Private ruling: Tax treatment of company rental properties
Published: August 2013
Ruling period: Year ended 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Are you a small business entity (in order to be eligible for the simplified depreciation rules)? | A1: No

Relevant facts and circumstances: You derive rent from two residential high rise apartments. Your only activity with one property is collecting the rent from the tenant and your other property is managed by a real estate agent. Your annual gross income is less than $2 million.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 328-110

Reasons for decision: Summary: 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. 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 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.) In contrast to American Leaf Blending Co, on 23 December 1992, in the Federal Court of Australia case of Kennedy Holdings & Property Management Pty Ltd v. Federal Commissioner of Taxation 92 ATC 4918 ( Kennedy Holdings ), the judgment was made that a company, which co-owned one commercial rental property, was not carrying a business for income tax purposes. The Federal Court of Australia judgment, in Kennedy Holdings , is consistent with the view found in the Tax Office publication Rental properties 2011-12 (NAT 1729-6.2012), which, on page 4, states: 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 the 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. Notwithstanding the above, 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… Consistent with and also citing the judgment in American Leaf Blending Co , IT 2423 states: Whether the letting of property amounts to the carrying on of a business will depend on the circumstances of each case…[i.e., is a question of fact] 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…. 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. In addition, another matter to consider is the United Kingdom judgment of Lord Diplock is from a foreign legal system and thus not binding in Australia (paragraph 121 of Taxation Ruling TR 2001/13 ). In other words, the judgment in American Leaf Blending Co does not necessarily take precedence over the judgment in Kennedy Holdings . In your case, we consider your passivity of activity resembles that in Kennedy Holdings and is decidedly more passive than the activity described in American Leaf Blending Co . Further, we consider your passive rental of two high rise resident apartments distinguishes your case even further from both American Leaf Blending Co and Kennedy Holdings , who (respectively) rented a former business factory and warehouse (which they significantly modified for tenants) and a commercial rental property. To conclude, we consider you are not carrying on a business of rental properties.