Edited version of your private ruling

Authorisation Number: 1012456267417

Ruling

Subject: Non-commercial losses - Commissioner's discretion

Question

Will the Commissioner exercise the discretion in subsection 35-55(1) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your rental activity in your calculation of taxable income for the 200X to 20YY financial years?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commenced on

1 July 2009

Relevant facts and circumstances

Your family acquired a property in a foreign country comprising a block of flats which you inherited.

You visited the location and gross rents were estimated on the condition that electricity and water services would not be cut off for non-payment of arrears rates. Payments of arrears have not been made.

Sporadic amounts of rent are paid to your bank account with no other details than the tenant's name. One caretaker used the property for their private use rent free contrary to your instruction.

The authority where your property is located has not responded favourably to your concerns regarding the maintenance of services and utilities. You estimate there was a fall in valuation of your property which can be attributable to several things including the authority's actions and inactions.

You may visit the property this year as it is possible that where will be no further income from the property however further maintenance may have to be undertaken. You will pursue new avenues of business.

You take the following action in regard to the property;

· Travel overseas to the property

· Search for entities interested in development or alternative use

· Inspecting and reviewing developments around the property

· Expending considerable physical exertion in maintenance

· Trying to engage a suitable caretaker

· Registering objections to the local authority

· Preparing leases for tenants

· Defending legal action

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 35-55(1)

Reasons for decision

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 ATO publication Rental properties 2011-12 (NAT 1729-6.2012) 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 is about 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 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.

Taxation Ruling TR 97/11 is about 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:

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

· the repetition and regularity of the activities;

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

· the volume of the operations; and

· the amount of capital employed.

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.

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 the activities. Regarding rental properties, the fact of profit making is not a salient indicator (although, as stated in TR 97/11, where an activity looks like it will never produce a profit, the activity will not amount to a business).

In your situation, the Commissioner considers you are not carrying on a business of rental properties. You derive sporadic rental income from two properties and although you perform some of the activities required for the management of the properties yourself, the size and scale of your rental activities is not considered to be extensive enough to amount to a business for tax purposes.

Non-commercial losses

Under subsection 35-55(1) of the ITAA 1997, the Commissioner's discretion can be exercised where the business activity satisfies four requirements. These are: 

(a) the business activity has started to be carried on; and

(b) the business activity was or will be affected in that or those income years by special circumstances outside the control of the operators of the business activity, including drought, flood, bushfire or some other natural disaster; or

(c) because of its nature it has not yet satisfied a test in Division 35; and

(d) there is an objective expectation that within a period that is commercially viable for the industry concerned it will pass one of the tests or make a tax profit.

In your circumstances your rental property activity is not considered to be carrying on a business. Therefore under subsection 35-55(1) of the ITAA 1997, the Commissioner's discretion cannot be exercised.