Private ruling: Tax Break
Published: September 2011
Ruling period: 1 July 2009 to 30 June 2011
Date scheme commenced: 1 July 2009

Ruling: Q1: Is the Family Trust considered to be carrying on a business of letting out commercial property for the purposes of claiming the Tax break under Division 41 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes

Relevant facts and circumstances: The Family Trust (the Trust) was established for the purpose of acquiring, developing and managing industrial and commercial properties. The aim of the trust was to acquire and/or develop positively geared properties which were essentially self-funded. The trustee of the Trust is XX Pty Ltd. The directors and shareholders of XX Pty Ltd are Mr & Mrs Y. Mr Y was previously a licensed real estate agent and prior to that was involved with the acquisition and management of industrial properties in his employment. The Trust has X properties, each property with X tenancies; Property A was acquired for $xxx,000. The property had a gross rental return of 1X% and was funded by borrowings at X%. An additional $xxx,000 was spent on various improvements in the 2009-10 income year. · Property B was acquired after Property A and was later developed into three tenancies at a cost of $X,XXX,000 · The funding of the Trust's original acquisition was obtained by providing as collateral several properties owned by Mr and Mrs Y. The trust is currently financed by bank bills to the amount of $x. million. Business plan You do not have a formal business plan. You examine potential acquisitions to enable the expansion and growth of the trust, in accordance with the aims of the trust. Real estate agents regularly refer proposals to you for consideration. Some of these proposals are quickly dismissed. Some are examined in detail and include the preparation of feasibility studies, inspections, meetings with builders and council. You recently spent three months examining a property and determining the feasibility of the purchase and development proposals. Although you bid on the property, it was eventually sold for an amount you did not consider would have been a financially sound proposition for the trust aims. Funding is currently in the form of Bank Bills which are subject to varying daily market rates. The trust also operates two bank accounts for the receipt of rentals and the payment of outgoings. These are monitored daily for the best rates for draw-downs, and the early identification of non payments by tenants. The rent roll is maintained by the trustees. Marketing strategy/advertising Properties are marketed jointly by the trustees and a real estate agent. Property signage, web site listing and local and national newspaper advertising are undertaken jointly. The trustees exclusively arrange television advertising, cold canvassing of selected target businesses, and letterbox drops of flyers. The agent usually conducts the initial inspection and refers prospective tenants to the trust for evaluation of financial capacity and business suitability. Lease arrangements Commercial properties are leased for terms of 1, 3, 4 or 5 year terms with option periods. You undertake all lease and fit-out negotiations in consultation with the trust solicitor, builders, council and other relevant authorities. You organise garden and grounds maintenance, air conditioning contracts, fire and safety inspections, general repairs and maintenance and waste disposal. Some costs are on-charged to the tenants. Ongoing activities You handle all aspects of the property management as well as the selection and assessment of sites/properties, assessment of new tenants, and the negotiation of leases. You are responsible for payment of outgoings, collection of rent and invoicing. You also maintain the accounts including the preparation of BAS statements The buildings periodically require major maintenance eg new guttering, repainting, driveway and parking resurfacing. In addition, refurbishment and new fit out have been necessary to attract new tenants. You have spent X months trying to increase parking spaces at Property A and repairs on this property in the 2009-10 year amounted to $xxx,000. Activities undertaken include planning, obtaining quotes, council approvals, and the undertaking of the works. You also spend time on day to day issues arising from tenant requests, minor repairs and maintenance. The time spent on activities relating to the leasing of your commercial properties varies week by week, and year by year. Some weeks you may spend between X-XX hours checking the banking, reading and responding to emails, and accounting issues. During other periods, such as when developing a project, you may spend 60 hours per week on activities related to the properties. Generally, Mr Y works in the home office between the hours of Xam and Xpm managing the properties owned by the trust, as well as those owned by Mr and Mrs Y either individually or jointly. The time spent on the properties individually cannot be determined as no time sheets as such are kept. Other properties owned include Z industrial/commercial properties. Mrs Y is the strata secretary for Property A and will have the same role for Property B. Responsibilities include; repairs and maintenance, banking, collecting strata fees, organising meetings, information dissemination, insurance, and fire safety inspections. You project managed the development of Property B. This involved X years of planning and design. X months was spent in failed negotiations with a prospective tenant. Activities undertaken during this period included negotiations with builders, solicitors, council, engineers, surveyors and road management consultants. You also spent considerable time examining large volumes of complex documentation and plans and addressing a substantial amount of correspondence. During the construction phase activities undertaken included inspection and supervision of building design and construction. You estimate time spent on these activities to during this period to be 60 hours per week. You have provided documentation including building and lease schedules, a tenant invoice, occupancy rate and history schedules, and a feasibility study and plans for the proposed development at xyz Rd. You purchased three air conditioning units for the new development at Property B. You purchased a further unit for Property A. The units were installed and paid for in 200X. You are requesting a ruling as to whether you are carrying on a business of commercial property rental in order for you to access the tax break provisions.

