Edited version of your written advice

Authorisation Number: 1051450348012

Date of advice: 6 November 2018

Ruling

Subject: Small business concessions

Question

Are the intangible capital gains tax (CGT) assets disposed of by Company X (the Company) as part of the sale of the Serviced Apartments business active assets as defined in section 152-40 of the Income Tax Assessment Act 1997 (ITAA 1997) for the purpose of applying the small business concessions?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Company acquired two Serviced Apartment franchises to operate within two prescribed territories.

The X Serviced Apartments business has been sold and is the subject of this ruling. The Y business has not been sold.

The business carried on by X Serviced Apartments involved:

● obtaining access to numerous residential apartments via lease agreements with the freehold owners of the apartments; and

● in turn, licensing those apartments to corporate clients (clients) on a short to medium term basis for a fee (the Occupancy Fee). It is noted that the clients required the apartments to provide accommodation to employees of the clients (the guests) who were travelling or were otherwise required to live away from their usual place of residence for a period of time.

The X Serviced Apartments received reservations through relocation agents, corporate travel desks and directly from the clients. The business also advertised on the internet via the Apartments webpage and was listed through third parties. The accommodation was referred to on the webpage as ‘serviced apartments’.

The directors of the Company are X and Y. Up until the time of the sale of the X Serviced Apartments, X and Y had combined working hours of up to 120 hours per week. Of these hours, approximately 75% of their time was spent in relation to the X apartments and 25% in relation to the Y apartments.

As at the date of sale, the Company/X Serviced Apartments:

● was the lessee of approximately 20-25 strata titled apartments within the X franchise territory and offered those apartments to the clients of the Company. The X apartments were situated within several large apartment complexes;

● had medium to long-term leases in place with the freehold owners of the X Serviced Apartments;

● offered accommodation, in the X Serviced Apartments, for short to medium term stays with the average length of stay in the 20XY calendar year being a number of nights. A small number of guests stayed for a period of over six months;

The agreements between the Company and the clients with respect to the accommodation provided in the X Serviced Apartments included the following terms:

● the agreement was not a residential tenancy agreement;

● the occupant obtained a license to occupy the accommodation;

● cleaning and management staff, as contracted by the Company, maintained the right to access the apartment (permission to be sought in advance from the occupant where possible);

● parties, functions, excessive noise and loud music was not permitted;

● smoking in apartments was prohibited; and

● the apartments were subject to a ‘no pets policy’.

● The following amenities were included in the Occupancy Fee:

● the apartment was provided on a ‘fully furnished’ basis;

● utilities;

● linens and towels; and

● fully equipped kitchen.

The Company (via X and Y) provided the following services to the guests during their stay in the X Serviced Apartments:

● personally greeting the guests at the commencement of their stay;

● providing a tour of the space and a demonstration of how utilities are used;

● conducting a thorough fire safety and emergency exit procedure briefing with the guests;

● organising a weekly service clean of the apartment where requested and after each stay (the cleaning itself is outsourced);

● 24-hour telephone support to the guests and attending to any issues they may have during their stay;

● arranging airport pickup services; and

● internet on request.

In addition to the above services and the running of the apartments, X and X (as employees of the Company) also undertook various business development and marketing activities to secure new clients.

The X Serviced Apartments business was sold after approximately four years to an unrelated purchaser.

As part of the sale, the purchaser was assigned the benefit of, and assumed the burden of, the leases that Company had entered into with the freehold owners of the apartments.

The sale and purchase agreement for the apartments prescribed that the following intangible CGT assets were included in the sale:

● the goodwill of the X Serviced Apartments;

● the leases; and

● other intangible property.

The sale agreement did not provide an apportionment of the consideration as between these three assets.

Depreciable assets (e.g. furniture and other chattels) were also sold as part of the sale of the business. These assets are not the subject of this ruling.

The annual turnover of the Company, in respect of both the X Serviced Apartments business and the Y business, for the tax year prior to the sale year was less than $XXX.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Subsection 152-10(1A)

Income Tax Assessment Act 1997 Subsection 152-10(1B)

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Subsection 152-35(1)

Income Tax Assessment Act 1997 Subsection 152-35(2)

Income Tax Assessment Act 1997 Section 152-40

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

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

Reasons for decision

Small business concessions

Division 152 of the ITAA 1997 contains the provisions relating to capital gains tax relief for small business.

