Edited version of your written advice

Authorisation Number: 1013055773400

Date of advice: 20 July 2016

Ruling

Subject: Am I in the business of letting rental properties?

Question 1:

Are you and your spouse carrying on a business of letting rental properties?

Answer:

No.

Question 2:

Will the properties be considered active assets for the purposes of the capital gains tax (CGT) concessions for small business?

Answer:

No.

This ruling applies for the following periods

Income year ending 30 June 2016; and

Income year ending 30 June 2017.

The scheme commences on

1 July 2015.

Relevant facts and circumstances

Information and documentation has been provided with this ruling which should be read in conjunction with, and forms part of the scheme.

Background

After 20 September 1985, you and your spouse purchased a property (Property A) and acted for yourselves throughout settlement. You and your spouse painted Property A and advertised it for rent in the local paper. You and your spouse chose the tenant and managed the property, being the first point of call for any repairs.

You and your spouse have modified your approach for other properties in that you and your spouse use a rental agency, to attract high-end tenants by taking a more professional approach. You engaged the services of a rental consultant to assist you to find tenants from their database who were willing to pay a rental premium for your property. Once the tenant was secured, it was your plan to then assume the management and ongoing running of the property yourselves in that you would communicate directly with the tenant as needed, collect the rent and be directly responsible for all repairs and maintenance.

As your approach worked, you made it a practice for all future properties that were of a higher standard, although you and your spouse have continued to advertise Property A and Property E.

The rental consultant has been engaged by you and your spouse as needed to provide expert advice on the market rental/sales and to assist you with the process of attracting tenants willing to pay premium rental. You have used their services to find tenants for Properties B, C, D, H and J. After the tenant is chosen from the rental consultant's client database, you and your spouse take over full management of the property yourselves, including all repairs and maintenance. You also handle the rollover agreements yourselves.

Property J was purchased in your child's name with funds you and your spouse lent to them, which were sourced from the proceeds from the sale of Property F. You and your spouse's names are not on the title of Property F, with your child's name being the sole name on the title.

Your child lived in Property J for over 12 months and then for a number of periods of shorter periods. Property J is rented out and you and your spouse maintain and manage it at all other times. There is a separate bank account in relation to this property. You and your spouse charge interest rates against this property to your child when it is rented out and include the same amount as income in your income tax returns.

Your child still owes the majority of funds you and your spouse loaned to them to acquire Property J.

Property G was initially owned in partnership with a relative and their share was subsequently purchased by Person A, with the property being sold a few years later to provide funds to purchase Property E in partnership with the Trustee.

Facts of you and your spouse's situation

You and your spouse, being Person A and/or Person B, currently own and have sold a number of properties (Refer to table below).

Person A is the director of a company (the Trustee) which is the Trustee of the Superannuation Fund.

Person A and the Trustee jointly own Property E (Refer to table below). .

The Trustee solely owns Property H (Refer to table below).

You and your spouse wish to transfer your properties into your self-managed superannuation fund and to hold onto your assets to receive retirement income in future years.

You and your spouse have engaged the service of a rental consultant as needed to provide expert advice on market rentals/sales and to assist you with the process of attracting tenants willing to pay premium rental for your properties. The tenant is chosen from the rental consultant's database after which you and your spouse take over full management of the property, including repairs and maintenance.

The rental consultant vets the rental applications, and draws up and negotiates the lease agreements for new tenants

You and your spouse pay a specified number of weeks rent to the rental consultant for their services. This fee is the same with or without the lease agreements.

You and your spouse have used the services of the rental consultant in relation to Properties B, C, D, H and J.

You and your spouse:

• advertise and manage Properties Property A and Property E; and

• review the rental applications and prepare the lease agreements for those properties.

You and your spouse advertise properties on an internet website and in your local paper.

The terms of the leases for the properties are for around six months and longer, with subsequent extension agreements negotiated directly between you and your spouse and the tenants.

