Del Castillo and Commissioner of Taxation (Taxation)
[2022] AATA 4233
•12 December 2022
Del Castillo and Commissioner of Taxation (Taxation) [2022] AATA 4233 (12 December 2022)
Division:Small Business Taxation Division
File Number(s): 2021/1862
Re: Jovita Del Castillo
APPLICANT
AndCommissioner of Taxation
RESPONDENT
Decision
Tribunal:Deputy President Bernard J McCabe
Date:12 December 2022
Place:Sydney
The decision under review is affirmed.
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Deputy President Bernard J McCabe
Catchwords
Concessions available to small business entities under Division 152 of the Income Tax Assessment Act 1997 – Did the applicant carry on a business in the relevant year of income – active asset within the meaning of s 152-40 ITAA97 – exemption to active assets – vacant land – residential letting business – unable to satisfy active asset test – decision affirmed.
Legislation
Income Tax Assessment Act 1997
Cases
C.H. Bailey Ltd v. Memorial Enterprises Ltd [1974] 1 All ER 1003
Commissioner of Taxation v Eichmann [2019] FCA 2155
Construction Forestry, Maritime, Mining and Energy Union v Australian Building and Construction Commissioner [2020] FCAFC 192
Jakjoy Pty Ltd and Commissioner of Taxation [2013] AATA 526
Radaich v Smith (1959) 101 CLR 209
Spriggs v Commissioner of Taxation; Riddell v Commissioner of Taxation [2009] HCA 22
United Scientific Holdings Ltd v. Burnley Borough Council [1977] 2 All ER 62REASONS FOR DECISION
Deputy President Bernard J McCabe
12 December 2022
The applicant, Ms Jovita Del Castillo, made a capital gain on the sale of a rental property in the year ended 30 June 2018. She included the amount of the gain in her return but objected to the assessment because she says she is entitled to a concession available to small business entities under Division 152 of the Income Tax Assessment Act 1997 (ITAA97). If she is right, the whole amount of the gain would not be included in her return and her taxable income (derived from other sources) would be a much lower figure.
The Commissioner of Taxation says Ms Del Castillo does not satisfy all the requirements of Division 152. That means she is not entitled to the concession. The two requirements in contention can be expressed as questions:
(a)Did the applicant carry on a business in the relevant year of income?
(b)Was the property that was sold a ‘active asset’ within the meaning of s 152-40 ITAA97?
The Commissioner points out there is an exception contained within s 152-40(4)(4) which says an asset cannot be an ‘active asset’ in certain circumstances. The Commissioner says the exception applies in this case. If he is right, it is irrelevant whether the applicant carried on a business.
I am not satisfied the concession is available to the applicant. I explain my reasons below.
What did the taxpayer do?
The applicant purchased a block of vacant land in Lawnton in 2003. In her statement (exhibit one), she said she had it in mind that she would develop a ‘multi-dwelling’ on the land which she could use as part of what she described as a “residential letting business”. Once the purchase was complete, and after she obtained finance and approvals, she constructed four residential dwellings on the property. She had rented three of the dwellings to tenants by February 2007, and she came to occupy the fourth dwelling herself in April of that year.
Ms Del Castillo retired from her full-time occupation on medical grounds in July 2009. Thereafter, she says she devoted herself to managing the rental properties. She says rent from the three dwellings was her principal source of income. With the exception of the 2007 year when the dwellings were first let, she said her business was profitable every year until the property comprising the four dwellings was sold in September 2017. She says the capital gain she realised in that sale should be offset by the small business capital tax concessions available under Division 152.
The applicant’s statement includes a detailed explanation of what she did to develop the properties, and the research she conducted into the rental market. The statement also includes a detailed description of the steps she took in marketing, leasing, and managing the properties. She referred to the detailed records she kept of rents received and expenditures incurred. She did not retain an agent to act on her behalf; she lived on-site and oversaw all the work connected with the properties. All that took time. She explained (at [85] of her statement):
When the business was operating smoothly, I spent between 15 to 20 hours working on it per week from 2007 until 2018. When the business was not operating smoothly, such as where there was a significant breach of a tenancy agreement not remedied by the tenant, and the tenant was asked to leave but would not leave, I had to apply with the Small Claims Tribunal or Queensland Civil and Administrative Tribunal (QCAT) to terminate the lease contract and order warrant o possession of the property. This was a long and stressful process and could spend up to 40 hours working on it per week.
