The tax trap of leasing commercial property

4 minute read

There are important effects on capital gains tax that GPs need to know when they lease a practice premises.

Many businesses that operate in the medical industry will acquire their medical rooms by using a separate entity to the one that runs the practice. The owner of the property will then lease the medical rooms to the practice.

There are many reasons for doing this, including asset protection and segregation of different components of the business. However, this separation of ownership can have significant consequences from a Capital Gains Tax (CGT) perspective on a subsequent sale of the property.

This is because the property is not regarded as an “active asset” where its main purpose is leasing.

Where an asset is not an “active asset”, the owner of the asset loses the opportunity to access the CGT small business concessions on a future sale. If the asset has been sold for a profit and has increased in value considerably, this can result in a material CGT liability that is unable to be mitigated.

There is one exception to this general rule however, and that is where the modified active asset test applies. Generally, where a property is leased to a “related” business, the property can be characterised as an active asset so long as the related business is carrying on an “active” business.

For GPs, this means that so long as the rooms are used by an affiliate or a connected entity in conducting their medical practice, the rooms should be characterised as an “active asset”.

On this basis, an important consideration is whether the owner of the property and the entity carrying on an active business are affiliates or sufficiently connected and if so, what the nature of the active business is.

This requires an analysis of the underlying ownership structure, the breakdown of who in substance and in form controls the entities and the historical entitlements to profits.

Importantly, if an external party is involved (for example, an additional ownership interest in the medical practice who does not hold an ownership interest of the property owning entity), this could jeopardise or limit the ability to access the CGT small business concessions on the basis that the affiliate / connected entity test is failed.

In addition to GP clinics, this is also a common issue for farming clients, particularly where a farm has been inherited within a family group and the new owners elect to lease the property rather than continue with a farming enterprise.

In this situation, notwithstanding that a farm is typically regarded as an active asset, the change of use by the owners to “leasing” can re-characterise the property as a passive investment. Unless the affiliate / connected entity tests can be satisfied, there is a risk that owners will be unable to avail themselves of the CGT small business concessions.

So, before you buy a commercial property or agree to transfer an asset within a structure where ownership interests have changed, make sure you:

  1. Get personalised advice to ensure you are aware of the risks and your obligations.
  2. Aim to settle the acquisition structure prior to purchase so there are no inadvertent risks to accessing the CGT small business concessions.

If you require any assistance or would like to discuss a potential property purchase, contact Josh Flett for a preliminary discussion.

Josh Flett is a director at Fletcher Clarendon Lawyers. He advises professionals and business owners on setting up, running, and acquiring or divesting of interests in businesses, with a particular focus on the medical and technology industries. This piece was commissioned by DPM.

Disclaimer: This article is intended to provide commentary and general information. It should not be relied on as legal or financial advice. Formal legal advice from specialist medical law firm Fletcher Clarendon

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