SMSF 'carrying on a business' of managing rental properties?

Mr Allen, a banker by occupation, managed a large number of rental properties and sought an ATO private ruling that he was 'carrying on a business'. The Commissioner of Taxation in its private rulings found Mr Allen (in his own right and as trustee of a trust (not an SMSF)) was not 'carrying on a business'. Mr Allen appealed the decision in the Administrative Appeals Tribunal (Tribunal) [1]. The intention behind the private ruling was so that Mr Allen's properties were 'business real properties' and therefore could be transferred into a related party's SMSF. The Tribunal agreed with Mr Allen, and found that he was in fact 'carrying on a business' but only in his own right and only in some of the tax years.

This article examines the factors which informed the Tribunal's decision, and highlights how difficult it can be to establish that activities in relation to residential properties amount to 'carrying on a business'.

SMSF acquiring business real property

An SMSF can only acquire real property from a related party if, when it is acquired, the property is 'business real property' of the seller. The law defines 'business real property' as follows:

• "... where the real property is used wholly and exclusively in one or more businesses (whether carried on by the entity or not)." [2]

Accordingly, in order to satisfy the 'business real property' test, at the time the SMSF intends to acquire the property from the related party seller, the seller or the seller's tenant (where the seller is leasing out the property), must use the property 'wholly and exclusively in one or more businesses'.

Mr Allen argued that his properties were 'business real property' and therefore his parents' SMSF could acquire them.

Ordinarily, leasing residential properties does not constitute carrying on a business. However, in some circumstance it does. In our earlier article, here, we explained what factors point to the carrying on of a business in relation to residential real estate and how those factors point to a property being regarded as 'business real property' - some of these included the frequency and scale of the leasing operation.

Background

Mr Allen owned 9 properties in his own name and 5 properties as trustee for the Allzams Trust, all of which were rented out.

Mr Allen applied for private rulings to the Commissioner as to whether:

• either or both of he and the trustee were 'carrying on a business' of renting properties;
• whether the relevant properties were therefore business real property; and
• whether the relevant properties could therefore be acquired by his parents' SMSF under super law. [3]

Mr Allen managed the properties during the FY15-FY17 years. In 2018 he was made redundant from his full-time job as a banker and thereafter his only occupation was managing the properties and he spent a significant amount of his time doing so.

In the private rulings the Commissioner found that neither Mr Allen nor the trustee were carrying on a business in financial years FY15 - FY19.

Mr Allen applied to the Tribunal in two separate cases, one application in his own right and the other as trustee of the Allzams Trust, appealing the Commissioner's decision.

The Tribunal found that Mr Allen in his own capacity was carrying on a business of renting properties during FY18 and FY19 but not during FY15 - FY17.

Factors for carrying on a business - Relevant ATO Rulings

Some of the factors set out in the Commissioner's SMSFR 2009/1 (entitled 'Self Managed Superannuation Funds: business real property for the purposes of the Superannuation Industry (Supervision) Act 1992') which are relevant to determining whether or not an entity carries on a business of leasing real property include:

• the scale of the relevant entity's leasing operation: that is, how many properties and the nature of the properties (is the property an apartment complex with various different leases);
• the regularity and repetition with which the owner of the property conducts the activities;
• the nature of the operation: are there indicators of activity being undertaken which take the activities from mere investment activities, to the conduct of a business?;
• further to the above point, whether the entity asserting that it is carrying on a business:
  • has a business plan;
  • maintains business records;
  • has an ABN; and/or
  • is registered for GST purposes.

Mr Allen's activities

Some of the activities which Mr Allen carried out in relation to the properties included the following:

• day to day management of qualified professionals needed to facilitate the development;
• building retaining fences around the properties;
• planting 250 trees and plants in the seven gardens;
• preparing documentation for a mediation on a fencing dispute; and
• painting eaves and fascia boards.

Allzam trust's activities

The activities which Mr Allen as trustee for the Allzams trust carried out included the following:

• administrative duties such as paying for repairs and maintenance, council rates, water rates, land tax, rent reconciliation and preparation of financial statements,
• rent collection;
• tenant duties such as interviews, phone calls, emails and correspondence;
• preparing lease agreements;
• all property inspections usually every six months;
• gardening, cleaning, general ad hoc duties and travel the block of units; and
• repairs and maintenance duties as required. Denis engages the services of electricians, building professionals and plumbers to conduct some of the repairs. No fee is charged for the repairs and maintenance activities performed by Denis.

