1 Is the Property an active asset of the Company under section 152-40 of the Income Tax Assessment Act 1997 (ITAA 1997)?
1 No. Question 2 Does the Property satisfy the active asset test under to section 152-35 of the ITAA 1997? Answer 2 No. This ruling applies for the following periods: Year ending 30 June 20XX Year ending 30 June 20XX The scheme commenced on: 1 July XXXX
The Company is a private company. Person A is a director and XX% shareholder of the Company. Person B is a director and XX% shareholder of the Company. The Company provided contracting services between Month 19XX and Month 20XX. The Company was contracted by an entity to provide them with the technical expertise of Person A to that entity. During the contract years, only specific work was performed at the contractor's premises. The Company purchased a block of land (the Property). The Company developed the land by building a house on the Property. The purchase and development of the land was funded by an initial bridging loan and then mortgage held in the Company's name. Person A and Person B were guarantors for the Company. This is the only property owned and rented by the Company. The Company maintained a bank account in its own name for at least XX years where all income was deposited, and expenses were paid from relating to the contracting services and the rental of the Property. The Company no longer holds a bank account in its own name due to the running expenses of having a separate bank account for the Company.
Since the closure of the Company bank account all Company expense relating to the rental of the Property are now paid out of Person A and Person B's personal bank account. Person A worked as an employee from late 20XX until retirement. Person A was also employed doing contract for the Company for X months. This work had no connection with the Company. Person B worked an industry from 19XX to 20XX. Since Month 20XX the Company has only preformed the administration and management of the Property where it uses X% of the Property to perform these duties. The X% usage was based on the floor area of the room used by the Company. This space is approximately XX metres square and the Property including the garage is approximately XXX metres square. The administration and management of the Property activities included monthly transactions which provided income, accounts maintained, and services provided. Person B undertakes all the financial transaction of the Company. Annually, Person B coordinates finalising accounts and submitting to the accountant for preparation of tax returns. Person A authorises and supervises the maintenance and repairs which includes validation of invoices.
The administration and management activities would vary each month but would typically be approximately X hours per month and for peak periods of the year approximately XX hours per month in relation to the maintenance of the Company's IT infrastructure. IT infrastructure consists of network attached storage, servers, and desktops sufficient to run a contracting business. The Company holds user licences to all Microsoft software and uses an accounting package. The Company records are maintained, and returns are compiled by a registered tax accountant and signed by both directors. Since Month 19XX to present the Company has leased the Property to its directors. Person B pays out of personal income for all costs of the Property. Initially a formal rental agreement was in place. Since misplacement of the document, it has not been recreated as the agreement was between the Company and its directors. The Property has never been rented out to a third party. Since Month 20XX the only income received by the Company is rent.
The Company's financial statement for year ended 30 June 20XX, details comparative figures with the previous financial year, with both financial years being in negative profit position. Since 20XX income year the Company has not reported any taxable income. Person A and Person B are considering winding up the Company and retiring from all forms of paid work. Person A and Person B are also considering alternative ideas for the use of the Property to be undertaken by the Company.
