Edited version of private ruling

Authorisation Number: 1011631012995

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Ruling

Subject: Active asset test and deriving rent

Question

Do the premises used in a business of providing rooming accommodation for reward satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997) notwithstanding the exclusion in paragraph 152-40(4)(e) of the ITAA 1997 for assets whose main use is to derive rent?

Answer: No

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You own two adjoining properties which provides accommodation to tenants.

The two properties are separately titled and on each title there are accommodation blocks containing self contained units and other units which have shared amenities.

The tenants in the self-contained units lease the units under standard residential tenancy agreements (a copy of which was provided). Under this tenancy agreement the tenant has to pay a security deposit. The agreement places limitation on how the tenant can terminate the lease and how the property owner can terminate the lease.

A lease agreement is entered into in respect of the other but it is not the standard residential tenancy agreement ( a copy of this agreement was also provided). Under the tenancy agreement the tenant is not required to pay a security deposit. In addition the tenant is only required to give two days notice when wishing to vacate the bedsit whilst the owner has to give the tenant either 14 or 28 days notice. These tenants have their own key to their own room. You do not have access to these rooms except for maintenance and inspection, showing other tenants, and emergencies.

Under both lease agreements payments have to be made fortnightly and are referred to as rent.

Activities performed by you:

A list of activities performed by you was provided.

Tenancy periods

A profile of occupancy duration was provided.

Relevant legislative provisions

ITAA 1997 Section 152-35

ITAA 1997 paragraph 152-40(4)(e)

Reasons for decision

As explained in paragraphs 18 to 21 of TD 2006/78, for the small business concessions in Division 152 of the ITAA 1997 to apply to reduce or disregard a capital gain, the relevant capital gains tax (CGT) asset must satisfy the active asset test in section 152-35 of the ITAA 1997. The active asset test requires the relevant CGT asset to be an active asset, both at a particular time and for half a particular period. However certain assets are excluded from being active assets and paragraph 152-40(4)(e) of the ITAA 1997 excludes, among other things, assets whose main use is to derive rent. Such assets are excluded even if they are used in the course of carrying on a business.

In respect of deriving rent paragraph 22 of TD 2006/78 states:

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 (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).

In this case the assets in question are buildings in which accommodation is provided in return for a payment to use that accommodation. There are two types of accommodation self-contained units and units where occupants uses some shared facilities. There are separate tenancy agreements to cover each type of accommodation.

The lease agreements for the self-contained units are standard residential tenancy agreement. This means that the tenant's occupancy rights are the same as those of normal landlord/tenant arrangements where the tenant leases the whole property from the landlord. The occupant has exclusive rights to the possession of that unit and the periodic payment referred to as rent in the lease agreement is a payment of rent as described in paragraph 22 of TD 2006/78.

Therefore the assets are clearly being used to derive rent. What we need to determine is the extent that they are being used to derive rent in order to determine if paragraph 152-40(4)(e) of the ITAA 1997 applies.

In respect of deriving rent paragraphs 23 and 24 of TD 2006/78 state:

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). 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.

If premises are operated as a boarding house, the issue arises as to whether an occupant of part of the premises is a tenant or alternatively only a lodger/boarder with a licence to occupy. Similarly, if residential units are operated as holiday apartments, the issue arises as to whether the occupants of the apartments are tenants/lessees or only have licences to occupy.

In looking at paragraphs 23 and 24 of TD 2006/78 what we are looking at in determining if the payment from the occupier of a units who also share facilities is rent. This means looking at whether under their tenancy agreement they are given exclusive possession or a licence to occupy part of the premises.

Example 3 of TD 2006/78 (paragraphs 8-10) looks at boarding houses and states:

David owns an 8 bedroom property which he operates as a boarding house. He resides on the premises. Boarders enter into arrangements to occupy single rooms with the average length of stay being 4-6 weeks. No notice is required to quit the rooms. There are rules requiring visitors to leave the premises by a certain time and David retains the right to enter the rooms. David pays for all utilities (gas, electricity, water) and provides the following services and facilities to boarders:

· room cleaning and general maintenance;

· linen and towels; and

· common areas such as a TV/lounge room, kitchen, bathrooms, laundry and a recreation area.

In this example, the services and facilities provided to boarders are relatively significant and the average length of stay is relatively short. David retains a significant degree of control over the premises through being on the premises most of the time. The arrangements entered into indicate that those staying in the boarding house do not have the right to exclusive possession of a room but rather only a right to occupy the room.

These circumstances indicate that the relationship between David and those staying at the boarding house is not that of landlord/tenant under a lease agreement. Accordingly, the income derived is not 'rent' and therefore the paragraph 152-40(4)(e) exclusion does not apply. If David's activities amount to the carrying on of a business, the boarding house will be an active asset under section 152-40 of the ITAA 1997.

In looking at example 3 of TD 2006/78, and the facts of this case, there are a number of differences, with the most important difference, being the fact that the tenant has exclusive possession of a room with a right to occupy the shared facilities. Although you clean and maintain the shared areas you do not clean the room they lease (unless specifically asked by the tenant). Otherwise you only enter the room to perform repairs and maintenance and to undertake inspections.

Under this agreement if the tenant decides to quit the room they are required to give notice (albeit only two days), but if you want the tenant to vacate you have to give them either 14 or 28 days notice (similar to that contained in normal residential tenancy agreements).

Although these tenants have to share facilities and follow house rules they cannot use these shared facilities without first signing a lease giving them exclusive possession of a room in the building.

As explained in TD 2006/78 a payment for exclusive possession of premises is rent and although these rooms are not leased under a standard residential tenancy agreement, the agreement entered into does give the tenant exclusive possession of the room in return for a payment. Therefore this payment to allow the tenant exclusive possession of the bedsit room is rent.

Both lease agreements being entered into gives the tenant exclusive possession of part of the asset. Given the formal nature of the agreements being entered into between the tenant and yourself to allow them exclusive possession, all the payments being made to you is rent as described in paragraph 22 of TD 2006/78.

Given that the assets are not used to derive any other types of income the main use (in fact the only use) is to derive rent. Therefore paragraph 152-40(4)(e) of the ITAA 1997 will apply to exclude these assets from the active asset test contained in section 152-35 of the ITAA 1997.

As stated in paragraph 21 of TD 2006/78 these assets will be excluded even if they are used in carrying on a business.