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Can a partner in a partnership include the value of land used for the partnership business in the Real Property test calculation in section 35-40 of the Income Tax Assessment Act 1997 (ITAA 1997) if another partner has sole legal title to the land?

Yes. A property that has become partnership property will not be excluded under section 35-25 of the ITAA 1997, and can be included for the purpose of the Real Property test calculation in section 35-40 of the ITAA 1997. In the absence of a written agreement, the conduct of the partners may determine whether the property is treated as a partnership asset.

A partnership operates a business activity that commenced after 1 July 2000. The expenses incurred during the income year in question that were attributable to the business activity exceeded the assessable income derived from the business in that year.

The partnership is made up of two partners. There is a formal partnership deed in place. One of the partners (Partner A) has legal title to the land that is used for the business. Partner A does not charge the partnership rent for using the land.

The second partner (Partner B) does not have legal title to the land.

Partner A and Partner B are both Individuals.

The land is used exclusively for the carrying on of the partnership business activity.

All legislative references are to the ITAA 1997 unless otherwise stated.

Division 35 applies to defer a non-commercial loss from a business activity carried on by a taxpayer who is an individual, unless: • their business activity satisfies one of the four tests in Division 35; or • the Commissioner has exercised the discretion in section 35-55; or • the individual comes within the Exceptions to Division 35, contained in subsection 35-10(4). (refer subsection 35-10(1)) Note: With effect from 1 July 2009, subsection 35-10(2E) imposes an income requirement that also has to be satisfied.

One of the four tests is the Real Property test in section 35-40, which provides that the loss deferral rules in section 35-10 do not apply for an income year if the reduced cost base or the market value of real property, or interests in real property, used on a continuing basis in carrying on the business activity in that year is at least $500,000. For the purposes of this test the following assets are not counted: • A dwelling, and any adjacent land used in association with the dwelling that is used mainly for private purposes (paragraph 35-40(4)(a)); and • Fixtures owned by an individual as a tenant (paragraph 35-40(4)(b)).

'Dwelling' has the same meaning in this test as for capital gains tax purposes (refer to the definition in section 118-115).

To value real property or interests in real property, the individual can choose the reduced cost base or the market value of the property or interest, if that value is more than the reduced cost base (subsection 35-40(2)). The meaning of reduced cost base is the same as for capital gains tax purposes in Subdivision 110-B.

For the purpose of applying the test in section 35-40 where a person carries on a business activity as a partner, the values of assets owned or leased by another partner that are not partnership assets and used in carrying on the activity in that year must be ignored (paragraph 35-25(d)).

In this case, if the land is a partnership asset, section 35-25 will not exclude the asset from being used in the Real Property test calculation. If the Real Property test is met, the Rule in subsection 35-10(2) will not apply.

A 'partnership asset' is not defined for the purposes of the ITAA 1997. Whether an asset is a partnership asset is ultimately a question of fact and depends on the agreement of the parties and their acts and intentions (see Harvey v. Harvey (1970) 120 CLR 529; O'Brien v. Komesaroff (1982) 150 CLR 310; Kelly v. Kelly (1990) 120 CLR 529).

In this case, the partner with the legal title in the property, Partner A, is using the land exclusively for the partnership business. Partner A is not charging the partnership rent for the use of the land. Where one party provides property for the partnership business without express agreement, although there had been no formal conveyance of the property, a practice of charging rent for the property would indicate that the premises remained separate property of that partner (see Robinson v. Ashton (1875) LR 20 Eq 25). Therefore, Partner A is treating the property as a partnership asset.

As it can be concluded that the property is a partnership asset, and that it is used in carrying on the partnership business activity, paragraph 35-25(d) does not exclude the value of the asset from being used by Partner B (the partner who does not have legal title) in determining, for their purposes, whether the Real Property test in section 35-40 is met.