Edited version of your written advice

Authorisation Number: 1013033113117

Date of advice: 13 June 2016

Ruling

Subject: Investment property

Question 1

Are you carrying on a business in relation to your investment property?

Answer

No.

Question 2

Is the property held as a passive investment?

Answer

Yes.

Question 3

Can the rental loss reduce your assessable income in the 20xx-yy financial year?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 20yy

The scheme commenced on

1 July 20xx

Relevant facts

You acquired a share in an investment property for the sole purpose of providing rental accommodation and to earn rental income. All tenants paid rent on a commercial arms-length basis.

You had no management entitlement or responsibility in relation to the property.

The property was later sold to a third party as a going concern.

The property has never been used for private purposes, but continued as rental accommodation.

You did not organize the leases or manage the property.

The investors in the property reported a profit in most years.

You made a capital gain on the sale of your interest in the property.

In the 20xx-yy financial year you made a rental loss.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5(1).

Reasons for decision

Under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997), the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all 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 considers whether rental income constitutes proceeds of a business. IT 2423 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 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).

In applying the above indicators to your circumstances, it is considered that you are not carrying on a business in relation to your investment property.

Your activities are not conducted on a sufficient scale to be considered a business. You do not help to manage the property. Activities constituting the mere maintenance of an asset and the mere collection of income do not indicate the existence of a business. Although the property has many tenants and there is a profit making purpose, this is not sufficient to regard your activities as a business. It is considered that you held the property as a passive investment.

As you are not carrying on a business in relation to your property, Division 35 of the ITAA 1997, which is about the deferral of losses from non-commercial business activities, does not apply.

As your loss is not deferred under Division 35 of the ITAA 1997, the net loss from your property can reduce your other assessable income in calculating your taxable income for the 20xx-yy financial year.

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