Edited version of private ruling

Authorisation Number: 1011730555200

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Ruling

Subject: House provided to Individual

Issue 1

Question 1

Is the provision of a house an exempt benefit under section 58ZC of the Fringe benefits Tax Assessment Act 1986 (FBTAA)?

Answer

No.

This ruling applies for the following periods:

Year ended 31 March 2011

Year ended 31 March 2012

Year ended 31 March 2013

Year ended 31 March 2014

The scheme commences on:

1 December 2010

Issue 2

Question 1

Are the interest expenses incurred under a loan agreement deductible to the extent that they relate to borrowings for the house under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will Division 40 of the ITAA 1997 apply to the purchase of the solar hot water system installed at the house?

Answer

No.

Question 3

Will Division 43 of the ITAA 1997 apply to the construction of the house?

Answer

No.

Question 4

Are 100% of the electricity expenses incurred in respect if the house deductible under section 8-1 of the ITAA 1997?

Answer

No.

Question 5

If the answer to question 4 is no, are electricity expenses incurred in respect of the house deductible to the extent that the expenses relate to the farming enterprise under section 8-1 of the ITAA 1997?

Answer

Yes.

Question 6

Is the taxpayer entitled to claim a deduction for rates in respect of the house under section 8-1 of the ITAA 1997?

Answer

Yes, but only to the extent they relate to the farming enterprise.

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

The scheme commences on:

1 July 2010

Relevant facts and circumstances

The Trust runs a farming enterprise which for the purposes of the FBTAA is in remote area.

The Trust constructed a four bedroom residence at that property for Individual A to reside in. The Trust also pays all the ongoing expenses in respect of the house.

Prior to this our records show that Individual A resided at another residence owned by the Trust which had previously been listed in our records as the Trust's business address. This house is not in a remote area for the purposes of the FBTAA.

The trust's latest income tax return does not list any fringe benefits tax (FBT) employee contributions and the Trust is not currently registered for FBT

Individual A is the only employee of the Trust, is a primary beneficiary of the Trust and a Trustee of the Trust.

Individual A is also employed by another employer.

Individual A's spouse also resides in this house and is also a beneficiary of the Trust and the other Trustee of the Trust.

No housing is provided to any other beneficiaries of the Trust.

Employment Conditions

A one page employment agreement was provided. It listed a set amount of salary and specifically referred to the house. The document did not contain any conditions attached to the use of the house.

Trust Deed

The trust deed contains a clause allowing beneficiaries to use trust property at the discretion of the Trustee. The deed also required Trustees to act jointly.

Electricity account

Only one electricity connection used for the entire property.

Hot water system

This was purchases and is attached to the home.

Relevant legislative provisions

Section 58ZC of the FBTAA

Subsection 136(1) of the FBTAA

section 160ZH of the Income Tax Assessment Act 1936 (ITAA 1936)

subsection 318(3) of the ITAA 1936

section 4-5 of the ITAA 1997

section 8-1 of the ITAA 1997

Division 40 of the ITAA 1997

section 40-25 of the ITAA 1997

Division 43 of the ITAA 1997

section 43-170 of the ITAA 1997

section 960-100 of the ITAA 1997

Section 995-1 of the ITAA 1997

Issue 1

Question 1

Is the provision of a house an exempt benefit under section 58ZC of the FBTAA?

Summary

The benefit was not provided in respect of employment but is provided to Individual A in his capacity as a beneficiary. As a result a fringe benefit as defined in subsection 136(1) of the FBTAA does not arise in this case.

However had a fringe benefit arisen the exemption in section 58ZC of the FBTAA would not have applied as the provision of the benefit would not have been provided under an arm's length arrangement.

Detailed reasoning

For a benefit to be a fringe benefit as defined in subsection 136(1) of the FBTAA the benefit has to be provided in respect of a person's employment.

It was determined in J & G Knowles & Associates Pty Ltd v. Commissioner of Taxation (2000) 96 FCR 402; 2000 ATC 4151; (2000) 44 ATR 22 (Knowles Case) that there has to be more than a causal employer employee relationship for a fringe benefit to arise. To be a fringe benefit there has to be a 'nexus, some discernible and rational link, between the benefit and employment' for it to be a fringe benefit. If in looking at the benefit we cannot establish this nexus between the benefit and the employment the benefit is not a fringe benefit.

Where a person is simply an employee and there is no other capacity for which a benefit could be provided then it is easy to conclude that the benefit is provided in respect of employment. However in this case Individual A is a beneficiary of the Trust and is also a trustee of the Trust. As a result there is more than an employer employee relationship and if the required nexus cannot be established the benefit will not be a fringe benefit.

The employment agreement specifically refers to the house however the trust deed allows the Trustee to let a beneficiary use trust property. Therefore even if Individual A was not an employee of the trust, the trust deed provides for use of the house by Individual A as a beneficiary.