Section 152-10 of the ITAA 1997 sets out the basic conditions to be satisfied in order to access the small business concessions. These conditions are:

(a) a CGT event happens in relation to a CGT asset in an income year (apart from CGT event D1);

(b) the event would (apart from Division 152 of the ITAA 1997) have resulted in the gain;

(c) at least one of the following applies:

(i) you are a CGT small business entity for the income year (that is, your aggregated turnover is less than $2,000,000);

(ii) you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997;

(iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership; or

(iv) the conditions in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year; and

(d) the CGT asset satisfies the active asset test.

In the case of the Company, the X Serviced Apartments business was disposed of which triggered CGT event A1, the event resulted in a capital gain and the Company was a small business entity for the income year.

As the Company satisfied conditions (a), (b) and (c), it now needs to be determined whether the assets of the business satisfied the active asset test.

Active asset test

Where you have owned a CGT asset for 15 years or less, the asset satisfies the active asset test if the asset was an active asset of yours for a total of at least half of the period between when you acquired the asset and the earlier of when the CGT event happens or the relevant business ceased (subsections 152-35(1) and 152-35(2) of the ITAA 1997).

Subsection 152-40(1) of the ITAA 1997 provides the meaning of ‘active asset’. A CGT asset will be an active asset at a time if, at that time:

a) you own the asset (whether the asset is tangible or intangible) and the asset was used or held ready for use by you, an affiliate of yours, or by another entity that is ‘connected with’ you, in the course of carrying on a business.

b) if the asset is an intangible asset, you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

An intangible asset need satisfy only paragraph (a) or paragraph (b). An example of an asset that is inherently connected with a business is goodwill or the benefit of a restrictive covenant.

However, a CGT asset cannot be an active asset if its main use is to derive passive investment income such as rent, unless the use was only temporary (paragraph 152-40(4)(e) of the ITAA 1997).

Taxation Determination TD 2006/78 (TD 2006/78) sets out the Commissioner’s view on how the rental income exclusion in paragraph 152-40(4)(e) of the ITAA 1997 applies in the context of the active asset test.

Paragraph 21 of TD 2006/78 explains that assets whose main use is to derive rent (unless the use was only temporary) are excluded from being an active asset even if they are used in the course of carrying on a business. If the activities carried on do not amount to the carrying on of a business, it is unnecessary to consider whether the main use of the asset is to derive rent.

Therefore, in the case of the Company, it must be determined whether the activities involved with the X Serviced Apartments constitute the carrying on of a business and if so, whether the main use of the assets was to derive rent.

Business being carried on

Taxation Ruling TR 97/11 sets out a number of indicators that the courts have held to be relevant in determining if a business is being carried on:

● 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

● whether the activity is better described as a hobby, a form of recreation or a sporting activity.

In the case of the Company, we note that the X apartments business comprised of on average 20-25 apartments, X and Y spent significant hours per week working in the business and they provided various services to clients in addition to the accommodation provided. The activities clearly had a significant commercial character and were carried on in a businesslike manner.

Consequently, in comparing the activities carried out to the criteria set out in TR 97/11 we consider that it is evident that a business was being carried on.

Main use of assets to derive rent

Whether an asset’s main use is to derive rent will depend on the particular circumstances of each case. From TD 2006/78, the factors that indicate that the main use of an asset may not be to derive rent include:

● The occupier does not have exclusive possession and only has a right to occupy.

● There is a certain degree of control exercised by the owner.

● There are various services provided by the owner in addition to the provision of the room.

● The length of stay is usually of short duration.

In the case of the Company, we note that the terms and conditions of occupying the apartments expressly stated that the agreement constituted a licence to occupy and was not a residential tenancy agreement. Further, the other conditions are consistent with the owner exercising a degree of control, various services were provided by the owner in addition to the provision of the room, and the average length of stay per guest was relatively short in duration. Ultimately, it is accepted that the majority of income derived is considered to be related to the provision of services to the clients.

Therefore, we consider that the main use of the assets of the business was not to derive rent.

Conclusion

The intangible CGT assets disposed of by the Company as part of the sale of the X Serviced Apartments were active assets as defined in section 152-40 of the ITAA 1997.