Edited version of your written advice

Authorisation Number: 1051508299313

Date of advice: 18 April 2019

Ruling

Subject: Active asset- short term accommodation

Question

Will the property satisfy the active asset test set out in section 152-35 and 152-40 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following period:

Year ended 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

You (Person A and Person B) purchased your main residence.

You subdivided part of the land from your main residence and constructed a residential property on the land. You let the property for short term accommodation for a period (the property). You did not use the property for private purposes.

You were not registered for GST purposes.

You declared the property’s income and expenses in a rental property schedule in your individual taxation returns.

You also jointly own a rental property with two other individuals. That property is rented out to long term tenants.

Person A works full time and Person B works on part time basis.

Property details

The property is a self-contained accommodation and contains a number of appliances, blankets and washing facilities. The property has a BBQ and linen for guests.

You have provided details of how guests obtain access to the property.

Property Management

You did not have a formal business plan for your short term accommodation activities.

You accessed a user login for your online account with the online booking service provider, kept a diary and kept a yearly planner to manage bookings. You used an excel spreadsheet to manage your income and expenses records. You also used a diary to record expenses on a daily basis.

You advertised the property with an online booking provider. It charged commission for each night the property was occupied. The property was listed on a local online accommodation directory. You also printed brochures which were made available to visitor information centres.

Short term accommodation activities

You spent approximately a limited number of hours per week doing the following activities for the property:

● cleaning- prior to check ins and mid-stay cleans

● laundering of sheets

● gardening

● general property maintenance

● booking administration

● purchasing of supplies for the house

You were the point of contact for all repairs and services. You engaged the services of contractors- electricians, plumbers as required.

For online bookings, guests paid a deposit on booking and the balance prior to arrival. For other bookings, guests were required to pay the full amount in cash to the owners on check in. You collected the charges for extra guests at check out.

You have provided details of how guests were charged. The rate applied throughout the whole year. You did not charge separate fees for linen and house-keeping services. You did not collect GST.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 995-1

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 paragraph 152-40(4)(e)

Reasons for decision

Summary

The Commissioner considers you are not carrying on a business of providing short term accommodation. While you performed the activities required in managing and maintaining your property, the scale, amount of activities and volume of operations is too small to be considered as carrying on a business. The income is derived predominantly from the actual letting of the property and not from activities 'carried on' in relation to renting the property out.

Detailed reasoning

Active Asset Test

The active asset test contained in section 152-35 of the ITAA 1997 and is satisfied if:

● you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the test period detailed below; or

● you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7.5 years during the test period.

The test period is from when the asset is acquired until the CGT event. If the business ceases within the 12 months before the CGT event (or such longer time as the Commissioner allows) the relevant period is from acquisition until the business ceases.

A CGT asset is an active asset if it is owned by you and is used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child or an entity connected with you.

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 outlines the important factors that are considered in determining if your activity is a business for tax purposes. The factors are:

● whether the activity has a significant commercial purpose or character

● whether there is 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 and scale and permanency of the activity, and

● whether the activity is better described as a hobby, a form of recreation or a 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 Withholding tax: whether rental income constitutes proceeds of business - permanent establishment- deduction for interest, 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.

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. Taxation Ruling TR 93/32 Income tax: rental property- division of net income or loss between co-owners, states at paragraph 22 and 23:

22. As a general proposition, it is more accurate to describe the owners of rental property in the words of Beaumont J in McDonald's case at ATR p.969; ATC p 4552 'as co-owners in investment rather than as partners in a business operation.'

23. That is not to say that co-owners cannot carry on a business of property rental and therefore be partners at general law. As already noted, whether an activity constitutes the carrying on of a business is a question of fact to be decided on a case by case basis.

In Commissioner v. McDonald (1987) 15 FCR 172; 18 ATR 957; 87 ATC 4541 (McDonald's case), the taxpayer 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.

In Carson & Anor v. FC of T AAT 156 (Carson's case) the taxpayers owned one property jointly 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 applicant's 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 providing brochures relating to the property as required 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.

Assets held to derive rent

Paragraph 152-40(4)(e) of the ITAA 1997 states, however, that an asset whose main use in the course of carrying on the business is to derive rent cannot be an active asset unless the main use for deriving rent was only temporary.

Taxation Determination TD 2006/78 discusses the circumstances in which premises used in the business of providing accommodation for reward can be active assets notwithstanding the exclusion in paragraph 152-40(4)(e) of the ITAA 1997.

Whether an asset's main use is to derive rent will depend upon the particular circumstances of each case. In accordance with paragraph 22 of TD 2006/78, the term 'rent' has been described as follows:

● the amount payable by a tenant to a landlord for the use of the leased premises (C.H. Bailey Ltd v. Memorial Enterprises Ltd [1974] 1 All ER 1003 at 1010, United Scientific Holdings Ltd v. Burley Borough Council [1977] 2 All ER 62 at 78, 86, 93, 99);

● a tenant's periodical payment to an owner or landlord for the use of land or premises (The Australian Oxford Dictionary, 1999, Oxford University Press, Melbourne); and

● recompense paid by the tenant to the landlord for the exclusive possession of corporeal hereditaments...... The modern conception of rent is a payment which a tenant is bound by contract to make to his landlord for the use of the property let.

