The impact of this case on ATO policy is discussed in Decision Impact Statement: Bocaz and Federal Commissioner of Taxation (2010/4160 ).
BOCAZ v FC of TMembers:
G Lazanas SM
Administrative Appeals Tribunal, Sydney
MEDIA NEUTRAL CITATION:
 AATA 847
Ms G Lazanas (Senior Member)
1. Ms Edith Bocaz is a retired school teacher who is in dispute with the Commissioner of Taxation (Commissioner) with respect to deductions that she claimed in her tax return for the income year ended 30 June 2008. The deductions claimed by Ms Bocaz were in respect of her share of interest expenses and other expenses relating to two residential properties in Eastlakes, New South Wales.
2. The Commissioner takes the view that rent was not derived from either of the residential properties and, therefore, Ms Bocaz is not entitled to claim any deductions. In the alternative, the Commissioner states that if rent was derived from the residential properties, any expenses that were incurred would only be deductible to the extent of the assessable income. There is the additional issue of Ms Bocaz not having substantiated all of the deductions which were claimed to have been incurred in the relevant year and to have claimed expenses for the entire year, when in fact she owned the properties, as a co-owner, for only part of the relevant year.
3. The Commissioner's primary position is premised on the fact that both residential properties were occupied in the relevant income year by relatives. Ms Bocaz's ex-husband occupied one residential unit, while the other unit was occupied by one of her sons. The Commissioner states that these tenancy arrangements were private and domestic arrangements such that any payments to Ms Bocaz for occupation did not possess the requisite characteristics of assessable income. The Commissioner states that they were non-commercial arrangements evidenced by the non-arm's length rate of rent, if any, charged. Accordingly, the Commissioner has denied the claims made by Ms Bocaz for deductions.
4. I am satisfied, based on the evidence, that Ms Bocaz earned rent from the tenancy arrangements. I am also persuaded by the explanations provided by Ms Bocaz with respect to the tenancy arrangements and find that they were not non-commercial arrangements. Therefore, Ms Bocaz should not be generally denied all her claims for the deductions nor should her claims be limited to the extent of the rent earned from the residential properties. However, Ms Bocaz cannot claim all of the expenses as allowable deductions, as she held her interest in the properties for only part of the year and some of these expenses need to be pro-rated for the relevant period. Accordingly, I have decided to set aside the Commissioner's objection decision and to remit it to the Commissioner for reconsideration in accordance with these Reasons.
5. Ms Bocaz is 63 years of age and retired. In the relevant income year ended 30 June 2008, she was a school teacher. She had been married to Hector Gutierrez Cuitino but had been divorced from about 1997. Mr Cuitino passed away in January 2010. Ms Bocaz has two sons, Hector Gutierrez Bocaz (Mr Bocaz) and Dr Christian Gutierrez.
6. Mr Bocaz was the co-owner of both residential properties with his mother in the relevant income year, and purchased the interest of Ms Bocaz in one of the residential units part way through the year. Her other son, Dr Christian Gutierrez, purchased the interest of Ms Bocaz in the other residential unit part way through the relevant year of income. As explained below, Ms Bocaz's claims for deductions are referable to her 50 per cent interest of each of the properties and, in most cases, for that part of the year for which she was a co-owner. Although the calculations in Ms Bocaz's tax return did not reflect this latter factor, she accepted during the hearing that that was the proper analysis for certain expenses and the issue of apportionment based on period of ownership of the properties was, therefore, no longer in dispute.
7. In February 1999, Ms Bocaz and her son, Mr Bocaz, purchased a residential unit at Barber Avenue, Eastlakes (the Barber Avenue Property), as joint tenants, for $170,000. During the 2008 income year, the Barber Avenue Property was occupied by Ms Bocaz's ex-husband. Her ex-husband had moved into the property in or about 2000, after he returned from living overseas. Ms Bocaz sold her interest in the Barber Avenue Property to her other son, Dr Gutierrez, in mid-January 2008.
