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Ruling

Subject: Are you carrying on the business of renting property?

Question

Is the trust carrying on a business of renting out properties?

Answer

No.

This ruling applies for the following period

For the year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

You rent out four commercial properties. The total value of these properties is approximately $X. The properties contain depreciable equipment.

No property manager is engaged. The properties are managed by key members of the unit holders.

There has never been a need to advertise the properties for rent. You have stated that there is no normal or average term for lease periods.

Rent is paid by direct credit. There has not been a need to formulate a collection enforcement policy.

The properties have been purchased in the last few years, in good condition. There has not been a need to effect repairs of any note, except for one small item.

There is no firm rule on who completes repairs. It depends on the nature of the repairs required. Internal repairs are affected by lessees.

One hour per month is spent on accounting for business activities by someone from the group.

There are separate financial records maintained for the unit trust and it has a separate bank account. The income tax return is prepared from these records.

The lessees are responsible for the payment (liability) for rates, water rates and land tax, which is the most common commercial arrangement.

You have borrowed funds to purchase these properties.

Reasons for decision

Summary

You are not considered to be carrying on a business of letting out commercial properties. The activity is not considered to be of sufficient scale/number of properties, the management services required are minimal and you are not involved in providing other associated services that derive income.

The income is predominantly from the letting of the property. The properties do not require day to day management. It is considered that there is passive income derived from the letting of the property by the unit trust, not business income.

Detailed reasoning

Normally the receipt of income from the letting of property to a tenant(s) does not amount to the carrying on of a business (Wertman v. Minister of National Revenue (1964) 64 DTC 5158; Federal Commissioner of Taxation v. McDonald (1987) 15 FCR 172; 87 ATC 4541; 18 ATR 957 (McDonald's Case); Cripps v. FC of T 99 ATC 2428 (Cripps' Case); Case X48 90 ATC 384; (1990) 21 ATR 3389). 

The Commissioner's view on whether the letting of property amounts to the carrying on of a business is found in a number of places.

The ATO publication Rental properties 2010 (NAT 1729-6.2010) states on page 4:

A person who simply co-owns an investment property or several investment properties is usually regarded as an investor who is not carrying on a rental property business, either alone or with the other co-owners. This is because of the limited scope of the rental property activities and the limited degree to which a co-owner actively participates in rental property activities.

Taxation Ruling No. IT 2423 is about whether rental income constitutes proceeds of business (for withholding tax purposes). IT 2423 states:

Whether the letting of property amounts to the carrying on of a business will depend on the circumstances of each case, (Californian Copper Syndicate (Limited and Reduced) v. Harris (1904) 5 TC 159).

A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations. An individual who derives income from the rent of one or two residential properties would not normally be thought of as carrying on a business. On the other hand if rent was derived from a number of properties or from a block of apartments, that may indicate the existence of a business.

Taxation Ruling TR 93/32 is about rental property and division of net income or loss between co-owners. TR 93/32 quotes the legal case of Federal Commissioner of Taxation v McDonald (1987) 18 ATR 957; 87 ATC 4541, were Beaumont J said at ATR p 968; ATC p 4550:

The reference to "business" . . . indicates a "commercial enterprise as a going concern": see Hope v Bathurst City Council (1980) 144 CLR 1 at 8; 12 ATR 231 at 236 per Mason J. Purely domestic transactions are thus excluded from the definition: see Fletcher, op cit p 28. The "business" must be "carried on". This suggests some active occupation or profession: see IRC v The Marine Steam Turbine Co Ltd (1919) 12 TC 174 per Rowlatt J at 179.' . . . 'On the other hand, in the case of a private individual as distinct from a company, "it may well be that the mere receipt of rents from properties that he owns raises no presumption that he is carrying on a business." see American Leaf Blending Co Sdn Bhd v Director-General of Inland Revenue (1979) AC 676 per Lord Diplock at 684.

and at ATR page 969; ATC page 4552, where Beaumont J continued:

In the present case, a number of indications point to the conclusion that the parties were not carrying on a business, with the consequence that their relationship was that of co-ownership rather than partnership. Their investment involved little, if any, active participation from either party ... This was not a case of the active joint participation by the parties in a business activity. Rather, it was a case of a renting out of premises without the provision of other services of the kind discussed in Wertman, supra. In my view, there was here a mere investment in property rather than a partnership in the properties or their profits.