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). If premises are leased to a tenant under a lease agreement granting exclusive possession, the payments involved are likely to be rent and the premises not an active asset. On the other hand, if the arrangement allows the person only to enter and use the premises for certain purposes and does not amount to a lease granting exclusive possession, the payments involved are less likely to be rent.

For example, 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. These will be questions of fact depending on all the circumstances involved. Relevant factors to consider in determining this question include:

● whether the occupier has a right to exclusive possession

● 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. Allen (1966) 1 NSWR 572; Appah v. Parncliffe Investments Ltd [1964] 1 All ER 838 and Marchant v. Charters [1977] 3 All ER 918).

Example 4 of TD 2006/78 states:

11. Linda owns a complex of 6 holiday apartments. The apartments are advertised collectively as a motel and are booked for periods ranging from 1 night to 1 month. The majority of bookings are from 1 to 7 nights.

12. Linda is responsible for bookings, checking guests in and out and cleaning the apartments. She also provides clean linen and meal facilities to guests. Linda does not enter into any lease agreement with guests staying at the apartments.

13.In this example, the apartments are operated similar to a motel. The guests do not have exclusive possession of the apartment they are staying in but rather only a right to occupy the apartment on certain conditions. The usual length of stay by guests is very short term and room cleaning, linen and meals are also provided to guests.

14. These facts indicate that the relationship between Linda and the guests is not that of landlord/tenant under a lease agreement. Accordingly, the income derived is not 'rent'. If Linda's activities amount to the carrying on of a business, the paragraph 152-40(4)(e) of the ITAA 1997 exclusion would not apply and the apartments would be active assets under section 152-40 of the ITAA 1997.

However, many arrangements involving holiday apartments are unlikely to be active assets because no business is being carried on or, even if a business is being carried on, it amounts to the derivation of rent. This is because in many cases the services provided are not sufficient to change the nature of the income from passive to active. For example if meals or daily cleaning are not provided.

In Carson's case, the taxpayers provided short-term tourist accommodation to the public. The subject asset was one unit, presumably within a group of residential units. Occupants generally stayed for one or two weeks. Crockery, cutlery and linen were included but cleaning was done only after each stay. The taxpayers relied on TD 2006/78 and contended that the unit was an active asset for the purposes of the small business CGT concessions. 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 Swan v. Uecker [2016] VSC 313 (Swan’s case) the issue of whether Airbnb agreements constituted a lease or a license, and whether the Airbnb guests were given ‘exclusive possession’ was considered. The Supreme Court held that the use of the words ‘guest’ and ‘licence’ in the Airbnb agreement did not prevent the arrangement from being characterised as a lease. The Court held that ‘self-serving subjective statements’ could not be used to ‘escape the legal consequences of one relationship by professing that it is another’. The Court held that it was not bound by such ‘labels’ and it could look at the surrounding circumstances to determine the substance (as opposed to the form) of the arrangement.

Justice Croft held that the effect of the agreement, fully analysed, was that the Airbnb guests enjoyed a right of exclusive possession. While the Airbnb terms and conditions repeatedly used the word ‘licence’, Justice Croft stressed the well-established principle that the substance of an agreement prevails over its form. He held that the effect of the agreement, fully analysed, was that the Airbnb guests enjoyed a right of exclusive possession.

Application to your circumstances:

You own one short term accommodation property and jointly own a rental property with two other individuals. You have much less in size and scale compared to the number of properties in Case 26 and Cripps’ Case. Even if there were 22 units and 16 properties in the said cases, it was held that the activities carried on by the owners did not amount to carrying on a business. The owners were considered to be mere passive investors.

You received payments for the use of your property by the guests. You did not engage in housekeeping services, mid-stay linen laundering, making up the beds on a daily basis or guest pick-up or transfers. You also did not provide meals. It is essential that to be carrying on a business of providing short term accommodation that you have to do more than just let out the properties.

You did not have a formal business plan. You relied on diaries, yearly planners and user logins for your online account in managing your bookings. You used excel spread sheets in managing your financial records. Your activity is not planned, organised and carried on in a businesslike manner.

In accordance with the judicial comments above and guidelines set down in Taxation Rulings IT 2423 and TR 97/11, your activities lack the level of repetition and regularity required, commercial character, and are not of a size or scale necessary to be characterised as carrying on a business of providing short term accommodation.

As you were not carrying on a business in relation to the short-term rental activities in relation to the property, the property cannot be considered an active asset.

Additionally, based on the information you have provided it is considered that the relationship between you and the guests is viewed as that of a landlord and tenant. The main use of the property for short term accommodation was to derive rent. As the main use of the property was to derive rent, the property will not satisfy the active asset test under section 152-35 of the ITAA 1997, even if you were considered to be carrying on a business.