The small business Capital Gains Tax (CGT) concessions operate to reduce the CGT payable on the disposal of active assets by eligible taxpayers. Therefore, key issues are the definitions of active assets and eligible taxpayers.
‘Eligible taxpayers’ are generally those that are small business entities or taxpayers that satisfy the maximum net asset value test. Small business entities are taxpayers that carry on a business with aggregated turnover of less than $2 million. The maximum net asset value test is passed if the net CGT assets of the taxpayer and connected and affiliated entities do not exceed $6 million.
An ‘asset’ is an active asset where it is used, or held ready for use, in a business.
These definitions can be problematic when considering the eligibility to the concessions of capital gains arising from the sale of rental properties.
Generally, the leasing of properties, residential or commercial, is not considered to be the operation of a business. Such activities are considered to generate passive income. Therefore, the concessions would not be available to the taxpayer.
It may be possible in certain circumstances to demonstrate that such activities are performed in conducting a business. However, even if this can be demonstrated, the asset would need to be considered an active asset.
The Australian Taxation Office (ATO) has advised that certain assets cannot be active assets even if they are used, or held ready for use, in the course of carrying on a business. In particular, assets used mainly to derive rent from third parties (that are not affiliates of or connected with the taxpayer) are specifically excluded from being active assets.
Rachael owns five investment properties that she rents to tenants under lease agreements that give the tenants exclusive possession. The lease terms vary from six months to two years. The properties are not active assets because Rachael uses them mainly to derive rent. This is the case even if Rachael rents the properties as a business activity.