The tenants transfer the rental amounts electronically into your bank accounts. The rental income for all of the properties, with the exception of Properties H and E, are banked in one bank account. The rental income for Property H and the relevant portion of the rental income for Property E are banked in the Superannuation Fund's bank account

You and your spouse personally vet all tradesmen/suppliers directly before engaging them. You personally attend and supervise their work and pay them directly, or contributed in the case of the Superannuation Fund ownership interests.

You and your spouse deal with suppliers directly and pay all invoices yourselves.

You and your spouse personally maintain the properties, with Person A being able to attend to most problems. If the problem requires a tradesman, or if it is beyond Person AS's ability, you and your spouse have regular tradesmen whose services you use. Person B is in a relevant industry that does most of the painting and repainting of all properties.

You and your spouse have undertaken the following activities in relation to your properties:

• stripped and installed new bathroom and kitchen in Property A. Replaced skirting boards, architraves and doors. Work undertaken by you and your spouse, and other tradesman.

• repainted Property J numerous times since it was purchased. Replaced skirting boards and architraves. New wiring and lights installed by electrician.

• completed extension in Property H. Installed new kitchen and bathroom, timber floor ceilings and walls replastered. New wiring, new doors installed and other various renovations using the services of a builder.

• repainted Property I prior to its sale

• installed new kitchen, undertook repairs with house at Property E. Work completed by Person A with the house being full repainted by Person B

• renovation undertaken by you and your spouse over a period of more than 12 months, with assistance from a builder, and other tradesman; and

• installed new bathroom, removed carpets, sanded and polished floorboards, repainted walls, windows and doors in Property F. Work undertaken by you and your spouse with the assistance of relevant tradesman. Repainted prior to its sale.

The lessees contact you and your spouse directly for any assistance in relation to repairs/maintenance issues. Your contact details are on the lease agreements and you make yourselves available and aim to attend to all problems within 24 hours.

The receipts in relation to the properties are maintained in folders and spreadsheets kept by you and your spouse.

Property inspections are undertaken on a quarterly basis by you and your spouse, at a time agreed by the tenant, usually with one week's notice.

You and your spouse have estimated that you each spend up to 20 hours per week on the properties when not renovating, and up to around 50 hours per week when renovating a property. The renovations have taken up from 6 months to over 12 months to complete, on occasions working 7 days per week during the renovation. You and your spouse worked 10 hour days, usually seven days a week, for over 12 months. You have outlined that you spend the following time on the properties:

• Due to the number of properties you and your spouse own, there is a quarterly inspection for one of the properties around every two weeks. The average time spent on the inspections is around two hours per inspection

• You and your spouse average less than 6 hours per week on maintenance and repairs. This time is increased when the property is between tenants as you take that opportunity to undertake more major repairs/projects, such as repainting, indoor and outdoor cleaning, repair of broken or damaged items

• Properties B and E both have gardens which you and your spouse maintain as the tenants generally tend to overlook their care. This takes on average one full day for each property with both of you undertaking the work, around every four weeks; and

• Accounting and administration, including checking rents and have been paid, paying bills such as council rates, levies, water rates and gas. This takes on average less than seven hours per week.

You and your spouse have borrowed funds in relation to the properties and currently have a total amount of borrowings of $X,X00,000.

You and your spouse control, maintain, and manage your properties and the properties and ownership interests owned by the Superannuation Fund and your child.

You and your spouse have received receipts from the Superannuation Fund during the previous income years.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Paragraph 152-40(4)(e)

Income Tax Assessment Act 1997 Section 995-1

REASONS FOR DECISION

QUESTION 1:

Are you and your spouse carrying on a business of letting rental properties?

Summary

The Commissioner considers you and your spouse are not carrying on a business of letting rental properties. Whilst you personally perform most of the activities required for the managing and maintenance of your rental properties, your scale of your activities and volume of operations is too small to be considered as carrying on a business.

The income received in relation to your properties from the letting of the properties, is viewed as being passive income and not business income.

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, investment income 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.

Whether the letting of property amounts to the carrying on of a business will depend on the circumstances of each case.

