On 5 April 2019, the ATO released its long-awaited final ruling on when a company carries on a business for the purposes of:
- the definition of "small business entity" in s 328-110 of the Income Tax Assessment Act 1997 (ITAA 1997); and
- s 23 of the Income Tax Rates Act 1986 as it applied in the 2015–2016 and 2016–2017 income years, when a lower corporate tax rate was available to companies that were small business entities. From 2017–2018, a company needs to satisfy the definition of "base rate entity" to qualify for the lower rate.
Taxation Ruling TR 2019/1 finalises Draft TR 2017/D7, which was confined to whether a company carries on a business for the purposes of the Income Tax Rates Act 1986. While the final ruling has been expanded and restructured, the ATO's overall approach and conclusions are largely unchanged. In particular, the ATO accepts that a company can be carrying on a business even if its activities are relatively limited and consist of passively receiving investment returns or rent that it distributes to shareholders. However, the ATO cautions that TR 2019/1 only applies to and binds it in relation to the particular sections of the Acts, and that "care must be exercised in applying the reasoning and conclusions expressed in this Ruling when applying other provisions".
As if to prove this point, Draft Taxation Determination TD 2019/D4 was also issued on 5 April 2019. It states that a company carrying on a business in a general sense (as described in TR 2019/1) but whose only activity is renting out an investment property cannot claim any CGT small business concessions in relation to that property.
Taxation Ruling TR 2019/1 considers whether a company incorporated under the Corporations Act 2001 (other than a company limited by guarantee) carries on a business "in a general sense". Once this is established for a particular company, it is still necessary to consider the scope and nature of that business when determining the tax consequences of the company's activities and transactions (eg whether an amount is income or capital).
The ruling emphasises that it is not possible to state with precision whether a company is carrying on a business. As this is a question of fact, the ATO says that the answer ultimately turns on an overall impression of the company's activities, having regard to the indicators of carrying on a business (as identified by the courts). One key indicator is whether the company's activities have a purpose of profit. The ATO accepts that where a profit-making purpose exists, it is likely the other indicators will support a conclusion that the company carries on a business.
In the case of limited, proprietary limited and no liability companies, the ATO accepts that these companies would normally be carrying on a business in a general sense if they:
- are established and maintained to make a profit for their shareholders; and
- invest their assets in gainful activities that have both a purpose and prospect of profit.
In the case of a corporate trustee, TR 2019/1 only applies in relation to the activities it conducts on its own behalf. In determining whether the company carries on a business, any activities conducted in its capacity as a trustee are ignored. The ruling also notes that "the same profitable activity undertaken by a trustee is less likely to amount to the carrying on of a business, than if it were to be carried on by a company".
The example section of TR 2019/1 concludes that the following companies are carrying on a business in the general sense:
- an inactive company that derives interest income from retained profits – the ATO's preliminary view had been that the company was not carrying on a business;
- a newly formed company investigating the viability of carrying on a particular business, but which derives a small amount of interest income – again, the ATO's preliminary view had been that the company was not carrying on a business;
- a property investment company that lets out a commercial property, and either manages the property itself or engages a professional property manager;
- a share investment company, whether or not it engages a professional investment advisor and manager to manage its portfolio of shares;
- a company that leases multiple boats to unrelated parties;
- a holding company that only holds shares in a subsidiary, where it invests the shares and also manages the company group; and
- a holding company that holds shares in, and provides loans to, a subsidiary, where it invests the shares and manages the group.
The draft of the ruling had included an example of a family company with income consisting only of an unpaid trust entitlement (UPE) which it reinvested. The draft concluded that if the company did not reinvest the UPE or receive its entitlement in cash, it would not be carrying on a business. This example has been omitted from the final ruling.
Taxation Ruling TR 2019/1 applies before and after its date of issue.
Draft Taxation Determination TD 2019/D4, also issued on 5 April 2019, states that a company carrying on a business "in a general sense" as described in Taxation Ruling TR 2019/1 but whose sole activity is renting out an investment property cannot access the CGT small business concessions in relation to that property. This is because a CGT asset whose main purpose is to derive rent is specifically excluded from being an active asset (s 152-40(4)(e) of the ITAA 1997).
When finalised, the determination is intended to apply both before and after its date of issue.
Source: www.ato.gov.au/law/view/view.htm?docid=%22TXR%2FTR20191%2FNAT%2FATO%2F00001%22; www.ato.gov.au/law/view/view.htm?docid=%22DXT%2FTD2019D4%2FNAT%2FATO%2F00001%22.