Edited version of private advice

Authorisation Number: 1012636796497

Ruling

Subject: CGT - active asset

Questions and Answers

1. Is the company carrying on a business of providing short term and longer term lodger accommodation?

Yes

2. Is each of the m dwellings owned by the company as a residential accommodation facility an active asset under section 152-40 of the Income Tax Assessment Act 1997 (ITAA 1997) and not subject to the exclusions in paragraph 152-40(4)(e) of the ITAA 1997?

Yes

This ruling applies for the following periods

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commenced on

1 July 2012

Relevant facts and circumstances

Company A (the company) is engaged in providing longer term and short term accommodation.

B is the director of the company. B owns the majority of the company.

The company satisfies the turnover test and $6m net asset test for the purposes of the small business concessions.

Since 1985, the company has purchased vacant land, erected m houses (dwellings) for the purposes of providing accommodation. The company has been renting out up to more than 30 rooms for short term and longer term accommodation in those m dwellings. The properties are in the name of the company.

Each dwelling has X rooms for letting. The rooms are all fully furnished. The kitchen and bathrooms are shared.

The addresses of the m dwellings have been provided, along with a description of when the land was bought and when the dwelling was built and ready for accommodation purposes.

Each dwelling has been used for accommodation purposes for several years and for more than half of the period of ownership by the company.

The company has had in total over X lodgers to date. B has provided details of the names of each lodger for each dwelling, the date they began lodging and the period of their stay.

The boarders occupy single rooms in each property under an agreement that does not specify or provide the right to exclusive possession of a room, but rather only a right to occupy the room subject to complying with the rules.

The company has unrestricted access to the room provided to a lodger and retains a high degree of control.

A real estate agent has not been engaged.

B, on behalf of the company, manages the properties themself. The tasks they undertakes include advertising of rooms, making and receiving phone calls daily, collecting rent, chasing up late or non-payment of rent, writing references, attending to correspondence, payment of bills, preparing rooms including cleaning walls, carpet, and bathrooms, showing rooms to prospective lodgers, and preparing and issue of 'time to move out' or warning notices.

B, on behalf of the company may change the rooms which a resident occupies at any time, may terminate the stay at any time for a breach of the rules and has the right to enter a room at any time for the purpose of cleaning or inspecting it.

B provides a range of services to lodgers, including unlocking room doors, when lodgers have locked their keys inside, meeting overseas students at the airport, arranging for bedding for students, dealing with lodgers' personal issues, checking on the wellbeing of lodgers, carrying out small maintenance jobs, ensuring rubbish bins are placed outside, dealing with break-ins, thefts and so forth.

B is on call from 7am till midnight 7 days a week for emergencies, such as lock-outs or medical or late interstate or overseas arrivals.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 152-35.

Income Tax Assessment Act 1997 Subsection 152-40(1).

Income Tax Assessment Act 1997 Subsection 152-40(4).

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

Small business concessions

In order for the capital gains tax (CGT) small business concessions to apply certain conditions must be met. Section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the CGT asset in question, must be an active asset. In the present case the m dwellings used for the accommodation of short and longer term lodgers are CGT assets. We need to determine if they qualify as active assets.

The meaning of an active asset is set out in section 152-40 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 subsection 152-40(1) of the ITAA 1997 a CGT asset is an active asset (subject to the exclusions) if it is owned and used, or held ready for use, in the course of carrying on a business by a taxpayer or the taxpayer's small business CGT affiliate or another entity that is connected with the taxpayer under paragraph 152-40(1)(c) of the ITAA 1997.

The combined effect of sections 152-35 and 152-40 of the ITAA 1997 is that the property will meet the active asset test if the asset was used, or held ready for use, in the course of carrying on a business for at least half of the time period it was owned, subject to the exclusions in subsection 152-40(4) of the ITAA 1997.

The definition of active asset states that an asset whose main use in the course of carrying on the business is to derive rent cannot be an active asset (unless that main 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 present case, there are two matters that need to be considered before each house is accepted as an active asset and eligible for the small business relief under Division 152 of the ITAA 1997.

1) Are the m dwellings used by the company in the course of carrying on a business?

2) Is the predominant use of the m dwellings to derive rent?

1. Carrying on a business

Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

As a general rule, the receipt of income from the letting of property to tenants does not amount to the carrying on of a business. However, under some circumstances the letting of property may amount to the carrying on of a business (Californian Copper Syndicate (Limited and Reduced) v. Harris (1904) 5 TC 159). Generally, it is easier for a company that derives income from the letting of property to show that it carries on a business than it is for an individual (paragraph 3 of Taxation Ruling IT 2423). In the present case, Company A is the entity which is deriving the income from the letting of the rooms.

In Case G10 75 ATC 33 (Case G10), the taxpayer owned two properties of which six units were let as holiday flats for short term rental. The taxpayer 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.

