Edited version of private advice

Authorisation Number: 1051914777459

Date of advice: 11 November 2021

Ruling

Subject: Small business entity

Question

Is entity A a small business entity?

Answer

No.

This ruling applies for the following period

Year ended 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts

Entity A has property and an investment portfolio.

The trustees of entity A are entity B and entity C.

Entity A is required to be registered for GST.

The trustees are employees and are provided with motor vehicles subject to FBT.

Income details for entity A for the xxxx income year have been provided.

Entity A purchased a property on xxxx.

Entity A looks after the property themselves and it is not managed through a real estate agent. Entity A organises the leases, bills and works for the property.

There is a long-term tenant in the property.

Time spent by entity A on inspections, bookwork, repair, research, banking and finance activities is x hours per week on average across the year.

Entity A invoices periodic rents and attends to outgoings such as maintenance, rates, waste and water. Entity A responds to and organises necessary maintenance requests from the tenant. Entity A performs routine inspections and issues inspection reports to the tenant. Entity A also organises safety and regulatory compliance checks.

The property was rented for the whole xxxx income year and has a lease until xxxx.

The weekly rent received for the property is $xxxx per week.

The property is positively geared. The property makes a profit each income year.

No business plan was provided.

Another property was with a real estate agent. Entity A is not involved in managing this property at all.

Entity A also manages the investments and lending practices.

Entity C manages the property and spends approximately x hours a week on the property activities. Entity C does tax preparation with the Accountant. Entity C's time on entity A activities is xx% for the commercial property.

Entity B spends x hours per week on average across the year for other activities on investments as outlined including the sale of a property.

Entity B's time on activities for entity A is xx% on the property and xx% on other assets and investments of entity A.

The only related entity of entity A is entity D which owned a jointly held property which was sold in xxxx.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 328-110

Income Tax Assessment Act 1997 Section 995-1

Detailed reasoning

Small business entity

Under subsection 328-110(1) of the Income Tax Assessment Act 1997 (ITAA 1997), an entity is a small business entity if:

(a) it carries on a business in the current year, and

(b) one or both of the following applies:

(i) it carried on a business in the income year (the previous year) before the current year and its aggregated turnover for the previous year was less than $10 million, and

(ii) its aggregated turnover for the current year is likely to be less than $10 million.

Please note that the $10 million threshold is different for capital gains tax small business concession purposes and for certain other concessions.

Therefore to determine if entity A is a small business entity, we first need to determine if entity A is carrying on a business.

Carrying on a business

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

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? 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. The question of whether a business is being carried on is a question of fact and degree.

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).

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 2021 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 business of letting rental properties, either alone or with the 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.

Income tax ruling IT 2423 Withholding tax: whether rental income constitutes proceeds of business - permanent establishment - deduction for interest states:

A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations. An individual who derives income from the rent of one or two residential properties would not normally be thought of as carrying on a business. On the other hand if rent was derived from a number of properties or from a block of apartments, that may indicate the existence of a business.

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).

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 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.

Applying the relevant 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.

Entity A's main activity is the owning a property as well as some investments. Entity A receives income from the property and the investments which is a managed investment fund.

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.

Entity A currently manages the property. No details of a business plan have been provided.

Prospect of profits

The taxpayer's involvement in a 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.

Entity A makes a profit from the property and receives income from their other investments.

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.

Entity A manages the property as well as spending time on other investments. Approximately x hours per week is spent on the property activities and approximately another x hours on the other investments and loans. As entity A has one long term tenant, the involvement with the property is not considered to be significant and it cannot be concluded that the level of repetition and regularity of activity is a business.

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).

Generally, where the property owners and tenant have a landlord/tenant relationship, 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 and paying expenses do not indicate the existence of a business.

Entity A's activity is receiving rental income from the property. Entity A also receives income from investments.

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.

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.

Example 4 on page 5 of the Australian Taxation Office's Rental properties 2021 booklet involves taxpayers, who own 26 properties, spend approximately 25 hours per week each on managing the properties.

Although entity A does the maintenance and management of the property, the size and scale of the activities are not considered to be significant. Entity A does not spend a significant amount of time each week on the activities.

Hobby or recreation

The level of active involvement in relation to the property is significantly less than those noted in Case G10. In comparison to the taxpayer in Case G10 their activity involved a significant amount of their time devoted to the holiday letting activity. In this case, entity A spends little time on the property and investment activities. Approximately xx hours per week is not considered to be a significant amount of time for a business activity.

Conclusion

The making of a profit is not, on its own, sufficient to establish that a business is being carried on. Where a business exists, there is usually a business plan of how the activities will be conducted.

As shown in the legal 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 activities. The quantum of rental income derived does not affect the characterisation of the activity.

We acknowledge entity A owns and manages a property that is not regarded as a residential property. However, this is not considered to be of a scale to take the activity beyond a passive income producing activity. The mere collection of funds to be used to pay for the associated expenses of the property does not indicate the existence of a business. After considering the specific circumstances and weighing up the relative business indicators, it is considered that entity A is not carrying on a business for taxation purposes. The activities are not conducted on a sufficient scale to be considered to be a business. As entity A is not carrying on a business, it is not a small business entity for tax purposes.