Taxpayer wins in Episode III of Eichmann Saga (Return of the Active Asset Test)
Insights by Andrew Henshaw and Rosalind Li, Velocity Legal
On 18 September 2020, the Full Federal Court handed down the third instalment of the Eichmann saga concerning the active asset test under the small business CGT concessions (Eichmann v FCT  FCAFC 155) (Eichmann).
The Eichmann saga is a lot like the original Star Wars trilogy. How so?
- in the first instalment (Eichmann v FCT  AATA 16, there was ‘a new hope‘. The AAT determined that the land which was used to store tools and materials was an ‘active asset’ under the small business CGT concessions;
- in the second instalment (FCT v Eichmann  FCA 2155), the ‘empire struck back‘, the Federal Court considerably raised the bar for qualifying as an active asset by reading in a number of ‘sub-tests’ (e.g. ‘direct functional relevance’ and the ‘ordinary course of business’ test). A win for the Commissioner; and
- in the third instalment, there was a ‘return‘. While no Jedi were involved, the Full Federal Court unanimously quashed the Federal Court’s decision, returning the active asset test to its former glory as provided by the words of the legislation (and not dissimilar to the destruction of the second Death Star). The taxpayer wins again.
In allowing the taxpayer’s appeal, the Full Federal Court made some very important observations regarding not only the active asset test, but also the statutory construction of the small business CGT concessions as a whole.
Please see below for more details, where we first recap on the background of the case, the earlier decisions of the AAT and Federal Court, as well as the key takeaways from the Full Federal Court’s decision.
Recap on the background
The Eichmann case arose from the taxpayer applying for, and then objecting to, the Commissioner’s private ruling decision. For that reason, the ‘facts’ before the AAT and the Court were those described by the Commissioner in the private ruling. The key facts are set out below:
- the taxpayer’s family trust carried on a building, bricklaying and paving business for many years;
- in 1999, the taxpayer and his wife acquired a piece of vacant land adjacent to their main residence;
- the land mainly comprised of open space, other than 2 sheds that are situated on the land;
- the sheds were used to store work tools, equipment and materials. The open space on the land was used to store other materials (e.g. bricks). The tools and materials were collected from the land daily;
- work vehicles were also parked on the land;
- the land was sold in 2016 and the taxpayer sought a private ruling on whether the land was an ‘active asset’ for the purposes for the small business CGT concessions. In particular, s 152-40 of the ITAA 1997 requires the asset to be ‘used’ or ‘held ready for use’ in the course of carrying on a business.
The Decision of the AAT
As discussed in our earlier article, ‘Eichmann case – Taxpayer wins on ‘Active Asset’ Test, and a timely reminder on statutory interpretation’, the AAT emphasised that the primary consideration (and often the sole consideration) when interpreting legislation is the ordinary meaning of the statutory text itself. Based on this interpretation, the AAT held that the ordinary meaning of the term ‘use’ is not limited to activities that are ‘integral’ to the business. The AAT ultimately found that the land in question was ‘used’ in the taxpayer’s business and satisfied the active asset test.
The Federal Court Decision
The Federal Court reversed the decision of the AAT and held that the land was not an ‘active asset’. As discussed in an earlier article, ‘Commissioner wins in Eichmann appeal: Federal Court tightens the screws on the ‘Active Asset’ Test’, the Federal Court arguably shifted the goalposts by imposing the following additional ‘sub-tests’ to the active asset test:
- the ‘whole, or predominantly the whole’ of the asset must be ‘used’ in the course of carrying on a business;
- the ‘use’ must have a ‘direct functional relevance’ to the business which requires the ‘use’ to be a ‘constituent part or component of the day to day business activities’; and
- the taxpayer must show that its use of the land has a direct nexus to ‘the carrying on of the normal day-to-day activities of the business which are directed to the gaining or production of assessable income’, and cannot be ‘preparatory’ in nature.
The Full Federal Court Decision
The Full Court of McKerracher, Steward, and Stewart JJ released its decision only a few weeks after the hearing on 25 August 2020 and unanimously allowed the taxpayer’s appeal.
Of note, the Full Federal Court made 3 important observations:
- private rulings and disputes: the private rulings system will not always be an apt mechanism to address disputes concerning facts, and even issues of characterisation of those facts (paragraph  of the decision). It was noted that the AAT and the Federal Court had considerable difficulty throughout the saga, as the dispute ultimately stemmed from an unsuccessful private ruling;
- sufficient that the asset is used: it is sufficient if the asset is used at some point in the course of the carrying on of an identified business (paragraph ). The legislation uses the word ‘used’, and there is no justification for reading in additional requirements (e.g. that the asset must be ‘integral’, or have a ‘direct functional relevance’); and
- small business CGT concessions interpreted broadly: the provisions conferring small business relief (Division 152 of the ITAA 1997) should be construed beneficially rather than restrictively in order to promote the purpose of the concessions.
