Edited version of private advice

Authorisation Number: 1051505321390

NOTICE

The private ruling on which this edited version is based has been overturned on objection.

This notice must not be taken to imply anything about the correctness of other edited versions.

Edited versions cannot be relied upon as precedent or used for determining how the ATO will apply the law in other cases.

Date of advice: 17 May 2019

Ruling

Subject: Carrying on a business of property rental

Question 1

Is the Applicant able to apply the 15-year retirement exemption under subdivision 152-B of the Income Tax Assessment Act 1997 (the 1997 Act) to its sale of the Storage Property?

Answer

No.

Question 2

Is the Applicant able to apply the Small Business 50% reduction under subdivision 152-C (via s 152-49) of the 1997 Act to its sale of the Storage Property?

Answer

No.

Question 3

Was the applicant carrying on a business over 18yrs from 19XX to 20XX of leasing the property?

Answer

No.

Question 4

Did separate nearby premises used to store the bulky long term repair and maintenance equipment qualify as an active asset of the business?

Answer

No.

Question 5

Rental business ceased trading in 20XX; does the subsequent sale of the storage property constitute the winding up of the rental business?

Answer

No.

Question 6

Did the applicant retire from the property rental business when the rental properties were sold?

Answer

No.

Question 7

Will the applicant retire from the rental property business at the time of the CGT vent A1 (sale of the storage property)?

Answer

No.

Question 8

Does either retirement qualify in connection with the applicant's retirement under the 15 year exemption?

Answer

No.

This ruling applies for the following period:

For the period 1 July 20XX to 30 June 20XX.

The property and usage

In 19XX you ceased working in your previous profession. You and your wife invested in real estate under a partnership arrangement; using funds you received through redundancy and superannuation payments.

In 19XX you purchased the Rental Property; comprising two factories and common property. The Rental Property was used to produce rental income from the time of purchase until you ceased ownership.

In 19XX you purchased the Storage Property. Your intention was to use that property for income producing purposes. The intended use changed over time from using it as a sporting facility to manufacturing to plant production. None of these intended uses resulted in a business operation and the site was used by you to store tools and other items relating to the Rental Property.

The Storage Property has not been used to derive any income, including rent, since it was acquired by you. You intended to maximise long term profits from the Rental Property by performing most of the maintenance and repairs yourself. You only engaged tradespersons for tasks that were dangerous or specialised in nature. The machinery and tools required for the maintenance of the Rental Property were stored at the Storage Property.

You performed all administration, management, repair, maintenance and upgrading of the rental property on a regular and as required basis. Tenants were to contact you directly for any issues such as leaks. You performed a wide range of tasks and the time required to perform tasks varied.

You have not been in paid employment since the properties were purchased.

In the information you provided you referred to an error in a previous ruling that looked at whether you conducted a business from the Storage Property. You have clarified that this is not what you are claiming. Your claim is that the storage property was used as a storage facility enabling you to conduct a rental business; and was an 'active asset'.

You have requested that the Commissioner rely on the facts as provided in the previous ruling application in addition to the facts as provided in this application. The Commissioner accepts that the facts of the previous ruling application form part of this ruling decision.

Relevant legislative provisions

Division 152 of the Income Tax Assessment Act 1997

Reasons for Decision

These reasons for decision accompany the Notice of private ruling.

Before considering whether the Small Business exemptions would apply to the sale of the property it would need to establish:

·         That you operated a business.

·         That the property was an active asset.

If it were considered that you operated a business and that the Storage Property was an active asset, the Commissioner would then consider whether the SB concessions apply.

·         Even if the basic conditions under the Small Business concessions are met, the SB concessions will not apply if the business was for the purpose of obtaining rent.

Question 1

Is the Applicant able to apply the 15-year retirement exemption under subdivision 152-B of the Income Tax Assessment Act 1997 (the 1997 Act) to its sale of the Storage Property?

Summary

The Applicant is unable to apply the 15 year retirement exemption because the activities did not amount to conducting a business; therefore the small business concessions do not apply to the sale of the Storage Property.

Detailed reasoning

Under subdivision 152-B of the ITAA97, a CGT small business entity can disregard a capital gain arising from a CGT asset it has owned for at least 15 years if certain conditions are met:

·         the basic conditions under subdivision 152-A must be satisfied; (these are not satisfied; see discussion below)

·         the entity must have continuously owned the asset for the 15 year period leading up to the CGT event; (this would be satisfied)

·         if the entity is an individual, the individual retires or is permanently incapacitated; (this would be satisfied at the time of the event).

The basic conditions under subdivision 152-A are contained in section 152-10:

·         A CGT event happens in relation to a CGT asset of yours in an income year.

This condition would be satisfied upon the sale of the storage property. The property is a CGT asset and a sale would be CGT event A1.

·         The event would (apart from Division 152) have resulted in the gain.

This condition would be satisfied if a capital gain is realised upon sale of the property.

·         At least one of the following applies:

·         You are a CGT small business entity for the income year; (not satisfied, see below).

