Edited version of private advice

Authorisation Number: 1052267236491

Date of advice: 8 July 2024

Ruling

Subject: CGT - active asset

Question

Do you satisfy the requirements of subsection 152-10(1A) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question

Does the property satisfy the active asset test as outlined in section 152-35 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Income year ended 30 June 2023.

The scheme commenced on:

12 January 2023

Relevant facts and circumstances

You acquired the property XX September 20XX.

The property is approximately XXX square meters in size. There are two buildings (industrial sheds) on the Property with a total lettable area of 768 Square meters.

Building 1 has a floor area of approximately XX square meters, with XX square meters of mezzanine area. (XX square meters of lettable area- 77.5% of total lettable area.)

Building 2 has a floor area of approximately XX square metres with XX square metres of mezzanine area (XX square metres of usable area - 22.5% of total lettable area).

Building 1 was used exclusively as the business premises for Entity 1 from XX September 20XX to X April 20XX.

You owned 75% of the shares in Entity 1 at all times, with the remaining 25% of the shares being owned by your spouse.

Entity 1 is taken to have been connected with you as outlined in section 328-125 of the ITAA1997 when it occupied the Property.

Entity 1 ceased business in April 20XX and the company was deregistered in February 20XX.

Building 1 was leased to unrelated parties from X April 20XX to the date of sale of the Property in early 20XX.

The rental income generated from Building 1 is summarised below:

Table 1: The rental income generated from Building 1 is summarised below:

Building 2 has been used exclusively as the business premises Entity 2 at all times from September 20XX to the date of sale of the Property in early 20XX.

Entity 2 continued to occupy Building 2 up to the date of the sale and vacated after the sale of the Property.

Entity 2 used Building 2 as the office for its building and construction business. Building 2 was also used by Entity 2 for the storage of equipment and materials used in its business, and occasionally for preparatory works associated with the building and construction business.

You owned 100% of the shares in Entity 2.

Entity 2 was taken to have been connected with you as outlined in section 328-125 of the ITAA1997 when it occupied the Property.

The annual turnover of Entity 2's building and construction business for 20XX to 20XX income years is summarised below:

Table 2: The annual turnover of Entity 2's building and construction business for 20XX to 20XX income years is summarised below:

A contract of sale was executed on XX January 20XX and was settled on XX February 20XX.

A capital gain was realised from the sale of the property.

Entity 2 conducted a business in the 20XX financial year with an annual turnover of $XXX,XXX.

You operate a holiday rental business in partnership with your spouse. This partnership's annual turnover for the 20XX income year was $XXX,XXX.

You are not an affiliate of or connected to any other entities.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-10(1A)

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 328-125

Reasons for decision

An entity is a CGT small business entity in an income year if:

•       The entity carries on business in the income year; and

•       The aggregated turnover of the entity was less than $2 million.

Section 152-10 of the ITAA1997 allows for a capital gain that you make to be reduced or disregarded under this Division if the following conditions are satisfied for the gain:

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

(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;

(iv) the conditions mentioned 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

In order to satisfy section 152-10(c)(iv) of the ITAA 1997, conditions in subsection 152-10(1A) or (1B) must be satisfied.

(1A) The conditions in this subsection are satisfied in relation to the CGT asset in the income year if:

(a) your affiliate, or an entity that is connected with you, is a CGT small business entity for the income year; and

(b) you do not carry on a business in the income year (other than in partnership); and

(c) if you carry on a business in partnership--the CGT asset is not an interest in an asset of the partnership; and

(d) in any case--the CGT small business entity referred to in paragraph (a) is the entity that, at a time in the income year, carries on the business (as referred to in subparagraph 152- 40(1)(a)(ii) or (iii) or paragraph 152-40(1)(b)) in relation to the CGT asset.

Subsection 152-10(1A)(a) of the ITAA1997 requires that an affiliate, or a connected entity, is a CGT small business entity for the income year.

Under subsection 328-125(1) of the ITAA 1997, an entity is connected with another entity if either entity controls the other entity, or if both entities are controlled by the same third entity in a manner described in the section. Control may be direct or indirect.

