Edited version of private advice

Authorisation Number: 1051391753466

NOTICE 

This edited version has been found to be misleading or incorrect. It does not represent the ATO's view of the relevant law.

This notice must not be taken to imply anything about:

·        the binding nature of the private advice issued to the applicant

·        the correctness of other edited versions.

Edited versions cannot be relied upon as precedent or used for determining how the ATO will apply the law in other cases.

Date of advice: 5 July 2018

Ruling

Subject: Am I in business, is the income rent, short term accommodation

Question One

Are you carrying on a business of providing short term accommodation?

Answer

Yes

Question Two

Are the properties used to provide short term accommodation excluded from being active assets by subsection 152-40(4)(e) of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following periods:

1 July 2017 to 30 June 2018

1 July 2018 to 30 June 2019

The scheme commences on:

1 July 2001

Relevant facts and circumstances

The partnership (You) runs a tourism accommodation operation.

You have extensive experience in the holiday rental accommodation field.

In 198X you established and ran a tourist resort.

You purchased your first property (Property One) in 200W.

You purchased additional property in 200X. Extensive renovations were required at the time of purchase.

Prior to purchasing the properties you prepared an extensive business plan. You have continued to update and refine your business plan over time. The business plans initially projected that you would reach profitability by the third year, and make back your losses by year four. Subsequently you expected a return on capital of around 10-12%.

In the first years (phase one) after purchasing properties you rented them short term via the resident agent/managers and local real estate agents.

Your initial capital investment in the properties was an amount, composed of land and buildings, capital works and plant and equipment. This was composed of around one third your capital, one third borrowed from your family trusts and one third borrowed from banks.

To purchase the properties you took out long term (30 year) housing loans from banks, secured by mortgages over the two properties. You also paid interest on the trust loans at investment rates

In 200Y you took over control of the management, marketing and letting of the properties yourselves. You refer to this as phase two of the operation. You continued to let exclusively to short term guests.

You have carried out substantial renovations of the properties to increase the quality of accommodation and boost the price you can charge. You have established a strong theme for all the properties.

You have run the operation from your home in a city. You have subcontractors to provide clean linen, cleaning services and maintenance on the properties.

You run a website and take bookings for the properties. You also list the properties on third party online booking sites. You update the calendars on your own website and the accommodation portals each time you take a booking.

You vary the pricing according to the time of year and the demand for accommodation; you offer standby and last minute discounts to fill vacancies. You promote your websites and try to market to fill vacancies in the bookings.

Guests pay a deposit at the time a booking is taken and pay in full a month before the stay begins.

You initially took payment from guests via direct bank deposits and cheques. In time you established a merchant facility to allow you to take credit card payments and security for extra charges and damages.

Considerable work was put into maintaining webpage and online listings on multiple online travel agent sites. Every time a booking was taken on one website, all online calendars needed to be updated.

All potential bookings needed to be screened to prevent problems and on-site parties. You only accepted between five and ten percent of initial enquiries as actual bookings.

You keep extensive records of your operations. You track booking numbers and vacancies across years and analyse the data to determine higher and lower demand times. You track monthly and annual performance against historical performance and monitor trends.

You use accounting software to keep accounting records. You maintained management analysis on excel spreadsheets, a booking calendar database and bookings reports to organise cleaners and suppliers ahead of time, and to reconcile listing fees and commissions.

During the low season when necessary you travel to each property and carry out extensive maintenance and upgrades. Generally you have spent two weeks a year at each property carrying out maintenance and upgrades. When carrying out the renovations you stayed at the properties and so they were not available for rent for those two weeks every year. You attend owner's corporations meetings and participate in management of one property.

You have generated small taxable profits in three of the fifteen years you have been running the operation. Using accounting figures the profits were larger in those years and you had small profits in other years.

You registered the business names and the domain names.

You enter into an agreement with your tenants that states it is a licence to occupy and you retain the right to terminate the agreement and cancel the accommodation if the guests breach the terms of the agreement. Over the years there have been several occasions where you have terminated agreements and evicted guests.

You are or have been members of a number of industry organisations, and receive various newsletters and reports to keep up to date with the industry. You attend seminars, participate in online forums and monitor the media to stay up to date with trends.

You sell short term holiday accommodation to your guests with ancillary entertainment and self-catering facilities.

