Edited version of private advice

Authorisation Number: 1051895897225

Date of advice: 7 September 2021

Ruling

Subject: CGT - small business concessions - property - active asset

Question

Does the xxxx satisfy the active asset test for the purpose of the capital gains tax (CGT) small business concessions under section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period:

Income year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You operated a xxxx in partnership.

The premises were acquired in 19XX.

The boarding house was sold in June 20XX.

The premises provided AA guest rooms in total - BB with ensuite facilities and C with a shared bathroom. All rooms were furnished with bed, bed covers, linen, TV, fridge, microwave, toaster and kettle. Guests were provided with all utilities inclusive of their occupancy.

In addition to the guestrooms a manager's office was located on premises along with a shared kitchen, laundry, common area, external courtyard and parking. Management was located on the premises usually between the hours of Xam and Xpm each day, otherwise on call at all other times.

Management was done by a partner.

You provided substantial services with respect to operating the boarding house including the following:

•                    Provision of bedding

•                    Provision and restocking of basic supplies in communal kitchen and bathrooms

•                    A lost and found service

•                    Keeping the peace between tenants, resolving disputes.

•                    Maintenance and cleaning of communal areas (kitchen, bathrooms, courtyard, etc).

The boarding house was operated under the provisions of the state legislation that specifies standard occupancy principles.

In addition to the occupancy principles contained in the state legislation, guests were required to agree to a series of house rules that were applied consistent with the Act (notices, inspections, terminations)

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Reasons for decision

Active asset test

Subsection 152-35(1) of the ITAA 1997 states that a CGT asset satisfies the active asset test 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 period of ownership, 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 and a half years.

The test period begins when you acquired the asset and ends at the time of the CGT event (subsection 152-35(2) of the ITAA 1997).

Subsection 152-40(1) of the ITAA 1997 provides that a CGT asset is an active asset if you own it and:

•                    you use it or hold it ready for use in the course of carrying on a business (whether alone or in partnership)

•                    it is an intangible asset (for example, goodwill) inherently connected with a business you carry on (whether alone or in partnership).

Was the property used in the course of carrying on a business?

Whether the letting of property amounts to the carrying on of a business will depend on the circumstances of each case, (Californian Copper Syndicate (Limited and Reduced) v. Harris (1904) 5 TC 159).

A conclusion that an entity is carrying on a business of letting property would depend largely upon the scale of operations. An entity which 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.

Paragraph 51 of Taxation Ruling TR 2003/4 Income tax: boat hire arrangements (TR 2003/4) (which is about whether boat charter activities generate business or investment income) states:

Beaumont J indicated (quoting Wertman v. Minister of National Revenue 64 DTC 5158) 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.

Aa 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. There has to be something special about the activity to reach the conclusion that a business is being carried on. This will generally relate to the provision of additional services to the client in a manner that enhances the gross return above investment levels.

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

In the Commissioner's view, the factors that are considered important in determining the question of business activity are:

(a)          whether the activity has a significant commercial purpose or character

(b)          whether the taxpayer has more than just an intention to engage in business

(c)          whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

(d)          whether there is regularity and repetition of the activity

(e)          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

(f)           whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

(g)          the size, scale and permanency of the activity, and

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

TR 97/11 states 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.

In Rental Properties 2021 (Rental Properties guide) published by the Australian Taxation Office the Commissioner sets out two examples that discuss the issue of whether or not the owner of one or more rental properties can be said to be carrying on a business.

Example 3 on page 5 of the Rental Properties guide, outlines a situation in which the owners are not carrying on a rental property business. The Commissioner states:

The Tobin's own, as joint tenants, two units and a house which they derive rental income. The Tobin's occasionally inspected the properties and also interview prospective tenants. Mr Tobin performs most repairs and maintenance on the properties himself, although he generally relies on the tenants to let him know what is required. The Tobin's do any cleaning or maintenance that is required when tenants move out. Arrangements have been made with the tenants for the weekly rent to be paid into an account at their local bank. Although the Tobin's devote some of their time to rental income activities, their main sources of income are their respective full-time jobs.

The Tobin's are not partners carrying on a rental property business, they are only co-owners of several rental properties.

Example 4 on page 5 of the guide, outlines a situation in which the owners are carrying on a rental property business. The Commissioner states:

The D'Souza's own a number of rental properties, either as joint tenants or tenants in common. They own eight houses and three apartment blocks - each block comprising six residential units - a total of 26 properties.

The D'Souza's actively manage all of the properties. They devote a significant amount of time - an average of 25 hours per week - to these activities. They undertake all financial planning and decision making in relation to the properties. They interview all prospective tenants and conduct all of the rent collection. They carry out regular property inspections and attend to all of the everyday maintenance and repairs themselves or organise for them to be done on their behalf. Apart from income Mr D'Souza earns from shares, they have no other sources of income.

The D'Souza's are carrying on a rental property business. This is demonstrated by:

•                     the significant size and scale of the rental property activities;

•                     the number of hours the D'Souza's spend on the activities;

•                     the D'Souza's extensive personal involvement in the activities; and

•                     the business-like manner in which the activities are planned, organised and carried on.

As shown in the above cases and the views of the Commissioner listed above, the indicators with the greatest weighting are the scale or volume of operations and the repetition and regularity of the activities.

Application to your situation

It is accepted that you operated the xxxx as a business. This is demonstrated by:

•                    the significant size and scale of the xxxx activities (number of rooms, high turnover of many rooms, services provided);

•                    the number of hours you spend on the activities (a partner was usually on site from Xam to Xpm each day and on call at other times;

•                    as above your extensive involvement in the activities (time spent on activity and services provided); and

•                    the business-like manner in which the activities are planned, organised and carried on.

Active Asset exceptions

Subsection 152-40(4) of the ITAA 1997 provides a number of exceptions to the active asset test. Paragraph 152-40(4)(e) provides that an asset whose main use is to derive rent cannot be an active asset. 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 (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).

Paragraphs 23 to 25 of TD 2006/78 continue:

23.          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; Tingari Village North Pty Ltd v. Commissioner of Taxation [2010] AATA 233 at paragraphs 44-46, 2010 ATC 10-131, 78 ATR 693 and associated Decision Impact Statement 2008/4646 & 2008/4647). If, for example, 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 unlikely to be rent.

24.          If premises are operated as a boarding house, the issue arises as to whether an occupant of part of the premises is a tenant or alternatively only a lodger/boarder with a licence to occupy. Similarly, 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.

25.          Ultimately, these are questions of fact depending on all the circumstances involved. Relevant factors to consider in determining these questions (in addition to whether the occupier has a right to exclusive possession) include 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).

Application to your situation

In your situation the xxxx agreements with occupiers did not provide a right to exclusive possession but rather a licence to occupy. In addition the average length of stay was relatively short, you provided services and facilities to guests such as the provision of bedding, provision and restocking of basic supplies in communal kitchen and bathrooms, a lost and found service, keeping the peace between tenants and resolving disputes and maintenance and cleaning of communal areas (kitchen, bathrooms, courtyard). You retained a significant degree of control over the premises through being on the premises for a significant time.

It is considered that the arrangement with your guests is properly characterised as a licence to occupy rather than as a right to exclusive possession. As a result, the payments received under the terms of the arrangement are not rent. Therefore, the property is not excluded from being an active asset under paragraph 152-40(4)(e) of the ITAA 1997 and satisfies the active asset test for the purpose of the capital gains tax (CGT) small business concessions under section 152-35 of the ITAA 1997.