Edited version of your written advice

Authorisation Number: 1051179880286

Date of advice: 21 February 2017

Ruling

Subject: Am I carrying on a business - can I claim certain deductions

Question 1

Are you carrying on a business of letting rental properties?

Answer 1

No

Question 2

Can I claim my overseas travel to conferences and my membership to an Australian Association?

Answer 2

No

This ruling applies for the following period:

Year ended 30 June 20ZZ.

The scheme commences on

1 July 20YY.

Relevant facts and circumstances

You travelled to conferences at various locations around the world during your employment.

You invested in property in Australia while upgrading infrastructure as part of your employment.

You are recently retired from employment.

You want to maintain your knowledge in your previous employments technology.

You want to continue to travel to conferences around the world to maintain your technical knowledge.

You want to continue to invest in property in Australia where infrastructure is being upgraded.

You are a member of the previous employments Association.

You own a number of rental properties in different states across Australia.

You own a number of rental properties which were purchased over a period of approximately XX years that have a valuation of approximately $X.

In the 20WW-XX income year you received almost $X, in rental income and made a profit of $X.

You use real estate agents as the immediate point of contact for tenants to address any minor issues for all of your rental properties. The real estate agents provide a local face to the tenant as they are able to attend to the matter directly and report back to you.

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

The real estate agent undertakes the following activities in relation to your rental properties:

● Draws up lease agreements

● Collect rent monies due

● Advertise rental properties through their internet network

● Field complaints

● Conduct property inspections

● Conduct screening of tenants

● Provide general maintenance and repair

● Rent arrears control and issuing of breach/termination notices

● Prepare a Property Condition Report when the tenants move out of the property

● Conduct final bond inspection

You have regular contact with all property agents, spending some hours per week overseeing property agents, administering your existing properties, maintaining accounts and records, inspecting and upgrading properties, overseeing repairs and searching for new properties.

You also attend most property inspections and some open homes at locations within your state alongside your property agent.

You are a member of the body corporate for one of your interstate apartments where you travel for meetings.

You are currently in the process of selling a property in another state where you have made several trips for inspections and maintenance upgrades.

You complete a spreadsheet for the end of the financial year so that you know your financial position and use accountants to prepare your income tax returns.

The intention of your rental property activity is to fund your retirement.

You do not have a business plan.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Subsection 8-1(1)

Income Tax Assessment Act 1997 Subsection 8-1(2)

Income Tax Assessment Act 1997 Section 12-5

Income Tax Assessment Act 1997 Section 995-1

Question 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 a '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 and 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 and Co. on their behalf. No charge was made by F and 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 2016 (NAT 1729-6.2016) publication provides the following example of taxpayers considered to not be carrying on a rental property business:

….The Tobin's own, as joint tenants, two units and a house from which they derive rental income. The Tobin's occasionally inspected 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 Tobin's 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 Tobin's devote some of their time to rental income activities, their main source of income are their respective full-time jobs. The Tobin's are not partners carrying on a rental property business; they are only co-owners of several rental properties.…..

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

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 5 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 manages 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 is 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.

Application 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 less than 20 residential rental 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.

You have been investing in residential properties for many years. You oversee the running and maintenance of the properties.

You receive rental income from your investment properties. You outsource the management of your properties to a real estate agent. You undertake some of the maintenance activities yourself.

Your intention in relation to the rental properties is to set up a property rental profile and receive rental income when you retired.

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 less than 20 residential rental properties which on most occasions are all tenanted. The properties are located in various states. You intend to sell one of your properties and have a contract of sale for another property. You have made profit and losses over the past X years.

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, and investments for your residential properties.

You have only recently retired and now spend some hours a week on the management of your investment properties but you do not have a business plan or operate in a businesslike manner.

This is in contrast with the example above where the D'Souza's 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.

In Case G10 75 ATC 33; 19 CTBR (NS) Case 103, involving 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.

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, the repetition and regularity of activities and because of the business-like manner, in which the activities are planned, organised and carried on.

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

When considering this factor, we are looking at the scale in terms of the number of properties and what management input that may be required to conduct the activity.