A person who simply owns an investment property or several investment properties, either alone or with other co-owners, is usually regarded as an investor who is not carrying on a rental property business. The person receives the rental income due to being the owner of the investment property as compensation for making the property available for the tenant's use and enjoyment and not as a result of any services provided to the tenant. The person would also be expected to incur holding costs and maintenance expenses which become deductible due to the relationship to the rental income.

A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations.

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 (Cripps case), 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.

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 Income Tax: am I carrying on a business of primary production? (TR 97/11) provides the Commissioners view of the factors used to determine if a taxpayer is in business for tax purposes. Its principles are not restricted to questions of whether a primary production business is being carried on.

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.

Taxation Ruling IT 2423 Withholding tax: whether rental income constitutes proceeds of business - permanent establishment - deduction for interest, states at paragraph 5:

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.

The issue of whether the owner of one or several properties, in providing accommodation, is carrying on a business has arisen in a number of cases. Taxation Ruling TR 93/32 Income tax: rental property - division of net income or loss between co-owners, states at paragraph 22 and 23:

22. As a general proposition, it is more accurate to describe the owners of rental property in the words of Beaumont J in McDonald's case at ATR p.969; ATC p 4552 'as co-owners in investment rather than as partners in a business operation.

23. That is not to say that co-owners cannot carry on a business of property rental and therefore be partners at general law. As already noted, whether an activity constitutes the carrying on of a business is a question of fact to be decided on a case by case basis.

In the Rental Properties 2015 guide (Rental Properties guide) published by the Australian Taxation Office the Commissioner sets out two examples that discuss the issue of whether or not the owner of one or more rental properties can be said to be carrying on a business.

The first example, Example 4 on page 5 of the guide, outlines a situation in which the owners are not carrying on a rental property business. The Commissioner states:

The Tobin's own, as joint tenants, two units and a house from which they derive rental income. The Tobin's occasionally inspected the properties and also interview prospective tenants. Mr Tobin performs most repairs and maintenance on the properties himself, although he generally relies on the tenants to let him know what is required. The Tobin's do any cleaning or maintenance that is required when tenants move out. Arrangements have been made with the tenants for the weekly rent to be paid into an account at their local bank. Although the Tobin's devote some of their time to rental income activities, their main sources of income are their respective full-time jobs.

The Tobin's are not partners carrying on a rental property business - they are only co-owners of several rental properties.

The second example, Example 5 on page 6 of the guide, outlines a situation in which the owners are carrying on a rental property business. The Commissioner states:

The D'Souza's own a number of rental properties, either as joint tenants or tenants in common. They own eight houses and three apartment blocks - each block comprising six residential units - a total of 26 properties.

The D'Souza's actively manage all of the properties. They devote a significant amount of time - an average of 25 hours per week - to these activities. They undertake all financial planning and decision making in relation to the properties. They interview all prospective tenants and conduct all of the rent collection. They carry out regular property inspections and attend to all of the everyday maintenance and repairs themselves or organise for them to be done on their behalf. Apart from income Mr D'Souza earns from shares, they have no other sources of income.

The D'Souza's are carrying on a rental property business. This is demonstrated by:

• the significant size and scale of the rental property activities;

• the number of hours the D'Souza's spend on the activities;

• the D'Souza's extensive personal involvement in the activities; and

• the business-like manner in which the activities are planned, organised and carried on.

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

In many instances, it is obvious that an activity is being carried on as a business and no further investigation is required.

Where it is less obvious, regard must be had for any other potential outcome when determining whether a particular activity should be considered to constitute a business and in determining the tests are to be applied in reaching such a determination.

There are many decided cases that consider the issue where the potential outcome is between 'business or hobby'. In this case, we are considering the question of 'Are you carrying on a business' with the other potential outcome being that the activity constitutes an investment that generates assessable income.

Commissioner considers matters on a case by case basis according to the facts of that case. Therefore, we have taken the factors from TR 97/11 as outlined above into consideration and applied them to the facts of your situation when making our decision as to whether or not you are carrying on a business of letting your rental properties.

