Edited version of private advice

Authorisation Number: 1051772578134

Date of advice: 29 October 2020

Ruling

Subject: Business - am I in business? - rental properties

Question:

Are you carrying on a business in relation to your rental property activities?

Answer:

No.

This ruling applies for the following period

Income year ending 30 June 2020

The scheme commences on

1 July 2019.

Relevant facts and circumstances

Background

You have completed a Bachelors degree and several Masters degrees.

You were employed by a company who prepared reports in relation to property and industry sectors, exposing you to the property industry and market economics, assisting with your understanding of economics, markets and industry sectors.

Your professional goal was to acquire knowledge in relation to strategy, operations, supply chain and procurement in global companies so that you could apply your skills across industries.

You:

·         attended numerous courses, seminars and webinars dealing with topics such as personal development and growth, professional development, wealth and financial building, shares and investing, options trading, properties and real estate, and social media; and

·         spent a significant amount of time reading publications and listening to audio tapes and compact discs relating to property related issues.

Your goal was to seek equity growth and cash flow in relation to your property portfolio. You researched different models in relation to purchasing the properties and used the following theory when purchasing properties:

·         property located an area of high demand and low supply.

·         property must be easily sold

·         properties that enable you to undertake generate a capital gain

·         properties that need some cosmetic work either internally and/or in the garden

·         properties with potential to be leased cost effectively for long term

·         properties that are lower priced properties.

·         ascertain the current zoning of potential properties and any potential rezoning of the area in which the property is located.

Your aim/plan was to:

·         invest in property to develop a property rental and investment business

·         purchase property that would generate yields of greater than 7.8% in areas with a ten-year history of capital gains exceeding 7%

·         aim for a minimum 5% increase in rental income each year for each property with rental income increasing if you have undertaken any improvements at the properties, such as a new paved parking area, based on market conditions

·         properties are hedged so that when some properties are in a more depressed economy, others are not

·         fund the purchase of the properties with 20% savings, or refinanced capital gains from other properties, and 80% from borrowings. Loans are principal and interest, with your investments being for a long term as you won't be selling to pay off the principal. You may refinance a property loan and withdraw amounts against a property up to 80% to ensure that you have a 20% buffer.

Your properties have not achieved the minimum rental income increase of 5% in each income year since they were purchased.

Your financial rules for your properties are:

·         capital gains will average 7%, with property values doubling each 10 years

·         rental returns will increase on average 5% per annum

·         property holding costs will generally be 27% of the rental income, allowing for rates, strata, water, insurance and minor repairs not including refurbishments; and

·         50% of the after-cost income, excluding borrowings will be used to determine a property's contribution to income in 10 years.

You have adopted the following stages in relation to your property activities:

1.    Acquisition phase, which involves buying, preferably when prices are down and then readying them for rental

2.    Consolidation phase, which allows the properties time to develop equity; and

3.    Realisation phase, which is to commence in 202X when you will review your properties value, and measure the rental income after tax, and if necessary, sell a property/ies to reduce borrowings. At this stage your target is less than 25% borrowings, after off-sets, to ensure that interest rate hikes do not adversely affect your income buy properties to maintain them for the longer term and may undertake improvements to derive a significant capital gain to improve the returns on your properties; and invest in the properties for long term, being 20-30 years

You subscribe to several property information services to enable you to source information in relation to properties, such as CoreLogic (formerly RP Data), RP Data and NMD Data.

You have not purchased or sold any rental properties since 200X.

By 200X, you had left full-time employment and had become a contractor. You worked full time as a consultant and director of large corporate clients during the current income year.

In 200X your sibling wanted to purchase a hotel, with the plan to purchase the lease of the premises and then using the profits to purchase the commercial premises, which included the hotel, other commercial premises and apartments. You entered into the investment, but it was not successful, with you and your sibling being out of the daily management of the hotel in 201X, with legal action being undertaken from which you received a payout. You still had debts in relation to this venture several years later.