Income Tax Assessment Act 1997 Division 152 Income Tax Assessment Act 1997 Subdivision 152-A Income Tax Assessment Act 1997 subsection 152-40(1) Income Tax Assessment Act 1997 subsection 152-40(4) Income Tax Assessment Act 1997 subsection 152-35(1) Income Tax Assessment Act 1997 subsection 152-35(2) Income Tax Assessment Act 1997 section 328-110 Income Tax Assessment Act 1997 subsection 328-125(1) Income Tax Assessment Act 1997 subsection 328-125(2) Income Tax Assessment Act 1997 section 995-1 Does IVA apply to this private ruling? Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement. If Par
Question 1 Is the Property an active asset of the Company under section 152-40 of the Income Tax Assessment Act 1997 (ITAA 1997)? Detailed reasoning For a capital gains tax (CGT) asset to be an active asset for the purpose of Subdivision 152-A of the ITAA 1997, it must firstly satisfy one of the 'positive tests' in subsection 152-40(1) of the ITAA1997, and then also not be excluded by one of the exceptions in subsection 152-40(4) of the ITAA 1997. Paragraph 152-40(1)(a) of the ITAA 1997 provides that a CGT asset is an active asset at a time if, at that time you own the asset and the asset is used in the course of carrying on a business that is carried on by you, your affiliate or an entity connected with you 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. As stated in subsection 152-40(4A) of the ITAA 1997, for the purpose of paragraph 152-40(4)(e) of the ITAA 1997, in determining the main use of an asset:
(a) disregard any personal use or enjoyment of the asset by you; and (b) treat any use by your affiliate, or an entity that is connected with you, as your use. In determining if a property is an active asset of the Company, it is necessary to determine whether, as a whole, it can be considered to be used in carrying on a business. Carrying on a business Business is defined under section 995-1 of the ITAA 1997 to include any profession, trade, employment, vocation or calling, but does not include occupation as an employee. 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. As per paragraph 18 of TR 2019/1 'whether the activities of an entity constitute the carrying on of a business is a question of fact, and must be answered based on a wide survey, and the overall impression gained, of the activities of the entity having regard to the indicia of carrying on a business as a whole'. Intention to carry on a business As already noted, the general presumption is that companies are formed for the purposes of carrying on a business. However, this presumption can be rebutted where a wide survey of the activities of the company, and having regard to the relevant indicia, indicate otherwise.
The nature of a company's activities and whether they have a purpose of profit Paragraph 25 of TR 2019/1 states that 'case law highlights that the differences between companies, individuals and trusts influence the characterisation of the activities they carry on'. Whether a company's activities have a purpose of profit is critical in determining whether it is carrying on a business. Where a purpose of profit exists, it is likely a company will be carrying on a business. However, ultimately this is a question of fact to be determined in light of all the circumstances. In some situations, a company's activities may have a non-commercial nature or a purpose inconsistent with a conclusion it is carrying on a business At paragraphs 36 and 37 of TR 2019/1 some examples of companies whose activities would not have commercial nature or purpose of making a profit, and therefore would not carry on a business and include: • a company that exists solely to hold and maintain personal use assets; for example, a boat or holiday house, for the sole use of its members who are the sole source of funding used to cover the running costs of those assets
• a body corporate whose sole purpose is to maintain and manage land for its owners. Repetition and regularity As at paragraph 38 of TR 2019/1: the degree of repetition or regularity of the company's activities is relevant to determining whether it carries on a business. While there is a need for activity, this may be satisfied even if a company's activity is relatively limited, irregular or has periods of inactivity. Organisation of activities in a systematic and business-like manner Paragraph 42 of TR 2019/1 provides: whether activities are carried out in a systematic and organised way, or carried on in a business-like manner, is relevant to determining whether they amount to carrying on a business. This may involve, for instance, keeping detailed records of income, preparing formal business plans or budgets, or seeking professional advice. Size and scale of company's operations including the amount of capital employed in them Further at paragraph 46 of TR 2019/1 'the size and scale of the activities in question are relevant, but not necessarily conclusive, of whether they amount to the carrying on of a business'.
Often small-scale activities by an individual that do not constitute the carrying on of a business exhibit other factors supporting the conclusion. Paragraph 47 of TR 2019/1 provides an example of such a factor, being where 'the activity serves a domestic need, or arises from a purely domestic arrangement'. This factor is typically not present in the case of a company carrying on gainful activities. Main use to derive rent Taxation Determination TD 2021/2 Income tax: can a company that carries on a business in a general sense as described in Taxation Ruling TR 2019/1 Income tax: when does 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? (TD 2021/2) provides the Commissioners view on whether a company whose only activity is renting out an investment property can claim the CGT small business concessions in Division 152 of the ITAA 1997.
