Edited version of your written advice

Authorisation Number: 1013108249948

Date of advice: 18 October 2016

Ruling

Subject: Am I in business? - Rental properties

Are you carrying on a business of letting rental properties?

Answer:

No.

This ruling applies for the following periods

Income year ending 30 June 20TU

Income year ending 30 June 20VV

Income year ending 30 June 20VW

Income year ending 30 June 20XX

Income year ending 30 June 20XY; and

Income year ending 30 June 20ZZ.

The scheme commences on

20TT

Relevant facts and circumstances

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

You purchased a property (the Property) and a detached carpark, with settlement occurring in 20TT.

The Property and carpark are rented out separately.

A condition of the contract of sale is that the leasing and advertising of the Unit must be carried out by a nominated party (Party A) and the leasing and advertising of the carpark is managed by another nominated party (Party B).

For the period commencing a number of months after settlement had occurred until the present time you have used the services of Party A and Party B in relation to the leasing and advertising of the Property and carpark.

The Property is located near a university (the University) which does not have any official involvement in the leasing of the Property. However, support staff and student advisors may recommend interested parties contact Party A for accommodation.

The lease period for the Property is usually either for a six month or twelve month period.

The tenants do not pay any other expenses other than the rental amount per month, and a bond which is equal to one month's rent.

You set the lease amount for each tenant agreement based on your research of similar properties in the area.

Party B determines the leasing periods and amount s for the carpark and any amounts received from the leasing of the carpark are used to reduce fees arising in relation to the Property.

The tenants rent the Property as fully furnished with the following items included:

● a study desk and chair;

● internet facilities;

● a double bed;

● a kitchenette which has a cooktop, microwave, refrigerator, sink, pantry, cutlery and crockery;

● television and DVD player; and

● reverse cycle air conditioner.

You undertake the following activities in relation to the Property and carpark:

● research and set rental prices based on similar properties in the area;

● pay all outgoings, including all utility bills, body corporate fees, maintenance; fees, council rates, landlord insurance and legal fees;

● source replacement furniture and appliances;

● bookkeeping and filing annual tax return; and

● inspecting the properties when necessary.

You and Party A undertake inspections of the Property and carpark, with Party A routinely inspecting the Property every six months, being twice a year, and you inspecting the Property and carpark three times a year on average.

You have included the following amounts in your rental schedules and income tax returns:

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

Reasons for decision

Summary

You are not carrying on a business of letting rental properties. You only have one unit and a carpark and 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

Carrying on a business of renting a property

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. This is because of the limited scope of the rental property activities and the limited degree to which an owner actively participates in rental property activities. A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations.

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 and 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 and Co. on their behalf. No charge was made by F and 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.

The ATO publication Rental properties 2016 (NAT 1729-6.2016) states on page five:

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.

The publication 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 3 on page 5 of the guide, outlines a situation in which the co-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 4 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' or 'employee or independent contractor' (with an independent contractor being considered to carry on a business). 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.

Reference has been made in the private ruling application to Self Managed Superannuation Funds Ruling SMSFR 2009/1 which outlines the Commissioner's views in relation to the term business real property in relation to self managed superannuation funds for the purposes of the Superannuation Industry (Supervision) Act 1993 and the Superannuation Industry (Supervision) Regulations.

While we are not determining whether your activities are “business real property”, we would refer you to Example 13 and Example 14 in the ruling as follows:

Example 13: Letting holiday flats - no business

Ms Hend owns 2 holiday flats, which she lets for short-term accommodation at a popular holiday destination. Ms Hend and her partner manage and maintain the flats, which includes cleaning and repairing the flats, and financial tasks such as banking.

Ms Hend and her partner set up the Hend SMSF and both become members of the fund. They propose that the Hend SMSF acquire the flats from Ms Hend.

The elements of repetition and continuity of acts and transactions indicate the possibility of there being a rental property investment business being carried on. However, the scale of the operation is such that it is not considered to be a business. As there is no business conducted in respect of the premises, the property is not business real property. Any sale of the flats to the Hend SMSF would contravene the related party asset acquisition rule in section 66.

Example 14: Residential property held in a property investment business

Mr Wood owns 20 residential units that are leased to long-term residents. Mr Wood manages and maintains the flats on a full time basis living on the income generated from the leases. The units are not mortgaged.

Mr Wood would like his SMSF to acquire some of the units rather than sell the units to a non-related party.

The scale of the operation together with the elements of repetition and purpose indicate that Mr Wood is carrying on a property investment business.

Even though the tenants use the properties for their own private or domestic purposes, this use remains incidental and relevant to Mr Wood's property investment business. Consequently, Mr Wood's interest in the property on which the units are built is business real property. Provided the acquisition takes place at market value, the units may be acquired by the SMSF without contravening the related party asset acquisition rule in section 66.

Based on the information and documentation provided, it cannot be viewed that your situation is similar to the taxpayer in Example 14 as your activities are not of the same scale, nor is there the same elements of repetition and purpose. Example 13 deals with the lack of scale in relation to the activities of the taxpayer which results in the view that the taxpayer does not have a business and that the properties are not business real property. This is similar to your situation given that you only have one property and a carpark. Therefore, it would be viewed that your property and carpark are not business real property in accordance with the application of SMSFR 2009/1.

The 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 property and carpark as follows:

Significant commercial purpose or character

This indicator generally covers aspects of all the other indicators. The business should be carried out on such a scale and in such a way as to show it is being operated on a commercial basis and in a commercially viable manner and that the taxpayer's involvement in the activity is capable of producing a tax profit.

