Edited version of private advice

Authorisation Number: 1052017070243

Date of advice: 5 August 2022

Ruling

Subject: CGT - small business relief

Question 1

Will the properties be excluded from being Active assets within the meaning of section 152-40 of the Income Tax Assessment Act 1997 (ITAA 997) by reason of the operation of paragraph 152-40(4)(e) of the ITAA 1997?

Answer

No.

Question 2

Was a business of providing short-term accommodation being carried on?

Answer

Yes.

This ruling applies for the following period

Financial year ended 30 June 20xx

The scheme commences on

1 July 20xx

Relevant facts and circumstances

The properties

You owned serviced apartments (the properties):

The properties generally consisted of various unitised serviced apartments made available to the public for short-term accommodation stays with incidental services (cleaning, linen, refreshments and warm drinks etc.)

The properties were sold to 3^rd parties in the 20xx financial year

Applicant, business and services

You operated a business as a sole trader, using the properties since their acquisition, and ending on or about the sale date of the properties

No rental agreements or lease arrangements were made with customers

As part of the terms and conditions of the stay, to which customers would agree, your employees maintained the ability to enter a unit of accommodation whilst under occupation by customers, for the purpose of cleaning or providing marketed services

Each unit was fully furnished with beds, linen, doonas, pillows, towels, tea towels, lounge, dining table and chairs, coffee table, TV, iron, ironing board, washing machine, fridge, saucepans, fry pans, utensils, cutlery, crockery, serving bowls, sandwich maker, tea, coffee, sugar, milk and some units have a dishwasher and or a vacuum cleaner

Each unit included as part of the accommodation and service fee (amongst other things):

•         unlimited Wi-Fi

•         power, water and gas and

•         a compendium to advise guests of local services and facilities including recommendations on restaurants and other local businesses that may be required

More bespoke services were available on request

The properties were cleaned:

•         on a weekly basis for guests staying longer than one week

•         on departure of each guest, or

•         occasionally when new guests came in under the same booking

You were the person guests would contact in relation to all aspects of their stay. Your number was located on signage and business cards in each unit

Booking and payment

Guests paid in advance by direct deposit or credit card into an account specifically for income and expenses related to the business

Upon arrival, the typical process of onboarding customers was as follows:

•         their booking is recorded in a booking system

•         an invoice is imported into the accounting software

•         the invoice is emailed to the customer, together with a confirmation of the customers booking details and the terms and conditions of their stay

Primarily clientele consisted of a range of corporate clients and travellers. Additionally, corporate booking agencies handled a select group of corporate clients

Arrival and departure

On the day of arrival visitors were sent a text with the unit number and address of the unit they were booked into along with an entry code to enter into the keypad on the door

Guests were asked to check in via the COVID check-in QR code

On departure guests were expected to have done their own washing up and removed rubbish to the bins at the back door of their unit

During COVID guests were also asked to strip the sheets off the bed as an extra COVID precaution for the health and safety of the cleaners

Charges and financials

Typical rates were charged for accommodation and associated services to guests, depending on the number of guests and length of stay

Internal management reports were prepared by Accountants

The business maintained a number of bank accounts, loans and credit facilities

Marketing

The properties were collectively advertised in street signage and on multiple websites

Bookings were made online through the websites or by phone and email

You were the designated contact to field website and telephone enquiries regarding the properties. There was no external agent managing the properties

Commissions were payable on bookings made by third party travel websites

Employees and hours worked

Employees included casually employed cleaners

You worked a number of hours on a weekly basis.

External contractors included:

• linen supply service - including sheets, pillowcases, towels, bathmats and tea towels
• garden and building maintenance
• accounting and bookkeeping of approximately 8 hours per week
• marketing and tourism

You held a number of business and professional memberships.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997section 152-40

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

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

All references are to the Income Tax Assessment Act 1997 unless otherwise stated

Question 1

Summary

The properties are not excluded from being active assets by reason of the operation of paragraph 152-40(4)(e) because the units were used to carry on a business and not to derive rent

Question 2

Summary

A business of providing short-term accommodation was being carried on

Detailed reasoning

Taxation Determination TD 2006/78 Income tax: capital gains: are there any circumstances in which the premises used in a business of providing accommodation for reward may satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 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? provides at paragraphs 18 - 20 that:

18. For the small business concessions in Division 152 of the ITAA 1997 to apply to reduce or disregard a capital gain, the relevant CGT asset must satisfy the active asset test in section 152-35 of the ITAA 1997. The active asset test requires the relevant CGT asset to be an active asset:

•         for a total of at least half of the period specified in subsection 152 35(2) of the ITAA 1997 if you have owned the asset for 15 years or less; or

•         for a total of at least 7 ½ years during the period specified in subsection 152 35(2) of the ITAA 1997 if you have owned the asset for more than 15 years.

