Edited version of private advice

Authorisation Number: 1052040608200

Date of advice: 6 October 2022

Ruling

Subject: CGT - main residence exemption and small business CGT concessions

Question 1

Do you meet the criteria under Subdivision 118-B of the Income Tax Assessment Act 1997 to apply the main residence exemption and disregards the capital gain realised on the sale of the property?

Answer

Yes, you meet the eligibility criteria for a partial main residence exemption under Subdivision 118-B of the Income Tax Assessment Act 1997.

Question 2

Does section 118-190 of the Income Tax Assessment Act 1997 apply to partially tax the capital gain realised on the sale of your dwelling situated on the property due to you using part of the dwelling as a home office?

Answer

No

Question 3

Do you meet the conditions under Subdivision 152-A of the Income Tax Assessment Act 1997 to be eligible for the small business CGT concessions in relation to capital gain realised on the disposal of the property?

Answer

Yes

This ruling applies for the following period:

Income year ended 30 June 20XX

Relevant facts and circumstances

You acquired the property in XX 20XX.

The property's total land size is XX hectares and includes a number of building structures. The property has one single title.

A number of the buildings on the property were used in the course of operation of your business.

The majority of the total land area of the property was used as part of your business. A small part of the land area was used as your residence, and the remaining land area was not in use.

The nature and location of the property provided your business' clients with a unique experience.

At the date of purchase of the property, the previous owner already had a number of business bookings in the future which included the use of a specific building on the property. You honoured these bookings upon your purchase of the property.

You commenced major renovations across multiple buildings on the property immediately following your purchase of it.

One of the buildings located on the property had historical and community importance, therefore, its restoration was a key part of the renovations on the property.

You were required to be present at the property to oversee the renovations the property, and to make arrangements for existing bookings passed to you from the previous owner upon your purchase of the property.

At the time of acquisition, you resided overseas. You travelled between another country and Australia during the renovation period.

Although living conditions were difficult at times, you stayed at the dwelling located on the property for substantial periods of time during the renovation period when you were visiting Australia.

You moved into the dwelling upon completion of capital works in XX 20XX and commenced operating your business.

The majority of the land area of the property was actively used in operating your business, with your business' clients' experience beginning upon their entry to the property.

Due to the nature of your business, all the areas of the property that clients could use or see were required to be kept in pristine condition.

You made a contractual agreement with a third party to assist with upkeeping the property to a high standard, as required by the nature of your business.

The registered address of your business was the address of the property.

You used part of the dwelling located on the property as a home office whereby you would perform administrative tasks associated with your business.

The home office was not exclusively used by you and included personal belongings of the rest of your family.

You entered into a contract to dispose of the property during the 20XX financial year, with the disposal contract completing in XX 20XX.

You operated your business at the property from the date you moved into the dwelling until the disposal of the property.

You realised the capital gain as the result of the disposal of the property during the 20XX financial year.

Your business' turnover for the 20XX, 20XX and 20XX financial years were less than $2 million

You were an Australian resident for tax purposes from the date you moved into the dwelling.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 118-B

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 118-110

Income Tax Assessment Act 1997 Section 118-115

Income Tax Assessment Act 1997 Section 118-120

Income Tax Assessment Act 1997 Section 118-130

Income Tax Assessment Act 1997 Section 118-135

Income Tax Assessment Act 1997 Section 118-145

Income Tax Assessment Act 1997 Section 118-185

Income Tax Assessment Act 1997 Section 118-190

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Section 328-110

Income Tax Assessment Act 1997 Section 328-115

Income Tax Assessment Act 1997 Section 328-120

Reasons for decision

Question 1

Do you meet the criteria under Subdivision 118-B of the Income Tax Assessment Act 1997 ('ITAA 1997') to apply the main residence exemption and disregard the capital gain realised on the sale of the property?

Summary

You are entitled to a partial exemption under Subdivision 118-B from the date you moved into the dwelling to date of settlement of disposal of the property.