Since early 201X you have been reviewing block of apartments located in specified states to potentially purchase which will have a minimum of a specified minimum number of apartments, specified construction, with potential for cosmetic improvements, plus development opportunity, for the purchase price of under $X,XXX,XXX.

In 202X you will be around 65 years of age and intend retiring and you have always intended that your property activities would be disbanded to fund your retirement.

Rental properties held during the ruling period

You currently have ownership interests in the following properties that were used for rental purposes during the ruling period (collectively referred to as the Properties):

Rental activities during the ruling period

You engaged the services of real estate agents to manage the Properties during the period covered by this ruling, to undertake the following activities in relation to the Properties:

·         advertising for tenants, tenant selection and drawing up lease agreements

·         collecting rent for all properties, ensuring tenants pay their rent, and removing tenants when required

·         addressing landlord and arbitration issues

·         completing property inspections

·         responding to tenant's issues, with the property manager being the contact person for the tenants

·         approving up to $XX to address issues arising in relation to all properties without your approval

·         ensuring tenants and buildings are safe

·         inspecting the properties:

-         after the tenants leave, being an exit inspection

-         several weeks after the tenants have moved in; and

-         during the lease period when the properties are leased for longer terms, mid-term inspections

·         providing photos of the Properties for you to review and identify and raise any issues with you; and

·         providing relevant documentation and end of financial year financial summaries for each property.

All properties are leased for a minimum of X months, not furnished, with:

·         the Property D units being X month leases; and

·         Property B being leased for XX months.

Rental income may be increased if the tenants wish to renew their leases.

You undertook the following activities in conjunction with the property managers:

·         working closely with the agents to ensure that all properties are well presented and attractive to renters

·         providing input into advertisements for the properties and have discussions in relation to the rental amounts being sought for the properties

·         reviewing the shortlist of potential tenants provided by the property managers and usually accept their recommendations on the best tenant

·         you did not attend the inspections of the properties undertaken by the property managers, but review the report and photos provided by the property manager

·         discussing rental amounts and rental increases when leases have ended; and

·         you were advised of all issues at any property by the property managers during the period covered by this ruling which you organised to have rectified.

You paid other parties to maintain the gardens and surroundings of the buildings to keep them in a neat and good condition.

Cosmetic improvements during the period covered by this ruling were minimal and you addressed issues occurring at the Properties in relation to the following:

·         organised for the fire protection of the Properties to be inspected to ensure smoke alarm compliance at the Properties

·         organised the repair of part of a balcony due to storm

·         obtained quotes in relation to several of the issues listed below

·         obtained photos from the party undertaking the activity before and after the issue had been addressed for you to review

·         issue with oven and after investigating having it repaired it was determined that you needed to purchase a new oven. You requested the property manager to provide a photo of the existing oven with measurements. You researched ovens and purchased an oven on special on-line. Your property manager sourced several quotes in relation to the delivery and installation of the oven, with the best quote being selected. You received photos on the completion of the installation of the oven from the tradesman.

·         engaged the services of tradesmen/handyman to:

-        repair water leaks due to holes in the eaves, unblock downpipe and clean out awning

-        install a new air-conditioner at a property

-        repair and/or replace light fittings, reposition and replace power points

-        replace vanity, taps, mixer tap in a kitchen, service basin taps, replace washer in garden tap, replace tiling in bathroom, fix leaking shower and replace shower rose

-        replace glass in oven door

-        service a hot water system at one property

-        replace blinds/curtains in main bedroom at one property

-        maintaining gardens, such as lawn mowing, landscaping and weed spraying

-        repair front door at one property after it was damaged by tenants, repair sliding doors

-        rubbish removal

-        reposition pelmet box and repair hanger inside cupboard

-        repair television cables and antennae

-        pest control at one property; and

-        clean gutters and reattach fascia board at one property

Several of the activities listed above were undertaken due to you being advised that the issue was due, or was required, with you indicating that you confirmed/approved the property agent's course of action in relation to the issue.

