Edited version of your written advice

Authorisation Number: 1012887694582

Date of advice: 30 September 2015

Ruling

Subject: CGT

Question 1

Will the accommodation facility used by the Company's business qualify as an active asset under section 152-40 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Are X and Y affiliates of the Company in accordance with section 328-130 of the ITAA 1997?

Answer

No

Question 3

Is Z an affiliate of the Company in accordance with section 328-130 of the ITAA 1997?

Answer

Yes

Question 4

Are any of the other Related Companies and/or their directors affiliates of the Company in accordance with section 328-130 of the ITAA 1997?

Answer

Yes.

Question 5

Are any of the Related Companies and/or their directors connected with the Company in accordance with section 328-125 of the ITAA 1997?

Answer

No

Question 6

Should the Properties be sold in the 20XX-YY income year, and a replacement property (ies) be acquired in the same year, the for the purposes of calculating the Company's annual turnover in accordance with 328-120 of the ITAA 1997, will the Company be considered to be carrying on a business for the whole of the 20XX-YYincome year and is not required to annualise its income as per section 328-120(5) of the ITAA 1997?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2016

The scheme commenced on:

1 July 2015

Relevant facts and circumstances

There are less than 15 companies (Related Companies) that operate under a brand.

While there are some common shareholders between the Related Companies, there is no entity or group of entities with family or personal connections or who are otherwise affiliated who together hold % or more in the Company or any of the other Related Companies.

Apart from the co-founders and one other shareholder who was an employee at the time of purchasing their shares, there are no shareholders with previous involvement or expertise in the industry.

The Directors of the Company and the Related Companies are A and B.

A and B do not have any family connections. They have known each other for a long time, but have had very limited dealings outside of a business relationship.

Each of the Related Companies was established for the purpose of acquiring its own properties for the purpose of conducting an accommodation business.

The Company owns a number of properties (the Properties) from which it operates a business.

The business has been carried on by the Company from each of the Properties for more than half of the ownership period.

The Company's historical turnover has been under $2 million. It is likely that the Company's turnover for the 20WW-XX income year will be just over $2 million.

The Company intends on disposing of the Properties in the 20XX-YY income year.

The Properties will be sold on the open market. It is the Company's intention to acquire one or more replacement properties prior to the sale of the Properties to allow the movement of existing customers to the new premises. Failing this, the Company will consider selling the Properties with extended settlement periods in order to source a replacement property prior to settlement.

The Company will retain its employees to support moving customers to the new facilities and to continue management of the new/existing facilities.

Any stock held by the Company will be transferred to the new premises or stored in a leased warehouse for future use.

It is likely that the Company's turnover for the 20XX-YY income year will be under $2 million.

There are some shared services utilised by both the Company and the other Related Companies that all carry on businesses under the brand.

There is a formal agreement in place between the Company, X and Y. The agreement allows the Company to operate under the brand and use intellectual property owned by X and Y for a fee.

A number of the related companies have subscribed for capital in Z, another Related Company. The profits from Z will be shared across the group. The investment will enable the Related Companies to increase their market share and geographical presence, to expand their clientele and product range and to target further acquisitions within the industry.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Section 328-110

Income Tax Assessment Act 1997 Section 328-120

Income Tax Assessment Act 1997 Section 328-125

Income Tax Assessment Act 1997 Section 328-130

Reasons for decision

A capital gains tax (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 (section 152-40 of the ITAA 1997).

Paragraph 152-40(4)(e) of the ITAA 1997 states, however, that an asset whose main use in the course of carrying on the business is to derive rent cannot be an active asset unless the main use for deriving rent was only temporary.

Taxation Determination TD 2006/78 discusses the circumstances in which premises used in the business of providing accommodation for reward can be active assets notwithstanding the exclusion in paragraph 152-40(4)(e) of the ITAA 1997. The following example is provided:

Christine carries on a business of providing commercial accommodation space. The accommodation facility comprises 50 accommodation sheds which are available for hire for periods of 1 week to 2 years or more. Christine provides office facilities and 24 hour on-site security. She also provides various items of equipment for sale or loan to clients such as trolleys, cardboard boxes, brooms, tape, pens, locks, bolt cutters, torches and shelves. A cleaning service is also provided and charged for.

