Edited version of your written advice

Authorisation Number: 1013038311175

Date of advice: 1 July 2016

Ruling

Subject: Trading Stock

Question 1

Is the Family Trust running a business for the purpose of section 70-100 of the Income Tax Assessment Act (ITAA 1997)?

Answer

Yes

Question 2

Can the trading stock transferred from ('the Partnership') to the Family Trust be valued at cost (trading stock value) instead of market value, using an election made under s70-100(4) of Income Tax Assessment Act (ITAA 1997)?

Answer

Yes

Question 3:

Will the Commissioner exercise his discretion and allow an election to be made under s70-100(4) of the ITAA 1997 after the due date of September 20XX?

Answer:

Yes

This ruling applies for the following period:

1 July 20WW to 30 June 20XX

The scheme commences on:

July 20WW

Relevant facts and circumstances

1. The partnership is made up of family trusts. Each family trust is controlled by one each of the siblings and their respective spouses. Each family trust is a discretionary trust for the benefit of each respective sibling and their immediate families.

2. The partnership is a developer of residential units. The partnership completed a development. Most of these units were sold to unrelated third parties for market value.

A total of Y units remained unsold and were subsequently sold to each family trust partner. Each family trust partner received a number of units each. The XX Family Trust was the recipient of units.

3. The market value of these units at the time of transfer was $XXX excluding GST. The cost (trading stock) value of these units is estimated at $XXX including GST.

4. The Family Trust owns a rental property portfolio. The portfolio held during the period in which this application applies, includes:

• 18 x residential unit

• 3 x commercial shops

5. The following characteristics relate to the Family Trust:

(a) The Trustee of the Trust is xx ('the Trustee).

(b) The directors and shareholders of the Trustee are A and B

(c) The beneficiaries of the Trust are A and B and their children.

(d) All properties are managed by the directors of the Trustee except for Z units which are managed by a property agent.

(e) For the remaining C properties, the directors of the Trustee interview all prospective tenants and organise collection of all rents and outgoing reimbursements.

(f) The directors of the Trustee carry out regular property inspections and organise for repairs and maintenance work to be carried out on their behalf.

(g) The directors of the Trustee have dedicated significant time managing these properties since the formation of the Trust.

(h) The directors of the Trustee undertake all financial planning and decision making in relation to the properties.

(i) All properties are run at a profit, with a profit-making intention and are rented at a commercial arms-length basis.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 70

Reasons for decision

Question 1:

Is the Family Trust running a rental property business?

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).

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).

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? (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 case law and the views of the Commissioner listed above, the indicators with the greatest weighting is the scale or volume of operations and the repetition and regularity of the activities.

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.

Applying the relevant cases and indicators to your circumstances

Significant commercial purpose

This is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators.

The Family Trust has held and rented out properties since 20DD. It currently holds more less than 20 properties which are rented out and managed by the Directors of the Trustee.

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 Directors of the Trustee undertake the daily running and maintenance of the properties spending a significant amount of time 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.

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 directors of the Trustee spend significant time interviewing prospective tenants, undertaking financial planning and decision making, organising the collection of rents and outgoing reimbursements, carrying out regular property inspections and organising for repairs and maintenance.

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.

The activities undertaken are similar to those of other rental property businesses.

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 are owned by the Family Trust

The size and scale of the activity

The business should be large enough to make it commercially viable and 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 V properties some of which are managed by the directors of the Trustee. Considering the relative business indicators and the facts of the case the directors of the trustee perform 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.

Question 2

Can the trading stock transferred from the Partnership to thei Family Trust be valued at cost (trading stock value) instead of market value, using an election made under s70-100(4) of Income Tax Assessment Act (ITAA 1997)?

Detailed Reasoning

Under subsection 70-100(1) of the ITAA 1997 a partial change in the ownership of trading stock is treated as a notional disposal of the trading stock at market value. A partial change of ownership under section 70-100 of the ITAA 1997 occurs if, after the change, a new owner and the old owner or at least one of the old owners has an ownership interest in the trading stock.

However, under subsections 70-100(4) and (5) of the ITAA 1997 the old owners and new owners may agree that the trading stock is to be taken to have disposed of at its tax value, not at its market value. This result can only occur if the transferor and transferee make an election. Under subsection 70-100(6) of the ITAA 1997 an election can only be made if:

(a) immediately after the item stops being trading stock on hand of the transferor, it is an asset of a business carried on by the transferee; and

(b) immediately after the item stops being trading stock on hand of the transferor, the entities that owned it immediately beforehand have (between them) interests in the item whose total value is at least 25% of the item's market value on that day; and

(c) the value elected is less than that market value; and

(d) the item is not a thing in action. 

(a) Immediately after the item stops being trading stock on hand of the transferor, it is an asset of a business carried on by the transferee.

The information provided shows that the trading stock has stopped being trading stock of the holder, and immediately became an asset of a business carried on by the transferee.

(b) Immediately after the item stops being trading stock on hand of the transferor, the entities that owned it immediately beforehand have (between them) interests in the item whose value is at least 25% of the item's market value on that day.

This requirement is satisfied as after the transfer the Family Trust owns % of the trading stock that was on hand before the transfer. Since the Family Trust was one of the entities that owned the trading stock immediately before the transfer the condition that the entities that owned the item immediate before transfer must own at least % of the items market value (between them) is satisfied.

(c) The value elected is less than the market value

The value elected is less than the market value.

(d) The item is not a thing in action (for example, shares or debentures)

The residential units are property and not a thing in action.

Conclusion

The information provided shows that subsection 70-100(6) of the ITAA 1997 would be satisfied. Therefore an election can be made under subsection 70-100(4) of the ITAA 1997. The method of making the election is provided in subsections 70-100(7) and (8) of the ITAA 1997. The election should have been made before September 2015 however, the Commissioner can allow the election to be made later.

Question 3

Will the Commissioner exercise his discretion and allow an election to be made under s70-100(4) of the ITAA 1997 after the due date of 1 September 2015?

Detailed Reasoning

The Commissioner, in accordance with his powers under subsection 70-100(7) of the ITAA 1997, may grant an extension of time for an election to be made under subsection 70-100(4) of the ITAA 1997.

You have requested an extension in time to make the election in relation to the Z units that were trading stock of the partnership and were sold to the Family Trust in December 20WW. The units then became trading stock of the Family Trust.

The delay in making the election occurred because there were different accountants for different entities resulting in an oversight.

Based on the facts provided the Commissioner will not be prejudiced if he grants the extension of time for making the election as the election would only result in the deferral of assessable income, not a permanent difference, and the parties were initially entitled to make the election.

When considering if an extension of time should be granted, the Commissioner will treat each case on its own merits. The Commissioner must look at all the circumstances in deciding whether it would be fair and equitable to exercise the discretion. That involves balancing all relevant factors on the basis that the legislation gives the Commissioner discretion to accept the late election in certain circumstances.

There is little guidance on the factors the Commissioner should take into account when considering the extension in time to make the election. The wording in the legislation is very simple and gives no qualifications for this extension in time to make the election.

The basis of the overall section is to allow a choice of deciding on how to treat an item of trading stock where there is a continuation of a business and no actual disposal of the entirety of a particular item, particularly in the family situation (as per the example in subsection 70-100(1) of the ITAA 1997). There is a deferral of assessable income and this is for an unknown period of time in any situation, it is not dependant on when the election is made. Even when the election is made within the designated time the income from disposal at market value will not happen until the trading stock is actually disposed of. There is no prejudice to the Commissioner to allow this extension in time to make the election.

Provided all the other requirements under the section for making the election are met, it will be accepted as a valid election.