You have preferred supplier lists for each property and approve and/or source all tradespeople working on your properties who communicate to you any updates and explanation of any extra costs, with before and after photos being provided to you before you pay the relevant tradespeople.

You estimate that you spend XX.X days per year, or X.X days per month, in relation to your rental properties which includes:

·         X days for you to undertake activities in relation to the preparing and lodging of your income tax return; and

·         X days in relation to Property X, which is not being considered in this ruling, as discussed below.

The total gross rental amount of $XXX,XXX was received from the Properties during the period covered by this ruling consisting of the following amounts:

Due to Covid-19, there has been less need for deep cleaning of premises and discussions about rental due to less vacancy rates and changeover of tenants.

You have two businesses, being Company A from which you received around $XX,XXX during the ruling period, and Company B which is in its start-up phase and from which you are endeavouring will be the source of other significant income other than your property income. However, you have been caring for your parent for several years and have derived little income from these businesses.

You receive a trust distribution in relation to Property X, as discussed below, of around $X,XXX which is sourced from the rental income of that property. Your late relative's estate also has an ownership interest in the property, with any rental income it receives being reinvested backed into the property.

You use separate bank accounts in relation to your rental property activities.

You keep records in relation to the properties, such as:

·         documentation on any loans so that you are aware of what position you are in in relation to any property; and

• spreadsheets to keep records of the financial position of each property, such as purchase price, loan value, loan redraw value, offset account value, monthly repayments, estimated market value, monthly expenses and profit and loss on each property.

You use the services of an accountant for taxation purposes in relation to the rental properties.

Rental amounts recorded in your assessments

Rental amounts were recorded in the rental section of your income tax returns and from the 201X-1X income year to the 201X-1X income year in which:

·         your gross rental ranged from $XX,XXX to $XXX,XXX

·         you made a net rental loss of less than $1,000 in one income year; and

·         you made net rental profits less than $40,000 in the other income years.

Three properties were rented in all but the last income year when Property B had commenced being used for rental purposes for X weeks.

No amounts were recorded at the Business expenses and/or income section/s of your assessments.

Property held by trusts

The ownership interests in the following property are held by the estates of your deceased parent and relative as follows:

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 a passive investor leasing several residential properties to receive passive income from a stream of rental income for substantial periods and obtaining the benefit of any capital growth in the future arising as a result of the length of your ownership period of those properties.

Detailed reasoning

Carrying on a business

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

Paragraph 8 of Taxation Ruling TR 2003/4 (which is about whether boat charter activities generate business or investment income) states:

The receipt of income from the lease of an asset does not of itself amount to the carrying on of a business (see FC of T v. McDonald 87 ATC 4541; (1987) 18 ATR 957), but instead would generally be the passive receipt of income from property.

Paragraph 51 of Taxation Ruling TR 2003/4 states:

Beaumont J indicated (quoting Wertman v. Minister of National Revenue 64 DTC 5158) 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.

These statements indicate that a person who simply owns 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. There has to be something special about the activity to reach the conclusion that a business is being carried on. This will generally relate to the provision of additional services to the client in a manner that enhances the gross return above investment levels.

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 (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. The Tribunal also made the following observation about Taxation Ruling IT 2423:

The Applicant asked me to note in particular paragraph 5 of Taxation Ruling IT 2423 (a non-binding ruling) which is referred to in clause 17 of TR 93/32 to the effect that: ''... 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 suggests only that a number of properties may indicate the presence of a business; it follows of course that it will not of itself be determinative.

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. In reaching that conclusion, the Board found:

It was clearly established in evidence that the money received by the taxpayer from the occupants of the flats was not solely a payment for the right to rent a flat for a certain period.

Taxation Ruling TR 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:

a)    whether the activity has a significant commercial purpose or character

b)    whether the taxpayer has more than just an intention to engage in business

c)    whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

d)    whether there is regularity and repetition of the activity

e)    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

f)     whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

g)    the size, scale and permanency of the activity, and

h)    whether the activity is better described as a hobby, a form of recreation or sporting activity.

