Edited version of private advice

Authorisation Number: 1051824016243

Date of advice: 1 July 2021

Ruling

Subject: Carrying on a business and the active asset test for CGT purposes

Question 1

Are you considered a CGT Small Business Entity under section 152-10(1aa) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Is the property an Active Asset for CGT purposes under Division 152 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ended DD MM YYYY

The scheme commences on:

DD MM YYYY

Relevant facts and circumstances

On DD MM YYYY you inherited a boarding house located (the property).

The property can occupy short- and long-term boarders.

The property consists of:

•                     X bedrooms (each bedroom includes a kitchenette),

•                     X bathrooms,

•                     X laundry,

•                     Seating area (on the upper floor) and

•                     External seating area (in the garden).

Occupants are entitled to:

•                     Access and use of a designated bedroom.

•                     Bedding.

•                     The use of shared facilities including bathrooms, laundry and seating areas.

The rights of the proprietor:

•                     A right of entry into the bedrooms without notice at reasonable times for reasonable purposes.

•                     A right to designate another room from time to time

•                     As right to terminate upon reasonable written notice

•                     A right to evict without first obtaining a Court order

As the owner of the property, you also act as the manager and undertake the following activities:

•                     You maintain of all areas (bedrooms, bathrooms, laundry and seating areas).

•                     You provide and maintain all furnishings (such as fridges, washing machines, beds and cupboards).

•                     You provide linen to new tenants.

•                     You are responsible for the payment of all utilities including gas, water, electricity, internet and phone.

•                     You are responsible for the compliance with the Department of Housing and the City Council.

You employ a caretaker who is responsible for:

•                     Collecting rent.

•                     Managing income and outgoing boarders.

•                     Organising repairs and maintenance.

•                     Cleaning of bedrooms and common areas.

Your aggregated turnover is less than 2 million.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 995-1

Income Tax Assessment Act 1997 subsection 152-10(1AA)

Income Tax Assessment Act 1997 subsection 152-10(1)

Income Tax Assessment Act 1997 subsection 152-35

Income Tax Assessment Act 1997 subsection 152-40

Income Tax Assessment Act 1997 Division 328- 110

Reasons for decision

Summary

You satisfy the conditions in subsection 152-10(1AA) the Income Tax Assessment Act 1997 (ITAA 1997) are considered a small business entity for the purposes of the small business CGT concessions.

The property satisfies the active asset test under Division 152 of ITAA 1997 and is therefore considered an active asset for small business CGT concession purposes.

Detailed reasoning

To qualify for any of the CGT small business concessions, an entity must satisfy several conditions that are common to all the concessions, known as the basic conditions. The basic conditions for relief are contained in subsection 152-10(1) of the ITAA 1997:

a)            a CGT event happened in relation to a CGT asset of yours in an income year;

b)            the event would (apart from this Division) have resulted in the gain;

c)            at least one of the following applies:

(i)            you are a small business entity for the income year;

(ii)           you satisfy the maximum net asset value test;

(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;

(iv)         the conditions mentioned in subsection (1a) or (b) are satisfied in relation to the CGT asset in the income year;

d)            the CGT asset satisfies the active asset test in section 152-35.

Small Business entity

The term 'small business entity' is defined in section 328-110 of the ITAA 1997.

Subsection 328-110(1) of the ITAA 1997 provides that you are a small business entity for an income year if:

a)            you carry on a business in the current year; and

b)            one or both of the following applies:

(i) you carried on a business in the income year before the current year and your aggregated turnover for the previous year was less than $10 million;

(ii) your aggregated turnover for the current year is likely to be less than $10 million.

The definition is changed for the purposes of the small business CGT concessions in that the aggregated turnover is reduced to below two million dollars for the relevant year and/or the previous year (subsection 152-10(1AA) of the ITAA 1997).

Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

Taxation Ruling TR 97/11 Income Tax: am I carrying on a business of primary production?

provides the Commissioners view of the factors used to determine if a taxpayer is in business for

tax purposes. Its principles are not restricted to questions of whether a primary production

business is being carried on.

Paragraph 13 of TR 97/11 states that the courts have held that the following indicators are relevant

in determining whether a business is or is not being carried on:

•                     whether the activity has a significant commercial purpose or character

•                     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 regularity and repetition of the activity

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

•                     whether the activity is planned, organised and carried on in a businesslike manner such that it is described as 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 sporting activity.

No one indicator is decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). The indicators

must be considered in combination and as a whole and whether a business is being carried on depends on the 'large or general impression gained' (Martin v. FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551) from looking at all the indicators, and whether these factors provide the operations with a 'commercial flavour' (Ferguson v. FC of T (1979) 37 FLR 310 at 325; 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884). However, the weighting to be given to each indicator may vary from case to case.

Tax Ruling GSTR 2012/6 Goods and Services Tax: Commercial Residential Premises (GSTR 2012/6) outlines what are considered to be commercial residential premises. It provides guidance and a comparison of whether activities are the same as those undertaken by hotels, hostels and boarding houses.

