Edited version of your written advice

Authorisation Number: 1013061618147

Date of advice: 28 July 2016

Ruling

Subject: Business - Am I in business? - Rental properties.

Question 1:

Are you carrying on a business of letting rental properties?

Answer:

No.

Question 2:

Are you a Small Business Entity pursuant to Subdivision 328-C of the Income Tax Assessment Act 1997?

Answer:

No.

Question 3:

Have you met the basic conditions for Small Business Capital Gains Tax under Subdivision 152-A of the Income Tax Assessment Act 1997 met?

Answer:

No.

This ruling applies for the following period

Income year ending 30 June 20BB

The scheme commences on

1 July 20AA

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.

You, being a partnership consisting of Person A and Person B, was founded after 20 September 1985, after Persons A and B had retired.

Persons A and B currently own, or have owned, the following properties:

Persons A and B purchased the Properties B and C around the time they retired.

The services of a real estate agent were engaged to manage Properties A, B and C. This included the advertising for tenants and to undertaking the initial screening of potential tenants. Persons A and B vetted the tenants and the real estate agent prepared the lease agreements and collected the rents for the properties.

The lease agreements for the properties were for around 12 month periods.

The rent from the properties is paid directly into a specified bank account, which is also used to make payments in relation to expenditure incurred in relation to the properties.

Any requests for repairs in relation to the properties were reviewed by Persons A and B. They would personally carry out the repairs if they were within their capability, otherwise they would engage the services of the appropriate professional/s.

Persons A and B were listed as the contact point for the lessees to contact when they needed assistance.

Persons A and B carried out inspections of the properties on a half-yearly basis.

Persons A and B would spend less than 15 hours per week on the properties when they owned the X properties. After the sale of Y of the properties, they would spend less than 10 hours per week on the property.

Persons A and B managed Property B after the other Y properties were sold.

Persons A and B keep records of the property/ies, relevant software, and engage the services of an accountant.

Persons A and B use their home in relation to their activities, and have the usage of computers, facsimile machine and telephone.

Persons A and B do not have any plans to expand their rental property activities.

You included rental amount relating to the X properties in your income tax returns.

The Management Agency Agreement (the Agreement) entered into with the real estate agent (the Agent) in relation to the X properties provided with this ruling outlines that they were appointed as the Agent to lease and manage the properties. The Agreement outlines that the Agent would undertake the following activities in relation to the properties:

• Arrange inspection and show prospective tenants

• Obtain references

• Recommend tenants

• Enter into and sign tenancy agreements

• Collect rent

• Issue receipts for monies received from tenants

• Collect and lodge rental bonds

• Undertake periodic inspections

• Repairs and maintenance on authority from the principal; and

• Pay accounts for repairs and maintenance.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Subsection 152-10(1)

Income Tax Assessment Act 1997 Subdivision 328-C

Income Tax Assessment Act 1997 Section 328-110

Reasons for decision

QUESTION 1

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

Summary

You are not carrying on a business of letting rental properties. 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'.

Generally, the receipt of income from the letting of property to tenants does not amount to the carrying on of a business.

Therefore, 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. There must be something special about the activity to reach a conclusion that a business is being carried on.

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.

In the Rental Properties 2015 guide (Rental Properties guide) published by the Australian Taxation Office the Commissioner sets out Y 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 X 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' or 'employee or independent contractor' (with an independent contractor being considered to carry on a business). In this situation, 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.

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

• Persons A and B purchased the first property before 20 September 1985, and the other properties after 20 September 1985.

• The services of a real estate agent had been engaged to manage the X properties until Y of them were sold in the 20AA-BB income year, after which Persons A and B took over management of the Property B.

• Persons A and B undertake some of the repair/maintenance activities themselves and engage the services of professionals to complete some activities.

• Persons A and B keep records in relation to the properties, utilising their home to undertake those activities. They also engage the services of an accountant.

• Persons A and B inspect the properties on a half yearly basis.

• Persons A and B spent ten hours per week on the properties when they owned the X properties. After the sale of Y of the properties, they would spend no more than five hours per week in relation to the Property B; and

• Persons A and B do not have any intention to purchase any additional rental properties.

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 the properties held by you, or that you had held. 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 your seven properties.

Also, your circumstances are not similar to the examples provided in the Rental Property guide as outlined above.