Detailed reasoning

Section 102-20 of the ITAA 1997[1] provides that a taxpayer may make a capital gain or loss when a capital gains tax (CGT) event occurs to a CGT asset. Subsection 108-5(1) defines a CGT asset as any kind of property or a legal or equitable right that is not property.

CGT event A1 - disposal of a CGT asset

Section 104-5 sets out a list of CGT events. Most relevant to you, CGT event A1 is the disposal of a CGT asset pursuant to subsection 104-10(1).

Subsection 104-10(2) states that a taxpayer will dispose of a CGT asset if a change of ownership occurs from the taxpayer to another entity.[2]

Paragraph 104-10(3)(a) of the provides that the timing of the CGT event will be when the contract to dispose of the asset is entered into by the taxpayer. Paragraph 104-10(3)(b) explains that if there is no contract, the time of disposal will be when the change of ownership occurred.

Main Residence exemption

Broadly, Subdivision 118-B allows taxpayers to ignore a capital gain or loss made from a CGT event that occurs with regards to a dwelling that is their main residence (main residence exemption).

The basic rules that must be satisfied in order for a taxpayer to be eligible for the main residence exemption are provided in section 118-110. Specifically, subsection 118-110(1) provides that a capital gain or loss from a CGT event in relation to a taxpayer's main dwelling, or ownership interest in it, is disregarded if:

a.            the taxpayer is an individual

b.            the dwelling was the individual's main residence throughout the ownership period, and

c.             the interest did not pass to the individual as a beneficiary in, and was not acquired as a trustee of, a deceased estate.

Subsection 118-110(2) further explains that the main residence exemption is only available in relation to CGT events A1, B1, C1, C2, E1, E2, F2, K3, K4 and K6.

The meaning of the term 'dwelling' is defined in subsection 118-115 as a unit of accommodation that is a building and consists of wholly or mainly of residential accommodation.

The meaning of the term 'ownership interest' in land or a dwelling is defined in subsection 118-130(1) as:

a.            for land - if an entity has a legal or equitable interest in it or a right to occupy it; or

b.            for a dwelling that is not a flat or home unit - if an entity has a legal or equitable interest in the land on which it is erected; or

c.             for a flat or home unit - if an entity has a legal or equitable interest in a stratum unit in it or a licence or right to occupy it.[3]

Subsection 118-130(2) further explains that where land or a dwelling is acquired under a contract, a taxpayer will acquire an ownership interest in it from:

a.            the time the taxpayer obtains legal ownership, or

b.            if the contract, or related contract, gives the taxpayer a right to occupy the asset at an earlier time, then the earlier time.

Where a taxpayer has a contract for a CGT event happening to land or dwelling, subsection 118-130(3) provides that their ownership interest continues until their legal ownership of the land or dwelling ends.

Section 118-120 applies to land adjacent to a dwelling, if the same CGT event happens to that land. Relevantly, subsection 118-120(3) provides that the maximum area of adjacent land covered by the main residence exemption for the same CGT events is 2 hectares, less the area of the land immediately under the dwelling.

Taxation Determination TD 1999/67[4] provides that in applying the main residence exemption, you can select which 2 hectares of the property the exemption applies to. Paragraph 4 of TD 1999/67 provides guidance on the calculation capital gain or loss that is made on the remainder of the land not subject to the main residence exemption:

"If your selected area of land cannot be separately valued, your capital gain or loss on the remainder of your land may be calculated by apportioning the capital proceeds and the cost base or reduced cost base (if applicable) on an area basis."

Moving into a dwelling

Section 118-135 provides that a dwelling is treated as your main residence from when you acquired the interest in the dwelling, if it becomes your main residence by the time it was first practicable for you to move into.

The Explanatory Memorandum to Act No 46 of 1998 (EM 1998) provides guidance on what period would be covered by the expression 'first practicable'. EM 1998 provides that the period covered would depend on the circumstances of the particular case. It states that section 118-135 is to "take account of situations where, for example, there is a delay in moving in because of illness or other reasonable cause...[the exemption] would cover a period after the end of the tenancy if the owner could not take up residence immediately because of the nature of repairs required to the dwelling".