A hotel, motel, inn, hostel or boarding house consists of more than the rooms or apartments that are occupied by guests. It must also of necessity include common areas such as reception areas, dining areas, car parks and the like, such as were the subject of the management lot. The supply that consisted only of the rooms or apartments or accommodation units in a hotel complex is not, without those other areas, the supply of commercial residential premises.

Paragraph 12 of GSTR 2012/6 identifies a number of characteristics common to those exhibited by operating hotels, motels, inns, hostels and boarding houses:

•                     commercial intention

•                     multiple occupancy

•                     holding out to the public

•                     accommodation is the main purpose

•                     central management

•                     management offers accommodation in its own right

•                     provision of, or arrangement for, services

•                     occupants have status of guests.

Paragraphs 36 to 40 of GSTR 2012/6 provide the following detail on the characteristics of hostels and boarding houses:

Features of Boarding Houses

36. A boarding house is a dwelling at which board and lodging are provided to guests or residents.

37. A boarding house provides accommodation for a commercial purpose. Non-profit entities can also operate commercial residential premises. For example, various non-profit organisations operate boarding houses in a business-like manner.

38. A boarding house has the capacity to supply accommodation for multiple occupancies.

39. While the term 'boarding house' indicates that the premises ordinarily consist of a single dwelling, premises are not precluded from being a boarding house where the premises consists of a building with an additional stand alone structure in which board (meals), or lodging, or both, is provided. However, premises are not a boarding house where the premises consist of a central building used as a communal dining/meeting area with a number of independent living units.

40. A boarding house may provide accommodation to occupants as the occupant's principal place of residence. It is not necessary for accommodation in the premises to be limited to guests who need or desire accommodation while away for business or pleasure.

Active Asset Test

The active asset test is contained in section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997) and is satisfied if:

•                     you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the test period detailed below, or

•                     you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7.5 years during the test period.

The test period:

•                     begins when you acquired the asset;

•                     ends at the earlier of:

•                     the CGT event, and

•                     when the business ceased, if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows).

Section 152-40 of the ITAA 1997 provides that a 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.

However, paragraph 152-40(4)(e) of the ITAA 1997 provides that an asset whose main use is to derive rent cannot be an active asset.

Taxation Determination TD 2006/78 Income Tax: capital gains: are there any circumstances in which remises used in a business of providing accommodation for reward may satisfy the active asset test in section 152-35 of the Income Tax Assessment At 1997 notwithstanding the exclusion in paragraph 152-40(4)(e) of the Income Tax Assessment Act 1997 for assets whose main use is to derive rent? (TD 2006/78), outlines the circumstances when premises that provide accommodation may satisfy the active asset test. Whether an asset's main use is to derive rent will depend on the particular circumstances of each case.

As outlined in paragraph 22 of TD 2006/78, the term 'rent' has been described as follows:

•                     the amount payable by a tenant to a landlord for the use of the leased premises (C.H. Bailey Ltd v. Memorial Enterprises Ltd [1974] 1 All ER 1003 at 1010, United Scientific Holdings Ltd v. Burley Borough Council [1977] 2 All ER 62 at 78, 86, 93, 99);

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

•                     recompense paid by the tenant to the 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, Vol 27 (1) 'Landlord and tenant', paragraph 212).

A key factor therefore 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 not 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 less likely to be rent.

Relevant factors to consider in determining whether rent is derived include:

•                     whether the occupier has a right to exclusive possession

•                     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. Charters [1977] 3 All ER 918).

Payments are generally not rent if the following factors exist:

•                     no notice is required to quit the rooms,

•                     there are rules requiring visitors to leave the premises by a certain time,

•                     the owner/manager retains the right to enter the accommodation,

•                     the owner pays for all utilities (gas, electricity, water),

•                     the owner provides services and facilities to guests such as room cleaning and general maintenance, linen and towels and common areas such as a TV/lounge room, kitchen, bathrooms, laundry and a recreation area,

•                     the average length of stay is relatively short,

•                     the owner/manager retains a significant degree of control over the premises through being on the premises most of the time,

•                     the arrangements entered into indicate that those staying in the accommodation do not have the right to exclusive possession of a room but rather only a right to occupy the room.

A 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.

Application to Your Circumstance

In your case, the activity meets a number of the indicators and when these indicators are considered in combination and as a whole it is considered that you are carrying on a business. As you are considered to be carrying on a business and have an aggregated turnover of less than $2 million, you meet the conditions to be considered a small business entity for the purposes of the small business CGT concessions.

The property is actively used in your business and as the occupier does not have a right to exclusive possession, a high level of control is maintained by the owner and additional services are provided by the owner, it is considered that the payments received would not be considered rent. As such the exclusion under paragraph 152-40(4)(e) of the ITAA 1997 will not apply.

You acquired the property less than 15 years ago, however it has been an active asset of yours for more than half the period held as it has been used as an active asset in your business since acquisition.

The property therefore satisfies the active asset test for the purposes of the small business CGT concessions.