The Federal Court recently overturned an Administrative Appeals Tribunal (AAT) decision and outlined a number of conditions that must be met for an asset to be considered an active asset for the purposes of the small business CGT concessions.
The decision in Commissioner of Taxation v Eichmann  FCA 2155 (20 December 2019) by Justice Derrington provides some long-awaited guidance on just what “used in the course of carrying on a business” means (which is necessary for an asset to be an active asset). However, the decision will no doubt leave many tax agents scratching their heads with the multiple, significant requirements read into the law.
TAXPAYER USED LAND FOR STORING BUSINESS ASSETS
This case first began back in December 2016 when the taxpayer (Mr Eichmann) requested a private ruling from the Commissioner of Taxation (Commissioner) in relation to land located next to his family home and owned by him and his wife.
In the private ruling, the taxpayer outlined how the land was used in the building, bricklaying and paving business of the Eichmann Family Trust. There were two 4m × 3m sheds on the land and the sheds were used to store work tools, equipment and materials. Other items that did not need to be stored under cover, such as bricks, blocks, pavers, mixers, wheelbarrows, drums, scaffolding and iron were also stored on the property. Work vehicles and trailers were also parked there.
The land was sold in October 2016 for $935,000. Because the Eichmann Family Trust’s business had an aggregated turnover of less than $2 million, the question arose as to whether the land was an active asset as this was necessary to gain access to the small business CGT concessions.
IS LAND USED USED TO STORE BUSINESS ASSETS USED IN THE COURSE OF CARRYING ON A BUSINESS?
Subdivision 152A of the Income Tax Assessment Act 1997 (ITAA 1997) sets out the basic conditions that need to be satisfied to gain access to the small business CGT concessions.
As stated above, the key question was whether the asset was an active asset as defined in s 152-40(1) of the ITAA 1997 which relevantly states that:
A *CGT asset is an active asset at a time if, at that time:
(a) you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a *business that is carried on (whether alone or in partnership) by:
(iii) another entity that is *connected with you...
There was no dispute that the land was used in a connected entity’s business for storing its business assets, but the key question was whether its use was sufficient for it to be considered to be used “in the course of carrying on a business” as required by s 152-40(1)(a).
Following an unsuccessful private ruling application in which the Commissioner took the view that the land was not an active asset, the taxpayer submitted an unsuccessful objection to that private ruling decision before taking the matter to the AAT.
AAT: ORDINARY AND COMMON SENSE MEANING OF THE WORDS “USED IN THE COURSE OF CARRYING ON A BUSINESS” SHOULD BE APPLIED
The AAT made the telling remarks that the Eichmann Family Trust used the land for the purpose of its business to: store material in the sheds; store material outside the sheds; and to store tools. This was all undoubtedly done for the purpose of operating the business. Further, the taxpayer did not hold the land passively as an investment and its use was not trivial or insignificant.
Contrary to the Commissioner’s submissions that the phrase “in the course of” required the use to be integral to the process by which the business is carried on, the AAT stated that section 152-40(1)(a) only required the asset to be used “in the course of carrying on a business,” encompassing, necessarily, a fairly wide range of activities. Accordingly, the AAT set aside the decision of the Commissioner and substituted it with a decision that the land was an active asset for the purposes of section 152-40(1) of the ITAA 1997.
The Commissioner appealed.
FEDERAL COURT: PHRASE MUST BE CONSTRUED IN THE CONTEXT IN WHICH IT IS USED SO CASE LAW PRECEDENTS MUST BE CONSIDERED
Before the Federal Court, Mr Eichmann’s legal team submitted that statutory construction should begin and end with the words of the statute so the Commissioner’s attempt to impose extra requirements, including that the asset must be integral to the business, was unwarranted.
Although the Federal Court agreed that there was no requirement for the asset to be integral to the business, Derrington J stated that the words must nevertheless be considered in their context and this required an analysis of the case law that had considered its meaning. Emanating from this analysis came a list of three (and possibly four) requirements:
Requirement 1: Whole or predominantly the whole of the asset must be ‘used’ in carrying on a business.
The first part of the analysis centred on the ‘use’ of the asset. For this, reference was made to the decision in Council of the City of Newcastle v Royal Newcastle Hospital (1957) 96 CLR 493 (Newcastle).
In Newcastle it was said that where an exemption is prescribed by reference to use for a purpose or purposes, it needed to be shown that the land in question had been wholly devoted to that purpose. This was the case even if the fulfilment of the purpose did not require the immediate physical use of every part of the land.
The decision in that case was taken to mean that where it was claimed that an asset had been used in the course of carrying on a business, such that the owner is entitled to a CGT concession in relation to the gains made on its disposal, it needed to be established that the whole, or predominantly the whole, of the asset had been so used.