The Commissioner does not consider a company in this circumstance to be eligible to claim the small business concessions. This is because an asset whose main use is to derive rent is subject to an exclusion from those concessions, even if it is used in the course of carrying on a business. Relevantly at paragraphs 2 and 3 of TD 2021/2 an example is provided. In the example a company owns and rents, on commercial terms, a commercial property to an unrelated party. No other services in relation to the property are provided and the company undertakes no other activities. The company has posted a profit each year it has rented the property. In this example the Commissioner accepts the company is engaged in ongoing activities and has a purpose and prospect of profit and carries on a business in the general sense. However, the only use of the property is to derive rent, and it is therefore excluded from being an active asset under paragraph 152-40(4)(e) of the ITAA 1997 regardless of whether the activities constitute the carrying on of a business in a general sense. 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? (TD 2006/78)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 of the ITAA 1997 notwithstanding the exclusion in paragraph 152-40(4)(e) of the ITAA 1997 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. Further at paragraph 26 of TD 2006/78
If an asset is used partly for business and partly to derive rent at any given time, it will be 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 will necessarily be determinative, and resolving the matter is likely to involve a consideration of a range of factors such as: • the comparative areas of use of the premises (between deriving rent and other uses); and • the comparative levels of income derived from the different uses of the asset.
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. Case law has decided the issue of exclusive possession by examining the rights and obligations conferred on those occupying premises and the owners of the premises under the occupancy agreement. In Tingari Village North Pty Ltd v FC of T [2010] AATA 233 ( Tingari
) the Tribunal examined features of occupancy agreements that had been used to determine whether exclusive possession had been granted under the agreement in question in that case. In Tingari proprietors of the Tingari Village North Mobile Home Park sought capital gains concessions under Division 152 of the ITAA 1997 on the sale of the park. The Tribunal disallowed their appeal on the grounds that the park had been used to collect rent and was not an active asset as described in section 152-40 of the ITAA 1997. Key features of the park's use by the proprietors considered in this case were: • the owners right to enter and inspect the premises, • the right of the occupant to quiet enjoyment of the premises • the right of the owner to end the occupancy arrangement and take possession of the premises on non-payment of the occupancy fees and • the services provided by the proprietor. The Tribunal in this case discussed these rights with reference to the occupancy agreement in use and the legislation governing letting in caravan parks.
In making their decision the Tribunal noted that previous case law had examined whether exclusive possession had been granted under the instrument in question in 'substance and effect'. In deciding the question in this case, they looked to both the occupancy agreement in use and the legislation and regulations governing the accommodation offered by the Tingari Village North Mobile Home Park. On finding that the occupancy agreement did, in fact, provide exclusive possession they also found that the rights of residents under that agreement were consistent with the rights conferred in the relevant legislation. Application to your circumstances For the Property to be an active asset under section 152-40 of the ITAA 1997 it must be used in the course of carrying on a business by you, your affiliate or an entity connected to you and not be an excluded asset. Carrying on a business Most companies are in business if they intend to and are likely to make a profit. However, some companies are not in business. For example, a company is not in business if it:
• holds assets solely for its shareholders' private use, and its running costs are funded solely by its shareholders. Looking at the indicia provided in TR 2019/1 the following is noted. Intention to carry on a business The general assumption is that a company is formed for the purposes of carrying on a business. However, as already stated, ultimately whether a company is carrying on a business or not is a question of fact to be determined in light of all the circumstances. The nature of a company's activities and whether they have a purpose of profit Since the end of the contracts the Company has only existed to hold the Property. The Property has only been used by Person A and Person B. The Property has also been the main residence of Person A and Person B since it was acquired and developed by the Company. The Company financials provided for year ended 30 June 20XX, displayed comparative figures with the previous financial year, with both financial years being in negative profit position. Further to this, the Company has not reported taxable income since at least Month 20XX. Repetition and regularity
The Company has held the Property for approximately XX years and has leased the Property to its directors for the entire period. The Company did not expand its rental property portfolio. The Property has been used in the current manner for an extended period of time without there being any significant changes undertaken to enhance your return. The directors of the Company are responsible for keeping the Property in a fit state of repair with the work carried out by contractors which they organise. The average time spent on the Property's administration and management would vary each month but would typically be approximately X hours per month and for peak periods of the year approximately XX hours per month in relation to the maintenance of the Company's IT infrastructure. In comparison to some rental property owners, your monthly involvement is minor.