8. In February 2003, Ms Bocaz and her son, Mr Bocaz, purchased another residential unit at Dalby Place, Eastlakes (the Dalby Place Property), as joint tenants, for $281,000. During the 2008 income year, the Dalby Place Property was occupied by Ms Bocaz's son, Mr Bocaz with his girlfriend. Ms Bocaz sold her interest in the Dalby Place Property to Mr Bocaz in mid-November 2007.
9. On 4 September 2008, Ms Bocaz filed her income tax return for the year ended 30 June 2008 through her tax agent. She declared, besides her salary from teaching, gross rental income of $6,128 and she claimed interest expenses of $11,769 and other expenses of $11,345 with respect to the two residential properties. She did not prepare any part of her tax return but handed over folders containing the receipts for her tax agent to attend to the calculations, including as to the depreciation of items.
10. In late September 2008, the Commissioner notified Ms Bocaz that he intended to undertake an income tax audit with respect to her return for the year ended 30 June 2008. The Commissioner subsequently issued a Notice of Assessment on 18 March 2009 adjusting the amounts claimed by Ms Bocaz, including with respect to the two residential units, as follows:
- • the gross rent of $6,128 was excluded from her assessable income;
- • the interest deductions of $11,769 were disallowed in full; and
- • other rental deductions of $11,345 were disallowed in full.
11. On 18 September 2009, Ms Bocaz lodged an objection to the assessment. On 12 April 2010, the Commissioner disallowed the objection as to the parts relating to the residential properties. On 27 May 2010 the Commissioner issued a Notice of Amended Assessment to Ms Bocaz as a result of other parts allowed by him in the objection decision. On 24 September 2010, Ms Bocaz applied to this Tribunal for review of the Commissioner's objection decision dated 12 April 2010.
12. There are two key issues in these proceedings. First, whether any amounts received by Ms Bocaz from her ex-husband and one of her sons for occupation of the two residential units are considered to be assessable income for the purposes of s 6-5 of the Income Tax Assessment Act 1997 (the 1997 Tax Act). Second, whether the expenses incurred are allowable deductions on the basis that they were incurred in gaining or producing assessable income for the purposes of s 8-1(1)(a) and not of a private or domestic nature for the purposes of s 8-1(2) of the 1997 Tax Act.
13. The Commissioner contends that the Applicant did not receive rental payments that amounted to assessable income because the payments, if any, received by her do not have the characteristics of income and instead are reflective of a private or domestic arrangement between the Applicant and her ex-husband and son in respect of the properties. The Commissioner also argues that any expenses incurred by the Applicant are not deductible in accordance with paragraph 8-1(2)(b) of the 1997 Tax Act as they are of a private or domestic nature. Not surprisingly, these issues arise because the deductions claimed by Ms Bocaz exceed the rental payments in respect of the two residential properties.
THE EVIDENCE OF MS BOCAZ
14. Ms Bocaz stated that she and her son, as co-owners of the Barber Avenue Property, together received $200 rent per week in cash from Mr Cuitino, her ex-husband, who occupied this property since about 2000 until January 2010 when he passed away. Ms Bocaz stated that she received rent of $165 rent per week in cash for her 50 per cent interest in the Dalby Place Property from her son, Mr Bocaz, who occupied that property. Mr Bocaz owned the other 50 per cent interest in each of the properties.
15. Ms Bocaz told the Tribunal that there was no written tenancy agreement with respect to either of the properties nor was there any real estate agent involved in these arrangements and, therefore, she did not pay any commission to an agent. Ms Bocaz gave evidence that she trusted her ex-husband to pay the rent and to look after the Barber Avenue Property and did not arrange for any rental bond or landlord insurance. Ms Bocaz also trusted her son to pay the rent in respect of the Dalby Place Property and, further, it was in his interest to do so, as he was the co-owner of both properties.
