Edited version of your written advice

Authorisation Number: 1013034125979

Date of advice: 24 June 2016

Ruling

Subject: Am I in Business - Short term holiday accommodation

Question 1:

Are you carrying on a business of providing short stay accommodation?

Answer 1:

No.

Question 2:

Will the properties known as property one & property two be considered active assets for the purposes of accessing the small business CGT concessions under Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 2:

No.

This ruling applies for the following periods:

Year ended 30 June 20aa.

Year ended 30 June 20bb.

Year ended 30 June 20cc.

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

You and your spouse live in an area that is off the electricity and town water grid.

All dwellings in this area must be powered by generators and/or solar power.

You own two properties in this area that you let out for short term accommodation.

You are a registered builder.

You plan to place both properties on the market. You will list them for sale as short term accommodation properties with forward bookings well into the next two years.

Ideally you will sell both properties at the same time; however you are prepared to sell them separately if needed. It may take some time to sell both properties due to the remote location.

You will continue the short term accommodation activity in regard to just one property if one sells prior to the other.

Property one

This property is a two story residence which is identical on both levels, the lower level is rented to customers on a weekly or fortnightly basis and the upper level is where you and your spouse live.

You have owned the property for many years and built the residence and began renting the lower level as short term accommodation as soon as construction was completed.

The proportionate split between private and short term accommodation usage in regard to this residence is 50% to each. This is based on floor area.

The garden is approximately x sq. metres and is a shared area between you as owner and guests. Guests have full access to the gardens and there is an area available in the garden for leisure activities, as well as car parking. The gardens and lawns are one of the deciding features in families renting the property due to areas for children to play, which are in view of the house at all times. The garden requires regular maintenance.

Property two

This property is a self-contained house that is rented on a weekly or fortnightly basis.

You have owned this property for many years and you began renting it as short term accommodation as soon as you owned it.

The property has a fully maintained lawn, which requires constant upkeep due to the nature of the soil; water soaks in immediately meaning lawn maintenance is constant.

Management in regard to both properties

As both properties are off the grid, you are constantly monitoring the solar panels and generators for both properties to ensure that these are working at all times. If these were to fail the water supply and sewerage systems would also fail. Given the salt water conditions the electrical systems require regular maintenance and repair due to corrosion issues. The sewerage system must comply with certain standards 100% of the time.

Both properties are advertised as short term accommodation on the internet.

You pay a commission for accommodation that is booked through a relevant website.

Specials are run during the year to increase occupancy.

No bond is taken, but a deposit is taken to confirm the booking.

Guests must pay in full prior to entry.

Generally there are no refunds for stays that are cut short as the properties are rented in weekly blocks. There is some discretion by you but it is generally not used. Refunds are given with eight weeks' notice unless the booking is transferred to another date.

Booking figures are over x% for the last two years - average y weeks.

You have made profits in the year ended 30 June 20xx and in the year ended 30 June 20ww, prior years are similar.

There is no formal application to complete in order to stay, however the online booking site takes guest information and there is a form at your end to complete to confirm the booking, there is not a specific contract that is signed by the guest.

You provide the property keys to guests and you retain a key to access the properties should emergencies arise, however you generally do not enter the houses whilst guests are staying.

If there is a problem at any of the properties you are the first point of call for the guests. You provide a caretaker if you are away to take care of things.

No meals are provided.

Cleaning is included in the tariff and is carried out by you and your spouse at the end of each guest stay. Your spouse has an ABN and is contracted to clean at both properties.

No linen is provided unless there are extenuous circumstances.

You hold a B & B licence for both properties.

You have an Insurance Policy for property one and you have another insurance policy to cover property two. The cover does not include cover for rent default or theft by the tenant.

The following is a break up of your management activities:

• Marketing and Administration - varies from day to day depending on what is required regarding office work;

• Maintaining booking system;

• Bookkeeping; and

• Bookings for other properties.

• Gardening and Maintenance - the properties are subject to extreme salt exposure requiring constant maintenance and the garden requires constant watering and upkeep.

• Generator maintenance;

• Generator re-fuelling;

• Solar system maintenance including battery changes;

• Garden maintenance and watering;

• Sewerage system maintenance; and

• General repairs and maintenance.

• Cleaning on exit of guests, depending on the exit state on either a weekly or fortnightly basis.