We are looking at those activities that would be required in the renting of properties. If there was a block of 30 holiday units rented on a short time basis there is an extensive amount of work conducted on a daily basis in meeting tenants, providing and cleaning linen and other services. The fees paid by the tenants are for both the services and the use of the property and if it is of sufficient scale, because of the regularity of these services it can be argued that they would be carrying on a business of renting properties. Your property activities are of a different nature to this. Your lease period is of a longer time frame, and you provide no other services except for the rental of the Property. Organisation of activities in a systematic and business-like manner Paragraph 42 of TR 2019/1 provides: whether activities are carried out in a systematic and organised way, or carried on in a business-like manner, is relevant to determining whether they amount to carrying on a business. This may involve, for instance, keeping detailed records of income, preparing formal business plans or budgets, or seeking professional advice.
The activities conducted by, or on behalf of the Company, should be carried out in a systematic and organised manner. This will usually involve matters such as the keeping of appropriate business records by the Company. If the activities are carried out on the Company's behalf by someone else, there should be regular reports provided to the Company on the results of those activities. However, it is also reasonable to expect anyone investing in rental properties, including passive investors, to keep records in relation to their rental property or properties so that they can keep informed as to whether or not they are making a profit in relation to the rental property or properties and to make decision as to what activities to undertake in relation to their rental property to maximise their returns. Whilst it is apparent you keep some records in relation to the Property the following factors are not considered to be business-like. There is no rental agreement since original misplaced. An entity in the business of renting properties would be expected to have a rental agreement for each tenant.
The Company no longer maintained its own bank account. An entity carrying on a business would be expected to maintain their own account. The tenants paying for expenses of the Property. In a commercial arrangement for a residential property the tenants would not be expected to meet the expenses of the Property. Additionally, in a commercial arrangement the tenants would be expected to pay rent to the owner of the property. In your case this does not happen as the company no longer holds bank accounts in their name. The expenses are met through the personal accounts of the tenant and no rent is paid to the company as it doesn't have an account. The recording of transactions is merely a 'paper' transaction with no money actually changing hands. The Property has never been advertised for rent nor rented to any unrelated party. The Company is not subject to any additional risks or receiving any additional rewards over and above those borne by any traditional landlord.
The above factors indicate an informal and domestic type of arrangement where profit or the act of carrying on a business is not the purpose of the entity. The affairs of the company are not carried on in a business-like manner. Size and scale of company's operations including the amount of capital employed in them When considering this factor, we are looking at the scale in terms of the number of properties and what management input that may be required to conduct the activity. Where size and scale is a relevant factor, the activity should be large enough to make it commercially viable as a business. The Company has rented out one residential property to a related party and provides no other services related to the Property. As noted above, some of the factors are indicative of the activities servicing a domestic need and arising from a domestic arrangement. Main use to derive rent The only income since Month 20XX that the Company receives is from the rental of the Property.
TD 2021/2 relevantly provides an example of a company that rents a commercial property. In this example the Commissioner considers the company to be carrying on a business. The company in this example rents a commercial property to an unrelated party on commercial terms, provides no other services relating to the property and derives a profit each year. Your circumstances can be contrasted to the example. You do not rent the Property on commercial terms as there is no rental agreement, the expenses are met out of the personal account of the tenants and no rent is actually 'paid'. The Property is rented to a related party and has never been rented to an unrelated party nor advertised for rent. In any case considering the 'main use' your circumstances mirror that of the example. Your only income comes from the rental of the Property and the Company does not provide any other services. Therefore its 'main use' is to derive rent.
The Commissioner does not consider a company in this circumstance to be eligible to claim the small business concessions. This is because an asset whose main use is to derive rent is subject to an exclusion from those concessions, even if it is used in the course of carrying on a business. The only use of the Property is to derive rent, and it is therefore excluded from being an active asset under paragraph 152-40(4)(e) of the ITAA 1997 regardless of whether the activities constitute the carrying on of a business in a general sense. For the purposes of determining the main use of an asset under paragraph 152-40(4)(e) of the ITAA 1997, subsection 152-40(4A) of the ITAA 1997 disregards any personal use by you and treats any use of your affiliate, or an entity connected with you, as your own. The Company has no personal use of the Property, and its only use is to rent the Property to derive rent. Person B worked in an industry from 19XX to 20XX and Person A worked as an employee from late 20XX until their retirement in 20XX.
Since Month 20XX the Company has only used X% of the Property to perform administrative duties. The X% usage was based on the floor area of the room used by the Company. These activities do not result in the generation of any income and are only performed as a subset of the rental activity. The Company does not provide any other services. As above, the only income generated is the rental of the Property. Since Month 20XX the only use of the Property by your affiliates or entities connected with you has been personal use. 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.
