Private ruling: Income tax - carrying on a business - annual turnover
Date of advice: 8 April 2021
Published: June 2021
Ruling period: Year ended 30 June 2020
Date scheme commenced: 1 July 2019

Ruling: Q1: Is the assessable income derived in the 2020 income year by you from the leasing of assets owned by you to arm's length parties included in your annual turnover for the 2020 income year for the purposes of section 328-120 of the ITAA 1997? | A1: No

Relevant facts and circumstances: 1. The Passive Leasing Entities comprise several entities which leased real property to arm's length parties: 2. The Passive Leasing Entities have appointed a Property Agent to be the contact point for tenants of the leased real property. The Property Agent's main roles are to negotiate and renew leases and take care of ad hoc repairs and maintenance for those properties where it is not the responsibility of the tenant. The real properties are predominantly comprised of stand-alone commercial or retail premises leased out to one or two tenants of varied business types. There is no day to day management of the real properties by the Passive Leasing Entities for directors, controllers or employees of the Passive Leasing Entities or the Property Agent. 3. In addition to the real property set out above, the taxpayer owns a licence for a separate activity that it leases to arm's length parties for consideration. There is no active management of this asset by the owner or any of its associates beyond entering into and renewing the lease as and when necessary.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 328-120 | Income Tax Assessment Act 1997 subsection 6-5

Reasons for decision: Summary: Section 328-120(1) provides: An entity's annual turnover for an income year is the total ordinary income that the entity derives in the income year in the ordinary course of carrying on a business . Ordinary income has the meaning given by section 6-5 and includes income under ordinary concepts. Section 995-1 of the ITAA 1997 defines 'business' as including 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'. The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators to determine the matter, these indicators are summarised in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production. These indicators are applicable to business activity generally. 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 and • the size, scale and permanency of the activity There have been many court cases regarding whether the activities relating to holding property and deriving rental income amount to the carrying on of a business. In Federal Commissioner of Taxation v. McDonald (1987) 15 FCR 172; 87 ATC 4541; (1987) 18 ATR 957 (McDonald's Case) it was found that the taxpayer and his wife, who owned two investment properties, were not carrying on a business; their relationship was that of co-ownership rather than partnership. There was a mere investment in property rather than a partnership in the properties or their profits. The principle from McDonald's Case was followed in Cripps v. FC of T 99 ATC 2428; (1999) 43 ATR 1202 (Cripp's Case). In Cripp's Case the taxpayer and his wife purchased as joint tenants 14 double storey townhouses. The acquisition was financed entirely by borrowed funds, which were secured by a mortgage over the properties. After renovations, the townhouses were rented out. They were managed by a real estate agent. Substantial tax losses were incurred over a number of years in respect of the properties. The taxpayer allocated full losses to himself on the basis that a general law partnership existed (which implied that a business was being carried on). Objections to the Commissioner's decisions were disallowed and the taxpayer appealed. The taxpayer contended that the acquisition and renting out of the properties by him and his wife constituted the carrying on of a business. The taxpayer supported his contention by pointing to the use of a business name by he and his wife, the existence of a business plan, his involvement in the management of the townhouses and the number of properties involved. The Commissioners decision was upheld, it was ruled that the arrangement between the taxpayer and his wife was merely that of an investment and not a business. As the Passive Leasing Entities have little or no active involvement in the leasing activities and maintenance of the leased properties, and no active ongoing management in respect of the lease of non-real property assets, the passive rental of assets by the Passive Leasing Entities do not constitute the carrying on of a business. These assets held by the Passive Leasing Entities have the indicia of being held to maintain and derive income as investments rather than from carrying on a business. The activities of the Passive Lending Entities and their Property Agent are not considered to constitute carrying on a business of leasing property, but rather the absence of their involvement in repetitive activities of a business-like manner indicates that these assets are held as passive investments. For the purposes of calculation of annual turnover for the Passive Leasing Entities under section 328-120, the lease income for the real property and leased non-real property is not included.