In your case, you own one property which is rented out to specified types of tenants and a carpark.

The Property and carpark were advertised and leased by other parties, being Party A in relation to the Property and Party B for the carpark. The Property is leased out for periods of six or twelve months and the leasing of the carpark is determined by Party B.

The Property generated gross rental amounts of less than 1% of the purchase price in the 20TT-TU to 20VW-XX income years.

It is viewed that your activities are of renting a residential property and leasing the carpark. Your activities and holdings are considerably less than in the Cripps case and Case 26 as outlined above when it was determined that the taxpayers were not in the business of letting rental properties.

Purpose and intention to engage in business and nature of the activities

A taxpayer should be able to demonstrate an intention to derive assessable income from the business activity. A taxpayer should also be able to demonstrate that appropriate activities have been carried out by that taxpayer, or on the taxpayer's behalf, to allow this to occur.

You purchased the Property for the purpose of residing in the Property until you had completed your tertiary education, after which you would rent out both the Property and the carpark to tenants.

Your stated reason for seeking to have the Property and carpark designated as a “Business Real Property” is to allow for a self-managed super fund, which has yet to be created, to purchase them from you at their market value. That you and your partner have a business plan which would allow you and your partner to invest your employer superannuation contributions into the business and therefore increase income by at least $X,XXX per annum based on your current salaries, which will enable the mortgage on the existing properties to be paid back in a shorter timeframe. You will then be able to refinance to purchase future properties. You have calculated that you returns would be industry superannuation funds by over 60%, offering you and your partner greater and more secure retirement benefits.

Intention to make a profit and prospect of profits

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

You have received rental income from the Unit and the income earned in relation to the leasing of the carpark has been used to reduce your body corporate fees.

In your case, rental losses have been recorded in your income tax returns for the 20TT-TU to 20VW-XX income years. The gross rental amounts received for the Property during those income years is less than 1% of the amount you paid to purchase the Property.

Repetition and regularity

The taxpayer's activities should involve repetition and regularity and have an air of performance 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 have owned the Property and carpark for a number of years. Based on the information provided, you have not bought any other properties since you acquired them.

The advertising and leasing of the Property and carpark are undertaken by other parties, with the Property being leased for between 6 to 12 months, and the carpark as determined by Party B.

In our view, your mode of dealing with the rental of the Property and carpark does not differ to someone who is utilising a property manager to manage rental properties.

The Property is leased fully furnished and you source and provide all of the contents of the Property.

In the private ruling you have stated that you spend between one to two days per week managing the Property and carpark. You pay all expenses, undertake research and set rental prices based on similar properties in the area, source replacement items for the Unit, keep records and inspect the properties when necessary.

It is viewed that your activities are similar to someone who has an investment property/ies. Given the activities of other property owners who are considered to be carrying on a business of letting properties, it cannot be concluded that the level of repetition and regularity of your activities are the same.

The overall impression is that you are not carrying on a business of renting properties. The income is derived predominantly from the letting of the Property and carpark and not from activities 'carried on' in relation to renting the properties out.

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

The taxpayer's activities or those conducted on the taxpayer's behalf should, unless circumstances dictate otherwise, be based around business methods and procedures of a type ordinarily used in ventures that would commonly be said to be businesses. The activities should be carried out using accepted practices.

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.

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

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

The documentation provided with the private ruling supports that your activities in relation to the Unit and carpark are residential properties at market rates. Hence the relationship is considered to be that of a landlord and tenant.

Organisation, systematic, business-like manner

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

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.

The size and scale of the activity

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

You have stated in the private ruling that the rental income generated from the Property and carpark accounts for a third of your total 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.

It is apparent when compared to the above cases that your activity is not conducted on a sufficient size to be considered to be a business. It is not of a scale to take your activity beyond that of a passive income-producing activity. An ordinary business of managing rental properties would involve many more properties as indicated above.

Hobby or recreation

The activity does 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.

The level of repetition and regularity of your activities are not as great as that noted in Case G10 where the taxpayer rented out 12 units as short term holiday units. The activities of the taxpayer in that case was far greater than in your activities in relation to the Property and carpark, being a seven day a week activity and the size and scale of the activities undertaken by the taxpayers.

The advertising and leasing of the Property and carpark are undertaken by other parties, with you providing the contents of the fully furnished Property. The scale of your activities and volume of operations is too small to be considered as carrying on a business as they are not extensive enough to amount to a business for tax purposes.

Your case can be distinguished from Cripp's case as in that case the scale, being 14 townhouses, was far greater than your one unit and carpark. 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 one unit and carpark.

Also, you circumstances are not similar to the Example 4 provided in the Rental Property guide as outlined above.

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

It is reasonable to expect anyone with an investment property, either as a passive investor or in business, to keep records in relation to their rental property/ies to enable to determine how their investment is going.

Based on the information and documentation provided, it is our view that your activities in relation to the leasing of the Property and carpark are better described as leasing properties to receive income from a stream of rental income. The income is not derived from the services you provide, but from the letting of the properties.

It is viewed that your activities in the income years covered by this private ruling support that while you own a property and a carpark, you are a passive investor. Regardless of the nature of the tenant or characterisation of the property, you only had one property and one carpark. Therefore, the size, scale, volume and the activities that you personally undertook in relation to those properties are not viewed as being sufficient to be viewed as the carrying on of a business.

Accordingly, it is our view that you are not carrying on a business of letting rental properties, but are a passive investor who owns a property that you rent out to a specified type of tenant and a carpark that you lease out.

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