Edited version of private ruling

Authorisation Number: 1011815314283

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: Income - agreements

Question 1

Are the proceeds received from the agreements assessable as ordinary income?

Answer: Yes.

Question 2

Does the fee received by you in relation to agreement B form part of the proceeds from the agreements?

Answer: Yes.

Question 3

Is the rental income received in relation to agreement B assessable income?

Answer: Yes.

Question 4

Is the income paid under agreement B considered an instalment for the purchase price of the property?

Answer: Yes.

Question 5

Are you entitled to a deduction for the rent paid and legal expenses incurred in drawing up the lease agreement as part of agreements?

Answer: Yes.

Question 6

Are the commission, fee paid to enter into agreement A, travel, advertising, vouchers and tickets expenses deductible against the proceeds received from the agreements?

Answer: Yes.

This ruling applies for the following period

Year ended 30 June 2010
Year ending 30 June 2011
Year ending 30 June 2012

The scheme commenced on

1 July 2009

Relevant facts

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· a private ruling application

· a copy of a number of agreements

· a letter from a solicitor

· a residential tenancy agreement

· a contract of sale.

You entered into agreement A with the owner of a property.

Under agreement A you were granted the choice to purchase the property from the owner and you were also entitled to sub-lease the property.

You entered into a agreement B with a purchaser to purchase the property.

You have entered into the agreements as an investor with the purpose of making a profit.

Before entering into the agreements you have undertaken a number of courses in relation to these agreements.

You have not entered into these types of agreements previously. 

You expect to make a profit from the agreements when the purchaser purchases the property.

You have sub-leased the property to the purchaser under agreement B and as part of the terms of agreement part of the rent is credited off the purchase price of the property and you will provide the purchaser with a voucher and a number of tickets.

You received a fee from the purchaser to enter into agreement B.

You paid an agent a fee to find a property owner who had a property to sell.

You paid the owner of the property a fee to enter into agreement A.

You paid travel costs to meet with prospective buyers of the property; an agent and a solicitor to drawn up contract of sale, the agreements and the residential lease agreement.

You are paying rent to the owner for leasing the property under agreement A.

The property was rented during the income year.

You place advertisements in the local papers to find a tenant/buyer for the property.

You paid legal fees to have the agreements, the sub-lease agreement and contract of sale agreements drawn up.

You have documentation to substantiate your expenses.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5
Income Tax Assessment Act 1997 subsection 6-5(1)
Income Tax Assessment Act 1997 subsection 6-5(2)
Income Tax Assessment Act 1997 subsection 6-10(2)
Income Tax Assessment Act 1997 section 15-15
Income Tax Assessment Act 1997 subsection 995-1.
Income Tax Assessment Act 1997 section 8-1
Income Tax Assessment Act 1997 paragraph 8-1(1)(a)

Reasons for decision

Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that your assessable income includes income from ordinary concepts, which is called ordinary income.

Subsection 6-5(2) of the ITAA 1997 provides that if you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia during the year of income.

To be income according to ordinary concepts, a payment must be received by a taxpayer as part of trading activities or normal income producing activities. If the payment arises from an isolated transaction that is not part of business activities, it may still be income if the taxpayer entered into the transaction with the intention of making a profit.

Subsection 6-10(2) of the ITAA 1997 provides that an amount is statutory income if it is not ordinary income but is included in assessable income by a provision of the Income Tax Assessment Act 1936 (ITAA 1936) or the ITAA 1997.

A profit arising from the carrying on, or carrying out, of a profit-making undertaking or plan, is assessable under section 15-15 of the ITAA 1997. The section does not apply to a profit that is assessable as ordinary income under section 6-5 of the ITAA 1997 or which arises in respect of the sale of property acquired on or after 20 September 1985.

Carrying on a business

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 a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the facts.

