This is an important question, primarily for the small business entity concessions which require the entity to be carrying on a business. It is also important for applying the lower company tax rate before 1 July 2017, when a company had to be carrying on a business to get the lower rate as the rate was linked to being a small business entity.
Therefore, probably 3 years after we lodged our first company return in July 2016 where we could claim the lower company tax rate, the Commissioner has provided some guidance to this question.
In Taxation Ruling TR 2019/1 Income tax: when does a company carry on a business? he answers the question. But only for companies. But only for the small business entity rules and the lower company tax rate rules. He seriously says that the word “business” in Division 328 mean what this ruling says but we cannot use this where the word “business” is in other places in the tax acts. And he seriously says it does not apply to understanding if a trust or an individual is carrying on a trust.
What does he say? He states that the key indicia considered by the courts in determining whether the activities carried on by an entity amount to the carrying on of a business are:
- Whether the person intends to carry on a business;
- The nature of the activities, particularly whether they have a profit-making purpose;
- Whether the activities are repeated and regular and organised in a business-like manner, including the keeping of books, records and the use of a system;
- The size and scale of a company’s activities including the amount of capital employed in them; and
- Whether the activity is better described as a hobby, or recreation.
That is all well, but it is how he applies these criteria that is awesome for us.
“However, where a limited (including a proprietary limited) or NL 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.”
“A limited (including a proprietary limited) or NL company engaged in gainful activities may be able to establish that it is not carrying on a business in limited circumstances. The most common situations are where it can be shown, on the facts, that the company has no purpose or prospect of profit, and its activities lack a commercial character.”
And look at what he says about our bucket companies…
“Most corporate beneficiaries of family discretionary trusts are formed and appointed beneficiaries of trusts, with the clear expectation of being made entitled to any trust income that exceeds the amounts the trustee will appoint to individuals in the family. They are usually appointed income, often repeatedly. They either reinvest the income in the trust, by way of a formal loan, by leaving the income uncalled for, or invest it in other ways that give rise to an entitlement to a return of profits. These companies are carrying on a business to profit in connection with the trust. This conclusion is stronger for companies investing in widely held or fixed trusts.”
Have a look at these examples he gives.
Example 1 – inactive company with retained profits
InactiveCo is a company incorporated in Australia. InactiveCo carried on a trading business that was wound up in the 2015-16 income year. InactiveCo has $400,000 of retained earnings which it holds in a bank account.
In the 2016-17 and later income years, the company’s income has consisted solely of interest of $12,000 a year. InactiveCo has no intention of resuming its trading business. InactiveCo pays an annual company review fee of $254 to ASIC. The company’s income is consistently greater than its expenses. As a result, the company has made a profit in each income year from 2016-17.
InactiveCo’s activities have both a purpose and prospect of profit. InactiveCo is carrying on a business.
Example 2 – company is engaged in preliminary activities invests its assets in producing income
Future Co is a newly incorporated company. Its activities consist of investigating whether it would be viable to carry on a particular business in the future and investing its $300,000 in share capital in income producing bank accounts. No decision has been made to carry on the business under investigation. However, it derives $9,000 a year in interest from its bank accounts. While Future Co’s activities of investigating the potential business may be preliminary in nature and not a business, it nonetheless carries on a business as a result of its activity of investing for profit.
Example 4 – share investment company
ShareCo is a company incorporated in Australia. ShareCo holds a portfolio of listed shares worth $400,000. The shares generate $20,000 in income a year, after expenses. ShareCo was formed for the purpose of investing in shares with the intention of earning income from dividends. Its share portfolio was selected with this in mind.
ShareCo has applied its assets in ongoing activities that have both a purpose and a prospect of profit. ShareCo has also invested a substantial amount of capital, and the dividend income is received by way of periodic payments.
If ShareCo does not engage a third party to manage its portfolio of shares. ShareCo carries on a business.
If Share Co engages a professional investment advisor and manager to manage its investment portfolio. ShareCo carries on a business.
But just so you don’t get too excited, on the same day he released this Ruling he released Draft Taxation Determination TD 2019/D4 Income tax: can a company that carries on a business in a general sense as described in TR 2019/1 but whose only activity is renting out an investment property claim the CGT small business concessions in relation to that investment property? So does this new understanding of business increase our access to the small business CGT concessions… No.
Example: property investment company
InveproCo is a company incorporated in Australia. InveproCo owns a commercial property, which it has rented to 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, including letting out the property.
In this situation, the company has derived rental income from the leasing of a property. 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 paragraph 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 section 152-35 and InveproCo would not meet the requirement in paragraph 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.