Edited version of private advice

Authorisation Number: 1051850259281

Date of advice: 15 June 2021

Ruling

Subject: Small business entity

Question 1

Is the Trust a small business entity as per section 328-110 of the Income Tax Assessment Act 1997 (ITAA 1997?

Answer

No

Question 2

Are you eligible to claim the cost of an air conditioner installed in your rental property as an income tax deduction under the instant asset write-off rules in Subdivision 328-D of the Income Tax Assessment Act 1997 (ITAA 1997) or temporary full expensing rules under Subdivision 40-BB of the ITAA 1997?

Answer

No

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The trust, was established to acquire a property at xxxxxxxx for the purpose of adding to the family's growing portfolio of commercial rental properties. At the time of purchase, the property was leased to a major supermarket chain and continues to be leased by this tenant.

Recently it became aware the air conditioning system needed replacing. Per the lease agreement the landlord is responsible for the cost of replacing the air-conditioning system. The new air-conditioning system was installed in XXXX 20XX at a cost of $xxx,xxx.

The Trust is part of a larger family group who own and lease to third parties, a number of large commercial rental properties (estimated value of all property to be between $xx -$xx million).

Each property is owned by a different entity (typically a discretionary trust) for asset protection purposes and to assist with operational flexibility.

The family manage the operation of these properties from an office located within one of their properties. The family is responsible for the management of all properties, their tasks include but are not limited to;

•         performing ad hoc maintenance and cleaning,

•         correspondence with tenants,

•         facilitating contractors to complete repairs and maintenance,

•         collection of rent,

•         negotiating and coordinating the drafting of new lease arrangements,

•         advertising and promotion of properties for example Christmas and school holiday promotions.

The Trust has an aggregated turnover of less than $XX million.

You've made the following comments in relation to the activities conducted by family group

a.    The intention of the family is to expand its portfolio by acquiring additional properties.

b.    The group has generated profits between $XX million and $Xmillion for a number of years

c.     Profits and operations have been consistent since inception

d.    The family has been involved in the manage of commercial rental properties since the 1XX0's.

Relevant legislative provisions

Section 6-1 of the Income Tax Assessment Act 1997

Section 8-1 of the Income Tax Assessment Act 1997

Section 995-1 of the Income Tax Assessment Act 1997

Subdivision 40-BB of the Income Tax Assessment Act 1997

Subdivision 328-C of the Income Tax Assessment Act 1997

Subdivision 328-D of the Income Tax Assessment Act 1997

Reasons for decision

Small business entity

Section 328-110 provides that you are a small business entity for the income year if;

(a)        you carry on a *business in the current year; and

(b)  one or both of the following applies:

(i)      you carried on a business in the income year (the previous year ) before the current year and your *aggregated turnover for the previous year was less than $XX million;

(ii)     your aggregated turnover for the current year is likely to be less than $XX million.

Business is defined in section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) to be 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'.

The Commissioner's view on whether the letting of property amounts to the carrying on of a business is found in a number of places.

The Tax Office publication Rental properties 2020 states on page 5:

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 the other co-owners....

Most rental activities are a form of investment and do not amount to carrying on a business.

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 Withholding tax: whether rental income constitutes proceeds of business-permanent establishment-deduction for interest (IT 2423).

Taxation Ruling TR 93/32 Income tax: rental property - division of net income or loss between co-owners quotes the legal case of Federal Commissioner of Taxation v McDonald (1987) 18 ATR 957; 87 ATC 4541, where Beaumont J said at ATR p 968; ATC p 4550:

The reference to "business"... indicates a "commercial enterprise as a going concern": see Hope v Bathurst City Council (1980) 144 CLR 1 at 8; 12 ATR 231 at 236 per Mason J. Purely domestic transactions are thus excluded from the definition: see Fletcher, op cit p 28. The "business" must be "carried on". This suggests some active occupation or profession: see IRC v The Marine Steam Turbine Co Ltd (1919) 12 TC 174 per Rowlatt J at 179.'... 'On the other hand, in the case of a private individual as distinct from a company, "it may well be that the mere receipt of rents from properties that he owns raises no presumption that he is carrying on a business." see American Leaf Blending Co Sdn Bhd v Director-General of Inland Revenue (1979) AC 676 per Lord Diplock at 684.

The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the particular facts.

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).

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 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 Income tax: am I carrying on a business of primary production? (TR 97/11) outlines some factors that indicate whether or not a business of primary production is being carried on. These factors equally apply to other types of businesses. No individual factor is determinative but should be weighed up in conjunction with the other factors.

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, and no one indicator will be decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922).

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.

Applying the relevant indicators to your circumstances

After weighing up the relative business indicators and objective facts surrounding your case it is considered that you are not carrying on a business of letting rental properties.

Your case can be distinguished from Cripp's case as in that case the scale, being 16 townhouses, was far greater than your one property. Despite the fact that XX townhouses were rented the Tribunal found that the taxpayers were mere passive investors and not in the business of deriving income from rental properties.

Similarly, in Case 26, despite the scale of operations of XX units, the Tribunal found a business was not being carried on by the owners of the block of flats. Again, the quantity of rental units is far in excess of your one property. The level of repetition and regularity and the scale of your activities related to your rental property is not as great as that noted in Case G10 where the taxpayers rented out short term holiday units and not as great as 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.

The trust on its own, owns one property which is currently leased to a major supermarket chain. The management of this one property is not considered to be in the business of managing rental property. There is nothing about the manner in which you conduct your rental activities that transform those activities from an investment into a business. The fact that the family control a number of trusts which each own a rental property does not change the fact that the XXXXX Property trust is not carrying on a business.

Depreciation and capital expenses

You generally can't deduct spending on capital assets immediately. Instead you claim the cost over time, reflecting the assert's depreciation (or decline in value).

This applies if you use the depreciating asset to earn assessable income including:

•         small and large businesses

•         rental property investors

•         employees (for equipment and tools they provide at their own expense for use in their work).

Section 328.175(1) ITAA 1997 provides as follows:

(1)  You can choose to calculate your deductions and some amounts of assessable income under this Subdivision instead of under Division 40 for an income year for all the * depreciating assets that you * hold if:

(a)    you are a * small business entity for the income year; and

(b)    you started to use the assets or have them * installed ready for use, for a * taxable purpose during or before that income year.

Section 328-175(6) ITAA 1997 provides that You cannot deduct amounts for a depreciating asset under this Subdivision if the asset is being or might reasonably be expected to be let predominantly on a depreciating asset lease.

Instant asset write-off

Eligible business can claim an immediate deduction for the business portion of the cost of an asset in the year the asset is first used or installed ready for use, assets first used or installed ready for use between 12 March 2020 until 30 June 2021, and purchased by 31 December 2020.

Eligibility criteria limits the deduction to eligible small businesses. However, as you are not a business you are ineligible to claim the installation of the air conditioning system under this provision.

Temporary full expensing

Businesses can access temporary full expensing if their aggregated turnover is less than $5 billion. The eligible new assets must be first held, and first used or installed ready for use for a taxable purpose, between 7.30pm AEDT on 6 October 2020 and 30 June 2022. However, as you are not in business this method of claiming the cost of the air conditioning system is not available to you.

As the trust is not considered to be carrying on a business it is not eligible for the small business concessions including the instant asset write off under Subdivision 328-D of the ITAA 1997. Similarly, as the trust is not carrying on a business it is not eligible to claim the cost of the air conditioning unit under the temporary full expensing rules under Subdivision 40-BB of the ITAA 1997.