Private ruling: Tax break - Am I in business
Published: September 2011
Ruling period: 1 July 2008 to 30 June 2012
Date scheme commenced: 1 July 2008

Ruling: Q1: Are you carrying on a rental property business for the purposes of the small business and general business tax break (tax break) provisions in Division 41 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No

Relevant facts and circumstances: The Family Trust was established post 2000. The turnover of the trust is below $2 million. The trust holds; · Farmland · Cash investments · Shares Some years later you purchased as tenants in common a commercial. You have provided a copy of the contract which shows the property was purchased as tenants in common in equal shares by a company as trustee for a Discretionary Trust and another company as trustee for you. You wish to confirm if the leasing of this commercial property meets the definition of 'for the principal purpose of carrying on a business' in relation to the business tax break legislation. You advise; · There is no written or legal partnership agreement. · Capital, income and expenses are shared by the partners 50/50. · No property manager has been engaged for the property. · The two trusts actively manage all income and expenses. · One trustee primarily performs the bookkeeping and administrative role. · The trusts incur the expenses for repairs and maintenance and invoice these to the tenant. · Approximately two hours per month is spent on activities relating to the property - recording income and expenses, following up debtors, providing invoices, paying expenses and general administration. · There is one tenant occupying the building. Under the terms of sale the property was leased back to the vendor on commercial terms at sale. Renovations to the property were undertaken resulting in the premises being let to a new tenant at a significantly higher rent. The monthly income has increased as a result of the improvements tenfold. You intend to purchase and lease further commercial premises when funds become available. You have recently registered a Partnership for GST to simplify the property transactions (such as invoicing).

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 40-25 | Income Tax Assessment Act 1997 Division 41 | Income Tax Assessment Act 1997 Division 43 | Income Tax Assessment Act 1997 Section 995-1

Reasons for decision: Summary: All legislative references are to the ITAA 1997 unless otherwise specified. You are not carrying on a rental property business. | Detailed Reasoning - Small business and general business tax break: In order to claim a tax break deduction under Division 41 of the ITAA 1997, paragraph 41-20(1)(d) requires that at the first use time of the asset, it would be reasonable to conclude that the asset will be used for the principal purpose of carrying on a business. To be eligible for the tax break an entity must be 'carrying on a business', as opposed to carrying on an 'enterprise'. Further, the depreciating asset must be used in that business. You have submitted that you are carrying on an enterprise. | Detailed Reasoning - Carrying on an Enterprise: An enterprise includes a business. It also includes other commercial activities but does not include: · private recreational pursuits and hobbies · activities carried on as an employee, labour hire worker, director or office holder · activities carried on by individuals (other than trustees of charitable funds) or partnerships (in which all or most of the partners are individuals) without a reasonable expectation of profit. The enterprise test is defined in the legislation and covers a wide range of activities including leasing, and activities done by religious and charitable institutions. Activities done by particular entities are included in the definition of enterprise so that those entities can become registered for ABN and GST purposes and to potentially allow them to obtain input tax credits. As the definition of 'enterprise' is broader than that of 'business', the concept of 'carrying on a business' is examined below. | Detailed Reasoning - Carrying on a Business: Section 995-1 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. However, this definition simply states what activities may be included in a business. It does not provide any guidance for determining whether the nature, extent, and manner of undertaking those activities amount to the carrying on of a business. 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 of carrying on a business, and no one indicator will be decisive ( Evans v FC of T 89 ATC 4540; (1989) 20 ATR 922). Whether the letting of property amounts to the carrying on of a business will depend on the circumstances of each case. 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. As a general proposition, it is more accurate to describe the owners of rental property in the words of Beaumont J in FCT v. McDonald (1987) 78 ALR 588; 87 ATC 4541 (McDonald's case) at ATR p.969; ATC p 4552 'as co-owners in investments rather than as partners in a business operation.' Consequently, co-owners of rental property are generally not partners at general law. That is not to say that co-owners cannot carry on a business of property rental and therefore be partners at general law. As already noted, whether an activity constitutes the carrying on of a business is a question of fact to be decided on a case by case basis. A factor identified in McDonald's Case by Beaumont J was the minimal active participation from either party. To be a business activity, there must be active joint participation by the parties to the activity. Renting out of premises without the provision of other services would be a mere investment in property rather than a partnership in the properties or their profits. Paragraph 5 of Taxation Ruling IT 2423 states that 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. Basically, this states that where a person's income is derived from the co-ownership of property, a partnership for tax law purposes only exists. Income is derived from the co-ownership of the property, not from the distribution of a partnership profits/losses. Taxation Ruling TR 97/11 considers whether a taxpayer is carrying on a primary production business. (However, it is not limited to primary production activities). 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 ). | 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. Your activity is the leasing of a commercial property. You own 50% of the property as tenants in common with another trust. You and the co-owner do not have a formalised partnership agreement or a business plan. To simplify transactions in relation to the property you have recently registered as a Partnership for GST purposes. The relationship of the co-owners and the management of the property does not appear to be commercial in character. The informal arrangements are more indicative of investors than business operators. | 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. You purchased the commercial property on a vendor leaseback arrangement. Substantial improvements have been made to the property and you have obtained new tenants. | 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. You have committed (in partnership) a substantial sum to the acquisition and improvement of the property. The monthly income has increased as a result of the improvements tenfold. You have not provided any financial projections to demonstrate the profitability of the property. | 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 do not engage an agent to manage the property. You spend approximately two hours per month on activities relating to the property - recording income and expenses, following up debtors, providing invoices, paying expenses and general administration. The level of repetition and regularity of your activity is no more than that undertaken by a passive investor. | 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. You have one tenant. The additional activities undertaken in relation to the property are akin to a passive landlord who collects rental income, conducts basic maintenance, and maintains accurate records. Your activities are not at a level that would be considered similar to those carrying on a business of letting properties. | 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 does not own other commercial properties and has no apparent prior experience in purchasing, developing, and managing commercial properties. Until recently the co-owners were not registered as a partnership for GST purposes. The activities of collecting rent, paying expenses, and maintaining accurate records are typically those of a landlord. The record management of the property, specifically the delayed registration as a GST partnership, indicate the enterprise was not maintaining it's records in a similar manner to an entity operating a business of renting properties. | 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 is small with one commercial property and one tenant. You spend approximately two hours per month on activities relating to the property. | Detailed Reasoning - (8) whether the activity is better described as a hobby or form of recreation.: The activity does not have the nature of a hobby or recreational pursuit. The nature of your activity is similar to other rental property owners who are actively involved in some aspect of the properties they own. | Detailed Reasoning - Conclusion: After considering all the indicators, in particular the number of properties you own and the level of activity undertaken, the factors indicate that you are in receipt of income as a property owner rather than from carrying on a business. Although your activities may amount to an enterprise for the purposes of the GST legislation, they do not amount to the carrying on of a business and as such a tax break deduction will not be allowable to you.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.