This approach was later confirmed in an Australian context in Rus v Federal Commissioner of Taxation (2018) 108 ATR 212 where land that had two storage containers for a business and which accounted for 10% off the land’s use was held not to be an active asset as it could not be said that the land was relevantly used in the carrying on of that business.
Although recognising some ambiguity regarding how the land was used in Eichmann’s situation, and the extent to which the property was used for purposes associated with the business, it was accepted that all of the land was used for the identified purposes and no others. Therefore, the taxpayer did not fail this ‘use’ aspect of the active asset test.
Requirement 2: The asset’s connection to the business must be more than temporal.
The Commissioner’s submission that certain comments made in Victoria Power Networks Pty Ltd v Federal Commissioner of Taxation  FCA 77 were relevant was also accepted by the Federal Court.
In that case it was noted that “a mere temporal connection between a payment and the carrying on of business and that the payment had some connection to the business was insufficient to establish that it was received in the ordinary course of the business”.
Derrington J accepted this as being consistent with several authorities. For the purposes of the “active asset” test, this was interpreted as meaning the mere fact that the asset is owned by the entity while it is carrying on business and is used in some connection to the business is insufficient to conclude that it is being used in the course of carrying on a business.
Requirement 3: Use of the asset must have functional relevance to business activities directed towards gaining assessable income.
In First Provincial Building Society Ltd v Commissioner of Taxation (1995) 56 FCR 320 (First Provincial), the meaning of bounties or subsidies “received in or in relation to the carrying on of a business” was considered. It was held that the activities needed to be directed towards gaining or producing assessable income, rather than merely to the business itself. For example, bounties relating to the commencement or cessation of the business would not be caught.
Applying the observations of that decision to the definition of “active asset”, the Federal Court determined that the use or intended use of the asset must have a functional relevance to those business activities that are directed towards gaining or producing assessable income.
When applied to the facts in Eichmann, Derrington J found that the land’s use was not a constituent part or component of the day-to-day business activities [presumably being the actual building, bricklaying and paving activities]. At best, the use was “in relation to” the course of carrying on of a business. This fell short of the required “used in the course of carrying on of the business”.
Possible requirement 4? Asset must relate to the carrying on of the normal day-to-day activities of the business.
Another case reference referred to in Derrington J’s decision was that of Doutch v Federal Commissioner of Taxation (2016) 248 FCR 211 (Doutch).In this case it was noted that income would be received “in the course of business” where it was an incident of, or directly related to, the carrying on of the normal day-to-day activities of the business.
Frustratingly, Derrington J didn’t explicitly state in the “Answers to the questions of law raised” part of the judgement whether this would also be necessary for an asset to be an active asset as was clearly stated as being necessary for requirements 1, 2 and 3. However, when responding to Mr Eichmann’s submissions that the observations in Doutch were not on point (see paragraph below), it would appear that the comments in Doutch are still relevant to the construction of “in the course of business” and therefore the active asset test.
DESPITE RELATING TO INCOME (AND NOT ASSETS), THE PRINCIPLES IN REQUIREMENTS 3 AND 4 ARE STILL RELEVANT TO UNDERSTANDING THE MEANING OF “USED IN THE COURSE OF CARRYING ON A BUSINESS”
The respondent contended (and Tax & Super Australia agrees) that the supposed principles referred to First Provincial (Requirement 3) and Doutch (Requirement 4) were not appropriate to the construction of the active asset test because the contexts in which the expression “carrying on of its business” were construed were quite different to Mr Eichmann’s situation. Both of those cases looked at whether various income sources were related to the “carrying on of a business”. This is a very different question to whether an asset is used in the course of carrying on a business. Justice Derrington conceded that this submission had some force but the cases were ultimately considered relevant case law principles to the construction of “used in the course of carrying on a business”.
APPLICATION OF THE ACTIVE ASSET REQUIREMENTS TO MR AND MRS EICHMANN - LAND USED FOR STORING BUSINESS ASSETS WAS NOT USED IN THE ORDINARY COURSE OF BUSINESS.
Putting the various case law precedents together, the Federal Court made the concluding comments:
The business of the company was the provision of services in the nature of construction, bricklaying and paving, and the activities engaged in the course of that business would be those directed to the securing and performing of those services. To a large extent that occurred on the work sites where the services were provided.
Conversely, the uses to which the land was put were preparatory to the undertaking of activities in the ordinary course of business. The property was used for the storage of materials for use by the company when it engaged in its business activities if those materials were required, but the storage itself was not an activity in the ordinary course of Eichmann & Sons’ [the taxpayer’s] business.”
Consequently, the Federal Court concluded that the Commissioner was correct to conclude that the land was not an active asset.
From now on, taxpayers and their tax agents should ensure the above requirements are met when determining whether an asset is an active asset.