19. A CGT asset is an active asset at a given time if, at that time, you own it and:

•         it is used (or held ready for use) in the course of carrying on a business by you, your affiliate or an entity connected with you (paragraph 152-40(1)(a) of the ITAA 1997); or

•         it is an intangible asset that is inherently connected with a business that is carried on by you, your affiliate, or an entity connected with you (paragraph 152-40(1)(b) of the ITAA 1997).

20. Certain assets are, however, excluded from being active assets under subsection 152-40(4) of the ITAA 1997

Paragraph 152-40(4)(e) generally excludes, among other things, assets whose main use is to derive rent, even if they are used in the course of carrying on a business. The paragraph provides the following CGT assets cannot be active assets:

(e) an asset whose main use by you is to derive interest, an annuity, rent, royalties or foreign exchange gains unless:

(i) the asset is an intangible asset and has been substantially developed, altered or improved by you so that its market value has been substantially enhanced; or

(ii) its main use for deriving rent was only temporary.

Example:

A company uses a house purely as an investment property and rents it out. The house is not an active asset because the company is not using the house in the course of carrying on a business. If, on the other hand, the company ran the house as a guest house the house would be an active asset because the company would be using it to carry on a business and not to derive rent.

The Commissioner accepts that certain premises used in a business of providing accommodation for reward may be active assets because they are used in carrying on a business rather than for deriving rent

A key factor determining whether an occupant of a premises is a lessee is whether they have a right to exclusive possession. 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

Alternatively, if an 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 (paragraph 23 of TD 2006/78)

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 (paragraph 25 of TD 2006/78)

In this case the guests do not enjoy exclusive possession to the premisses/units that they occupy during their stay. The ability for employees to enter the premises without consent indicates this. There is no landlord/tenant relationship that exists between you and the guests staying in the apartments

However, arrangements involving holiday apartments and the like will not satisfy the active asset test where the activities do not amount to the carrying on of a business or where the arrangement does in fact involve the derivation of rent (paragraph 27 TD 2006/78)

TD 2006/78 provides the following example 4 at paragraphs 11-14 that is relevant to this case:

Example 4: holiday apartments

11. Linda owns a complex of 6 holiday apartments. The apartments are advertised collectively as a motel and are booked for periods ranging from 1 night to 1 month. The majority of bookings are from 1 to 7 nights.

12. Linda is responsible for bookings, checking guests in and out and cleaning the apartments. She also provides clean linen and meal facilities to guests. Linda does not enter into any lease agreements with guests staying at the apartments.

13. In this example, the apartments are operated similar to a motel. The guests do not have exclusive possession of the apartment they are staying in but rather only a right to occupy the apartment on certain conditions. The usual length of stay by guests is very short term and room cleaning, linen and meals are also provided to guests.

14. These facts indicate that the relationship between Linda and the guests is not that of landlord/tenant under a lease agreement. Accordingly, the income derived is not 'rent'. If Linda's activities amount to the carrying on of a business, the paragraph 152-40(4)(e) of the ITAA 1997 exclusion would not apply and the apartments would be active assets under section 152-40 of the ITAA 1997.

Carrying on a business

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

The question of whether you are carrying on a business is a question of fact and degree. There are no rigid rules for determining whether the activity amounts to the carrying on of a business. The facts of each case must be examined

However, the courts have developed a series of indicators that can be applied to determine whether you are carrying on a business. Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? at paragraph 13 contains general indicators of carrying on a business:

•         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 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 business-like manner such that it is directed at 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 a sporting activity

No one indicator is decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922), and there is often a significant overlap of these indicators. For example, an intention to make a profit will often motivate a person to carry out the activity in a systematic and organised way (TR 97/11 paragraph 15)

The table at paragraph 18 of TR 97/11 provides a summary of the main indicators of carrying on a business as set out alongside their application to your circumstances:

In determining whether you were carrying on a business, it is acknowledged the activity undertaken had a profit purpose and was characterised by regular and repetitive activity over a significant period of time. There are characteristics that aligned the activity as a business rather than a hobby

Your activities had 'significant commercial purpose or character'. There were business premises, staff, and greater than ordinary full-time hours given to the activity with an intention to carry on business

You carried on the activities in a similar manner to ordinary traders in the same industry with a permanency to the activities

There was a high degree of involvement in the day-to-day activities by you, and an engagement of employees and contractors to fulfill a wide array of practical and administrative tasks. These factors all create the impression of the existence of a business

There was a significant market value of assets used, as well as this the quantum of both income and expenditure from the activities displays a commercial purpose and character having the size, scale and permanency to evidence the existence of a business

After weighing up the factors outlined above, it is considered that you were carrying on a business. It therefore follows that the properties would not be excluded from being active assets under section 152-40(4)(e) as you were carrying on a business for these purposes.