iscover ATO signals narrow approach on CGT for home-based business
BusinessRunning a business from home can have many perks for clients, but it can also come with a sting in the tail when it comes time to sell the home, writes Matthew Tse.
Often when clients operate a business from their home the immediate focus is on whether they can claim deductions for home occupancy costs (e.g., interest) and the impact that this might have on their ability to access the main residence exemption for capital gains tax (CGT) purposes. However, recently updated guidance from the ATO serves as a reality check for clients who assume they can access the small business CGT concessions when the property is sold.
When an individual operates a business from home and they can claim a deduction for some of the occupancy costs relating to the property on the basis that it represents a place of business, this will normally prevent access to a full exemption under the main residence rules. Often a partial exemption will be available instead.
Where only a partial main residence exemption is available, we turn to other CGT concessions such as the general CGT discount for assets held for more than 12 months, but also the small business CGT concessions which can potentially provide generous CGT savings.
One of the key conditions to access the small business CGT concessions is that the property must pass an active asset test. This broadly requires the property to have been actively used in a qualifying business activity for at least 7.5 years across the ownership period, or for at least half of the ownership period.
A property is either an active asset or not. That is, it isn’t really possible for part of a property to pass the active asset test. This makes things difficult when a property is used partly as a home and partly in business activities.
Previous ATO guidance on home-based business scenarios indicated that the small business CGT concessions could potentially apply in situations like this. However, the ATO has updated its guidance in this area and is appearing to take a reasonably narrow approach (see Home-based business and CGT implications).
The ATO is indicating that running a business from your home doesn’t necessarily mean that the property is an active asset, even if it represents a place of business and you are able to claim a deduction for occupancy expenses. If the business use is incidental to the property’s main use as a home, the ATO’s view is that the property isn’t an active asset.
The view that incidental or minor business use is insufficient draws support from the Administrative Appeals Tribunal (AAT) decision in Rus and Commissioner of Taxation [2018] AATA 1854 (Rus v FCT). In that case the AAT agreed with the ATO’s ruling that the property wasn’t an active asset.
The case involved a 16-hectare largely vacant rural property. Only a small portion (less than 10 per cent by area) was used for business purposes: a home office, a shed for storing tools/equipment/vehicles and related supplies tied to a plastering and construction business operated through a controlled company. The balance of the land remained vacant or used residentially.
Examples provided in the ATO’s updated guide suggests that a property could be an active asset if 50 per cent of the floor area is used in the business activities, while a property wouldn’t be an active asset where only 7 per cent of the property is used in the business activities on a part-time basis.
There is some other ATO guidance in this area which is worth reviewing when encountering scenarios like this. ATO ID 2002/753 suggests that if 20 per cent - 30 per cent of a property is used in the business activities it could potentially be an active asset. Likewise, an example in the ATO guide Active asset test suggests that a property could be an active asset if 20 per cent of the land area is used in the relevant business.
While the ATO acknowledges that the definition of an active asset doesn’t require exclusive use of the property for business purposes, the ATO makes it clear that it is necessary to consider whether a sufficient portion of the property is used in the business activities.
Given the ATO’s latest guidance and the complexity of the rules dealing with the small business CGT concessions, it is important to carefully consider the active asset test when dealing with properties that have been used for mixed purposes and to ensure clients are aware that using their home in a genuine business activity isn’t necessarily enough to access the concessions.
Matthew Tse is a senior tax adviser at Knowledge Shop.