The following statements have been provided in relation to you and your spouse's plan and approach to your properties:

• You and your spouse had decided to make property investment and creating a property business our core strategy to build our wealth, generate an income, and provide for our retirement

• Between the two of you, one of you had numerous years' experience in owning properties and the other has skills useful in relation to the properties. The combination of your skills and experience would enable you and your spouse to run a rental property business yourselves and turn it into a profitable enterprise

• It became apparent that the better presented properties commanded a premium rental and generated more profits, so you and your spouse have continued to focus your efforts in that direction and to acquire properties that you can renovate to a high standard and then to rent out for a premium, while maintaining and managing them yourselves

• You and your spouse control, maintain and manage not only the properties in your names, but those held by the Trustee and your child

• You and your spouse have always been thinking of ways to increase profits and make your enterprise more successful and professional and have taken every opportunity to grow your holdings, such as when the equity on your properties increased due to an increase in market value as a proportion of your loans, you have borrowed against this increase to assist in the purchase of other properties, noting your serviceability of interest against your debt of a specified percentage rate

• You and your spouse purchased properties for the purpose of providing an income for living, to support your family, and to support yourselves in your retirement. Any property purchase, with the exception of your family home, has been purchased for the purpose of producing income

• You and your spouse devise and develop your strategies on an ongoing basis. The only change to your current business strategy is that you are investigating the idea of turning Property E into a short term fully serviced short stay accommodation to meet the demands of overseas travellers not wanting to stay in hotels could be a positive move with great profit potential; and

• For many years, you and your spouse have developed knowledge and skills that you intend refining to produce higher returns

In the context of considering the above authorities and factors, the following general observations of the arrangement can be made:

• It is stated that you and your spouse manage numerous properties. However, based on the information provided with this ruling you and your spouse only have ownership interests in some of the properties, with the Trustee having ownership interests in some of the properties, and your child having a 100% ownership interest in one property.

While you and your spouse undertake activities in relation to the ownership interests owned by the Trustee and your child, those properties and activities will not be taken into consideration when we are considering whether or not you and your spouse are carrying on a business of letting rental properties. Only the properties in which you and your spouse have ownership interests and the activities you and your spouse undertake in relation to those properties will be taken into consideration.

• It is viewed that the time you and your spouse spend in relation to the ownership interests held in the other properties by the Trustee and your child is a private arrangement, and not part of you and your spouse's activities in relation to your ownership interests in your properties

• You and your spouse advertise and manage Property E

• You and your spouse have engaged the services of a rental consultant to source tenants from their database in relation to Properties B, C, D, H and J. After the tenant is chosen from the rental consultant's client database, you and your spouse take over full management of the properties yourselves, including all repairs and maintenance. You also handle the rollover agreements yourselves.

• It is stated in the ruling that the rental return from the properties under your umbrella accounts for the majority of you and your spouse's income, and is your main source of income. However, whether rental income is a taxpayer's sole, or main, source of income is not in itself a determinative of carrying on a business.

As outlined above, the ownership interests in properties held by the Trustee and your child will not be taken into consideration when we are determining whether or not you and your spouse are carrying on a business of letting rental properties. Therefore, the income earned from those ownership interests will not be considered.

You and your spouse have not lodged your income tax returns for the income years covered by this ruling. Therefore, we cannot determine the correctness of the above statement made in the ruling. However, in the 2014-15 income year you and you're your spouse received a combined net rental amount which was less than half the amount of combined receipts you received from the Superannuation Fund

It has been stated that due to your efforts in regards to major renovations, ongoing tenant care, property maintenance and management, you and your spouse have seen profits increase.

It is a rare business that does not seek to maximise its revenue by maintaining its assets to an acceptable standard, and while not decisive, it is relevant. But in doing that, it does not mean that they have conducted their activities in owning and managing the properties in a manner that is business-like.

You have stated that renovations of some of the properties have taken considerable time, being from around six months to over 12 months, with you and your spouse undertaking the activities, with the assistance of professionals in relation to the activities you and your spouse could not undertake.