Guests were presented with terms and conditions on booking and lists of house rules on arrival.

The terms and conditions include clauses that state the guests are granted a limited permission to occupy the premises for the approved purposes, that it is not a residential tenancy agreement except as required by law and that a failure to comply with the terms and conditions may result in termination of the guests occupancy with no refund. The terms and conditions do not mention a right to terminate a stay if a condition is not breached.

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 8-1 of the Income Tax Assessment Act 1997

Section 104-10 of the Income Tax Assessment Act 1997

Section 152-35 of the Income Tax Assessment Act 1997

Paragraph 152-40(4)(e) of the Income Tax Assessment Act 1997

995-1 of the Income Tax Assessment Act 1997

Section 27 of the Residential Tenancies and Rooming Accommodation Act 2008 (Qld)

Section 31 of the Residential Tenancies and Rooming Accommodation Act 2008 (Qld)

The Property Law Act 1974 (Qld)

Reasons for decision

Question 1

Summary

Weighing the factors provided in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production and Taxation Ruling IT 2423 Withholding tax: Whether rental income constitutes proceeds of business - permanent establishment - deduction for interest against your circumstances, even though your activities are on a small scale, on balance the Commissioner is persuaded that you are carrying on a business of renting properties.

Detailed reasoning

Are you 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'.

The question of whether you are carrying on a business is a question of fact and degree. There are no rigid rules for determining whether the activity amounts to the carrying on of a business. The facts of each case must be examined. In Martin v FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551, Webb J said:

The test is both subjective and objective; it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and, as counsel for the taxpayer put it, the determination is eventually based on the large or general impression gained.

However, the courts have developed a series of indicators that can be applied to determine whether you are carrying on a business.

Taxation Ruling TR 97/11 (TR 97/11) provides the indicators established by the courts that need to be considered when determining whether a business is being carried on. It should be noted that TR 97/11 specifically deals with carrying on a business of primary production but the indicators established can be equally applied to most other activities. Paragraph 13 of TR 97/11 states that the following indicators are relevant:

·                 whether your activity has a significant commercial purpose or character.

·                 whether you have more than just an intention to engage in business.

·                 whether you have a purpose of profit as well as a prospect of profit from the activity.

·                 whether there is repetition and regularity of your activity.

·                 whether your activity is of the same kind and carried on in a similar manner to businesses in your industry.

·                 whether your activity is planned, organised and carried on in a businesslike manner.

·                 the size, scale and permanency of your activity.

·                 whether your activity is better described as a hobby, recreation or sporting activity.

Paragraph 15 of TR 97/11 states that no one indicator is decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). In addition, paragraph 16 of TR 97/11 states that the indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the general impression gained from looking at all the indicators (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470 at 474; 5 AITR 548 at 551), and whether these factors provide the operations with a 'commercial flavour' (Ferguson v. Commissioner of Taxation (1979) 37 FLR 310 at 325; 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884).

Taxation Ruling IT 2423 states at paragraph 5:

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.

As a general rule, to be carrying on a business of letting rental properties the size and scale of the activity must be significantly larger than that of a business of providing short term accommodation with a significant degree of services. To be clear, one or two properties will not be sufficient. A number closer to 20 or an entire block of apartments is closer to the number required to characterise the activity as a business of letting rental properties.

The issue of whether the owner of one or several properties, in providing accommodation, is carrying on a business has arisen in a number of cases.

In Commissioner of Taxation v. McDonald (1987) 15 FCR 172; 18 ATR 957; 87 ATC 4541 (McDonalds Case), the taxpayer and his wife owned two properties, one of which was let on a short term basis to holiday makers, which were subsequently let through letting agents. The Federal Court considered that for a business to be carried on by owners of property, one would expect that they would be involved in providing services in addition to the process of letting property (as with a boarding house), not merely receiving payments for the tenants occupation of the property. It was considered that this was not a case of the active joint participation of parties in a business activity.

In Carson & Anor v FC of T [2008] AATA 156 (Carson's Case) the taxpayers owned one property jointly in south-east Queensland, which was used to provide short term tourist accommodation, usually for stays of about a week to two weeks. Senior Member BH Pascoe stated that whether a business is being carried on, is a question of fact and an objective consideration of the extent of the applicants' activities relating to the property. He pointed out that appointing a real estate agent to arrange rentals and minor repairs, spending one week every six months servicing the property and provided brochures relating to the property as required are activities with all the earmarks of maintaining and deriving income from an investment rather than the carrying on of a business. Similarly, activities such as financing the property, dealing with rating authorities and body corporate are no more than any investor in real estate would do.

