Edited version of private advice

Authorisation Number: 1051522143398

Date of advice: 27 May 2019

Ruling

Subject: Carrying on a business of letting rental properties

Question:

Are you carrying on a business of letting rental properties?

Answer:

No

This ruling applies for the following periods

Year ended 30 June 2016

Year ended 30 June 2017

Year ended 30 June 2018

Year ending 30 June 2019

The scheme commences on

1 July 2015

Relevant facts and circumstances

Background

Person B, is a professional who was made redundant from their position, after which they established a company, being Company X, so that they could continue providing professional services, and to undertake property developments and construction activities for their clients.

Company X recorded losses for many income years, with a profit being made in a small number of income years and breaking even in an income year, resulting in tax losses being carried forward.

Person A and Person B established a partnership, being you, so that Person A could develop blocks of land by constructing units that could be leased for the purpose of operating rental property activities to derive a profit to sustain their living costs.

You have been operated with Person A and B receiving a portion of the rental income in accordance with a Partnership Agreement and not in accordance with their ownership interests in the properties..

From 2000, Person A and B have developed and held properties to earn long term rental income. Person A has actively been involved in the design and project management of the properties held in relation to your long-term rental property operations.

Your business plan involves the building of several rental properties to be kept for as long as possible to derive an appropriate level of rental return and then sell some of the properties to reduce the level of debt. Through Person A undertaking building activities, and doing as much of the physical work as possible, the aim was to build a lot of equity in the properties to facilitate the borrowing of more money against the properties to enable the construction of the next project.

The profitability and sustainability of the rental activities has been part of a long-term strategy in paying down the loans to reduce interest costs and ensure that operations are profitable.

Person A and B relied on their inheritance to sustain their living costs when losses were made in some income years. Also, adjustments were made to sell down properties to pay down debt and supplement living costs.

Person A ceased providing contract professional services a number of years after you were created, with Person B continuing their employment for an additional number of years.

Persons A and B undertook some part-time work for a number of years prior to the 2015-16 income year.

During the 2015-16 income year Persons A and B received some bank interest but have not undertaken any employment and do not receive any government pensions. They took out their superannuation.

A number of properties were owned by Persons A and B that were used by you prior to 30 June 2015 for rental purposes. Some of the properties were disposed of for various reasons, including financial, health and Person A and B's expectation that they would take on additional development and rental activities.

The properties were as follows:

The full amounts for the purchase of the properties and the construction activities were borrowed by Persons A and B by mortgaging other rental properties and their family home.

Persons A and B managed the properties prior to 30 June 2015, receiving all of the rental income, sourcing tenants and attending to tenant's needs.

A number of properties were sold prior to 1 July 2015 with Persons A and B recording capital gains tax amounts in their assessments.

For the 1999-2000 to 2014-15 income years, net tax rental losses were recorded in your assessments in all income years with the exception of two income years when net gains of less than $20,000 were recorded.

The following properties (the Properties), whose details are outlined above, have been used by you in relation to your rental activities during all or part of the period from 1 July 2015 to the present time, for which you have included the following amounts in your income tax returns:

A block of land (Property L) was purchased by Persons A and B in equal shares as follows which is anticipated to increase the overall long-term profitability from the increased rent earned in relation to the property:

·         contract of purchase entered into during the 2017-18 income year;

·         the block was purchased due to its location as it will be able to earn rent on both a full permanent or holiday rental basis depending on how local area develops;

·         it is anticipated that the construction of the house will be completed in about five months;

·         a multi storey house will be constructed on the block by registered builder;

·         the house will be used as a rental property;

·         the services of a real estate agent will be engaged to assist with the management of the property in relation to long-term leasing; and

·         if the property is used for short-term rental in the future it is anticipated that the services of a real estate agent will be engaged to assist with the advertising and bookings in conjunction with online booking sites.

Persons A and B have appointed real estate agents to manage all of the Properties due to their health and ages. The real estate agents managing one of the properties has recently been changed due to Persons A and B not being satisfied with their service.

