Private ruling: capital gains tax concessions
Published: August 2015
Ruling period: Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017 | Year ended 30 June 2018 | Year ended 30 June 2019 | Year ended 30 June 2020
Date scheme commenced: 1 July 2013

Ruling: Q1: Are the entities carrying on a rental business? | A1: No. | Q2: Are the rental properties held by the entities active assets for the purposes of Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: No.

Relevant facts and circumstances: The individual's full time occupation has been the growth and management of their rental activities and their sole source of income has been from the rent received from these properties. The individuals have experience in the industry. When considering properties to add to purchase, the individuals look for properties where significant increases in the rental income can be achieved through changing the usage from residential to commercial, through subdivision and development or through seeking a better mix of tenants where the property contains multiple tenancies. They also look for properties where existing land can be subdivided and either developed or sold in order to maintain the same rental income, but reduce the capital committed. The individuals also regularly review their property portfolio with a view to maximising their rental return by rental increases, changes to tenants, or even the sale of properties in order to release capital which can then be invested in new properties providing a higher yield. The individuals are involved in all of the letting activities for each of their properties including; securing new tenants for vacant tenancies, calculation of rental increases for CPI and on-charging of outgoings, negotiating lease renewals, preparation of lease documents, negotiations with tenants who are in default of their lease, and all matters relating to the eviction of tenants who break their lease and recovery of rent owing. Where necessary the services of other professionals, such as solicitors, are engaged to carry out certain activities. The individuals purchase properties in different entities for asset protection purposes, so that the other properties are not at risk to meet liabilities which relate to another property. The relevant entities currently own less than 5 properties.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 995-1 | Income Tax Assessment Act 1997 section 152-35 | Income Tax Assessment Act 1997 section 152-40 | Income Tax Assessment Act 1997 paragraph 152-40(4)(e)

Reasons for decision: Summary: Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'. The question of whether you are carrying on a business is a question of fact and degree. There are no rigid rules for determining whether the activity amounts to the carrying on of a business. The facts of each case must be examined. In Martin v FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551, Webb J said: The test is both subjective and objective; it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and, as counsel for the taxpayer put it, the determination is eventually based on the large or general impression gained. However, the courts have developed a series of indicators that can be applied to your circumstances to determine whether you are carrying on a business. Taxation Ruling TR 97/11: 'Income tax: am I carrying on a business of primary production?' summarises these indicators. 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. 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 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. Having considered your circumstances and the factors outlined above, we do not consider that the activities amount to the carrying on of a business. While the activities have been profitable, we consider the scale of activities and volume of operation is even less than the case noted above. Currently there are less than 5 properties held by the relevant entities. Further, where the property owners grant exclusive possession of the property to the residents the relationship between the two parties is one of tenant and landlord. This activity is more likely to be passive investment rather than a business. Similarly, activities constituting the mere maintenance of an asset and the mere collection of income do not indicate the existence of a business. The entities are renting out the buildings to tenants; hence we consider the relationship is that of a landlord and tenant. We acknowledge that the individuals perform all of the activities required for the managing and maintenance of the properties. However, the undertaking of managing and maintenance, level of involvement, scale of activity and volume of operation is insufficient to be considered a business. Active asset test The active asset test is contained in section 152-35 of the ITAA 1997. The active asset test is satisfied if: • you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the test period detailed below, or • you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7.5 years during the test period. The test period is from when the asset is acquired until the CGT event. If the business ceases within the 12 months before the CGT event (or such longer time as the Commissioner allows) the relevant period is from acquisition until the business ceases. A CGT asset is an active asset if it is owned by you and is used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or an entity connected with you. Paragraph 152-40(4)(e) of the ITAA 1997 states, however, that an asset whose main use in the course of carrying on the business is to derive rent cannot be an active asset unless the main use for deriving rent was only temporary. Taxation Determination TD 2006/78 discusses the circumstances in which premises used in the business of providing accommodation for reward can be active assets notwithstanding the exclusion in paragraph 152-40(4)(e) of the ITAA 1997. TD 2006/78 provides the following example: Commercial Property Co owns 5 commercial rental properties. The properties have been leased for several years under formal lease agreements to various commercial tenants which have used them for office and warehouse purposes. The terms of the leases have ranged from 1 year to 3 years with a 3 year option and provide for exclusive possession. The company has not engaged a real estate agent to act on its behalf and manages the leasing of the properties itself. In this situation, the company has derived rental income from the leasing of a number of properties. Accordingly, the main (only) use of the properties is to derive rent and they are therefore excluded from being active assets under paragraph 152-40(4)(e) of the ITAA 1997 regardless of whether the activities constitute the carrying on of a business. As discussed above, we do not consider that your activities amount to the carrying on of a business. However, even if there was a business activity the properties are being used to produce rental income. Therefore, the properties would be excluded from being active assets under paragraph 152-40(4)(e) of the ITAA 1997.