Active asset test

The active asset test is satisfied if:

• you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the test period detailed below, or
• you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of least 7.5 years during the test period.

The test period:

• begins when you acquired the asset, and
• ends at the earlier of
• • the CGT event, and
  • when the business ceased, if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows).
   

The periods in which the asset is an active asset do not need to be continuous. However, they must add up to the minimum periods specified above, depending on the total period of ownership.

The asset does not need to be an active asset just before the CGT event.

Example

Jodie ran a florist business from a shop she has owned for eight years. She ran the business for five years, and then leased it to an unrelated party for three years before selling. The shop satisfies the active asset test because it was actively used in Jodie's business for more than half the period of ownership, even though the property was not used in the business just before it was disposed of.

Cessation of a business

If the CGT event happens within 12 months after the business ceased, the test period can end when the business ceased.

This aspect of the active asset test allows some flexibility in the situation where a business is sold, or has otherwise ceased, and an asset previously used in the business is sold after that time. The asset only needs to be an active asset for half (to a maximum of 7.5 years) of the shorter test period during the total time the asset was owned.

If the CGT event happens more than 12 months after the business ceased, the test period ends either:

• when the CGT event happens, or
• when the business ceased, if the Commissioner grants you an extension of time.

Extension of time requests are considered on the merits of each case.

For the purposes of the active asset test, the cessation of a business includes the sale of a business - that is, it is not limited to a business that ends in the sense that no-one continues to carry it on, but also includes a business that has ceased to be carried on by an entity because the entity has sold that business.

Example

Laura purchased business premises in February 2003 and immediately started to carry on her business from the premises. Her business expanded and she moved to larger premises across the street in April 2006. She entered into a contract to sell the original premises in July 2006. The premises were an active asset for at least half the period beginning in February 2003 and ending just before the CGT event in July 2006. The active asset test is satisfied even though Laura had not ceased her business and the premises were not used or held ready for use in her business just before the CGT event.

For 2005-06 and earlier years, to satisfy the active asset test the CGT asset must have been an active asset just before the CGT event or just before the business ceased (if that happened in the 12 months before the CGT event, or longer if the Commissioner allowed). Following from the above example, the premises would not have satisfied the active asset test if Laura had sold the premises in the 2006 income year.

Death and the active asset test

Where you are one of the following, you may be eligible for the concessions to the same extent that the deceased would have been just prior to their death:

• beneficiaries of deceased estates
• legal personal representatives (executors)
• surviving joint tenants
• trustees and beneficiaries of testamentary trusts (trusts created by a will).

You will be eligible for the concessions where the CGT event happens within two years of the individual's death. The active asset test applies to you for any capital gain made on a sale of the assets after the two-year time limit. This means that if you do not continue to carry on the deceased's business, or use the asset in another business, after the two-year time period, the active asset test may not be satisfied and the small business concessions may not be available.

The Commissioner can extend this two-year period.

See Death and the small business CGT concessions.

Continuing time periods for active asset test for involuntary disposals

There are modified rules to determine if the active asset test is satisfied for CGT assets acquired or transferred under the rollover provisions relating to assets compulsorily acquired, lost or destroyed, or to marriage breakdown (Subdivisions 124-B and 126-A of the ITAA 1997 respectively).

If you acquired a replacement asset to satisfy the rollover requirements for the compulsory acquisition, loss or destruction of a CGT asset, the replacement asset is treated as if:

• you acquired it when you acquired the original asset, and
• it was an active asset at all times when the original asset was an active asset.

If you have a CGT asset transferred to you because of a marriage breakdown, and the capital gain arising from that transfer was rolled over under the marriage breakdown rollover provisions, for purposes of the active asset test you can choose whether to:

• include the ownership and active asset periods of your former spouse, or
• commence the ownership and active asset periods from the time the asset was transferred to you.

If you choose to include your former spouse's ownership and active asset periods of the CGT asset, that asset is treated as if it had been:

• acquired by you when your former spouse acquired the asset, and
• was an active asset of yours at all times when the asset was an active asset of your former spouse.

Modified active asset test for CGT event D1

A modified active asset test applies if you make a capital gain from CGT event D1 (about creating rights in another entity).

The active asset test requires you to own the CGT asset before the CGT event happens. However, under CGT event D1, the relevant CGT asset (the rights) are created in the other entity without you owning them, so it would not be possible to satisfy the active asset test.

Accordingly, the test is modified to require the right you create that triggers the CGT event to be inherently connected with another CGT asset of yours that satisfies the active asset test.

Meaning of active asset

A CGT asset is an active asset if it is owned by you and is:

• used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or an entity connected with you, or
• an intangible asset that is inherently connected with a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or another entity that is connected with you, carries on - for example, goodwill.