16. Ms Bocaz stated that both units were in very poor condition when they were purchased and that considerable work was required, including renovations to the respective kitchens, bathrooms and flooring. It was Ms Bocaz's position that the rent that she received, in particular from her ex-husband for the Barber Avenue Property over a period of some 10 years, reflected the condition of the property and the arrangements that she had made for the renovations and repairs.
Barber Avenue Property
17. Ms Bocaz told the Tribunal that she and her son had opted to lease the Barber Avenue Property to her ex-husband for $200 per week in 2000 when he moved in, on the basis that he would live in the property in the condition it was in at that time, and undertake the necessary renovations and repairs to the unit over a period of time.
18. The Barber Avenue Property was described as a ground floor, small two bedroom unit with a bathroom and balcony in a building that is more than 50 years old and located in a noisy area. Being a ground floor unit, Ms Bocaz considered that there were also security concerns.
19. Ms Bocaz stated that prior to her ex-husband moving in, the Barber Avenue Property was rented by a local real estate agent to tenants for $175 per week for approximately a year after she purchased the property with her son in 1999. She said that it was the cheapest flat for sale at that time because the condition of the property was "really bad". She said that there was no functioning stove and no floor coverings, only a concrete slab. The tenants living there beforehand used the property as sleeping quarters only on the basis, as she observed, that there were some 12 bunk beds throughout the residential unit but no functioning kitchen.
20. Ms Bocaz stated that she purchased the property as a residential investment but could not afford to undertake the renovations to the Barber Avenue Property all at once, and agreed with her ex-husband, after he returned from living overseas for some years following their divorce, that he could rent the property and undertake the works over a period of time. She explained to the Tribunal that she needed the rent to pay her mortgage and other expenses and that the renovation works were carried out in a piecemeal manner, as and when she could afford them. The renovations included putting in new parquetry flooring, a new kitchen, bathroom and built-in wardrobes. She said that she decided to rent the Barber Avenue Property to him as it benefited her to have a tenant who would pay the rent and also fix the property and make it liveable, as she could not do this herself or afford to pay for the labour costs as she could not get another loan. She stated that it was unnecessary to have a written agreement about the works with her ex-husband because she trusted him to do what he said he would do.
21. In cross-examination, Ms Bocaz explained that her husband was on the pension, and he could have chosen to rent another property, probably cheaper, as he did not need a two bedroom unit. In terms of her relationship with him, she did not consider him to be a member of her family at that time, having divorced in about 1997. However, she also said that her relationship with him was good with respect to the upbringing of their children.
22. The rent paid by her ex-husband was never increased over the years that he occupied the Barber Avenue Property as, according to Ms Bocaz, it did not make sense to do so in circumstances where he was fixing it and maintaining it, the renovations having concluded in about 2008. She did not want the hassle of the property being vacant and she also did not want to risk any damage to the property; her ex-husband was reliable in that he would not only pay the rent but he would keep the unit in the best possible condition. Further, she did not think that she could get a lot more rent, possibly only a small increase. Ms Bocaz also stated that her husband became quite ill in late 2008.
Dalby Place Property
23. Ms Bocaz told the Tribunal that the rent that was paid by the tenants, at the time of purchase of the Dalby Place Property in February 2003, was $977 per month (approximately $225 per week), organised through a local real estate agent. She stated that the tenants vacated of their own accord after about a few years of occupation and left the property in a mess. Ms Bocaz had some difficulty at the hearing remembering in which year the tenants actually vacated and, consequently, when her son moved into the Dalby Place Property. However, she was definite that she had arranged for renovations over a December to February period, coinciding with the school holiday period as she was a school teacher. Ms Bocaz described the renovations undertaken to this property as including the removal of carpets and old built-in wardrobes.
24. Based on the evidence of Ms Bocaz and the numerous receipts in evidence from hardware stores, many of which were issued in the months of February and March 2007, I find that the renovation works occurred in the period from about December 2006 to March 2007. I also find that her son and his girlfriend were in occupation at the Dalby Place Property, at the latest, by the beginning of July 2007.
