Edited version of private ruling

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Ruling

Subject: Prepaid rent

Question:

Is the amount of prepaid rent assessable in the year of receipt where there is no provision for a pro-rata refund if the lease is terminated during the period covered by the pre-paid rent?

Answer:

Yes

This ruling applies for the following periods

Year ended 30 June 2010

Year ending 30 June 2011

The scheme commenced on

1 July 2009

Relevant facts and circumstances

You own an investment property and received a voluntary prepaid rent amount from your tenant.

The prepaid amount was for the period which covered two financial years.

The lease agreement between you and the tenant is silent about whether there is an obligation for any of the rent to be refunded if the lease is terminated early.

Reasons for decision

Subsection 6-5(2) of the Income Taxation Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Ordinary income is defined as income according to ordinary concepts. Factors like periodicity, recurrence, regularity or services performed have been identified by the courts as indicating that an amount is income according to ordinary concepts. However an amount received in a lump sum can also be ordinary income depending on the nature of the lump sum payment.

If the purpose of the lump sum payment is to provide a substitute for an income stream then that lump sum may take on the character of those payments it is intended to replace.

In the circumstances here the issue is whether this lump sum was intended to replace future rental income and whether it amounted to a lump sum payment of prepaid rent.

We can take some guidance on this issue from Taxation Ruling TR 2002/14 which deals with the characterisation of receipts on the granting of occupancy rights in the context of retirement villages. Although this ruling applies to the taxation of retirement village operators the principles discussed in determining whether an amount is pre paid rent are relevant here.

Where:

· a person is prepared to make a lump sum payment in exchange for the right to occupy a dwelling for a fixed term

· the person is entitled to receive a pro-rata refund for the unexpired portion of the term (if any); and

· the intention of the parties is that the lump sum payment in advance is for the use and enjoyment the dwelling for the fixed term,

the payment should generally be accounted for as rent in advance and be brought to account over the period for which the payment is made. For example if you are paid a lump sum of $12,000 in lieu of a monthly rent of $100 under a 10 year lease and the tenant is entitled to a pro-rata refund of this lump sum should the lease be broken early you would return the rent as income of $1,200 each year over the term of the lease in accordance with the principles laid down in Arthur Murray (NSW) Pty Ltd v. Federal Commissioner of Taxation 114 CLR 314; 14 ATD 98; (1965) 9 AITR 673.

However, amounts representing rent in advance that are non-refundable are assessable in full in advance (Paragraph 23 of TR 2002/14).

In your case it is accepted that the lump sum payment is as consideration for rent under the lease. However the Residential Tenancy Agreement does not indicate that any rent paid in advance may be refundable.

Where there is no provision for a pro-rata refund to the tenant if the lease is terminated early the prepayment is assessable in the year of income in which it was received.