Edited version of your written advice

Authorisation Number: 1012847090720

Date of advice: 24 July 2015

Ruling

Subject: Capital Gains Tax

Question 1

Are you carrying on a business?

Answer

Yes.

Question 1

Are you eligible for the 50% active asset reduction in relation to the disposal of the units?

Answer

Yes.

Question 2

Are you eligible for the retirement exemption in relation to the disposal of the units?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2016

Year ended 30 June 2017

Year ended 30 June 2018

Year ended 30 June 2019

The scheme commences on

1 July 2015

Relevant facts and circumstances

The partnership carries on a business providing short term accommodation to guests in apartments.

X of the apartments is owned by you and they were purchased under a contract completed on the XXXX.

Settlement occurred in XXXX.

The partnership commenced a short term accommodation business on the day of settlement.

The other apartments are owned by individuals who are at arm's length to you.

These apartments are leased by you and are used to provide short term accommodation to guests.

Both leases were terminated on the XXXX.

Guests make contact by a telephone number, or use the facility available on the website to make a booking or to make after hours contact.

Lease agreements are not entered into with guests.

Stays have ranged from X nights but the vast majority are from X to X nights.

Guests pay for their accommodation by credit card over the phone.

The partnership is registered for GST.

The aggregated turnover of the partnership is less than $2 million.

You intend to cease business in XXXX and retire, at least for the immediate future.

You are considering selling the business as a going concern or leasing the units long term and then selling them individually.

You are over the age of 55.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 subdivision 152-C

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 subsection 152-10(1)

Income Tax Assessment Act 1997 section 152-220

Income Tax Assessment Act 1997 section 152-110

Income Tax Assessment Act 1997 subdivision 152-D

Income Tax Assessment Act 1997 section 152-315

Income Tax Assessment Act 1997 section 152-305

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

Income Tax Assessment Act 1997 section 152-320

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Detailed reasoning

In order to be eligible for the small business CGT concessions, a number of basic conditions must be satisfied. The basic conditions for the small business CGT concessions are outlined in subsection 152-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997):

(a) a CGT event happens in relation to an asset that the taxpayer owns

(b) the event would otherwise have resulted in a capital gain

(c) one or more of the following applies

(i) the taxpayer satisfies the maximum net asset value test

(ii) the taxpayer is a "small business entity" for the income year

(iii) the asset is an interest in an asset of a partnership which is a small business entity for the income year, and the taxpayer is a partner in that partnership, or

(iv) the special conditions for passively held assets in sub-sections 152-10(1A) or 152-10(1B)are satisfied in relation to the CGT asset in the income year, and

(d) the asset satisfies the active asset test.

In this case, a CGT event will occur when a contract is entered into and the event will result in a capital gain if the capital proceeds exceed the cost base of the assets.

Small business entity

Section 328-110 of the ITAA1997 provides that you will be a small business entity if you are an individual, partnership, company or trust that:

• is carrying on a business, and

• has less than $2 million aggregated turnover.

Aggregated turnover is your annual turnover plus the annual turnovers of any businesses that are connected with your or that are your affiliates.

Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'. Normally the receipt of income from the letting of property to a tenant does not amount to the carrying on of a business (Wertman v. Minister of National Revenue (1964) 64 DTC 5158; Federal Commissioner of Taxation v. McDonald (1987) 15 FCR 172; 87 ATC 4541; 18 ATR 957; Cripps v. FC of T 99 ATC 2428; Case X48 90 ATC 384; (1990) 21 ATR 3389). 

Taxation Ruling TR 97/11 incorporates the general factors that are considered important in determining the question of whether a business activity is being carried on:

• 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.

TR 97/11 states the indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impression gained from looking at all the indicators, and whether these factors provide the operations with a commercial flavour. However, the weighting to be given to each indicator may vary from case to case.

Having regard to the circumstances, it is accepted that the partnership is carrying on a business of short term accommodation and the turnover of the business is less than $2 million. Accordingly, you meet the following requirement, the asset is an interest in an asset of a partnership which is a small business entity for the income year, and the taxpayer is a partner in that partnership.

Active asset test

The active asset test is contained in section 152-35 of the ITAA 1997. The active asset test is satisfied if:

• you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the test period detailed below, or

• you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of least 7.5 years during the test period.

The test period:

• begins when you acquired the asset, and

• ends at the earlier of

• the CGT event, and

• when the business ceased, if the business in question ceased in the 12 months before the CGT event (under subparagraph 152-35(2)(b)(ii) of the ITAA 1997 the Commissioner can allow a longer period than 12 months).

