Edited version of private advice

Authorisation Number: 1051609464707

Date of advice: 19 November 2019

Ruling

Subject: Active asset

Question

Was your interest in the Q Unit Trust an active asset for the purposes of section 152-40 of the Income Tax Assessment Act 1997?

Answer:

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts and circumstances

Ownership interests

You held XXX units (33 1/3^rd interest) in the W Unit Trust, R Unit Trust and the Q Unit Trust.

These trusts are all fixed unit trusts which provided you with a proportionate share of income and capital of the trusts.

The interests in all of these unit trusts were commonly held by:

·        You (XXX units - 33 1/3^rd interest)

·        X discretionary trust (XXX units - 33 1/3^rd interest)

·        Y discretionary trust (XXX units - 33 1/3^rd interest)

Accordingly, each of the relevant unit holders held a 1/3^rd share in each of the trusts.

Business arrangement

The following three separate trusts have an involvement in a hospitality business:

(i)     W Unit Trust conducts the operational activities of the business;

(ii)    R Unit Trust has not operated; and

(iii)  Q Unit Trust owns the real property and plant and equipment used in the business.

The asset ownership was structured purely for asset protection purposes.

There is no formal lease arrangement between the respective trusts as the stakeholders manage the business as a single operation. Accordingly, the amount charged by Q Unit Trust is simply calculated to cover the expenses (bank charges, borrowing costs, depreciation and interest) so the Q Unit Trust has a nil income each year.

The unit holders collectively have executed a Stakeholders Agreement which stipulates that the conduct of the 'Group' (defined to include Q Unit Trust, W Unit Trust and R Unit Trust) is to be managed as an entirety.

Your CGT transaction

You disposed of your interests in all of the three unit trusts during the 20XX income year.

You made a capital gain in relation to the disposal of your interests in both W Unit Trust and Q Unit Trust. There was no capital gain in relation to the disposal of your interest in R Unit Trust.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Section 328-125

Income Tax Assessment Act 1997 Section 328-130

Reasons for decision

All legislative references that follow are to the Income Tax Assessment Act 1997.

Summary

Q Unit Trust's assets are not active assets as the trust does not carry on a business and W Unit Trust, which uses the assets in its business, is not an affiliate of, or an entity connected with, Q Unit Trust.

As Q Unit Trust's assets are not active assets, your interest in that trust is not an active asset.

Detailed reasoning

The issue in question is whether your interest in Q Unit Trust was an active asset for the purposes of section 152-40.

Under subsection 152-40(3) your interest in an Australian resident trust is an active asset at a given time if, at that time, the total of the market values of the trust's active assets, financial instruments and cash that are inherently connected with a business that the trust carries on, is 80% or more of the market value of all of the assets of the trust.

Therefore, it must be determined whether Q Unit Trust's assets (that is, its real property and plant and equipment) are active assets of that trust.

Q Unit Trust's assets will be active assets under subsection 152-40(1) if either:

(i)     The assets are used, or held ready for use, in the course of carrying on a business by Q Unit Trust

(ii)    The assets are used, or held ready for use, in the course of carrying on a business by an affiliate of, or entity connected with, Q Unit Trust.

(i) Whether Q Unit Trust carries on a business

Normally the receipt of income from the letting of property does not amount to the carrying on of a business.

Whether the letting of property activities amount to the carrying on of a business will depend on the circumstances of each case.

A person, who simply owns an investment property or several investment properties, either alone or with other co-owners, is usually regarded as an investor who is not carrying on a rental property business. This is because of the limited scope of the rental property activities and the limited degree to which an owner actively participates in rental property activities. A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations.

Generally, it is easier for a company that derives income from the letting of property to show that it carries on a business than it is for an individual. Taxation Ruling TR 2019/1 Income tax: when does a company carry on a business (TR 2019/1) states that:

The case law highlights that the differences between companies, individuals and trusts influence the characterisation of the activities they carry on... These differences have led the courts to observe that profit-making activities, such as receiving rent from property, do not give rise to a presumption that an individual is carrying on a business, whereas it would if those same activities are undertaken by a company.

TR 2019/1 explains that the difference between companies compared to individuals and trusts are that:

...companies are typically formed for the purpose of carrying on a business. In Westleigh and American Leaf, it was observed that where a company aims to make, and has a prospect of profit, it is presumed that the company intends to, and does in fact, carry on a business. In American Leaf , Diplock LJ observed that this means any gainful use to which a company puts its assets will, on its face, amount to the carrying on of a business. However, this presumption can be rebutted if it can be shown that, on the facts, the company had no aim or prospect of making a profit.

In the present case, Q Unit Trust owns the premises and the plant and equipment that are used by W Unit Trust in conducting its hospitality business.

Q Unit Trust charges W Unit Trust an amount for the use of its premises and related plant and equipment.

