Private ruling: Income Tax – Small Business Entity
Date of advice: 14 December 2018
Published: April 2019
Ruling period: Year ended 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Is the trust a small business entity? | A1: No.

Relevant facts and circumstances: The trust owns a commercial property (the property). The property was purchased in 20XX and can accommodation up to X tenants. The directors of the corporate trustee of the trust manage the property. The trust does not have a business plan. The trust produced a profit in the 20XX-20XX financial year. The trust has produced both profits and losses in previous financial years. The lease terms for the property cover a X year period and have rent increases of 5% per year. When the properties are full tenanted Individual A, a director of the trustee company of the trust, spends on average X hours per week at the property. This is the only activity the trust undertakes is the rental of the property to third parties. The aggregated turnover of the trust is above $10 million. To find tenants for the property the directors would place an advertisement in the newspaper. The trust issues a monthly rental tax invoice to the tenants. The trust engages a consultant to keep financial records up to date and to lodge Business Activity Statements.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 328-110

Reasons for decision: Detailed Reasoning - Small Business Entity: To work out if you are eligible for small business entity concessions, you first need to work out if you are a 'small business entity' in an income year. You must review your eligibility each year to check if you are able or required to use a particular concession. From 1 July 2016, you are a small business entity if you are a sole trader, partnership, company or trust that: ● operates a business for all or part of the income year, and ● has an aggregated turnover less than $10 million (the turnover threshold). You have advised that your aggregated turnover is above $10 million and therefore you will not be eligible for the concessions. In the next section we will consider whether the trust carries on a business. | Summary: It is considered that the scale of activity and volume of operations carried on by the trust is insufficient to be considered as carrying on a business. | Detailed Reasoning - Carrying on a business: Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'. 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). 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). 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 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. A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations. 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 Taxation Ruling IT 2423). 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, 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. 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. Taxation Ruling TR 97/11 incorporates the general factors. 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: ● 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. Page 6 of the Rental properties 2018 (NAT 1729-6.2018) publication provides the following example of taxpayers considered to be carrying on a rental property business: ... 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 each – 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 collections. 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’Souzas spend on the activities ● the D’Souzas’ 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 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 the activities. Taxation Ruling No. IT 2423 which is about whether rental income constitutes proceeds of a business, states a conclusion that an individual is carrying on a business of letting property largely depends on the scale of operations. To be a business activity, there must be active participation by the parties to the activity. Renting out of premises without the provision of other services would be mere investment in property. | Detailed Reasoning - Applying the relevant cases and indicators to your circumstances: The trust derives rental income from 1 property that has the capacity to hold X tenants which are leased on a long term basis as opposed to the operation carried on by the taxpayer in Case G10 . In terms of business organisation, the trust does not have a business plan and there is no intention of expanding the activities. We acknowledge that there are some elements of the activity that add weight that the activity has a business like nature such as investment of capital and the length of time the activity has been undertaken. However, the majority of the activities are considered to be in line with those required of a passive investor in rental properties. The overall impression is that the trust is not carrying on a business of renting properties as the income is derived predominantly from the letting of the property and not from activities 'carried on' in relation to renting the properties out. Whilst the directors perform most of the activities required for the managing and maintenance of the property, the scale of the activities and volume of operations is too small to be considered as carrying on a business.