Edited version of private advice

Authorisation Number: 1012641193435

Ruling

Subject: Small business capital gains tax concessions

Question 1

Is the company carrying on a business of letting/leasing rental properties?

Answer

No.

Question 2

Would the properties owned by the company satisfy the active asset test?

Answer

No.

This ruling applies for the following period

Year ending 30 June 2014

Year ending 30 June 2015

The scheme commences on:

1 July 2013

Relevant facts and circumstances

The company has purchased a number of rental properties.

The shareholders of the company are individuals A and B.

The portfolio of properties consists of X residential and Y commercial properties.

A number of the residential properties are managed by an external third party; all other properties are managed by the company.

The company employs several staff members to assist in the management and day to day running of these properties.

A number of the residential properties are rented to related parties being employees, shareholders or directors.

The remaining residential properties are not being leased to external parties at this stage as they have recently been renovated.

The company intends to lease or sell these residential properties in the future.

One of the commercial properties is leased to an external third party; the other is leased to a related business entity.

The shareholders of this company are individuals C and D.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 995-1

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

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

Reasons for decision

Question 1

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

The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the particular facts.

Taxation Ruling TR 97/11 provides the Commissioner's view of the factors used to determine if you are in business for tax purposes.

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.

No one indicator is decisive. The indicators must be considered in combination and as a whole. Whether a 'business' is carried on depends on the large or general impression.

Taxation Ruling IT 2423 considers the liability to interest withholding tax where a non-resident of Australia borrows moneys from financial institutions outside Australia to purchase properties in Australia from which rental income is derived.

The ruling also considers when renting properties constitutes a business for tax purposes. In this ruling the question of whether you are carrying on a business of letting property largely depends 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.

Application to your circumstances

In this situation, the Commissioner considers that the company is not carrying on a business of leasing rental properties. The company has acquired X properties. The portfolio consists of several residential and a number of commercial properties. Several of the residential properties owned by the company are managed by an external third party.

Some of the residential properties are currently vacant and the other residential properties are being rented by employees, directors or shareholders. Some of the commercial properties are leased to a related party, but the others are leased to an external third party.

The volume of operations is insufficient to be considered a business activity. Several properties owned by the company are managed externally and several are currently vacant. Although the daily management of the properties is undertaken by employees of the company, the level of repetition and regularity of the activity is not sufficient. To conclude, the Commissioner is not satisfied that the company is carrying on a business of leasing rental properties.

Question 2

A CGT asset is an active asset at a given time if, at that time you own it and it is used (or held ready for use) in the course of carrying on a business by you, a small business CGT affiliate of yours or an entity connected with you.

Certain assets are, however, excluded from being active assets under subsection 152-40(4) of the ITAA 1997. An asset whose main use is to derive rent (unless such use was only temporary) is excluded from being an active asset. Such assets are excluded even if they are used in the course of carrying on a business.

Example 1 in Taxation Determination TD 2006/78 deals with commercial rental properties:

Commercial Property Co owns 5 commercial rental properties. The properties have been leased for several years under formal lease agreements to various commercial tenants which have used them for office and warehouse purposes. The terms of the leases have ranged from 1 year to 3 years with a 3 year option and provide for exclusive possession. The company has not engaged a real estate agent to act on its behalf and manages the leasing of the properties itself.

In this situation, the company has derived rental income from the leasing of a number of properties. Accordingly, the main (only) use of the properties is to derive rent and they are therefore excluded from being active assets under paragraph 152-40(4)(e) of the ITAA 1997 regardless of whether the activities constitute the carrying on of a business.

Application to your circumstances

In this case, we do not consider that the company is carrying on a business of leasing commercial properties. Therefore, the properties cannot satisfy the active asset test.

However, even if the company were carrying on a business, the main (or only) use of the properties is to derive rent. While it was stated in the application that one property is leased to a related entity, there has been no evidence provided that suggests this entity is either an affiliate of or connected with the company.

Therefore, regardless of our determination regarding whether the activities of the company amount to carrying on a business, the properties would not satisfy the active asset test.