There is a general rule in paragraph 19 of Miscellaneous Taxation Ruling MT 2019 regarding employees who are also shareholders. This paragraph states in part:

As a general rule, where there are no facts or circumstances which positively indicate that a loan to a shareholder/employee is associated with that person's employment and the loan is consistent with his or her status as a shareholder, it would ordinarily be inferred that the loan was made by virtue of the shareholding. . .

Although referring to a loan and shareholding, this conclusion can be expanded to any benefit that could be provided to a person with two roles. If there is insufficient evidence to show the benefit is provided in respect of employment it will be inferred that the benefit is provided by virtue of Individual A's status as a beneficiary.

Normally to make this comparison we would look at whether similar benefits are provided to other employees, however this cannot be done as Individual A is the only employee. In addition we would also look at whether similar benefits are provided to other beneficiaries, but the only other comparable beneficiary is Individual A's spouse who also lives at the property.

The current arrangement does not provide conclusive evidence either way as to why the house was provided. However if we look back at how benefits provided to Individual A were treated in the past this would give us an indication of how this benefit should be treated.

Before moving Individual A resided in another residence owned by the Trust. This residence is not in a remote area and if provided in respect of employment would not have been exempt under section 58ZC of the FBTAA.

In looking at the Income Tax return lodged it did not include (as income) any amount in respect of employee contributions towards the provision of a fringe benefit. In addition the Trust did not lodge an FBT return in respect of the use of that residence.

These factors indicate that earlier housing provided by the Trust was not considered to have been provided in respect of employment. Unless there is compelling evidence to suggest otherwise the house provided now is a continuation of the benefit previously provided.

In looking at the employment agreement it does no more that state the address of the house. It does not provide for any limitation of the use of that property. For example the agreement does not require Individual A to vacate the house on cessation of employment.

The fact that Individual A has lived in Trust property in the past without FBT being accounted for does demonstrate the use of a residence of the Trust in a capacity other than that of an employee.

Therefore following the decision in Knowles case and the general rule contained in paragraph 19 of MT 2019 we would have to conclude that the ability to use the house is an extension of the benefits previously enjoyed and therefore provided to Individual A in their capacity as a beneficiary.

Arm's length Arrangement

For the exemption under section 58ZC of the FBTAA to apply all of the conditions contained in the section need to apply. One of these conditions is that the housing right has to be provided under an arm's length arrangement. Nor can it be an arrangement entered into by any of the parties for the purpose of obtaining the exemption.

As Individual A has signed the employment agreement as both employer (as Trustee) and the employee we need to look at whether this agreement was entered into at arm's length. The expression 'at arm's length' is defined in The CCH Macquarie Concise Dictionary of Modern Law , 1988, CCH Australia Ltd/ Macquarie Library Pty Ltd, Sydney as meaning that the parties to a transaction are not connected in such a way as to bring into question the ability of one to act independently of the other.

In Granby Pty Ltd v. FCT (1995) 30 ATR 400; 95 ATC 4240, where the expression 'dealing with each other at arm's length' in section 160ZH of the Income Tax Assessment Act 1936 (ITAA 1936) was in question, Lee J said (at ATR 403; ATC 4243):

The expression "dealing with each other at arm's length" involves an analysis of the manner in which the parties to a transaction conducted themselves in forming that transaction. What is asked is whether the parties behaved in the manner in which parties at arm's length would be expected to behave in conducting their affairs. Of course, it is relevant to that enquiry to determine the nature of the relationship between the parties, for if the parties are not parties at arm's length the inference may be drawn that they did not deal with each other at arm's length.

Clearly there is not an arm's length arrangement in place as there is only one party to the agreement. However, the exemption can still apply if the agreement is seen to be have been made at arm's length. To do this we need to look at whether Individual A acted in a way in which two separate parties would have acted. In other words would this agreement have been entered into if Individual A (as an employer) was dealing with an unrelated third party being offered employment?

In returning to the employment agreement (which is the only evidence of employment), the one page document has an extensive list of duties to be performed which provides a flat rate of salary. It does not list the time Individual A has to spend performing those duties. An employee dealing at arm's length with an employer would either want to be remunerated for the work actually being performed and if being offered a flat rate know in advance the hours they need to work to receive that flat amount.

The agreement does not place any compulsion on Individual A (as an employee) to abide by the agreement. For example it requires Individual A to perform certain tasks but at the same time Individual A is free to be employed by another employer. If the agreement was a true arm's length employment agreement an employee would expect remuneration for these tasks and because of the nature of the tasks the employer would ensure that the employee was performing those tasks (which would make it difficult for Individual A to be employed elsewhere).

Therefore the employment agreement entered into is not an agreement that would be entered into under an arm's length employee/employer relationship and therefore any housing provided under the agreement is also not at arm's length.

Individual A was already residing in Trust owned property before the house was built and there is nothing provided that would suggest that Individual A would not have continued to live in Trust owned property if not an employee. This further suggests that the decision to provide the house was not made as part of an arm's length employment agreement.

The previous house (if provided in respect of employment) would not have been eligible for the section 58ZC of the FBTAA exemption because it was not in a remote area. However this house is in a remote area. This raises the question as to whether the reason for providing the new house under the employment agreement whilst the old house was not provided under an employment agreement was for the purpose of obtaining the exemption.