Relevant legislative provisions: Income Tax Assessment Act 1997 section section 6-5 | Income Tax Assessment Act 1997 section section 8-1 | Income Tax Assessment Act 1997 Division 41 | Income Tax Assessment Act 1997 section section 40-25 | Income Tax Assessment Act 1997 section section 41-5 | Income Tax Assessment Act 1997 section section 41-10 | Income Tax Assessment Act 1997 section 152-40(4)(e) | Income Tax Assessment Act 1997 section 995-1

Reasons for decision: Summary: The Commissioner considers you are carrying on a rental property business for the purposes of the Tax break provisions. | Detailed Reasoning - Small business and general business tax break: The small business and general business tax break is available under Division 41 of the ITAA 1997 for businesses that undertake new investment in tangible, depreciating assets such as plant and equipment, for which it can claim a deduction under Subdivision 40-B of the ITAA 1997. A deduction is available for the decline in value of a depreciating asset that is held or installed ready for use by the business under Subdivision 40-B of the ITAA 1997. The tax break does not apply to capital works for which a deduction is allowable under Division 43 of the ITAA 1997. Division 43 of the ITAA 1997 provides a deduction for certain construction expenditure incurred in respect of the construction of capital works which includes alterations or improvements to buildings or structural improvements. In order to claim a tax break deduction under Division 41 of the ITAA 1997, it must be determined whether your activities amount to the carrying on of a business. | Detailed Reasoning - Carrying on a Business: Section 995-1 of the ITAA 1997 defines a business as including 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 2011 (NAT 1729-6.2011) provides the following example of 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 apartment block comprising six residential units) making 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. In the Federal Court case of Federal Commissioner of Taxation v McDonald (1987) 18 ATR 957; 87 ATC 4541(McDonalds case), a factor identified was the minimal active participation from the property owners. 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 a mere investment in property. Taxation Ruling IT 2423 is about whether rental income constitutes proceeds of business (for withholding tax purposes). IT 2423 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. 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. Taxation Ruling TR 97/11 considers whether a taxpayer is carrying on a primary production business. It states that in deciding whether a business is being carried on, regard should be had to the following indicators: 1. whether the activity has a significant commercial purpose or character 2. whether the taxpayer has more than just an intention to engage in business or to commence in the future 3. whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity 4. whether there is repetition and regularity of the activity 5. whether the activity is of the same kind and carried on in similar manner to that of the ordinary trade in that line of business 6. whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit 7. the size, scale and permanency of the activity, and 8. whether the activity is better described as a hobby or form of recreation. Every case must be decided on its own particular facts. In essence, whether a business is being carried on will depend upon whether the indicators, as a whole, provide the activities with a commercial flavour: Ferguson v. Federal Commissioner of Taxation (1979) 37 FLR 310; 79 ATC 4261; (1979) 9 ATR 873 ( Ferguson's case ). The application of TR 97/11 to your circumstances is considered below. | Detailed Reasoning - (1) whether the activity has a significant commercial purpose or character;: 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. The Trust was set up for the purpose of acquiring, developing and managing industrial and commercial properties. There is a corporate trustee, the directors of which are Mr & Mrs Y. The Y's own other commercial properties individually as well as in partnership. The trust currently has X properties each with X tenancies and is actively seeking further development opportunities. The aim of the trust is to own positively geared properties which also provide long term growth. Significant research is conducted into the profitability of property prior to acquisition, including the development of feasibility studies and concept plans. The Y's are experienced property managers and also manage another X commercial/industrial properties which they own. Mr Y has previously been employed in a high level position in roles responsible for commercial property acquisition and management and held a real estate licence. | Detailed Reasoning - (2) whether the taxpayer has more than just an intention to engage in business;: 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. Prior to the establishment of the Family Trust, Mr and Mrs Y were property investors who owned several commercial properties. The Trust was established in post September 19XX. The initial property purchased, Property A was first available for rent within two months. There have been significant outlays on improvements to that property, and a further property has been acquired, developed, and tenanted. The trust is actively seeking further development opportunities. There is clearly more that just an intention to engage in business. | Detailed Reasoning - (3) whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity;: The intention to make 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. Where numerous rental properties are negatively geared, depending on the circumstances of the case, that