Ms Del Castillo was not available to give evidence at the hearing because of her ill-health. I was provided with a medical certificate and specialist reports which establish she was unable to give evidence or be cross-examined. Mr Anderson, her counsel, said the Tribunal could rely on the applicant’s statement. The Commissioner did not oppose the tender of the witness statement although Mr Coveney, the Commissioner’s counsel, made written and oral submissions about how that evidence might be weighed and used given the applicant’s unavailability.
Small business capital gains tax exemptions
Division 152 establishes four different concessions that enable small businesses to reduce taxable capital gains in some circumstances. One of them is the so-called ’15-year exemption’ in sub-division 152-B. That exemption permits the small business entity to disregard the entirety of the capital gain arising from the disposal of an asset the entity has owned for at least 15 years if the entity satisfies the conditions in Division 152.
The basic conditions for relief are set out in s 152-10. They include the requirement in s 152-10(1)(c)(i) that the taxpayer be a ‘CGT small business entity for the income year’. Section 152-10(1AA) provides that a ‘CGT small business entity’ is a ‘small business entity’ which meets a turnover test. The definition of ‘small business entity’ is ultimately found in s 328-110(1). That sub-section provides:
You are a small business entity for an income year (the current
year) if:
(a) you carry on a *business in the current year; and
(b) one or both of the following applies:
(i) you carried on a business in the income year (the
previous year) before the current year and your
*aggregated turnover for the previous year was less than
$10 million;
(ii) your aggregated turnover for the current year is likely to
be less than $10 million.
Section 152-10(1AA) substitutes a lower turnover figure which means the concessions in Division 152 will only be available to those small business entities that have an aggregate turnover of less than $2 million, rather than $10 million. Nothing turns on that distinction for present purposes because the applicant’s turnover (such as it is) was less than $2 million. The real question is whether she could be said to ‘carry on a business’ in the relevant year of income.
The term ‘business’ is defined in s 995-1 in very broad terms. It includes “any profession, trade, employment, vocation or calling, but does not include occupation as an employee.” The legislation does not define what it means to carry on a business. That concept is left to the common law. I will return to that issue below.
The other requirement in s 152-10 which is relevant for present purposes is found in s 152-10(1)(d). That sub-section requires that the asset satisfy the ‘active asset test’. The test is set out in s 152-35 but the expression ‘active asset’ is defined in s 152-40. Relevantly, s 152-40(1)(a) provides the CGT asset is an active asset of the small business entity if the asset was owned by the entity and “used, or held ready for use, in the course of carrying on a business that is carried on by” the entity. That sub-section brings us back to the concept of carrying on a business, which will be discussed next. Importantly, s 152-40(4) also includes exceptions. If an asset falls within the exceptions, it cannot be regarded as an ‘active asset’. The Commissioner says the exception referred to in s 152-40(4)(e) applies in this case. I will deal with that exception below.
What does it mean to ‘carry on a business’?
The parties generally agree about how I should determine whether the applicant is carrying on a business. As the High Court explained in Spriggs v Commissioner of Taxation; Riddell v Commissioner of Taxation [2009] HCA 22 (at [59], per French CJ, Gummow, Heydon, Crennan, Kiefel and Bell JJ):
The existence of a business is a matter of fact and degree. It will depend on a number of indicia, which must be considered in combination and as a whole. No one factor is necessarily determinative. Relevant factors include, but are not limited to, the existence of a profit-making purpose, the scale of activities, the commercial character of the transactions, and whether the activities are systematic and organised, often described as whether the activities are carried out in a business-like manner.
While the parties agree on the approach I should apply, the devil is, as they say, in the detail. The Commissioner concedes the evidence includes at least some of the indicia of a business, although Mr Coveney points out the evidence may be incomplete in some respects and he says I should give limited weight to the applicant’s claims about (for example) the number of hours she devoted to the management of the properties. Importantly, the Commissioner says the applicant cannot succeed whatever view I take on this issue because the exception in s 152-40(1)(e) applies. If the asset in question is not an active asset by reasons of that sub-section, it does not matter whether the applicant was carrying on a business.
Does the exception apply in this case?
Section 152-40(4) lists several different CGT assets that cannot qualify as ‘active assets’. Section 152(4)(e) refers to:
an asset whose main use by you is to *derive interest, an
annuity, rent, royalties or foreign exchange gains unless:
(ii) the asset is an intangible asset and has been
substantially developed, altered or improved by you so
that its *market value has been substantially enhanced;
or
(ii) its main use for deriving rent was only temporary. [emphasis added]
The subsection is accompanied by an example which says:
Example: A company uses a house purely as an investment property and rents it out. The house is not an active asset because the company not using the house in the course of carrying on a business. If, on the other hand, the company ran the house as a guest house the house would be an active asset because the company would be using it to carry on a business and not to derive rent.
