Edited version of private ruling

Authorisation Number: 1011850062102

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Ruling

Subject: Active asset

Question

Is the property an active asset under section 152-40 of the Income Tax Assessment Act 1997 (ITAA 1997) for the whole period of your ownership?

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 are two individuals (Individual A and Individual B).

You jointly purchased a property containing several units which were used for short term accommodation.

You owned another business (Business A) in close proximity to the units which Individual A managed. Individual B operated another business (Business B) and assisted with Business A.

Your long term plan was, in summary:

· Individual A to run Business A.

· Individual B to step back from Business B, work as required to help with Business A, and spend the rest of their time improving and running the units.

· Plan to sell Business A and move to the units. The funds from the sale of the Business A to be used to improve and further develop the units and associated manager's residence.

The units were purchased as a going concern. The purchase included a planning permit and plans for further units and included pre bookings.

After the purchase of the units, Individual B ceased Business B and began working at the units for an estimated XX hours per week. This time was spent maintaining and running the accommodation, for example bookings, cleaning, linen changes and property maintenance.

Individual A continued operating Business A and assisted approximately X hours per week with administrative work for the units.

You advertised the units in a guide, they had a phone listing in the white pages, and a yellow pages advertisement, and the main sign at the front of the units had contact phone numbers, as well as a vacancy/no vacancy option.

Several years later, you sold Business A and moved into one unit as on-site managers. The remaining units remained available to clients.

Daily activities following the sale of Business A included:

Individual A - You were employed X day(s) per week in other employment. You primarily ran the units and were responsible for gardening, window cleaning, book work, and the cleaning of the units including daily servicing as required.

Individual B - you returned to Business B on a part time basis. Your activities at the units involved daily path cleaning and general tiding, mowing when possible, and assisting with cleaning after guest departures.

There was an accommodation building boom in the area. Instead of planning further development you decided to run boutique accommodation and decided to renovate the units.

You offered the units as serviced units. Linen, towels, soaps, tea, coffee and condiments were provided.

The majority of bookings were two night stay, but did vary from one night to two weeks. On extended bookings the units were serviced periodically or on request.

You did not enter into lease agreements with guests. Tariffs were usually charged on a nightly basis.

Individual A worked on average XX hours per week running the units.

Individual B worked an average of XX hours per week at the units. Their activities included the cleaning and maintenance of the property.

The units were then sold as a going concern several years later.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Summary

To satisfy the active asset test the asset must have been an active asset for at least half of the period of ownership. It is not considered that the operation of the units prior to the sale of Business A constituted the carrying on of a business. As the period prior to the sale of Business A constituted more than half the period of ownership, the units were not an active asset for at least half the period of ownership and do not satisfy the active asset test.

Detailed reasoning

Active asset

Section 152-40 of the ITAA 1997 provides the meaning of active asset. An asset will be an active asset at a time if, at that time, the asset is used in the course of carrying on a business. However, paragraph 152-40(4)(e) of the ITAA 1997 provides that an asset whose main use is to derive rent, cannot be an active asset (unless that main use was only temporary).

Active asset test

If you have owned the CGT asset for less than 15 years the active asset test in section 152-35 of the ITAA 1997 will be satisfied if the asset was an active asset of yours for a total of at least half of the period outlined in subsection 152-35(2) of the ITAA 1997. The period commences when you acquired the asset and ends at the earlier of either (i) the CGT event, or (ii) if the relevant business ceased to be carried on in the 12 months before that time - the date on which the business ceased.

Carrying on a business

Business is defined in section 995-1 of the ITAA 1997 to be 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'.

Indicators used by the courts to determine whether activity amounts to the carrying on of a business are set out in Taxation Ruling TR 97/11. No individual factor is determinative, but should be weighed up in conjunction with the other factors. The factors include:

· whether you have more than just an intention to engage in business

· whether there is regularity and repetition of the activity

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

· whether the activity has a significant commercial purpose or character

· whether you have a purpose of profit as well as a prospect of profit from the activity

· whether the activity is planned, organised and carried on in a businesslike manner such that it is described as 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 sporting activity.