The business should be large enough to make it commercially viable. The rental properties you own are valued at $X million. In the 20WW-XX financial year you received rent of approximately $X thousand and you made a profit of approximately $X.

In Cripps' Case, it was held that the renting of 14 two storey townhouses was not a business and in McDonald's Case it was held that the letting of two units in different strata plans was also not a business. Similarly in Cases 24 and 26 the renting of 22 units and three properties respectively was also not considered a business.

You have stated in the private ruling that the rental income generated from letting of your residential rental properties is now your primary source of income. However, whether rental income is a taxpayer's sole, or main, source of income is not in itself a determinative of carrying on a business.

You currently rent out less than 20 properties. As stated above, whether an activity of letting of property amounts to the carrying on of a business will depend on the circumstances of each case as noted at paragraph 5 of IT 2423.

The scale of your activities and volume of operations can be aligned and compared to these cases as you have less than 20 properties.

Conclusion

The properties are not rented as short-term (nightly or weekly) rentals, but are rented under lease agreements which are typically long-term in nature.

The relationship between you and the residents of the properties is that of a landlord and tenant; where the tenants have exclusive possession and control access to and from the properties.

Although you may spend a considerable amount of time in your body corporate role (including travel), you only own one property in the complex and the activity is performed voluntarily. The role is considered to be separate from your rental property activity.

Although you state that you spend a great deal of time managing your property managers, some measure of supervision and management is considered the ordinary practice of a passive investor in rental properties. Excessive time spent managing property managers is a result of your choice of property managers and does not strengthen your argument that you are carrying on a business.

The undertaking of managing and maintenance, level of involvement, scale of activity and volume of operation in your rental property activity is considered to be aligned closer with the circumstances in Case 24 and Case 26. Your activity lacks the repetition and regularity that is expected of a person carrying on a rental property business.

Your activities are better described as leasing residential properties to receive passive income from a stream of rental income. The income is not derived from the services you provide; it is derived from the letting of the properties and is considered to be passive income. We do not consider that you are carrying on a rental property business.

Question 2

Reasons for decision

Summary

You are not allowed to claim the overseas travel for specific conferences or the membership to the Related Association as a deduction against your rental income.

Detailed reasoning

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

The High Court of Australia has indicated that the expenditure must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense.

There must be a connection between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of the assessable income.

Taxation Determination (TD) 95/60 discusses the deductibility of expenses incurred in obtaining investment advice.

In TD 95/60, the Commissioner considers that expenditure for drawing up an investment plan is not deductible for income tax purposes. This is because the expense is not incurred in the course of gaining or producing assessable income, but rather is relevant to outlaying the price of acquiring the investment. The expense is incurred at a point too soon to be considered part of the income earning process from the investment.

ATO ID 2003/324 also discusses the deductibility of expenses incurred for attending a property investment seminar; the Commissioner reiterates that the expenditure must be incidental and relevant in the sense of having the essential character of expenditure incurred in the course of gaining or producing assessable income.

In ATO ID 2003/324, a significant proportion of the content of the seminar related to future property investment. As such the primary purpose of the seminar was to give the taxpayer the required knowledge to establish a strategy or structure for investing in rental properties.

This primary purpose is incurred at a point too soon to be incidental and relevant to the taxpayer's income earning activities from any future investment properties (Federal Commissioner of Taxation v. Maddalena 71 ATC 4161; (1971) 2 ATR 541). There is insufficient connection between this expense and the earning of rental income from current investment properties.

Application to your circumstances

In your case, all of the content of the conferences related to your field of interest and their related technologies and maintenance. The purpose of you attending the seminar and membership to the Association is to increase your knowledge to establish an approach to property investing.

This expenditure is incurred at a point too soon to be incidental and relevant to your income earning activities from any future investment properties and does not have the essential character of expenditure incurred in gaining or producing assessable income. Accordingly, as this expenditure is not incurred in gaining or producing assessable income no deduction for this portion is allowable under subsection 8-1(1) of the ITAA 1997.