Eichmann wins – Land used to store tools, equipment and materials is an active asset

[lwptoc]

Background

Eichmann v FCT [2020] FCAFC 155 (Eichmann’s case) is about whether a block of land used by a building, bricklaying and paving business connected to the Taxpayer for the storage of work tools, equipment and materials was an ‘active asset’, defined in s. 152‑40 of the ITAA 1997, for the purposes of the small business CGT concessions. The case stems from the Taxpayer’s objection to a private ruling in which the Commissioner ruled that the land was not used in course of carrying on a business and therefore was not an active asset.

Facts

The Taxpayer and his spouse ran a business of building, bricklaying and paving, through their family trust (the Trust), with an aggregated turnover of less than $2 million for the 2016–17 income year. The Taxpayer and his spouse were beneficiaries of the Trust.

From 1997 until October 2016, the Taxpayer owned a block of land (‘the Property’) adjacent to his family home in Mooloolaba, Queensland. The Property had located on it two 4 metre × 3 metre sheds, as well as a two metre high block wall and a gate.

The Taxpayer used the Property for the following purposes:

• the two sheds were used for the storage of work tools, equipment and materials;
• the open space was used to store materials that did not need to be stored under cover (including bricks, blocks, pavers, mixers, wheelbarrows, drums, scaffolding and iron);
• work vehicles and trailers were parked on the Property.

The Taxpayer collected tools and other items from the Property on a daily basis, and sometimes visited the Property a number of times a day in between jobs. On occasion, some preparatory work was done on the Property. There was no business signage on the Property.

Following the sale of the Property in the 2016–17 income year, the Commissioner in a private binding ruling (‘the Private Ruling’) ruled that the Taxpayer was not entitled to the small business CGT concessions in respect of the sale of the Property because it was not an ‘active asset’ within the meaning of that term in s. 152-40(1)(a).

The Tribunal’s decision

The Tribunal set aside the Commissioner’s objection decision, finding that:

• the Commissioner had erred in determining that the Property did not satisfy the requirements for being an ‘active asset’ for the purpose of the small business CGT concession provisions;
• there was nothing in the definition of ‘active asset’ in s. 152-40(1)(a) which required the use of the land to be integral to the process by which the business was carried on;
• it was clear on the facts that the Taxpayer used the land for the purpose of operating his business.

The Federal Court’s decision

Following an appeal, the Federal Court (Derrington J) held that:

• the Tribunal had erred in determining that land used by the Taxpayer to store materials, tools and other equipment satisfied the requirements for being an ‘active asset’;
• for an asset to be an active asset it must be used ‘in’ the course of carrying on a business which requires that the use has a direct functional relevance to the carrying on of the normal day-to-day activities of the business which are directed to the gaining or producing of assessable income;
• in the Taxpayer’s case, the uses to which the land was put were preparatory to the undertaking of activities in the ordinary course of business — the storage itself was not an activity ‘in the ordinary course of’ the Taxpayer’s business.

In reaching this decision, Derrington J agreed with the Tribunal that there is no requirement that the use of the asset is ‘integral’ i.e. critical or fundamental to the business processes.

Relevant legislative provisions

Section 152-35(1)(b) provides that a CGT asset will satisfy the active asset test if the taxpayer:

• owned the asset for more than 15 years; and
• the asset was an active asset for a total of at least 7.5 years, during the test period.

Definition — Test period

The ‘test period’ begins when the taxpayer acquired the asset, and ends at the earlier of a ‘CGT event’ or, if the business ceased to be carried on in the 12 months before that CGT event, the cessation of the business.

The term ‘active asset’ is defined in s. 152-40, the relevant parts of which are replicated in the following table:

Full Federal Court’s decision

Mckerracher, Steward and Stewart JJ unanimously held that the Property was an active asset. Relevantly, the judges made the following observations and findings:

1. The small business CGT concession provisions should be constructed beneficially rather than restrictively in order to promote the beneficial purpose of the concessions.
2. The language of s. 152-40(1)(a) relevantly requires ascertaining three matters: the use of a particular asset; the course of the carrying on of a business; and then whether the asset was used in the course of the carrying on of that business. These inquiries involve issues of fact and degree. As these three matters should be applied widely, in the spirt of the beneficial construction, it is sufficient if the asset is used at some point in the course of the carrying on of an identified business.
3. Section 152-40(1)(a) does not require the use of the relevant asset to take place within the day to day or normal course of the carrying on of a business. Nor does the provision require a relationship of direct functional relevance between the use of an asset and the carrying on of a business.
4. Applying s. 152-40(1)(a) to the ruled facts, the taxpayer’s property was used in the course of carrying on the relevant business of building, bricklaying and paving on a daily basis.

The Full Federal Court also observed that the ruled facts could have been clearer and, with the benefit of hindsight, could have had more detail to address the specific issues before the court. The judgment notes:

That is not meant as a criticism of the Commissioner’s staff. They cannot be expected to predict all of the legal arguments that might subsequently be made in relation to the facts they identify in a ruling. But it does suggest that the rulings system contained in Div. 359 of Sch. 1 to the Taxation Administration Act 1953 … will not always be an apt mechanism to address disputes concerning facts, and even issues of characterisation of those facts.

Take-aways

Facts are critical in a private ruling application. Much of this dispute centred on the particular facts and the application of the law to them. By being very clear with the facts presented to the Commissioner in the ruling process, the Taxpayer may avoid unwanted disputes with the Commissioner. In this regard, the broad parameters of the business should be set out with great specificity in an application for a private binding ruling.

The small business CGT concession provisions are to be applied beneficially. Much emphasis was made in this case as to the beneficial nature of the relief provided by the small business CGT concessions. The Full Court concluded that:

… a beneficial construction of legislation may, in our view, legitimately influence constructional choices in a given case which arise from the use of generalised language to describe a necessary connection between two things; here those two things are the use of an asset and the carrying on of a business.

The final, and arguably the most important, take-away is that the determination of whether an asset is used in the course of carrying on a business involves:

1. identifying the use of a particular asset;
2. identifying the course of the carrying on of a business; and
3. then determining whether the asset was used in the course of the carrying on of that business.

Accordingly the following assets, where they are not directly used in the actual production activity but are used in the course of the business generally, can — subject to meeting all of the requirements in s. 152-40(1)(a) — be active assets:

• land that a taxpayer uses to store tools, equipment and materials needed on a daily basis for its business;
• a separate warehouse in which a taxpayer stores raw or finished goods for its business; and
• land used by a taxpayer to operate an office with staff to manage its business affairs.