Where you own an asset that your spouse or child uses in their business, they will be taken to be your affiliate for the purposes of the:

• active asset test
• $6 million maximum net asset value test, and
• $2 million aggregated turnover test.

Where we say 'child', we mean your child under 18 years.

Your spouse (or child) may also be taken to be your affiliate where:

• an asset is owned by you and that asset is used in a business carried on by an entity that your spouse (or child) owns or has an interest in, or
• an asset is owned by an entity that you own or have an interest in, and that asset is used in a business carried on by your spouse (or child), or an entity that your spouse or child has an interest in.

The rule is applied in two stages. The first stage treats an individual's spouse or child as their affiliate for the purposes of working out whether the entity that uses the CGT asset, or holds it ready for use in its business, is an affiliate of, or connected with, the entity that owns the CGT asset.

If by applying the first stage of the rule the entity is taken to be an affiliate of, or connected with, the entity that owns the asset, then the asset is an active asset. The asset must still meet the active asset test.

The second stage of the rule treats the spouse or child as an affiliate for other purposes in the basic conditions. See Are spouses and children affiliates?

The treatment of spouses and children as affiliates in certain circumstances changed as a result of the second round of changes for 2007-08 and later income years arising from the June 2009 amendments. If this would result in you being ineligible for the concessions, there is a transitional rule.

Under the first round of changes to the meaning of affiliate for 2007-08 arising from June 2007 amendments, a spouse or child was not automatically an affiliate. However, an asset used by a spouse or child in their business was treated as an asset used by an affiliate for the purpose of the active asset test. This was to ensure that an asset does not lose active asset status as a result of the June 2007 amendments.

For 2006-07 and earlier years, a 'small business CGT affiliate' included a spouse or child.

Businesses that are winding up

If you are accessing the concessions using the basic condition for passively-held assets or a partner's assets, there is a special rule that affects the period of time that your asset is an active asset in the CGT event year. It applies in the income year the CGT event happens where:

• a business previously carried on by your affiliate, an entity connected with you or a partnership in which you are a partner, is being wound up and the asset is no longer being used in the business, and
• the asset was used, held ready for use in, or inherently connected with the business at a time in a previous income year when you ceased to carry on the business.

This rule treats the entity as carrying on the business for a moment in time in the income year the CGT event happens and treats the asset as being used, held ready for use in, or inherently connected with, the business at that same moment in time in the CGT event year. The asset must still pass the active asset test.

This rule is also required to enable you to meet the basic condition for passively- held assets and partner's assets.

When an asset is 'held ready for use'

For an asset to be held ready for use in the course of carrying on a business, it needs to be in a state of preparedness for use in the business and functionally operative. As such, premises still under construction, or land upon which it is intended to construct business premises, could not be said to be 'held ready for use' and would, therefore, not be active assets at that time.

Example

Margaret carried on business at various customer on-site locations. She acquired some land with the intention of constructing premises in which to carry on her business. Soon after Margaret acquired the land she was approached by another party that was keen to acquire the land. Margaret sold the land and made a capital gain. She was only part way through the construction of the premises at that time.

In this situation, the land was not held ready for use by Margaret in the course of carrying on her business at any time. It was not in a state of preparedness from which Margaret could carry on her business. Accordingly, the land was not an active asset at any time.

When shares and trust interests are active assets

A CGT asset is also an active asset at a given time if you own it and:

• it is either a share in a company that is an Australian resident at that time or an interest in a trust that is a resident trust for CGT purposes for the income year in which that time occurs, and
• the total of the following is 80% or more of the market value of all of the assets of the company or trust
• • the market values of the active assets of the company or trust, and
  • the market value of any financial instruments of the company or trust that are inherently connected with a business that the company or trust carries on, and
  • any cash of the company or trust that is inherently connected with such a business.
   

Cash and financial instruments are not active assets, but they count towards the satisfaction of the 80% test provided they are inherently connected with the business.

Inherent connection

Inherent connection necessarily requires something more than just some form of connection between the financial instrument and the business. A thing might be regarded as inherently connected to a business when it is a permanent or characteristic attribute of the business - for example, goodwill, or trade debtors. Where a business is holding excess funds arising from a temporary spike in trading activity or the sale of a business asset, the excess funds might also reasonably be regarded as inherently connected with the business. A financial instrument must be inherently connected with a business that the owner of the financial instrument carries on, rather than any business a related entity carries on.

Example

Archimedes Pty Ltd carries on a manufacturing business. It lends $300,000 to a related company, Galileo Pty Ltd, to acquire various assets to be used in the businesses of both companies. However, a loan a company makes to a related entity to fund the acquisition of assets is not considered to be a permanent or characteristic attribute of the business the company carries on. As such, loans made between members of a corporate group as part of the overall financing of the group are not considered to be inherently connected with the business the lender carries on. Accordingly, the loan by Archimedes Pty Ltd to Galileo Pty Ltd is not taken into account in determining whether the shares in Archimedes Pty Ltd are active assets.