These factors are framed in TR 97/11 to reflect that the alternate outcome is as described in the final dot point. The analysis in this case must reflect that the alternate outcome would be to conclude that activities in relation to rental properties would be an investment.

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 Rental Properties 2020 (Rental Properties 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.

Example 3 on page 5 of the Rental Properties guide, 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 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.

Example 4 on page 5 of the guide, 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.

We have made the following observations when making our decision on whether you are carrying on a business in relation to your rental property activities for taxation purposes.

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.

You do not have an ownership interest in Property X, so this property will not be taken into consideration when determining whether you are carrying on a business in relation to your rental properties.

In your situation you own X properties, one consisting of several units, that were acquired in 198X, 199X, 199X and 200X. 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 you obtained loans that were principal and interest, for long-term investments and that you won't be selling any property to pay off the principal. Additionally, you may refinance a property loan and withdraw amounts against a property up to 80% to ensure that you have a 20% buffer. The amount of borrowed funds in relation to two of the Properties has significantly increased, decreasing in relation to the other two properties during your ownership period.

Your activities in relation to continuing to have mortgages and claim deductions for interest on the loans is not dissimilar to property investors. Using the equity in any of the properties to acquire any additional property/ies to earn additional rental income, or to invest to achieve greater returns, would be more indicative of a business seeking to use its current assets to further its activities and the potential to increase its prospect of making profits.

Nor have you undertaken any improvements in the majority of the Properties during the income year covered by this ruling in an endeavour to earn higher rental income, with the information provided supporting that the last improvements to any property were made several years ago, with the installation of an air-condition at one property during the period covered by this ruling which may increase the rental income received for that property. While a development approval was granted in relation to a major renovation at Property A it had not commenced during the period of this ruling and is therefore outside of the scope of this ruling.

You made a net tax profit of $XX,XXX in the 201X-1X income year, being the last tax return lodged. The level of the return from the Properties in the earlier income years appears to be consistent with other forms of investment given your situation and the majority of the expenses recorded in those tax returns are the traditional ownership expenses that would be incurred by any landlord in the rental section of their income tax return.

It is stated that gross rental received for the Properties during the period covered by this ruling was $XXX,XXX. It is the net tax profit that is taken into consideration and we are not able to determine the net tax profit/loss made in relation to the Properties during the ruling period based on the information provided.

However, the gross rental recorded for the Properties in your last assessment was $XXX,XXX when Property B had been rented for only X weeks in addition to the other properties, while it has been rented for 52 weeks during the ruling period. This is an increase of around $X,XXX gross rental income for an additional XX weeks rental which is not considered to be a significant increase in the gross rental income.

You invested a total of $XXX,XXX to acquire the Properties and it is estimated that the combined market value of the Properties is $X,XXX,XXX. The rental yield percentage of a property should be based on the current market value of the Properties.

Based on the market value of the Properties the gross rental amount received during the ruling period is significantly less than what would viewed as investment level, such as 6% of the market value. A business in your situation would be seeking a higher return than you are receiving, being a business-like return, in relation to the Properties given their market value.

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.

The three stages you have adopted in relation to your properties includes holding them for XX or more years before you review their value and rental income and determine if you will sell the Properties. You state that you have always intended that your property activities would be disbanded to fund your retirement. This is not dissimilar to property investors who are seeking to hold properties to earn rental income and then sell them to fund their retirement.

You have held the same properties since 200X and have used:

·         two of them solely for rental purposes since they were purchased in 199X and 200X; and

·         two for both private and rental purposes with one being acquired in 198X that was your main residence until 198X when it commenced being used for rental purposes and the other being acquired in 199X that has been used for private purposes for around XX years and rental purposes for around X years during your ownership period, with the latest period of rental commencing in 201X.

It is stated that you have been looking to purchase a building containing a specified number of apartments since 201X. However, no additional rental residential property/ies was purchased during the ruling period, or since 200X, and whether you will acquire any additional property/ies is hypothetical and speculative at this point as to what may happen in the future and how that may impact on any potential for future profits in relation to your rental activities.