In Chapman's case[5], the taxpayer purchased a property in Perth in June 2001, but because he worked in Kalgoorlie and for financial reasons, the property was rented out until he took up residence in September 2003. The AAT held that the words 'the time it was first practicable' in section 118-135 should not be read down to mean 'the time it was first convenient' and, in this situation, it was clear that the taxpayer did not move into the residence by the time it was first practicable to do so after the property was acquired.

Partial Main Residence Exemption

Subsection 118-185(1) provides that you may only be entitled to a partial main residence exemption, where a dwelling was your main residence during part of the ownership period. This partial exemption is to be calculated in accordance with the formula contained in subsection 118-185(2) which applies to adjust the capital gain or loss amount calculated on disposal of the property to take into account the proportion of your main residence days to the total number of ownership days in the property.

Subsection 118-185(2) states that:

(2) You calculate your *capital gain or *capital loss using the formula:

CG or CL amount x Non-main residence days

Days in your ownership period

Where:

"CG or CL amount" is the capital gain or capital loss you would have made from the CGT event apart from this Subdivision.

"non-main residence days" is the number of days in your ownership period when the dwelling was not your main residence.

Application to your circumstances

In XX 20XX, you purchased and obtained an ownership interest in the property. The property has a number of different buildings located on it. As one of these properties is a house that you lived in for a period of time, it satisfies the definition of the term "dwelling" in subsection 118-115. Your legal ownership in the dwelling was obtained on the settlement date of purchase of the property per subsection 118-130(2).

You sold the property on XX XX 20XX. The sale of the property is the disposal of a CGT asset and as a result, a CGT event A1 occurred pursuant to subsection 104-10(1). Your legal ownership in the dwelling ends on the settlement date of disposal of the property per subsection 118-130(3).

In order to determine whether you are eligible to ignore the capital gain associated with the sale of the property, it is necessary to establish that you satisfy the applicable provisions of Subdivision 118-B.

As the total land size of the property exceeds the prescribed maximum of 2 hectares in subsection 118-120(3), you can choose which 2 hectares of the property the main residence exemption applies to. These 2 hectares include the area of the land immediately under the dwelling. To calculate your capital gain for the remainder of the property, please refer to guidance provided in paragraph 4 of TD 1999/67.

Relevantly, after acquiring the property in XX 20XX, you undertook major renovations on a number of buildings on the property.

You were living overseas during the renovation period, but you stated that your presence on the property was required to oversee the renovation. As a result, you travelled between another country and Australia to oversee the renovations on the property during this time. You stayed at the dwelling anytime you were in Australia during the renovation period. You only moved into the property in XX 20XX, upon the completion of renovations on the property.

As provided by EM 1998, section 118-135 is intended to only accept delays between purchasing a dwelling and moving in if they were outside the control of the taxpayer. You stated that you stayed at the dwelling during the renovation period when you were in Australia to oversee the renovations on the property. Therefore, it is considered that the condition of the dwelling, although difficult, was fit and liveable from the date you acquired the property.

In accordance with EM 1998 and Chapman's case, it is considered that you did not move into the property as soon as practicable as required by section 118-135. Therefore, you are not entitled to treat the dwelling as your main residence for the entire duration of ownership of the property.

In accordance with section 118-185, you are only entitled to a partial main residence exemption as the dwelling was only your main residence from the date you moved into the dwelling in XX 20XX, to the end of your ownership period on the settlement date for the disposal of the property. To calculate your partial capital gain, please refer to the formula stated in subsection 118-185(2). The Non-main residence days will be from settlement date of the contract to purchase the property to the day before you moved into the dwelling. The ownership period will be the number of days between the purchase and disposal settlement dates.

Conclusion

After considering your facts and circumstances, it is considered that you do not meet the criteria under Subdivision 118-B to apply the full main residence exemption for the entire ownership period. However, you are entitled to a partial main residence exemption, for the period of time the dwelling was your main residence from the date you moved into the dwelling to the settlement date of disposal of the property.

Question 2

Does section 118-190 of the Income Tax Assessment Act 1997 apply to partially tax the capital gain realised on the sale of the taxpayer's dwelling situated on the property due to her using part of the dwelling as a home office?

