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Ruling

Subject: Small business CGT concessions - holiday house

Question 1:

Are you eligible to apply the small business capital gains tax (CGT) concessions under Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997), and specifically the retirement exemption, on the sale of the property?

Answer: No.

This ruling applies for the following periods:

1 July 2011 to 30 June 2012.

The scheme commences on:

1 July 2011.

Relevant facts and circumstances

You and your wife jointly purchased a property after September 1985. The property is used for holiday rental and is rented as a two night minimum but average rental is about five nights. The occupancy rate is 60-70% and the property is available for rent all year round.

The property is rented fully furnished and you also provide a pantry that has basic ingredients and condiments. Beds are made up for guests on arrival and changed on a weekly basis or upon request thereafter.

The number of hours you spend on the activity each week varies according to maintenance and servicing demands but you state would average approximately 20 hours. Activities that you carry out are taking bookings, following up enquiries and emails, invoices and receipts, banking, paying accounts, creating and updating websites, cleaning of house before and after occupancy, washing windows, making up beds prior to arrival of guests, delivering and collecting linen from laundry, washing and ironing quilt covers and soft furnishings, gardening and mowing lawns, painting, general maintenance and repairs, fresh flower arrangements, splitting and carting firewood, making curtains, shopping and rubbish collection

You employ others to do the following:

§ Rubbish collection, cleaning and mowing only when we are unable to do it yourselves, linen hire and laundry service and trades people when required.

§ You do not own any other properties used in a similar manner and you have no written business plan.

§ The property is advertised in a number of locations including the internet, holiday accommodation handbooks and tourism associations.

§ You do not have a fulltime occupation elsewhere but you have other passive investments.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 paragraph 104-10(3)(a)

Income Tax Assessment Act 1997 Subdivision 152-E

Income Tax Assessment Act 1997 section 104-185

Income Tax Assessment Act 1997 subsection 104-185(1)

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 subsection 152-40(1)

Income Tax Assessment Act 1997 subsection 152-40(4)

Income Tax Assessment Act 1997 paragraph 152-40(1)(a)

Income Tax Assessment Act 1997 paragraph 152-40(4)(e)

Income Tax Assessment Act 1997 section 995-1

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 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 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

The conditions that must be met in order to obtain relief under the retirement exemption are set out in Subdivision 152-D of the ITAA 1997. However, before the retirement exemption can be examined you must firstly satisfy the basic conditions for the small business CGT concessions found in Subdivision 152A of the ITAA 1997.

The small business CGT concessions are dealt with in Division 152 of the ITAA 1997.

Subsection 152-10(1) of the ITAA 1997 contains the following basic conditions to be satisfied:

(a) a CGT event happens in relation to a CGT asset of yours in an income year. This condition does not apply in the case of CGT event D1.

(b) the event would (apart from Division 152 of the ITAA 1997) have resulted in the gain

(c) at least one of the following applies:

(i) you are a small business entity for the income year

(ii) you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997

(iii) 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

(iv) the conditions in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year

(a) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

All of these basic conditions need to be satisfied for you to qualify for the small business CGT concessions. Some concessions also require that other conditions be satisfied.

In your circumstances, it is necessary to examine if the property will satisfy the active asset test.

Definition of active asset

For a CGT asset of a business to be an active asset for the purposes of Division 152 of the ITAA 1997 it must firstly satisfy one of the 'positive tests' in subsection 152-40(1) of the ITAA 1997 and then also not be excluded by one of the exceptions in subsection 152-40(4) of the ITAA 1997.

Under paragraph 152-40(1)(a) of the ITAA 1997, a CGT asset is an active asset at that time, you own the asset and it is used, or held ready for use, in the course of carrying on a business that is carried on by you; or your affiliate; or another entity that is connected with you.

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 such use was only temporary. That is, even if the asset is used in a business it will not be an active asset if its main use is to derive rent.

In the course of 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.

Whether a business is being carried on depends on the large or general impression gained (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548) from looking at all the indicators of carrying on a business, and no one indicator will be decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922).