·         You satisfy the maximum net asset value test; (according to the information you provided, you would satisfy the maximum net asset value test).

·         You are a partner in a partnership that is a CGT small business entity for the income year and the CGT asset is an interest in an asset of the partnership; (your partnership was not a small business entity).

·         the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year; (these deal with passively held assets).

·         The CGT asset satisfied the active asset test in section 152-25. (The asset does not satisfy the active asset test; see the discussion at Question 5).

A small business entity is an entity that carries on a business and satisfied the aggregate turnover test.

For the purpose of the small business entity test, an entity is taken to be carrying on a business if the entity is winding up a business that it formerly carried on and it was a small business entity for the year in which it stopped carrying on that business (s328-110(5)).

Small business entity - carrying on a business

For the small business concessions to apply, you must be (or have been, as per the provision mentioned above) carrying on a business.

Under the definition of 'business' in section 995-1 of the ITAA97 a business includes any profession, trade, vocation or calling. Whether a business is being carried on is a question of fact and degree; this is determined by weighing up facts and evidence. In your ruling application you stated that 'if all other indicia are favourable, a property rental business cannot be excluded on the number of properties alone', and '[t]herefore, the Commissioner, at law, must determine the Private Ruling favourably towards the Applicant'. This is incorrect. The indicators that have been found by the courts to be relevant are not legal elements to be satisfied; they are tools to assist in determining whether a business is being carried on.

Taxation Ruling TR 97/11 provides the indicators established by the courts that need to be considered when determining whether the activities amount to carrying on a business. Paragraph 13 states:

The most important factors are: profitability, size, effort, business records.

Passive investments often include some elements that are seen with the running of a business but will not be considered to be a business. For example, investments often include an intention to make a profit (whether or not that is realised), comprehensive record keeping, significant effort and a large outlay of capital.

Generally, if an individual owns a rental property or properties this will not be considered being in the business of letting rental properties. Usually the person will be regarded as an investor who is not carrying on a rental business. Some investors may spend more time or take a greater interest in their investments. As stated by Senior Member Block in Cripps:

In any event it seems to me that if by way of example one share investor takes a greater interest in his investments than does another, and for example phones his broker regularly, that will not convert his investments into a business.

Cases where individuals or other entities have been considered to be carrying on a business have included circumstances where:

·         A taxpayer managed and maintained six holiday units. The task in managing the units was a seven day a week activity.

·         A taxpayer company built and developed commercial/industrial buildings for third party clients. They acquired commercial land, developed the land and held some properties for long term rental purposes.

You pointed out in your request for a private ruling that scale is not the only consideration and that if all other indicia are favourable a property rental business cannot be excluded on the number of properties alone. Although a decision should take into account all the indicators, a single indicator may push the balance in favour of a decision.

The comments in Cripps stress that holding a number of properties may suggest the presence of a business but will not, on its own, be determinative. This discussion was in the context of a factual scenario where a taxpayer had a number of rental properties (14 townhouses, a rural property and a Sydney property) but was found to not be conducting a business. Senior Member Block was clarifying that just because the taxpayer owned a fairly significant number of properties; that alone did not determine whether or not there was a business.

Small scale operations are often seen in non-rental businesses, such as small hobby farms, and small creative businesses such as jewellery making. When it comes to carrying on a business of rental properties (commercial or residential), it is unlikely that producing rent from a small number of properties will amount to running a business; it will usually be a passive investment. Where a small number of properties are considered part of a business there is an additional element to merely collecting rent and routine maintenance, such as running a boarding house or serviced holiday apartments. In these cases typically there is something more to the activities than a landlord-tenant relationship.

Although scale is not the only consideration, scale and size of operations is weighted heavily in relation to the question of whether or not a business of letting property is being carried on. Paragraph 5 of TR 2423 states that "[a] conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations." This articulates the ATO view of the application of the law.

Investments in real property involve a degree of maintenance, and involvement in day to day management of the investment. This can be done by the investor or by outsourcing the related management, maintenance etc. Whether these are done by the investor or outsourced and as was stated in Cripps, a high degree of involvement will not convert investments into a business. Even with a high degree of involvement the landlord-tenant relationship is apparent. As discussed in YPFD v Federal Commissioner of Taxation (2014) 94 ATR484, outsourcing, for example, using a property manager and maintaining other employment, do not necessarily preclude activities from being considered to be carrying on of a business.

Application of the indicators in TR 97/11 to your circumstances

1.    Significant commercial purpose or character

The purchase and use of the Rental Property and the Storage Property have the character of property investment. The income produced is passive and the effort involved in maintaining and administering the rental property was very much about maintaining the income producing assets and facilitating ongoing rental arrangements. The effort did not in itself produce income. The relationship with the tenants was a typical landlord-tenant relationship.

2.    Intention of the taxpayer

The intention of the Applicant was to be involved in property investment as a business venture. However, over time rental income was only received in relation to the Rental Property, the Storage Property was used for storing tools used at the Rental Property, no further properties were purchased and no other proposed venture was every brought to fruition.