A CGT asset is an active asset if it is owned by you and is used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or an entity connected with you.

Your interest in the partnership means that you are connected to the partnership. Accordingly, the assets which are owned by you are used in a business carried on by 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.

Taxation Determination TD 2006/78 states (paragraph 22) that whether an assets main use is to derive rent will depend on the particular circumstances surrounding the derivation of income.

The term rent has been described as the amount payable by a tenant to a landlord for the use of the leases premises (C.H. Bailey LTD v Memorial Enterprises Ltd 1 All ER 1003, United Scientific Holdings Ltd v Burnley Borough Council 2 All ER 62).

A key factor therefore in determining whether an occupant of premises is a lessee is whether the occupier has a right to exclusive possession ( Radaich v. Smith (1959) 101 CLR 209).

If premises are operated as a boarding house, the issue arises as to whether an occupant of part of the premises is a tenant or alternatively only a lodger/boarder with a licence to occupy. Similarly, if residential units are operated as holiday apartments, the issue arises as to whether the occupants of the apartments are tenants/lessees or only have licences to occupy.

Ultimately, these are questions of fact depending on all the circumstances involved. Relevant factors to consider in determining these questions (in addition to whether the occupier has a right to exclusive possession) include 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 ( Allen v. Aller (1966) 1 NSWR 572), Appah v. Parncliffe Investments Ltd [1964] 1 All ER 838 and Marchant v. Charters [1977] 3 All ER 918).

In Carson & Anor v FC of T [2008] AATA 156, the Administrative Appeals Tribunal considered this issue in relation to holiday rentals and stated:

In this matter, the subject asset is one unit, presumably within a group of residential units. Occupants generally stay for one or two weeks. Crockery, cutlery and linen are included but cleaning is done only after the occupants depart. I have no doubt that the occupants regard themselves as having "rented" the unit for the period of their stay and during that stay have exclusive possession. Unsurprisingly, no formal lease agreement is signed but this does not mean that there is no landlord/tenant relationship. On the facts provided, I am of the opinion that the main use of the subject property is to derive rent and, therefore, it is excluded from being an active asset under s 152-40(4) of the Act…

In this case, you provide short term accommodation for your guests in multiple apartments. You clean the properties and provide linen to your guests. The relationship between you and your guests is not that of a landlord and tenant under a lease agreement. Consequently, the main use of the properties is not to derive rent.

You have owned the apartments for less than 15 years and consequently the assets needs to be active assets of yours for a total of at least half of the test period. The test period commenced when you acquired the assets. If you sell the apartments during the period specified for this ruling you will satisfy this test and the apartments will be active assets.

Active Asset Reduction

The 50% active asset reduction contained in subdivision 152-C of the ITAA 1997 applies automatically to reduce an eligible capital gain if the basic conditions are met. However, in accordance with section 152-220 of the ITAA 1997, a taxpayer can choose not to apply the 50% active asset reduction.

Application to your circumstances

As you will meet the basic conditions, the capital gain from the sale of the apartments that remains after applying any current year capital losses and any unapplied prior year net capital losses will be reduced by 50%. However, you can choose not to apply the 50% active asset reduction.

Retirement exemption

Section 152-305 of the ITAA 1997 contains the general provision that allows exemption of the capital gain. If you are an individual, you can disregard all or part of a capital gain if:

(a) you satisfy the basic conditions in section 152-10 of the ITAA 1997 for the gain; and

(b) if you were under 55 years of age just before you received an amount of capital proceeds from the CGT event, you roll over an amount equal to the exempt amount under the ETP provisions. (If you were 55 or older, there is no requirement to roll over any amount.)

In your case, it has already been established that you satisfy the basic conditions contained in section 152-10 of the ITAA 1997. You will be over the age of 55 when you make the choice to apply this concession and therefore condition (b) is not relevant.

You are eligible to disregard a capital gain under this provision as long as you have not accessed the entire $500,000 limit contained in section 152-320 of the ITAA 1997.

The amount of the capital gain that you choose to disregard (that is, the CGT exempt amount) must not exceed your CGT retirement exemption limit. This limit is currently $500,000 reduced by previous CGT exempt amounts you have disregarded under the retirement exemption.

If you are 55 or older when you make the choice to access the retirement exemption, there is no requirement to pay any amount to a complying superannuation fund or RSA even though you may have been under 55 years of age when you received the capital proceeds.