In 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.

Application to your situation

You use the properties to undertake your short term accommodation activities. The following criteria have been considered in reaching a conclusion.

Intention of the taxpayer

You selected the properties for their location and attractiveness to guests. You began using the properties for short-term accommodation from the time you purchased them. After the first few years (phase one), you took over the direct management of the properties to increase control and attempt to boost returns. Likewise, you invested considerable amounts of capital in upgrading the properties to increase income.

It is apparent that your intent was more than just to manage a property investment.

Prospect of profits

The taxpayer's involvement in the business activity should be motivated by wanting to make a 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 a profit from participating in the business of the taxpayer.

At the time you started your activities you believed you had a real prospect of profits, and at times after you had taken over the management personally and invested significant amounts of capital in renovations did make profits. Circumstances changed to reduce the profitability of your activities over time. You attempted to adapt your operation to deal with the changes. Your later year returns were low in comparison to the capital invested, and you struggled to be profitable.

Repetition and regularity

Frequent and regular transactions are the usual feature of business operations. Turnover is maximised if the processes are repeated over a long period. Frequent activity does not necessarily mean a business is carried on but it will support this argument (FC of T v. Radnor 91 ATC 4689; 22 ATR 344).

You had your properties available for booking all year (other than the two weeks you were renovating, which you fitted in around bookings) and you did book them for a significant portion of the time. You developed procedures to manage your guests from a distance and you repeated the same processes with each booking for many years, only making changes to improve efficiencies. Your income earning activities were regular and repeated for many years.

Significant commercial purpose

This indicator is closely linked to the others and is a generalisation drawn from the interaction between them. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators.

While your activities are on a small scale, involving only a few properties, there is repetition and regularity in the use of the properties for short-term accommodation. You have developed knowledge and skills in the industry. Your business plan allowed for further expansion had you been able to achieve the level of profitability you were targeting. You have displayed commercial purpose in your activities.

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.

A large part of the short-term holiday stay accommodation market is comprised of investment activities rather than business. However, we need to compare your activities to those who are in business, which would include resorts, hotels and large scale apartment providers. You have suggested you occupy a small (indeed, unique) niche in the market, and cannot be compared to other market participants. We do not believe it is necessary to segment the market to such an extent.

As you identified early on, the internet has allowed you to have your own website, and manage bookings and guests at a distance and to a level that might previously only been available to live-in managers or larger scale organisations.

Your activities have been carried on in a manner similar to businesses that operate in the short- term holiday rental market.

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 have estimated that over 50 hours a week are spent on running the operation.

You made use of contractors to clean maintain and prepare the properties. You have managed the screening of tenants in a systematic manner. You have kept detailed records of occupancy and analysed them against other years and other industry participants. You have managed the accounts of your professionally. Given the small scale, you have conducted your activities in a business-like manner.

The size and scale of the activity

While no indicator is decisive, generally more weight is given to size and scale. The larger the scale of the activity the more likely it is that the taxpayer is carrying on a business. This is not conclusive and a person may carry on a business in a small way (Thomas v. FC of T 72 ATC 4094; 3 ATR 165).

In your case, you have only a few properties. While you have a number of beds available, they are only available in several blocks. At any time you only have a maximum of a number of properties hired or available for hire. This is low on a comparison to other businesses in the industry, even considering that a business of short-term accommodation can be conducted on a smaller scale than a business of renting properties. Your income per property was at the high end for holiday rentals, although your costs were also high.

While no one indicator is decisive, generally operating on a scale this low would be enough to rule you out of being considered to be in business.

Hobby or recreation

The short-term accommodation activities do not have the nature of a hobby or recreational pursuit.

Conclusion

Despite the small scale of your activities, in other respects you have run the operation in a businesslike manner. Your activities have been organised in a businesslike fashion and you have always treated it as a business. On balance, we find that there is enough weight to accept that you were carrying on a business of short-term accommodation.

Question 2

Summary

The income from the properties is rent, and therefore subsection 152-40(4)(e) of the ITAA 1997 prevents the properties from being active assets.