The real estate agents undertake the following activities:

·         carry out advertising campaigns;

·         prepare lease agreements;

·         receive and vet applications and references from potential tenants which they discuss with Persons A and B;

·         carry out 'open inspections' for potential tenants to view the property/ies;

·         managing bond amounts in relation to new tenants and tenants whose leases are ending;

·         collect rent and deposit it into your nominated bank account;

·         provide statements in relation to rental amounts received;

·         liaise with tenants;

·         carry out property inspections and provide condition reports;

·         advise you of any maintenance issues; and

·         issue 'Notice to Vacate' to tenants as required.

The average period of the leases is 12 months and it is estimated that in 80% of all tenancies the tenants renew their leases.

The rental income is paid into a nominated bank account that is used specifically for the receipt of the rental income and associated costs, after the real estate agents have taken out their commission and fees.

Persons A and B research online to review the rental returns received for properties in the same area as their properties. Rental amounts are generally reviewed a number of months before the lease expires and are discussed with the real estate agent/s.

It is estimated that Person A spends around 30-35 hours per week on the properties undertaking the following activities:

·         reviewing rental and property markets;

·         overseeing the design and construction;

·         research and review of rental prices;

·         planning and making strategic decisions for management and reduction of debt, disposal and acquisition of properties with a view of returning higher rental income;

·         reviewing agents services;

·         reconciling income and expenses incurred in relation to the properties' and updates a spreadsheet kept in relation to the properties in addition to keeping records of maintenance activities, estimated to take eight hours per week;

·         personally undertaking repair and maintenance activities at the properties, or engaging the services of professionals to complete; and

·         driving past the front of each of the properties to inspect their condition on average twice per week.

It is estimated that Person B spends 10-15 hours per week on the following activities:

·         checking to ensure that rental amounts are being deposited into the nominated bank account;

·         liaising with real estate agents and tenants;

·         undertakes shopping, such as purchasing fly wire doors, curtains, internal fixtures or plants to replace existing items at the properties; and

·         forecasting and management of cash flow and payment of expenses.

The real estate agents are the advertised point for tenants to contract when they need assistance/repairs and/or maintenance. They contact Person A, who decides whether they will attend the issue, or if a qualified tradesman's services will be engaged to address the issue.

Person A, or other parties organised by Person A or the real estate agent/s, have attended to repair and maintenance issues at various properties less than ten times in the 2015-16 to 2017-18 income years, and less than five times from 1 July 2018 until the present time.

All receipts relating to the properties are kept and files in addition to keeping copies of agent's rental contracts, residential tenancy agreements, rental statements, condition reports, landlord insurance and rates notices. Financial statements are prepared for you.

The following amounts were recorded in your 2015-16 to 2017-18 income tax returns:

No money is owed on any of the properties at the present time and it is anticipated that as a result of reducing the loans that the rental activities are expected to be profitable in the income years covered by this ruling. It is anticipated that following the completion of construction on Property K the gross rent amount will be increased to just over $100,000.

No other development activities other than Lot XXX have been undertaken since 1 July 2015. There are no immediate plans to purchase another property, however this will be reviewed after the completion of the construction of the house on Lot XXX.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Summary

It is the Commissioner's view that you are not carrying on a business of letting rental properties. Your activities are better described as leasing residential properties to receive passive income from a stream of rental income and are those of a passive investor.

Detailed reasoning

Carrying on a business

Section 995-1 of the Income Tax Assessment Tax 1997 (ITAA 1997)defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

Normally the receipt of income from the letting of property to a tenant(s) does not amount to the carrying on of a business and is the passive receipt of income from a property by granting a lease to a tenant for the right to exclusive possession of the property.

Whether the letting of property amounts to the carrying on of a business will depend on the circumstances of each case. 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.

Simply owning an investment property or several investment properties, either alone or with other co-owners, is usually regarded as an investor who is not carrying on a rental property business. This is because of the limited scope of the rental property activities and the limited degree to which an owner actively participates in rental property activities. A conclusion of whether a business of letting properties is being carried on depends largely upon the scale of the operations.

The issue of whether a business of letting properties has been considered in a number of cases, some of which are discussed below.

