the condition is a condition precedent to its formation or whether it is a condition precedent to performance of the contract. In the first case, the contract does not come into existence until the condition is met. In the second case, the condition does not prevent the creation of the contract - non-fulfilment of the condition merely entitles a party to terminate the contract: see Perri v. Coolangatta Investments Pty Ltd (1982) 149 CLR 537. (See, for example, ATO ID 2004/668 Income tax Capital gains tax: buy-sell agreement - time of CGT event A1).

Application in these circumstances

The Commissioner considers that, on balance, having regard to the factors set out below, the Taxpayers would not be undertaking a business operation or commercial transaction by selling the Property in its entirety on an 'as is' basis on arm's length terms.

The Property was originally acquired by Individual A with the intention to use it as a farm. The Property was used for those purposes until Individual A's death in XXXX. The Property was not bought for resale at a profit.

Following Individual A's death, the Taxpayers either attempted to maintain farming activities on the Property or leased the Property to an unrelated entity for them to conduct their farming activities.

Individual A had minimal involvement in the attempt to re-zone land surrounding the Property. The Taxpayers' involvement in the re-zoning process, which eventually encompassed the Property, was driven by the desire to the protect their interests.

The Property had been used and held by Individual A until his death as a capital asset. There has been no accounting/tax treatment suggesting the Property is a revenue asset.

The proposal is to sell the Property in its entirety on an 'as is' basis on arm's length terms (either to a related or an unrelated party).

For these reasons, it is considered that the proposed sale of the Property does not amount to carrying on a business or the undertaking of a profit-making scheme. The long length of time the Property was held as a capital asset, the intention at the time of purchase and the lack of change in intention at the time of inheritance, the limited activities to sell the Property (in its entirety and on an as is basis) all suggest the mere realisation of an asset. Even if the Taxpayers' involvement in the re-zoning process were also motivated by the desire to maximise the value of the Property, the extent of the Taxpayers' involvement in the re-zoning process suggests the mere realisation of an asset in the most enterprising way.

As the sale of the Property would be considered a mere realisation of a CGT asset, CGT event A1 will happen when the Taxpayers enter into a contract to sell the Property (assuming that there are no conditions precedent to the contract).

Question 2

Summary

To the extent the pattern of activities remain consistent with that for the period XXXX to date and continue for the relevant test period required for the active asset test in subsection 152-35(1) of the ITAA 1997, the Taxpayers would be able to satisfy the requirement that the Property has been used by them in carrying on a business for the relevant years (for the purposes of section 152-40 of the ITAA 1997 and thereby paragraph 152-10(1)(d)).

Detailed reasoning

Active asset test

Under subsection 152-35(1) of the ITAA 1997, a CGT asset will satisfy the active asset test if:

a)    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 test period, or

b)    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 7½ years during the test period.

Under subsection 152-35(2) of the of the ITAA 1997 the period:

a)    begins when you acquired the asset; and

b)    ends at the earlier of:

i)      the CGT event; and

ii)     if the relevant business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows - the cessation of the business.

Meaning of an active asset

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

For a CGT asset of a business to be an active asset for the purposes of Division 152 of the ITAA 1997 it must firstly satisfy one of the 'positive tests' in subsection 152-40(1) of the ITAA 1997 and then also not be excluded by one of the exceptions in subsection 152-40(4) of the ITAA 1997.

Positive test

Relevantly, under paragraph 152-40(1)(a) of the ITAA 1997 a CGT asset is an active asset (subject to the exclusions) if it is owned and used, or held ready for use, in the course of carrying on a business.

The principles and factors that are relevant in determining whether an activity amounts to carrying on a business are set out above.

Taxation Ruling TR 2019/1 Income tax: when does a company carry on a business? explains when a change in activities and purpose may amount to the cessation of business - these principles are equally relevant to other entites:

Need for an ongoing assessment - changes in activities and purpose

53. Whether a company carries on a business must be assessed based on its activity and status at that time.

...

55. Whether a company ceases to carry on any business requires careful consideration of all the facts. A company that becomes dormant and where there is no further activity or no intention to resume its former or any other business, may cease to carry on a business. This is not likely to be the case where its activities are simply limited in nature (see paragraph 39 of this Ruling). It is also not likely if activities are paused, even for a lengthy period, where there is an intention to resume them. As with starting a business, care needs to be taken to distinguish situations where the company has ceased a particular business, from the situation where the company has ceased carrying on any business. For example, a company may cease trading operations permanently but retain some investments. For this reason, it may still be carrying on a business in the general sense.

