Edited version of private ruling

Authorisation Number: 1011503405277

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Ruling

Subject: Service Trust Income and Deductions

Question 1

Will Entity A be required to include an amount in its assessable income pursuant to section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of the assignment of Lease X?

Answer

No (to the extent that the income amount is reduced in accordance with section 21A of the Income Tax Assessment Act 1936)

Question 2

Will the capital proceeds from CGT event A1, being the assignment of Lease X, be taken to be the market value of Lease X in accordance with subsection 116-30(1) of the ITAA 1997?

Answer

No

Question 3

Will Entity A be required to include an amount equal to the Landlord's Fitout Contribution in its assessable income under section 6-5 of the ITAA 1997?

Answer

No

This ruling applies for the following period/s:

Income year ending 30 June 20XX to 20XX

The scheme commences on:

During the year ended 30 June 20XX

Relevant facts and circumstances

Scheme:

1. Entity A carries on a business of providing administrative support services to Entity B in return for a service fee. As part of the services, Entity A enters into leases of commercial premises and then makes those premises available to Entity B. The service fee derived by Entity A is included in its assessable income.

2. Lease X provides that Entity A:

(a) Is granted a lease of the relevant premises for a specified term

(b) Is required to pay rent monthly in advance during the term of the Lease

(c) Is required to pay a proportion of certain rates, taxes and operating expenses in relation to the leased premises to the Landlord on receipt of notice from the Landlord but, generally, monthly in advance

(d) The Lease can only be assigned, or the premises sub-let, with the Lessor's consent

(e) Is required to maintain, repair and keep the premises in good and substantial repair, working order and condition; and make good any breakage, defect or damage to the premises caused by Entity A's want of care, misuse or abuses, during the term of the Lease

(f) Is not required to make good any of the premises on the expiry of the Lease

(g) Is not required to make good or remove any fixtures or items of fitout on the expiry the Lease however, if Entity A elects to remove certain items of fitout and such removal damages the premises, Entity A is required to make good that damage, and

(h) Has no right to terminate or surrender the Lease prior to 20XX, except where the premises are destroyed or otherwise become unfit for use.

Agreement for Lease (AFL)

3. Entity A entered into an AFL with Entity C. Pursuant to the AFL, Entity C agrees to construct a building and after completion of the building, Entity C will grant a lease (Lease Y) of the building to Entity A.

Assignment of Lease X

4. As an incentive to encourage Entity A to enter into Lease Y, Entity C has agreed to take an assignment of the Lease X provided certain conditions are met.

5. As a result of the assignment, Entity A's obligations under Lease X will be the responsibility of Entity C after Entity A vacates the old building.

6. Although Entity C will have responsibility to meet the obligations under lease X, Entity A will not obtain a release of its obligations under lease X unless it can obtain the consent of the Lessor (old landlord (OL)).

7. The proposed assignment is to cover the remainder of the term of Lease X.

8. Entity A and OL have no intention of surrendering lease X.

Fitout Works

10. In accordance with the AFL, Entity C is obliged to procure that the works necessary to fitout the building (Fitout Works), as designed by or on behalf of Entity A, are undertaken by a third party builder.

11. Entity C's contribution to the cost of the Fitout Works will be applied in paying claims made by the builder in relation to the Fitout Works until such time as Entity C's Fitout Contribution is fully expended. Entity A is required to pay all costs in relation to the Fitout Works in excess of Entity C's Fitout Contribution (Tenant's Fitout Contribution).

12. In contracting with the builder in relation to the Fitout Works, Entity C will be acting as principal and as disclosed agent of the Tenant (to the extent of the Tenant's Fitout Contribution).

13. Entity A will be required to prepare a schedule specifying which items of the Fitout Works were paid for by Entity C's Fitout Contribution and which items were paid for by the Entity A's Fitout Contribution. Entity C will own all items of the Fitout Works paid for with Entity C's Fitout Contribution (Entity C's Fitout) and Entity A will have no right to remove these items. To the extent the Fitout Works are paid for with the Entity A's Fitout Contribution, those works will be owned by Entity A (Tenant's Fitout) and Entity A will have a right to remove these items unless Lease Y provides otherwise.