Based on the information provided, you have taken a longer-term view in relation to the Properties, receiving passive market level rental, being more indicative of an investment level of return whereas it is reasonable to expect a business to adapt or alter to ensure that its resources are being used to derive a business-like return.

While there may have been a profit making intention, in accordance with the judicial comments above and guidelines set down in IT 2423 and TR 97/11 your activities lack a significant commercial character and are not of a size or scale necessary to be characterised as carrying on a business of letting rental properties.

Both business and investment will have a profit-making intention. The taxpayer's involvement in the activity should be motivated by wanting to make a profit and the taxpayer's activities should be conducted in a way that facilitates this.

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 more open to taking risks to pursue these outcomes.

Additionally, 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.

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

You have made net rental profits in each year since 201X-1X until 201X-1X, with a net rental loss being made in one income year. As outlined above, we are not able to determine if a net tax profit was made during the ruling period.

The Properties are rented out for X to XX months and 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 you own the Properties and not from any services provided.

The profitability and sustainability of your rental activities has been part of a long-term strategy. As provided above, you have not been paying off several of your loans to reduce interest costs and ensure that operations are profitable as would be reasonable action undertaking by property owners who are seeking to reduce mortgages on their rental properties to achieve a greater net profit from their rental properties.

It was stated that:

·         your aim/plan and financial rules included receiving a minimum of 5% increase in rental income for each property, which has not been achieved

·         you used a theory in relation to purchasing properties which would not be dissimilar to the factors a property investor would take into consideration when selecting a potential rental property. Additionally, you have not purchased any rental properties since 200X until 30 June 202X with any future property purchases being hypothetical; and

·         you have adopted three stages in relation to your property activities which includes buying properties preferably when their price is low and then preparing them for rental, allowing the properties time to develop equity and the third stage which is realising the properties in 202X.

Your business plan as outlined above has not changed since you purchased the last of the Properties in 200X. A business plan should be a living guide that changes as a business grows and develops, and or conditions change, and should provide details about how profits will be made, such as by owning and/or reinvesting in properties or reducing mortgages and should provide contingency plans to account for unforeseen circumstances.

Your purchasing theory included that the property must be easily sold, while it stated that you would not be selling any of the Properties until 202X. This supports that you were not going to sell any of the Properties in an endeavour to benefit from any capital growth, and or invest the proceeds from the sale of the property in undertaking any activities that would provide you with a greater return prior to 202X.

Nothing has been provided to support that you were seeking to earn higher business-like returns from all of the properties during the ruling period, such as undertaking renovations to receive higher rental returns, or using any of the Properties for short-term accommodation to potentially receive a higher rental return for any of the Properties.

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 with your lease periods being for a longer time frame. The daily management of the Properties is under the management of the property managers who collect the rent, advertise, deal with tenants and tenancy agreements and provide relevant documentation in relation to the Properties. The engagement of property managers neither supports nor rules out that a business is being carried on.

You spent an estimated XX.X days during the ruling period in relation to your rental property activities, which includes X days in relation to activities in relation to your income tax return, and X days in relation to Property X, which is not being considered in this ruling.

While you undertake activities in relation to issues arising in connection with the Properties, the majority of those activities are to keep the Properties in a suitable condition so that they can be rented out, or continue to be rented, being activities that any investor would undertake to ensure that they attract potential tenants and keep the Properties habitable condition during the leases.

Additionally, some of the activities undertaken were activities that are required in accordance with state legislation, such as ensuring that the smoke detectors are installed and working in each of the Properties and having the gas heater serviced.

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 so that they do not have to engage the services of tradesmen. Additionally, it would be viewed that any property owner would undertake activities to reduce costs arising in relation to their property, such as obtaining multiple quotes, using preferred tradesmen, ensuring the that work is undertaken to the required standard. The undertaking and/or the supervision of repair and maintenance activities does not change the character of your rental property activities from investment to business.

