Edited version of your written advice

Authorisation Number: 1012998726982

Date of advice: 18 April 2016

Ruling

Subject: Rental properties

Question 1

Are you carrying on a rental property business?

Answer

No.

Question 2

Are you entitled to claim input tax credits (ITCs) for GST paid on the acquisition of new residential properties?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2016

The scheme commenced on

1 July 2015

Relevant facts

You are not an Australian resident for tax purposes.

You purchased some residential properties. You previously had one rental property.

Two of the new residential properties purchased were bought from the builder and included GST. The properties have the physical characteristics of residential premises as they contain facilities for day-to-day living such as bedrooms, bathroom and kitchen.

You acquired the properties with intention to rent the properties to your relations who operate a business called B.

You have borrowed funds to acquire the properties and have the intention of being profitable as quickly as possible.

You and B entered into a X year lease agreement for each of the properties. The rent payable under the lease agreement is the arms-length market rates.

You do not help in finding tenants for the properties or actively manage the properties.

You have obtained an ABN and are registered for GST.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5.

A New Tax System (Goods and Services Tax) Act 1999, Section 9-5

A New Tax System (Goods and Services Tax) Act 1999, Section 11-5

A New Tax System (Goods and Services Tax) Act 1999, Section 11-15

A New Tax System (Goods and Services Tax) Act 1999, Section 40-35

Reasons for decision

Question 1

Under subsection 6-5(3) of the Income Tax Assessment Act 1997 (ITAA 1997), the assessable income of a foreign resident includes ordinary income derived directly or indirectly from all Australian sources during the income year.

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business.

Business is defined in section 995-1 of the ITAA 1997 to be 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'.

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 Tax Office publication Rental properties 2015 (NAT 1729-06.2015) 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.

Income tax ruling IT 2423 Withholding tax: whether rental income constitutes proceeds of business - permanent establishment - deduction for interest states:

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.

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).

Taxation Ruling TR 93/32 Income tax: rental property - division of net income or loss between co-owners quotes the legal case of Federal Commissioner of Taxation v McDonald (1987) 18 ATR 957; 87 ATC 4541, where 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:

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 question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the particular facts.

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). 

In 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 Income tax: am I carrying on a business of primary production? outlines some factors that indicate whether or not a business of primary production is being carried on. These factors equally apply to other types of businesses. No individual factor is determinative, but should be weighed up in conjunction with the other factors.

In the Commissioner's view, the factors that are considered important in determining the question of business activity are:

• 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, and no one indicator will be decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922).

Applying the relevant 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.

Your activity is the owning residential properties. Currently you own a few investment residential properties. You receive regular income from the properties. You do not manage these properties.

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.

You recently acquired some rental properties and already owned one property. The properties will be rented to your relations at a market rate. You will not actively manage the properties. Your intention is to receive a regular flow of income from the properties.

Prospect of profits

The taxpayer's involvement in a 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.

You have borrowed money to acquire the properties and intend to make a profit as quickly as possible, however no estimated timeframe has been provided to show when a profit might be made. An increase in rent is how your income will increase.

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.

You do not manage any of your properties. Your involvement with the properties is minimal and it cannot be concluded that the level of repetition and regularity of your activity is a business.

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).

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.

Your activity is receiving rental income from your residential properties from your relations.

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.

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.

Example 5 on page 6 of the Australian Taxation Office's Rental properties 2015 booklet involves taxpayers, who own 26 properties, spend approximately 25 hours per week each on managing the properties. You do not do the maintenance or management of your properties and the size and scale of your activities are not considered to be significant. You do not spend much time each week on your rental property activities.

Hobby or recreation

Your level of active involvement in relation to your properties is significantly less than those noted in Case G10. In comparison to the taxpayer in Case G10 their activity involved a significant amount of their time devoted to the holiday letting activity. In your case, you rent the property to your relations and spend very little time on rental property activities. This is not considered to be a significant amount of time for a business activity.

Conclusion

The intention to make a profit is not, on its own, sufficient to establish that a business is being carried on. Where a business exists, there is usually a business plan of how the activities will be conducted.

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. The quantum of rental income derived does not affect the characterisation of the activity.

We acknowledge you own some rental properties and receive regular income from them. This is not considered to be of a scale to take the activity beyond a passive rental income producing activity. After considering your specific circumstances, it is considered that you are not carrying on a rental property business for taxation purposes. Your activities are not conducted on a sufficient scale to be considered to be a business.

After weighing up the relative business indicators and objective facts surrounding your case it is considered that you are not carrying on a rental property business.

