Edited version of private advice

Authorisation Number: 1052207067376

Date of advice: 21 December 2023

Ruling

Subject: Assessable income - prepaid rent

Question

Will the rental income received in advance and used to offset the sales price of the property, be included in your assessable income progressively over the term of the lease for the purposes of subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

You derived an amount of ordinary income on the receipt of prepaid rental income. In accordance with subsection 6-5(4) of the ITAA 1997 you were entitled to direct that the advanced rent amount be used to reduce the purchase price of the property that you have secured. The rental income received in advance is assessable in full, in the income year it was derived, for the purposes of subsection 6-5(2) of the ITAA 1997.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You are an Australian resident for tax purposes.

On XX XX 20XX, you signed a Promissory Contract of Sale and Purchase (the Contract) on a property (the Property).

The Property is in Country Y.

The Contract details at that you recognise and accept that the touristic facility, currently in force over the Property, is granted the exclusive right to operate the Property for a period of X years.

On XX XX 20XX, you also signed a Promissory Lease Agreement for Non-Dwelling Purposes (the Lease).

You entered into the Lease with the lessee (the Lessee).

The Lease is enforceable for X years, with no renewal.

The total amount of rents due for the full X-year period of the Lease was payable to you on the date of signature and deed of sale and purchase.

You received an amount totalling XXX,XXX.XX. Comprised of:

•         Monthly rent of X,XXX.XX, which corresponds to

•         Annual income of XX,XXX.XX

The prepaid rental income you received was subject to withholding tax rate of 25%.

The withholding tax has been paid in Country Y.

To complete the purchase, you paid the vendor $XXX,XX.XXAUD, in total, for the Property.

The payments were made in instalments on the following dates:

•         XX XX 20XX

•         XX XX 20XX

•         XX XX 20XX

•         XX XX 20XX

•         XX XX 20XX

•         XX XX 20XX

•         XX XX 20XX

You only paid the net amount owing as the prepaid rental income you received was used to offset the sale price of the Property.

You did not borrow any funds to purchase this Property.

If you do not honour the Lease, you will be required to repay all the rental income you have received, plus a XX% penalty, to the Lessee.

The Lessee does not have a right to a pro rata refund if they dishonour the Lease.

On XX XX 20XX, the Property settled and was immediately available for rent.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 6-5(2)

Income Tax Assessment Act 1997 subsection 6-5(4)

Income Tax Assessment Act 1997 subsection 51(1)

Reasons for decision

Ordinary Income

Under subsection 6-5(2) of the ITAA 1997, a taxpayer's assessable income includes *ordinary income (i.e. income according to ordinary concepts) derived directly or indirectly from all sources, during the income year.

As the term 'income' is not explicitly defined in the Australian tax legislation, it takes on its ordinary meaning. Characteristics have been determined through case to law to help define the meaning of income according to ordinary concepts. Income that flows from property, including rent, is generally considered income according to ordinary concepts.

Income Tax ruling IT 2167 - Income tax: rental properties - non-economic rental, holiday home, share of residence et. Cases, family trust cases states at paragraph 4 that, ordinarily, where a taxpayer grants a lease or licence of property, whether wholly or in part, whether at arm's length or otherwise, the amount received as rent or in respect of the licence is assessable income.

Therefore, the prepayment of rent made by the Lessee to you, constitutes ordinary income.

Timing of derivation

Rent means any consideration paid or given by a lessee under a lease and includes consideration (whether paid or given by a lessee or another person) in the nature of a rental consideration.

Subsection 6-5(4) of the ITAA 1997 provides that you derive an amount of ordinary income as soon as it is applied or dealt with in any way on your behalf, or as you direct. That is, income is derived when it 'comes home' to the taxpayer in a realised or immediately realisable form (Commissioner of Taxes (SA) v. Executor Trustee and Agency Co of South Australia Ltd (1938) 63 CLR 108; [1938] HCA 69).

In Federal Commissioner of Taxation v. Clarke (1927) 40 CLR 246 AT 261; [1927] HCA 49, Issacs J said that 'derived' simply means 'obtained' or 'got' or 'acquired' and that 'all income is derived from something and by someone'. Issacs J also added in Federal Commissioner of Taxation v. Thorogood (1927) 40 CLR 454 at 458; [1927] HCA 36 that 'derived' does not necessarily mean actually received, although receipt is the ordinary mode of derivation.

The principle of constructive receipt involves the notion of control of, or the capacity to control, an amount that is receivable or otherwise held in a matter satisfying the concept of derivation.

When you are able to direct how income is dealt with on your behalf as provided for in subsection 6-5(4) of the ITAA 1997, you are taken to have received an amount of income at the time the amount is credited and made available to you to do with as you wish.

ATO Interpretative Decision (ATO ID) 2003/526 - Income tax Assessability of lump sum payment - for life time right to reside in a property - rent in advance was considered in relation to your circumstances. Similarly, in this case, the taxpayer has received a lump sum payment for their investment property and therefore the income is 'ordinary income' as per section 6-5 of the ITAA 1997. However, your circumstances differ in that while you must repay rent if you do not honour the lease; the Lessee does not have a right to a pro rata refund if they want to vacate the property. Therefore, you have nothing further to do to 'earn' the income.

You are taken to have received the lump sum payment of prepaid rent from the lessee in advance of your future rental income. Consequently, it is assessable income in the financial year in which it was derived and made available to you as you have fulfilled all the conditions under the contract.

Application to your circumstances

You received the equivalent of X-years of rent upfront, on condition that that amount would be used (as directed by you) to reduce the sale price of the Property that you bought and have acquired an ownership interest in.

You have leased the Property at arm's length to a third party, who in turn will have exclusive rights to operate a touristic facility in the Property for the X-year period. If you do not honour the lease before the expiration of the term, you are required to repay the lessee any rental income you receive, with an additional 20% penalty.

The lease agreement does not place any other obligation on you. Your position is secured in that you retain ownership of the property and therefore the rent is considered to have 'come home' to you, in the sense that there is nothing more for you to do to earn the income.

You derived an amount of ordinary income on the receipt of prepaid rental income. In accordance with subsection 6-5(4) of the ITAA 1997 you were entitled to direct that the advanced rent amount was to be used to reduce the purchase price of the property that you have secured.

In the event that you are required to make a payment to the lessee and refund any prepaid rent, the refund would be deductible under subsection 51(1) of the ITAA 1997.

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