Edited version of private advice

Authorisation Number: 1051617444399

Date of advice: 9 December 2019

Ruling

Subject: Income Tax - Am I in business - rental properties

Question 1

Are you carrying on a business of the management of commercial rental properties pursuant to the Income Tax Assessment Act 1997?

Answer

No

Question 2

If the answer to question one is yes, are you able to access the small to medium business depreciation rules?

Answer

Not applicable. The answer to question one is no.

Question 3

If the answer to question one is yes, are you able to share the partnership rental property profits and losses according to the Partnership agreement or Partnership Distribution Resolution rather than based on each partner's ownership percent?

Answer

Not applicable. The answer to question one is no.

This ruling applies for the following periods:

Year ended 30 June 2019

Year ended 30 June 2020

Year ended 30 June 2021

Year ended 30 June 2022

The scheme commences on:

1 July 2018

Relevant facts and circumstances

The partnership owns and manages three adjoining commercial rental properties.

The properties were purchased by the partners of the partnership as joint tenants.

Two properties were purchased in 20XX to rent to a closely held family Company and also to non-related tenants.

In 20XX the third property was purchased.

Both partners are employees of the closely held company which is a tenant.

One partner is also the director and Member of the closely held company.

The nature of the business of the company is not related to commercial rental.

The partners perform duties for the company for 50-60 hours per week between the partners.

The partners do not have any other employment other than the company.

The partners are onsite five days per week and are available to deal with any tenancy issues and monitor the non-related tenants.

The three properties contain 15 individual tenancies.

You advertised for tenants using online advertising.

The management of the commercial rental properties is carried out directly by the partners.

These duties include:

·        Advertise for lease any vacant space

·        Show prospective tenants through premises

·        Prepare lease documents

·        Issue rent invoices

·        Follow up any non-payments

·        Cleaning and maintenance of common area, including ensuring consumables are stocked (eg toilet supplies)

·        Collect post and deliveries and distribute to tenants

·        Maintain and manage NBN internet connection for all offices

·        Maintain external areas and gardens.

The daily duties of the partners in relation to the rental of the properties include:

·        Collect and distribute mail

·        Direct people to the correct business if required

·        Clean common areas

·        Address tenant maintenance

·        General enquiries

The partners provide these daily services to the tenants for less than an hour per day.

The partnership does not have any employees assisting with the rental of the properties.

The partnership was created in 20XX to register for GST as the GST turnover threshold was approaching.

All of the income from the partnership is derived from the rental of the properties.

The partnership does not have a business plan in relation to their rental properties.

The partnership expects to make a profit from the rental properties over the next five years.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Summary

It is considered that the scale of activity and volume of operations carried on by the partnership is insufficient to be considered as carrying on a business.

Reasons for Decision

Carrying on a business

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

Normally the receipt of income from the letting of property to a tenant(s) does not amount to the carrying on of a business (Wertman v. Minister of National Revenue (1964) 64 DTC 5158; Federal Commissioner of Taxation v. McDonald (1987) 15 FCR 172;87 ATC 4541; 18 ATR 957 (McDonald's Case); Cripps v. FC of T 99 ATC 2428 (Cripps' Case); Case X48 90 ATC 384; (1990) 21 ATR 3389).

Whether the letting of property amounts to the carrying on of a business will depend on the circumstances of each case, (Californian Copper Syndicate (Limited and Reduced) v. Harris (1904) 5 TC 159). Generally, it is easier for a company that derives income from the letting of property to show that it carries on a business than it is for an individual (paragraph 3 of Taxation Ruling IT 2423).

A person who simply co-owns an investment property or several investment properties is usually regarded as an investor who is not carrying on a rental property business, either alone or with other co-owners. This is because of the limited scope of the rental property activities and the limited degree to which a co-owner actively participates in rental property activities. A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations. If rent was derived from a number of properties or from a block of apartments, that may indicate the existence of a business (paragraph 5 of IT 2423).

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

In Cripps v. FC of T 99 ATC 2428; (1999) 43 ATR 1202, 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 Ruling TR 97/11 incorporates the general factors. 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.