It would be reasonable to expect anyone carrying on a business of letting properties to have any repairs/renovations undertaken in a timely manner to ensure that any period the rental property is not available for rent, or is rented out, is minimised.

It would be reasonable to expect that major renovations would not be undertaken by the property owners themselves, but that they would engage the services of professionals to undertake renovations so that they are completed in an expedient and professional manner.

While we can appreciate that you and your spouse had wanted to complete as much of the renovation work yourselves to save money, your approach in relation to the renovations appears to be of a more passive nature during which you and your spouse have undertaken much of the renovation activities in a leisurely fashion at your own pace. It would not be considered reasonable to expect that anyone carrying on a business would have spent such lengthy periods of time on renovations, forgoing rental income for such long periods.

Also, if the rental income was you and your spouse's main source of income, then it would be reasonable to expect that you and your spouse would have wanted the renovations completed as quickly as possible so that you could make a profit from the rental income.

• You and your spouse spend a full day around every four weeks on the garden at Property E.

It would be reasonable to expect that the rental amount received for the property would be increased to account for you and your spouse undertaking the maintenance of the garden at this property. Otherwise, it would be reasonable to expect that the tenant would lose some of their bond if the property, including the garden, was not left in good condition at the end of the lease. It is viewed that you and your spouse have committed time beyond what would be expected under normal lease agreements in relation to the maintenance of the property and that you have chosen to undertake the gardening activities in relation to this property.

Also the gardening activities are considered to be services to the property and not services provided for the tenant. The undertaking of this activity by you and your spouse does not differentiate you from either private or passive investors who are maintaining the gardens at their properties

It is noted that Property E is a terrace property with small front and back yards.

• You and your spouse engage the services of a rental consultant to assist you in finding tenants from their database for Properties B, C, D, H and J.

After the tenant has been chosen, you and your spouse take over the management of the properties. The leases for the properties are for periods of six months and longer, and you and your spouse negotiate extensions to lease agreements directly with the tenants

• The market value of you and your spouse's ownership interests in the properties is $X,XXX,000. The loan amount owing on your combined ownership interests as stated with this ruling is $X,XXX,000. You and your spouse's combined net rental for the 2014-15 income year was less than X% of the loan amounts owing and less than X% of the market value of your ownership interests in the properties. These represent investment level returns on the value of the assets

• It is stated that you and your spouse have always been thinking of ways to increase profits and make your enterprise more successful and professional and have taken every opportunity to grow your holdings, such as when the equity on your properties increased due to an increase in market value as a proportion of your loans, you have borrowed against this increase to assist in the purchase of other properties, noting your serviceability of interest against your debt of XX%.

You and your spouse purchased the properties over numerous years between 1995 and 2013. You and your spouse sold the following properties:

• Property F to source funds to loan to you child so that they could purchase Property J; and

• Property I, which was sold to source funds to purchase to purchase Property E in partnership with the Trustee.

The size and scale of your rental property activities have not changed for a number of years. Based on the information provided, the reason you have sold any properties was to finance the purchase of your child's property and a obtain a joint ownership interest in a property with the Trustee

• It is stated that you and your spouse purchased properties for the purpose of providing an income for living, to support your family, and to support yourselves in your retirement. Any property purchase, with the exception of your family home, has been purchased for the purpose of producing income.

The net rental income from you and your spouse's properties in the 2014-15 income year was $X0,XXX

• You and your spouse spent time on accounting and administration activities, including checking rents and have been paid, paying bills such as council rates, levies, water rates and gas.

It is reasonable to expect anyone investing in rental properties, including passive investors, to keep records in relation to their rental property/ies so that they can keep informed as to whether or not they are making a profit in relation to the rental property/ies and to make decisions as to what activities to undertake in relation to their rental properties to maximise their returns.