25. Mr Bocaz paid rent of $165 per week to Ms Bocaz for her 50 per cent interest in the Dalby Place Property. As noted above, Ms Bocaz sold her 50 per cent interest in the Dalby Place Property to Mr Bocaz in late November 2007, although settlement did not occur until mid-January 2008. However, I find that her son only paid rent for the 19 weeks from July to November 2007, as shown in Ms Bocaz's income tax return.
DID MS BOCAZ RECEIVE RENT IN RESPECT OF THE RESIDENTIAL PROPERTIES?
26. I find that Ms Bocaz earned rent in the year of income ended 30 June 2008 from the Barber Avenue Property based on the amount of $200 per week paid to her and her son by her ex-husband. As she owned a 50 per cent interest in the property and sold her interest to her other son, Dr Gutierrez, part way through the relevant year ended 30 June 2008, her assessable income should include the amount of $2,800 referable to a period of 28 weeks (1 July 2007 to 16 January 2008).
27. I also find that Ms Bocaz earned rent in the relevant income year from the Dalby Place Property based on the amount of $165 per week paid to her by her son, Mr Bocaz, (who was also the co-owner of the Dalby Place Avenue Property) for the 50 per cent interest owned by Ms Bocaz in this property. He paid rent to Ms Bocaz for a period of 19 weeks (1 July 2007 to mid-November 2007). Her assessable income for the year ended 30 June 2008 should accordingly include rent of $3,135 from the Dalby Place Property.
28. Therefore, the gross rent earned by Ms Bocaz in respect of the two residential units in the year ended 30 June 2008 was $5,935.
WERE THE ARRANGEMENTS NON-COMMERCIAL?
29. The Commissioner argued that the tenancy arrangements were non-commercial arrangements as evidenced by the non-arm's length rent, if any, charged by Ms Bocaz and her son to her ex-husband, Mr Cuitino, in relation to the Barber Avenue Property such that the expenses were not incurred in gaining or producing assessable income. Alternatively, the Commissioner submitted that Ms Bocaz had at least a dual purpose in allowing her ex-husband to live in the Barber Avenue Property because Ms Bocaz wanted to assist him. The Commissioner made similar arguments with respect to the Dalby Place Property which Ms Bocaz's son occupied, namely, that the rent charged was non-commercial because of their close relationship and non-arm's length dealings.
30. The Commissioner referred to a number of authorities in support of his position. First, it was argued that in circumstances where the Applicant has not proven that any income has been produced, it is necessary to consider the subjective purpose or motives of the taxpayer for which the expenditure was incurred:
Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1. Specifically, the High Court stated as follows at 18-19:
The position may, however, well be different in a case where no relevant assessable income can be identified or where the relevant assessable income is less than the amount of the outgoing. Even in a case where some assessable income is derived as a result of the outgoing, the disproportion between the detriment of the outgoing and the benefit of the income may give rise to a need to resolve the problem of characterization of the outgoing for the purposes of the sub-section by a weighing of the various aspects of the whole set of circumstances, including direct and indirect objects and advantages which the taxpayer sought in making the outgoing... Where that is so, it is a 'commonsense' or 'practical' weighing of all the factors which must provide the ultimate answer... If, upon consideration of all those factors, it appears that, notwithstanding the disproportion between outgoing and income, the whole outgoing is properly to be characterized as genuinely and not colourably incurred in gaining or producing assessable income, the entire outgoing will fall within the first limb of s.51(1) unless it is either somehow excluded by the exception of 'outgoings of capital, or of a capital, private or domestic nature' or 'incurred in relation to the gaining or production of exempt income'. If, however, that consideration reveals that the disproportion between outgoing and relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective and that part only of the outgoing can be characterized by reference to the actual or expected production of assessable income, apportionment of the outgoing between the pursuit of assessable income and the pursuit of that other objective will be necessary.
