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Ruling

Subject: whether the entity is in business, related party asset acquisition rule and the active asset test.

Question 1

Is the entity considered to be carrying on a business of letting rental properties?

Answer

Yes.

Question 2

If the activity is considered a business, would the individual properties satisfy the active asset for the purposes of section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following periods

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

The scheme commenced on

1 July 2012

Relevant facts

The entity owns a large number of rental properties. The entity has held a similar number of properties for several years.

The properties are located in various locations and are all rented on twelve month tenancies.

The entity manages the properties.

The entity attends to all the major maintenance requirements including general repairs, refurbishments, gas fitting and repairs, plumbing and maintenance of, air conditioning and small electrical faults. It also encompasses all other aspects of tenancy, paperwork, bookkeeping, bank liaison, computer input, advertising, small maintenance and other duties.

The entity has made a profit on the investments over a number of years.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Subsection 152-35(1)

Income Tax Assessment Act 1997 Subsection 152-35(2)

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Subsection 152-40(1)

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

Reasons for decision

Business

The Commissioner's view on whether the letting of property amounts to the carrying on of a business can be sourced from a number of areas.

Taxation Ruling IT 2423 discusses whether rental income constitutes proceeds of business (for withholding tax purposes). IT 2423 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.

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.

Taxation Ruling TR 97/11 discusses whether a taxpayer is carrying on a business.

TR 97/11 states the question of whether a person is carrying on a business is determined by the facts in each individual case. This is done by considering the following factors that have been used in court cases:

ð the nature of the activities, particularly whether they have the potential of profit making;

ð the repetition and regularity of the activities;

ð organisation in a business-like manner, the keeping of books or records and the use of a system;

ð the volume of the operations; and

ð the amount of capital employed.

Your situation will now be discussed in relation to the above factors.

The nature of the activities, particularly whether they have the potential of profit making

For the last several years the trust has made profits from renting out the properties.

Scale of activities

The scale of the activities is considerable. The number of properties held by the trust, and actively managed by you, is currently in excess of ten. The properties are spread out between several towns. The scale of the operation is considered to be substantial.

Repetition and regularity of activities

You have been engaged by the trust to manage the properties. You are paid a fee to manage the properties. One of the trustees is also paid a travelling allowance to assist in managing and maintaining the properties. You actively manage the properties by:

ð finding tenants

ð leasing the properties

ð collecting rents

ð paying for expenses

ð undertaking repairs

ð managing cash flow; and

ð maintaining electronic records.

You are both responsible for the day to day running of the properties.

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

You both actively manage the day to day running of the operation. One of the trustee's duties includes all aspects of tenancy, paperwork, bookkeeping, bank liaison, computer input and advertising. The trustee also maintains a computerised tenancy ledger, computerised loan history and forecasts, renovation cost spreadsheets and running property inventories. The trustee also maintains ledgers including full double entry bookkeeping using MYOB.

The volume of the operations

The trust owns, and you currently manage, the rental properties on behalf of the trust. These properties are located in several locations. You also manage properties on behalf of other trusts.

The amount of capital employed

The amount of capital employed is substantial as the trust rents out a substantial number of rental properties.

After considering the above factors in relation to your activities it is considered that the trust is carrying on a business of letting rental properties.

Active Assets

Subsection 152-35(1) of the ITAA 1997 states a CGT asset satisfies the active asset test if:

(a) you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the period specified in subsection (2); or

(b) you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7½ years during the period specified in subsection (2).

Subsection 152-35(2) of the ITAA 1997 states the period:

(a) begins when you acquired the asset; and

(b) ends at the earlier of:

(i) the CGT event; and

(ii) if the relevant business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows - the cessation of the business.

Section 152-40 of the ITAA 1997 contains the meaning of 'active asset'.

Subsection 152-40(1) of the ITAA 1997 states a CGT asset is an active asset at a time if, at that time:

(a) you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a business that is carried on (whether alone or in partnership) by:

(i) you; or

(ii) your affiliate; or

(iii) another entity that is connected with you; or

(b) if the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

Exceptions

There are some exceptions or assets which cannot be active assets. One of those exceptions is covered under paragraph 152-40(4)(e) of the ITAA 1997. That paragraph states an asset whose main use by you is to derive interest, an annuity, rent, royalties or foreign exchange gains unless:

(i) the asset is an intangible asset and has been substantially developed, altered or improved by you so that its market value has been substantially enhanced; or

(ii) its main use for deriving rent was only temporary.

cannot be an active asset.

Taxation Determination 2006/63 states at paragraph 8 that 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). Such assets are excluded even if they are used in the course of carrying on a business. Of course, if the activities carried on do not amount to the carrying on of a business, it is unnecessary to consider whether the main use of the asset is to derive rent.

For example where an entity uses a property such as a guest house for short term stays the house would be an active asset because the entity would be using it to carry on a business and not to derive rent. On the other hand if an entity used the house purely as an investment property and rents it out, the house would not be an active asset because the main (or sole) use would be to derive rent.

In your case the trust operates a business of renting properties as outlined above however, as the main use of the houses is to derive rent, and the rental of the properties is not temporary, the assets (houses) are excluded from being active assets.