Edited version of your written advice

Authorisation Number: 1051364166131

Date of advice: 24 April 2018

Ruling

Subject: Active Asset - Sharefarming

Question

Does the farming land qualify as an ‘active asset’ within the meaning of that term in section 152-40 of the Income Tax Assessment Act 1997?

Answer

No

This ruling applies for the following period:

For the income year ended 30 June 2018

Relevant facts and circumstances

The taxpayer and their spouse are the registered owners of farming land. The taxpayer and their spouse have owned the farming land for more than 15 years. The farming land consists of a certain amount of acreage of which a portion is cropped on a rotational basis.

An agreement was made between the taxpayer and Company X more than 15 years ago. The agreement is signed by the taxpayer and a representative of Company X.

The agreement provides that Company X is in the business of primary production. It also stipulates that the taxpayer wishes to make the land available for the purposes of primary production and Company X wishes to utilise the land for the purposes of primary production. Further, it provides that the taxpayer shall for the consideration and on the terms and conditions set out in the arrangement make the land available to Company X for primary production. The salient terms of the agreement follow:

● An annual rent is payable together with a specified share of the gross proceeds received from the land under cropping.

● All statutory outgoings e.g municipal rates, water rates are to be borne by Company X. The taxpayer will be reimbursed by Company X for any statutory outgoings paid by them.

● Company X is required to maintain certain fixtures on the property e.g certain fencing on the property, dams, gates and watercourses. The taxpayer is required to maintain some fencing.

● Company X is to comply with all provisions of any statutory requirements in regard to vermin and noxious weeds.

● Company X is to cultivate, manure and manage the farm land.

Company X is not an affiliate of the taxpayer or the taxpayer’s spouse. Also, Company X is not connected to either the taxpayer or their spouse for the purposes of section 152-40 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 subsection 152-40(1)

Income Tax Assessment Act 1997 paragraph 152-40(1)(ii)

Income Tax Assessment Act 1997 paragraphs 152-40(1)(iii)

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

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

Income Tax Assessment Act 1997 paragraph 152-47

Income Tax Assessment Act 1997 paragraph 328-10

Reasons for decision

For a CGT asset to be an active asset under subsection 152-40 of the Income Tax Assessment Act (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.

One of the exceptions mentioned in subsection 152-40(4) is where the main use of an asset is to derive rent (unless that main use was only temporary) (paragraph 152-40(4)(e) of the ITAA 1997). 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.

Subsection 152-40(1) relevantly states that a CGT asset is an active asset if at a time, at that time:

(a) you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a *business that is carried on (whether alone or in partnership) by:

(i) you; or

(ii) your *affiliate; or

(iii) another entity that is *connected with you; or

In the present circumstances, Company X uses the farming land to conduct its business of primary production under the terms of the arrangement entered into with the taxpayer. However, as Company X is not the taxpayer’s *affiliate, or an entity *connected to the taxpayer, the farming land cannot qualify as an active asset pursuant to paragraphs 152-40(1)(ii) and 152-40(1)(iii) of the ITAA 1997.

Alternatively, the farming land will be an active asset of the taxpayer pursuant to paragraph 152-40(1)(ii) of the ITAA 1997 where the taxpayer’s spouse uses this property in the course of carrying on a business and also qualifies as an *affiliate within the meaning of that term under section 328-10 or section 152-47 of the ITAA 1997.

It has been determined by the Commissioner that the taxpayer’s spouse was not using this property in the course of carrying on a business, and therefore the farming land does not qualify as an active asset pursuant to paragraph 152-40(1)(ii).

Consequently, for the farming land to qualify as an active asset, the property must have been used or held regularly for use in the course of carrying on a business by the taxpayer.

Carrying on a business

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production provides general guidance as to whether activities undertaken amount to the 'carrying on of a business’.

At paragraph 13, a number of indicators by reference to case law are listed which are relevant to determining whether activities constitute carrying on a business, which are as follows:

● whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators;

● 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 repetition and regularity of the activity;

● whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business;

● whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at 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 a sporting activity.

TR 97/11 explains that the facts of each case must be examined. No one indicator is decisive and the and there is often a significant overlap of these indicators. 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.