Detailed reasoning

Active Asset

A CGT asset is an active asset at a given time if, at that time you own it and it is used (or held ready for use) in the course of carrying on a business by you, a small business CGT affiliate of yours or an entity connected with you.

Certain assets are, however, excluded from being active assets under subsection 152-40(4) of the ITAA 1997. An asset whose main use is to derive rent (unless such use was only temporary) is excluded from being an active asset. Such assets are excluded even if they are used in the course of carrying on a business.

Taxation Determination TD 2006/78 states (paragraph 22) that whether an assets main use is to derive rent will depend on the particular circumstances surrounding the derivation of income.

The term rent has been described as the amount payable by a tenant to a landlord for the use of the leases premises (C.H. Bailey LTD v Memorial Enterprises Ltd 1 All ER 1003, United Scientific Holdings Ltd v Burnley Borough Council 2 All ER 62).

A key factor therefore in determining whether an occupant of premises is a lessee is whether the occupier has a right to exclusive possession (Radaich v. Smith (1959) 101 CLR 209) (Radaich).

If premises are operated as short term accommodation, the issue arises as to whether an occupant of part of the premises is a tenant or alternatively only a lodger/boarder with a licence to occupy. Similarly, if residential units are operated as holiday apartments, the issue arises as to whether the occupants of the apartments are tenants/lessees or only have licences to occupy.

Ultimately, these are questions of fact depending on all the circumstances involved. Relevant factors to consider in determining these questions (in addition to whether the occupier has a right to exclusive possession) include the degree of control retained by the owner and the extent of any services provided by the owner such as room cleaning, provision of meals, supply of linen and shared amenities ( Allen v. Aller (1966) 1 NSWR 572), Appah v. Parncliffe Investments Ltd [1964] 1 All ER 838 and Marchant v. Charters [1977] 3 All ER 918).

In Carson & Anor v FC of T [2008] AATA 156, the Administrative Appeals Tribunal considered this issue in relation to holiday rentals and stated:

In this matter, the subject asset is one unit, presumably within a group of residential units. Occupants generally stay for one or two weeks. Crockery, cutlery and linen are included but cleaning is done only after the occupants depart. I have no doubt that the occupants regard themselves as having "rented" the unit for the period of their stay and during that stay have exclusive possession. Unsurprisingly, no formal lease agreement is signed but this does not mean that there is no landlord/tenant relationship. On the facts provided, I am of the opinion that the main use of the subject property is to derive rent and, therefore, it is excluded from being an active asset under s 152-40(4) of the Act...

The AAT held that the main use of the property was to derive rent and therefore it was excluded from being an active asset. Although no formal agreement was signed, there was a landlord/tenant relationship in that the occupants of the unit would no doubt regard themselves as having rented the unit and having exclusive possession thereof.

In the case Janusauskas v Director of Housing [2014] VSC 650 (17 December 2014), Justice Emerton endorsed the earlier VCAT "useful directions" to ascertaining when there had been a grant of exclusive possession.

·                 Sole occupation - sole occupation does not amount to exclusive possession,

·                 Words used by the parties - The words used by the parties are not conclusive, one must look at the rights created.

·                 Rights of grantor - it the grantor of the right to occupy has unlimited rights of entry, there cannot be exclusive possession by the grantee,

·                 Intention of parties - it is not necessary in the formation of a lease for the parties to intend to become landlord and tenant - one does not look to the intentions of the parties, but to the rights created.

·                 Other requirements - a lease can be created without a written agreement, a bond, over part of the premises, over empty or furnished rooms, and with or without the grantors personal possessions.

In the case Swan v Uecker (Swan V Uecker [2016] VSC 313; 50 VR 74) the judge states that just because an accommodation agreement referred to a licence rather than a lease, it did not mean that there was not possession by the occupant and therefore a lease:

"the characterisation of an agreement ... as a lease or a licence depends upon the proper construction of that agreement-looking to substance and not form-and having regard to relevant surrounding circumstances."

A short stay is also not decisive - a lease can be created for days or even hours.

As stated in Radaich, the retention of a limited right by a landlord to enter the premises is not inconsistent with the grant of exclusive possession, While a landlord may reserve the right to enter the premises to enforce conditions of the accommodation agreement, or to evict residents who have breached the conditions, this alone does not invalidate the general possession by a resident of the premises. Radaich established the principle that where the leasee needs possession for the purpose of the contract, possession will be granted, regardless of the wording of the contract.

