Edited version of private advice

Authorisation Number: 1052218134602

Date of advice: 05 February 2024

Ruling

Subject: Income tax carrying on a business

Question

Is the Partnership carrying on a business of letting rental properties?

Answer

Yes

This ruling applies for the following periods:

Income year ending 30 June 2024

Income year ending 30 June 2025

Income year ending 30 June 2026

Relevant facts and circumstances

1.    The Partnership undertakes multiple activities, namely the acquisition of real estate for development and sale, the acquisition of residential real estate for use in providing short-term and long-term accommodation in consideration for rent, and primary production activities.

2.    The Partnership has rented residential real estate continuously for over 15 years, catering to a diverse class of renters including families, students and high-income earners. As at MM 20XX, the partners owned over 70 residential properties for rent valued at approximately $40 million.

3.    The Partnership seeks to maximise the profitability of its rental activities, consistent with its business plan, by only seeking out for acquisition residential properties that at least return a specified rate of return and disposing of those properties which fail that target, for example, because of increasing maintenance costs as they get older.

4.    Each partner performs management duties in relation to their portfolio of real estate for rent. This includes the management of repairs and maintenance to the properties, taking calls directly from tenants, liaising with real estate agents as required, managing the financial aspects of the activities and negotiating with insurers and banks. In all, it is anticipated that each partner spends approximately 30 hours per week managing the Partnership's rental activities.

5.    The Partnership also employs staff to perform administrative tasks and other property management duties in relation to its rental activities,and utilises the services of real estate agents to undertake specified tasks including the collection of rent, advertisement of the properties to prospective tenants and lodgment of relevant tenancy documents with the relevant statutory body.

6.    The partners are the trustees and sole members of a self managed superannuation fund (the SMSF).

7.    The partners intend to make an in specie contribution of some of their properties to the SMSF at market value.

8.    The properties to be contributed to the SMSF have only ever been used by the Partnership wholly and exclusively for the purposes of being leased to tenants for rent, and the partners hold a freehold interest in each of those properties.

Relevant legislative provisions

Superannuation Industry (Supervision) Act 1993 subsection 66(5)

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

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

In determining whether a particular activity constitutes a business involves questions of fact and degree, and consideration of a multitude of factors.2 The courts have developed a series of indicators, as enshrined in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production, in aid of determining whether an entity is carrying on a business.

Paragraph 13 of TR 97/11 states that the courts have held that the following indicators are relevant:

•         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 repetition and regularity of the activity;

•         whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business;

•         whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at 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 a sporting activity.

Notably, paragraph 15 of TR 97/11 emphasises that no single indicator is decisive3, such that the indicators must be considered in combination and as a whole.

In Martin v FCT4, the court held that:

The test is both subjective and objective: it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and the determination is eventually based on the large or general impression gained.

Application to the Partnership's circumstances

Whether the activity has a significant commercial purpose or character

The significant commercial purpose or character of a business activity can be established through the interaction of the other indicators, in particular the size and scale of the activity and the requisite intention to make a profit (discussed in turn further below).5

The Partnership has provided a copy of its business plan describing the nature of the business as the provision of short-term and long-term rental properties to a diverse market segment using targeted promotion and pricing strategies.

The Partnership's policies allow for the acquisition of additional properties that meet the prescribed rental yields and the disposal of existing properties that drop below that threshold.

Relevantly, the Commissioner's view in Taxation Ruling 2019/1 Income tax: when does a company carry on a business endorses the rebuttable presumption (cited in American Leaf6)in which activities that are carried on by a company have a prima facie commercial character, unlike those of an individual or a trust that are likely undertaken for personal or domestic purposes. Although TR 2019/1 is intended for companies, the principles are largely applicable to a partnership on the basis that partnerships are generally formed with a view to profit.

Whether the Partnership has more than just an intention to engage in business

Each partner spends approximately 30 hours per week to undertake the management of their residential real estate portfolio.