3.    Purpose and prospect of profit

The properties were purchased with the purpose, and a reasonable prospect, of making a profit. However, this is typical of property investment and does not indicate the operation of a business rather than an investment. The purpose in relation to the income producing property was to make a profit through renting the factories.

4.    Same kind and carried out in a similar manner to ordinary trade in that line of business

An individual who invests in property will usually be classed as an investor earning passive income from their investment, not as being in the business of renting property. Where a person is carrying on a business of property rental there is usually a higher degree of involvement in the day to day running of the property which changes the relationship from mere tenant-landlord.

Despite being well organised and well managed, the Applicant has carried out the activities in line with that of rental property investors, not rental property businesses.

5.    Planned, organised and carried on in a businesslike manner - directed at making a profit

The property was well managed by the Applicant. Maintenance, advertising for tenants, dealing with occupancy issues etc. was largely undertaken by the Applicant. Records were well kept and the Applicant appears to have dealt with the properties in a way to maximise profit.

However, an investment does not become classified as a business based on it being well managed or a high degree of involvement in upkeep of the property.

6.    Size, scale and permanency of the activity

The properties were a long term investment. The Rental Property comprising two factories and the Storage Property were not a large portfolio and it would be rare for the renting of one or two commercial properties to be considered a property rental business.

7.    Whether it is better described as a hobby, form of recreation or sporting activity

The last indicator is not particularly useful in considering property rental. However, the activities are better described as passive investment activities.

Question 2

Is the Applicant able to apply the Small Business 50% reduction under subdivision 152-C (via s 152-49) of the 1997 Act to its sale of the Storage Property?

Section 152-200 provides that the Small business relief in section 152-205 will apply if the basic conditions in subdivision 152-A are satisfied.

Summary

The basic conditions in subdivision 152-A are not satisfied as discussed in the answer to Question 1.

Question 3

Was the applicant carrying on a business over 18yrs from 19XX to 20XX of leasing the property?

Summary

No, as discussed in the answer to Question 1.

Question 4

Did separate nearby premises used to store the bulky long term repair and maintenance equipment qualify as an active asset of the business?

Summary

No. Although it was not necessary to consider this question, as the activities did not amount to the carrying on of a rental business, for completeness I have considered the application of paragraph 152-40(4)(e) of the ITAA 1997. It is concluded that even if a business was being conducted, the storage property would have been excluded from the definition of 'active asset' due to the application of 152-40(4)(e).

Detailed reasoning

Tax Determination 2006/78 provides the Commissioner's opinion about the application of paragraph 152-40(4)(e).

Even if the activities had amounted to the carrying on of a business, the Storage Property would not qualify as an active asset due to the operation of paragraph 152-40(4)(e) which excludes an asset whose main use is to derive rent, unless the use for deriving rent was only temporary.

The Explanatory Memorandum states that:

1.33 The definition of active asset specifically excludes those assets that are held to produce passive investment income. Examples of such assets are loans, debentures, bonds and assets whose main use is to derive interest and rental income. [Item 1, subsection 152-40(4)]

The Applicant derived rental income from the leasing of the Rental Property. The Storage Property was used to facilitate the maintenance of the Rental Property which produced rental income. Therefore, the main use of the Storage Property would be considered to be to derive rent (from the Rental Property). The purpose of holding the Storage Property was to produce passive income. Therefore, even if the alternative view had been taken and the activities were considered to be the running of a rental business, the Storage Property would have been excluded from being an active asset under paragraph 152-40(4)(e).

This is the approach taken in Jackjoy Pty Ltd v FC of T [2013] AATA 526. In that case the taxpayer had previously obtained a private ruling confirming that it was carrying on a business of leasing properties. However, a subsequent ruling held that the three properties were not considered 'active assets' as they did not satisfy the active asset test. The taxpayer objected and then sought a review of the Commissioner's decision. The AAT held that it was clear on the face of the words used in section 152-40(4)(e) that an asset whose main use by the taxpayer was to derive rent could not be an active asset.

Question 5

The rental business ceased trading in 20XX; does the subsequent sale of the storage property constitute the winding up of the rental business?

Summary

There was no rental business, as discussed in the answer to Question 1.

In the information you provided, you stated that the winding up provisions of section 152-49 do not require an extension of time under paragraph 152-35(2)(b)(ii). This is incorrect. The basic conditions for relief under Division 152 apply to Subdivision 152-A. So the asset must still pass the active asset test.

Question 6

Did the applicant retire from the property rental business when the rental properties were sold?

Summary

There was no rental business, as discussed in the answer to Question 1.

Question 7

Will the applicant retire from the rental property business at the time of the CGT vent A1 (sale of the storage property)?

Summary

There was no rental business, as discussed in the answer to Question 1.

Question 8

Does either retirement qualify in connection with the applicant's retirement under the 15 year exemption?

Summary

The basic conditions in subdivision 152-A are not satisfied as discussed in the answer to Question 1.

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