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Own rental properties? Are you conducting a ‘business’?

The recent case of YPFD v Commissioner of Taxation1 (YPFD) considered whether the taxpaying owner of a number of residential rental properties was ‘conducting a business’. This article:

  • reviews the circumstances of YPFD, which led to the Administrative Appeals Tribunal finding the applicant was conducting a business
  • provides some guidance to SMSF trustees and members to draw from YPFD.

Overview

The Administrative Appeals Tribunal (Tribunal) recently considered an appeal from the decision of the Commissioner of Taxation (Commissioner) to deny a number of deductions broadly relating to YPFD’s rental property invesments.

While much of the Tribunal’s reasoning relates to the particular deductions claimed, including items such as attendance at speculative property seminars, the decision provides useful guidance on the factors relevant in determining whether a taxpayer is conducting a business when they are investing in residential property.

Such guidance is useful for taxpayers considering investing in property through their SMSF or acquiring property in their SMSF from a related party.

The facts

While the Tribunal was generally critical of YPFD’s evidence, on the question of whether the taxpayer was carrying on a business of letting rental properties during the relevant period, the relevant facts were:

  • the taxpayer and her husband have owned nine properties since the 1990s
  • the taxpayer worked full time as an industrial chemist, but also spent a lot of time undertaking tasks in connection with the rental properties, including inspecting each property quarterly, checking accounts and advertising for tenants
  • the taxpayer had engaged real estate agents to look after the properties, but had to involve herself in property related matters, partly because the agents were inefficient or did not do what she intended
  • in each of the relevant years, the taxpayer made substantial losses in conducting the rental ‘business’ and had never actually returned a profit. However, the taxpayer intended to make a profit, by increasing rents and purchasing further properties
  • the taxpayer did not have a business plan.

The decision

Citing a range of authorities on the test for determining whether a taxpayer was conducting a business, the Tribunal noted:

  • no single factor was determinative – the determination involves the general impression gained after having regard to the nature and extent of activities under review as well as the purpose of the individual engaging in them
  • relevant considerations include:
    • the nature of the activities and whether they have a profit-making purpose
    • the complexity and magnitude of the undertaking
    • an intention to engage in trade regularly, routinely or systematically
    • operating in a business-like manner and the degree of sophistication involved
    • whether any profit/loss is regarded as arising from a discernible pattern of trading
    • the volume of the taxpayer’s operations and the amount of capital employed by him or her.

The Tribunal determined that the taxpayer was carrying on a business of letting rental properties. In deciding this, the Tribunal was satisfied that:

  • the taxpayer had the intention of making a profit
  • there was a certain repetition and regularity to the taxpayer’s activities related to the rental properties
  • a reliance on estate agents to manage real estate did not preclude the taxpayer herself from carrying on a business of letting rental properties.

What does this mean for SMSF investments?

The decision may be relevant in two SMSF contexts.

Firstly, SMSFs are generally prohibited from acquiring an asset from a related party. There is an exemption to this general rule where the SMSF acquires ‘business real property’. The Tribunal’s decision in YPFD reinforces the notion, previously acknowledged in a 2009 SMSF Ruling published by the Commissioner that in some circumstances rental properties can satisfy the definition of ‘business real property’.

Secondly, certain restrictions apply to SMSF investments in related trusts or companies, where those investments would amount to ‘in-house assets’ (which cannot total more than 5% of an SMSF’s assets).

However there are exemptions available in some circumstances if, for instance, the trustee of the related trust does not ‘conduct a business’. The Tribunal’s decision in YPFD highlights the risk that a trustee of a related trust may breach these provisions if the trustee’s letting of rental properties is on such a scale to amount to conducting a business. This would mean that the SMSF’s investment in that related trust would be an ‘in-house asset’, and, could represent no more than 5% of the SMSF’s assets.

________________________________

1. YPFD and Commissioner of Taxation [2014] AATA9.
2. See Self Managed Superannuation Funds Ruling – SMSFR 2009/1 ‘Self Managed Superannuation Funds: business real property for the purposes of the Superannuation Industry (Supervision) Act 1993.
3. See regulation 13.22D of the Superannuation Industry (Supervision) Regulations 1994 (Cth).

