Edited version of private advice

Authorisation Number: 1052299496970

Date of advice: 15 November 2024

Ruling

Subject: Active asset - boarding house

Question

Does the Property satisfy the active asset test pursuant to section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997) and the meaning of active asset pursuant to section 152-40 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

1.         The Company purchased a large property in YYYY.

2.         The property was known as the Property.

3.         The Company initially ran the Property as a boarding house for 8 years and during this time it provided cooked meals, cleaning of general area, linen change and room cleaning services.

4.         Then an unrelated third party leased the Property and ran it as a fully accredited supportive care facility.

5.         From 20XX the Company cancelled the lease and undertook similar services of providing short-term accommodation.

6.         The premises had XX rooms which could accommodate up to XX people.

7.         Each room had a bed with a mattress, and a built-in cupboard and desk.

8.         Each room was supplied with lighting and power.

9.         There were no ensuites in the rooms.

10.      Linen was no longer provided due to the rising costs of replacement from theft and damage.

11.      There were common areas including the laundry, restrooms, a large commercial kitchen with cooking facilities and refrigerator, a dining room, and a lounge room with a television. The garden, balconies and verandas were accessible to all as part of the occupancy fee.

12.      The Company provided cleaning of the shared facilities including the shared commercial kitchen, laundry and bathrooms.

13.      Vacancies were advertised by various means.

14.      The occupants were selected based on first in basis provided they have sufficient identification and the funds to pay boarding fees upfront. There was no investigative process such as undertaken in a longer-term rental tenant.

15.      The rooms were advertised as $XXX per week depending on the size of the room.

16.      There were no written leases.

17.      The occupancy agreement contained the following:

•                the occupiers paid rent weekly in advance and a few occupiers paid a bond

•                the occupiers could continue to occupy their room provided they paid their weekly rent

•                the occupiers could leave at any time with one day's notice to end the periodic agreement

•                the Property manager could access the room from time to time to inspect and ensure they were kept to a good standard and had a right to reasonable access at other times

•                the occupiers were required to obey the House Rules, with a copy of the rules displayed near evacuation instructions

•                occupiers were prohibited from using the room for anything illegal

•                animals could not be kept without permission

•                occupiers were required to keep the room in a safe condition

•                the Company agreed to give the occupier 14 days notice for renovations to their allocated room

•                the Company was responsible for the cost of utilities including electricity and water

•                the Company agreed to maintain the room and ancillary property in a reasonable state of repair and abide by all the legal requirements.

18.      The Company was required to give 60 days written notice to end the agreement where the occupier displayed one of the following:

•           threating behaviour by the occupier towards the Company, their agent, contractors or employee

•           occupier allowing another person to stay in their room without the proprietors consent

•           occupier inducing the Company into an occupier agreement by falsely representing or concealing information about their identity or place of occupation.

19.      The Company could end the agreement sooner where the occupier displayed the following conduct:

•           rent arrears of greater than 2 weeks

•           occupier behaviour causing serious damage, danger or interfering with the peace.

20.      The House Rules the occupiers were required to follow related to both shared space and personal spaces.

21.      The House Rules that impacted on the occupiers personal space included the following:

•           no smoking or vaping inside the house

•           drugs and implements to use drugs are not permitted in the house and will lead to instant termination of the lease

•           no open fires allowed including candles

•           respect other occupants

•           dress appropriately in the common areas of the house

•           keep your belongings in your room only

•           no parties

•           keep the noise to a minimum both inside and outside

•           do not remove any furniture provided from your room

•           do not bring additional furniture into the house without written consent

•           do not leave the air conditioner on either in your bedroom or shared space unless you are spending time in that room.

22.      The sole director and secretary of the Company was responsible for engaging all contractors and paying invoices. He engaged an accounting firm for the accounting and a real estate agent for property management and regular inspections.

23.      There was a live in manager at the premises who was responsible for the everyday chores including cleaning and arranging other workers.

24.      Accredited tradesmen undertook repairs, commercial cleaners would clean the premises and a gardener was provided regularly.

25.      The occupants could lock their individual rooms to protect their personal possessions.

26.      Residents could stay from X month to X years, with the average stay approximately X months.

27.      The Company sold the Property.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 subsection152-40(1)

Income Tax Assessment Act 1997 subsection152-40(4)

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

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated.

Issue

Question

Summary

As the Company has held the Property for more than 15 years and it was used in the Company's short-term accommodation business for a total of at least 7 ½ years during the relevant period, the Property was an active asset for the purposes of section 152-35 and within the meaning of section 152-40. The Property's main use was not to derive rent, so it does not fall within the exception in paragraph 152-40(4)(e).

Detailed reasoning

To qualify for the capital gains tax (CGT) small business concessions, you must satisfy the basic conditions in section 152-10 that are common to all the concessions.

One of those basic conditions is for the CGT asset to satisfy the active asset test in section 152-35.

Subsection 152-35(1) states:

A CGT asset satisfies the active asset test if:

•           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 relevant period; or

•           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 relevant period.

