1 Are you entitled to a partial main residence exemption in relation to the potential disposal of the dwelling located at the Property under subsection 118-190 of the Income Tax Assessment Act 1997 (ITAA 1997)?
1 Yes. Question 2 Will any capital gain on the sale of the Property be a discount capital gain with a discount amount of 50% under Division 115 of the ITAA 1997? Answer 2 Yes. Question 3 Will the taxpayers satisfy the basic conditions under Subdivision 152-A of the ITAA 1997 for small business relief upon the sale of the Property? Answer 3 Yes. Question 4 Whether the XX% portion of the Property will be considered an "active asset" for the purposes of small business CGT relief provisions? Answer 4 No. This ruling applies for the following periods : Year ended 30 June 20XX Year ended 30 June 20XX Year ended 30 June 20XX Year ended 30 June 20XX The scheme commenced on: XX XXXX 20XX
Person A and Person B jointly referred to as you. On XX XXXX 20XX, as tenants in common with equal shares, you purchased the dwelling located at the Property. On XX XXXX 20XX, Person B sold their previous main residence. Settlement occurred XX XXXX 20XX. For a period, Person B treated both properties as their main residence. On XX XXXX 20XX, settlement occurred, and you moved into the Property as your main residence. The property is less than 2 hectares in size. For a period, you entered into a written rental agreement with the Company for the exclusive use of the detached garage comprising of XX% of the total dwelling floor area. The rental arrangement was established at market rates comparable to similar co-working and individual office space rentals in the local area. The Company is controlled by Person B The Company operated various online business activities from the premises, including digital publishing and the sale of educational material through a custom-built e-commence platform. Person A was employed by the Company as a web developer. After XX XXXX 20XX, you have not maintained an exclusive business area in the Property.
You intend on selling the Property prior to XX XXXX 20XX. You will be Australian tax residents at the time of selling the Property. You satisfy the maximum net asset value test. The Company is a CGT small business entity with annual turnover of approximately $XX.
Income Tax Assessment Act 1997 section 102-20 Income Tax Assessment Act 1997 section 104-10 Income Tax Assessment Act 1997 Division 115 Income Tax Assessment Act 1997 section 118-110 Income Tax Assessment Act 1997 section 118-120 Income Tax Assessment Act 1997 section 118-190 Income Tax Assessment Act 1997 section 152-10 Income Tax Assessment Act 1997 section 152-35 Income Tax Assessment Act 1997 section 152-40
Summary Question 1 In your case, you cannot claim the full main residence exemption, as part of the dwelling has been used to produce assessable income. Therefore, in accordance with section 118-190 of the ITAA 1997, you are entitled to a partial main residence exemption. You will need to calculate this on a reasonable basis taking into account your use of the Property for both main residence and income producing purposes. Apportioning on the basis of the floor area used for each purpose is appropriate in most cases as set out in paragraph 4 of TD 1999/66. Question 2 In your case, you meet all of the above conditions and therefore are entitled to reduce your capital gain using the discount method under Division 115 of the ITAA 1997. Question 3 You will satisfy the basic conditions under Subdivision 152-A of the ITAA 1997 if the Property is sold by 30 June 20XX, as it will satisfy the active asset test and will have been used in business for over half the test period while being owned for less than XX years. Question 4 The entire 100% of the Property, being a single asset, will be considered an active asset for the purposes of small business CGT relief provisions. Detailed reasoning
Section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a taxpayer makes a capital gain or loss as a result of a capital gains tax (CGT) event happening to a CGT asset. CGT assets include real estate acquired on or after 20 September 1985. Under section 104-10 of the ITAA 1997, CGT event A1 happens if you dispose of a CGT asset. Disposal of a CGT asset happens when a change of ownership occurs from one entity to another. Main residence Section 118-110 of ITAA 1997 provides that a taxpayer can disregard a capital gain or capital loss made from a CGT event that happens to a dwelling that is their main residence. To qualify for the full exemption, the dwelling must have been your main residence throughout your ownership period and must not have been used to produce assessable income.
Section 118-120 of ITAA 1997 provides that you can choose the area adjacent to the dwelling to apply the main residence exemption to the extent that the land was used primarily for private or domestic purposes in association with the dwelling. Subsection 118-120(6) includes a garage, storeroom or other structure associated with a flat or home unit as an adjacent structure of the flat or home unit to the extent that the structure was used primarily for private or domestic purposes in association with the flat or home unit. Further, subsection 118-120(3) of the ITAA 1997 specifies that the total of the land (including the land on which the dwelling is situated) must not exceed 2 hectares. Adjustment to the main residence exemption for income producing use Section 118-190 of the ITAA 1997 is directed at reducing the main residence exemption and only allowing you a partial exemption if the dwelling is used for income producing purposes. Paragraph 4 of Taxation Determination TD 1999/66 Income tax: capital gains: what factors should be taken into account in determining the 'amount that is reasonable' in applying subsection 118-190(2) of the Income Tax Assessment Act 1997
? provides the general rule for apportioning the main residence exemption is to adjust based on floor area and the period of income-producing use. Paragraphs 7 and 8 of TD 1999/66, provides an example of an adjustment for a dwelling used to produce income according to the floor area: Example 1 7. John, a carpenter, has lived in his home for 10 years and he owns it. He has used the garage as a workshop for his carpentry business for the whole 10 years. Based on the area of the dwelling occupied by the garage, John estimates the workshop is 20% of the area of the whole dwelling. This is the basis on which John would have claimed an interest deduction if he had a mortgage on the property. John sells the home and makes a capital gain of $25,000 from that CGT event. 8. Apart from section 118-190, as the dwelling was John's main residence he would have been able to disregard the whole capital gain of $25,000. However, applying subsection 118-190(2), John has a capital gain of $5000 (20% of $25, 000) to be included in his assessable income.
