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Ruling

Subject: Non-commercial losses - Real property test

Question 1

Is a council valuation a reasonable value to use for the purposes of calculating whether you have met the real property test for non-commercial losses?

Answer

Yes.

Question 2

Is leased property able to be used for the purposes of the real property test for non-commercial losses?

Answer

Yes.

Question 3

Can the value of other land that is not owned or leased by you be included for the purposes of the real property test?

Answer

No

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

You have operated a primary production business for many years.

The value of your land is stated on the council rates notice. Of this amount a portion of the property is used for the business with the remainder for private use.

You also own a separate paddock block, which also has its value stated on the council rates notice, which is used solely for the business.

The business has also leased land adjacent to the property for some years. You have determined the market value of this leased land.

There is also other land used in the business that is not owned or leased by you.

There are also other structural assets on the property that are used in the business that are insured for a value.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 35-10(2)

Income Tax Assessment Act 1997 Paragraph 35-40

Reasons for decision

The real property test in section 35-40 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the loss deferral rule in subsection 35-10(2) of the ITAA 1997 does not apply to defer any loss incurred by the individual from the activity for that income year if real property of at least $500,000 in value is used in the business activity on a continuing basis.

Real property includes:

· land

· interests in land such as leases

· structures, such as buildings, fixed to the land.

Real property, for the purposes of this test, does not include:

· a dwelling and adjacent land that is used mainly for private purposes; or

· fixtures owned by you as a tenant.

To value real property or interests in real property, the individual can choose the reduced cost base, or the market value of the property or interest in real property if that value is more than the reduced cost base (subsection 35-40(2)). The meaning of reduced cost base is the same as it is for capital gains tax purposes. This meaning is to be found in Subdivision 110-B.

If the permission to use the real property creates a tenancy of some sort, the tenant will have a leasehold interest in the land. The case Radaich v Smith (1959) 101 CLR 209 suggests that the test for the existence of a tenancy is whether exclusive possession is granted, that is, a right that enables its holder to exclude others from the premises.

If the relationship a taxpayer has with the property owner results in the creation of a tenancy, or exclusive possession is granted to the individual, with or without payment, that will be sufficient for the individual to have an 'interest' in that land.

A form of tenancy that may arise in a case where exclusive possession is granted but no rent is paid, is a tenancy at will. A tenancy at will creates an interest in land. Halsbury's Laws of Australia at 245-85 describes a tenancy at will as created by possession of the premises, with the consent of the lessor, subject to a right of determination by either party at any time. A tenancy at will can be created either expressly by contract or by implication of law from the conduct of the parties.

If the relationship between an individual and another party results in the creation of a tenancy at will, or exclusive possession is granted to the individual, that will be sufficient for the individual to have an 'interest' in that land. The individual will be able to take into account the market value or reduced cost base of that interest or the underlying property if they choose, for the purposes of the real property test.

Factors to consider in determining the market value of a lease would include the amount of the lease payments, the term of the lease and any premium payable.

You cannot include the value of the asset towards meeting the $500,000 threshold if you use an asset:

· on a short-term basis

· for a one-off task, or

· through an agreement for intermittent use on an hourly, daily, weekly, monthly or other short-term basis.

In applying the real property test in section 35-40 of the ITAA 1997 the only land that is taken into account is the physical area that is used on a continuing basis in carrying out the activity. This is emphasised by paragraph 66 of Taxation Ruling TR 2001/14 Income Tax: Division 35 Non-Commercial Business Losses which states that for something to be used on a continuing basis it requires something more than transient or insubstantial use see FC of T v Stewart (1984) 154 CLR 385; 84 ATC 4146; (1984) 15 ATR 387.

The following applies to your circumstances in relation to the real property test:

You may use a council valuation to value the property value for the real property test, provided you consider apportionment for the area used in the business on a continuing basis.

In the case of land that you lease, as the holder of an interest in real property, you can choose either the market value or reduced cost base of that interest or the underlying property for the purposes of the real property test

You cannot use the value of other land that is not owned or leased by you, unless as you can demonstrate that you have exclusive possession of it, meaning you have a right that enables you to exclude others from using it.

You can also include the structures fixed to the land that you own, for the purposes of the real property test, provided that they are used in the business on a continuing basis.