Edited version of private advice

Authorisation Number: 1052129473718

Date of advice: 17 August 2023

Ruling

Subject: Active asset - properties used to derive rent

Question 1

Is each of the properties (the Properties) sold in the 20XX income year an 'active asset' of the Unit Trust for the purpose of subparagraph 152-40(1)(a)(i) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No. None of the Properties are an 'active asset' of the Unit Trust for the purposes of:

• paragraph 152-40(1)(a) of the ITAA 1997, as subparagraph 152-40(4)(e) applies, the main income derived from each of the Properties being rent; and
• paragraph 152-40(1)(b), as none of the Properties are intangible assets.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

1.         The Unit Trust is a Small Business Entity for the purposes of Division 328 of the ITAA 1997 as its aggregated turnover is less than $2 million.

2.         The Unit Trust sold a number of properties that had been redeveloped and then leased to tenants or made available for rent for significant periods until they were sold.

3.         The Unit Trust entered into lease agreements in relation to each of the Properties sold over the course of the period they were available for rent and in fact rented.

4.         The lease agreements allowed the tenant use of the Properties 'without interference from the landlord', other than for service and maintenance of the Properties with notice.

5.         The Unit Trust 'employed staff, purchased equipment, land and materials to redevelop each of the properties with the specific intention of engaging in the activity of property management, ...'

6.         While there was no formal business plan, the principals discussed the objective of the Unit Trust in developing the land, finding suitable tenants, building for those tenants, and managing the site thereafter. The Properties were acquired with the view to develop sustained management activities of commercial rental activities.

7.         The Trustee manages the assets of the Unit Trust including multiple commercial rental properties and a commercial storage facility.

8.         A real estate agent was engaged by the Unit Trust only to find prospective tenants.

9.         The activities conducted by the Trustee in relation to the Properties are those ordinarily undertaken by landlord, and included:

(a)  carrying out repairs and maintenance

(b)  collection of rent

(c)  payment of creditors

(d)  general administrative duties including the maintenance of the accounting records of the Unit Trust

(e)  developing and maintaining rapport with tenants and

(f)   management of the financial affairs of the Unit Trust.

Financial information regarding the Properties

10.      The income disclosed in connection with the Properties in each of the financial statements for the income years was identified as "rents received".

11.      There is no other income derived from the activity in relation to the Properties identified from the financial statements provided.

12.      There are no separate management agreements with tenants. The agreement for agents of the Unit Trust to access the properties to conduct maintenance and repair of the Properties is included in the lease agreements.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 paragraph 152-40

Income Tax Assessment Act 1997 paragraph 152-40(1)(a)

Income Tax Assessment Act 1997 paragraph 152-40(1)(b)

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

Income Tax Assessment Act 1997 paragraph152-40(4)(e)

Income Tax Assessment Act 1997 sub-paragraph152-40(4)(e)(i)

Reasons for decision

1.         In order that a realised capital gain may be reduced or disregarded under Subdivision 152, and with reference to the basic conditions set out in subsection 152-10(1) of the ITAA 1997, in the given circumstances:

(a)  the Properties are the CGT assets in relation to which the CGT event (i.e. the CGT event A1 of disposal) happens, as referred to in paragraph 152-10(1)(a); and thus

(b)  it is those Properties that are assets which must satisfy the active asset test in section 152-35, as referred to in paragraph 152-10(1)(d) of the ITAA 1997.

2.         The active asset test requires that the CGT asset disposed of must be an 'active asset' for the purpose of section 152-40 of the ITAA 1997.

Subsection 152-40(1) and meaning of "active asset"

3.         Section 152-40 of the ITAA 1997 sets out the meaning of the term 'active asset'. In relation to an asset directly held by the taxpayer, subsection 152-40(1) provides that a CGT asset is an active asset at a time if, at that time:

(a)  you own the asset (whether the asset is tangible or intangible) and it is used in the course of carrying on a business that is carried on by 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 by you.

4.         In the 20XX income year the Unit Trust disposed of the Properties under contracts for the sale and purchase of land. In each case, the contract evidences that the asset disposed of is real property, i.e. land and buildings and other items affixed to that land.

5.         For the purpose of paragraph 152-40(1)(a), the issue then is whether your use of each of the Properties in the course of you carrying on a business.

Paragraph 152-40(1)(a) and carrying on a business

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

7.         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. In Martin v FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551, Webb J said:

8.         The test is both subjective and objective; it is made by regarding the nature and extent of the activities under review, as well as the purpose of the entity engaging in them.

9.         However, the courts have developed a series of indicators that can be applied to determine whether you are carrying on a business and TR 97/11[1], provides the Commissioner's view of the indicators 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 indicators that are considered important in determining the question of business activity as outlined in TR 97/11 are as follows:

•        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.

10.      Paragraph 15 of the TR 97/11 states that no one indicator is decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). In addition paragraph 16 of 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 271; (1979) 9 ATR 873 at 884). However, the weighting to be given to each indicator may vary from case to case.

