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Ruling

Subject: Am I in business

Question 1

Does the activity of managing rental properties constitute carrying on a business for the purposes of the income tax legislation?

Answer

No.

Question 2

Are you entitled to a deduction for expenses incurred to purchase memberships, DVDs, books, magazines and journals related to property investment and attend seminars and exhibitions about property investment?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You own several rental properties which produce rental income.

You purchased your first property about 10 years ago, but it has accelerated in the last few years and you aim to purchase at least one property every year.

You have a job but only because it boosts your chances of getting approved when applying to a bank for a new home loan for another property.

You have a separate phone number and separate finance accounts for your property investment income, expenses and other matters. You keep these separate from your personal income and expenses.

You incurred various expenses which you believe are related to managing your rental properties. Theses expenses include purchasing memberships, DVDs, books, magazines and journals related to property investment and also attending seminars and exhibitions about property investment.

As your properties are in various locations, you engage property managers from real estate agencies local to each property.

Your portfolio consists of units, houses and studio apartments.

All the properties are intended for long term rental. You have no intention of living in any of the properties yourself.

You keep in close contact with all the property manages of your properties as well as other real estate agents.

You receive paperwork in your mail which needs to be reviewed everyday.

Maintenance issues often arise which require your action.

You do a lot of research and investigation to try to improve your properties and portfolio. This include planning renovations, financial planning, searching for appropriate professional services and more.

You attend open inspections of properties each week to search for your next property to buy as well as keeping up with the existing property market.

You have subscribed to various magazines and internet services to improve your knowledge of property investment.

You attend various seminars and have joined programs associated with residential property markets.

You estimate you spend at least 30 hours per week on activities relating to your properties.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 995-1 and

Income Tax Assessment Act 1997 section 8-1.

Reasons for decision

Question 1

Summary

We consider that your activities are not conducted on a sufficient scale to be considered a business. The finding that your activities are not a business does not change whether or not income from theses activities is assessable or the expenses are deductible.

Detailed Reasoning

Business is defined in section 995-1 of the Income Tax Assessment Act 1997 (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 2011 (NAT 1729-6.2011) 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.

Taxation 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.

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.

Taxation Ruling TR 97/11 is of general application. 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.

Whether a business is being carried on depends on the large or general impression gained (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548) from looking at all the indicators of carrying on a business, and no one indicator will be decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922).

In Case G10 (1974) 75 ATC 33 (Case G10) the taxpayer owned a block of holiday flats for short term lettings at a beach resort. Helped by his wife, he also managed and maintained the flats. This involved the hiring out of linen, laundering, showing visiting inquirers over the premises, correspondence and banking, most of the cleaning, the mowing of lawns, internal and external painting, taking care of the boiler room and various running repairs.

The Board of Review, in Case G10, found that the taxpayer's activity in owning and managing his holiday flats for short term lettings constituted the carrying on of a business. The elements of repetition and continuity of acts and transactions were sufficient evidence of the existence of a business - it was not a case of a person who simply owns flats which bring to him income vicariously through a letting agent.

Whether the letting of your several rental properties amounts to the carrying on of a business, rather than the passive receipt of income, will depend on the level of services you provide in addition to the letting of the properties and the other indicators noted above.

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.

You own several rental properties including units, houses and studio apartments. Your properties are rented to tenants on a long term basis. The properties typically generate substantial gross income per annum.

Intention of the taxpayer

You purchased the properties to rent to tenants. You have invested capital into the activity.

Prospect of profits

The property provides a substantial gross income per annum.

Repetition and regularit

You estimate that you spend at least 30 hours per week on activities relating to your properties. Your level of personal involvement in managing the properties on a daily basis covers only some of the activities required to manage rentals. You have engaged the services of property managers to manage your properties.

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).

This indicator requires a comparison between the activities of the taxpayer in question and those undertaken by a person in business in the same type of industry. Where the taxpayer's activities are similar in nature to the business, further support is given to the fact that a business exists.

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.

Your properties are rented out on a long term residential basis. You do not provide the services noted in Case G10. Your level of active involvement in relation to a number of activities is significantly less than those noted in Case G10.

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. If the activities are carried out on the taxpayer's behalf by someone else, there should be regular reports provided to the taxpayer on the results of those activities.

You keep in close contact with your property managers and have a separate phone number for dealing with rental properties matters. You also keep a bank account, separate from your personal finances for your rental property income and expenditure.

The size and scale of the activity

In contrast to Case G10 the scale and the size of your activity is small as you have several rental properties available for rent.

Hobby or recreation

The activity does not have the nature of a hobby or recreational pursuit. The nature of your activity is similar to other property owners who are involved in renting properties to tenants.

Conclusion

In your case, you own several rental properties which return an income stream. While some aspects of your activity are similar to that of a commercial operator, your level of personal involvement in providing services is significantly less than that noted in Case G10 as your tenants are long term. A large portion of your time is spent on preliminary activities to expand your property portfolio.

We consider that your activities are not conducted on a sufficient scale to be considered a business. The finding that your activities are not a business does not change whether or not income from theses activities is assessable or the expenses are deductible.

Question 2

Summary

You have incurred expenses to purchase memberships, DVDs, books, magazines and journals related to property investment and attend seminars and exhibitions related to property investment. These expenses are not incurred in producing your current assessable income and are therefore not deductible under section 8-1 of the ITAA 1997.

Detailed reasoning

Subsection 8-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for any loss or outgoing to the extent that it is incurred in gaining or producing assessable income, or is necessarily incurred in carrying on a business for the purpose of producing assessable income. Subsection 8-1(2) of the ITAA 1997 however, excludes a loss or outgoing of a capital, private or domestic nature, or where the loss or outgoing is incurred in gaining or producing exempt income.

You are not carrying on a business of letting properties. Therefore, we have to determine whether the expenses you incurred were in gaining or producing your assessable income under the first limb of subsection 8-1(1) of the ITAA 1997.

For a deduction to be allowed under the first limb of subsection 8-1(1) of the ITAA 1997, the expenditure must be incidental and relevant in the sense of having the essential character of expenditure incurred in the course of gaining or producing assessable income. There must be a sufficient connection between the expense and the operations or activities which gain or produce the assessable income.

Taxation Determination TD 2004/1 relates to the deductibility of investment information services and investment journal. It allows a deduction for the cost of subscriptions to investment information services and investment journals to the extent that the expenditure is incidental and relevant to gaining or producing assessable income (whether or not a business is carried on) and is not a capital cost of putting the income earning investment in place. A deduction is not allowable to the extent that an expense is capital, private or domestic in nature.

In your case, the expenses to purchase memberships, DVDs, books, magazines and journals related to property investment provides you with information regarding property acquisition for future investments. This is also the case for the expenditure incurred to attend seminars and exhibitions related to property investment. These expenses are not incurred in producing your current assessable income and are therefore not deductible under section 8-1 of the ITAA 1997.