This means a share in a company or an interest in a trust is an active asset if the company or trust itself has active assets (and inherently connected financial instruments and cash) with a market value of at least 80% of the market value of all its assets.

The active asset test requires a CGT asset to have been an active asset for at least half of a particular period, as outlined earlier - for example, for a share in an Australian resident company to meet this requirement, the company must satisfy the 80% test for that same period.

The 80% test will be taken to have been met:

• where breaches of the threshold are only temporary in nature, and
• in circumstances where it is reasonable to conclude that the 80% threshold has been passed.

Example

John sells an active asset that meets the basic conditions and makes a capital gain of $500,000. He acquired shares in Fruit and Veg Co, which runs his family business, as replacement assets. The shares in Fruit and Veg Co meet the 80% test - as a result, they are active assets.

Some time later, Fruit and Veg Co borrows money to pay a dividend, and fails the 80% test. Two weeks later the dividend is paid and the shares pass the 80% test again. For the two weeks, the shares are treated as active assets even though they do not pass the 80% test.

Example

Jack and Jill are the only shareholders of Hill Water Supplies Pty Ltd, an Australian resident company that carries on a water supply business. The market values of the company's CGT assets are as follows:

The total market value of the company's active assets is $900,000, which is more than 80% of the total market value of all the company's assets. Therefore, Jack and Jill's shares in the company are active assets.

The company sells its water filtration plant (for its market value of $200,000) and then immediately contracts to purchase new plant, which is delivered and installed two months later. The funds from the sale are held in the company's bank account before being used to pay for the new plant.

In this situation, although the market value of the company's active assets has dropped below the 80% mark, the company's bank account holding the $200,000 is a financial instrument inherently connected with the company's business and is therefore included in the calculation. This means the 80% test remains satisfied.

Although gains from depreciating assets may be treated as income rather than capital gains, depreciating assets, such as plant, are still CGT assets and may, therefore, be active assets and included in the 80% test.

Interests in holding entities

An interest in an entity that itself holds interests in another entity that operates a business may be an active asset, depending on the successive application of the 80% test at each level.

Example

Ben owns 100% of the shares in Holding Co, which, in turn, owns 100% of the shares in Operating Co (both are resident companies). The only assets of Holding Co are the shares in Operating Co, and all of Operating Co's assets are active assets.

As Operating Co satisfies the 80% test, the shares owned by Holding Co in Operating Co are active assets. As those shares are the only assets owned by Holding Co, then Holding Co also satisfies the 80% test. As a result, the shares owned by Ben in Holding Co are also active assets.

If Ben sold the shares in Holding Co, all the small business concessions may potentially apply to any gains made.

If Holding Co sold its shares in Operating Co, the small business concessions may apply because Ben is a CGT concessional stakeholder in Operating Co as well as having a small business participation percentage in Holding Co of at least 90%.

If Operating Co sold its active assets, Operating Co may be entitled to the small business concessions because Ben is a significant individual and CGT concessional stakeholder in Operating Co as a result of his direct and indirect small business participation percentage - for more information, see the significant individual test.

Assets that cannot be active assets

The following CGT assets cannot be active assets (even if they are used, or held ready for use, in the course of carrying on a business):

• shares in companies or interests in trusts, other than those that satisfy the 80% test - see When shares and trust interests are active assets
• financial instruments, such as bank accounts, loans, debentures, bonds, futures and other contracts and share options (Note: if a financial instrument is inherently connected with the business, it can nevertheless count towards the satisfaction of the 80% test)
• assets whose main use is to derive interest, an annuity, rent, royalties or foreign exchange gains (unless the main use for deriving rent was only temporary or the asset is an intangible asset that you have substantially developed or improved so that its market value has been substantially enhanced)
• shares and trust interests in widely-held entities, unless held by a CGT concession stakeholder in the widely-held entity.

Trade debtors are not considered to be financial instruments for the purposes of the active asset exclusions. Rather, they are a business facilitation mechanism that assists in the conduct of the business and are inherently connected with the business. Accordingly, trade debtors can be included in the value of active assets when calculating the 80% test.

Deriving rent

As already noted, an asset whose main use is to derive rent (unless that main use is only temporary) cannot be an active asset. This is the case even if the asset is used in the course of carrying on a business.

Whether an asset's main use is to derive rent will depend on the particular circumstances of each case. The term 'rent' has been described as referring to the payments made by a tenant or lessee to a landlord or lessor for exclusive possession of the leased premises. As such, a key factor in determining whether an occupant of premises is a lessee paying rent is whether the occupier has a right to exclusive possession.