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 per paragraph 26 of TD 2006/78 If an asset is used partly for business and partly to derive rent at any given time, it will be 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 will necessarily be determinative, and resolving the matter is likely to involve a consideration of a range of factors such as: • the comparative areas of use of the premises (between deriving rent and other uses); and • the comparative levels of income derived from the different uses of the asset.
From Month 20XX onwards, the Company only used X% of the Property, however this use did not result in any income being derived outside the rental activity. There were no other services provided by the company and the tenants enjoyed exclusive use of the Property. Therefore, it can be said that the Property was used to derive rent in this period. The Commissioner has not considered the period from Month 19XX to Month 20XX, being the period the company was contracted, and the Property was constructed and available for use. It was not necessary for the Commissioner to consider this period as the active asset test would necessarily fail as this period is only approximately X years and an asset would be required to be an active asset for 7½ years in your circumstances. However, the same factors above would be applied to determine whether the Company was considered to be carrying on a business and whether the main use of the Property was to derive rent. Conclusion For the reasons outlined above, it is considered that the Company is not carrying on a business of renting residential properties. The Company has only derived rental income from one property since ownership of that Property.
Since Month 20XX the company has only existed to hold and rent the Property to a related party. The Property has been used as a main residence of Person A and Person B. Since being in receipt of rental income only the Property has not, to date, reported any taxable income. The Company does not provide any other services other than making the Property available for rent. The Property has never been advertised and has never been rented by an unrelated party. There is no rental agreement since original was misplaced, the Company has not maintained its own bank account, and expenses of the Property are paid by the tenants (Person A and Person B). Further, the tenants do not actually 'pay' the company any money for rent. The arrangement is that of a domestic nature servicing a domestic need rather than the pursuit for profit and operations of a business-like manner. Having considered the relative business indicators and the facts of the case, it is the Commissioner's view that the Company is not carrying on a business of letting a rental property since at least Month 20XX.
Further, and even if the company was considered to be carrying on a business, the main use of the Property is to derive rent. The Property has provided no other services since Month 20XX, and during the same period the Property has not been used by your affiliate, or an entity connected with you, to carry on a business. As such the Property is also excluded from being an active asset under paragraph 152-40(4)(e) of the ITAA 1997, since at least Month 20XX. Question 2 Does the Property satisfy the active asset test under to section 152-35 of the ITAA 1997? Detailed reasoning Active asset test 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 test period, 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 7½ years during the test period (subsection 152-35(1) of the ITAA 1997). Under subsection 152-35(2) of the ITAA 1997, 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. Subsection 152-40(1) of the ITAA 1997 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, or held ready for use, in the course of carrying on a business that is carried on (whether alone or in partnership) by: (i) you, or (ii) your affiliate, or (iii) another entity that is connected with 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 (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you. However, an asset whose main use by you is to derive rent cannot be an active asset unless its main use for deriving rent was only temporary (subparagraph 152-40(4)(e)(ii) of the ITAA 1997). Connected entity
Under subsection 328-125(1) of the ITAA 1997, an entity is connected with another entity if either entity controls the other entity. Subsection 328-125(2) of the ITAA 1997 provides that an entity controls another entity if it or its affiliate (or all of them together): (a) owns, or has the right to acquire the ownership of, interests in the other entity that give the right to receive at least 40% (the control percentage) of: (i) any distribution of income by the other entity; or (ii) if the other entity is a partnership, the net income of the partnership; or (iii) any distribution of capital by the other entity; or (b) if the other entity is a company - owns, or has the right to acquire the ownership of, equity interests in the company that give at least 40% of the voting power in the company. Application to your circumstances The Property is a CGT asset. The Company purchased the Property in Month 19XX and in Month 19XX developed the Property by building a house. The Company has owned the Property for approximately XX years.
As the Property has not been used, or held ready to use, in the course of carrying on a business that is carried on by you, your affiliate or entity connected with you for minimum period of 7½ years, as detailed in Question 1, the Property does not satisfy the active asset test under section 152-35 of the ITAA1997.