Private ruling: Income tax – company tax rate
Date of advice: 29 November 2018
Published: March 2019
Ruling period: Year ended 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Does the company carry on a business? | A1: Yes. | Q2: Is the company eligible to apply a tax rate of 27.5%? | A2: No.

Relevant facts and circumstances: The company owns two commercial properties. One of the commercial properties is a shopping centre that is rented to third parties. The other commercial property is rented to a related business at market rate rent on normal commercial terms. The company does not engage an agent to manage the properties and the director manages the day to day ongoing activities of the properties. These activities include: ● advertising to find tenants ● organise and negotiate lease agreements for all tenants ● collection of rent ● issue monthly rental tax invoices ● monthly inspection of properties ● review yearly rent increases based on lease agreement ● maintenance of common areas ● organise repairs ● organise the service of fire and safety equipment The company also engages a consultant to keep financial records up to date and lodge Business Activity Statements. The aggregated turnover for the company is above $10 million but less than $25 million for the 2017-18 financial year. The company produced a profit in the 2017-18 financial year and has done so in previous years. The company receives more than 80% of its income from rental activities.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 328-110 | Income Tax Rate Act 1986 section 23AA | Income Tax Rate Act 1986 section 23AB

Reasons for decision: Detailed Reasoning - Carrying on a Business: Section 328-110 of the Income Tax Assessment Act 1997 includes in its qualification criteria that, to be a small business entity for an income year, you must carry on a business. For a business to be carried on requires some active occupation or profession ( IRC v. The Marine Steam Turbine Co Ltd (1919) 12 TC 174). ‘It is not possible to definitively state whether a company is carrying on a business. It is always a question of fact to be determined by reference to the relevant principles as to when a person carries on a business’ ( Brookton Co-operative Society Ltd v. FCT (1981) 147 CLR 441 (Brookton) per Aicken J at 28) and is ‘ultimately based on the overall impression of the activities of the company’ ( Martin v. FC of T (1953) 90 CLR 470 5 AITR 548). When determining if a company carries on a business there are many elements that should be considered, such as the nature of the activates, particularly if they have the purpose of making a profit, repetition and regularity, the organization of the activities in a businesslike manner, the keeping of books, records and the use of a system and the volume of operations and capital employed. These elements were set out in the often sited case of Ferguson v. FC of T (1979) 37 FLR 310. Taxation Ruling TR 97/11 provides the Commissioner’s view of the factors used to determine if you are in a business for tax purposes. 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, and no one indicator will be decisive ( Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). Whether a company has a purpose or prospect of profit is an important factor in determining whether a taxpayer’s activities amount to carrying on a business. However it is ultimately a question that must be determined by reference to all the relevant facts relating to the company and its activities. The nature of the activities is often closely related to whether a company has a profit making purpose and prospect of profit. In addition the organisation of the activities in a limited company will have a more commercial character than they would if undertaken by an individual. Taxation Ruling IT 2423, issued on 24 December 1987, is about whether rental income constitutes proceeds of a business, for withholding tax purposes. IT 2423 refers to the United Kingdom Privy Council judgment, of 18 July 1978, in the case of American Leaf Blending Co. Sdn Bhd v. Director-General of Inland Revenue (Malaysia) [1978] 3 All E.R. 1185 ( American Leaf Blending Co ), where Lord Diplock concluded 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. (In this case, the taxpayer rented the factory area and warehouse of its former tobacco business to a number of tenants under a number of short term lease contracts.). However 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.). Whether the activity said to amount to a business is repeated and regular is relevant to determining whether a taxpayer carries on a business. In American Leaf Blending Lord Diplock observed that: The carrying on of 'business', no doubt, usually calls for some activity on the part of whoever carries it on, though, depending on the nature of the business, the activity may be intermittent with long intervals of quiescence in between. Both the judgment in American Leaf Blending Co and the ruling in IT 2423 do not take an absolute position in respect to company ownership of rental properties. Consistent with the phrase ‘ prima facie inference’, in American Leaf Blending Co , Lord Diplock said: …that…the letting of its property was one of the objects set out in its memorandum of association… was in law conclusive that in making any letting of its premises it was carrying on a business…is, in their Lordships' view, too broad a proposition. Their Lordships would not endorse the view that every isolated act of a kind that is authorised by its memorandum if done by a company necessarily constitutes the carrying on of a business. …the question whether the company was carrying on a business of letting out its premises for rent was one of fact… Further, in American Leaf Blending Co, Lord Diplock did highlight and consider the prerequisite of repetition of ‘activity’ in carrying on a business, where he said: The carrying on of 'business', no doubt, usually calls for some activity on the part of whoever carries it on…In the instant case, however, there was evidence…of activity in and about the letting of its premises by the company during each of the five years that had elapsed since it closed down its former tobacco business. There were three successive lettings of the warehouse negotiated with different tenants; there was the removal of the machinery from the factory area which made it available for use for storage and a separate letting of that area to a fresh tenant; and as recently as October 1968 there was the negotiation of a letting to a single tenant of both the factory area and the warehouse… there is nothing in the evidence capable of rebutting the prima facie inference…the company was carrying on a business of letting out its premises for rent. On the contrary the evidence serves only to reinforce that prima facie inference. American Leaf Blending Co has been used as an authority in a number of rulings by the Commissioner, generally in relation to residency or whether an overseas company is carrying on a business. It is clear that the Commissioner does apply weight to the view that an activity undertaken by a company carries an assumption of business activity. Operating as a company will apply extra weight to the activities being considered businesslike. A company by nature is a formal structure which requires ongoing maintenance, this includes having director(s) who formally control and manage the activities of the company and who have various duties to the company and its shareholders affecting how they must manage a company, including duty to ensure a company doesn’t trade while insolvent. This formal structure differentiates them from individuals and lends a more businesslike character to its activities. In this situation it is clear that the company actively manages its assets to produce assessable income with a view to make a profit. The activities conducted by the company are regular and in a businesslike manner therefore the Commissioner considers that the company is carrying on a business. | Detailed Reasoning - Company tax rate: From the 2017–18 income year, co mpanies that are base rate entities must apply the lower 27.5% company tax rate. A base rate entity is a company that both: ● has an aggregated turnover less than the aggregated turnover threshold – which is $25 million for the 2017–18 income year ● 80% or less of their assessable income is base rate entity passive income – this replaces the requirement to be carrying on a business. Base rate entity passive income is: ● corporate distributions and franking credits on these distributions ● royalties and rent ● interest income (some exceptions apply) ● gains on qualifying securities ● a net capital gain ● an amount included in the assessable income of a partner in a partnership or a beneficiary of a trust, to the extent it is traceable (either directly or indirectly) to an amount that is otherwise base rate entity passive income. The company satisfies the first requirement of the base rate entity test as the aggregated turnover is less than $25 million; however the company’s primary source of income is rent. You have advised that the company’s assessable income is produced from base rate entity passive income. This income exceeds the 80% threshold; therefore as this requirement is not satisfied the company is not considered to be a base rate entity and is not eligible to apply the tax rate of 27.5%.