56. Where a company has entered liquidation, the courts consider whether there has been a change in the company's activities, their purpose and nature. If the liquidator is no longer carrying on any of the company's profit-making activities and whose only aim is to realise the company's assets in the most advantageous manner for the purpose of liquidating the company and distributing assets to its creditors and members, it may no longer carry on a business. In contrast, if it continues to trade in the process of winding a business down, it likely still carries on that business. If a company sells the entirety of its former business it ceases to carry on that business from the date it is sold.

Exception

Paragraph 152-40(4)(e) of the ITAA 1997 provides that an asset whose main use in the course of carrying on the business is to derive rent cannot be an active asset (unless that main use was only temporary). That is, even if the asset is used in a business, it will not be an active asset if its main use is to derive rent.

Taxation Determination TD 2021/2 Income tax: can a company that carries on a business in a general sense as described in Taxation Ruling TR 2019/1 Income tax: when does a company carry on a business? but whose only activity is renting out an investment property claim the capital gains tax small business concessions in relation to that investment property? confirms that even a company that is carrying on company that carries on a business in a general sense as described in Taxation Ruling TR 2019/1 but whose only activity is renting out an investment property cannot claim the capital gains tax (CGT) small business concessions in Division 152 of the Income Tax Assessment Act 1997 in relation to that investment property because an asset whose main use is to derive rent (unless such use was only temporary) is subject to an exclusion from those concessions, even if it is used in the course of carrying on a business. These principles are not restricted to the use of CGT asset by a company.

In TD 2006/78 (Income tax: capital gains: are there any circumstances in which the premises used in a business of providing accommodation for reward may satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 1997 notwithstanding the exclusion in paragraph 152-40(4)(e) of the Income Tax Assessment Act 1997 for assets whose main use is to derive rent?) the Commissioner explains the circumstances in which it is considered that the asset's main use is to derive rent.

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).

Whether an asset's main use is to derive rent will depend on the particular circumstances of each case.

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; Tingari Village North Pty Ltd v. Commissioner of Taxation [2010] AATA 233 at paragraphs 44-46, 2010 ATC 10-131, 78 ATR 693). Where 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.

Relevant factors to consider (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 (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).

It is noted that for the purposes of section 152-40 of the ITAA 1997 it is the use of the asset in the business, and not by the taxpayer who owns it, that is relevant. Where the taxpayer treats any use by their affiliate, or an entity that is connected with them, as their use, it is that entity's use of the property in their business that is relevant in this context. As such, property would not be excluded on the basis that it is a rental property in the hands of the taxpayer.

Application in these circumstances

The Taxpayer's acquired their interest in Property on XXXX. This means that they have held those interests for less than 15 years (i.e. from XXXX to a proposed sale date before XXXX) - consequently, they would need to establish the Property has been an active asset for at least half of the test period being (with reference to the holding period encompassing XXXX to a date prior to XXXX):

•         XXXX until XXXX: Whilst Individual A may have been carrying on a business at some point, it is not free from doubt that they were doing so at the date of their death (as they only had X animals). Consequently, as the Taxpayers maintained the activities following Individual A's death, it may be considered that the Taxpayers were not carrying on a business at this point.

•         XXXX to XXXX: The Taxpayers were preparing the Property for the conduct of primary production business. The Taxpayers decided to continue farming animals on the Property and had commenced the process of purchasing animals (about X to X). It would be reasonable to accept the Taxpayers were carrying on a business during this period.

•         XXXX to XXXX: the Taxpayers leased the land to a local farmer. They would not be carrying on a business - and even if they were, the exception in paragraph 152-40(4)(e) of the ITAA 1997 would apply to exclude the Property from being an active asset.

•         XXXX to date - The Taxpayers bought animals and were working with the agent for the purpose of making a profit (notwithstanding mistakes that were made). It would be reasonable to accept the Taxpayers were carrying on a business during this period.

To the extent the pattern of activities remain consistent with that for the period XXXX to date and continue for the relevant test period required for the active asset test in subsection 152-35(1) of the ITAA 1997, the Taxpayers would be able to satisfy the requirement that the Property has been used by them in carrying on a business for the relevant years (for the purposes of section 152-40 of the ITAA 1997 and thereby paragraph 152-10(1)(d)). For example, if the Property is sold on XXXX, the Property would have been used by the Taxpayers in carrying on their business for at least half of the test period - being X years (with reference to the X year holding period from XXXX).

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