Ordinarily, leasing out a single commercial premise along with related plant and equipment would not amount to the carrying on of a business as the level of activity required of the owner of the premises would be limited.

However, as stated in TR 2019/1, the conclusion may be different for a company as companies are typically formed for the purpose of carrying on a business and therefore are normally inherently commercial in nature.

You contend that Q Unit Trust should be treated like a company for the purpose of applying the principles in TR 2019 as it is a unit trust that provides the unit holders with a definitive and fixed entitlement to the income of the trust and there is no substantive practical difference between the interests of a shareholder and a unit holder.

However, even if we accepted that Q Unit Trust should be treated like a company for the purpose of applying the principles in TR 2019, we still do not consider that Q Unit Trust is carrying on a business. This is because TR 2019 states that the presumption that a company carries on a business is rebutted if, on the facts, the company has no aim or prospect of making a profit. Q Unit Trust has no aim or prospect of profit as the amount it charges for the use of its premises and related plant and equipment only covers its expenses (bank charges, borrowing costs, depreciation and interest) so the Q Unit Trust has a nil income each year.

Also, even if Q Unit Trust was carrying on a business, the rental exclusion set out in paragraph 152-40(4)(e) would apply to prevent the trust's assets from being active assets unless the entity renting the assets is an affiliate of, or connected with, Q Unit Trust (the latter issue is considered further below).

It is noted that you contend that the amount charged by Q Unit Trust is not rent as there is no lease agreement giving W Unit Trust exclusive possession. However, there is no requirement that a rental/lease arrangement must be the subject of a formal written agreement. Also, the courts have regard to the surrounding circumstances when determining whether the occupant has exclusive possession and therefore a lease. For example, McTiernan J in Radaich v. Smith (1959) 101 CLR 209 (Radaich v. Smith) stated that a business of a milk bar could only be carried on in reasonable convenience by persons having exclusive possession of the premises and therefore held that the agreement was in substance a lease even though the document used terminology like 'licence' rather than 'lease', 'lessor' and 'lessee'. It is considered that W Unit Trust could only carry on its hospitality business if it had exclusive possession of the premises and related plant and equipment. Consequently, the amount paid by W Unit Trust to Q Unit Trust is considered to be rent.

(ii) Whether W Unit Trust is an affiliate of, or entity connected with, Q Unit Trust

If W Unit Trust is an affiliate of, or entity connected with, Q Unit Trust then Q Unit Trust's assets would meet the requirement under subsection 152-40(1) to be active assets and the rental exclusion set out in paragraph 152-40(4)(e) would not apply.

The term 'affiliate' is defined in section 328-130 to only include an individual or company. As W Unit Trust is a trust, it cannot be an affiliate.

Subsection 328-125(1) states that:

An entity is connected with another entity if:

(a) Either entity controls the other entity as described below; or

(b) Both entities are controlled in a way described below by the same third entity

Under subsection 328-125(2), an entity controls a unit trust if the entity or its affliliate/s (or all of them together) own interests in the unit trust that gives the right to receive at least 40% (the control percentage) of any distribution of income or capital by the unit trust.

W Unit Trust and Q Unit Trust do not own interests in each other. Consequently, paragraph 328-125(1)(a) is not applicable.

You, X discretionary trust and Y discretionary trust each own a third of the units in each of W Unit Trust and Q Unit Trust.

As none of the owners of W Unit Trust and Q Unit Trust have a control percentage of at least 40%, W Unit Trust and Q Unit Trust are not controlled by a common single entity with a control percentage of at least 40% of each of them.

Therefore, paragraph 328-125(1)(b) does not apply to make W Unit Trust and Q Unit Trust connected entities.

However, you contend that the stakeholders in the hospitality business (that is, you, X discretionary trust and Y discretionary trust) should be considered together in determining whether paragraph 328-125(1)(b) applies.

To support your contention you have referred to paragraph 23(b) of the Acts Interpretation Act 1901 (AIA 1901) which provides that when reading and interpreting any Commonwealth Act, words in the singular are to include plural.

However, subsection 2(2) of the AIA 1901 states that the application of the AIA 1901 and any of its provisions is subject to a contrary intention in the Commonwealth legislation being interpreted.

Subsection 328-125(2) refers to 'an entity' being 'the first entity' and then to 'the first entity, its affiliates, or the first entity together with its affiliates'.

If your contention that 'an entity' should be interpreted to include a collective of entities for the purposes of applying section 328-125 was correct, then there would be no need for the wording in subsection 328-125(2) referred to above.

Therefore, we consider that section 328-125 shows an intention contrary to the general principle provided by paragraph 23(b) of the AIA 1901.

Consequently we do not accept that the stakeholders in the hospitality business can be considered together in determining whether paragraph 328-125(1)(b) applies.