Taxation Ruling TR 97/11 provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. These factors 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 business-like 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.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impression gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

In applying these factors to your situation, you have undertaken a number of courses in relation to agreements. You have no prior history of being involved in these type of agreements. Your intention into entering the agreements was to make a profit as an investor. The agreements are a once off arrangement. You have engaged a solicitor to draw up the agreements and contract of sale and sought a tenant/buyer to enter into the agreement. The size and scale of the activity is small.

Therefore it is considered that you are not carrying on a business of entering into these types of agreements.

Isolated transactions

The Commissioner's view on whether profit from isolated transactions is assessable as ordinary income is found in Taxation Ruling TR 92/3. 'Isolated transactions' are:

· those transactions outside the ordinary course of business of a taxpayer carrying on a business; and

· those transactions entered into by non-business taxpayers.

 TR 92/3 states profits on an isolated transaction will be ordinary income when:

· the intention or purpose of a taxpayer in entering into the transaction was to make a profit or gain; and

· the transaction was entered into, and the profit was made in the course of carrying on a business operation or commercial transaction.

The intention of the taxpayer is determined by an objective consideration of the facts and circumstances (paragraph 38 of TR 92/3). Further, paragraph 40 of TR 92/3 indicates that a profit making purpose need not be the sole or dominant purpose for entering into the transaction. It is sufficient if profit making is a significant purpose.

Paragraph 41 of TR 92/3 indicates that you must have the requisite purpose at the time of entering into the relevant transaction or operation. If the transaction involves the sale of property, it is usually necessary that you have the purpose of profit making at the time of acquiring the property.

If a taxpayer is not carrying on a business and makes a profit, that profit is income if:

· the taxpayer had a profit-making intention when entering the transaction or operation, and

· the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

A transaction may be characterised as a business operation or commercial transaction if the transaction is business or commercial in character.

Paragraph 13 of TR 92/3 lists some matters which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction:

· the nature of the entity undertaking the operation or transaction;

· the nature and scale of other activities undertaken by the taxpayer;

· the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

· the nature, scale and complexity of the operation or transaction;

· the manner in which the operation or transaction was entered into or carried out;

· the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

· if the transaction involves the acquisition and disposal of property, the nature of that property; and

· the timing of the transaction or the various steps in the transaction.

Applying the criteria to your circumstances

You do not carry on a business in regards to these agreements. You have no prior history of being involved in the agreements and the current agreements entered into are a once-off arrangement. Your intention into entering the agreements was to make a profit as an investor. You engaged a solicitor to draw up the agreements and a contract of sale and also engaged the services of an agent to find a seller of a property. In addition, you advertised for a purchaser for the property and had undertaken travel to show the prospective buyers the property. All costs in relation to this activity have been paid by you. The size and scale of the activity is small.

Based on the facts and circumstances noted above we have determined that entering into the agreements do not amount to a business operation. However, given your profit making intention and your level of participation in the entering into the agreements, leads to the conclusion that the agreements are an isolated transaction of a commercial nature.

Any proceeds made from the isolated transaction will be assessable to you in the financial year in which the settlement of the property occurs. The expenses such as legal expenses in drawing up the agreements and the sale contracts, the advertising, the travelling expenses, vouchers, tickets, the commission expense and the fee paid to the owner of the property are essentially deductible under paragraph 8-1(1) (a) of the ITAA 1997 on the basis that the costs are incurred in producing or gaining assessable income. However, these costs are taken into account in calculating the net profit and no amount would be deductible until settlement.

Therefore it is only the net profit that will be brought to account under section 6-5 ITAA 1997 (Commercial and General Acceptance Limited v Federal Commissioner of Taxation (1977) 13 CLR 373).

Fee

In Taxation Ruling TR 98/1 the Commissioner provides a guide to determining when income is considered to have been derived. Paragraph 17 of TR 98/1 states that:

When accounting for income in respect of a year of income, a taxpayer must adopt the method that, in the circumstances of the case, is the most appropriate. A method of accounting is appropriate if it gives a substantially correct reflex of income.

Whether a particular method is appropriate to account for the income derived is a conclusion to be made from all the circumstances relevant to the taxpayer and the income.

