Edited version of your private ruling

Authorisation Number: 1012357597472

This edited version of your ruling will be published in the public register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.

Ruling

Subject: Rental properties

Question

Are you carrying on a rental property business?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2013

The scheme commences on:

1 July 2012

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· the application for private ruling, and

· the documents provided with the application for private ruling.

Up until recently, you had engaged the services of a real estate agent to manage some of your properties.

You and your spouse have devised a plan to take control of all of the investment properties and administer the properties yourselves.

You currently spend X hours per week, including travel time over the course of each year, tending to the properties for both maintenance purposes, administration of finances including payment of bills, carrying out property inspections and attending committee meetings associated with each property.

This does not take into account the time spent researching other potential future property investment ventures.

You have had extensive training in property investment, property lending and credit analysis.

You have had many dealings with property valuers, real estate agents and other lenders throughout your career.

You hold less than X investment properties.

Your investment decision was based on research leading you to high growth areas. Your strategy is now geared with a focus of high returns from investment is now providing a good mix of capital growth and return on investment.

In making your investment decisions, you have attended numerous investment seminars and rely heavily on you own experience and industry network contact base that you have built up over the years.

You research databases, economic reports and read articles in financial newspapers as well as discussion with contact within the building industry.

You seek advice from your accountant on a regular basis in relation to the best debt structures in which to manage your portfolio and you have risk insurance in place to protect all assets contained within your portfolio.

You do not use accounting software to manage your portfolio. However, you do use a computer spreadsheet system to track the income and expenses of each investment property.

You have an office at your residence where all records are stored. The current records are stored in filing cabinets and archived into storage cupboards at the end of each financial year.

Your spouse carries out all repairs and maintenance needed on the properties including tending to the gardens and painting of interior and exterior structures.

All of the properties are tenanted and all tenants are non-related parties of both you and your spouse. The properties are not holiday homes. They are rented out long-term.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5(1),

Income Tax Assessment Act 1997 section 8-1 and

Income Tax Assessment Act 1997 section 995-1.

Reasons for decision

Summary

It is considered that the scale of activity and volume of operations carried on by you is insufficient to be considered as carrying on a business.

Detailed reasoning

Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states that your assessable income includes income according to ordinary concepts. This 'ordinary income' includes amongst other things, income from salary and wages and business operations.

Section 8-1 of the ITAA 1997 allows you to claim a deduction for a loss or outgoing that is incurred in gaining or producing your assessable income, or necessarily incurred in carrying on a business to gain or produce assessable income. These deductions are limited by the exclusion of losses or outgoings that are capital, private or domestic in nature.

Carrying on a business

Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

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). 

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). Generally, it is easier for a company that derives income from the letting of property to show that it carries on a business than it is for an individual (paragraph 3 of Taxation Ruling IT 2423).

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 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. A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations. If rent was derived from a number of properties or from a block of apartments, that may indicate the existence of a business (paragraph 5 of IT 2423).

The issue of whether individuals are carrying on a business of letting property has been considered in a number of cases, some of which are discussed below.

In Cripps v. FC of T 99 ATC 2428; (1999) 43 ATR 1202, the taxpayer and his wife purchased, as joint tenants, 14 townhouses which they rented out. They also purchased a property which was used initially as a holiday home but was later periodically rented out. A further property was purchased for residential purposes. After a failed attempt to sell it, it was also rented out. The Administrative Appeals Tribunal found that the taxpayer and his wife were mere passive investors and were not in the business of deriving income from rental properties. They rejected the taxpayer's argument that he had greater involvement with his 16 properties.

In 11 CTBR (OS) Case 24 (Case 24), the taxpayer's income included rents from three properties. The taxpayer employed a manager and an accountant - he was principally a letting clerk with authority to refuse tenants. He collected and banked rents, attended to repairs and supervised them, and controlled the caretaker and cleaners. He kept books in connection with rents and repairs, and rates and other outgoings. The taxpayer said he personally carried out the principal part of the management of his rent-producing properties and directed policy, attended to the financial arrangements and made decisions regarding repairs. The taxpayer claimed that he was carrying on a business. In holding that he was not carrying on a business, a majority of the members of the Board of Review said:

It is obvious that some measure of supervision and management must ordinarily be exercised by a property owner who lets offices, &c., and if that does not amount to the carrying on of a business, the fact that he employs others to assist him, either in the letting of the properties or in the preparation of the accounts relating to his rents and outgoings, will not make any difference. For the foregoing reasons we are unable to uphold the claim that the taxpayer is engaged in a 'business as property owner' ... .

In 15 CTBR (OS) Case 26, (Case 26) the taxpayer derived income substantially from her joint ownership of a block of flats (containing 22 living units) with her sister-in-law. A swimming pool was shared with a neighbouring block of flats owned by the taxpayer's husband and his brother. A garden was maintained and a staff of one caretaker and one cleaner employed on both buildings with casual labour as required. The building was erected and financed by F & Co., the husbands of the joint owners, in the course of their business as building contractors. The general supervision of letting, rent collecting, servicing and maintenance was carried out by the owners or by F & Co. on their behalf. No charge was made by F & Co. for the extensive assistance given in the supervision of the flats. It was held that a business was not being carried on by the owners of the block of flats. A

On the other hand, Case G10 75 ATC 33 (Case G10), the taxpayer owned two properties of which six units were let as holiday flats for short term rental. The taxpayer, with assistance from his wife, managed and maintained the flats. Services included providing furniture, blankets, crockery, cutlery, pots and pans, hiring linen and laundering of blankets and bedspreads. The taxpayer also showed visiting inquirers over the premises, attended to the cleaning of the flats on a daily basis, mowing and trimming of lawns, and various other repairs and maintenance. The taxpayer's task in managing the flats was a seven day a week activity. The Board of Review held that the activity constituted the carrying on of a business.

