Edited version of private ruling

Authorisation Number: 1011470784643

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Ruling

Subject: am I in business

Question

Are you carrying on a business of property ownership and management?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

You and your partner own and manage three properties. The properties were purchased several years ago.

You have been involved in property management services and the rental of residential and commercial property for several years.

One partner's employment for several years involved the acquisition, management and maintenance of various properties.

One property is let to holiday tenants and is managed by a real estate agent.

You source the tenants for the other two properties. Rent for these properties are paid into your joint account and the bonds are held in your joint name.

The properties produced an overall net profit in the income year.

One partner spends approximately 2 hours each week and the other partner spends approximately 1 hour per week on the properties. Activities include maintenance and tenant liaison.

You do not immediately intend to purchase or sell properties.

You do not have a written business plan for your property management and maintenance activities. You rely on your experience and skills to manage the properties.

Your purpose is to hold, manage and maintain the properties efficiently and profitably.

Rents are adjusted to market levels when appropriate to increase profits.

You keep records for your properties.

Research and other material which is available from industry associations, real estate groups, banks, specialist magazines and print media are used from time to time.

Your superannuation fund owns and manages three industrial/commercial units. Possibly additional properties may be purchased within your self managed superannuation fund.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5(2).

Reasons for decision

Summary

You are not considered to be carrying on a business of managing and owning property for taxation purposes.

Detailed reasoning

Under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997), the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources during the income year.

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.

Business is defined in section 995-1 of the ITAA 1997 to be 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'.

The Commissioner's view on whether the letting of property amounts to the carrying on of a business is found in a number of places.

The Tax Office publication Rental properties 2009 (NAT 1729-6.2009) states on page 4:

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.

Income tax ruling IT 2423 considers whether rental income constitutes proceeds of a business (for withholding tax purposes). IT 2423 states:

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.

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 (paragraph 3 of Taxation Ruling IT 2423).

Taxation Ruling TR 93/32 is about rental property and division of net income or loss between co-owners. TR 93/32 quotes the legal case of Federal Commissioner of Taxation v McDonald (1987) 18 ATR 957; 87 ATC 4541, were Beaumont J said at ATR p 968; ATC p 4550:

The reference to "business" . . . indicates a "commercial enterprise as a going concern": see Hope v Bathurst City Council (1980) 144 CLR 1 at 8; 12 ATR 231 at 236 per Mason J. Purely domestic transactions are thus excluded from the definition: see Fletcher, op cit p 28. The "business" must be "carried on". This suggests some active occupation or profession: see IRC v The Marine Steam Turbine Co Ltd (1919) 12 TC 174 per Rowlatt J at 179.' . . . 'On the other hand, in the case of a private individual as distinct from a company, "it may well be that the mere receipt of rents from properties that he owns raises no presumption that he is carrying on a business." see American Leaf Blending Co Sdn Bhd v Director-General of Inland Revenue (1979) AC 676 per Lord Diplock at 684.

and at ATR page 969; ATC page 4552, where Beaumont J continued:

Their investment involved little, if any, active participation from either party ... This was not a case of the active joint participation by the parties in a business activity. Rather, it was a case of a renting out of premises without the provision of other services of the kind discussed in Wertman, supra. In my view, there was here a mere investment in property rather than a partnership in the properties or their profits.

The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the particular facts.

Normally the receipt of income from the letting of property to a tenant(s) does not amount to the carrying on of a business (Wertman v. Minister of National Revenue (1964) 64 DTC 5158; Federal Commissioner of Taxation v. McDonald (1987) 15 FCR 172; 87 ATC 4541; 18 ATR 957 (McDonald's case); Cripps v. FC of T 99 ATC 2428 (Cripps' case); Case X48 90 ATC 384; (1990) 21 ATR 3389). 

In 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 outlines some factors that indicate whether or not a business of primary production is being carried on. These factors equally apply to other types of businesses. No individual factor is determinative, but should be weighed up in conjunction with the other factors.

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, and no one indicator will be decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922).

Applying the relevant indicators to your circumstances

Significant commercial purpose

The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators.

Your activity is the managing and maintenance of residential properties. Currently you own three investment residential properties and manage two of these properties. You do not have a business plan.

Intention of the taxpayer

The carrying on of a business is not a matter merely of intention, it is a matter of activity. It is appropriate to look at when the activities started and whether they add up to more than a mere intention to conduct a business.

You have had your properties for several years. The properties have been rented and you have received rental income from these properties. The two partners spend approximately 3 hours per week on the managing of the properties. Your intention is to hold and manage the properties in an efficient and profitable manner.

Prospect of profits

The taxpayer's involvement in a 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 business of the taxpayer.

Your properties produce an overall profit. An increase in rents is how your profits will improve.

Repetition and regularity

The taxpayer's activities should involve repetition and regularity and have an air of permanence 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 manage two of your properties. Your property activities are approximately 3 hours each week.

Your involvement with the management of your properties is more than some rental property owners, however, it could not be concluded that the level of repetition and regularity of your activity is a business.

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

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 (IR Commissioners v. Livingston 11 TC 538).

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.

Your activity is collecting rental income and maintaining your residential properties. Hence the relationship is that of a landlord and tenant.

Organisation in a business-like manner, the keeping of books, records and the use of a system

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.

You keep records in relation to the properties you own.

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.

Example 4 on page 5 of the Australian Taxation Office's Rental properties 2009 booklet involves taxpayers, who own 26 properties, spend approximately 25 hours per week each on managing the properties. Although you do the maintenance and management of two of your properties, the size and scale of your activities are not considered to be significant and you spend considerably less time each week on your rental property activities.

Hobby or recreation

Your level of active involvement in relation to your properties are significantly less than those noted in Case G10. In comparison to the taxpayer in Case G10 their activity involved a significant amount of their time devoted to the holiday letting activity. In your case, you find the tenants for two of your properties and spend approximately 3 hours a week on your management and maintenance activities. This is not considered to be a significant amount of time for a business activity. Your activities are more in the nature of a recreational pursuit.

Conclusion

The intention to make a profit is not, on its own, sufficient to establish that a business is being carried on. Where a business exists, there is usually a business plan of how the activities will be conducted.

As shown in the legal 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 activities. The quantum of rental income derived does not affect the characterisation of the activity.

We acknowledge you carry out the maintenance and management work on two of your properties and there are some elements of your activity that add weight that the activity has a business like nature such as being profitable and the keeping of records. However, after considering your specific circumstances, it is considered that your activities are not carried on as a business for taxation purposes.

The tenants of one property are obtained by your real estate agent. In addition, in terms of business organisation, you do not have a business plan. Any increase in profit is as a result of increasing rent. Your activities are not conducted on a sufficient scale to be considered to be a business. You own three properties. This is not considered to be of a scale to take the activity beyond a passive rental income producing activity. Although two of your properties are managed by you and you have kept records of the associated income and expenses, this is not sufficient to regard your activities as a business. Furthermore, the fact that your self managed superannuation fund also owns and manages three industrial properties does not convert your activities to a business. The superfund is a separate entity for taxation purposes.

After weighing up the relative business indicators and objective facts surrounding your case it is considered that you are not carrying on a business of managing and maintaining residential properties.