Edited version of private advice

Authorisation Number: 1051825065504

Date of advice: 13 April 2021

Ruling

Subject: Am I in business

Question

Are you a small business entity for taxation purposes?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced in:

1 July 20XX

Relevant facts and circumstances

You are a Trust.

You purchased a commercial rental property in 19xx.

The property provides 3 commercial tenancies.

A property manager, manages the property, finds new tenants and is first point of call for any maintenance issues. However, the rent is paid directly into the trust bank account.

The trustee is also on call to arrange contractors for property maintenance and supervision of same.

The trustee contracts out the daily administration required for the three commercial tenancies plus common areas.

One of the tenants of the building is a related entity.

Annual turnover is under $XXXX.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

From 1 July 2016, you are a small business entity for the small business entity concessions if you are an individual, partnership, company or trust that:

•         Is carrying on a business, and

•         Has a turnover of less than $10 million.

The $10 million turnover threshold applies to most concessions, except for:

•         the small business income tax offset - which has a $5 million turnover threshold

•         the capital gains tax (CGT) concessions - which continue to have a $2 million turnover threshold.

Taxation ruling IT 2423 Withholding tax: whether rental income constitutes proceeds of business-permanent establishment-deduction of interest states;

Whether the letting of property amounts to the carrying on of a business will depend on the circumstances of each case, (Californian Copper Syndicate (Limited and Reduced) v. Harris (1904) 5 TC 159). Generally, it is easier for a company that derives income from the letting of property to show that it carries on a business than it is for an individual. If a company's objects are business objects and are, in fact, carried out it carries on business, (IRC v. Westleigh Estates [1924] 1 KB 390 at pp 408, 409 per Sir Ernest Pollock, M.R.). In American Leaf Blending Co. Sdn Bhd v. Director-General of Inland Revenue (Malaysia) [1978] 3 All E.R. 1185 at p 1189 Lord Diplock concluded that it would be difficult to displace the prima facie inference that the gainful use of a company's property in letting it out for rent would constitute the carrying on of a business.

More recently in the Federal Court, Pincus J, in Lilydale Pastoral Co. Pty. Ltd. v. FCT 87 ATC 4235; 18 ATR 508, held, in the context of the withholding tax provisions, that the purchase of property to rent out, whether or not after renovating it, and the proprietorship of that property, constitute an undertaking of a business or commercial kind.

A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations. An individual who derives income from the rent of one or two residential properties would not normally be thought of as carrying on a business. On the other hand if rent was derived from a number of properties or from a block of apartments, that may indicate the existence of a business.

Paragraph 8 of Taxation Ruling TR 2003/4 Income tax: boat hire arrangements (TR 2003/4) (which is about whether boat charter activities generate business or investment income) states:

The receipt of income from the lease of an asset does not of itself amount to the carrying on of a business (see FC of T v. McDonald 87 ATC 4541; (1987) 18 ATR 957), but instead would generally be the passive receipt of income from property.

Paragraph 51 of Taxation Ruling TR 2003/4 states:

Beaumont J indicated (quoting Wertman v. Minister of National Revenue 64 DTC 5158) that for a business to be carried on by owners of property, one would expect that they would be involved in providing services in addition to the process of letting property (as with a boarding house), not merely receiving payments for the tenants' occupation of the property.

These statements indicate that 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 has to be something special about the activity to reach the conclusion that a business is being carried on. This will generally relate to the provision of additional services to the client in a manner that enhances the gross return above investment levels.

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.

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:

a)    whether the activity has a significant commercial purpose or character

b)    whether the taxpayer has more than just an intention to engage in business

c)    whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

d)    whether there is regularity and repetition of the activity

e)    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

f)     whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

g)    the size, scale and permanency of the activity, and

h)    whether the activity is better described as a hobby, a form of recreation or sporting activity.

These factors are framed in TR 97/11 to reflect that the alternate outcome is as described in the final dot point. The analysis in this case must reflect that the alternate outcome would be to conclude that activities in relation to rental properties would be an investment.

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 Rental Properties 2020 (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.

Example 3 on page 5 of the Rental Properties 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 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.

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.

Applying the relevant cases and indicators to your circumstances

While there may have been a profit making intention, in accordance with the judicial comments above and guidelines set down in IT 2423 and TR 97/11 your activities lack a significant commercial character and are not of a size or scale necessary to be characterised as carrying on a business of letting rental properties.

Both business and investment will have a profit-making intention.

In general terms, a business activity will be seeking to more efficiently allocate resources than a mere investment and will seek to conduct the activity in a way that provides a return that is higher than the investment levels received by others conducting similar activities.

Conclusion

After weighing up the relative business indicators and objective facts surrounding this case and based on the information and documentation provided, it is the Commissioner's view that the Trust's rental property activities are better described as leasing/renting a commercial property to receive income from a stream of rental income. The income is not derived from the services the Trust provides, but from the letting/renting of the property. Consequently, the trust does not meet the definition of small business entity.

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