Edited version of private advice

Authorisation Number: 1051959828697

Date of advice: 23 March 2022

Ruling

Subject: Business - rental properties

Question

Does the Commissioner consider that the trustee for XXXX XXXX Trust is in the business of renting commercial properties?

Answer

No.

This ruling applies for the following periods:

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Income year ending 30 June 20XX

The scheme commences on:

DDMM20XX

Relevant facts and circumstances

You are a Trust.

You purchased X commercial rental properties on the DDMM 19XX (Units X-X).

Y properties have since been sold.

You engage the services of a real estate agent to advertise the properties online and negotiate lease agreements on your behalf.

Properties are leased for X plus X-year term, most tenants have been long term between X to X years.

Rent is paid directly into trust bank accounts.

Repairs and maintenance are carried out by the trustees approximately every X or X months in replacing items and other wear and tear items, these are completed on a needs basis.

The trustees also conduct property inspections when tenants vacate.

The trustees spend approximately ZZ hours per week in daily financial and office administration required in the rental of the properties. Tasks included online banking, reconciling all incoming invoices and statements, paying all accounts and expenses, maintaining income and expenditure cashbooks, preparing tenant statements and scanning and emailing them, attending to tenant's inquiries, ensuring sufficient cover for building insurance, filing workers compensation submissions, liaising with insurance broker, real estate agent, lawyer and accountant and preparing end of financial year papers. You have always returned the income and expenses from the activity as rental income/expenses on your tax returns, not as business income/expenses.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

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 commercial properties. Your activities are better described as a passive investor leasing a commercial property 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 this property. Consequently you are not considered to be a small business entity for taxation purposes.

Detailed reasoning.

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

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

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. If a company's objects are business objects and are, in fact, carried out it carries on business, (IRC v. Westleigh Estates [1924] 1 KB 390 at pp 408, 409 per Sir Ernest Pollock, M.R.). In American Leaf Blending Co. Sdn Bhd v. Director-General of Inland Revenue (Malaysia) [1978] 3 All E.R. 1185 at p 1189 Lord Diplock concluded that it would be difficult to displace the prima facie inference that the gainful use of a company's property in letting it out for rent would constitute the carrying on of a business.

More recently in the Federal Court, Pincus J, in Lilydale Pastoral Co. Pty. Ltd. v. FCT 87 ATC 4235; 18 ATR 508, held, in the context of the withholding tax provisions, that the purchase of property to rent out, whether or not after renovating it, and the proprietorship of that property, constitute an undertaking of a business or commercial kind.

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.

Paragraph 8 of Taxation Ruling TR 2003/4 Income tax: boat hire arrangements (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.

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 2021 (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'Souzas 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'Souzas 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'Souzas 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.

Furthermore, Tax Determination TD 2006/78 example 1 (TD 2006/78) also gives an example much like your circumstances.

Example 1: rental properties

Commercial Property Co owns 5 commercial rental properties. The properties have been leased for several years under formal lease agreements to various commercial tenants which have used them for office and warehouse purposes. The terms of the leases have ranged from 1 year to 3 years with a 3 year option and provide for exclusive possession. The company has not engaged a real estate agent to act on its behalf and manages the leasing of the properties itself.

In this situation, the company has derived rental income from the leasing of a number of properties. Accordingly, the main (only) use of the properties is to derive rent and they are therefore excluded from being active assets under paragraph 152-40(4)(e) of the ITAA 1997 regardless of whether the activities constitute the carrying on of a business.

Applying the relevant cases and indicators to your circumstances

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 commercial properties.

Both business and investment will have a profit-making intention.

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.

Conclusion

After weighing up the relative business indicators and objective facts surrounding this case and based on the information and documentation provided, it is the Commissioner's view that your rental property activities are better described as leasing/renting a commercial property to receive income from a stream of rental income. The income is not derived from the services you provide, but from the letting/renting of the property. Your situation is very similar to Example 1 in TD 2006/78 except in that example a real estate agent is not used whereas you do use an agent to find new tenants.

Consequently, you are not considered to be carrying on a business and therefore do not meet the definition of a small business entity.

Further in discussions with your accountant it has been explained that a favourable ruling may allow you access to the small business capital gains tax concessions. As mentioned previously to your Tax agent, you would not be able to pass step two of the small business capital gains tax conditions as the commercial properties in question would have to be considered active assets. This is not the case as explained above and as shown in example one of TD 2006/78.