Taxation Ruling TR 97/11 is of general application. Its principles are not restricted to questions of whether a primary production business is being carried on.

In the Commissioner's view, the factors that are considered important in determining the question of business activity are:

§ whether the activity has a significant commercial purpose or character

§ whether the taxpayer has more than just an intention to engage in business

§ whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

§ 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 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.

Significant commercial purpose

The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators.

You have owned the holiday rental property for a number of years. Holidaymakers stay for periods ranging from two nights to two weeks.

In some aspects, your activity is similar to that of a commercial operator such as: advertising, cleaning, repair and maintenance and paying accounts. However, you only have one property and you do not have a business plan.

Intention of the taxpayer

You purchased the property as a holiday rental. You provide a desirable holiday home for short term rental.

Prospect of profits

You have stated that you have a 60-70% occupancy rate. You generate some income however not a considerable amount.

Repetition and regularity

You have spent some time with regard to the activity. The property is advertised and you carry out most of the day to day work yourselves. You clean the property and maintain the property and yard. The laundering of sheets and towels is by a linen hire and laundry service but you make the beds and wash the quilt covers and soft furnishings.

You take bookings and enquiries and pay invoices.

The house is fully furnished and you will change the linen weekly or as requested. You do not provide any meals but the pantry is stocked with relevant provisions.

Activities of the same kind and carried on in a similar manner to those of the ordinary trade in that line of business

If a taxpayer carries out their activity in a manner similar to other taxpayers in the industry, it is more likely that their activity amounts to the carrying on of a business. That is, the taxpayer's operations are of the same kind and carried on in the same way as those characteristic of ordinary trading in that particular line of business (IR Commissioners v. Livingston 11 TC 538).

This indicator requires a comparison between the activities of the taxpayer in question and those undertaken by a person in business in the same type of industry. Where the taxpayer's activities are similar in nature to the business, further support is given to the fact that a business exists.

Activities constituting the mere maintenance of an asset and the mere collection of income do not indicate the existence of a business of renting premises.

The following information found in the Rental Properties 2010-11 provides an example of a business being carried on:

The Hitchmans' neighbours, the D'Souzas, own a number of rental properties, either as joint tenants or tenants in common. They own eight houses and three apartment blocks (each apartment block comprising six residential units) making a total of 26 properties.

The D'Souzas actively manage all of the properties. They devote a significant amount of time, an average of 25 hours per week each, to these activities. They undertake all financial planning and decision making in relation to the properties. They interview all prospective tenants and conduct all of the rent collections. They carry out regular property inspections and attend to all of the everyday maintenance and repairs themselves or organise for them to be done on their behalf. Apart from income Mr D'Souza earns from shares, they have no other sources of income.

The D'Souzas are carrying on a rental property business. This is demonstrated by:

§ the significant size and scale of the rental property activities

§ the number of hours the D'Souzas spend on the activities

§ the D'Souzas' extensive personal involvement in the activities, and

§ the business-like manner in which the activities are planned, organised and carried on.

The issue of whether individuals are carrying on a business of letting property has been considered in a number of cases, some of which are discussed below.

In Cripps v. FC of T 99 ATC 2428; (1999) 43 ATR 1202 (Cripps), the taxpayer and his wife purchased, as joint tenants, 14 townhouses which they rented out. They also purchased a property which was used initially as a holiday home but was later periodically rented out. A further property was purchased for residential purposes. After a failed attempt to sell it, it was also rented out. The Administrative Appeals Tribunal found that the taxpayer and his wife were mere passive investors and were not in the business of deriving income from rental properties. They rejected the taxpayer's argument that he had greater involvement with his 16 properties.

