Edited version of private advice

Authorisation Number: 1052367005550

Date of advice: 28 February 2025

Ruling

Subject: CGT - small business concessions

Question 1

Is the Company eligible for the small business retirement exemption under Subdivision 152-D of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

No.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The Company was originally set up in 19XX as a building company.

However, one partner went through hardship and had to sell their half of the Company.

The Company purchased land in June 19XX.

The Company built X townhouses on the land which were completed in October 19XX.

After building the X townhouses it made no further transactions and did not trade as a building company as per its original purpose since 19XX.

The Company sold X of the townhouses in December 20XX.

The Company was left with X townhouse (the property) that was used solely as a rental property.

The property was sold in October 20XX.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 Subdivision 152-D

Reasons for decision

Basic conditions

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.

Active asset test

Sections 152-35 and 152-40 of the ITAA 1997 discuss the active asset test. Section 152-35 of the ITAA 1997 says the active asset test is satisfied if:

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

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

The test period is from when the asset is acquired until the CGT event. If the business ceases within the 12 months before the CGT event (or such longer time as the Commissioner allows) the relevant period is from acquisition until the business ceases.

Section 152-40 of the ITAA 1997 sets out the meaning of the term 'active asset'. In relation to an asset directly held by the taxpayer, 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 (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a business that is carried on (whether alone or in partnership) by you.

Rental exemption

However, subsection 152-40(4) of the ITAA 1997 lists CGT assets that cannot be active assets that need to be considered.

Under paragraph 152-40(4)(e) of the ITAA 1997, an asset whose main use is to derive rent cannot be an active asset unless the main use for deriving rent was only temporary.

Taxation Determination 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? (TD 2006/78) considers the active asset test and the main use to derive rent concept.

Whether an asset's main use is to derive rent will depend upon the particular circumstances of each case. In accordance with paragraph 22 of TD 2006/78, 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).

Example 1 in TD 2006/78 considers if the main use is to derive rent and states:

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.

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.

The issue of whether a taxpayer's rental properties can be active assets when they are carrying on a business of letting rental properties was considered in Jakjoy Pty Ltd v FC of T [2013] AATA 526, (Jakjoy).

In Jakjoy the taxpayer was carrying on a business of leasing commercial properties. It was held that despite the fact the taxpayer was carrying on a business of leasing properties that the properties were not considered 'active assets' under section 152-40 of the ITAA 1997 and did not satisfy the 'active asset test' in section 152-35 of the ITAA 1997. Given the main or only use of the properties was to derive rent, the properties were excluded from being active assets under section 152-40(4)(e). This was regardless of the fact that the taxpayer's activities amounted to the carrying on of a business. It was affirmed that

....although it was common ground that the taxpayer was carrying on a business of renting properties, it did not automatically follow based on a clear reading of the text in section 152-40 of the ITAA 1997, that the properties the taxpayer used in carrying on its business were 'active assets'.

Indeed, those properties were expressly excluded from being 'active assets' by the exception in section 152-40(4)(e) of the ITAA 1997.

Retirement exemption

Subdivision 152-D of the ITAA 1997 sets out the conditions for the small business retirement exemption. If you are company, you can choose to disregard all or part of a capital gain under this provision if:

•                     you satisfy the basic conditions

•                     the entity satisfies the significant individual test in section 152-50

•                     the company or trust conditions in section 152-325 are satisfied.

Application to your circumstances

The only use of the property by the Company was to derive rental income and the circumstances can be likened to example 1 of TD 2006/78. Therefore, the property is excluded from being an active asset under paragraph 152-40(4)(e) of the ITAA 1997. As the property doesn't satisfy the active asset test, the Company does not satisfy the basic conditions under Subdivision 152-A. Therefore, the Company is not eligible for the retirement exemption under Subdivision 152-D as it does not meet all the relevant conditions.

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