The Commissioner also relied upon the following observations made by Thurlow J. in the Exchequer Court of Canada in Wertman v. Minister of National Revenue 64 DTC 5158 at p. 5167:

On the evidence in the present case the sum received as rentals from the Park Strand should I think be regarded as having accrued to the appellant and his wife and son predominantly, if not entirely, in their capacity as owners of the property rather than as traders, and I also think that the rentals should be regarded as having accrued predominantly, if not entirely, from the use by tenants of the property in the sense that they represent payments for the tenants' occupation thereof rather than payments arising from the process of letting apartments and providing certain limited services such as heat of which the tenants have the benefit. To my mind while there is a sense in which the rentals can be said to be revenues from a business of letting apartments or operating an apartment building for the purpose of securing rentals, it is a fanciful and unrealistic way of describing them for it puts the emphasis of the description of their source where it does not belong viz., on the mere sine qua non or conduit pipe of the letting activity rather than on the fact that they arise from the use or exercise of the owners' right of occupation of the property by tenants who pay not for the letting but for the use of the property.

Taxation Ruling TR 97/11 is about whether a taxpayer is carrying on a business.

TR 97/11 states the question of whether a person is carrying on a business is determined by the facts in each individual case. This is done by considering the following factors that have been used in court cases:

§ the nature of the activities, particularly whether they have the potential of profit making

§ the repetition and regularity of the activities

§ organisation in a business-like manner, the keeping of books or records and the use of a system

§ the volume of the operations

§ the amount of capital employed.

TR 97/11 states the indicators must be considered in combination and as a whole and whether a business is being carried on depends on the 'large or general impression gained' ( Martin v. FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551) from looking at all the indicators, and whether these factors provide the operations with a 'commercial flavour' ( Ferguson v. FC of T (1979) 37 FLR 310 at 325; 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884). However, the weighting to be given to each indicator may vary from case to case.

As shown in the legal cases and the views of the Commissioner listed above, the indicators with the greatest weighting are the scale or volume of operations and the repetition and regularity of activities. Regarding rental properties, the fact of profit making is not a salient indicator (although, as stated in TR 97/11, where an activity looks like it will never produce a profit, the activity will not amount to a business).

In your situation, the Commissioner considers you are not carrying on a business of letting a commercial property.

Scale of activities

In your case some may consider the scale to be substantial because of the value of the property. When considering this factor, we are looking at scale in terms of the number of properties and what management input that may be required to conduct the activity.

There are four commercial properties and one domestic property. The management of these properties appears to require minimal input. You have indicated that:

· one hour per month is required on accounting for the activities

· no advertising has been required

· rent is paid by direct credit

· internal repairs are effected by lessees

· the lessees are responsible for payment of rates, water rates and land tax.

The scale of the activities is not considered to be extensive in terms of saying that a business is being carried on.

Repetition and regularity of activities

Again, we are looking at those activities that would be required in the renting of properties. If there was a block of 30 holiday units rented on a short time basis there is an extensive amount of work conducted on a daily basis in meeting tenants, providing cleaning, linen and other services. The fees paid by the tenants are for both the services and the use of the property and if it is of sufficient scale, because of the regularity of these services it can be argued that they could be carrying on a business of renting properties.

Your commercial properties activity is of a different nature to this, as would be the norm with most commercial properties. The lease periods are usually on a long term basis. From the information you have provided there appears to be minimal management required in terms of services provided.

There is no repetition or regularity of services to indicate that you are carrying on a business of renting properties.

The overall impression is that you are not carrying on a business of renting properties. The income is derived predominantly from the letting of the property and not from activities 'carried on' in relation to renting the properties out.

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