In Cripps v. FC of T 99 ATC 2428; (1999) 43 ATR 1202 (Cripps case), the taxpayer and his wife purchased, as joint tenants, 14 townhouses which they rented out. They also purchased a property which was used initially as a holiday home but was later periodically rented out. A further property was purchased for residential purposes. After a failed attempt to sell it, it was also rented out. The Administrative Appeals Tribunal found that the taxpayer and his wife were mere passive investors and were not in the business of deriving income from rental properties. They rejected the taxpayer's argument that he had greater involvement with his 16 properties.

In 11 CTBR (OS) Case 24 (Case 24), the taxpayer's income included rents from three properties. The taxpayer employed a manager and an accountant - he was principally a letting clerk with authority to refuse tenants. He collected and banked rents, attended to repairs and supervised them, and controlled the caretaker and cleaners. He kept books in connection with rents and repairs, and rates and other outgoings. The taxpayer said he personally carried out the principal part of the management of his rent-producing properties and directed policy, attended to the financial arrangements and made decisions regarding repairs. The taxpayer claimed that he was carrying on a business. In holding that he was not carrying on a business, a majority of the members of the Board of Review said:

It is obvious that some measure of supervision and management must ordinarily be exercised by a property owner who lets offices, &c., and if that does not amount to the carrying on of a business, the fact that he employs others to assist him, either in the letting of the properties or in the preparation of the accounts relating to his rents and outgoings, will not make any difference. For the foregoing reasons we are unable to uphold the claim that the taxpayer is engaged in a 'business as property owner'...

In 15 CTBR (OS) Case 26 (Case 26) the taxpayer derived income substantially from her joint ownership of a block of flats (containing 22 living units) with her sister-in-law. A swimming pool was shared with a neighbouring block of flats owned by the taxpayer's husband and his brother. A garden was maintained and a staff of one caretaker and one cleaner employed on both buildings with casual labour as required. The building was erected and financed by F & Co., the husbands of the joint owners, in the course of their business as building contractors. The general supervision of letting, rent collecting, servicing and maintenance was carried out by the owners or by F & Co. on their behalf. No charge was made by F & Co. for the extensive assistance given in the supervision of the flats. It was held that a business was not being carried on by the owners of the block of flats.

On the other hand, 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.

Taxation RulingTR 97/11 Income Tax: am I carrying on a business of primary production? (TR 97/11) provides the Commissioners view of the factors used to determine if a taxpayer is in business for tax purposes. Its principles are not restricted to questions of whether a primary production business is being carried on.

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 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.

In the Rental Properties 2018, a guide published by the Australian Taxation Office the Commissioner sets out two examples that discuss the issue of whether or not the owner of one or more rental properties can be said to be carrying on a business.

The first example, Example 3 on page 6 of Rental Properties 2018 outlines a situation in which the owners are not carrying on a rental property business. The Commissioner states:

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 sources 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.

The second example, Example 4 on page 6 of Rental Properties 2018 outlines a situation in which the owners are carrying on a rental property business. The Commissioner states:

The D'Souza's own a number of rental properties, either as joint tenants or tenants in common. They own eight houses and three apartment blocks - each block comprising six residential units - a total of 26 properties.

The D'Souza's actively manage all of the properties. They devote a significant amount of time - an average of 25 hours per week - 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 collection. 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'Souza's are carrying on a rental property business. This is demonstrated by:

·         the significant size and scale of the rental property activities;

·         the number of hours the D'Souza's spend on the activities;

·         the D'Souza's extensive personal involvement in the activities; and

·         the business-like manner in which the activities are planned, organised and carried on.

As shown in the above cases and the views of the Commissioner listed above, the indicators with the greatest weighting are the scale or volume of operations and the repetition and regularity of the activities.

Applying the relevant cases and indicators to your circumstances

In many instances, it is obvious that an activity is being carried on as a business and no further investigation is required.

Where it is less obvious, regard must be had for any other potential outcome when determining whether a particular activity should be considered to constitute a business and in determining the tests are to be applied in reaching such a determination.