31. Secondly, the Commissioner argued that the arrangements that the Applicant had entered into with her ex-husband and her son were of a familial nature of the kind described in the decisions of
Federal Commissioner of Taxation v Groser (1982) 65 FLR 121,
Federal Commissioner of Taxation v Kowal (1983) 79 FLR 75 and
Madigan v Commissioner of Taxation (1996) 68 FCR 12, such that the Tribunal should apportion the expenses to reflect the dual purpose of earning assessable income and the private and domestic nature of the arrangements.
32. In Groser's case, Jenkinson J held that where the outgoings exceeded assessable income and the assessable income was at a gross undervalue, an apportionment of outgoings should be made between what could be regarded as incurred in gaining or producing that rent and what could not be so regarded. However, on the facts of that case, Jenkinson J found that the $2 per week amount received was in fact not assessable income and disallowed all of the deductions. The reason was that his Honour concluded that the arrangements involved the care of the taxpayer's mentally retarded brother who was the tenant and that this private arrangement explained the receipts. His Honour held that the weekly amounts of $2 were a contribution to the funds out of which the taxpayer would defray expenses for caring for his brother and did not constitute assessable income.
33. In Kowal's case, the property was rented to the taxpayer's mother for $10 per week when the commercial rent would have been $50 per week. An apportionment of the outgoings was ordered so that 80 per cent for the outgoings were found to have the characteristic of being incurred for earning assessable income. This was because although it was held that one of the taxpayer's purposes in acquiring the property was to give his mother a home in which to reside at a moderate non-commercial rental, it was clear that the taxpayer's predominant purpose in incurring the expenses was to gain or produce assessable income in the form of rent which would, over the years, exceed the outgoings and produce a profit.
34. In Madigan's case, Hill J found that the explanation for the low rent paid was the private relationship which the persons had. In that case, the taxpayer was a beneficiary under a family trust, the trustee of which leased trust property to the taxpayer's father at a rate which was approximately 25 per cent of the market rate. In calculating the net income of the trust estate, the trustee sought to deduct all of the expenses in respect of the property but his Honour held that the case was one in which it was appropriate to apportion the expenses. His Honour stated as follows at 17:
Matters of motivation or purpose will generally be irrelevant in determining the characterisation of an outgoing. But where the circumstances are such that the outgoings in question are considerably in excess of the assessable income derived, and furthermore it is known that the assessable income derived is but a small fraction of an arm's length assessable income, it will be necessary to consider the facts further to determine whether the outgoings in question are properly to be characterised as expenditure incurred wholly in gaining or producing assessable income or whether the expenditure in part should be characterised differently: Cf
Fletcher v Commissioner of Taxation (Cth) (1991) 173 CLR 1 at 17ff. Although that case merely concerned interest, the principles laid out in the unanimous judgment of all seven members of the High Court have application to the present facts.
35. After referring to Groser's case and Kowal's case, Hill J also considered the case of
Ure v Federal Commissioner of Taxation (1981) 50 FLR 219, where the taxpayer had borrowed money at commercial rates of interest up to 12.5 per cent per annum and on lent them at 1 per cent to his wife or a family company. His Honour then concluded in Madigan's case as follows at 18:
The mere fact that the rental is thus below market rental will not preclude deductibility of the whole of the outgoings. But where the circumstances are such that the explanation for the low rent lies in the private relationship which the parties occupying the premises have to the trustee, it is not possible to say that the whole of the outgoings have the character of outgoings incurred in gaining or producing assessable income. The explanation is to be found rather in private or non-income earning considerations.