In 11 CTBR (OS) Case 24, the taxpayer's income included rents from three properties. The taxpayer employed a manager and an accountant - he was principally a letting clerk with authority to refuse tenants. He collected and banked rents, attended to repairs and supervised them, and controlled the caretaker and cleaners. He kept books in connection with rents and repairs, and rates and other outgoings. The taxpayer said he personally carried out the principal part of the management of his rent-producing properties and directed policy, attended to the financial arrangements and made decisions regarding repairs. The taxpayer claimed that he was carrying on a business. In holding that he was not carrying on a business, a majority of the members of the Board of Review said:

It is obvious that some measure of supervision and management must ordinarily be exercised by a property owner who lets offices, &c., and if that does not amount to the carrying on of a business, the fact that he employs others to assist him, either in the letting of the properties or in the preparation of the accounts relating to his rents and outgoings, will not make any difference. For the foregoing reasons we are unable to uphold the claim that the taxpayer is engaged in a 'business as property owner' ... .

In 15 CTBR (OS) Case 26, the taxpayer derived income substantially from her joint ownership of a block of flats (containing 22 living units) with her sister-in-law. A swimming pool was shared with a neighbouring block of flats owned by the taxpayer's husband and his brother. A garden was maintained and a staff of one caretaker and one cleaner employed on both buildings with casual labour as required. The building was erected and financed by F & Co., the husbands of the joint owners, in the course of their business as building contractors. The general supervision of letting, rent collecting, servicing and maintenance was carried out by the owners or by F & Co. on their behalf. No charge was made by F & Co. for the extensive assistance given in the supervision of the flats. It was held that a business was not being carried on by the owners of the block of flats.

On the other hand, Case G10 75 ATC 33; 19 CTBR (NS) Case 103 (Case G10), the taxpayer owned two properties of which six units were let as holiday flats for short term rental. The taxpayer, with assistance from his wife, managed and maintained the flats. Services included providing furniture, blankets, crockery, cutlery, pots and pans, hiring linen and laundering of blankets and bedspreads. The taxpayer also showed visiting inquirers over the premises, attended to the cleaning of the flats on a daily basis, mowing and trimming of lawns, and various other repairs and maintenance. The taxpayer's task in managing the flats was a seven day a week activity. The Board of Review held that the activity constituted the carrying on of a business.

Your property is rented out for periods ranging from two days to two weeks. You have owned the property for a number of years and state that you spend approximately 20 hours per week maintaining grounds, cleaning after guests, email correspondence, bookwork, linen supply and garbage removal.

It is not considered that your activity is carried out in a similar manner to those that are in the business of property letting. Your activity is more akin to that of Cripps in that most of your customers stay for a number of days at a time, thus reducing your involvement.

Organisation in a business-like manner, the keeping of books, records and the use of a system

The activities conducted by, or on behalf of the taxpayer, should be carried out in a systematic and organised manner. This will usually involve matters such as the keeping of appropriate business records by the taxpayer. If the activities are carried out on the taxpayer's behalf by someone else, there should be regular reports provided to the taxpayer on the results of those activities.

You carry out bookwork in relation to the property however, you do not have a business plan in place.

The size and scale of the activity

In contrast to Case G10 the scale and the size of your activity is small as you have one property consisting of one house. You have owned the house for a number of years and do not have a business plan to increase the size of the activity,

Hobby or recreation

The activity does not have the nature of a hobby or recreational pursuit. The nature of your activity is similar to other property owners who let a property for income.

Conclusion

In your case you own one short term holiday rental which returns some income. Whilst there are aspects of your activity that are similar to that of a commercial operator your level of personal involvement in providing some services is significantly less than that noted in Case G10 as you generally only service the property when clients leave and as most clients stay for several days you are not servicing the property daily and you only have one property.

You do not meet many of the indicators required to determine if a business is being conducted and therefore we consider that your activities are not conducted on a sufficient scale to be considered a business.

The finding that your activities are not a business does not change whether or not income from these activities is assessable or the expenses are deductible.

As a business is not being carried on the property does not qualify as an active asset and you do not qualify for the small business CGT retirement concession.

In your circumstances, it is not relevant to determine whether the main use of the asset is to derive rent as we have determined that you are not carrying on a business and therefore the asset can not be considered an active asset as it is not used in carrying on a business.