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Ruling

Subject: Carrying on a business

Question

Is the unit trust considered to be carrying on a business if it rents X long term residential units to arms length parties?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts

The trustee of your family unit trust ('unit trust') owns X strata titled residential units which were acquired from a related party.

These residential units are the only assets of the unit trust.

The unit trust is considering selling the properties to a related entity.

The units are rented under long term residential contracts on an arm's length basis.

The unit holders are responsible for the day to day management and maintenance of the rentals. They are responsible for the operation, control and oversight of the real estate. The services of a real estate agent are not used.

The rent is paid by direct deposit into a bank account.

One of the unit holders is a member of the body corporate.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Reasons for decision

Summary

It is considered that the unit trust is not carrying on a business of renting properties due to the small scale of the activities. Therefore, the income is assessable income as ordinary income under section 6-5 of the Income Tax Assessment 1997 but is not business income.

Detailed reasoning

Taxation Ruling TR 97/11 provides the Commissioner's view of the factors used to determine if you are in a business for tax purposes.

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).

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).

Guidance on whether a person is carrying on a business of rental properties is provided in the Tax Office publication Rental properties 2010-11 (NAT 1729).

To be carrying on a business, the taxpayer must be involved in the activities that make up that business. This would be evidenced by an element of control over, and/or an ongoing participation in, the business. The involvement should be direct or immediate, rather than passive. The payment of expenses relating to the ownership of property would not, without more, be sufficient.

Paragraphs 3 to 5 of Taxation Ruling IT 2423 are also relevant in determining whether the renting of property amounts to the carrying on of a business. In particular, paragraph 5 states `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.'

Generally, an entity such as a company, partnership or trust that predominantly derives investment income such as rental income, share dividends and interest income would not be carrying on a business because of the passive nature of such investments (Cripps v. FC of T 99 ATC 2428; (1999) 43 ATR 1202).

In Carson and Commissioner of Taxation [2008] AATA 156 (26 February 2008), the AAT said that the taxpayers' activities had all the hallmarks of maintaining and deriving an investment rather than the carrying on of a business. The activities such as financing the property, dealing with rating authorities and the body corporate were no more than what any investor in real estate would do. On the facts, therefore, the AAT said it was unable to distinguish the case from Cripps' case.

Self Managed Superannuation Fund Ruling SMSFR 2009/1 includes examples to illustrate how the business real property principles apply to various cases and scenarios. For instance, the scale of operation indicating a property investment business in Example 14 refers to 20 long-term residential units being a business.

Based on the information you have provided, we have determined that the unit trust will not be considered to be carrying on a rental property business. The reasons behind this decision are:

· the unit trust only owns X residential units which it leases to tenants;

· even though the unit holders manage the day to day aspects of the properties the size and scale of the rental activities are not considered to be extensive enough to amount to a business for tax purposes.

The rental activities would be better described as those of a property investor who is leasing residential properties to receive a stream of passive income.