Christine enters into a accommodation agreement with each client. The agreements provide that in certain circumstances she can relocate the client to another space or enter the space without consent and that the client cannot assign the rights under the agreement.

The arrangements entered into in this situation indicate that the users of the accommodation sheds do not have the right to exclusive possession but rather only the right to enter and use the sheds for certain purposes. Some of the arrangements entered into were short term and a range of services were provided to the users. There was also no intention by the parties to grant a lease.

Having regard to all the circumstances, the Tax Office considers a tenant/landlord relationship does not exist between the parties in this example and therefore the amounts received are not rent. Accordingly, the accommodation facility is not excluded by paragraph 152-40(4)(e) of the ITAA 1997 and is therefore an active asset.

The Company's situation is similar to the example provided in TD 2006/78.

Accordingly, the exclusion contained in Paragraph 152-40(4)(e) of the ITAA 1997 will not apply and the Properties are considered to be active assets for the purposes of section 152-40 of the ITAA 1997.

Affiliates

Subsection 328-130(1) of the ITAA 1997 states that an individual or a company is an affiliate of yours if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual or company.

Subsection 328-130(2) of the ITAA 1997 clarifies that an individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share.

The first part of the 'affiliate' definition looks at the actual acts of the potential affiliate to see if it acts, or has acted, in accordance with the entity's directions or wishes or in concert with the entity in relation to the potential affiliate's business affairs (that is, 'acts in the relevant way'). Where the potential affiliate has not actually acted in the relevant way, the second part of the definition considers whether the potential affiliate 'could reasonably be expected' to have acted in the relevant way at that time despite not actually having done so.

The three categories of behaviour caught by the definition (that is, acting according to the directions, wishes or in concert with an entity) represent alternatives in terms of control, influence or cooperation. Only one of these alternatives needs to be present for the definition to apply.

Meaning of 'could reasonably be expected'

'A reasonable expectation requires more than a possibility' (FC of T v. Peabody (1994) 181 CLR 359; 94 ATC 4663; (1994) 28 ATR 344). In the High Court's view the phrase involves a prediction that must be sufficiently reliable for it to be regarded as reasonable.

The conclusion that such a relationship exists or existed in the relevant year may be based on:

• inferences drawn from events, transactions or patterns of behaviour which show that the entity has been, is, or will be able to direct or influence the potential affiliate's behaviour; and

• the presence of a relationship between the two entities which enables or has enabled the entity to influence or direct the potential affiliate.

The types of relationships that may constitute a relationship of control or influence include:

• family or other close personal relationships;

• financial relationships and dependencies; and

• relationships created through links such as common directors, partners or shareholders.

Whether a person acts in such a manner, is a question of fact dependent on all the circumstances of the particular case. The key consideration is the actions of the parties. If the parties act together in pursuit of a common goal or purpose or the taxpayer is able to direct the other entity in relation to (not merely where the entity is involved in, connected to or participating in) the carrying on of the business, these are factors that may support a conclusion that the parties act in concert or the other person acts in accordance with the taxpayer's directions or wishes.

The likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements. Relevant factors may include the existence of a close family relationship or friendship between the parties and any agreement or common understanding between the parties about how the parties are to act in relation to each other.

Meaning of 'in concert'

The term 'in concert' is not defined in the ITAA 1997. It therefore needs to be interpreted according to its ordinary meaning and legislative context. Paragraphs 59 and 60 of Taxation Ruling TR 2002/6 explain that a potential affiliate will only be regarded as acting 'in concert' with another entity where:

(a) it is acting together with the other entity in pursuit of a common goal or objective; and

(b) that common goal or objective is the carrying on of a business by the potential affiliate with a substantial degree of connection with or dependence on the business carried on by the other entity.

The following factors may have a bearing on whether an individual or company is an affiliate of an entity to the extent that they show that two or more entities are acting in concert:

• family or close personal relationships;

• financial relationships or dependencies;

• relationships created through links such as common directors, partners, or shareholders;

• the degree to which the entities consult with each other on business matters; or

• whether one of the entities is under a formal or informal obligation to purchase goods or services or conduct aspects of their business with the other entity.

