Edited version of private ruling

Authorisation Number: 1011843116284

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Ruling

Subject: Income Tax - Capital Gains Tax

Issue 1

Question 1

Do storage sheds which are rented out by the partnership qualify as active assets in terms of section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following period

1 July 2010 to 30 June 2012

The scheme commenced on

1 July 2010

Relevant facts

The partnership has a property which has more than 20 self-storage sheds which were constructed by the previous owner and were later purchased by the partnership.

The partnership has engaged the services of a real estate agent to assist with the management of the self-storage sheds because they have other business interests which occupy their time.

The storage units are available for short term hire to customers with the minimum length of hire period being one week with no maximum period applicable.

The people who hire the sheds have personal locks however the landlord has the authority and legal capacity to enter the sheds in certain circumstances.

A typical contract for the storage is issued in the name of the partnership (not the real estate agent) and an application form must be completed before renting.

The landlord indemnifies the agent from all actions, claims, demands, losses, costs, damages and expenses properly incurred by the agent in carrying out its duties.

The agent is to act in the best interests of the landlord at all times.

The agent has authority to let the sheds without consulting the landlord before each letting.

The agent is authorised to let the sheds under the rental and letting conditions or at such other rental and lease conditions as the landlord from time to time may nominate in consultation with the agent and in particular to:

· advertise the sheds for let at the landlords expense as specified

· collect from the renter bond and rental moneys.

· account and render statements in writing to the landlord for all moneys received, paid or appropriated and to pay moneys due to the landlord monthly and upon completion of the letting, the bond to be returned to the tenants and the key to the property to be collected from the tenant.

· the landlord authorises and consents to the agent advertising the property for letting in such manner as the agent considers appropriate.

· the landlord acknowledged that the agent may receive a rebate on the total advertising expenses incurred by the agent in the conduct of its agency practise as a result of large volume advertising by the agent and the landlord consents to the agent receiving any such advertising rebate without further notice being given to the landlord.

The landlord acknowledges:

· that the agent duties and authorities are expressly limited to those contained in the agreement; and

· that the agent gives no warranty as to the credit worthiness or financial status of any renter.

· renters are not personally screened.

The landlord authorises the agent to deduct any moneys due and payable by the landlord to the agent pursuant to this agreement from any moneys received by the agent for and on behalf of the landlord.

A professional fee of 15% plus goods and services tax (GST) of the rental money received by the agent will be deducted from rental money on a monthly basis.

The landlord must arrange or keep the grounds free from weeds and rubbish and remove cobwebs from roller doors on a regular basis.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 paragraph 152-40(4)(e)

Reasons for decision

Issue 1

Question 1

Summary

The property is not considered to be an active asset for the following reasons:

· your activities do not amount to the carrying on of a business, and

· the main use of the property is to derive rent, therefore it is excluded from being an active asset under paragraph 152-40(4)(e) of the ITAA 1997.

Detailed reasoning

Active assets

Under section 152-40 of the ITAA 1997 a capital gains tax (CGT) asset is an active asset if at that time:

· you own the asset, and

· you use it, or hold it ready for use, in the course of carrying on a business.

Paragraph 152-40(4)(e) of the ITAA 1997 excludes, among other things, assets whose main use is to derive rent (unless such use was only temporary).

Carrying on a business

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 to determine the matter, these indicators are summarised in Taxation Ruling TR 97/11 which is called Income tax: am I carrying on a business of primary production. These indicators are applicable to business activity generally.

There have been many court cases regarding whether the activities relating to investment property management amount to the carrying on of a business. These activities rarely do.

In Federal Commissioner of Taxation v. McDonald (1987) 15 FCR 172; 87 ATC 4541; (1987) 18 ATR 957 (McDonald's Case) it was found that the taxpayer and his wife, who owned two investment properties, were not carrying on a business; their relationship was that of co-ownership rather than partnership. There was a mere investment in property rather than a partnership in the properties or their profits.