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 in relation to 22 units, 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 characteristics of ordinary trading in that particular line of business.

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.

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.

During the ruling period you received $XX,XXX from one of your businesses, being Company A, and a trust distribution of $X,XXX. We are unable to determine the net profit amount received in relation to the Properties during the ruling period, however the net rental profit in the last income year you lodged your tax return was less than the amount received from Company A when Property B was rented for only X weeks, which was rented for the full ruling period.

Based on the information provided we are not able to determine if the net rental income received from the Properties is more than your income received from other sources in the ruling period.

It is a rare business that does not seek to maximise its revenue by maintaining its assets to an acceptable standard, and while not decisive, it is relevant. But in doing that, it does not mean that they have conducted their activities in owning and managing the properties in a manner that is business-like. It would also be reasonable for an investor to renovate their rental properties to earn higher rental income and/or appeal to a different tenant market. This may involve seeking advice from real estate agents as to what activities could be done to the property to increase its rental appeal and potential rental returns.

It is essential that to be carrying on a business you must do more than just let out the Properties and are not merely receiving income from the letting of the properties.

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 you to earn those amounts.

You have tertiary qualifications, been employed by global companies, attended various seminars and read various books and articles in addition to seeking advice from professionals. However, your rental activities are no more sophisticated, complex or commercial in nature than many other property investors with several properties.

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.

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 make decisions as to what activities to undertake in relation to their rental properties to maximise their returns.

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.

You engaged the services of property managers to manage the Properties, who provide documentation and reports to you in relation to those properties. You keep separate bank accounts and keep your own records in relation to the Properties. You use the services of a tax agent to prepare your income tax returns. These activities are not unlike those undertaken by property investors.

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.

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 your activities and volume of operations can be distinguished from the Cripps case, Case 26 and the D'Souza example as provided above as there were fewer properties rented out during the ruling period.

The following statements were made in the ruling:

I train the agents representatives in good/great) property management. I work with the agents. I expect regular property reviews and reports. I ask for 3 quotes on work that needs to be done. I ask for itemised quotes, broken down at a min between materials and labour. I source the materials myself if I can get them more cheaply., which often I can and I have provided examples of this. I have specific trades to work on my properties. They are preferred suppliers which my agents are required to use. These preferred suppliers look after me and my interests. I personally visit my properties at least annually, to view them externally and internally if I can. I care about my properties and my tenants.

I negotiate with the agents on their commission and make them earn them.

As a property business owner, I am going to outsource services to the best external companies who can undertake them, like RE agents, and builders and service providers, but I do not allow them freedom to spend my money without my approval.(This is evident from the documents sent through.) For instance, I will send a handyman to assess a problem before sending a plumber, I will ask the agent to speak directly to the tenant to clarify an issue before just reacting.

People who own properties, regular mum and pop investors, do not do any of the above. (let alone make good property purchase decisions in the first place. And so often don't make much from their investments.)

Further, the current rental incomes and value of my estate would support the premise that I am far from a mom and pop investor.

They are all great properties in great locations and provide returns better than the market. (even when the returns are not great!) It has been difficult to not want to just sell a property for more money especially when we were going through the hotel experience.

As outlined above, we consider that a lot of the activities you undertake in relation to your rental properties are not dissimilar to other property investors. While you state that your activities can be distinguished from property investors:

·         it is not uncommon for property owners to work collaboratively with their property manager/s to ensure that they receive the highest rental income for their property in accordance with the current rental market environment

·         it is reasonable that the services provided by the property manager is appropriate given the costs involved with engaging them, and if not performing at an acceptable standard that a property owner seeking the best return for this expense would seek an alternative property manager to manage the property

·         persons in business would not continue to engage the services of a party who is not competently undertaking the activities involved with their engagement as it would not be considered business-like, and would seek to engage alternative parties to ensure that they are getting the appropriate service for the funds they are spending to engage the property manager

·         it is not uncommon for property investors to obtain quotes to obtain a cheaper price, source materials, determine which tradesmen are engaged, and undertake any activities they can to rectify any issues in their properties to reduce any costs arising in relation to those issues

·         it is not uncommon for property owners to have preferred tradesmen working on their properties

·         it is common practice for property investors to have limits on the amount that property managers can spend in relation to rectifying issues arising in relation to their properties without the owner's approval; and

·         as discussed above, it is viewed that your net rental income amounts are investment level returns when considering the market value of your properties.

