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Company deriving rental income cannot claim CGT concessions

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Tax Determination TD 2021/2 (the Determination), released on 24 February 2021, confirms that a company whose only activity is renting out an investment property cannot claim the small business CGT concessions in Div 152 of the ITAA 1997 even if it is ‘carrying on a business’ in a general sense as described in TR 2019/1 (the Ruling). This article sets out the Commissioner’s view in this recent Determination with references to other ATO pronouncements for context and explanation.

Why the small business CGT concessions do not apply

For the small business CGT concessions to apply to reduce a capital gain arising in relation to a CGT asset, the CGT asset must satisfy the active asset test in s. 152-35 of the ITAA 1997.

To pass the test, the asset must be an ‘active asset’ of the taxpayer for a minimum period of time during the ownership period (see the end of the article for details).

An asset is an ‘active asset’ at a particular time if it is being used in (or — in the case of an intangible asset — it is inherently connected with) a business that is carried on by the taxpayer, the taxpayer’s affiliate, or an entity connected to the taxpayer.

However, an asset whose ‘main use’ by the taxpayer is to derive rent is automatically excluded from the definition of an active asset. See below for details of ATO guidance on when an asset is mainly used to derive rent.

The Determination confirms that it is the Commissioner’s view that such assets are excluded even if they are used in the course of carrying on a business.

Example from the Determination

InveproCo is a company incorporated in Australia. InveproCo owns a commercial property, which it has rented to unrelated third parties at market rates on normal commercial terms since its inception. InveproCo provides no other services in relation to the property and conducts no other activities. InveproCo has produced a profit in each of the income years it has rented out the property. InveproCo is engaged in ongoing activities that have a purpose and prospect of profit, namely letting out the property.

In this situation, the company has derived rental income from the leasing of a property to an unrelated third party. Accordingly, the company carries on a business in a general sense described in TR 2019/1. However, the main (only) use of the property is to derive rent and it is therefore excluded from being an active asset under s. 152-40(4)(e) regardless of whether the activities constitute the carrying on of a business in a general sense. Therefore, the investment property would not satisfy the active asset test in s. 152-35 and InveproCo would not meet the requirement in s. 152-10(1)(d) to be eligible for the CGT small business concessions in Division 152 in relation to the disposal of the investment property.

Further explanation

Company renting out a property can be ‘carrying on a business’

A company whose only activity is renting out an investment may be considered to be ‘carrying on a business’ in a general sense in accordance with the Ruling.

The Ruling states that a company that carries on a business can do so ‘in a general sense’, irrespective of what is the actual business, or it can ‘carry on a particular business’.

The Ruling deals with the question of whether a company carries on a business in a general sense for the purposes of:

  • the lower corporate tax rate eligibility criteria for 2015–16 and 2016–17 in s. 23 of the Income Tax Rates Act 1986;
  • the small business entity (SBE) definition in s. 328-110 of the ITAA 1997.

NoteNote:
The Ruling does not deal with the meaning of ‘carrying on a businesss’ for the purposes of the active asset test; however it provides useful guidance as to the Commissioner’s views on when a company that passively derives rental income is carrying on a business for those purposes.

In the circumstances contemplated in the Determination, there is no practical difference in the outcome whether or not the company is carrying on a business in relation to the rental activity, given that the asset is excluded from the definition of an active asset if its main use is to derive rent. However the guidance in the Ruling may be relevant in considering whether other types of assets satisfy the active asset test, depending on whether the company is considered to be carrying on a business.

The Ruling makes the following observations:

  • where a company aims to make, and has a prospect of profit, it is presumed that the company intends to, and does in fact, carry on a business (Westleigh and American Leaf cases);
  • any profit-making activities a company conducts are unlikely to have a domestic or personal character, and are likely to be characterised as being commercial in nature — unlike those of an individual or trust.

The Ruling concludes that:

where a … company is established and maintained to make a profit for its shareholders, and invests its assets in gainful activities that have both a purpose and prospect of profit, it will normally be carrying on a business in a general sense …. This is so even if the company’s activities are relatively limited, and its activities consist of passively receiving rent or returns on its investments and distributing them to its shareholders.

Main use to derive rent

TD 2006/78 provides examples of when the Commissioner considers property is for the main use of deriving rent for the purposes of the active asset test exclusion. In some of the examples, the ATO considers that the income derived is not ‘rent’ and therefore the exclusion does not apply. These arrangements include:

  • the provision of commercial storage space;
  • an eight-bedroom boarding house where the average length of stay is four to six weeks;
  • a holiday apartment complex operated like a motel;
  • mixed used of land — 80 per cent of total income derived from the land relates to the taxpayer’s business and 20 per cent from rental.

The active asset test condition

The active asset test requires the CGT asset to be an ‘active asset’ of the taxpayer for:

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