If, for example, premises are leased to a tenant under a lease agreement granting exclusive possession, the payments involved are likely to be rent and the premises are not an active asset. On the other hand, if the arrangement allows the person only to enter and use the premises for certain purposes and does not amount to a lease granting exclusive possession, the payments involved are not likely to be rent.

An asset that is leased to a connected entity or affiliate for use in its business may still be an active asset. It is the use of the asset in that entity's business that will determine the active asset status of the asset.

The June 2009 amendments ensure all uses of an asset are considered in determining what the main use of the asset is and, therefore, whether it is an active asset. However, personal use of the asset by the asset owner, or by an individual who is their affiliate, is not considered in determining the main use of the asset.

The amendments apply to CGT events that happen on or after 23 June 2009.

Example

Rachael owns five investment properties which she rents to tenants under lease agreements that grant exclusive possession. The lease terms vary from six months to two years. The properties are not active assets because they are mainly (only) used by Rachael to derive rent. It is irrelevant whether Rachael's activities constitute a business.

Example

Michael owns a motel (land and buildings) which he uses to carry on a motel business. The motel provides room cleaning, breakfast, in-house movies, laundry and other services as part of the business. Guests staying in the motel do not receive exclusive possession, but simply have a right to occupy a room on certain conditions. The usual length of stay by guests is between one and seven nights. The motel would be an active asset because its main use is not to derive rent.

Main use to derive rent: CGT events happening on or after 23 June 2009

The June 2009 amendments ensure that all uses of the asset are considered when working out what the main use of the asset is and, therefore, whether it is an active asset. Previously, only the use of the asset by an affiliate or connected entity was considered. Personal use by the asset holder or their affiliate is not considered.

The following is considered use of the asset to derive rent, where the rent is derived:

• from an entity that is not an affiliate or connected with the asset owner (third party), or
• by an entity that is an affiliate or connected with the asset owner (relevant entity).

The use of the asset to derive rent from a third party will be considered use to derive rent, even if that entity uses the asset in their business. This is because the use of the asset by the asset owner is to derive rent.

However, use of the asset by a relevant entity is treated as the use by the asset owner, even if the asset owner receives rent from the relevant entity for the use of that asset.

This means, if the relevant entity uses the asset:

• in its business, that use is treated as use by the asset owner to carry on business
• to derive interest, rent, royalties, or foreign exchange gains from an entity that is a third party, that use is treated as use by the asset owner to derive passive income.

Example

Kiki owns a property and rents out 90% of the floor area to Lost Dog Pty Ltd that is neither her affiliate nor connected with her (that is, a non-related third party). Kiki earns 90% of the revenue derived from owning the property from renting it to Lost Dog Pty Ltd.

Beaglehole Pty Ltd, which carries on a dog-grooming business, uses the remaining 10% of the floor area of the property as its business premises and pays Kiki rent for using it - this rent forms 10% of the revenue Kiki earns from owning the property. As Kiki owns 60% of Beaglehole Pty Ltd, Beaglehole is connected with Kiki.

Beaglehole Pty Ltd's use of that 10% of the property is treated as Kiki's use because Beaglehole Pty Ltd is connected with Kiki. Because Beaglehole uses that part of the property as its business premises, Kiki is treated as using that part as business premises. This means that the rent Beaglehole Pty Ltd pays to Kiki is not treated as rent for the purposes of determining Kiki's main use of the property.

However, Kiki's main use of the property is to derive rent, because 90% of the revenue she derives from the property is rent received from Lost Dog Pty Ltd, a non-related third party.

Kiki's property is not an active asset in these circumstances. This only applies to CGT events happening on or after 23 June 2009.

Example

Neil owns a property that is used as follows:

Because personal use of an asset by the owner or an affiliate of the owner is ignored in determining its main use, the proportions of 60% and 15% have to be adjusted to represent a proportion of the whole use of the asset excluding the personal use.

This adjustment is made by multiplying the 60% and 15% each by 100/75 [that is, 100 / (60  15)].

Following the adjustments, Neil:

Andrea uses 50% of the 80% space rented to her in her business and rents the remaining 50% of the space to an entity that is neither Neil's affiliate nor connected with Neil (non-related third party). Andrea earns 50% of the revenue she derives from the property from her on-renting to the non-related third party.

Andrea's business use of the property is treated as Neil's use because she is his affiliate. Therefore, Neil is treated as:

The main use of the property is not to derive interest, an annuity, rent, royalties or foreign exchange gains. This is because:

Neil's property is an active asset in these circumstances. Neil's asset would still have to satisfy the active asset test over the period that he has owned the asset. This only applies to CGT events happening on or after 23 June 2009.