Edited version of your written advice

Authorisation Number: 1012900599828

Date of advice: 23 October 2015

Ruling

Subject: Whether you are operating a rental property business

Question

Are you carrying on a rental property business?

Answer

No

This ruling applies for the following period

Year ending 30 June 2016

The scheme commenced on

1 July 2015

Relevant facts

You have previously worked full time however you now work a few days a week in an occupation.

You own a number of commercial properties (which have a number of tenants in each) and a number of residential properties which are rented to tenants.

The majority of properties are located where you live and the remainder are interstate.

Generally, the length of tenancy in the residential properties is 12 months however some tenants had signed 6 month leases.

The total value of the properties is approximately $X. In the 2013-14 financial year you made $X profit. The properties have been acquired over a long period of time.

You use real estate agents as the immediate point of contact for tenants to address any minor issues and provide a cost effective resource. The real estate agents receive and record the rent paid and provide a local face to the tenant as they are able to attend to the matter directly and report back to you in a cost effective manner.

You handle all matters relating to financing, insurances, rates and taxes.

The time you spent on the rental properties is as follows:

• 2012 & 2013 - approximately 30%

• 2014 - approximately 10%

• 2015 - Jan to May - 10%

• 2015 - Jul to Dec - 20% - 30%

You visit the properties located in your home town once between every 6 to 12 months and the interstate properties once every one to two years.

Interstate tenants are generally fielded by the local real estate agent and a short list provided for your review. You are more involved with the local tenants and may meet the tenants to get a better understanding of their financial position, previous history and their business plan to ensure they are a fit to your overall business objective.

You have a written business plan.

You compile all financial information including book keeping, mortgage payments, collating interest payments, taxes, insurances, major repairs, renovations, investments and tax return preparation is done by you and forwarded to your accountant for his review and submission.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Summary

You are not operating a rental property business.

Detailed reasoning

Subsection 995-1(1) of the Income Tax Assessment Act 1997 (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 (IT2423)).

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 Taxation Ruling 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 the following examples/cases it was decided that the owners were not operating a property investment business:

In FC of Taxation v McDonald 87 ATC 4541 (McDonald's case), the taxpayer and his wife purchased several income-producing properties. In considering whether a business was being carried on the Federal Court considered the level of active participation by the parties. It was considered that this was not a case of the active joint participation by the parties in a business activity, as the investment involved little, if any, active participation from either party. Rather, it was a case of renting out of premises without the provision of other services.

In FC of T v. Cripps 99 ATC 2428 (Cripps case) 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 his 16 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.

Page 5 of the Rental properties 2014-15 (NAT 1729-6.2015) publication provides the following example of taxpayers considered to not be carrying on a rental property business:

… The Tobins own, as joint tenants, two units and a house from which they derive rental income. The Tobins occasionally inspect the properties and also interview prospective tenants. Mr Tobin performs most repairs and maintenance on the properties himself, although he generally relies on the tenants to let him know what is required. The Tobins do any cleaning or maintenance that is required when tenants move out. Arrangements have been made with the tenants for the weekly rent to be paid into an account at their local bank. Although the Tobins devote some of their time to rental income activities, their main source of income are their respective full-time jobs. The Tobins are not partners carrying on a rental property business, they are only co-owners of several rental properties.…..

In the following examples/cases it was decided that the owners were operating a rental property business:

Recently in Case 1/2014 2014 ATC 1-063 a taxpayer and her husband owned nine rental properties in various proportions since the 1990's. The taxpayer worked full-time on shift work as an industrial chemist but also spent a significant amount of time managing the rental properties. She inspected each property quarterly which would take at least half an hour per property and involved additional time, travelling depending on the location of the property. She estimated she spent nine hours every three months inspecting properties. She was also obliged to check accounts and carry out other tasks such as advertising for tenants in order to lease the properties. She engaged real estate agents to look after the properties, but that she had to follow up, advertise for new tenants, arrange repairs, and involve herself regularly with other work in relation to the properties. She did this partly because the agents were inefficient, or did not do what she intended. She had not made a profit but had a profit-making intention. It was decided that she was in the business of managing rental properties.

Case G10 75 ATC 33; 19 CTBR (NS) Case 103, involved a taxpayer who owned a block of holiday flats for short term lettings at a beach resort. Helped by his wife, he also managed and maintained the six flats, which were let furnished. This involved the hiring out of linen, laundering, showing visiting inquirers over the premises, correspondence, collecting all moneys payable and banking, most of the cleaning, the mowing of lawns, internal and external painting, taking care of the boiler room and various running repairs. It was held that the taxpayer's activity in owning and managing his holiday flats 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. The taxpayer was actively engaged personally from day to day in multifarious activities directed to the profitable operation of his income-producing holiday flats. His was not a case of a person who simply owns flats which bring to him income vicariously through a letting agent.