The recent case of YPFD v Commissioner of Taxation1 (YPFD) considered whether the taxpaying owner of a number of residential rental properties was ‘conducting a business’. This article:

  • reviews the circumstances of YPFD, which led to the Administrative Appeals Tribunal finding the applicant was conducting a business
  • provides some guidance to SMSF trustees and members to draw from YPFD.

Overview

The Administrative Appeals Tribunal (Tribunal) recently considered an appeal from the decision of the Commissioner of Taxation (Commissioner) to deny a number of deductions broadly relating to YPFD’s rental property invesments.

While much of the Tribunal’s reasoning relates to the particular deductions claimed, including items such as attendance at speculative property seminars, the decision provides useful guidance on the factors relevant in determining whether a taxpayer is conducting a business when they are investing in residential property.

Such guidance is useful for taxpayers considering investing in property through their SMSF or acquiring property in their SMSF from a related party.

The facts

While the Tribunal was generally critical of YPFD’s evidence, on the question of whether the taxpayer was carrying on a business of letting rental properties during the relevant period, the relevant facts were:

  • the taxpayer and her husband have owned nine properties since the 1990s
  • the taxpayer worked full time as an industrial chemist, but also spent a lot of time undertaking tasks in connection with the rental properties, including inspecting each property quarterly, checking accounts and advertising for tenants
  • the taxpayer had engaged real estate agents to look after the properties, but had to involve herself in property related matters, partly because the agents were inefficient or did not do what she intended
  • in each of the relevant years, the taxpayer made substantial losses in conducting the rental ‘business’ and had never actually returned a profit. However, the taxpayer intended to make a profit, by increasing rents and purchasing further properties
  • the taxpayer did not have a business plan.

The decision

Citing a range of authorities on the test for determining whether a taxpayer was conducting a business, the Tribunal noted:

  • no single factor was determinative – the determination involves the general impression gained after having regard to the nature and extent of activities under review as well as the purpose of the individual engaging in them
  • relevant considerations include:
    • the nature of the activities and whether they have a profit-making purpose
    • the complexity and magnitude of the undertaking
    • an intention to engage in trade regularly, routinely or systematically
    • operating in a business-like manner and the degree of sophistication involved
    • whether any profit/loss is regarded as arising from a discernible pattern of trading
    • the volume of the taxpayer’s operations and the amount of capital employed by him or her.

The Tribunal determined that the taxpayer was carrying on a business of letting rental properties. In deciding this, the Tribunal was satisfied that:

  • the taxpayer had the intention of making a profit
  • there was a certain repetition and regularity to the taxpayer’s activities related to the rental properties
  • a reliance on estate agents to manage real estate did not preclude the taxpayer herself from carrying on a business of letting rental properties.

What does this mean for SMSF investments?

The decision may be relevant in two SMSF contexts.

Firstly, SMSFs are generally prohibited from acquiring an asset from a related party. There is an exemption to this general rule where the SMSF acquires ‘business real property’. The Tribunal’s decision in YPFD reinforces the notion, previously acknowledged in a 2009 SMSF Ruling published by the Commissioner that in some circumstances rental properties can satisfy the definition of ‘business real property’.

Secondly, certain restrictions apply to SMSF investments in related trusts or companies, where those investments would amount to ‘in-house assets’ (which cannot total more than 5% of an SMSF’s assets).

However there are exemptions available in some circumstances if, for instance, the trustee of the related trust does not ‘conduct a business’. The Tribunal’s decision in YPFD highlights the risk that a trustee of a related trust may breach these provisions if the trustee’s letting of rental properties is on such a scale to amount to conducting a business. This would mean that the SMSF’s investment in that related trust would be an ‘in-house asset’, and, could represent no more than 5% of the SMSF’s assets.

________________________________

1. YPFD and Commissioner of Taxation [2014] AATA9.
2. See Self Managed Superannuation Funds Ruling – SMSFR 2009/1 ‘Self Managed Superannuation Funds: business real property for the purposes of the Superannuation Industry (Supervision) Act 1993.
3. See regulation 13.22D of the Superannuation Industry (Supervision) Regulations 1994 (Cth).