In your case, you cannot claim the full main residence exemption, as part of the dwelling has been used to produce assessable income. Therefore, in accordance with section 118-190 of the ITAA 1997, you are entitled to a partial main residence exemption. You will need to calculate this on a reasonable basis taking into account your use of the Property for both main residence and income producing purposes. Apportioning on the basis of the floor area used for each purpose is appropriate in most cases as set out in paragraph 4 of TD 1999/66. Discount capital gain Division 115 of the ITAA 1997 provides the conditions for a discount capital gain. You make a discount capital gain if the following requirements are satisfied: • you are an individual • a CGT event happens to a CGT asset of yours after 11:45am (by legal time in the Australian Capital Territory) on 21 September 1999 • you acquired the CGT asset at least 12 months before the CGT event, and • you do not choose to use the indexation method.
For Australian resident individuals the discount percentage is 50%. However, you can only reduce your capital gain after applying all your capital losses for the year and any unapplied net capital losses from earlier years. In your case, you meet all of the above conditions and therefore are entitled to reduce your capital gain using the discount method under Division 115 of the ITAA 1997. Basic conditions for the small business concession Section 152-10 of the ITAA 1997 provides the basic conditions that need to be met to apply the small business CGT concessions. Subsection 152-10(1) of the ITAA 1997 states that a capital gain that you make may be reduced or disregarded under Division 152-A of the ITAA 1997 if the following basic conditions are satisfied: (a) a CGT event happens in relation to a CGT asset of yours in an income year (b) the event would have resulted in a gain (c) at least one of the following applies: (i) you are a small business entity for the income year (ii) you satisfy the maximum net asset value test (iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership
(iv) you do not carry on a business, but your CGT asset is used in a business carried on by a small business entity that is your affiliate, or an entity connected with you (passively held assets as outlined in subsections 152-10(1A) and 152-10(1B) of the ITAA 1997), and (d) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997. Maximum net asset value test You satisfy the maximum net asset value test if the total net value of CGT assets owned by certain entities does not exceed $6 million just before the CGT event that results in the capital gain for which the concessions are sought. You must include the net value of CGT assets owned by: • you • any entities connected with you • any of your affiliates and entities connected with your affiliates. This figure includes the net value of assets of your affiliates, and entities connected with your affiliates, only if the assets are used, or held ready for use, in a business carried on by you or an entity connected with you. However, you don't include an asset if it is used in the business of an entity that is connected with you only because of your affiliate.
Active asset test The active asset test is satisfied 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 test period detailed below, 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 7.5 years during the test period. Active asset test period Subsection 152-35(2) of the ITAA 1997 provides that the active asset 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 the CGT event, or any longer period that the Commissioner allows - the cessation of the business. The asset does not need to be an active asset just before the CGT event. Under subsection 152-40(1) of the ITAA 1997, a CGT asset is an active asset if it is owned and used, or held ready for use, by you, your affiliate or another entity that is connected with you in the course of carrying on a business that is carried on (whether alone or in partnership).
However, subsection 152-40(4) of the ITAA 1997 lists CGT assets that cannot be active assets. Most relevantly to real property, a CGT asset whose main use is to derive rent cannot be an active asset unless the main use for deriving rent was only temporary. It is acknowledged that the definition of active asset does not require exclusive use of the asset for business purposes. It is also noted that once an asset satisfies the active asset test, the whole asset gains this status and it retains its active asset status in the hands of its owner until ownership changes. In your circumstances, you purchased the Property by contract which was dated XX XXXX 20XX and settled on XX XXXX 20XX. You intend to sell your Property by XX XXXX 20XX, being less than 15 years of ownership. Your Company's business commenced using the property on XX XXXX 20XX and ceased on XX XXXX 20XX, a period of XX days of business use.