Page 6 of the of the Rental properties publication provides the following example of taxpayers considered to be carrying on a rental property business:

…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 apartment block comprising six residential units) making 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.

Taxation Ruling TR 97/11 incorporates the general factors of whether a primary production business is being operated. TR 97/11 is of general application. Its principles are not restricted to questions of whether a primary production business is being carried on, they apply equally to non-primary production activities.

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 business-like 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.

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.

By way of comparison your activities are similar to McDonald's case in that your participation in your activities is no more than a mere investor who has a number of rental properties.

Your situation can be also compared to Case 24 in relation to the use of an agent. In that case even though the taxpayer only had three rental properties he employed a manager and an accountant. In holding that the taxpayer was not carrying on a business the 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 ...". You engaged real estate agents to manage your properties. Even if you hadn't engaged real estate agents to manage the properties your activities are still not considered at a level to be considered in business.

In relation to the number of properties, the taxpayers in Cripps case had 16 properties and in Case 26 where there were 22 units neither of these cases were considered to be in the business of rental properties whereas the D'Souza's example where they had a total of 26 properties were considered to be in the business of renting properties. You have a number of commercial properties (with a number of units in each) and a number of residential properties. The quantity of properties you own is not of a sufficient quantity for you to be considered to be running a rental property business.

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. This indicator is particularly related to:

• whether the activity is preparatory or preliminary to the ultimate activity

• whether there is an intention to make a profit; and

• whether the activity is better described as a hobby or the pursuit of a recreational or sporting activity.

Your activities are not preparatory or preliminary to the ultimate activity, there is an intention to make a profit and could not be described as a hobby or pursuit of a recreational or sporting activity.

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.

You currently have a number of commercial properties and each have a number of tenants in them. You also have a number of residential properties. All properties are situated in your home town except a small number which are located interstate. In the 2013-14 financial year you made a taxable profit.

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.

In this case there appears to be some repetition and regularity in that you have owned the vast majority of your properties for a very long period of time. Local real estate agents receive and record rents received and disburse the net amount to you. They also advertise for tenants and manage the properties in consultation with you. There does appear to be some element of repetition and regularity however there is not as much repetition and regularity as was shown in Case G10 75 ATC 33; 19 CTBR (NS) Case 103, which involved a taxpayer who owned a block of holiday flats for short term lettings at a beach resort.

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.

In your case you handle all matters relating to financing, insurances, rates and taxes. You also compile all financial information including bookkeeping, mortgage payments, collate interest payments, taxes, insurances, major repairs, renovations, investments and tax return preparation for your commercial properties and residential properties.

You have other employment which is another source of income, you also devote a relatively small amount of your time to managing the rental properties. This is in contrast with the example above where the D'Souzas own eight houses and three apartment blocks consisting of six units each. They spend an average of 25 hours per week each on their 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 either perform repairs themselves or organise for them to be done. They have no other source of income. They are considered to be operating a rental property business because of the significant size and scale of their activities, the number of hours they spend on the activities, their extensive personal involvement in the activities and because of the business-like manner in which the activities are planned, organised and carried on.

You visit your rental properties in your home town once every 6 to 12 months and you visit the interstate properties once every one to two years. Your frequency of inspections can be contrasted with Case 1/2014 where the taxpayer inspected their nine rental properties on a quarterly basis. The taxpayer also checked accounts and advertised for tenants and involved herself in the direct management of the properties as her real estate agent was inefficient or did not do as she intended. She was considered to be in the business of renting properties.

The activities you perform are in line with what ordinary rental property investors perform. The activities you perform are not to the level required by taxpayers in a rental property business as outlined above.

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 compile all financial information including book keeping, mortgage payments, collating interest payments, taxes, insurances, major repairs, renovations, investments and tax return preparation is done by you and forwarded to your accountant for his review and submission. This activity is no more involved than a mere investor who owns a number of properties.

The size and scale of the activity

The business should be large enough to make it commercially viable.

The rental properties you own are valued at $X which is a substantial amount. In the 2013-14 financial year you made a profit of $X. The activity is commercially viable.

Conclusion

Even though you meet the intention and prospect of profit criteria and there is an element of repetition and regularity your level of activity and number of rental properties are not at a sufficient level to be considered that you are operating a rental property business.