Edited version of private advice

Authorisation Number: 1051968111150

Date of advice: 9 June 2022

Ruling

Subject: CGT - small business concessions

Question 1

Do you satisfy the basic conditions under section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) to apply the CGT small business concessions?

Answer

No.

Question 2

Are you considered a base rate entity under section 23AA of the of the Income Tax Rates Act 1986 (ITRA 1986) to allow you to apply the reduced company tax rate?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Company A and Company B are partners in a partnership (the partnership)

The partners purchased a property (the property) after 20 September 1985.

Each partner owns a 50% interest in the property.

The property has two commercial shop fronts downstairs and a residential/office area upstairs.

A property manager was engaged to manage the property, collecting rent, advising the partnership of defects/maintenance required and liaising with tenants.

Property inspections were conducted by both the property manager and the partners.

Maintenance decisions were made by the partners and any required work was completed by the partner's preferred contractors.

The partners reviewed rental payments to identify unpaid or underpaid rent, implementation of agreed regular rental increases and incorrect water usage splits across tenants.

The partners and the property manager work together to identify new tenants to minimise vacancies, using their own network to find potential tenants.

The partnership's aggregated turnover is under $X million.

All the income of the partnership is derived from rent received.

The property was sold in period ending 30 June 20XX and resulted in a capital gain.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10

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

Income Tax Assessment Act 1997 subparagraph 152-10(1)(c)(i)

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 subsection 152-40(1)

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

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

Income Tax Assessment Act 1997 subsection 328-110

Income Tax Assessment Act 1997 subsection 328-110(1)

Income Tax Rates Act 1986 section 23AA

Income Tax Rates Act 1986 paragraph 23AB(1)(d)

Reasons for decision

Question 1.

Do you satisfy the basic conditions under section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) to apply the CGT small business concessions?

Detailed reasoning

To qualify for the CGT small business concessions, you must satisfy several conditions that are common to all the concessions.

Subsection 152-10(1) of the Income tax Assessment Act 1997 (ITAA 1997) contains the basic conditions you must satisfy to be eligible for the small business CGT concessions. These conditions are:

(a)    a CGT event happens in relation to a CGT asset in an income year.

(b)    the event would 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 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)          you do not carry on a business, but your CGT asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you.

(d)    the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

To be eligible to apply the small business CGT concessions you must satisfy all four of the basic conditions above.

CGT Small Business Entity

To be considered a CGT small business entity in Subparagraph 152-10(1)(i) of the ITAA 1997, the entity needs to meet the definition Subsection 152-10(1AA) of the ITAA 1997 as:

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

(b)        you would be a small business entity for the income year if each reference in section 328-110 to $10 million were a reference to $2 million.

Subsection 328-110(1) of the ITAA 1997 states:

You are a small business entity for an income year (the current 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 (the previous year) before the current year and your *aggregated turnover for the previous year was less than $10 million; and

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

Tax Ruling TR 2019/1 Income tax: when does a company carry on a business? (TR 2019/1) provides the Commissioners view on when a company carries on a business.

Example 3 in the ruling, talks about circumstances much like your own.

"InveproCo is a company incorporated in Australia. InveproCo owns a commercial property, which it rents to a third party at a market rate on normal commercial terms. InveproCo provides no other services in relation to the property and conducts no other activities. InveproCo has produced a profit in each of the income years it has rented out the property. InveproCo is engaged in ongoing activities that have a purpose and prospect of profit, including letting out the property.

Possibility A

InveproCo engages a professional property manager to manage the property, find tenants and do all the maintenance and ongoing inspections in relation to the property.

InveproCo carries on a business.

Possibility B

InveproCo does not engage a professional property manager to manage the rental property and its directors find tenants. All maintenance and inspections are carried out by its directors.

InveproCo carries on a business." (TR2019/1).

Active asset test

The fourth basic condition to be met is for the CGT asset to satisfy the active asset test in section 152-35 of the ITAA 1997.

Subsection 152-35(1) of the ITAA 1997 states:

A *CGT asset satisfies the active asset test if:

(a)       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 specified in subsection (2); or

(b)       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 71/2 years during the period specified in subsection (2).

Subsection 152-35(2) of the ITAA 1997 states:

The period:

(a)       begins when you *acquired the asset, and

(b)       ends at the earlier of

(i)         the *CGT event; and

(ii)        if the relevant business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows - the cessation of the business.

Subsection 152-40(1) of the ITAA 1997 relevantly states:

A *CGT asset is an active asset at a time if, at that time you:

(a)       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

(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.

The combined effect of sections 152-35 and 152-40 of the ITAA 1997 is that the asset will meet the active asset test if the asset was used, or held ready for use, in the course of carrying on a business for at least half of the time period it was owned (or 7 and a half years for assets owned more than 15 years), subject to the exclusions in subsection 152-40(4) of the ITAA 1997. An asset whose main use is for deriving rent is specifically excluded from being an active asset under paragraph 152-40(4)(e) of the ITAA 1997.

Tax Determination 2021/2 (TD 2021/1) Income tax: can a company that carries on a business in a general sense as described in Taxation Ruling TR 2019/1 Income tax: when does a company carry on a business? but whose only activity is renting out an investment property cannot claim the capital gains tax (CGT) small business concessions in Division 152 of the ITAA 1997 in relation to that investment property provides the Commissioner's view that although a company may be carrying on a business in a general sense, if the only activity is renting out an investment property the CGT small business concessions will not apply in relation to the investment property. This is because an asset whose main use is to derive rent (unless such use was only temporary) is subject to an exclusion from those concessions, even if it is used in the course of carrying on a business.

Application to your circumstances

In your case, a CGT event happened when you disposed of the property and the event resulted in a capital gain, satisfying the first two basic conditions. You are considered a CGT small business entity as you have carried on a business and your aggregated turnover is less than $2 million, satisfying the third basic condition. However, as the property is used to derive rent, paragraph 152-40(4)(e) of the ITAA 1997 specifically excludes the property from being an active asset. This is also supported by the Commissioners view in TD 2021/1. As such the active asset test cannot be satisfied and therefore the fourth basic condition has not been met.

As you have not satisfied all the basic conditions required under section 152-10 of the ITAA 1997, you are not eligible to apply the CGT small business concessions.

Question 2.

Are you considered a base rate entity under section 23AA of the Income Tax Rates Act 1986 (ITRA 1986) to apply the reduced company tax rate?

Detailed reasoning.

Subsection 23(2) of the ITRA 1986 provides that the rates of tax payable for a company that is a base rate entity is 25%, otherwise it is 30%.

Section 23AA states that an entity is a base rate entity for the income year if

a)    no more than 80% of its assessable income for the year of income is base rate entity passive income; and,

b)    its aggregated turnover (within the meaning of ITAA 1997) for the year of income, worked out as at the end of that year, is less than $50 million.

Paragraph 23AB(1)(d) of the ITRA 1986 provides that base rate entity passive income includes rent.

The partnership does not pay income tax on the assessable income it earns, each partner reports their share of partnership income in their own tax return. The partners of the partnership are two companies (Company A and Company B); therefore, we are considering this issue from the company level. As all the income derived by the partnership is rent, which is passive income, the companies do not meet the less than 80% passive income requirement under section 23AA of the ITRA 1986 and therefore the companies are not considered a base rate entity. As the companies are not a base rate entity the companies are not entitled to apply the reduced company tax rate of 25% under subsection 23(2) of the ITRA 1986.