Passive investors also undertake other activities such as paying bills in relation to their properties. Therefore, it is not considered that this is a determinative factor

• The amount of time you and your spouse spend on many of the activities related to the rental properties appears excessive and may not represent an efficient allocation of resources in the business sense. A business activity is always searching for more efficient ways of achieving outcomes; and

• You and your spouses' activities do not have the nature of a hobby or recreational pursuit. The nature of the activity is similar to other rental property owners who are actively involved in some aspect of the property they own.

Conclusion

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

This case can be distinguished from Cripp's case as in that case the scale, being 16 townhouses, was far greater than in you and your spouse's ownership interests in four and a half properties. Despite the fact that 16 townhouses were rented the AAT found that the taxpayers were mere passive investors and not in the business of deriving income from rental properties.

Similarly in Case 26, despite the scale of operations of 22 units, the AAT found a business was not being carried on by the owners of the block of flats. Again the quantity of rental units is far in excess of you and your spouse's properties.

Also, you and your spouse's circumstances are not similar to the examples provided in the Rental Property guide as outlined above.

We acknowledge that there are some elements of you and your spouse's activities that add weight that the activity has a business like nature such as the investment of capital, the length of time the activities have been undertaken and the activities you and your spouse personally undertake in relation to the properties. However, the majority of your activities are considered to be in line with those required of a passive investor in rental properties. They are activities undertaken to service the properties, such as repairs and maintenance. The properties are not furnished and no services are being provided for the tenants.

It would be reasonable to expect any property owner, either in general or a passive investor, to undertake any repairs/maintenance they have the capacity to undertake so that they do not have to engage the services of tradesmen, thereby reducing their expenses. The undertaking of the repair and maintenance activities does not change the character of your rental property activities from investment to business.

There is no evidence to suggest that the properties are rented as short term (nightly or weekly) rentals; rather, they are rented under lease agreements which are generally six months in length.

The relationship between you and your spouse, and the residents of the properties, is that of a landlord and tenant; where the tenants have exclusive possession and control access to and from the properties.

The undertaking of managing and maintenance, level of involvement, scale of activity and volume of operation in your activity is not as great as that noted in Case G10.

You and your spouse undertake activities in relation to the types of records and tracking for a rental investment would not be dissimilar for a passive investor and someone carrying on a business of letting rental properties given that rental income and expenses need to be recorded and property analysis reports and financial rations would be useful to invest further, or make any decisions about the performance of the rental property/ies.

You and your spouse spend time on administration and accounts relating to the properties. These activities are not different from those undertaken by a passive investor who owns a number of investment properties.

The rental income received in relation to the rental properties was at the market value. It can be viewed that the returns you and your spouse received in relation to the properties were merely from holding the properties and is passive income and not from selling, buying the properties. While you and your spouse had undertaken renovation activities to gain increased rental income, or obtain a profit from selling a property, based on the information provided these activities were not always undertaken in the most expedient manner as would be the course of action undertaken by someone seeking to gain rental income from their properties.

You and your spouse's activities in the income years covered by this private ruling support that while you and your spouse held ownership interests in a number of rental properties, you and your spouse are a passive investors. You have held the same ownership interests in the properties for a number of years.

Based on the information and documentation provided, it is the Commissioner's view that you and your spouse's rental property activities are better described as leasing residential properties to receive passive income from a stream of rental income. The income is not derived from the services you and your spouse provide to the tenants, but from the letting and servicing of the properties.

Accordingly, it is the Commissioner's view that you and your spouse are not carrying on a business of letting rental properties and are a passive investor with a number of rental properties.

Note: The 2016 Budget has announced some changes to superannuation which may affect your ability to implement your strategy.

QUESTION 2:

Will the properties be considered active assets for the purposes of the capital gains tax (CGT) concessions for small business?

Summary

Assets cannot be active assets if the assets whose main use by the taxpayer is to derive rent. Section 152-40(4)(e) of the ITAA 1997.

Detailed reasoning

A CGT asset will be an active asset for the purposes of the ITAA 1997 if it satisfies one of the positive tests set out subsection 152-40(1) of the ITAA 1997 and it is not excluded by one of the exceptions contained in subsection 152-40 of the ITAA 1997.

Positive test - Carrying on a business.