There are many decided cases that consider the issue where the potential outcome is between 'business or hobby' or 'employee or independent contractor' (with an independent contractor being considered to carry on a business). In this case, we are considering the question of 'Are you carrying on a business' with the other potential outcome being that the activity constitutes an investment that generates assessable income.

Reference has been made to the case Administrative Appeals Tribunal (AAT) case YPFD and Commissioner of Taxation [2014] AATA 9 at 16 (YPFD case), and that after the weighing up of the factors as provided in Shields v Deputy Federal Commissioner of Taxation (1999) ATR 1042 (Shields case) and, Smith and Commissioner of Taxation (2010) 79 ATR 934 (Smith case) a decision that you have been carrying on a business should be made for the following reasons:

·         there was a clear intention to carry on the rental property activities as a business as evidenced by your establishment, being the establishment of a partnership between Persons A and B;

·         while you have made losses in previous years, there continued to be a clear intention to derive a profit from the operations. Actual profits have been made from the activities in recent income years. The reduction of loans has meant that there is a real likelihood of future profits being made from the activities;

·         the profits have arisen due to the trading undertaken by Persons A and B in the management of a total of 11 properties, with the construction of the 12th property currently being undertaken. Their intention to trade regularly and routinely should be evidenced through the length of operations and their activity in the management of the properties including the engagement, review and supervision of agents, together with various other tasks such as reconciliation of income and expenses and maintenance of properties;

·         in accordance with the YPFD case finding, certain reliance on estate agents to manage the properties should not preclude you from being characterised as carrying on a business of letting rental properties as their services were engaged for carefully considered strategic business purposes after previously undertaking such activities themselves;

·         the activities of the real estate agents are constantly reviewed, with Persons A and B still actively engaged in the agent's operations, such as the maintenance of the properties. Change of real estate agents have been made when it has been determined appropriate; and

·         the volume of the operations and the capital outlay for the construction of the purpose built properties should further support the finding of a business being carried on as was the finding in the YPFD case.

The following statement about the tests that are relevant when the issue involves residential rental properties was made in the YPFD case:

16.  The Tribunal suggested in Shields v Deputy Federal Commissioner of Taxation (1999) 41 ATR 1042 and, more recently, in Smith and Commissioner of Taxation (2010) 79 ATR 934, that relevant matters might include:

(a)  the nature of the activities and whether they have the purpose of profit-making;

(b)  the complexity and magnitude of the undertaking;

(c)  an intention to engage in trade regularly, routinely or systematically;

(d)  operating in a business-like manner and the degree of sophistication involved;

(e)  whether any profit/loss is regarded as arising from a discernible pattern of trading;

(f)    the volume of the taxpayer's operations and the amount of capital employed by him; (by 'her' in the present case).

The AAT adopted the six indicia from the Smith case as to what activities constitute carrying on a business, with the AAT forming the overall impression that the taxpayer in the YPFD case carried on a business of letting rental properties specific to the taxpayer's circumstances.

The decision made by the AAT is based on the plaintiff's facts. The Commissioner's view is that the YPFD case has no wider ramifications beyond that taxpayer's circumstances and that this case does not have any further precedential value.

The Commissioner considers matters on a case by case basis according to the facts of that case and that the specific facts of the YPFD case distinguish it from your situation. Therefore, we have taken the factors from TR 97/11 as outlined above into consideration and applied them to the facts of your situation when making our decision as to whether or not you are carrying on a business of letting the rental properties.

Note: Persons A and B purchased a number of vacant lots of land which they have developed by constructing structures on them, subdividing the land into lots with a structure located on each subdivided lot, for the purpose of selling the majority of the newly subdivided lots and keeping a small number to be used as rental properties. This ruling will not consider Person A and B's activities in relation to the purchase, development and sale of the newly constructed structures on the subdivided lots as those activities are independent from the rental property activities and will not be considered when determining whether a business is being carried on in relation to the property letting activities.

After weighing up the relative business indicators and objective facts surrounding this case, it is considered that the information and documentation provided does not support that a business is being carried on in relation to the letting of the properties during the period covered by this ruling.

We have made the following observations when making our decision.