activity may be disqualified from being the carrying on of a business because its nature will be one of investment activity where profit is produced from long term capital gains rather than from regular or immediate revenue. Your activity is directed towards acquiring properties that provide long term growth as well as return. You are engaged in all aspects of the acquisition, development, management, and administration of the properties. You have committed significant financial resources to the acquisition and improvement of the properties. The Trust has consistently reported a profit from its activity. The annual projected income is $XX0,000. There is both a purpose and prospect of profit and the Trust activities are conducted in a way that facilitates this. | Detailed Reasoning - (4) whether there is repetition and regularity of the activity;: 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. You undertake the daily management of the properties, invoicing, repair and maintenance co-ordination, record keeping, banking, planning, tenant communication. You engage the services of an agent to assist in identifying new prospective properties and in advertising for tenants. You evaluate the tenants and undertake all aspects of lease and fit-out negotiations. The Trust first purchased commercial premises post September 1985. Seven years later an additional property was purchased and this was then developed to provide three tenancies. You are actively seeking further properties in which to invest. The enterprise is carried on in a systematic and organised manner and is consistent with ordinary commercial principles in the carrying on of a business. | Detailed Reasoning - (5) 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;: 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). Activities constituting the mere maintenance of an asset and the mere collection of income, such as the rental of a property, do not generally indicate the existence of a business relationship. A passive investor generally engages the services of a real estate agent or property manager to manage varying aspects of the tenant/landlord relationship. Renting out of premises without the provision of other services would be a mere investment in property rather than a business. The carrying on of a business involves an active participation in the activity. You engage a real estate agent to assist in the marketing of the properties only. As stated previously, you perform most of the activities required for the managing and maintenance of your rental properties. The duties undertaken are more akin to a property manager than a passive landlord collecting rental income and conducting basic maintenance of the investment. This appears to be in line with activity in commercial property management. | Detailed Reasoning - (6) whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit;: 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 Trust was set up for the purpose of purchasing, developing, and managing commercial properties which would provide a positive rental return. The trustees prior experience in the management of commercial properties and experience and qualifications in the real estate industry, as well as documentation provided, support the view that the activity is planned, organised and carried on in a businesslike manner. | Detailed Reasoning - (7) the size, scale and permanency 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. The size and scale of the activity appears relatively small with two properties each with three tenancies. However, the funds outlaid on the developments and the income generated are significant and appear sufficient to allow a sustainable profit. Your intention to expand the property portfolio with further positively geared properties further indicates permanency of the activity. The returns from this investment show the size and scale of the activity is sufficient for a commercial enterprise. | Detailed Reasoning - (9) whether the activity is better described as a hobby or form of recreation.: In your case, the level of commitment shown to research and marketing activities and the business-like manner in which the activity is carried out indicate that the venture is significantly more than a hobby. | Detailed Reasoning - Conclusion: Based on the information you have provided, we have determined that you are carrying on a rental property business You have shown that the activities involve significant capital investment, are profit making, are organised in a business-like manner and are undertaken with repetition and regularity. You have experience and prior qualifications in the field of property management and do not employ an agent or other entity to manage the properties. You spend a significant number of hours on the management of the properties each week. In addition, you are a trust, with a corporate trustee. Prior to the establishment of the trust Mr & Mrs Y were renting out commercial properties held in their names, and these properties provided the collateral for the trust to acquire its first property. This business structure further strengthens the overall impression you are carrying on a business. When viewed in conjunction with the above mentioned factors the overall impression is that the activities extend beyond that of a mere investment deriving passive income, they will be considered to be in the nature of a rental property business for the purposes of the Tax break legislation. | Detailed Reasoning - Small and general business tax break: This ruling finds that you are carrying on a business. Your entitlement to specific deductions under the Small business tax break provision in Division 41 of the ITAA 1997 has not been considered.

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