Vaughan and Commissioner of Taxation

[2011] AATA 758

Administrative Appeals Tribunal

DECISION AND REASONS FOR DECISION [2011] AATA 758

ADMINISTRATIVE APPEALS TRIBUNAL      )

)          No  2011/1227-1228

TAXATION APPEALS DIVISION		)
Re		VILMA VAUGHAN ALLAN VAUGHAN

Applicant

And  COMMISSIONER OF TAXATION

Respondent

DECISION

Tribunal Honourable Dr B H McPherson CBE Deputy President
Senior Member Bernard J McCabe

Date 27 October 2011

Place Brisbane

Decision  The decision under review is affirmed.

.....................[sgd].........................

CATCHWORDS

TAXATION — private ruling — capital gains tax — active asset — decision affirmed

Income tax Assessment Act 1997, ss 152-1, 152-35, 152-40

REASONS FOR DECISION

27 October 2011 Honourable Dr B H McPherson CBE Deputy President
Senior Member Bernard J McCabe         

1.      Vilma and Allan Vaughan were in the business of running child care centres. They owned a number of properties in Sydney that were used for this purpose. In 1997, they decided they wanted to give up the day-to-day operation of the businesses and entered into agreements with individuals who took over the operation of each centre. We are concerned in this case with the fate of the centre located in a property in Merrylands. That property was taken over by a pleasant young couple who had no experience in running child care centres. The couple relied heavily on the Vaughans for advice for a number of years before a new lease was negotiated with ABC Learning Centres in 2003. The Vaughans retained ownership of the property and received regular payments under the arrangement with the young couple and the subsequent lease to ABC until the property was sold in 2008. The arrangement with the couple was recorded in a document that is described as a lease. The Merrylands property has now been sold, and a question has arisen whether Mr and Mrs Vaughan are entitled to disregard the amount of the capital gain they received on that property pursuant to s 152-35 of the Income Tax Assessment Act 1997.

2.      Relief under s 152 is not available to the Vaughans unless we are satisfied the Merrylands property can be characterised as an “active asset” within the meaning of s 152-40.

3.      The taxpayers lodged their income tax returns in respect of the 2008 financial year. They reported the capital gain from the sale of the property but sought relief under s 152. The Commissioner’s objection decision is dated 4 February 2011. In that decision, he disallows the claim for relief. The Vaughans have now come to the Tribunal. For reasons we will explain, we are not satisfied relief is available. It follows the objection decision is affirmed.

The facts

4.      The Merrylands property was acquired in 1991. It comprises two lots, each of which includes a separate building. Both buildings and the entire property are used to conduct a child care business that was originally established by the taxpayers on the site.

5.      

Mr and Mrs Vaughan conducted the centre themselves for a number of years. They are obviously very experienced in this sort of business. Mrs Vaughan explained in her evidence that she and her husband were looking to withdraw from the business in the mid-1990s although she said it was possible the family might want to become involved again at the Merrylands site at some point in the future.

As well, Mr Vaughan had strong views about the sort of skills required to successfully manage a child-care centre in the area. He shared some of those views with us at the hearing. He wanted the new proprietors to be up to the task as he saw it. In due course, a suitable couple was identified. A document, described as a lease, was executed by the parties in June 1997. The document was stamped on the basis that it was a lease, as opposed to some other sort of instrument that would be subject to a different rate of stamp duty.

6.      As leases go, this document was unremarkable. It included many if not all of the conventional terms one might expect in a commercial lease in relation to this sort of property. It provided for the payment of rent and a bond. There was a clause dealing with rental reviews. There was another clause referring to a covenant of quiet enjoyment – a covenant that, on its terms, suggested the lessees would be entitled to quiet enjoyment and possession of the property provided they observed the terms of the lease. Another clause confirmed the lessees were not entitled to any payment in respect of goodwill when the lease concluded. Of course, the Vaughans, as landlords, retained certain powers of entry and responsibility for certain things. In particular, they retained responsibility for the cost of many repairs and some of the maintenance and other outgoings in relation to the property. Mrs Vaughan pointed out the lease to ABC which was signed in 2003 was more favourable, but that may merely reflect the Vaughans’ bargaining position with respect to ABC. The differences between the two arrangements do not really tell us anything about the nature of the arrangement executed in 1997.