While a clause of an agreement may purport to grant the owner the power to arbitrarily change or terminate the guest's stay purely on whim, where there is no evidence that this has occurred, or indeed, given the nature of the business, no reasonable prospect that this would ever occur, one may discount the value of that clause.

Where money is received in exchange for accommodation, the presumption will be that the income is rent. Where the occupants do not enjoy exclusive possession, it is less likely to be rent. However, even with exclusive possession, if an owner provides a significant level of service over and above the accommodation in exchange for the income, they may rebut the presumption that it is rent.

However, whether an occupant has, or reasonably expects that they have exclusive possession is a question of fact that turns on the individual situation. Even when a landlord claims that the occupant does not enjoy exclusive possession, it is a question of examining the facts to determine whether this is so.

Application to your situation

You provide a list of services provided to the guests at the property, such as emptying rubbish, supplying barbeques and gas, providing linen and consumables and providing a weekly cleaning service, as part of the payment for the use of the property, or for additional payment. However, these services are no greater than might be expected under a short-term rental arrangement. Generally the provision of these services would not interrupt the guest's quiet enjoyment of the properties. We do not consider the provision of these services provide significant value adding over and above the general value of the accommodation. Keeping the property "fit for purpose" is not an extra service to the guest. Where the property is of a "luxury" standard, the supplied luxuries would be expected to be at a higher level.

You have argued that the ability for you or your agents to enter the premises and evict the guests was a core element of your business model, in dealing with the "party house" issue. The guests are limited in the use they have of the properties, with rules (The Booking Conditions, the standard House Rules and the Code of Conduct) governing what can be done, the breach of which can, and indeed on occasion has, led to them being summarily evicted from the properties.

However, these rules are no more than required under law and local strata title rules. Further, the reserving of a right of entry to maintain the property as "fit for purpose" should not be seen as encroaching on a guest's possession.

Retaining the right to expel guests who do breach the terms of their stay is not an argument that there is no lease. While you assert you have retained the right to expel a guest on whim, in practice you have only ever evicted guests for breaches of the rules. Arguably the expelling of guests for not breaching the terms would be incompatible with the running of a reputation based short-term accommodation business, and is unlikely to ever take place.

You have stated that the Residential Tenancies and Rooming Accommodation Act 2008 (Qld) (RTRAA) and the previous Residential Tenancies Act imposes conditions on leases of residential property that would prevent the operation of your business. However, while the Act defines short term holiday accommodation as a tenancy agreement, Division Two, Section 31 of the Act, explicitly excludes a residential tenancy agreement given for holiday purposes for a period of 28 days or less.

Clearly it is not practicable that the full range of defenses and remedies for breaches of a residential tenancy would apply to a short term (days or hours) lease, and this appears to be accepted by the courts. You have stated that the Property Law Act 1974 (Qld) (PLA) prevents a lease agreement existing where it is not in writing and imposes conditions on a land-lord. It is a circular argument to suggest that if it were a lease you could not have legally done things in a certain way, and therefore it is not a lease. It should also be noted that according to the RTRAA the PLA does not apply to residential tenancy agreements. While the RTRAA does not apply to short term holiday residential tenancy agreements, it defines the meaning of a residential tenancy agreement and presumably therefore prevents the PLA from applying even to holiday rentals.

Carson's case, regarding short-term holiday accommodation in south-east Queensland, is particularly relevant to your case - notwithstanding the before-mentioned limitations imposed by the RTRAA and the PLA, the AAT found the income was rent. It may be that the courts will distinguish short-term lease agreements from longer term agreements, and likewise the remedies that apply.

Having regard to all the facts, we consider that the arrangement between you and your guests is a short-term lease. Accordingly where the income from the properties is for accommodation it will be rent. We do not believe that the services provided are sufficient to dilute the nature of the income as being primarily rent.

Therefore, even though you were carrying on a business of renting holiday properties the main or only use of the property is to derive rent. The properties are excluded from being an active asset under paragraph 152-40(4)(e) of the ITAA 1997. As you do not meet the basic conditions set out in section 152-10 of the ITAA 1997 you are not entitled to the small business CGT concessions.