Edited version of private ruling

Authorisation Number: 1011723354122

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Ruling

Subject: Capital Gains Tax

Question

Does the asset meet the Capital Gains Tax (CGT) active asset test in section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period:

1 July 2010 to 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it.

The taxpayer purchased a residential property and set up a business. A development application was submitted to council. Council would only approve a certain percentage of the property for business as the area was zoned residential.

The taxpayer states that it was his intention to use the premises for business however council limitations meant that he could only use the part for business and rented the remaining area to a residential tenant. The tenants could only access the premises from the rear as the front access was for the business only.

The taxpayer has been running the business for a number of years. He is now planning to retire and sell the property.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Section 152-40

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part. If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Unless otherwise stated, all legislative references in the following Reasons for Decision are to the Income Tax Assessment Act 1997.

Summary

We accept that the main use of the property is not to derive rent. Consequently, the property will be considered an active asset as defined in section 152-40. As it was being used as an active asset for more than half of the period of ownership, it will pass the active asset test in section 152-35.

Detailed reasoning

You are planning to dispose of a property which you have used to derive income. You wish to know if the property will satisfy the active asset test in section 152-35. The asset will satisfy the test if the asset was an active asset for at least half of the period specified in that section.

The meaning of an active asset is provided in section 152-40. Sub-section 152-40(1) states:

(1) 'A CGT asset is an active asset at a time if, at that time:

(a) 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:

(i) you; or

(ii) your affiliate; or

(iii) another entity that is connected with you; or

(b) if the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

However, certain assets are excluded from being active assets under subsection 152-40(4). Paragraph 152-40(4) (e) states that:

(4) the following CGT assets cannot be active assets:

an asset whose main use by you is to derive …rent, … unless:

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

Therefore, an asset whose main use in the course of carrying on a business is to derive rent is specifically excluded from being an active asset unless deriving rent was only temporarily the main use of the asset. Whether an asset's main use is to derive rent will depend upon the particular circumstances of each case.

Therefore, two questions need to be considered before the property can be accepted as an active asset and eligible for the small business concessions under Sub-division 152-D:

1. Is the property used by you in the course of carrying on a business?

2. Is the predominant use of the property to derive rent?

The answer to the first is in the affirmative. The portion of the property devoted to the non-rental activity is clearly used in conducting a business. As a result, the asset falls within the class of assets covered by the definition in subsection 152-40(1). Consequently, it is only a matter of determining whether the predominant use of the asset is in deriving rent which would disqualify it under subsection 152-40(4) even if it was used in the conduct of a business.

Taxation Determination TD 2006/78 considers, amongst other issues, the situation where there is part business and part rental use of an asset. It states that an asset owned by the taxpayer and used partly for business purposes and partly to derive rent can be an active asset under section 152-40 where it is considered that the main use of the premises is not to derive rent. In deciding if the property was mainly used to earn rent the Commissioner will consider a range of factors such as:

· the comparative areas of use of the premises (between rent and business)

· the comparative times of use of the premises (between rent and business), and

· the comparative levels of income derived from the different uses of the asset.

An examination of the facts in the present case indicates a majority of the area of the property is used for earning rental income. On the other hand, the information provided shows that a clear majority of the gross income is generated by the non-rental business.

The facts in this case can be compared with those in Example 5 of TD 2006/78. They are broadly similar. While the percentage of the property used for non-rental purposes is smaller than that in TD 2006/78, it is still significant. Furthermore, the clear majority of the gross income is generated by the business.

After considering the example given in TD 2006/78, we accept that the main use of the property is not to derive rent. For the purposes of this ruling, your circumstances do not differ from those in Example 5 of the TD 2006/78 in any particular way which would distinguish them from the circumstances of the taxpayer in that example.

Consequently, the property will be considered an active asset as defined in section 152-40. As it was being used as an active asset for more than half of the period of ownership, it will pass the active asset test in section 152-35.