14. Entity A is under no general obligation to transfer items of the Entity A's Fitout to Entity C during, or at the end of, Lease Y.

Assumptions:

1. Lease X terms and conditions remain materially the same as a consequence of the assignment of Lease X from Entity A to Entity C.

2. On expiry or determination of the lease Y, Entity C will not transfer the Entity C's Fitout works to Entity A.

Reasons for decision

Issue 1: Lease Incentive

All legislative references are to the Income Tax Assessment Act 1997 unless stated otherwise.

Subsection 6-5(1) provides that an amount is included as assessable income if it is income according to ordinary concepts (ordinary income).

The Full Federal Court in FCT v. Cooke and Sherden (1980) 10 ATR 696 held that a non cash business benefit could only be assessable income under section 6-5 if the benefit(s) were convertible to cash and in the nature of income according to ordinary concepts. In relation to both cash and non cash incentives, the question must be asked: does the benefit have an income character?

The distinction to be drawn between a receipt on account of income and a receipt on account of capital has been the subject of many decisions over the years. It has been said that the test to be applied is to be objective rather than subjective (Hayes v. FC of T (1956) 11 ATD 68 at 72; (1956) 96 CLR 47 at 55) and whether an amount is income in ordinary concepts, depends upon its quality in the hands of the recipient (FC of T v. Cooling 90 ATC 4472 at 4479 (Cooling)).

In Cooling the Federal Court was called upon to consider the assessability or otherwise of an amount received from a lessor as incentive to move to new premises. Hill J, spoke of the need to regard the 'whole factual matrix of which the contract forms part….the whole context in which the agreement was made to determine the character of the receipt'(4481).

Although the AFL does not explicitly refer to incentives provided to Entity A, it is clear that Entity C has agreed to take an assignment of Lease X in order to induce Entity A to enter into Lease Y. The inducement is to be implemented in accordance with the AFL and the proposed assignment. The inducement is considered to be in the form of a promise by Entity C to meet the remaining Lease X obligations of Entity A even though OL will not release Entity A from its obligations under Lease X.

Taxation Ruling IT 2631 states that where a business taxpayer is given a cash incentive to enter into a lease of business premises, the incentive is income of the taxpayer. This extends to non-cash incentives received in similar circumstances. That is, if a business taxpayer receives a non cash incentive to enter into or vary a lease of business premises, payment of removal costs or for the surrender of an existing lease, it will have an income character provided that is convertible to cash, either as a matter of fact or through the operation of section 21A.

Based on the circumstances of the arrangement, as Entity A is in the business of leasing premises, it is considered that Entity A is to receive the lease incentive in the normal course of its business and that the incentive will form part of Entity A's assessable income.

Amount of Assessable Income

In order to determine the amount of assessable income that A is required to return, it is necessary to consider whether the lease incentive is a 'non-cash business benefit' that falls within section 21A of the Income Tax Assessment Act 1936 (ITAA 1936). Under the proposed assignment arrangement A will not receive any monies from Entity C, but rather Entity C will be obliged to meet the remaining Lease X obligations.

Subsection 21A(5) of the ITAA 1936 defines a non-cash business benefit as:

non-cash business benefit as 'property or services provided after 31 August 1988:

(a) wholly or partly in respect of a business relationship; or

(b) wholly or partly for or in relation directly or indirectly to a business relationship

Services includes any benefit, right (including a right in relation to, and an interest in, real or personal property), privilege or facility…

In this case the non-cash business benefit is considered to be in relation to services provided after 31 August 1988 in relation to a business relationship established between Entity A and Entity C (via the AFL and proposed assignment). The benefit(s) are to be provided over the remaining term of lease X. Each benefit will be satisfied as and when Entity C meets those obligations.