7.      We note the lessees asked the Vaughans to replace some of the craft materials, like paints and other consumables used in the course of the business. That would not ordinarily be the responsibility of a lessor, and there is no mention of that obligation in the lease. It comes as no surprise that Mrs Vaughan pointed out in her evidence that she and her husband refused to pay for those things.

8.      We also note the Vaughans remained registered as the owners of the business name under which the centre traded after the young couple took it over. There was a suggestion towards the end of the first five year term of the lease that the name might be changed, but the Vaughans did not immediately agree. It is unclear why the business name remained registered in the name of the taxpayers, or what power they had to prevent a change in the name of the centre. There is no reference to the name of the business in the lease. Other matters that one might expect to see in an agreement to licence or franchise a business, such as provisions governing intellectual property, were also absent from the written agreement tendered in evidence.

9.      Mrs Vaughan was under the impression that rent collected under a lease did not attract GST. She pointed out GST was paid on these receipts. She suggested that was proof that the monies were collected under a licence rather than a lease. But as Mr Reeve for the Commissioner explained, commercial rents do attract GST. The fact GST was paid tells us little about the nature of the arrangement in this case.

10.     The taxpayers said they took a hands-on role with respect to the young couple. They provided lots of advice on how to conduct the business. The couple obviously relied on their experience and apparently made a habit of calling on the taxpayers regularly. The taxpayers said they were motivated in part by a desire to ensure the child care business conducted on the site remained viable in case they wished to take it back at some point in the future – perhaps so it could be operated by another family member.

11.     We note the taxpayers received a lump-sum payment when ABC Learning Centres took over the property. We assume the payment was made in return for assigning the lease. The fact of the payment is certainly consistent with that conclusion.

12.     We are satisfied the arrangement with the young couple between 1997 and 2003 was properly characterised as a lease. It was not a licence to conduct a business or a franchise or some other agreement. The taxpayers were the landlords, albeit they generously provided their time and expertise to the tenants. The payments they received under the terms of the agreement were properly characterised as rent.

The legislation

13.     Section 152-1 of the Act explains the Act offers relief from capital gains tax liabilities for individuals and small businesses in some circumstances. A taxpayer is only entitled to relief under this subdivision if he or she can satisfy the rules.

14.     The rules in question provide that a taxpayer can only obtain relief if the capital gain is realised on the disposal of an active asset within the meaning of the Act. That expression is defined in s 152-40. In section 152-40(4), a number of assets that would otherwise qualify as active assets are expressly excluded from the definition, including:

(e)  an asset whose main use by you is to derive interest, an annuity, rent, royalties or foreign exchange gains…

15.     If the property in question was used to generate rent, it would be excluded. In this case, the Commissioner agrees that the asset was used as an active asset prior to 1997 when it was leased to the young couple. Thereafter, it was used to derive rent. We have already accepted the payments received after 1997 were properly characterised as rent, and that the property was finally sold in 2008. So what is the position where the property was an active asset used in the course of the taxpayers’ business between 1991 and 1997, and was thereafter used as a source of rent?

16.     The answer is contained in s 152-35 which sets out the active asset test. The section provides relevantly:

(1)  A CGT asset satisfies the active asset test if:

(b)  you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7 ½ years during the period specified in subsection (2).

17.     Sub-section (2) provides that the relevant period begins when the asset was acquired and (for present purposes) concludes when it was disposed of. In this case, the relevant period is between 1991 and 2008 – a period of about 17 years.

18.     It follows the property was an active asset for only six years. That is not long enough to satisfy s 152-35(1). For the rest of the time it was owned by the taxpayers, it was a rental property. In those circumstances, the taxpayers cannot satisfy the active asset test in respect of the property. They cannot claim any relief under this sub-division.

Conclusion

19.     The rules are clear enough. The taxpayers are unable to succeed in their claim for relief from the capital gains tax liability. The Commissioner and the Tribunal do not have a discretion to waive the rules in the circumstances. The objection decision must therefore be affirmed.

I certify that the 19 preceding paragraphs are a true copy of the reasons for the decision herein the Honourable Dr B H McPherson CBE Deputy President and Senior Member Bernard J McCabe

Signed:........................[sgd].................................................
  Associate

Date of Hearing  17 October 2011
Date of Decision  27 October 2011
Applicants  Self-represented
Solicitor for the Respondent      Mr S Reeve, ATO Legal Services Branch