Under paragraph 152-40(1)(a) of the ITAA 1997 a CGT asset is an active asset (subject to exclusion that will be discussed below) if it is owned by a small business entity and is used or held ready for use by that small business entity in the course of carrying on a business.

Exception - Main use to derive rent.

Paragraph 152-40(4)(e) of the ITAA 1997 provides that an asset whose main use in the course of carrying on the business is to derive rent, cannot be an active asset unless that main use for deriving rent is only temporary.

In the Advanced guide to capital gains tax concessions for small business published by the Australian Taxation Office the Commissioner states:

Whether an asset's main use is to derive rent will depend on the particular circumstances of each case. The term rent has been described as referring to payments made by a tenant/lessee to a landlord/lessor for exclusive possession of the leased premises. As such, a key factor in determining whether an occupant of premises is a lessee paying rent is whether the occupier has a right to exclusive possession. If, for example, the premises are leased to a tenant under a lease agreement granting exclusive possession, the payments involved are likely to rent and the premises will not be an active asset. On the other hand, if the arrangement only allow the person to enter and use the premises for certain purposes and does not amount to a lease granting exclusive possession, the payments involved are not likely to be rent.

Example

Rachael owns five investment properties which she rents to tenants under lease agreements granting exclusive possession. The lease terms vary from six months to two years. The properties are not active assets because they are mainly (only) used by Rachael to derive rent. It is irrelevant whether Rachael's activities constitute a business or not.

Factors that are relevant for determining whether an occupier has a right to exclusive possession include the degree of control retained by the owner and the extent of any services provided by the owner such as room cleaning, provision of meals, supply of linen and shared amenities.

The issue of whether a taxpayer's rental properties can be active assets when they are carrying on a business of letting rental properties was considered in Jakjoy Pty Ltd v FC of T [2013] AATA 526, (Jakjoy).

In Jakjoy the taxpayer was carrying on a business of leasing commercial properties. It was held that despite the fact the taxpayer was carrying on a business of leasing properties that the properties were not considered 'active assets' under section 152-40 of the ITAA 1997 and did not satisfy the 'active asset test' in section 152-35 of the ITAA 1997. Given the main or only use of the properties was to derive rent, the properties were excluded from being active assets under section 152-40(4)(e). This was regardless of the fact that the taxpayer's activities amounted to the carrying on of a business. It was affirmed that '….although it was common ground that the taxpayer was carrying on a business of renting properties, it did not automatically follow based on a clear reading of the text in section 152-40 of the ITAA 1997, that the properties the taxpayer used in carrying on its business were 'active assets' Indeed, those properties were expressly excluded from being 'active assets' by the exception in section 152-40(4)(e) of the ITAA 1997.

Application to your situation

The first issue to be resolved is whether or not you and your spouse are carrying on a business. It has been determined in question 1 above that it is the Commissioner's view that you and your spouse are not carrying on a business of letting rental properties.

Accordingly, as you and your spouse are not carrying on a business, then you do not satisfy the positive business test set out in paragraph 152-40(1)(a) of the ITAA 1997.

However, for the purpose of completeness, the Commissioner will discuss the exception contained in paragraph 152-40(40)(e) of ITAA 1997 as the Commissioner is also of the view that the main use to derive rent exception will preclude the properties from qualifying as an active asset.

The Commissioner has formed the view that even if you and your spouse were held to be carrying on a rental property business, the rental properties will not qualify as active assets as the main use of the rental properties is to derive rent. The reasons for this are:

• Under the standard Tenancy Agreement, you grant each tenant exclusive possession of their individual rental property.

• You are not supplying any significant additional services to the tenants (such as room cleaning, meals, linen supply, etc.) but are rather carrying out activities that relate directly to your ownership of the rental properties.

Therefore, as the main use of the properties was to derive rent, the properties will not satisfy the active asset test under section 152-35 of the ITAA 1997. Consequently you and your spouse will not be able to access the small business CGT concessions under Division 152 of the ITAA 1997 in relation to your ownership interests in the properties.

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