TR 2002/6 discusses in detail some of the factors that can determine whether two entities are affiliated:

Relationships based on other common links

105. The entity should also consider any other relevant relationships or links between it and the potential *STS affiliate that may support a conclusion that the potential *STS affiliate will act as the entity directs or wishes. Examples of such links include common directors, shareholders or partners. This type of relationship is relevant because it may reveal that each entity is ultimately controlled or owned by the same group of individuals. Depending on the circumstances of the case, this may provide a mechanism by which one entity can seek to direct or influence the activities of the other entity in the relevant way.

Application to your circumstances

X and Y

We accept that the relationship between the Company and X and Y is purely contractual. A and Y do not carry on businesses in your industry and merely facilitate the use of the brand.

Accordingly, we consider that X and Y are not affiliates of the Company under section 328-130 of the ITAA 1997.

Related Companies

However, we consider that it would be reasonable to expect that all of the Related Companies are acting in concert with each other towards the pursuit of a common goal; the success and preservation of the brand.

There are significant relationships created between the Related Companies through links such as the common directors and shareholders. Additionally, considering the significant shared services of the Related Companies, we consider it would be reasonable to expect there to be a great degree to which the Related Companies consult each other on these matters. These services, along with the shared financial interests in Z have created financial links between the Related Companies.

Accordingly, we consider that all of the Related Companies are or would be reasonably expected to be 'acting in concert' with the Company and are affiliates of the Company under section 328-130 of the ITAA 1997.

Connected entities

An entity is connected with another entity if either entity controls the other entity, or if both entities are controlled by the same third entity (section 328-125 of the ITAA 1997).

Direct control of a company

An entity controls a company if the entity, its affiliates, or the entity together with its affiliates beneficially own:

• interests in the company that give them the right to receive at least % (the control percentage) of any distribution of income or capital; or

• equity interests in the company that carry between them the right to exercise at least % (the control percentage) of the voting power in the company.

There is no entity or group of entities with family or personal connections or who are otherwise affiliated who together hold % or more in the Company or any of the other Related Companies.

The Company does not hold any direct interests in any of the other Related Companies, other than a minority interest in Z.

Accordingly, none of the Related Companies and/or their directors are connected with the Company in accordance with section 328-125 of the ITAA 1997.

Annual turnover

Under section 328-110 of the ITAA 1997, you are a small business entity if you are carrying on a business in the current year and your aggregated turnover for the previous year, and/or current year, was less than $2 million (subject to certain conditions and exclusions).

Your aggregated turnover for an income year includes the annual turnover of:

• you

• entities connected with you; and

• entities that are an affiliate of yours in the relevant income year.

Under subsection 328-120(5), if an entity does not carry on a business for the whole of an income year, the entity's annual turnover for the income year must be worked out using a reasonable estimate of what the entity's annual turnover for the income year would be if the entity carried on a business for the whole of the income year.

Paragraph 2.29 of the Explanatory Memorandum to Tax Laws Amendment (Small Business) Bill 2007 states the intention underlying subsection 328-120(5): 

2.29 The intent of the provision is to ensure that the eligibility test of turnover, as an indicator of the size of a business, is based on income for a full year. Without this rule, entities that carry on a business for part of the income year would have a lower turnover than is truly representative of the size of the business.

ATO Interpretative Decision ATO ID 2009/49 provides an ATO view on subsection 328-120(5) stating that:

If a taxpayer carries on one business for the whole of an income year and a second business for only part of that same income year, subsection 328-120(5) of the ITAA 1997 applies in working out the annual turnover of the taxpayer. The provision is not limited to applying only where a taxpayer has ceased to carry on all their business."

In this case, we accept that the Company will continue to carry on the same business throughout the 20XX-YY income year. The Company intends to acquire new facilities before or as soon as possible after the disposal of the Properties and has made provisions to enable a smooth transition to the new facilities for clients and employees.

Accordingly, the Company will not be required to annualise its turnover under subsection 328-120(5) of the ITAA 1997.