• Vehicle maintenance is also substantial due to the effects of salt and lack of any mechanical services nearby. Maintenance can change from week to week should specific repairs be needed such as solar or sewerage system.

Your other source of income is from spotter fees; where you redirect enquiries to other accommodation providers when you have no vacancies.

Your spotter fee is the deposit for that booking.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Section 152-205

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Are you carrying on a business?

Taxation Ruling TR 97/11 provides the indicators established by the courts that need to be considered when determining whether a business is being carried on. It should be noted that TR 97/11 specifically deals with carrying on a business of primary production but the indicators established can be equally applied to most other activities. Paragraph 13 of TR 97/11 states that the following indicators are relevant:

• Whether your activity has a significant commercial purpose or character.

• Whether you have more than just an intention to engage in business.

• Whether you have a purpose of profit as well as a prospect of profit from the activity.

• Whether there is repetition and regularity of your activity.

• Whether your activity is of the same kind and carried on in a similar manner to businesses in your industry.

• Whether your activity is planned, organised and carried on in a businesslike manner.

• The size, scale and permanency of your activity.

• Whether your activity is better described as a hobby, recreation or sporting activity.

Paragraph 15 of TR 97/11 states that no one indicator is decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). In addition, paragraph 16 of TR 97/11 states that the indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the general impression gained from looking at all the indicators (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470 at 474; 5 AITR 548 at 551), and whether these factors provide the operations with a 'commercial flavour' (Ferguson v. Commissioner of Taxation (1979) 37 FLR 310 at 325; 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884).

Taxation Ruling IT 2423 Withholding tax: whether rental income constitutes proceeds of business - permanent establishment - deduction for interest, states at paragraph 5:

A conclusion that an individual is carrying on a business of letting property would depend largely 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.

The issue of whether the owner of one or several properties, in providing accommodation, is carrying on a business has arisen in a number of cases. Taxation Ruling TR 93/32 Income tax: rental property - division of net income or loss between co-owners, states at paragraph 22 and 23:

22. As a general proposition, it is more accurate to describe the owners of rental property in the words of Beaumont J in McDonald's case at ATR p.969; ATC p 4552 'as co-owners in investment rather than as partners in a business operation.

23. That is not to say that co-owners cannot carry on a business of property rental and therefore be partners at general law. As already noted, whether an activity constitutes the carrying on of a business is a question of fact to be decided on a case by case basis.

In Commissioner of Taxation v. McDonald (1987) 15 FCR 172; 18 ATR 957; 87 ATC 4541 (McDonalds Case), the taxpayer owned two properties, one of which was let on a short term basis to holiday makers, which were subsequently let through letting agents. The Federal Court considered that for a business to be carried on by owners of property, one would expect that they would be involved in providing services in addition to the process of letting property (as with a boarding house), not merely receiving payments for the tenants occupation of the property.

In Carson & Anor v FC of T [2008] AATA 156 (Carson's Case) the taxpayers owned one property jointly which was used to provide short term tourist accommodation, usually for stays of about a week to two weeks. Senior Member BH Pascoe stated that whether a business is being carried on, is a question of fact and an objective consideration of the extent of the applicants' activities relating to the property. He pointed out that appointing a real estate agent to arrange rentals and minor repairs, spending one week every six months servicing the property and provided brochures relating to the property as required are activities with all the earmarks of maintaining and deriving income from an investment rather than the carrying on of a business. Similarly, activities such as financing the property, dealing with rating authorities and body corporate are no more than any investor in real estate would do.

In accordance with the judicial comments above and guidelines set down in Taxation Rulings IT 2423 and TR 97/11, although there is some regularity to your activities and you have a profit making intention, your activities lack a significant commercial character and are not of a size or scale necessary to be characterised as carrying on a business of short stay accommodation. Therefore, the income that you received from the property is not from the carrying on of a business; rather it was received from an investment in property.

Small business concessions

To qualify for the small business CGT concessions, you must satisfy several conditions that are common to all the concessions. These are called the 'basic conditions'.

The basic conditions are contained in Subdivision 152 A - Income Tax Assessment Act 1997 (ITAA 1997).

The basic conditions applicable to your situation are:

• you must be a small business entity, and

• the asset in question must satisfy the active asset test

As discussed above, you are not considered to be carrying on a business and are not a small business entity for the purposes of Subdivision 152A of the ITAA 1997.

The requirements of an active asset and the active asset test are set out in Subdivision 152-A of the ITAA 1997.