The Commissioner says the applicant’s main use of the property was to derive rent. Mr Coveney referred me to authorities on the meaning of ‘rent’ which are noted in the appendix to the Commissioner’s public ruling published as Taxation Determination 2006/78.[1] The authorities included C.H. Bailey Ltd v. Memorial Enterprises Ltd [1974] 1 All ER 1003 at [1010] and United Scientific Holdings Ltd v. Burnley Borough Council [1977] 2 All ER 62 at [76], [86], [93], [99]. Those authorities conceive of rent as the amount payable by a tenant to a landlord for the use of leased premises. The Commissioner’s determination relies on authorities like Radaich v Smith (1959) 101 CLR 209 per Windeyer J at 222 to emphasise the tenant’s use of the premises must amount to exclusive possession, whereas a boarder or lodger merely has a licence to occupy a space that is not equivalent to exclusive possession. Mr Coveney says there is no doubt the tenants in Ms Del Castillo’s properties were paying rent, so the exception applies.
[1] Taxation Determination TD2006/78: “Income tax: capital gains: are there any circumstances in which the premises used in a business of providing accommodation for reward may satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 1997 notwithstanding the exclusion in paragraph 152-40(4)(e) of the Income Tax Assessment Act 1997 for assets whose main use is to derive rent?”
In making that submission, Mr Coveney referred me to the Tribunal’s decision in Jakjoy Pty Ltd and Commissioner of Taxation [2013] AATA 526. SM Walsh in that case held the plain meaning of the word ‘rent’ in s 152-40(4)(e) meant a residential rental property could not be regarded as an ‘active asset’.
The applicant says I should not follow the reasoning in Jakjoy because the Tribunal in that case:
(a)did not take account of the beneficial intent of the small business tax concessions. That intent was evident in s 152-1, which included a ‘Theme Statement’ in the Guide to the operation of the provisions, and in the explanatory memorandum. That beneficial purpose informed the interpretation of the text and suggested a more generous reading that benefitted the applicant; and
(b)did not give full effect to the example in the statute that accompanied s 152-40(4)(e). SM Walsh concluded the wording of the text of the sub-section was clear and there was no reason to have regard to the example. In her reasons, SM Walsh pointed out s 15AD of the Acts Interpretation Act 1901 (the AIA) as it was then drafted said an example should be disregarded if it was inconsistent with the text of the provision. The applicant points out s 15AD has since been amended. That section now provides “the example may extend the operation of the provision”.
To illustrate the first point, Mr Anderson referred me to the Full Court’s decision in Eichmann v Commissioner of Taxation [2020] FCAFC 155; (2020) 280 FCR 10. In that case, the taxpayer and his spouse were beneficiaries under a trust. The trustee company carried on a building and construction business. The taxpayer owned land which housed storage sheds. The company used the sheds to store tools and other supplies used in the building business. The land was sold. The taxpayer wanted to access the small business tax concessions to offset the capital gain. The taxpayer argued the land was an ‘active asset’ within the meaning of s 152-40(1). The primary judge took a narrow view of the requirement in the subsection that the use of the property must occur “in the course of carrying on a business”. The primary judge explained:[2]
the use of the appellant’s property did not have direct functional relevance to the carrying on of the normal day to day activities of a business of building, bricklaying and paving. That was because those business activities took place at building sites. It followed that the use of the appellant’s property was preparatory to the course of carrying on that business.
[2] Commissioner of Taxation v Eichmann[2019] FCA 2155 at [63]
The Full Court took a more generous interpretation of the words in light of the beneficial purpose that it identified in s 152-1 and in the explanatory memorandum. In a joint judgment, McKerracher, Steward and Stewart JJ explained (at [40]):
It follows that because s. 152-40(1)(a) is beneficial in nature, “its language should be construed so as to give the most complete remedy which is consistent “with the actual language employed” and to which its words “are fairly open””: Khoury v. Government Insurance Office of New South Wales [1984] HCA 55; (1984) 165 C.L.R. 622 at 638 per Mason, Brennan, Deane and Dawson JJ. In that respect, a beneficial construction of legislation may, in our view, legitimately influence constructional choices in a given case which arise from the use of generalised language to describe a necessary connection between two things; here those two things are the use of an asset and the carrying on of a business.