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

Six rental properties were used for rental purposes by you during all or part of the period covered by this ruling, with Property J being sold during the 2018-19 income year.

Property L was purchased in 2017 on which a house will be constructed which will be used for long-term rental purposes when the construction has been completed.

While the number of rental properties used in your activities are more than in Case 24, they are significantly less than in Cripps case and Case 26. In all of these cases it was held that a business of letting rental properties was not being carried on.

It is stated that:

·         Persons A and B monitored the expenses of the rental property operations closely to ensure that the operations were profitable as a core source of their income;

·         the rental property operations have been Person A's main source of income for a number of years;

·         Person A and B regularly look at what other rental properties are earning to ensure they get optimum rent for their properties, increasing rent as required; and

·         the nature of the activity of developing for the purpose of letting several residential properties, with the intention of deriving long term profits, are of a significant commercial nature and have continued to be Person A and B's main source of income.

However, during the income years prior to the 2014-15 income year profits were made in only two income years. In the 2015-16 to 2017-18 income years net income amounts of less than $26,000 were reported in relation to the rental activities.

Based on the amounts recorded in Person A and B's income tax returns it appears that their main source of income had been from the sale of the subdivided and developed lots sold during a number of income years and not from rental income earned from rental properties given the low amount of net rent earned from the properties. Additionally, it was stated that when losses had been made in a number of years Person A and B had relied on their inheritance to cover living costs.

The carrying on of a business is not merely a matter of intention alone. Rather, it is a matter of activity motivated by intention. It is appropriate to look objectively at the activity to reach conclusions about a taxpayer's state of mind in deciding to conduct the activity.

Both business and investment will have a profit making intention whereas a hobby will not. In general terms, a business activity will be seeking to more efficiently allocate resources than a mere investment and will seek to conduct the activity in a way that provides a return that is higher than the investment levels received by others conducting similar activities. A business may seek to adapt to changing circumstances by altering the form or nature of the allocation of those resources. A business may be seen as being more open to taking risks to pursue these outcomes.

Properties D, G, H, I, J and K had all commenced being used to earn rental income prior to 1 July 2015, and with the exception of Property J, have continued to be used in that manner until the present time.

Property J was sold during the 2018-19 income year for the purpose of funding the development of Property L in an endeavour to increase overall rental income and profits from the letting of the properties. Other disposals made in previous years had been undertaken to reduce debt, due to Person A and B's health and age, lifestyle and required level of living costs.

It is stated that all properties were constructed with the intention of using them as rental properties, which still remains the same, with the aim to provide affordable housing for your tenants. However, a business intention would be to maximise income-profits and to review activities to determine if better returns could be made, such as gains made from selling a property to capitalise on any capital growth with the resulting funds to be reinvested in activities that would provide a better return than the rental income being received from that particular property.

Person A undertakes some of the repair/maintenance activities, or organises tradesmen as required. However, based on the information provided the number of times those activities occurred appears to be modest and infrequent.

While Person A undertakes repairs and maintenance activities it is viewed that those activities are undertaken to keep the properties in a condition suitable for tenants. It would be reasonable to expect any property owner, either in general or a passive investor, to undertake any repairs/maintenance they have the capacity to undertake to reduce costs.

Additionally, the ongoing repair and maintenance of rental properties is considered incidental to the ownership of the properties and are incurred to bring the property back to its functional condition and are unlikely to result in an increased rental amount. If the owner spends extensive time carrying out those activities it does not indicate that the owner is carrying on a business.

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.

No money is currently owed on any of the Properties and the total current market value of the properties, excluding Property J and Property L, is estimated at over $2 million.

The total net income reported in the 2017-18 income year is less than 1% of the lowest estimated market value for the properties as outlined above. When compared with the net rent for the 2015-16 and 2016-17 income years, the net rental amounts are just over 1% of the lowest estimated market value of the five properties.

While profits have been made in the past three income years, the net rental income amounts and total net income from business amount received from the rental activities are not viewed as business-like returns and are viewed as investment levels that are substantially lower than that of a business or commercial level.