The additional activities Persons A and B undertake for the rental properties such as carrying out repairs and maintenance, and organising tradesman for repairs are not day-to-day activities.

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. The undertaking of the repair and maintenance activities does not change the character of the 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 typically long term in nature, for 12 month periods.

In comparison to some rental property owners, Persons A and B daily involvement is minor. Given the activities of other property owners who are considered to be carrying on a business of letting properties it could not be concluded the level of repetition and regularity of your Investments' activity is the same.

Generally, where the property owners grant exclusive possession of the property to the residents the relationship between the Y 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.

In this case, your activity is renting out the properties at market rates. Hence the relationship between you and the residents of the properties is that of a landlord and tenant.

The overall management of your rental properties is not dissimilar to other rental properties managed by an agent for a passive investor with the activities undertaken by the property manager. The activities that Persons A and B undertook in relation to the one remaining property are similar in nature to those activities being undertaken by a passive investor in relation to their investment properties.

Persons A and B keep records in relation to the properties and use relevant software. It is reasonable to expect anyone investing in rental properties, including passive investors, to keep appropriate 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.

The rental income received in relation to the rental properties was at the market value. It can be viewed that the returns you received in relation to your properties were merely from holding the properties and is passive income and not from selling, buying or continually renovating the properties to gain increased rental income or obtain a profit from selling a property. Nor are you undertaking activities such as those undertaken by the taxpayer in Case G10 who was actively involved with his units on a daily basis, and undertaking most of the activities arising in relation to the units himself, with the assistance of his wife.

Your properties are generally rented out for periods of 12 months. Therefore, the need to find new tenants or renew the existing leases is not on a frequent basis.

While Persons A and B had purchased one property before September 1985 and the other Y properties after September 1985, they have no intention to purchase any additional rental properties and have sold Y of the properties. There is no evidence to support that you are seeking to implement alternative strategies to increase or enhance the returns received from the properties that may be suggestive of a business-like intention.

Based on the information and documentation provided, it is the Commissioner's view that your 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 provide, but from the letting of the properties.

In short, there is nothing special about the manner in which activities related to the rental properties are undertaken that transform those activities from an investment into a business.

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

QUESTIONS 2 AND 3

Are you a Small Business Entity pursuant to Subdivision 328-C of the Income Tax Assessment Act 1997?

Are the basic conditions for Small Business Capital Gains Tax per Subdivision 152-A of the Income Tax Assessment Act 1997 met?

Summary

You were not carrying on a business of letting rental properties in the 20AA-BB income year. Therefore, you are not considered to be a small business entity and do not meet the conditions for the capital gains tax small business concessions to apply.

Detailed reasoning

What is a small business entity?

Subsection 328-110(1) of the ITAA 1997 states:

An entity is a 'small business entity' if it:

a. Carries on a business in the current year, and

b. One or both of the following applies:

i. It carried on a business in the income year (the previous year) before the current year and its aggregated turnover for the previous year was less than $2 million, and

ii. Its aggregated turnover for the current year is likely to be less than $2 million

Capital gains tax -Small business concessions

Small business entities are entitled to certain capital gains tax (CGT) concessions. To be eligible for these concessions, the taxpayer has to satisfy the basic conditions outlined in section 152-10 of the ITAA 1997 and the specific conditions set out in each various concession provision.

The basic conditions

Subsection 152-10(1) of the ITAA 1997 contains the basic conditions for small business relief in relation to capital gains. The basic conditions to be satisfied for the gain are:

(a) a CGT event happens in relation to a CGT asset of yours in an income year. This condition does not apply in the case of CGT event D1;

(b) the event would (apart from Division 152 of the ITAA 1997) have resulted in the gain;

(c) at least one of the following applies:

(i) you are a small business entity for the income year;

(ii) you satisfy the maximum net asset value test;

(iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership;

(iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year; and

(d) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

Application to your situation

Based on the information and documentation provided, you were not carrying on a business of letting rental properties in the 20AA-BB income year. Also, it could not be viewed that you would have been carrying on a business in relation to your rental properties in the 20ZZ-AA income year. Therefore, you are not a small business entity and do not meet the basic conditions in accordance with subsection 152-10(1) of the ITAA 1997.

Accordingly, the CGT small business concession will not be applicable in your situation.

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