Subsection 328-125(2) of the ITAA 1997 sets out the direct control of an entity other than a discretionary trust. For companies, paragraph 328-125(2)(b) provides that Entity A also controls Entity B that is a company if Entity A, its affiliates, or Entity A together with its affiliates own, or have the right to acquire the ownership of, equity interests in the company that carry between them the right to exercise, or control the exercise of, at least 40% of the voting power in the company.

The active asset test is outlined in section 152-35 of the ITAA 1997.

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 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 7 ½ years during the period specified in subsection (2).

For a CGT asset to be an active asset for the purposes of Division 152 of the ITAA 1997, it must firstly satisfy one of the positive tests in subsection 152-40(1) of the ITAA 1997, and then also not be excluded by one of the exceptions in subsection 152-40(4) of the ITAA 1997.

A CGT asset is an active asset at a time if, at that time you own the asset and it is used, or held ready for use, in the course of carrying on a business that is carried on by you, your affiliate or another entity that is connected with you (paragraph 152-40(1)(a) of the ITAA 1997).

However, an asset whose main use is to derive rent cannot be an active asset (unless that main use was only temporary) (paragraph 152-40(4)(e) of the ITAA 1997). 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.

If an asset is used partly for business and partly to derive rent at any given time, it is a question of fact dependent on all the circumstances as to whether the main use of the asset at that time is to derive rent. No one single factor is necessarily determinative, and consideration is given to a range of factors such as:

•         the comparative areas of use of the property (between deriving rent and other uses), and

•         the comparative levels of income derived from the different uses of the property.

Application to your circumstances

It is accepted that Entity 2 is connected with you as you own 100% of the shares in that company. It is also accepted to have been a small business that traded during the 20XX year with an annual turnover of $XXX,XXX. You were a partner in a partnership, the turnover of that partnership during the 20XX income year was $XXX,XXX. You were not connected to any other entities and as such the aggregated turnover of all connected entities was less than $X million. The property is not an interest of that partnership.

Based on these circumstances, you satisfy the requirements outlined in subsection 152-10(1A) of the ITAA 1997, in relation to the sale of the property during the 20XX income year.

The property was acquired on XX September 20XX. The CGT event took place on XX January 20XX, the ownership period considered under section 152-35 of the ITAA 1997 is approximately 8 years and 4 months.

As the property was owned for less than 15 years, the active asset test will be satisfied if the property was an active asset for more than half of the ownership period. Additionally, as specified at subsection 152-40(4) of the ITAA1997, an asset is not an active asset at a particular time if its main use is to derive rent.

Under subsection 152-40(4A), when determining the main use of an asset, any use by a connected entity is deemed to be used by the owner of the asset. That is, if the use of the Property by entity 2 and Entity 1 in operating your businesses is deemed to be your business use of the Property.

As both buildings on the property were used exclusively by Entity 2 and Entity 1 from the date of acquisition on XX September 20XX until X April 20XX; a period of approximately 2 years and 7 months. Entity 2 and Entity 1 were connected with you during this period. Thus, it is accepted that 100% of the use of the property was in the business conducted by connected entities.

From X April 20XX to XX January 20XX (approximately 5 years and 9 months), the Property has been used as

follows:

•         Building 1 has been leased to unrelated parties; and

•         Building 2 has been used exclusively by Entity 2 in operating its business.

It is accepted that Entity 2's use of the Property during this period satisfies the requirements of section 152-40 of the ITAA 1997; the Property was used by Entity 2 in carrying on its business.

Despite the fact that Building 1, represented 77.5% of the total lettable area and was rented to unrelated parties, the properties main use is taken to have been the use by Entity 2 as the business income generated over entirety of the rental period by Entity 2 is $X,XXX,XXX, mush greater than the rental income generated of $XXX,XXX. In all but one of the years of income data provided, the business income generated by Entity2 exceeded the rent received from letting building 1. On an income basis, it is considered the main use of the Property was not to derive rent and so the rental exclusion in paragraph 152-40(4)(e) of the ITAA 1997 does not apply.

As the Property was an active asset for at least 6 years and 7 months of the total ownership period, it is taken to satisfy the active asset test outlined in section 152-35 of the ITAA 1997.