To satisfy the active asset test where the business has ceased, the asset disposal must occur within 12 months of the cessation of the business, as required by paragraph 152-35(2)(b)(ii) of the ITAA 1997. This means that in order to satisfy the active asset test, you must sell your Property by XX XXXX 20XX. Therefore, the Property's test period commenced on XX XXXX 20XX and will end on XX XXXX 20XX, which would be XX days of ownership. XX days of business use out of a total possible ownership period of XX days of ownership represents roughly XX% (i.e. greater than 50%) of the test period. Accordingly, the Property will satisfy the active asset test if sold by XX XXXX 20XX. If the Property is not sold by XX XXXX 20XX, you will need to apply for another private ruling and request the Commissioner to allow a longer period whereby the business has ceased, as described in subparagraph 152-35(2)(b)(ii) of the ITAA 1997, to determine the active asset test period in subsection 152-35(2) of the ITAA 1997. 'Used in the course of' Section 152-40(1) requires the asset to be used 'in the course of carrying on a business'. That phrase was discussed at length in Eichmann v FC of T
2020 ATC 20-762; [2020] FCAFC 155. In Eichmann , the taxpayer carried on a business of building, bricklaying and paving, and purchased land next door to their family home and used it to store work vehicles, trailers, work tools, equipment and materials. The land had sheds and was secured by walls and a gate. Tools and items were collected from there on a daily basis. The court held that the secure storage of the tools and materials of the taxpayer's business on a daily basis was very much part of the course of the carrying on of that business. The court said that, since section 152-40(1)(a) of the ITAA 1997 is beneficial in nature, its language should be construed so as to give the most complete remedy that is consistent with the actual language employed and to which its words are fairly open. By contrast, in Rus and FCT
[2018] AATA 1854; 108 ATR 212, the taxpayers purchased a 16-hectare and used a minor portion to carry on a plastering and construction business. However, the majority of the business activities were conducted off site. On review, the AAT found that having regard to the nature of the CGT asset, the nature of the business and the relationship between the CGT asset and that business, it could not be said that the CGT asset was used in the course of carrying on the business. Taxation Ruling IT 2673 Income tax: capital gains tax - use of sole or principal residence for income producing purposes (IT 2673) discusses the application of tax laws to capital gains in situations where activities are undertaken in a sole or principal residence to derive income where: • a dwelling owned by the taxpayer is disposed of; • the dwelling was, during a particular period, the sole or principal residence of the taxpayer; and • the dwelling was, during the whole or part of that period, also used for the purpose of gaining or producing assessable income.
An appropriate part of any capital gain or capital loss on the disposal of a dwelling would come within the capital gains provisions in the income tax law where part of the dwelling is used for income producing purposes. Examples include where part of a dwelling is dedicated for use in deriving rental income from tenants and where a doctor's dwelling contains a surgery that is used solely as a place of business and is clearly identifiable as a place of business (Paragraph 9 of IT 2673). Whether a dwelling, or part of it, has the character of a place of business is a question of fact that turns on the particular circumstances of each case but the broad test to be applied is whether a particular part of the dwelling: • is set aside exclusively as a place of business; • is clearly identifiable as a place of business; and • is not readily suitable or adaptable for use for private or domestic purposes in association with the dwelling generally (Paragraph 11 of IT 2673).
You advised that the value of CGT assets you own is less than $XX million. Based on this information, you satisfy the maximum net asset value test for the purpose of accessing the CGT small business concessions. You have held your interests in the Property since XX XXXX 20XX, a period of less than 15 years. The Company you control has operated its businesses from your Property. Your entered into a rental agreement with your Company from XX XXXX 20XX to XX XXXX 20XX for the exclusive use of the detached garage, comprising of XX% of the total dwelling floor area. The business operated continuously. After XX XXXX 20XX you have not maintained an exclusive business area in the Property. You intend on selling the Property prior to XX XXXX 20XX; therefore, your Company has used the Property in the course of carrying on its business for at least half of the ownership period.
You advised that the detached garage that was never used for vehicle storage, with separate carport facilities available for parking purposes. The detached garage was specifically renovated with appropriate flooring to create a suitable workspace environment. A commercial lease agreement was entered into by you and your Company for the use of this space. Based on information provided, it is considered that this space has the character of a place of business and was used exclusively for business purposes up to XX XXXX 20XX. Despite your use of the Property as your main residence, it is accepted for the purposes of the active asset test that the Property was used by your Company in the course of carrying on its business and accordingly satisfies sections 152-35 and 152-40 of the ITAA 1997. You will satisfy the basic conditions under Subdivision 152-A of the ITAA 1997 for small business relief upon the sale of the Property, if you sell the Property by XX XXXX 20XX as discussed above. This ruling will only be valid if the Property is sold by this date.
If the Property is not sold by 30 June 20XX, you will need to apply for another private ruling and request the Commissioner to allow a longer period whereby the business has ceased, as described in subparagraph 152-35(2)(b)(ii) of the ITAA 1997. The Property is a single asset (i.e. it is real property that has not been subdivided into more than 1 lot) and therefore it cannot be 'apportioned' based on use for active asset purposes. However, as noted above in the answer to Question 3, because the asset is considered an active asset, the entirety of the asset is considered to be an active asset and therefore apportioning as you describe is not applicable nor relevant in your circumstances. The asset will retain its status as an active asset in your hands until you no longer own the asset.