Edited version of your private ruling

Authorisation Number: 1012519443120

Ruling

Subject: Carrying on a business

Question

Is the taxpayer carrying on a rental property business?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2014

The scheme commences on:

1 July 2013

Relevant facts and circumstances

1. The taxpayer owns a number of residential units most of which they have owned for over 10 years. The apartments are booked periods ranging from 4 weeks to 6 months. The majority are booked by guests for a number of months.

2. The taxpayer manages and maintains the properties on a full time basis and the income from this activity is their only income apart from a partnership distribution for managing X apartments which are not owned by them.

4. The taxpayer has rented a separate office in a building where most of the units are located since 200X. Y of their units are in the block.

5. In a phone conversation with the taxpayer's accountant they advised that the website rental was split with another person who owns about Z units.

6. The taxpayer spends 40 to 50 hours a week collecting rent, maintenance activities and receiving calls from clients whom want to lease, advertising the units on their website and all administration duties related to these properties.

The taxpayer pays cleaners to clean the apartments usually at the end of the day. The taxpayer is responsible for checking in guests for the apartments they own.

7. The taxpayer requires permission from guests to enter an apartment, all the apartments are fully furnished and guests require permission to alter an apartment in anyway.

8. The taxpayer does not use an agent.

Relevant legislative provisions

Income Tax Assessment Act 1997 6-5(1) and

Income Tax Assessment Act 1997 995-1.

Reasons for decision

Summary

It is considered that the scale of activity and volume of operations carried on by you is sufficient to be considered as carrying on a business.

Detailed reasoning

Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states that your assessable income includes income according to ordinary concepts. This 'ordinary income' includes amongst other things, income from salary and wages and business operations.

Carrying on a business

Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

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). 

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 (paragraph 3 of Taxation Ruling IT 2423).

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 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. A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations. If rent was derived from a number of properties or from a block of apartments, that may indicate the existence of a business (paragraph 5 of IT 2423).

The issue of whether individuals are carrying on a business of letting property has been considered in a number of cases, some of which are discussed below.

In Cripps v. FC of T 99 ATC 2428; (1999) 43 ATR 1202, the taxpayer and his wife purchased, as joint tenants, 14 townhouses which they rented out. They also purchased a property which was used initially as a holiday home but was later periodically rented out. A further property was purchased for residential purposes. After a failed attempt to sell it, it was also rented out. The Administrative Appeals Tribunal found that the taxpayer and his wife were mere passive investors and were not in the business of deriving income from rental properties. They rejected the taxpayer's argument that he had greater involvement with his16 properties.

In 11 CTBR (OS) Case 24 (Case 24), the taxpayer's income included rents from three properties. The taxpayer employed a manager and an accountant - he was principally a letting clerk with authority to refuse tenants. He collected and banked rents, attended to repairs and supervised them, and controlled the caretaker and cleaners. He kept books in connection with rents and repairs, and rates and other outgoings. The taxpayer said he personally carried out the principal part of the management of his rent-producing properties and directed policy, attended to the financial arrangements and made decisions regarding repairs. The taxpayer claimed that he was carrying on a business. In holding that he was not carrying on a business, a majority of the members of the Board of Review said:

It is obvious that some measure of supervision and management must ordinarily be exercised by a property owner who lets offices, &c., and if that does not amount to the carrying on of a business, the fact that he employs others to assist him, either in the letting of the properties or in the preparation of the accounts relating to his rents and outgoings, will not make any difference. For the foregoing reasons we are unable to uphold the claim that the taxpayer is engaged in a 'business as property owner' ... .

In 15 CTBR (OS) Case 26, (Case 26) the taxpayer derived income substantially from her joint ownership of a block of flats (containing 22 living units) with her sister-in-law. A swimming pool was shared with a neighbouring block of flats owned by the taxpayer's husband and his brother. A garden was maintained and a staff of one caretaker and one cleaner employed on both buildings with casual labour as required. The building was erected and financed by F & Co., the husbands of the joint owners, in the course of their business as building contractors. The general supervision of letting, rent collecting, servicing and maintenance was carried out by the owners or by F & Co. on their behalf. No charge was made by F & Co. for the extensive assistance given in the supervision of the flats. It was held that a business was not being carried on by the owners of the block of flats.

