Edited version of private advice

Authorisation Number: 1052359295679

Date of advice: 07 February 2025

Ruling

Subject: CGT - active asset

Question 1

Does the property satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

A commercial building (the property) was built which involved X strata titles.

You have ownership interests in X of the strata titles.

The zoning is Town Centre.

The common area consists of an arcade, stairs, toilet and carpark.

Under a third of the tenancies are to related parties with a majority leased to third parties.

Tenants enter into a 'retail lease' under the 'Commercial Tenancy (Retail Shops) Agreements Act 1985'.

The terms of the Lease are long term.

The Lease sets out the rent payable per year and requires payment of rent on the first day or each and every month.

The Lease provides for CPI review dates of rent each year.

The Lease includes a Lessor Covenant of "Quiet Enjoyment".

The Lease does allow the Lessor to enter/access the Premises to:

1.            make use of the external walls and roof for any purpose;

2.            to erect make excavate or install in or over the premises anything required for the Lessor's Purposes (i.e. passage or flow of services (water, gas etc.) through the Premises).

3.            inspect the property to ensure compliant and carry out repairs if required.

The Lease includes Rules and Regulations as well as Essential Terms that must be followed.

The Lease includes an Option of Renewal.

The Lease has a Security Bond or Bank Guarantee Clause.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Reasons for decision

Sections 152-35 and 152-40 of the ITAA 1997 discuss the active asset test. 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 at least half of the test period, or

•                     you have owned the asset for more than 15 years and the asset was an active asset of yours for at least 7.5 years during the test period.

The test period:

(a)          begins when you acquired the asset; and

(b)          ends at the earlier of:

(i)            the CGT event, and

(ii)           if the relevant business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows - 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)).

However, subsection 152-40(4) of the ITAA 1997 lists CGT assets that cannot be active assets. Under paragraph 152-40(4)(e) of the ITAA 1997, an asset whose main use is to derive rent cannot be an active asset unless the 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. However, use of the asset by an affiliate or connected entity is treated as the use of the asset owner.

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? (TD 2006/78) considers the active asset test and the main use to derive rent concept.

Taxation Determination TD 2006/78 considers, amongst other issues, the situation where there is part business and part rental use of an asset. It states that an asset owned by the taxpayer and used partly for business purposes and partly to derive rent can be an active asset under section 152-40 of the ITAA 1997 where it is considered that the main use of the premises is not to derive rent. In deciding if the property was mainly used to earn rent the Commissioner will consider a range of factors such as:

•                     the comparative areas of use of the premises (between rent and business)

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

Whether an asset's main use is to derive rent will depend upon the particular circumstances of each case. In accordance with paragraph 22 of TD 2006/78, the term 'rent' has been described as follows:

•                     the amount payable by a tenant to a landlord for the use of the 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).

A key factor, therefore, in determining whether an occupant of premises is a lessee is whether the occupier has a right of 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.

The Judgment of Windeyer J in Radaich v. Smith (1959) 101 CLR 209 provided that a right of exclusive possession is secured by the right of the lessee to maintain ejectment and, after his entry, trespass. A reservation to the landlord of a limited right of entry to view or repair is not inconsistent with a grant of exclusive possession.

Example 1 in TD 2006/78 considers if the main use is to derive rent and states:

Commercial Property Co owns 5 commercial rental properties. The properties have been leased for several years under formal lease agreements to various commercial tenants which have used them for office and warehouse purposes. The terms of the leases have ranged from 1 year to 3 years with a 3-year option and provide for exclusive possession. The company has not engaged a real estate agent to act on its behalf and manages the leasing of the properties itself.

In this situation, the company has derived rental income from the leasing of a number of properties. Accordingly, 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.

The issue of whether a taxpayer's rental properties can be active assets when they are carrying on a business of letting rental properties was considered in Jakjoy Pty Ltd v FC of T [2013] AATA 526, (Jakjoy).

In Jakjoy the taxpayer was carrying on a business of leasing commercial properties. It was held that despite the fact the taxpayer was carrying on a business of leasing properties that the properties were not considered 'active assets' under section 152-40 of the ITAA 1997 and did not satisfy the 'active asset test' in section 152-35 of the ITAA 1997. Given the main or only use of the properties was to derive rent, the properties were excluded from being active assets under section 152-40(4)(e). This was regardless of the fact that the taxpayer's activities amounted to the carrying on of a business. It was affirmed that '....although it was common ground that the taxpayer was carrying on a business of renting properties, it did not automatically follow based on a clear reading of the text in section 152-40 of the ITAA 1997, that the properties the taxpayer used in carrying on its business were 'active assets' Indeed, those properties were expressly excluded from being 'active assets' by the exception in section 152-40(4)(e) of the ITAA 1997.

Application to your circumstances

You have used your ownership interests in the property mainly to derive rent and your circumstances can be likened to example 1 in TD 2006/78. The shops within the property have been leased for several years under formal lease agreements to various commercial tenants which have used them for carrying on their own businesses. Although you provided management services and have the ability to enter the premises in certain circumstances, this is consistent with standard tenancy arrangements and is not inconsistent with a grant of exclusive possession. Additionally, the tenancy agreements refer to the payments as rent.

Therefore, the payments you received from the occupants are considered to have been rent. Accordingly, as the majority of the rental payments were received from third parties, the main use of the property is considered to have been to derive rent, and the property is excluded from being an active asset under paragraph 152-40(4)(e) of the ITAA 1997.