Taxation Ruling TR 97/11 (TR 97/11) provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. Whilst TR 97/11 specifically discusses primary production activities, the factors can be applied to other types of businesses. The factors include:

· whether the activity has a significant commercial purpose or character

· whether the taxpayer has more than just an intention to engage in business

· whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

· whether there is regularity and repetition of the activity

· whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business

· whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

· the size, scale and permanency of the activity, and

· whether the activity is better described as a hobby, a form of recreation or sporting activity.

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 above 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 the activities.

Applying the relevant cases and indicators to your circumstances

Significant commercial purpose

The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators.

You began renting out a property in June 20XX. There are currently less than ten rental properties being let to long term tenants.

Intention of the taxpayer

The carrying on of a business is not a matter merely of intention, it is a matter of activity. It is appropriate to look at when the activities started and whether they add up to more than a mere intention to conduct a business.

The first property was rented from June 20XX and four more properties have been purchased to date. You and your spouse have undertaken the daily running and maintenance of the properties.

Prospect of profits

The taxpayer's involvement in the business activity should be motivated by wanting to make a tax profit and the taxpayer's activities should be conducted in a way that facilitates this. This will require examining whether objectively there is a real prospect of making such a profit from participating in the business of the taxpayer.

The rental properties have not been profitable since their purchase. Although, you contend there is a profit making intent that will not be realised in the short-term.

Repetition and regularity

The taxpayer's activities should involve repetition and regularity and have an air of permanence about them. With regards to letting of properties, repetition and regularity may be measured by factors such as regularity of maintenance, collecting of rent, management and advertising of the properties, insurance, dealing with tenancy agreements and inspection reports.

The management and maintenance of the property is undertaken by you and your spouse. The level of repetition and regularity of the activity is not as great as that noted in Case G10 where the taxpayers rented out short term holiday units. The involvement is similar to the circumstances noted in Case 26. In this case, despite the management and maintenance activities undertaken, the property owners were not considered to be carrying on a business of letting properties.

Activities of the same kind and carried on in a similar manner to those of the ordinary trade in that line of business

If a taxpayer carries out their activity in a manner similar to other taxpayers in the industry, it is more likely that their activity amounts to the carrying on of a business. That is, the taxpayer's operations are of the same kind and carried on in the same way as those characteristic of ordinary trading in that particular line of business (IR Commissioners v. Livingston 11 TC 538).

This indicator requires a comparison between the activities of the taxpayer in question and those undertaken by a person in business in the same type of industry. Where the taxpayer's activities are similar in nature to the business, further support is given to the fact that a business exists.

Generally, where the property owners grant exclusive possession of the property to the residents the relationship between the two parties is one of tenant and landlord, and the activity is more likely to be passive investment rather than a business. Similarly, activities constituting the mere maintenance of an asset and the mere collection of income do not indicate the existence of a business of renting premises.

You are renting out residential properties on a long term basis hence the relationship is that of a landlord and tenant.

Organisation in a business-like manner, the keeping of books, records and the use of a system

The activities conducted by, or on behalf of the taxpayer, should be carried out in a systematic and organised manner. This will usually involve matters such as the keeping of appropriate business records by the taxpayer. If the activities are carried out on the taxpayer's behalf by someone else, there should be regular reports provided to the taxpayer on the results of those activities.

All properties are tenanted by non-related parties on a long term basis. You have an office at your residence where all records are stored and a property investment business plan. You possess expertise in the rental property market and carry out extensive research prior to acquiring a new property.

The size and scale of the activity

The business should be large enough to make it commercially viable. In Cripps' Case, it was held that the renting of 14 two storey townhouses was not a business and in McDonald's Case it was held that the letting of two units in different strata plans was also not a business. Similarly in Cases 24 and 26 the renting of 22 units and three properties respectively was also not considered a business.

The scale of your activities and volume of operations is similar if not less extensive than the cases listed above.

Hobby or recreation

The activity does not have the nature of a hobby or recreational pursuit. The nature of your activity is similar to other rental property owners who are actively involved in some aspect of the property they own.

Conclusion

In this case, it is considered that you are not carrying on a business of rental properties. You derive rental income from less than ten properties. There properties are rented on a long term basis as opposed to the short term holiday flats rented out by the taxpayer's in Case G10.

We acknowledge that you carry out extensive research prior to purchasing a property and perform all of the activities required for the management and maintenance of the properties. However, the undertaking of management and maintenance, level of involvement, scale of activity and volume of operations in the activity is far less extensive than the tasks noted in Case G10. The circumstances surrounding the management and maintenance are similar to the owners noted in Case 26 which was not considered to be a business.

Having given consideration to the relative business indicators and the facts of case, it is considered that you are not carrying on a business of renting properties.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).