In the case Commissioner of Taxes v. Executor, Trustee & Agency Co of SA Ltd (1938) 63 CLR 108 at 155; 5 ATD 98 at 132; (1938) 1 AITR 416 at 442 Dixon J stated:

Speaking generally, in the assessment of income the object is to discover what gains have during the period of account come home to the taxpayer in a realized or immediately realizable form.

Paragraph 89 of Taxation Ruling TR 97/9 considers when income is derived from the sale of real property in reference to the case Gasparin v. Federal Commissioner of Taxation (1994) 50 FCR 73; 94 ATC 4280; (1994) 28 ATR 130 (Gasparin's case) :

...a vendor in a real property transaction will not have performed all that is needed to become entitled to a payment prior to settlement. At settlement, transfers are effected which put the purchaser in a position to become registered as owner. As such, the vendor does not earn the income from the sale until settlement.

In your case, the purchaser has paid a fee to enter into agreement B with you. The payment of the fee grants the purchaser the choice to purchase the property for a price under the terms of the contract of sale. Under the terms of the agreement B you as the owner of the property are required to meet certain conditions under the agreement B before the purchaser takes up the choice to purchase the property or to terminate the agreement before the expiry date. As noted in Gasparin's case, the income from the sale of the properties was not derived until settlement at which point the vendor would have done all that is required to affect the sale and transfer of the property. Similarly the fee is not derived until the agreement is expired or until the sale of the property takes place under the agreement B.

Therefore, the fee forms part of the proceeds from the commercial transaction in working out the net profit or loss for the transaction.

Rental income

It is generally accepted that rent is ordinary income and included in assessable income under section 6-5 of the ITAA 1997. Rental income is ordinary income.

Income Tax Ruling IT 2167 provides the Commissioner's views on the arm's length letting of an identified part of a taxpayer's residence and notes that ordinarily, where a taxpayer grants a lease of a property, whether wholly or in part, whether at arm's length or otherwise, the amount received as rent is assessable income. This is illustrated by the decision FC of T v. Kowal, 84 ATC 4001; 15 ATR 125.

However, if the arrangement is considered to be non-commercial because of its nature, any deductions claimed may only be allowed up to the amount of rental income derived.

If the weekly instalments represent instalments of the sale price they will be capital receipts and not ordinary income (Foley v. Fletcher (1858) 157 ER 678).

In determining whether or not a payment is rent, it is the reality or substance of the matter, rather than the label given by the parties to the transaction which is decisive (Ex parte Lathouras; Re Vendardos [1964-1965] NSWR 254).

In your case, you have entered into an arm's length arrangement with the purchaser to sub-lease the property. The amount received by you for the sub-lease of the property is considered to be ordinary income in the form of rent and therefore forms part of your assessable income. You should therefore disclose the full amount of the rent received during the relevant financial year.

However, under the agreement B you also intend to sell the property and the wording of the agreement B indicates that part of the payment of rent paid to you by the purchaser represent instalments of the sale price under the agreement B.

Therefore, that part of the payment is not assessable income in the year of receipt as the payment is a reduction of the purchase price of the property. This amount should be included in working out the net profit or loss at the time of settlement of the property.

Rental deductions

Expenses may qualify as a deduction under section 8-1 of the ITAA 1997 if they satisfy the basic requirement for deductibility of being incurred in gaining or producing the taxpayer's assessable income and are not of a capital, private or domestic nature.

Deductions for rental expenses are generally claimed under section 8-1of the ITAA 1997 to the extent to which the expense is related to income production.

Outgoings incurred for bank interest, annual local and state government rates and taxes, preparing and registering lease, insurance, telephone and travel costs incurred in maintaining and managing a rental property are normally allowable deductions as they are incurred in earning the rental income and are not excluded as capital, private or domestic expenditure.

In your case, you have incurred rent and legal fees to prepare and register the lease with the purchaser are deductible under section 8-1of the ITAA 1997 to the extent to which the expenses is related to income production.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).