On the other hand, Case G10 75 ATC 33 (Case G10), the taxpayer owned two properties of which six units were let as holiday flats for short term rental. The taxpayer, with assistance from his wife, managed and maintained the flats. Services included providing furniture, blankets, crockery, cutlery, pots and pans, hiring linen and laundering of blankets and bedspreads. The taxpayer also showed visiting inquirers over the premises, attended to the cleaning of the flats on a daily basis, mowing and trimming of lawns, and various other repairs and maintenance. The taxpayer's task in managing the flats was a seven day a week activity. The Board of Review held that the activity constituted the carrying on of a business.

Taxation Ruling TR 97/11 (TR 97/11) provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. Whilst TR 97/11 specifically discusses primary production activities, the factors can be applied to other types of businesses. The factors include:

· 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) 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 above 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.

A further example of a taxpayer considered to be carrying on a rental property business is provided in page 5 of the ATO publication Rental properties 2010-11:

... the D'Souzas, own a number of rental properties, either as joint tenants or tenants in common. They own eight houses and three apartment blocks, each block comprising six residential units - a total of 26 properties.

The D'Souzas actively manage all of the properties They devote a significant amount of time - an average of 25 hours per week each - to these activities. They undertake all financial planning and decision making in relation to the properties. They interview all prospective tenants and conduct all of the rent collections. They carry out regular property inspections and attend to all of the everyday maintenance and repairs themselves or organise for them to be done on their behalf. Apart from income Mr D'souza earns from shares, they have no other sources of income.

The D'Souzas are carrying on a rental property business. This is demonstrated by:

· the significant size and scale of the rental property activities

· the number of hours the D'Souzas spend on the activities

· the D'Souzas extensive personal involvement in the activities, and

· the business-like manner in which the activities are planned, organised and carried on…

An individual who derives income from the rent of two or three 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, if the other indicators of a business are present.

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 others, such as McDonald's case and Cripps' case.

Applying the relevant cases and indicators to your circumstances

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.

The taxpayer has held and rented out the majority of the units for over 10 years and they are mainly let for short term periods.

Intention of the taxpayer

The carrying on of a business is not a matter merely of intention; it is a matter of activity. It is appropriate to look at when the activities started and whether they add up to more than a mere intention to conduct a business.

The taxpayer undertakes the daily running and maintenance of the properties spending 40 to 50 hours on activities related to them indicating there is more than a mere intention to conduct a business.

Prospect of profits

The taxpayer's involvement in the business activity should be motivated by wanting to make a tax profit and the taxpayer's activities should be conducted in a way that facilitates this. This will require examining whether objectively there is a real prospect of making such a profit from participating in the business of the taxpayer.

The rental properties have been profitable since their purchase. It is the taxpayer's only source of income apart from partnership distributions received for managing X units which are not owned by them.

Repetition and regularity

The taxpayer's activities should involve repetition and regularity and have an air of permanence about them. With regards to letting of properties, repetition and regularity may be measured by factors such as regularity of maintenance, collecting of rent, management and advertising of the properties, insurance, dealing with tenancy agreements and inspection reports.

You have advised that the taxpayer undertakes the management and maintenance of the property spending 40 to 50 hours a week collecting rent, maintenance activities and receiving calls from clients whom want to lease, advertising the units on his website and all administration duties related to these properties. The taxpayer also pays cleaners to clean the apartments usually at the end of the day. The taxpayer is responsible for checking in guests for the apartments he owns.

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.

The taxpayer requires permission from guests to enter an apartment, all the apartments are fully furnished and guests require permission to alter an apartment in anyway.

The properties are mainly let on a short term basis. The apartments are booked periods ranging from 4 weeks to 6 months and the majority are booked by guests for two to three months.

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.

All properties owned by the taxpayer are tenanted by non-related parties on a short term basis. A unit owned by the taxpayer in the building where most of the units are situated has been used as a separate office since 200X to manage the units. The business records relating to the renting of the units are manually maintained by the taxpayer and are stored in the office.

The size and scale of the activity

The business should be large enough to make it commercially viable. It is considered that the scale of your activities and volume of operations is extensive enough to amount to carrying on a business.

Hobby or recreation

The activity does not have the nature of a hobby or recreational pursuit.

Conclusion

It is considered that you are carrying on a business of rental properties as rental income is derived from X properties. These properties are rented out by the taxpayer mainly on a short term basis as holiday flats.

Considering the relative business indicators and the facts of the case the taxpayer performs all of the activities required for the management and maintenance of the properties. The level of involvement, scale of activity and volume of operations in the activity is sufficiently extensive to be considered a business of renting properties rather than a landlord and tenant relationship.

Further issues for you to consider

Whether the taxpayer's self-managed superannuation fund (SMSF) can acquire some of the residential units rather than sell the units to a non-related party.