11.      From the facts provided, the Commissioner is satisfied that the Unit Trust is carrying on a business in relation to the properties for the following reasons:

•        Significant capital was invested, and finance obtained, to purchase land to construct the Properties, and to comply with legal requirements.

•        Activities were undertaken, included holding, preparing, developing or renovating the property and/or land; and once the property had been developed, it being rented out to long term tenants.

•        Staff were employed to carry out the development and management activities.

•        After the sale of the Properties, the Unit Trust continues to manage industrial/commercial properties. The scale and size of your property acquisitions indicate a commercial and business-like approach to the Unit Trust's operations and activities.

•        The Unit Trust's ownership and management activities were repetitive and regular in the generation of your income.

•        The activities undertaken are not reflective of a hobby being carried on.

12.      It is noted that the Unit Trust is also conducting other activities with a completely separate commercial identity to the rental of the Properties.

13.      Accordingly, after reviewing the information and documentation provided and taking all the indicators in TR 97/11 into consideration and weighing those indicators, the Commissioner is of the view that the Unit Trust in relation to the Properties and other property owned by the Unit Trust is carrying on a business of purchasing properties, either with existing buildings or vacant land, and developing them so that on completion of development they are suitable for leasing to third parties on a long-term basis.

Main use of the assets in the business

14.      TD 2021/2[2] provides that a company that carries on a business in the general sense, as described in Taxation Ruling TR 2019/1[3], 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. This is because an asset whose main use is to derive rent (unless such use was only temporary) is subject to the exception in paragraph 152-40(4), even if it is used in the course of carrying on a business.

15.      In Re Jakjoy Pty Ltd and Federal Commissioner of Taxation 2013 ATC 10-328, the AAT confirmed that an asset whose main use by the taxpayer is to derive rent cannot be an 'active asset' despite its use in a taxpayer's business:

51. It is the Tribunal's view that it is clear on the face of the words used in s 152-40(4)(e) of the ITAA 1997 that an asset whose main use by the taxpayer is to derive rent cannot be an "active asset". That is, there is nothing ambiguous about the meaning of the words appearing in this provision. Based on the facts and evidence before the Tribunal, the main use of the Properties by Jakjoy is to derive rent. As such, the Properties are excluded from being (i.e. "cannot be") "active assets" (under s 152-40(1)(a) of the ITAA 1997) by s 152-40(4)(e) of the ITAA 1997.

...

54. Although it is common ground that Jakjoy is carrying on a business of renting properties it does not automatically follow, based on a clear reading of the text in s 152-40, that the properties Jakjoy uses in carrying on its business are "active assets". Indeed, those properties are expressly excluded from being "active assets" by the exception in s 152-40(4)(e). Whether one agrees or disagrees with this outcome from a policy perspective is not a matter for the Tribunal in performing its review functions.

...

56. In any event, the Tribunal shares the Commissioner's view that the EM, if anything, supports the proposition that whether a particular CGT asset is an "active asset" under s 152-40 of the ITAA 1997 is to be answered by reference to the use to which the asset is put by a taxpayer and not by reference to the nature of the taxpayer's particular business. That is, as correctly submitted by the Commissioner, the EM:

23.... confirms Parliament intended that assets whose main use is to derive rental income are not to be treated as 'active assets'. Whether or not the asset is held by a taxpayer [like Jakjoy] whose business involves earning income from the renting of assets is irrelevant.

24. That is a policy decision made by Parliament. An interpretation that produced results consistent with such a policy is not [as asserted by Jakjoy] absurd or manifestly unreasonable (cf Acts Interpretation Act s. 15AB(1)(b)(ii)) ...

16.      Whether an asset's main use is to derive rent will depend on the particular circumstances of each case. The term rent has been described as follows:

•        the amount payable by a tenant to a landlord for the use of a leased premises (C.H. Bailey Ltd v. Memorial Enterprises Ltd [1974] 1 All ER 1003 at 1010, United Scientific Holdings Ltd v. Burnley Borough Council [1977] 2 All ER 62 at 76, 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).

17.      A key factor therefore in determining whether an occupant of premises is a lessee is whether the occupier has a right to exclusive possession. 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.

18.      The payments for the use of the Properties are considered rent for the following reasons:

•        The financial statements of the Unit Trust discloses that the main source of income in relation to the Properties is rent.

•        The lease agreements in respect of the Properties provide the tenants with use of the Properties "without interference from the landlord", other than for service and maintenance of the Properties with notice.

•        There are no agreements between the Unit Trust and the tenants for the Unit Trust to provide other services to the tenants in regards to the Properties.

19.      TD 2006/78[4] sets out the Commissioner's view as to whether there are circumstances in which a premises used in a business of providing accommodation for reward may satisfy the active asset test in section 152-35 of the ITAA 1997, notwithstanding the exclusion in paragraph 152-40(4)(e) of the ITAA 1997. The taxation determination explains that whether an asset's main use is to derive rent will depend on the circumstances of each case.

20.      TD 2006/78 provides examples of when the Commissioner considers property is for the main use of deriving rent:

(i)    Example 1 (at paragraphs 2 and 3) considers the owner of five commercial properties under lease for periods of 1 to 3 years, with the owner granting tenants exclusive possession, and concludes at paragraph 3 that "the main (only) use of the properties is to derive rent and they are therefore excluded from being active assets under paragraph 152-40(4)(e) of the ITAA 1997 regardless of whether the activities constitute the carrying on of a business."