In accordance with subsection 21A(2), A will need to determine an arm's length value of each benefit, reduced by A's contribution, if any. Subsection 21A(5) defines:

Arm's length value, in relation to a non-cash business benefit, as:

(a) the amount that the recipient could reasonably be expected to have been required to pay to obtain the benefit from the provider under a transaction where the parties to the transaction are dealing with each other at arm's length in relation to the transaction; or

(b) if such an amount cannot be practically determined-such amount as the Commissioner considers reasonable.

Otherwise deductible rule

In respect of each benefit, Entity A may be entitled to a 'once only deduction' determined in accordance subsection 21A(3) of the ITAA 1936. This is known as the 'otherwise deductible rule'.

Taxation Ruling IT 2631 paragraph 21 provides guidance to the treatment of revenue expenses in accordance with this otherwise deductible rule. According to paragraph 21:

Revenue expenses such as rent which would have been deductible in that year, if they had been incurred, would be able to be taken into account to reduce the assessable income.

Thus revenue expenses (only to the extent to which they are for the payment of rent, rates and other revenue type expenses payable under Lease X) are considered to fall within the 'otherwise deductible rule' and therefore would be taken into account to reduce Entity A's assessable income.

Issue 2: Capital proceeds from CGT Event A1

In order to determine if subsection 116-30(1) will apply to the current arrangement we are required to firstly determine if CGT Event A1 occurs on implementation of the arrangement. According to section 104-10:

(1) CGT event A1 happens if you dispose of a CGT asset.

(2) You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur:

(a) if you stop being the legal owner of the asset but continue to be its beneficial owner; or

(b) merely because of a change of trustee.

Under the current proposal, Entity A is to assign Lease X to Entity C. According to Halsburys Laws of Australia, vol. 16 paragraph 245-1530:

An assignment is the transfer by agreement of the interest held by one person (the assignor) to another person (the assignee) and includes another party taking over the residue of the term of a lease, or where possession is given up for the remainder of the term. An assignment does not constitute the creation of a new lease.

In an assignment of lease a lessee transfers the entire unexpired remainder of the lease term. In an absolute assignment the assignor is left with no interest in the assigned property or right.

The current proposal to assign Lease X includes three parties: Entity A, Entity C and OL. The assignment includes a number of specific indemnities, including a clause confirming that Entity A will not be released by OL from its obligations under Lease X.

Given that Entity A will not be released from its obligations under Lease X, the proposal as outlined will not trigger a disposal of Lease X for the purposes of section 104-10(1). As a consequence, subsection 116-30 will not apply, as a CGT event A1 will not occur on assignment of Lease X.

Issue 3: Landlords Fitout Contribution

As an incentive to induce Entity A to enter into the Lease Y, Entity C is to procure and pay for the construction and installation of the Fitout Works (to the extent of the C's Fitout Contribution). Taxation Ruling IT 2631 provides guidance on such incentives in particular, benefits that may be covered by the operation of section 21A of the ITAA 1936. The incentives may take many forms including free fit-out of the premises by the lessor.

According to IT 2631 paragraph 25, the position as to whether free fit-outs are assessable is dependant on whether the ownership of the fit-out has passed to the tenant or remains with the landlord. If the landlord has ownership of the fitout so that the only benefit to the tenant is the use of the fitout during the term of the lease, the benefit will be tax free.

Taxation Ruling IT 2631 paragraph 28, also requires consideration as to whether Entity A has a contractual right to remove Entity C's fit-out. Under the arrangement the Fitout Works (to the extent of the Landlord's Fitout Contribution) which are fixtures, will be paid for and owned by Entity C. Entity A will have no right to remove Entity C's fit-out during the term of Lease Y. Furthermore, on expiry or determination of Lease Y, Entity C will not transfer Entity C's fit-out to Entity A and as a consequence, Entity A will have no right to remove Entity C's fit-out.

If the only value provided to Entity A is the use of Entity C's fit-out, such a benefit will be effectively tax free by the operation of subsection 21A(3) of the ITAA 1936: Taxation Ruling IT 2631 paragraph 26.

Given that the ownership of Entity C's fitout will remain with Entity C and that the only benefit to Entity A will be the use of Entity C's fit-out during the term of the lease, the benefit that Entity A receives from Entity C's fit-out will be effectively tax free.