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

Significant commercial purpose

The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators.

The partnership commenced purchasing two commercial properties in 20XX and a further commercial property in 20XX. There are currently three properties, with tenancies being let to fourteen tenants. You are currently seeking a tenant for the final vacancy in the property.

Intention of the taxpayer

The carrying on of a business is not a matter merely of intention, it is a matter of activity. It is appropriate to look at when the activities started and whether they add up to more than a mere intention to conduct a business.

The first two properties were purchased in 20XX and one more building has been purchased since then. There are fifteen tenancies available for rental between the three properties. The partnership has leased and received rental income from the tenancies on the properties since 20XX. The two partners have undertaken the majority of the daily running and maintenance of the property on behalf of the partnership.

Prospect of profits

The taxpayer's involvement in the business activity should be motivated by wanting to make a tax profit and the taxpayer's activities should be conducted in a way that facilitates this. This will require examining whether objectively there is a real prospect of making such a profit from participating in the business of the taxpayer.

The partnership has operated with an increasing number of tenancies which have been leased to tenants. The activity is expected to make a profit over the next five years.

Repetition and regularity

The taxpayer's activities should involve repetition and regularity and have an air of permanence about them. With regards to letting of properties, repetition and regularity may be measured by factors such as regularity of maintenance, collecting of rent, management and advertising of the properties, insurance, dealing with tenancy agreements and inspection reports.

The daily management and maintenance of the property is undertaken by the two partners on behalf of the partnership. The partners provide less than one hour of service to their tenants each day. The level of repetition and regularity of the activity is not as great as that noted in Case G10 where the taxpayers rented out short term holiday units.The trustees' involvement is similar to those circumstances noted in Case 26. In this case, despite the management and maintenance activities undertaken,the property owners were not considered to be carrying on a business of letting properties.

Activities of the same kind and carried on in a similar manner to those of the ordinary trade in that line of business

If a taxpayer carries out their activity in a manner similar to other taxpayers in the industry, it is more likely that their activity amounts to the carrying on of a business. That is, the taxpayer's operations are of the same kind and carried on in the same way as those characteristic of ordinary trading in that particular line of business (IR Commissioners v. Livingston 11 TC 538).

This indicator requires a comparison between the activities of the taxpayer in question and those undertaken by a person in business in the same type of industry. Where the taxpayer's activities are similar in nature to the business, further support is given to the fact that a business exists.

Generally, where the property owners grant exclusive possession of the property to the residents the relationship between the two parties is one of tenant and landlord, and the activity is more likely to be passive investment rather than a business. Similarly, activities constituting the mere maintenance of an asset and the mere collection of income do not indicate the existence of a business of renting premises.

The partnership is renting the commercial tenancies, hence the relationship is that of a landlord and tenant.

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.

The partners are responsible for preparing documents and invoices, and following up any non-payments. The partnership does not have a business plan for the commercial rental activity.

The size and scale of the activity

The business should be large enough to make it commercially viable. 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 the partnership activities and volume of operations can be distinguished from the cases noted above as there are only three properties consisting of 15 available tenancies.

Hobby or recreation

The activity does not have the nature of a hobby or recreational pursuit. The nature of the partnership activity is similar to other rental property owners who are actively involved in some aspect of the property they own.

Conclusion

In this case, it is considered that the partnership is not carrying on a business of renting commercial properties. The partnership derives rental income from three properties which have fifteen tenancies available in them. These tenancies are leased on a longer term basis as opposed to the short term holiday flats rented out by the taxpayer's in Case G10.

We acknowledge that the partners perform all of the activities required for the managing and maintenance of the properties on behalf of the partnership. However, the undertaking of managing and maintenance, level of involvement, scale of activity and volume of operation in the activity is far less extensive than the tasks noted in Case G10. The circumstances surrounding the management and maintenance are similar to the owners noted in Case 26 which was not considered to be a business.

Having given consideration to the relative business indicators and the facts of case, it is considered that the partnership is not carrying on a business of leasing commercial properties.