Please note that the definition of enterprise under the GST legislation is far broader than the definition of a business for the ITAA 1997 purposes. The fact that you may be carrying on an enterprise for GST purposes does not mean that you are carrying on a business for income tax purposes.

Question 2

You are entitled to an input tax credit for any 'creditable acquisition' that you make.

Section 11-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that you make a creditable acquisition if:

(a) you acquire anything solely or partly for a creditable purpose

(b) the supply of the thing to you is a taxable supply

(c) you provide, or are liable to provide, consideration for the supply, and

(d) you are registered, or required to be registered for GST.

From the facts given, you satisfy paragraph 11-5(b), 11-5(c) and 11-5(d) as follow:

(b) the supply of properties to you was taxable as new residential premises;

(c) you provided consideration for the properties, and

(d) you are registered for GST.

The next step is to determine whether you acquired the properties for a creditable purpose (as per requirement under paragraph 11-5(a) of the GST Act).

Section 11-15 of the GST Act outlines the meaning of a creditable purpose:

(1) You acquire a thing for a creditable purpose to the extent that you acquire it in carrying on your enterprise.

(2) However you do not acquire the thing for a creditable purpose to the extent that:

(a) the acquisition relates to making supplies that would be input taxed; or

(b) the acquisition is of a private or domestic nature.

(3) An acquisition is not treated, for the purposes of paragraph (2)(a), as relating to making supplies that would be input taxed to the extent that the supply is made through an enterprise, or a part of an enterprise, that you carry on outside Australia.

You acquire a thing for a creditable purpose to the extent that you acquire it in carrying on your enterprise (for example, a business). You do not acquire the thing for a creditable purpose to the extent that the acquisition relates to making supplies that would be input taxed (such as, financial supplies and the sale and rental of residential properties), or the acquisition is of a private or domestic nature.

Input taxed supplies

Subsection 40-35(1) of the GST Act provides that the supply of premises that is by way of lease, hire or licence is input taxed if:

a) the supply is of *residential premises (other than a supply of commercial residential premises or a supply of accommodation in commercial residential premises provided to an individual by an entity that owns or controls the commercial residential premises); or

b) the supply is of *commercial accommodation and Division 87 (which is about long-term accommodation in commercial premises) would apply to the supply but for a choice made by the supplier under section 87-25.

Paragraph 40-35(2)(a) of the GST Act states that the supply is input taxed only to the extent that the premises are to be used predominantly for residential accommodation (regardless of the term of occupation).

Residential Premises as defined in section 195-1 of the GST Act is

Residential premises means land or a building that:

(a) is occupied as a residence or for residential accommodation: or

(b) is intended to be occupied, and is capable of being occupied, as a residence or for residential accommodation; (regardless of the term of the occupation or intended occupation) and includes a *floating home.

Goods and Services Tax Ruling GSTR 2012/5, Goods and Services Tax: 'residential premises' provides guidance on residential premises.

Paragraph 10 of GSTR 2012/5 states:

10. The requirement for residential premises to be used predominantly for residential accommodation does not require an examination of the subjective intention of, or use by, any particular person. Premises that display physical characteristics evidencing their suitability and capability to provide residential accommodation are residential premises even if they are used for a purpose other than to provide residential accommodation (for example, where the premises are used as a business office).

Paragraph 15 of GSTR 2012/5 states:

To satisfy the definition of residential premises, premises must provide shelter and basic living facilities. Premises that do not have the physical characteristics to provide these are not residential premises to be used predominantly for residential accommodation.

Based on the facts provided, you are carrying on an enterprise of leasing properties which you own. The properties have the physical characteristics of residential premises as they provide sleeping accommodation and facilities for day-to-day living. As such, they are considered residential premises to be used predominantly for residential accommodation. Furthermore, the sale of contract shows that the properties were sold to you as new residential premises.

You advised us that B intends to use the properties to provide short term accommodation. The fact that B does not intend to use the properties to provide residential accommodation does not change the character of these properties from residential premises. B's intention is not a relevant factor in determining the character of the premises.

Based on the physical characteristics, the new residential properties are residential premises to be used predominately for residential accommodation. Therefore, your supply of properties by the way of lease will be an input taxed supply under section 40-35 of the GST Act.

Subsection 11-15 (2) of the GST Act states that if the acquisition relates to making supplies that would be input taxed, the acquisition is not for a creditable purpose. Therefore, paragraph 11-5(a) is not satisfied.

Accordingly, all the requirements of section 11-5 of the GST Act are not met as the acquisition is not for a creditable purpose. You are therefore not entitled to claim ITCs for the GST paid on the acquisition of these new residential properties as the acquisition relates to making supplies which are input taxed supplies of residential premises.

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