Summary

Your home office cannot be characterised as a place of business, as a result, section 118-190 does not apply.

Detailed reasoning

Subsection 118-190(1)(b) provides that you are only entitled to a partial exemption for a CGT event under Subdivision 118-B if the dwelling was used for the purpose of producing assessable income during all or part of its ownership period.

Taxation Ruling IT 2673 (IT 2673)[6] provides guidance on whether a dwelling, or part of it, was used for the purpose of producing assessable income. Paragraph 10 of IT 2673 provides that a dwelling will be regarded as being used for the purpose of producing assessable income where that part of the dwelling used for said activities has the character of a place of business. Paragraph 11 further states that whether a dwelling, or part of it, has the character of a place of business is a question of fact that turns on the particular circumstances of each case but the broad test to be applied is whether a particular part of the dwelling:

a.            is set aside exclusively as a place of business;

b.            is clearly identifiable as a place of business; and

c.             is not readily suitable or adaptable for use for private or domestic purposes in association with the dwelling generally.

Application to your circumstances

You used part of the dwelling as a home office. You would perform administrative tasks associated with your events business from your home office.

The home office was not exclusively used by you, and personal belongings of the rest of your family were also stored there. It is considered that the home office was not a part of the dwelling that was clearly identifiable a place of business and was readily suitable for your private and domestic purposes.

Conclusion

It is considered that your home office, although occasionally used for administrative tasks relating to your business, does not have the character of a place of business. Therefore, Section 118-190 does not apply.

Question 3

Do you meet the conditions under Subdivision 152-A of the Income Tax Assessment Act 1997 to be eligible for the small business CGT concessions in relation to capital gain realised on the disposal of the property?

Summary

You meet all basic conditions for relief under Subdivision 152-A.

Detailed reasoning

In order to qualify for the small business CGT concessions, the following basic conditions as outlined in section 152-10 must be satisfied. These conditions are:

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

Note: This condition does not apply in the case of CGT event D1: see section 152-12.

(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 *CGT small business entity for the income year;

(ii)           you satisfy the maximum net asset value test (see section 152-15);

(iii)         you are a partner in a partnership that is a CGT small business entity for the income year and the CGT asset is an interest in an asset of the partnership; and

(iv)         the conditions in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year;

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

Note: This condition does not apply in the case of CGT event D1: see section 152-12.

CGT Small Business Entity

An entity will be a CGT small business entity under sections 152-10(1AA) and 328-110 if they carry on a business in the current income year and their annual aggregated turnover is less than $2 million in the current or previous income year.

Section 328-115 provides that an entity's aggregated turnover for an income year is the sum of their annual turnover and the annual turnovers of their connected and affiliated entities, excluding the amounts derived between the entity and their connected and affiliated entities.

Section 328-120 provides that an entity's annual turnover for an income year is the total ordinary income that an entity derives in the income year in the ordinary course of carrying on a business. Relevantly, subsection 328-120(5) provides that if an entity does not carry on a business for the whole of an income year, the entity's annual turnover must be worked out by using a reasonable estimate of what the entity's annual turnover would be if it carried on a business for the whole income year.

There is no further guidance provided in legislation on what constitutes a 'reasonable estimate'. The Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill 2007 (EM 2007) provided the following commentary about calculating the turnover of an entity, where the entity carried on a business for only part of the income year:

2.29 The intent of this provision is to ensure that the eligibility test of turnover, as an indicator of the size of a business, is based on income for a full year. Without this rule, entities that carry on a business for part of an income year would have a lower turnover than is truly representative of the size of the business.

Active asset test

Section 152-35 outlines the active asset test. According to that section, an asset will satisfy the test if you have owned the asset for less than 15 years and it was an active asset of yours for at least half of the ownership period of the asset.

Section 152-40 provides the meaning of an active asset. For an asset to fall under that definition, it must have been used in the course of carrying on a business that is carried on by you, your affiliate or an entity connected to you.