Of relevance here are also the Commissioner’s views set out in Tax Determination TD 95/62 Income tax: will the owner (or lessor) of land who allows the land to be used in a sharefarming arrangement be considered to be engaged in a business of primary production as defined by the Income Tax Assessment Act 1936 ('the Act')? which provides guidelines about sharefarming arrangements

In TD 95/62 it is explained that in certain circumstances, a sharefarming arrangement may amount to carrying on of a business in partnership. The principles of carrying on a business in partnership are discussed in Tax Ruling 94/8 - which is referred to later in this report.

However, in TD 95/62 it is also pointed out that many arrangements do not amount to the carrying on of a business in partnership. In such cases, the fact that the land is used for cultivation in a business of primary production does not necessarily mean that the owner of the land is also carrying on that business.

The Commissioner considers that for a landowner to be carrying on a business under a sharefarming arrangement, the landowner must be involved in the activities that make up the business. This would be evidenced by an element of control over, and/or an ongoing participation in, the business. The involvement should be direct or immediate, rather than passive. The payment of expenses relating to the ownership of the land would not, without more, be sufficient.

In the absence of such involvement, the landowner would not be regarded as being engaged in the business of primary production. The receipt by the landowner of a payment from the farmer for use the use of the land would be in the nature of income from property rather than from carrying on a business.

In relation to the issue of whether a partnership exists, Taxation Ruling TR 94/8 Income tax: whether business is carried on in partnership (including ‘husband and wife’ partnerships) provides that there are no statutory rules in the income tax law for deciding whether entities are carrying on business as partners. The existence of a partnership is evidenced by the actual conduct of the parties towards one another and towards third parties during the course of carrying on business.

Paragraph 4 of TR 94/8 lists the following factors which are relevant in determining whether a partnership exists in a year of income:

● intention – the mutual assent and intention of parties

Conduct

● joint ownership of business assets

● registration of business name

● joint business account and the power to operate it

● extent to which parties are involved in the conduct of the business

● extent of capital contributions

● entitlements to a share of net profits, and

● business records

● trading in joint names and public recognition of the partnership.

Having regard to the indicators of carrying on a business, the relevant factors for determining if a partnership exists and the Commissioner’s more specific view regarding sharefarming arrangements, it is considered that the taxpayer’s sharefarming arrangements as set out in the agreement with Company X does not amount to carrying on a business. This view is based on the following:

● there is no evidence or suggestion that there was any intention for the taxpayer and Company X in entering into the sharefarming agreement to act as partners. Instead, it appears that the intention in entering the agreement was to enter into a mutually beneficial arrangement.

● the conduct of taxpayer and Company X further supports the conclusion that no partnership existed between them. In this regard, there were no joint ownership of business assets, no joint business name was registered, there were no joint bank accounts held and no joint business records were kept.

● the payments that the taxpayer received could not be described as a share of net profits i.e gross income less business expenses but rather the payments that were received include an amount of rental income plus a share of the gross proceeds from the land under cropping.

● the taxpayer was not actively or directly involved in the farming activities conducted on the farming land, nor is there any evidence that the taxpayer had any element of control over these activities.

In this regard, under the terms of the agreement, the taxpayer does not participate in any way in the cultivation of the land on this property. This responsibility falls on Company X which is required to cultivate and manage this property. Company X is also responsible for the maintenance of certain fixtures on the property, for example fences, dams and gates and for paying any statutory obligations in connection to this property, for example municipal rates.

The taxpayer’s involvement in the faming business is limited to maintaining some of the fencing on the property.

Therefore, as the taxpayer is not using the farming land in the course of carrying out a business, this property cannot qualify as an active asset of the taxpayer under section 152-40.

It should be noted that as the farming land is not an active asset, the active asset test in section 152-35 of the ITAA 1997 will also not be passed in relation to this property.

Accordingly, the taxpayer will not be entitled to access the small business CGT concessions in Division 152 for any gain made upon disposal of this property as the basic conditions for relief in section 152-10 of the ITAA 1997 will not be fully satisfied. One of the basic conditions in section 152-10 that is required to be met is that the CGT asset satisfies the active asset test, which in this case has not been met – see paragraph 152-10(1)(d) of the ITAA 1997.