(ii)   Example 2 (at paragraphs 4 to 7) considers the owner of a storage facility comprised of 50 storage sheds which are available for hire for period of 1 week to 2 years or more. Office facilities, 24 hour on-site security and cleaning services are provided.

The Commissioner (at paragraph 6) states that the arrangement entered into in this situation indicates that the users of the storage sheds do not have the right to exclusive possession, but rather the right to enter and use the sheds for certain purposes, i.e. there was no intention by the parties to grant a lease, and some of the arrangements entered into were short term and a range of services were provided to the users. As a tenant/landlord relationship does not exist between the parties in this example, the Commissioner concludes that the amount received are not rent.

21.      In the case of the Unit Trust, it is carrying a business of leasing properties and other separate commercial activities. The Properties sold were used in the Unit Trust's business, as part of the leasing of rental properties.

22.      Thus, each of the Properties satisfy the definition of 'active 'asset' in paragraph 152-40(1)(a), disregarding any exception to the definition.

Paragraph 152-40(4)(e) exception to active asset definition

23.      An asset that otherwise satisfies the definition of an active asset in subsection 152-40(1) is not an active asset if it falls under one of the exceptions in subsection 152-40(4) of the ITAA 1997.

24.      Relevantly, paragraph 152-40(4)(e) of the ITAA 1997 provides that an asset cannot be an active asset where the asset's main use is to derive rent. Such assets are excluded even if they are used in the course of carrying on a business. If the activities carried on do not amount to the carrying on of a business, it is unnecessary to consider whether the main use of the asset is to derive rent.

25.      The sole income-producing use of each of the Properties was to derive rent. That use was not temporary, and thus subparagraph 152-40(4)(e)(i) does not apply.

26.      As the Properties were solely used by the Unit Trust to derive rent, paragraph 152-40(4)(e) of the ITAA 1997 applies to each of the Properties, such that none of the Properties are an active asset of the Unit Trust.

Goodwill/intangible asset and paragraph 152-40(4)(e)(i)

27.      You have submitted that the Properties are not subject to the exception in paragraph 152-40(4)(e) of the ITAA 1997 because of the exclusion in subparagraph 152-40(4)(e)(i), as the Properties are intangible assets that have been substantially developed, altered or improved by the taxpayer, so that the market value of each has been substantially enhanced.

28.      This is on the basis that the purchasers of the Properties each paid a premium because of the quality of the tenants and the terms of the leases as a result of the activities of the Unit Trust. The higher price received for each of the Properties is reflective of the intangible goodwill asset created by the activities of the Trust.

29.      Goodwill is something that attaches to a business and is inseparable from the conduct of a business. It cannot be dealt with separately from the business with which it is associated. Provided the same business is carried on, the whole of the goodwill of a business remains the same single asset. (Paragraph 17 of the TR 1999/16[5]).

30.      If one or more (identifiable) assets of a business are disposed of, and not a discrete business, and the sale proceeds exceed the market value of the separate assets, the extra receipt is not for goodwill (there being no business disposed of). The extra receipt increases the capital proceeds received by the vendor for the assets and increases the acquisition cost of the assets to the purchaser (paragraph 79 of the TR 1999/16).

31.      In this case, the Properties were sold under contracts for sale and purchase of land and there is no indication as to a disposal of a business, goodwill of a business, or other intangible asset. In fact, the Unit Trust's business of leasing property continues after the sale of the Properties.

32.      Accordingly, the premium achieved on the sale of each of the Properties is associated with the disposal of that particular property, being real property (i.e. land and other items affixed to that land) under the contract terms, and is not connected with the disposal of the business' goodwill or other intangible asset.

33.      Consequently, as the Properties disposed of are real property, and not intangible assets, subparagraph 152-40(4)(e)(i) of the ITAA 1997 cannot apply to the Properties.

34.      Therefore, the Properties disposed of are not 'active assets' as defined in subsection 152-40(1)(a) of the ITAA 1997, as the exception in paragraph 152-40(4)(e) applies.

Paragraph 152-40(1)(b) and intangible assets

35.      As discussed above, the Properties disposed of are not intangible assets, and accordingly the Properties do not satisfy the definition of 'active asset' in subsection 152-40(1)(b).

36.      The Properties disposed of in the income year ended 30 June 20XX are therefore not 'active assets' for the purpose of subsection 152-40(1) of the ITAA 1997.

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

[2] Taxation Determination TD 2021/2 - Income tax: can a company that carries on a business in a general sense described in Taxation Ruling TR 2019/1 Income tax: when does a company a company carry on a business? but whose only activity is renting out an investment property claim the capital gains tax small business concessions in relation to that investment property?

[3] Taxation Ruling TR 2019/1 - Income tax: when does a company carry on a business?

[4] 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?

[5] Taxation Ruling TR 1999/16 - Income tax: capital gains: goodwill of a business.