Subsection 153-40(4) contains a number of exceptions to the definition of an active asset. An asset whose main use by you is to derive rent cannot be an active asset under paragraph 152-40(4)(e). However, when considering whether an asset's main use is to derive rent, subsection 152-40(4A) allows you to disregard any personal use or enjoyment of the asset by you or your affiliated or connected entities.

Application to your circumstances

As discussed in question 1, a CGT event A1 occurred pursuant to subsection 104-10(1) upon your disposal of the property on XX XX 20XX. You have stated that you realised a gain from the occurrence of this CGT event. Therefore, the first two conditions in paragraphs 152-10(1)(a) and (b) are satisfied.

In relation to paragraph 152-10(1)(c) you are seeking to qualify as a CGT small business entity for the income year ending 30 June 20XX under subparagraph 152-10(1)(c)(i).

For the purposes of qualifying as a CGT small business entity under sections 152-10(1AA) and 328-110, the current income year is the 20XX income year, and the previous income year is the 20XX income year.

In accordance with paragraph 328-110(1)(a) you stated that your business continued to operate until the date of disposal of the property on XX XX 20XX, meaning that you carried on a business in the current income year of 20XX.

Further, in accordance with paragraph 328-110(1)(b) your business had the aggregate turnover of $XX in the 20XX income year, and $XX in the 20XX income year. It is reasonable to conclude that a reasonable estimate for your annual aggregate turnover for the current income year would be less than $2 million. As your business' aggregate turnover was below the $2 million maximum aggregate turnover in both current and previous income years, you qualify as a CGT small business entity for the 20XX income year.

In order to determine whether the property satisfies the active asset test, it is first necessary to establish that it falls under the definition of an active asset under section 152-40, and that the exceptions in subsection 152-40(4) do not apply.

You stated that you used majority of the land area of the property continuously in the course of operating your business.

You have stated that two buildings on the property were occasionally rented out during the period of ownership of the property. You have stated that building 1 was primarily used by clients of your business. The renting of building 1 was only incidental to your business, and it is not considered to have been the main use of building 1.

Further, you stated that building 2 on the property was occasionally rented out to your friends and family during the ownership period of the property. As the renting of building 2 was only occasional, and to your friends and family, it is considered that it was temporary and for your personal enjoyment in accordance with subparagraph 152-40(4)(e)(ii) and paragraph 152-40(4A)(a). Therefore, it is not considered that the collection of rent was the main use of building 2.

In relation to the active asset test in section 152-35, you owned the property from XX 20XX to XX 20XX. In accordance with paragraph 152-35(1)(a), you are required to have used the property actively in the course of running your business for at least half of the ownership period.

You stated that you operated your business continuously from the date you moved into the dwelling in XX 20XX to the date of disposal of the property on XX XX 20XX. Therefore, in accordance with paragraph 152-35(1)(a) and subsection 152-40(1), you used the property in the course of carrying on your events business for at least half of its ownership period.

Overall, it is considered that the property falls under the definition of an active asset under section 152-40, and it satisfies the active asset test in section 152-35.

Conclusion

All basic conditions for relief under Subdivision 152-A are satisfied and you are eligible to elect any relevant CGT small business concessions if requirements for specific concessions are also satisfied.

[1] All future references to the legislation are to the Income Tax Assessment Act 1997, unless otherwise stated.

[2] However, subsection 104-10(2) of the ITAA 1997 also provides that a change in ownership will not occur if the taxpayer ceases to be the legal owner of the asset but continues to be its beneficial owner.

[3] Subparagraph 118-130(1)(c)(iii) defines ownership interest where a company owns the legal or equitable interest, which is not relevant in the current case.

[4] Income tax: capital gains: if your land (including land on which your dwelling is situated) exceeds 2 hectares, can you select which 2 hectares the main residence exemption in Subdivision 118-B applies to and, if so, how do you calculate any capital gain or capital loss you make on the remainder of your land?

[5] Chapman v FC of T 2008 ATC 10-029

[6] Taxation Ruling IT 2673 Income tax: capital gains tax - use of sole or principal residence for income producing purposes