Person A and B purchased Property L on which a house is being constructed that will be used by you for rental purposes. It is anticipated that following the construction of the house on Property L the rental income will increase to just over $100,000. However, based on the information provided that amount will still not be a business-like return given the properties involved and the effort both Person A and B spend in relation to the rental properties.

It is stated that the properties were purchased to hold as capital assets from which ongoing rental income would be derived, with the rental profits to be used to sustain Person A and B's living costs. This is not dissimilar to other taxpayers who have invested in a number of rental properties for the same desired outcome.

The properties are leased out for periods of twelve months with Property K having been on a permanent lease for a number of years. The rental income is not derived from any services provided directly to the tenants but from the letting of the properties. Therefore, the rental income is only being received because Person A and B own the properties and not from any services provided.

The profitability and sustainability of the rental activities has been part of a long-term strategy in paying down the loans to reduce interest costs and ensure that operations are profitable. This is not dissimilar to any passive investor who is seeking to reduce mortgages on their rental properties to achieve a greater net profit from their rental properties.

It is stated that Person A and B will review the future purchase of additional properties after the construction of the house at Property L is completed. However, the purchase of any further properties at this point is speculative as to what may happen in the future.

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.

We are looking at those activities that would be required in the renting of properties. If there was a block of 30 holiday units rented on a short time basis there is an extensive amount of work conducted on a daily basis in meeting tenants, providing cleaning, linen and other services. The fees paid by the tenants are for both the services and the use of the property and if it is of sufficient scale, because of the regularity of these services it can be argued that they could be carrying on a business of renting properties.

Your property activities are of a different nature to this. Your lease periods are of a longer time frame being around twelve months, with the leases being renewed in most instances.

The daily management of the properties is under the management of real estate agents who collect the rent, advertise, deal with tenants and tenancy agreements and provide inspection reports. The engagement of real estate agents neither supports nor rules out that a business is being carried on.

While Person A and B monitor the real estate agent's activities to ensure that they are undertaken appropriately, this is not different to any property investor who would monitor their agent's activities to ensure that they have undertaken their activities in relation to managing a rental property in an appropriate manner. If not, it would be reasonable to expect anyone to seek to engage the services of an alternative real estate agent.

Based on the information provided in relation to the amount of time both Person A and B spend on the rental property activities when compared with the net tax rental profit that has been made in the various income years, it is not viewed that a business-like return is being received for the effort Person A and B spend on undertaking activities in relation to the rental properties, in addition to the value of the properties involved in the rental activities.

The level of repetition and regularity of the activities in this case is not as great as that noted in Case 26 where despite the management and maintenance activities undertaken,the property owners were not considered to be carrying on a business of letting properties.

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.

Property owners who are carrying on a business in relation to their properties would be seeking positive business-like returns from their properties. In this case while profits from the rental activities have been made they are not of a business-like size given the value of the properties, the costs involved with the properties and the amount of time spent by Person A and B to earn those amounts.

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.

Person A and B have chosen a partnership as the entity through which they will operate their rental property activities. Rental amounts were reported in your income tax returns up to the 2016-17 income year. However, in your 2017-18 income tax return no rental amounts were reported, with an amount being reported as non-primary production other business income. The use of you as the relevant entity in relation to the rental properties and how the rental amounts have been reported in income tax returns neither supports nor disproves that a business is being carried on. It merely indicates how Person A and B have chosen to self-assess the rental activities and the relevant amounts arising in relation to those activities.

Your activity is renting out residential properties at market rates. This is similar to many other rental property owners who hold their properties as investments and who seek to obtain the highest market rate for the rental of their properties. Hence the relationship in respect of this test is indicative of a landlord and tenant.

It is stated that from 1 July 2015, Person A and B have not undertaken any other employment activities, with their sole focus being placed on the rental property activities to derive a profit to sustain their living costs. However, the net income received from the rental properties in the 2015-16 to 2017-18 income years were low when considering that they were intended to cover Person A and B's living costs. Based on the information provided the majority of income Person A and B received was from the capital growth on the sale of various properties over the years, including Property J in 2018, and not the rental income.

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.

