Edited version of your written advice

Authorisation Number: 1051321471802

Date of advice: 19 December 2017

Ruling

Subject: Am I carrying on a business – rental properties?

Question

Are you carrying on a business of letting rental properties?

Answer

No.

This ruling applies for the following period

Year ended 30 June 201F.

The scheme commences on

1 July 201E.

Relevant facts and circumstances

You and your spouse are both engaged in part time work.

You are a principal in an accounting practice, in which you have the largest shareholding. You work approximately X days a week on average.

You and your spouse own the following X properties as tenants in common:

Note: Properties that are owned by you and your spouse in their SMSF are not included in their individual property portfolio as they do not own them and therefore they are not taken into consideration in this ruling.

The X properties A, B, and C consist of X separate rented units and Y rented garages.

Your plan in relation to the properties is as follows:

● Before the purchase of each property you conduct intensive research and evaluations;

● Properties need to meet strict operational and performance criteria to be considered appropriate for purchase;

● Geographic spread of the properties reduces the risk of the investments being concentrated in one property market; and

● Except for the first few years of ownership the properties have returned substantial cash profits, as was your intention.

The gross income from each property is:

The services of real estate agents are engaged to oversee the X properties. This includes the advertising for tenants, obtaining references from, and undertaking initial screening for potential tenants. However you assess the tenants for suitability and the real estate agent prepares the lease agreements and collects the rents.

Other real estate agents duties include:

● Arranging inspections of the property by prospective tenants;

● Select tenants;

● Prepare and negotiate lease agreements;

● Enter into and sign tenancy agreement;

● Issue receipts for monies received;

● Receive, lodge, claim and disperse rental bonds;

● Provide tax invoices and receipts;

● Review rent;

● Serve notices in relation to any breach;

● Effect repairs and maintenance to the property to the pre-approved limit; and

● Carry out inspections to the property when required.

The properties are rented out on average for approximately X months at a time.

Over the preceding 12 month period you have calculated that you have spent approximately XYZ hours on your rental and SMSF property related activities, this average out to approximately XX hours per week.

Time spent on the X properties actually owned by you will be substantially less as the SMSF owns X rented units and one rented house.

You conduct much of the routine repairs and maintenance to the properties yourself; these requests are made through the real estate agents, however most tenants are aware you are the property managers and will contact you directly in emergencies and or where your real estate agents are not responding. You engage qualified trades persons where required.

The maintenance and repairs to the properties which you conduct includes but is not limited to:

● Mowing lawns, fixing gutters, repairing outdoor paths and pruning trees;

● Repairing oven door seals, shower screens, sliding doors and leaking taps; and

● Inspecting insulation, baiting for vermin and replacing exhaust fans.

You continuously monitor and oversee the performance of your real estate agents to ensure the smooth running of the tenancies.

Routine inspections are carried out by your real estate agents, however where particular concerns exist you accompany them or arrange access otherwise.

You keep the following records in relation to each property:

● Detailed log book of all activities and conversations regarding your properties;

● future expenditure plans/budget;

● Excel spreadsheet of all costs for tax return purposes;

● Tax receipts; and

● Repairs and maintenance records.

You have not disposed of any properties you own in an attempt to get a better return on the properties other than from the rental income.

You pay the council rates, water rates and land tax arising in relation to the properties.

You currently have loans totalling nearly $X.

The reason for applying for this private ruling is to be able to deduct travel expenses into the future.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Summary

Based on the information and documentation provided, 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.

Detailed reasoning

Subsection 6-5(1) 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.

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

Section 995-1 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.

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 and the repetition and regularity of your activities.

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 Administrative Appeals Tribunal (AAT) case of YPFD and FCT [2014] AATA 9 (YPFD case), the following statement about the tests that are relevant when the issue involves residential rental properties was made:

16. The Tribunal suggested in Shields v Deputy Federal Commissioner of Taxation (1999) 41 ATR 1042 and, more recently, in Smith and Commissioner of Taxation (2010) 79 ATR 934, that relevant matters might include:

(a) the nature of the activities and whether they have the purpose of profit-making;

(b) the complexity and magnitude of the undertaking;

(c) an intention to engage in trade regularly, routinely or systematically;

(d) operating in a business-like manner and the degree of sophistication involved;

(e) whether any profit/loss is regarded as arising from a discernible pattern of trading;

(f) the volume of the taxpayer's operations and the amount of capital employed by him; (by 'her' in the present case).

You have indicated that your circumstances are similar to those of the plaintiff in YPFD case. However, the decision made by the AAT is based on the plaintiff’s facts. The Commissioner considers matters on a case by case basis according to the facts of that case. We have taken the factors from TR 97/11 as outlined above into consideration.

In the Rental Properties 2017 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 3 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 acquire 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 5 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.

Application 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 that is characterised as passive income.

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

● You own X rental properties that are generally leased out at market rates for the period averaging X months. Hence the relationship is considered to be that of a landlord and tenant.

● You undertake most of the maintenance activities yourself. You are now undertaking an active role in managing the rental properties however you still employ the services of real estate agents to oversee the properties

● You receive rental income from your properties. You provided records that indicate that the properties are earning a positive income for the income year.

● The mortgages you have in place are totalling nearly $X.

● You have not disposed of any properties you own in an attempt to get a better return on the properties other than from the rental income.

● You keep loan accounts, rates bills and receipts for maintenance and repairs undertaken on the rental properties and complete an end of financial year spread sheet so that you know your financial position.

● 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.

● You are a principal in an accounting practice, in which you have the largest shareholding. You work approximately X days a week on average.

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 properties, was greater than the properties currently held by you. Despite the fact that 16 properties 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 in excess of the properties you own.

The activities in your case are diminished further by the fact that the X properties owned by your SMSF are not included in your personal property portfolio and therefore are not taken into consideration in determining whether you are in business of letting properties.

This excludes X rented units and X rented house from all information provided, having a major impact on the time allocated to your rental property activities.

Also, your circumstances are not similar to example 4 in the Rental Property guide as outlined above.

The additional activities you undertake for the rental properties such as carrying out repairs and maintenance, organising tradesman for repairs and overseeing your real estate agents 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 and 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.

You are also employed on average X days per week at an accounting practice where you are the major shareholder limiting the involvement you can have in your rental properties on these days.

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, averaging X month periods. Also, given the period of the leases, the need to find new tenants or renew the existing leases could not be viewed as needing to be undertaken on a frequent basis.

In comparison to some rental property owners, your 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 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.

You keep records in relation to the properties. 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.

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 real estate agent. The activities that you undertook in relation to the properties are similar in nature to those activities being undertaken by a passive investor in relation to their investment properties.

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.

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.

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