Edited version of private ruling

Authorisation Number: 1011882036296

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Ruling

Subject: Capital Gains Tax - Small Business Active Asset

Question

Can a set of residential units providing medium -term accommodation under lease agreement be considered an active asset for the purposes of the Small Business Capital Gains Tax (CGT) concessions in Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

T ruling applies for the following period:

1 July 2010 to 30 June 2011

1 July 2011 to 30 June 2012

The scheme commences on:

1 July 2010

Relevant facts and circumstances

The taxpayer and spouse own and operate a complex, providing accommodation. Due to age, the taxpayers are now planning to retire and wish to sell the units.

The average tenancy is several months. Occupancy rates are higher during certain times of the year.

The units have a common kitchen/dining area and lounge. Each unit has its own bathroom en suite.

The management and upkeep of the units is handled on-site by the taxpayer and spouse. A cleaning service is provided at certain intervals.

The nature of the agreement which the clients enter into is a form of lease. Notice is given prior to moving any tenant. In turn, tenants are required to give notice themselves prior to vacating although the arrangements are sufficiently flexible to allow for extenuating circumstances. When leaving, tenants are required to complete an Exit Condition Report. Tenants pay a bond which is returned to them upon satisfaction of the Exit Report.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-35 and
Income Tax Assessment Act 1997 Section 152-40.

Does Part IVA apply to t 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

Summary

Paragraph 152-40(4)(e) expressly excludes from the definition of an active asset an asset whose main use is to derive rent. Whilst there are some features of the arrangements which it has in common with boarding houses and holiday apartments, according to the generally accepted views of what constitutes rent, the amounts received by you from the property would be considered rent.

Regardless of whether or not the property is an asset used by you in the course of carrying on a business for the purposes of subsection 152-40(1), it cannot be regarded as an active asset for the purposes of paragraph 152-40(4)(e). As the property is not an active asset, it does not satisfy the basic conditions for the small business CGT concessions.

An asset cannot be apportioned into active and non-active components. In the event that there are both qualifying and non-qualifying uses of an asset it is necessary to determine which use predominates.

Detailed reasoning

You are planning to dispose of accommodation premises which you have used to derive income. You wish to know if such properties can be treated as active assets for the purpose of taking advantage of the small business CGT concessions. In order for you to choose to disregard all or part of a capital gain under the small business CGT concessions, certain conditions must be satisfied.

The first condition requires you to meet the basic conditions for the concessions in Sub-division 152-A. One of the basic conditions requires the relevant CGT asset to satisfy the active asset test in section 152-35. 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, paragraph 152-40(4)(e) states that:

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

(f) 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:

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

· Is the property predominantly used in that business to derive rent?

In respect of the first question, on the basis of the facts supplied it seems reasonable to conclude that the activities in relation to the management and running of the premises constitute the carrying on of a business for the purposes of paragraph 152-40(1) (a).

However, the existence of a business undertaking is a necessary but not sufficient condition to qualify for the small business concessions. Having satisfied paragraph 152-40(1)(a) with regard to carrying on a business it is necessary to consider if the arrangement falls within the exclusions contained in paragraph 152-40(4)(e). That is, it is necessary to consider if the answer to the second question above is in the affirmative, as in that case the asset will not be considered to be active regardless of whether it is used in the course of carrying on a business or not.

The term 'rent' has been described as follows:

· the amount payable by a lessee to a lessor 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, 80, 86, 93, 99),

· a tenant's periodical payment to an owner or landlord for the use of land or premises (Australian Oxford Dictionary, 1999, Oxford University Press, Melbourne),

· recompense paid by a tenant to a 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 landlord for the use of the property let (Halsbury's Laws of England 4^th Edition Reissue, Butterworths, London 1994, Ch 27(1) 'Landlord and tenant', paragraph 212).

Relevant factors include whether the occupier has a right to exclusive possession (Radaich v. Smith (1959) 101 CLR 209 at 222), the degree of control retained by the owner and the extent of any services provided by the owner such as room cleaning, provision of meals, supply of linen and shared amenities (Appah v. Parncliffe Investments Ltd [1964] 1 All ER 838 ; Marchant v. Charters [1977] 3 All ER 918).

In your application, reference is made to Examples Three and Four of TD 2006/78. Viewed objectively, your facts can be distinguished from those in both examples. In Example Three, the proprietor provides common areas and handles general maintenance as in your case. However, in other respects the differences are considerable. They can be summarised as follows:

Example three

No notice required to vacate
Proprietor retains the right to enter rooms
Average stay is 4 to 6 weeks
Regular room cleaning provided

Present case

Notice required to vacate
Proprietor's right to enter rooms severely restricted by the terms of Residential Tenancies and Rooming Accommodation Act 2008
Average stay is several months
Room cleaning provided generally every twelve weeks
Similarly, when comparing your case to Example Four:

Example Four

Average stay is 1 night to 1 month
Meals provided
No lease agreements used

Present case

Average stay is several months
No meals provided
Lease agreements required

In the circumstances described in Examples Three and Four, the taxpayer was providing such additional services as meals and regular cleaning not merely providing accommodation and services necessarily or ordinarily provided in the course of a normal rental agreement.

Generally speaking, with a boarding house there is not a landlord/tenant relationship and the boarder does not have exclusive right of occupancy. The terms on which the boarder is able to stay in the house are at the discretion of the owner. The owner may change the rooms which a boarder occupies at any time, may terminate the stay of the boarder at any time and has the right to enter a boarder's room at any time for the purpose of cleaning or inspecting the room. The owner makes provision for the cleaning and maintenance of the premises and maintains exclusive control of the premises and the room occupied by the boarder at all times.

In your case, renters have a degree of exclusive possession. Notice is given before they can be moved between rooms. Cleaning is performed only every few weeks rather than on an ongoing basis.

Whilst there are some features of the arrangements which it has in common with boarding houses and holiday apartments, it is generally significantly different to them and would seem to have far more in common with a typical rental arrangement. The agreement which is entered into is essentially a lease agreement.

According to the generally accepted views of what constitutes rent, the amounts received by you from the property would be considered rent and, as the property has not been used by you for any other purposes during the period that it has been held, the predominant use of the property during that time has been to derive rent. As a result, the asset is excluded from the small business concessions as a consequence of the operation of paragraph 152-40(4)(e).

In respect of your further question, an asset cannot be apportioned into active and non-active components. Sub-section 152-40(4) establishes that it is the main use of an asset which determines whether it is an active asset. In the event that there are both qualifying and non-qualifying uses of an asset it is necessary to determine which use predominates and classify the asset accordingly. Example Five in TD 2006/78 discusses the treatment of mixed use assets.