It is stated that Person A and B engaged the services of the real estate agents to:

·         assist them with the daily management and due diligence of tenants;

·         to reduce the risk of damage to the properties; and

·         to increase the likelihood of rent being received on time due to the agents have a greater understanding of the rental tenancy laws.

However, it could be considered that property investors could engage the services of real estate agents for similar reason.

The real estate agents provide documentation/reports in relation to the properties, which is not dissimilar to those that would be provided to property investors. Additionally, Person A and B keep records in relation to the income and expenses relating to the rental properties. However, it is also reasonable to expect anyone investing in rental properties, including passive investors, to keep records in relation to their rental property/ies so that they can keep informed as to whether or not they are making a profit in relation to the rental property/ies and to make decisions as to what activities to undertake in relation to their rental properties to maximise their returns.

It is stated that the activities have been carried on in a businesslike manner with separate bank accounts having been established for the receipt of rental income and outgoing amounts in relation to the properties which would generally be similar to investors having separate bank accounts in relation to their rental properties.

The types of records and tracking for a rental investment would not be dissimilar for a passive investor and someone carrying on a business of letting rental properties given that rental income and expenses need to be recorded and property analysis reports and financial rations would be useful to invest further, or make any decisions about the performance of the rental property/ies.

It is stated that detailed financial statements are prepared for you, aggregating the income derived and expenses incurred in relation to the activities. It may be arguable that rental property businesses might keep more detailed records than mere investments so that they can be better positioned to take advantage of opportunities that arise. This test is more relevant when the potential alternate outcome is that the activity constitutes a hobby. Your activity does not have the nature of a hobby.

When considering the size and scale of the activity 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.

Where size and scale is a relevant factor, the activity should be large enough to make it commercially viable as a business. 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.

The scale of your activities and volume of operations can be distinguished from the cases noted above as there were fewer properties rented out during the ruling period.

It had been determined that a business was being carried on in the D'Souza case as provided above, however this situation can be distinguished from the facts provided in that case as there are less rental properties and personal involvement in this situation.

Based on the information and documentation provided, it is the Commissioner's view that your rental property 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 provided to the tenants, but from the owning and letting of the properties.

While Person A and B have invested capital into the acquisition of the rental properties, and the activities have been undertaken for a significant period of time, the activities are considered to be in line with those required of a passive investor in rental properties, such as repairs and maintenance to service the properties.

The number of properties used in relation to the rental activities is small compared to some of the case listed above where it was viewed that a business of letting rental properties was not being carried on. Additionally, there is nothing special about the manner in which the activities related to the rental properties are undertaken that would transform those activities from an investment into a business. It cannot be considered that a business level return is being received on the properties, or for the level of effort Person A and B spend on the activities.

Accordingly, it is the Commissioner's view that you are not carrying on a business of letting rental properties and are a passive investor with a number of rental properties.

Note: It is stated that Person A and B receive rental income amounts in accordance with the percentages as outlined in the Partnership Agreement. The gains made on the sale of properties have also been apportioned according to the Partnership Agreement.

Taxation Ruling TR 93/32 Income tax: rental property - division of net income or loss between co-owners outlines the following:

1. This Ruling explains the basis upon which we will accept, for income tax purposes, the division of the net income or the loss from a rental property between the co-owners of that property.
2. The Ruling only examines the taxation position of co-owners whose activities do not amount to the carrying on of a business.
3. Co-ownership of rental property is a partnership for income tax purposes but is not a partnership at general law unless the ownership amounts to the carrying on of a business.
4. Where co-ownership is a partnership for income tax purposes only, the income/loss from the rental property is derived from co-ownership of the property and not from the distribution of partnership profits/losses.
5. Because co-owners of rental property are generally not partners at general law, a partnership agreement, either oral or in writing, has no effect on the sharing of income/loss from the property.
6. Accordingly, the income/loss from the rental property must be shared according to the legal interest of the owners except in those very limited circumstances where there is sufficient evidence to establish that the equitable interest is different from the legal title.

42. Any capital gain or loss should also be apportioned on the same basis as the rental income or loss.