Whether there is a purpose of profit as well as a prospect of profit

It is important for someone who claims to be carrying on a business to show that the activity or venture can make a profit. One way of showing this is evidence of research into the profitability of the venture or of advice that has been received from business consultants. It is important to demonstrate that it is likely that a profit can be earned from the venture at some stage, either now or in the future. It is also necessary to demonstrate that this can occur with the business being carried on in the same form as it is now.

The size, scale and permanency of the activity

Paragraph 77 of TR 97/11 states that the larger the scale of the activity the more likely it will be that the taxpayer is carrying on a business. However the size or scale of the activity is not a determinative test and a person may carry on a business though in a small way. A smaller scale of activity may detract from the commercial purpose or character of the activities, for example the activity may more properly be described as the management of a capital investment rather than a business.

The business should be large enough to be considered commercially viable. In Cripps and the Commissioner of Taxation (Cth), Re: Case [1999] AATA 937, it was held that the renting of 14 two storey townhouses was not a business and in Federal Commissioner of Taxation v. McDonald 5 FCR 172 (1987) 78 ALR 588 (1987) 18 ATR 957 it was held that the letting of two units in different strata plans was also not a business.

The Tax Office publication Rental properties 2009 (NAT 1729-6.2009) states that a person who simply co-owns an investment property or several investment properties is usually regarded as an investor who is not carrying on a rental property business.

Taxation Ruling IT 2423 considers whether rental income constitutes proceeds of a business and states:

A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations. An individual who derives income from the rent of one or two residential properties would not normally be thought of as carrying on a business. On the other hand if rent was derived from a number of properties or from a block of apartments, that may indicate the existence of a business.

A property owner may be considered to be carrying on a business in relation to a property where the activity can be said to be more than the passive receipt of income from the property.

Application to your circumstances

To satisfy the active asset test, the CGT asset must been used, or held ready for use, in the course of carrying on a business, for at least half of this period. In addition, its main use must not have been to derive rent.

There have been significant changes in the operation of the units during the period you have owned the property.

Prior to the sale of Business A

For an activity or venture to be a business, it must be carried on in a commercially viable manner. Commercial purpose or character is an overall impression that is gained from the activities being undertaken as a whole.

When you purchased the units, your business plan indicates that you had long term plans to operate it as a commercially viable venture, with a prospect of profit. Your short term plan, however, indicates activity more consistent with an investment in property. There were no immediate plans for expansion or substantial improvements. Business A was also your primary income source. The units were a secondary operation, and the close proximity of the properties enabled you to maintain the units with minimal disruption to your primary business.

Although there was some active participation on your part in the running of the units, your activities during this period were not of a sufficient scale to be considered as carrying on a business. Improvements made to the property during this period were minor and do not indicate part of a plan to substantially increase the commercial viability of the complex. Maintenance of the units and gardens is considered to a normal part of owning an investment property. There were also no significant changes made during this period to increase the commercial viability of the complex.

You would therefore not be considered to be carrying on a business during this period. Consequently, the units were not used in the course of carrying on a business and will not satisfy the requirements in section 152-40 of the ITAA 1997 to be an active asset for this period.

Following the sale of Business A

You sold Business A and moved into one of the units. From this time, Individual A ran the units and Individual B resumed Business B on a part time basis.

There were major renovations to the complex and you made significant changes to the way you carried on the activity. You also reduced the number of units available for booking during this period by moving into one of the units.

The manner in which the activity was conducted after renovations suggests a profit making purpose, specifically:

· the advertising of the units

· business plan and adaptation to market

· the capital invested in the activity; and

· the commitment in terms of availability, that is, being on call 24 hours per day.

You would therefore be considered to be carrying on a business during this period. In view of the services provided by you, the short term nature of the accommodation and the lack of exclusive possession of the units, the exception in paragraph 152-40(4)(e) of the ITAA 1997, relating to the main use of the asset to derive rent, will not apply for this period.

Consequently, the units will satisfy the requirements in section 152-40 of the ITAA 1997 to be an active asset for this period.

Summary

To satisfy the active asset test the asset must have been used in the course of carrying on a business for at least half of the period of ownership.

As discussed above, the units were an active asset only for the period following the sale of Business A, which is less than half of the period of ownership. Although the units were an active asset for this later period, the active asset test in section 152-35 of the ITAA 1997 will not be satisfied.