The principle from McDonald's Case was followed in Cripps v. FC of T 99 ATC 2428; (1999) 43 ATR 1202 (Cripp's Case). In Cripp's Case the taxpayer and his wife purchased as joint tenants 14 double storey townhouses. The acquisition was financed entirely by borrowed funds, which were secured by a mortgage over the properties. After renovations, the townhouses were rented out. They were managed by a real estate agent. Substantial tax losses were incurred over a number of years in respect of the properties. The taxpayer allocated full losses to himself on the basis that a general law partnership existed (which implied that a business was being carried on). Objections to the Commissioner's decisions were disallowed and the taxpayer appealed.

The taxpayer contended that the acquisition and renting out of the properties by him and his wife constituted the carrying on of a business. The taxpayer supported his contention by pointing to the use of a business name by he and his wife, the existence of a business plan, his involvement in the management of the townhouses and the number of properties involved. The Commissioners decision was upheld, it was ruled that the arrangement between the taxpayer and his wife was merely that of an investment and not a business.

Similarly, in Carson & Anor v. FC of T [2008] AATA 156; (2008) 2008 ATC 10-006; (2008) 71 ATR 301 (Carson's Case) the taxpayers purchased a rental unit which they used to provide short-term tourist accommodation, usually for stays of about one to two weeks.

The taxpayers engaged a real estate agent to arrange rentals and to attend to minor repairs. The taxpayers spent around one week every six months servicing the unit and attending to the surrounding garden. According to the taxpayers, the unit had an average annual turnover of $35,000, and they undertook activities in relation to the unit such as dealing with financial institutions in relation to loans and financing, dealing with rating authorities and body corporate matters, and maintaining proper accounting and tax records.

The taxpayers sought a private ruling confirming that the unit was an active asset for the purposes of the small business CGT concessions. The Commissioner ruled that the unit was not an active asset as a business was not being carried on. Their objection was also disallowed.

The case was appealed in the Administrative Appeals Tribunal. At issue was whether the unit was used in the course of carrying on a business and whether the unit was disqualified from being an active asset by having its main use to derive rent. In regard to the latter, the taxpayers relied on Taxation Determination TD 2006/78, which provided that certain premises used in a business of providing accommodation for reward would satisfy the active asset test.

The taxpayers' activities had many indicators of maintaining and deriving income from an investment rather than the carrying on of a business. Activities such as financing the property, dealing with rating authorities and maintaining accounting and tax records were no more than any investor in real estate would do. They were not the sustained, repetitive commercial activities representing the carrying on of a business activity. The Commissioners decision was upheld.

Your situation

In your case the administration of the storage sheds is conducted as part of the business carried on by the real estate agent and in consideration of the relationship between a principal and agent the property owners are acting through an agent and therefore the actions of the agent are considered to be the actions of the principal. However, the services provided by the real estate agent in relation to this property also do not amount to more than those deriving income from an investment.

Similar to McDonald's Case, Cripp's Case and Carson's Case your activities when considered objectively are more properly described as a passive investment. As a result, your activities do not amount to the carrying on of a business of property rental.

Unlike the example given in TD 2006/78 where a person carried on a business of providing accommodation for reward, there is no suggestion that services are provided to renters other than the use of the storage sheds. In that example there was the provision of office facilities and security and cleaning services as well as trolleys, boxes and other equipment. The property occupants could be relocated and could only enter and use the sheds for certain purposes thus they were considered to not have 'exclusive possession'.

In this case, however there are no services provided other than the right to occupy the premises and each occupant has been required to complete a rental agreement and hold personal locks. Therefore similar to Carson's case the occupants would consider that they were renting the premises and that they would have exclusive possession for that period. Therefore the income derived would correctly be considered to be 'rent'.

The partners own a property which is not used in the course of carrying on a business and the income derived from the property can correctly be described as rent therefore the asset does not pass the 'active asset test' in accordance with section 152-40 of the ITAA 1997.