Subsection 152-35(2) provides that the relevant period begins when you acquired the asset and ends at the earlier of the CGT event or the cessation of the business.

The term 'active asset' is defined at section 152-40. Subsection 152-40(1) provides that 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)); 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)).

The combined effect of sections 152-35 and 152-40 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 by you, a connected entity or affiliate for at least half of the time period it was owned.

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

Assets specifically excluded under paragraph 152-40(4)(e) include those that are mainly used by you to derive interest, annuities, 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.

Such assets are excluded even if they are used in the course of carrying on a business.

Whether the Company'sProperty is an active asset under section 152-40 will depend on whether the premises is mainly used to derive rent.

Carrying on a business

Taxation Ruling TR 2019/1 Income tax: when does a company carry on a business? (TR 2019/1) provides guidance on when a company carries on a business including for the purposes of section 328-110 and the meaning of a small business entity. It provides that there is a presumption that companies are formed for the purpose of carrying on a business, but that can be rebutted on the facts of the case.

Paragraph 21 of TR 2019/1 provides the key indicia considered by the courts in determining whether the activities carried on by an entity amount to the carrying on of a business as follows:

•           whether the person intends to carry on a business

•           the nature of the activities, particularly whether they have a profit-making purpose

•           whether the activities are

­   repeated and regular

­   organised in a business-like manner, including the keeping of books, records and the use of a system

•           the size and scale of a company's activities including the amount of capital employed in them, and

•           whether the activity is better described as a hobby, or recreation.

Whether the letting of property activities amount to the carrying on of a business will depend on the circumstances of each case. A person, who simply owns an investment property or several investment properties, either alone or with other co-owners, is usually regarded as an investor who is not carrying on a rental property business. This is because of the limited scope of the rental property activities and the limited degree to which an owner actively participates in rental property activities. A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations.

In Cripps v. FC of T 99 ATC 2428; (1999) 43 ATR 1202, the taxpayer and his wife purchased, as joint tenants, 14 townhouses which they rented out. They also purchased a property which was used initially as a holiday home but was later periodically rented out. A further property was purchased for residential purposes. After a failed attempt to sell it, it was also rented out. The Administrative Appeals Tribunal found that the taxpayer and his wife were mere passive investors and were not in the business of deriving income from rental properties. They rejected the taxpayer's argument that he had greater involvement with his 16 properties.

In 11 CTBR (OS) Case 24, the taxpayer's income included rents from 3 properties. The taxpayer employed a manager and an accountant - he was principally a letting clerk with authority to refuse tenants. He collected and banked rents, attended to repairs and supervised them, and controlled the caretaker and cleaners. He kept books in connection with rents and repairs, and rates and other outgoings. The taxpayer said he personally carried out the principal part of the management of his rent-producing properties and directed policy, attended to the financial arrangements and made decisions regarding repairs. The taxpayer claimed that he was carrying on a business. In holding that he was not carrying on a business, a majority of the members of the Board of Review said:

It is obvious that some measure of supervision and management must ordinarily be exercised by a property owner who lets offices... and if that does not amount to the carrying on of a business, the fact that he employs others to assist him, either in the letting of the properties or in the preparation of the accounts relating to his rents and outgoings, will not make any difference. For the foregoing reasons we are unable to uphold the claim that the taxpayer is engaged in a 'business as property owner'.

On the other hand, Case G10 75 ATC 33 (Case G10), the taxpayer owned 2 properties of which 6 units were let as holiday flats for short term rental. The taxpayer, with assistance from his wife, managed and maintained the flats. Services included providing furniture, blankets, crockery, cutlery, pots and pans, hiring linen and laundering of blankets and bedspreads. The taxpayer also showed visiting inquirers over the premises, attended to the cleaning of the flats on a daily basis, mowing and trimming of lawns, and various other repairs and maintenance. The taxpayer's task in managing the flats was a 7-day a week activity. The Board of Review held that the activity constituted the carrying on of a business. In reaching that conclusion, the Board found:

It was clearly established in evidence that the money received by the taxpayer from the occupants of the flats was not solely a payment for the right to rent a flat for a certain period.

Active Asset's main use is to derive rent

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 taxpayer's business:

51. It is the Tribunal's view that it is clear on the face of the words used in s152-40(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.

...

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))...

In 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? the Commissioner explains that in certain circumstances the premises used in a business of providing accommodation for reward will satisfy the active asset test in section 152-35 notwithstanding the exclusion in paragraph 152-40(4)(e) for assets whose main use is to derive rent.

Paragraphs 21 to 25 of TD 2006/78 explain factors which indicate that an asset is being used to derive rent. These factors include, whether the occupier of a premises has right to exclusive possession, how much control is retained by the owners of the premises, and the extent of services provided by the owner such as room cleaning, provision of meals, supply of linen, and shared amenities.

As discussed in TD 2006/78 a key issue in determining whether premises are being mainly used to derive rent is whether the occupants have the right to exclusive possession under the terms of their occupation. If this is the case then the payment for their occupation is likely to be rent and the premises will not be an active asset. If the terms of their occupation of the premise only allow them to enter and use the premises for certain purposes without granting exclusive possession payments for this access are unlikely to be rent. Factors taken into account in deciding if the premises are mainly used to derive rent include the degree of control retained by the owner and the extent to which the fees they charge are for the services they provide.