For a CGT asset of a business to be an active asset for the purposes of Division 152 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 paragraph 152-40(1)(a) 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.

However, paragraph 152-40(4)(e) of the ITAA 1997 provides 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.

Taxation Determination TD 2006/78 discusses the circumstances in which a premises used in a business of providing accommodation for reward may satisfy the active asset test, notwithstanding the exclusion mentioned above.

Whether an asset's main use is to derive rent will depend upon the particular circumstances of each case. In accordance with paragraph 22 of TD 2006/78, the term 'rent' has been described as follows:

• the amount payable by a lessee to a lessor for the use of the leased premises (C.H. Bailey Ltd v. Memorial Enterprises Ltd 1 All ER 1003 at 1010; United Scientific Holdings Ltd v. Burnley Borough Council 2 All ER 62 at 76, 80, 86, 93, 99);

• a tenant's periodical payment to an owner or landlord for the use of land or premises (Australian Oxford Dictionary, 1999, Oxford University Press, Melbourne);

• recompense paid by a tenant to a landlord for the exclusive possession of corporeal hereditaments. The modern conception of rent is a payment which a tenant is bound by contract to make to his landlord for the use of the property let (Halsbury's Laws of England 4th Edition Reissue, Butterworths, London 1994, Ch 27(1) 'Landlord and tenant', paragraph 212).

A key factor 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 leased to a tenant under a lease agreement granting exclusive possession, the payments involved are likely to be rent and the premises will not be an active asset. On the other hand, if the arrangement allows the person only to enter and use the premises for certain purposes and does not amount to a lease granting exclusive possession, the payments involved are unlikely to be rent.

For example, 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. This will be questions of fact depending on all the circumstances involved. Relevant factors to consider in determining this question include:

• whether the occupier has a right to exclusive possession (Radaich v. Smith (1959) 101 CLR 209),

• 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. Chaters [1977] 3 All ER 918).

Example 4 of TD 2006/78 states:

Linda owns a complex of 6 holiday apartments which are advertised collectively as a motel. The majority of bookings are from one to seven nights. Linda does not enter into any lease agreements with guests staying at the apartments. The guests do not have exclusive possession of the apartment they are staying in but rather only a right to occupy the apartment on certain conditions. Room cleaning, linen and meals are provided to guests. These facts indicate that the relationship between Linda and the guests is not that of landlord/tenant under a lease agreement. Accordingly, the income derived is not 'rent'.

However, many arrangements involving holiday apartments are unlikely to be active assets because no business is being carried on or, even if a business is being carried on, it amounts to the derivation of rent. This is because in many cases the services provided are not sufficient to change the nature of the income from passive to active. For example if meals or daily cleaning are not provided.

In Carson's Case, the taxpayers provide short-term tourist accommodation to the public. The subject asset was 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 each stay. The taxpayers relied on TD 2006/78 and contended that the unit was an active asset for the purposes of the small business CGT concessions. The AAT held that the main use of the property was to derive rent and therefore it was excluded from being an active asset. Although no formal agreement was signed, there was a landlord/tenant relationship in that the occupants of the unit would no doubt regard themselves as having rented the unit and having exclusive possession thereof.

The same reasoning can be applied to your case as the facts are similar. In your case, you do not provide additional services, such as meals, and the accommodation is only cleaned at the end of each stay.

You have provided a typical pattern of your day to day activities, including administration and maintenance activities.

However, the duties performed by you do not provided a significant value adding service to the guests stay. In regard to Property one, you would need to carry out the gardening and maintenance activities anyway because this is where you live. The necessity of the generator and solar system maintenance at both properties is more to do with the location of the property (the nature of the capital asset being located in an off grid area) rather than you providing a value added service to guests. It is possible that guests staying at Property two may only encounter you at the beginning and end of their stay and while you may have some informal ad hoc interactions with guests staying at Property one because you live on the top level of the premises.

Having regard to all the facts, we consider that the relationship between you and the guests is more properly characterized as that of landlord/tenant. Although no formal agreement was signed, we consider guests who stayed at either Property would believe they had exclusive possession of the property for the duration of their stay. Accordingly the main use of the properties was to derive rent.

As the main use of the assets was to derive rent, the properties will not satisfy the active asset test under section 152-35 of the ITAA 1997.

Consequently you will not be able to access the small business CGT concessions under Division 152 of the ITAA 1997 on the sale of either property.