The following were referenced in the ruling application to support that you were carrying on a business for taxation purposes in relation to your rental property activities during the period covered by this ruling:

·         It is stated that your circumstances are almost identical to the taxpayer the Administrative Appeals Tribunal (AAT) case YPFD and Commissioner of Taxation [2014] AATA 9 at 16 (YPFD case).

The decision made by the AAT was 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 for taxation purposes.

·         Self Managed Superannuation Funds Ruling SMSFR 2009/1

• Paragraph 115

Each case has its own facts on which a decision should be made, and we have taken the facts of your situation into consideration above and applied the factors as outlined in TR 97/11 to your facts when making our decision, with no one factor being a deciding factor.

·         SMSFR 2009/1 Example 14

Your situation can be distinguished from this example because:

-        you hold significantly fewer properties than Mr Wood in the example who held 20 properties

-        Mr Wood manages and maintains the flats on a full-time basis, while you use the service of property managers to manage your properties

-        the units in the example are not mortgaged, while your properties are all mortgaged; and

-        Mr Wood lives on the income generated from the leases, while you have two businesses, receiving income from one business during the period covered by this ruling in addition to a trust distribution.

·         D'Souza example in the Rental Property guide, as provided above.

Your situation can be distinguished from this example as:

• you own significantly fewer rental properties than in the example where they owned 26 properties
• you do not undertake the same activities personally, such as interviewing potential tenants, collecting the rent, carrying out property inspections as outlined in the example; and
• you do not spend as much time per week on the Properties based on your statement that you spend 31.5 days per year on them while the D'Souza's spend 25 hours per week on their rental properties, equating to around 3 days per week, or around 144 days per year for 48 weeks.

·         In accordance with the factors provided in TR 97/11

The factors contained in TR 97/11 have been taken into consideration above as outlined in our observations when making our decision on whether you are carrying on a business in relation to your rental properties for taxation purposes.

Conclusion

After reviewing the information and documentation provided with this ruling, taking all of the facts in TR 97/11 into consideration and on weighing the relevant business indicators and objective facts in relation to your situation, we have determined that you are not carrying on a business in relation to your rental property activities.

In accordance with the judicial comments above and guidelines set down in Taxation Rulings IT 2423 and TR 97/11, although there is some regularity to activities, your activities lack a significant commercial character, and are not of a size or scale necessary to be characterised as carrying on a business of renting properties.

Your activities are those of a passive investor looking after their investment and ensuring that you obtain a reasonable return. You don't provide additional services to your tenants outside of those required from property owners renting their properties and the rental amounts are merely received due to you owning the Properties.

We acknowledge that there are some elements of your activities that add weight that the activity has a business-like nature such as investment of capital and the length of time the activities have been undertaken. However, they by themselves are not decisive with most of your activities being like those required of a passive investor in rental properties.

You have sought to receive passive rental income from the Properties, with the expectation that you will benefit from the capital growth in the Properties in 202X after holding them for significant periods of time. This is not dissimilar to property investors who invest in property to receive a stream of rental income and the benefit from capital growth after a significant period to assist with the funding their retirement.

The number of properties used in relation to the rental activities is small compared to some of the cases 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, merely the market rental rate determined by the rental market environment.

Therefore, based on the information provided it has been determined that you are not carrying on a business in relation to your rental property activities during the ruling period for taxation purposes.

Note: As you are not considered to be carrying on a business in relation to your rental properties, the Properties will not be viewed as 'real business property'.