Relevantly, Example 3 in TD 2006/78, outlines a situation in which the rental property is considered to be an active asset:

Example 3: boarding house

8. David owns an 8 bedroom property which he operates as a boarding house. He resides on the premises. Boarders enter into arrangements to occupy single rooms with the average length of stay being 4-6 weeks. No notice is required to quit the rooms. There are rules requiring visitors to leave the premises by a certain time and David retains the right to enter the rooms. David pays for all utilities (gas, electricity, water) and provides the following services and facilities to boarders:

•         room cleaning and general maintenance;

•         linen and towels; and

•         common areas such as a TV/lounge room, kitchen, bathrooms, laundry and a recreation area.

9. In this example, the services and facilities provided to boarders are relatively significant and the average length of stay is relatively short. David retains a significant degree of control over the premises through being on the premises most of the time. The arrangements entered into indicate that those staying in the boarding house do not have the right to exclusive possession of a room but rather only a right to occupy the room.

10. These circumstances indicate that the relationship between David and those staying at the boarding house is not that of landlord/tenant under a lease agreement. Accordingly, the income derived is not 'rent' and therefore the paragraph 152-40(4)(e) exclusion does not apply. If David's activities amount to the carrying on of a business, the boarding house will be an active asset under section 152-40 of the ITAA 1997.

Application to your circumstances

For the Property to be an active asset, it must firstly satisfy one of the 'positive tests' in subsection 152-40(1), and then not be excluded by one of the exceptions in subsection 152-40(4).

Active asset - positive test in subsection 152-40(1)

The Company's activities included providing XX rooms for short term accommodation with services and other facilities, hosting up to XX persons. The activities have been undertaken on a repeated and regular basis. The creation of business records, and the size and scale of the activities, indicate the activities were organised in a commercial and business-like manner with the relevant record keeping in place. The Company engaged contractors and others to assist with the activities including cleaners, gardeners, property managers and a live in contract manager on the premises. The facilities were advertised and promoted. As the entity is a company, the presumption in TR 2019/1 that companies are formed for the purpose of carrying on a business is relevant. Based on the circumstances and in the absence of any facts to rebut the presumption, it is accepted that the Company was carrying on a business.

The positive test in paragraph 152-40(1)(a) is therefore satisfied, as the Property is a CGT asset of the Company used in the course of carrying on a business.

Active asset - exceptions in paragraph 152-40(4)(e).

Since the business activity of the Company involved the provision of accommodation, to determine whether the Property is an active asset under section 152-40 it is necessary to consider whether the premises were mainly used to derive rent. If the Property's main use was to derive rent it will not be an active asset, due to the exclusion in paragraph 152-40(4)(e).

TD 2006/78 sets out the degree of control retained by the owner and the extent to which the fees charged are for the services provided, as relevant factors to consider in deciding if a premises is mainly used to derive rent. It applies these principles in Example 3 to illustrate when a rental property is considered to be an active asset.

In Example 3 of TD 2006/78 the key reasons for determining that the rental property was an active asset were that the occupants did not have a right to exclusive possession under the terms of their occupation and their fees included services provided.

The Company's circumstances are analogous to those in Example 3 in TD 2006/78. The similarities between Example 3 and the Company include:

•           the accommodation was short-term with no written lease only requiring one day's notice to terminate the arrangement

•           the occupiers paid rent weekly and in return they had the right to use the room together with the associated facilities

•           the Company paid for the utilities like electricity and water

•           the existence of restrictive House Rules

•           in the first X years of operating the boarding house the Company provided the following services and facilities:

­   meals

­   linen and linen changing service

­   room cleaning services

­   furniture in the room and communal areas, including fridge, oven, and television

­   general maintenance of the room

­   common areas such as a TV/lounge room, kitchen, bathrooms, laundry and a recreation area.

­   cleaning of the common areas that extended beyond the communal stairwell and passage ways

­   an onsite caretaker.

Further, the services and facilities provided were significant. Although the occupants could lock their individual rooms to protect their personal belongings, the Company retained significant degree of control through the House Rules.

Like Example 3 in TD 2006/78, the extent of the facilities and services provided, together with the retention of significant control by the Company indicated that the occupants in the short-term accommodation did not have the right to exclusive possession of a room but rather only a right to occupy the room.As a result,the relationship between the Company and the occupants was not that of landlord/tenant under a lease agreement. Accordingly, the income derived was not rent and therefore the paragraph 152-40(4)(e) exclusion will not apply.

As the Property has been used by the Company in the course of carrying on a short-term accommodation business, during the period prescribed in subsection 152-35(2), it will be considered an active asset. The Company has held the Property for more than 15 years and the Company used it as an active asset in its short-term accommodation business for a total of at least 7½ years, during the relevant period. As a result, the Property was an active asset for the purposes of section 152-35 and within the meaning of section 152-40.