The main purpose and intended use of the rental properties when purchased by the Allzams trust was to build a significant property portfolio, which would derive sufficient rental income to be disbursed to the beneficiaries of the Allzams trust.

Tribunal's decision - Mr Allen

The Commissioner's arguments, and the Tribunals response, included:

• The fact that some of the properties were refurbished by Mr Allen meant that those activities were more likely to point to the carrying on of a property development business rather than a business of managing rental properties.

  The Tribunal did not accept that undertaking a development is a factor that goes against considering whether on examination of the relevant factors, there is a business being carried on [4].

• Mr Allen did not maintain a profit and loss statement in relation to his activities and he did not established a 'profit-making purpose' - which pointed to the fact that records were not being kept in a business-like manner.

  The Tribunal rejected this argument and found that Mr Allen's answers to the questions asked by the Commissioner in his private ruling submission did not indicate that records were not being kept in a business-like matter. Rather, they showed Mr Allen kept an 'income and expense account'. It did not matter that Mr Allen did not keep a 'profit and loss account' for his own activities (he only did so for activities carried on as trustee of the Allzams trust).

• Mr Allen did not seek professional advice in relation to his activities.

  However, the Tribunal pointed to the fact that he had degrees in accounting and applied finance and that the Commissioner was made aware of this fact.

The Tribunal found that the facts in the ruling omitted a number of matters which should have been included and that the Commissioner had additional information available to him in the questions asked of Mr Allen in anticipation of the ruling application being made which were not considered when making the ruling. The Tribunal found the correct and preferable decision is that Mr Allen was in 2018 and 2019 taxation years carrying on the business of renting properties.

Prior to 2018, Mr Allen balanced his full-time job as a banker as well as his property management activities. He was made redundant from his job in 2018 and then managed the properties full-time thereafter. The Tribunal did not know how much time Mr Allen spent on managing the properties while he was also employed full-time as a banker. The Tribunal could not infer this from the facts in the private ruling. Therefore the Tribunal only found that a business was carried on in FY18 and FY19 years being the period after Mr Allen was made redundant and the period where it was clear that the scale of his activities were more than just a passive investor. It is not clear whether the Tribunal would have also found in favour of Mr Allen if he had set out in more detail the scale of his property management activities before he lost his job.

Tribunal's decision - Allzams trust

The Tribunal found that there was insufficient evidence (from that provided with the ruling application) as to whether or not the Trust carried on a business of leasing property. The Tribunal decided that there was additional information that should be considered and this question was referred back to the Commissioner.

The Tribunal did note that the trustee prepared profit and loss statements for the trust, and also that the trustee did not charge a service fee to the trust for services he rendered to himself as trustee of the trust. The Tribunal relevantly noted that:

• "The rented property is five two-bedroom units on the one title. Whilst the trustee undertakes some duties normally performed by agents, attends to the banking and bookwork, attends to the garden, and has to travel to the premises, looked at through a lens that these are the baulk [sic] of the trustee's tasks, in isolation of the properties owned by the trustee in his own right, these are not unusual tasks for an owner of one rental property." [5]

Importance of seeking advice

It is better to have certainty on these matters before an SMSF proceeds with a related party acquisition. If the 'business real property' test is not established and the SMSF proceeds with the related party acquisition - it could result in a breach of super law.

Given the potential difficulty in establishing an argument for carrying on a 'business' in respect of residential properties - the best strategy would be to seek legal advice and apply for an ATO private ruling.

More information from Maddocks

For more information, contact Maddocks on (03) 9258 3555 and ask to speak to a member of the Commercial team.

More Cleardocs information on related topics

You can read earlier ClearLaw articles on a range of topics, such as:

• Superannuation Contributions - A Guide
• Superannuation Contributions and Income Tax - for Self-Managed Superannuation Funds
• Understanding - Contributions, Contributions Caps and Reserves

Order related document packages

• SMSF Minutes and Resolutions Package
• SMSF Pension Commutation
• SMSF Pension Pack
• Superannuation Trust (SMSF)
• Update to SMSF

[1] Allen and FCT [2021] Tribunal 2768, Allzams Trust and FCT [2021] Tribunal 2767

[2] S 66 Superannuation Industry (Supervision) Act 1993 (Cth)

[3] S 66(2)(b) Superannuation Industry (Supervision) Act 1993 (Cth)

[4] [87] Allen and Commissioner of Taxation (Taxation) [2021] AATA 2768 (6 August 2021)

[5] [62] Allzams Trust and Commissioner of Taxation (Taxation) [2021] AATA 2767 (6 August 2021)