It is noted that the Partnership utilises the services of real estate agents, albeit limited and ancillary only to the partners' primary duties. In Re YPFD v FCT7, the Tribunal considered that certain reliance on estate agents to manage real property does not preclude the taxpayer from being characterised as carrying on a business of letting rental properties, including engaging an experienced manager to handle the day to day management of the business activities.8

Whether the Partnership has a purpose and prospect of profit

The Partnership demonstrates a bona fide intention (and prospect) of profit through a pattern of continuous acquisition of additional rental properties with high prospective rental yields based on its research and extensive knowledge of the location.

New properties are intended to replace older properties so as to reduce any associated maintenance costs.

Rent adjustment clauses are incorporated in the Partnership's leasing agreements to further maximise profits.

Whether there is repetition and regularity of the activity

The Partnership has been letting residential properties for over 15 years. Its rental activities require constant management and also involve using equity on existing properties to purchase additional investment real properties and/or to pay off secured loans.

Properties are regularly being assessed and those that no longer meet the Partnership's prescribed rental yield targets are being sold.

Whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business

Whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit

The Partnership adheres to its business plan, consisting of its management and financial strategies. It has also developed a comprehensive promotion strategy so as to expand its market reach and presence in different residential areas.

The properties are offered in a variety of configurations to suit the needs of individual tenants. They are fully furnished and fitted with modern household technology.

Leasing agents are responsible for the advertisement of the property for occupancy, preparation of leasing agreements and lodgment of the rental bonds with the relevant statutory body.

Financial records of the Partnership's rental activities are prepared by an accountant and reported in the Partnership's financial statements.

The size, scale and permanency of the activity

The Partnership has a capital investment of a sizeable amount, consisting of more than 70 residential rental properties.

Properties currently valued at approximately $40 million.

Of relevance, paragraph 5 of Taxation Ruling IT 2423 Withholding tax: whether rental income constitutes proceeds of business - permanent establishment - deduction of interest states that an individual who derives income from the rent of one or 2 residential properties would not normally be viewed as carrying on a business, however rent which was derived from several properties or from a block of apartments would support a conclusion that a business exists.

Whether the activity is better described as a hobby, a form of recreation or a sporting activity

The Partnership's activities of letting rental properties would not be better described as a hobby, recreation or sporting activity due to its ostensible commercial character or purpose.

Conclusion

Having regard to the relevant factors set out in TR 97/11, the Commissioner is satisfied that the Partnership are carrying on a business of letting rental properties. Of particular relevance is the size and scale of the investment, the commercial nature and regularity of the activities and the purpose of profit.

href="#_ftnref1" name="_ftn1" title=">1 Subsection 66(5) of the SISAprovides a practically similar definition of the term 'business'.

href="#_ftnref2" name="_ftn2" title=">2 Evans v FC of T (1989) 20 ATR 922 (citing Ericksen v Last (1881) 8 QBD 414, TR 97/11 at paragraph 16).

href="#_ftnref3" name="_ftn3" title=">3 See also FCT v Radnor Pty Ltd (1991) 102 ALR 187 at para [42].

href="#_ftnref4" name="_ftn4" title=">4 (1953) 90 CLR 470.

href="#_ftnref5" name="_ftn5" title=">5 Hope v Bathurst City Council (1980) 144 CLR 1.

href="#_ftnref6" name="_ftn6" title=">6 American Leaf Blending Co Sdn Bhd v Director General of Inland Revenue [1978] 3 WLR 985.

href="#_ftnref7" name="_ftn7" title=">7 (2014) 94 ATR 484; [2014] AATA 9.

href="#_ftnref8" name="_ftn8" title=">8 Ferguson v FC of T 79 ATC 4261; (1979) 37 FLR 310; FCT v JR Walker 85 ATC 4179; (1985) 16 ATR 331; (1985) 79 FKR 161.