Mr Anderson said a proper understanding of the beneficial purpose suggested the language in s 152-40(4) that created exceptions should not be read in a way that arbitrarily excluded the applicant from benefitting from the concessions merely because of the kind of small business that she operated. Mr Anderson noted the Full Court in Eichmann had said (at [42]) the exceptions referred to in s 152-40(4) were assets used to derive passive income. Mr Anderson argued the applicant’s use of the asset in question here was not passive in that sense because she actively managed the dwellings as part of her residential property leasing business. As I apprehend the argument, Mr Anderson says the reference to using a property to derive rent in s 152-40(4) should be read down in light of the purpose of the concessions to refer only to rent derived from a passive investment in property, as opposed to rental income derived from assets that were more actively managed. Mr Anderson draws support from the example referred to in the notes accompanying s 152-40(4)(e). The example cites the operation of a guest house. It suggested such a property was being used as an active asset in a business that generated income from paying guests. Mr Anderson says the applicant is in the same position: she is using the asset actively, whereas the exceptions in s 152-40(4) are all passive assets.
The argument apparently assumes the applicant was indeed using the asset as part of a business in the relevant year of income, but the Commissioner says the argument is wrong in any event. Mr Coveney says there is no contextual basis for reading the reference in s 152-40(4)(e) to using a property to derive rent as if the provision only referred to rent derived passively from real estate, as opposed to rental income generated as part of a business that actively managed the real estate assets.
There is no doubt one must interpret the meaning of words in a statute having regard to their context. The rest of the statute – including objects clauses - forms part of the context. It might include extrinsic material that sheds light on the parliament’s purpose: see Construction Forestry, Maritime, Mining and Energy Union v Australian Building and Construction Commissioner [2020] FCAFC 192; (2020) 282 FCR 1 at [4] per Allsop CJ. One can accept an analysis of the context in this case suggests the parliament was intending to assist small businesses, and I accept – as the Full Court did in Eichmann – that the legislation should, to the extent possible, be interpreted in a way that gives effect to the purpose. But context sheds light on the interpretation of the actual text. It is not a substitute.
Words might have more than one meaning. Some meanings are less obvious than others. When interpretating words in a statute, the context may suggest the decision-maker should prefer a less obvious interpretation of a word to give effect to parliament’s intention. A word cannot be given an interpretation it does not legitimately bear. At some point, a statute says what it says and the decision-maker is not entitled to attribute strained or novel meanings to the language in order to achieve a purpose.
The word ‘rent’ is well-understood. I have already discussed the most obvious meaning: rent is a payment derived under a lease in return for exclusive possession of real estate. I accept the word might have secondary meanings which encompasses a broader range of payments, such as payments made in return for use of property (including personal property, like a car) under a licence or rental agreement. The word has also been used in economics to refer to earnings that exceed an amount which is economically or socially necessary – a form of rort. The word ‘rent’ also means ‘torn asunder’.
There is no contextual basis for concluding the parliament intended the words ‘main use…to derive… rent’ in s 152-40(4)(e) to comprehend anything other than a reference to real estate assets used to derive payments under a lease – a description which neatly captures what the applicant was doing, whether as part of a small business or not. She clearly does not fall within the scope of the exception to the exception. If parliament had intended to provide for a more nuanced treatment of leased assets, it presumably would have done so in express terms.
While the objects clauses and the explanatory memorandum speak of assisting small businesses, the exclusion of a particular species of activity from the concessions (in his case, deriving regular rent from leased premises) is not inevitably anomalous. Many, many Australians aspire to ownership of an investment property, and most of those properties are managed with a view to generating rent. The applicant may have devoted more of her time to the activities she described in her statement than most other individual landlords, and she might have undertaken more of that work herself with a degree of formality. But even if it were assumed in her favour that she was carrying on a business when she did so, there is no basis for assuming the plain words of the exception in s 152-40(4)(e) did not apply to her.
Conclusion
Having concluded the applicant is precluded from accessing the concessions because she is unable to satisfy the requirement that the asset in question was an ‘active asset’ for the purposes of Division 152, there is no point in considering whether she was engaged in a business. The objection decision must be affirmed.
I certify that the preceding 30 (thirty) paragraphs are a true copy of the reasons for the decision herein of
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Associate
Dated: 12 December 2022
Date(s) of hearing: 28 November 2022 Counsel for the Applicant: Mr A Anderson Solicitors for the Applicant: DBL Solicitors Counsel for the Respondent: Mr G Coveney Solicitors for the Respondent: Australian Taxation Office Litigation and Legal Services
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