Based on the facts in the private ruling, the Full Federal Court held that the land was ‘used’ in the course of carrying on the bricklaying business. Further, the Court said that even if the ‘direct functional relevance’ test is preferred, the taxpayer’s ‘use’ was sufficient because ‘the secure storage of the tools and materials of the business on a daily basis’ bore a ‘direct relationship’ to the activities of the business.
While this seems like good news for taxpayers using their land for storing, assembling or collecting business assets, it is important to note that each case will turn on its individual facts (and noting the Eichmann decision was based on ‘private ruling facts’; in other words, assumed facts). Whether the ‘use’ of the land (e.g. for storage) will be sufficient ‘use’ will ultimately depend on the particular circumstances.
Statutory Construction – ‘Construed beneficially rather than restrictively’?
In relation to the statutory construction of the provisions conferring small business relief, the Court opined at paragraphs  to  that:
the provisions conferring small business relief, being Div. 152 of Pt. 3-3 of the 1997 Act, should be construed beneficially rather than restrictively in order to promote the purpose of the concessions conferred by that Division…The beneficial nature of the small business relief is also discernible in the Guide to Div. 152, s. 152‑1, which states that, “[t]o help small business”, the small business concessions are available on satisfaction of the relevant conditions…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” [emphasis added]
Importantly, the above passage may have more wide-reaching implications for other aspects of the concessions where the words are ‘fairly open’. For example, the requirement in the 15-year exemption that the CGT event must be ‘in connection’ with retirement.
While it is not the first time that this principle of statutory construction (i.e. that concessionary provisions should be construed beneficially in line with its purpose) has been endorsed by a Court, the Eichmann decision arguably provides taxpayers with another arrow in the quiver when applying the small business CGT concessions or other concessions (e.g. whether in an ATO review or litigation).
‘Whole, or predominantly the whole of the asset’
The Federal Court said that the ‘whole, or predominantly the whole’ of the asset must be ‘used’ in the course of carrying on a business. The Full Federal Court’s decision did not examine this interpretation in detail because there was already a factual finding (based on the ruling) that all of the land was ‘used’ in the business.
Given this aspect was not overturned by the Full Federal Court, it would appear that the requirement that the ‘whole, or predominantly the whole’ of the asset must be used is here to stay (at least in the ATO’s view). However, that interpretation is arguably inconsistent with the ‘fairly open’ approach. For example, if 30% of the surface area of land is used and the rest is vacant land, is it not fairly open to construe ‘used’ to encompass that partial use? What if the land consisted of multiple separate titles? What if the land were subdivided in two?
It has become somewhat unclear where exactly the line should be drawn after the AAT decision in Rus and FCT  AATA 1854 (Rus), particularly as the AAT held there was insufficient ‘use’ where only 10% of the land in question was used in carrying on a business. These uncertainties remain following Eichmann. For instance, what does ‘predominantly’ mean? Is it 51%, 99% or somewhere in between? Is it based on surface area and would the calculation be limited to the part of the land that is capable of being ‘used’?
The Eichmann trilogy is a timely reminder that:
- reading words into legislation that do not exist is fraught with danger. The ‘active asset’ test merely requires the asset in question to be ‘used’ in the course of carrying on a business. Absent a fourth instalment (i.e. a High Court appeal), the concept that the level of ‘use’ must be integral to the business has ultimately been rejected;
- there are inherent limitations in challenging a private ruling. Tribunals or Courts do not have the power to redefine the ‘postulated facts’ of a private ruling (as described by the Commissioner) or make new factual findings. While this did not prove fatal to the taxpayer, arguments over these issues did take up significant oxygen in the AAT and Federal Court. Further, if the taxpayer’s actual circumstances differ from those stated in the ruling, the ATO could still pursue the matter by issuing an amended assessment;
- while the Full Federal Court has endorsed the broader approach in interpreting tax concession legislation, the active asset test and the small business CGT concessions more broadly are extremely complex. Many grey areas remain, with ‘all or nothing’ consequences; and
- finally, if at first you don’t succeed, try, try again! Do not be afraid to challenge unfavourable ATO decisions (either primary decisions or objections) in the appropriate situation.
So where to from here?
The Full Federal Court has now clarified the important issue of the nature of ‘use’ required for the active asset test and how the provisions of the small business CGT concessions should be construed. The latter point is important to emphasise as there are a number of other grey areas within the small business CGT concessions. By implication, the statutory construction principle should also apply to any other legislation bestowing concessional treatment (e.g. CGT rollovers, the Small Business Restructure Rollover, the employee share scheme start-up concessions).
Taxpayers considering whether their asset is ‘used’ in carrying on a business and therefore an ‘active asset’ for the purposes of claiming small business CGT concessions are strongly recommended to seek professional advice.
Who said tax lawyers can’t have personality? Rosalind has real international flair, having lived in New Zealand, a native speaker in Mandarin and experienced in multinational tax issues. She’s also a self-confessed ‘foodie’ enjoying exotic culinary delights with friends and family.
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Andrew acts for a diverse range of private businesses, high net-wealth individuals and family groups. He specialises in business structuring, tax disputes and complex tax issues. He is passionate about leading by example, getting wins for his clients, solving difficult legal issues and … snowboarding!