The general indicators of a business, as used by the Courts, are described in Taxation Ruling TR 97/11 Income tax: Am I carrying on a business of primary production? which summarises these indicators. The question of whether a business is being carried on is a question of fact and degree.

Taxation Ruling TR 97/11 incorporates the general factors. 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.

Application to the present circumstances

The company in the present case is carrying on a business as:

• The company has purchased vacant land, erected m dwellings and has been renting out up to more than 30 rooms for short term and longer term accommodation purposes in those m properties. This demonstrates significant commercial purpose.

• The company owns all the properties.

• B, on behalf of the company, is personally involved in the managing of the letting activities. A real estate agent has not been engaged.

• B has fully furnished all the rooms.

• B spends several hours a day conducting tasks for the company seven days a week.

• B has formal record keeping procedures. B has kept records of each boarder and their length of stay for each of the m houses since the company first began its letting activities.

• B is on call from 7am till midnight 7 days a week for emergencies, such as lock-outs or medical or late interstate or overseas arrivals.

• B provides personal assistance to boarders as required.

• B cleans and maintains the m houses and surroundings.

It is therefore concluded that the activities in relation to the management and running of the accommodation constitute the carrying on of a business by the company.

Active asset

A CGT asset is an active asset (subject to the exclusions) if it is owned and used or held ready for use in the course of carrying on a business under paragraph 152-40(1)(a) of the ITAA 1997.

Taking into consideration the scale of the company's business, the degree of control it retains over the premises and the shared amenities and personal services B provides, each of the m dwellings passes the active asset test.

2. Is the predominant use of each house to derive rent?

Having satisfied paragraph 152-40(1)(a) of the ITAA 1997 with regard to carrying on a business it is necessary to consider if the business falls within the exclusions contained in paragraph 152-40(4)(e) of the ITAA 1997. In Taxation Determination TD 2006/78, the Commissioner has considered whether there are any circumstances in which the premises used in a business of providing accommodation for reward may satisfy the active asset test.

The determination states that whether an asset's main use is to derive rent will depend on the particular circumstances of each case. It does, however, set out the factors to which the Commissioner will have regard in arriving at a decision; a number of those factors are discussed in paragraphs 8 to 10 of the Determination. Those considerations include whether:

• no notice is required to quit the rooms.

• there are rules requiring visitors to leave the premises by a certain time

• the owner/manager retains the right to enter the accommodation

• the owner pays for all utilities (gas, electricity, water)

• the owner provides services and facilities to guests such as room cleaning and general maintenance, linen and towels and common areas such as a TV/lounge room, kitchen, bathrooms, laundry and a recreation area .

• the average length of stay is relatively short.

• the owner/manager retains a significant degree of control over the premises through being on the premises most of the time.

• the arrangements entered into indicate that those staying in the accommodation do not have the right to exclusive possession of a room but rather only a right to occupy the room.

A boarding house scenario is provided in Example 3 in TD 2006/78. In the example David owns an 8 bedroom property which he operates as a boarding house. Boarders enter into arrangements to occupy singly rooms and no notice is required to quit the rooms. David retains the right to enter the rooms. He provides services including room cleaning and general maintenance, linen and towels and common areas such as TV/lounge room, kitchen, bathrooms, laundry and a recreation area. David retains a significant degree of control over the premises. Those staying in the boarding house do not have the right to exclusive possession of a room but rather only a right to occupy the room. These circumstances indicate that the relationship between David and those staying at the boarding house is not that of a landlord/tenant under a lease agreement.

Application to the present circumstances

The services provided and the degree of control exercised by the company in the present case is similar to the boarding house example in TD 2006/78. In this case, the company owns each of the m dwellings in question and B personally operates the accommodation consisting of numerous rooms. The boarders occupy single rooms in each property under an agreement that does not specify or provide the right to exclusive possession of a room, but rather only a right to occupy the room subject to complying with the rules.

The company has unrestricted access to the room provided to a lodger and retains a high degree of control. . No notice is required to quit the rooms. All the rooms are furnished. Some linen and a range of amenities are provided. B, on behalf of the company, engages in numerous services for the lodgers.

These factors indicate that there is not a landlord/tenant relationship. The terms on which the clients are able to stay in the premises are at the discretion of the owner. The company may change the rooms which a resident occupies at any time, may terminate the stay at any time for a breach of the rules and have the right to enter a room at any time. The company, through B, makes provision for the cleaning and maintenance of the premises. The company maintains exclusive control of the premises and the rooms occupied at all times.

Each of the m dwellings in question is a boarding house. Each boarding house is a CGT asset. Each boarding house does not fall within the exclusion contained in paragraph 152-40(4)(e) of the ITAA 1997.  The nature of the amenities and services provided is such that the income received is in the nature of a tariff rather than rent. The occupants have no right to exclusive possession; the company retains a high degree of control and provide services additional to the mere supply of the rooms. Each dwelling remains an active asset of the business and therefore relief under Division 152 is available provided all other conditions are met.