36. The Commissioner also sought to support his argument by reference to information compiled by the New South Wales Department of Family & Community Services (NSW Department) with respect to the median weekly rent information for a two bedroom unit in the suburb of Eastlakes for the quarter ended September 2007. The Commissioner stated that the statistics demonstrated that the median rental figure for such properties was $310 per week. As the median is a figure determined by arranging a list of values (in this case, weekly rent) from lowest to highest and selecting the middle value, it can be a useful figure as it is far less affected by unusually high or low values compared to the mean. However, I also note the following caution which is published by the NSW Department with respect to median rents:
When median rents from the Rent and Sales Report are used to examine trends in a local housing market, care must be taken. It is quite common for a number of negative quarterly changes in median rents to occur following large increases in the previous quarter. These variations are related to the method of data collection, which measures rents by taking a sample that is not random - it records the data only for bonds lodged during the quarter. The properties for which bonds are lodged in a particular quarter may be atypically low or atypically high.
37. In my view, the factual circumstances of Ms Bocaz are distinguishable from all of the abovementioned cases and are quite unusual. Ms Bocaz was prepared to rent the Barber Avenue Property to her ex-husband for $200 per week, because of the agreement she had with him as to the renovations when he moved in, at a time when the condition of the property was very poor. She elected not to increase the rent over the period, in part, because of the fact that he had fixed the Barber Avenue Property and maintained it since 2000. While the rent of $200 per week with no increase suggests that she was being paid less than the market rate, at least in the relevant 2008 income year, there was not a huge disparity having regard to the median rent figure. Accordingly, I find that this was not a non-commercial arrangement but one that was commercially advantageous to Ms Bocaz. As far as she was concerned, her ex-husband was a reliable and good tenant who would not only look after the property but who was willing to undertake substantial works to improve it for her while living in it and paying her rent. I have also taken into account her evidence (which I accept) that it was tenanted for $175 per week through real estate agents when she acquired the property. In the circumstances, I decline to draw an inference of a further purpose as the Commissioner contended, namely, of Ms Bocaz wanting to assist her ex-husband. Ms Bocaz's evidence at the hearing did not support such an inference.
38. With respect to the Dalby Place Property, I find that the arrangement between Ms Bocaz and her son, Mr Bocaz, was also not a non-commercial arrangement. He paid $165 per week to his mother for her 50 per cent interest in the Dalby Place Property which is equivalent to paying $330 per week for the property. This was in excess of the median weekly rent of $310 referred to by the Commissioner. In any event, the fact that she was renting the Dalby Place Property to her son does not of itself mean that the rent that he was paying was a non-arm's length amount.
DID MS BOCAZ INCUR DEDUCTIBLE EXPENSES IN RESPECT OF THE RESIDENTIAL PROPERTIES?
39. Ms Bocaz and her son incurred interest expenses of $11,978 and $11,890 in respect of loans for the purchase of the Barber Avenue Property and the Dalby Place Property, respectively. On account of the fact that Ms Bocaz sold her 50 per cent interest in each of the properties part way through the year, she needs to additionally apportion her interest deductions for that fact. Her tax agent had only apportioned these expenses on account of her 50 per cent interest in the properties.
40. While Ms Bocaz did not produce the receipts to support the claims for the water and council rates and for the strata levies for the relevant year ended 30 June 2008, having instead mistakenly provided the notices for the prior income year, I accept that she incurred these expenses as they are recurring expenses and the amounts claimed were substantively similar to the amounts on the notices for the prior year. These expenses had been pro-rated by her tax agent but as the calculations were incorrectly done, they should be adjusted to reflect the period of Ms Bocaz's ownership in the year ended 30 June 2008 in accordance with the findings above.
41. The deductions claimed for depreciation and borrowing expenses were also not pro-rated and I find that these should also be adjusted to reflect her period of ownership in the relevant income year. Certain other expenses that were incurred by Ms Bocaz in the relevant period of her ownership, such as for rubbish removal, do not require any apportionment, except as to her 50 per cent interest in the properties.
42. The objection decision under review in relation to the income tax assessment for Ms Bocaz for the year ended 30 June 2008 is set aside. The Tribunal remits the objection decision to the Commissioner for reconsideration in accordance with these Reasons.