As we do not consider the employment agreement to have been made at arm's length we do not need to look at whether the reason for placing the house under that agreement was for the purpose of gaining the exemption.

Issue 2

Question 1

Are the interest expenses incurred under a loan agreement deductible to the extent that they relate to borrowings for the house under section 8-1 of the ITAA 1997?

Summary

No as the house was built specifically for a beneficiary of the Trust to reside in, a deduction is not allowed.

Detailed reasoning

Section 8-1 of the ITAA 1997 allows a taxpayer to deduct from their assessable income any loss or outgoing incurred in producing their assessable income.

In this instance we have interest expenses incurred on money borrowed to build a house. The house is being provided for the use of a beneficiary and is not being provided to that person in respect of their employment.

In respect of beneficiaries living in a house owned by a trust, paragraphs 29 and 30 of Taxation Ruling IT 2167 Income Tax: Rental Properties - Non-economic Rental, Holiday Home, Share of Residence, Etc Cases Family Trust Cases, under the heading 'Purchase of a residence by a family trust and the subsequent leasing of it to family beneficiaries in the trust', looked at income tax deductibility where a family trust is established to acquire the private residence of the beneficiaries of the trust. These paragraphs state:

Situations under this heading are designed to obtain an income tax deduction for losses and outgoings which would otherwise be characterized as private or domestic expenditure. By way of illustration, a family trust may be established to acquire what is in fact the private residence of the beneficiaries of the trust. Financial arrangements for the purchase of the residence by the trustee may be highly geared. The trustee will let the residence to one or both parents at a commercial rental and the family would occupy the residence as the family home. The trustee lodges a return of income disclosing the rental as assessable income and claiming income tax deductions for the losses and outgoings attributable to the residence. Income from other sources is channelled into the trust to absorb the losses arising from the rental of the residence to the parents.

In situations such as this it is apparent that, had the parents acquired the residence in their own right, the losses and outgoings attributable to the residence would not have been allowable as income tax deductions - they would have been private or domestic expenditure. In cases of this nature that have arisen, the deductions claimed by the trustee have been reduced. A case in point has been heard by a Taxation Board of Review and is currently awaiting decision. In the meantime it should not be accepted in cases of this nature that the rent payable by the parents is assessable income of the trustee or that the losses and outgoings attributable to the residence are allowable as income tax deductions.

Although the Trust was not set up to provide a house to beneficiaries, the house in question was built specifically for Individual A to reside in. Had Individual A acquired this house in his or her own right there is no evidence to demonstrate that any losses and outgoings attributable to the residence would have been allowable as income tax deductions.

Therefore a deduction is not allowable under section 8-1 of the ITAA 1997 as the interest expenses on the house are not being incurred in producing assessable income of the Trust. The house is used to provide private benefits to a beneficiary of the Trust.

Question 2

Will Division 40 of the ITAA 1997 apply to the purchase of the solar hot water system installed at the house?

Summary

No a deduction is not allowed as the solar water system is not being used to produce assessable income of the Trust.

Detailed reasoning

Division 40 of the ITAA 1997 allows for an income tax deduction for the decline of value of a depreciated asset (see subsection 40-25(1) of the ITAA 1997).

However this deduction is reduced by the part of the asset's decline that is not used for a taxable purpose (see section subsection 40-25(2) of the ITAA 1997).

Subsection 40-25(7) of the ITAA 1997 defines a taxable purpose as:

(a) the *purpose of producing assessable income; or

(b) the purpose of *exploration or prospecting; or

(c) the purpose of *mining site rehabilitation; or

(d) *environmental protection activities.

Section 995-1 of the ITAA 1997 defines the purpose of producing assessable income as:

something is done for the purpose of producing assessable income if it is done:

(a) for the purpose of gaining or producing assessable income; or

(b) in carrying on a *business for the purpose of gaining or producing assessable income.

Given that the system is attached to the house we also need to address subsection 40-30(4) of the ITAA 1997 which states:

Whether a composite item is itself a depreciating asset or whether its components are separate depreciating assets is a question of fact and degree to be determined in the light of all of the circumstances of the particular case

A test used in determining that outcome is a test of function, the functional test.

The Commissioner's views as to the application of the functional test are set out in Taxation Ruling TR 94/11. Some of the factors to be considered in applying the functional test include:

§ being separately identifiable

§ being capable of performing its own separate function, and

§ the item varies the performance of another item.

A solar hot water system does all of the above and although part of the house is separate depreciating asset from the house.

By extension to the reasoning in paragraph 30 of IT 2167 quoted above there is no evidence to demonstrate that the use of a separate asset attached to a house (in this case the solar hot water system) would have been used in producing assessable income if Individual A had installed it in his or her own right.

Question 3

Will Division 43 of the ITAA 1997 apply to the construction of the house?

Summary

No a deduction is not allowed as the house is being used as a residence of the Trustee and section 43-170 of the ITAA 1997 operates to deny a deduction.

Detailed reasoning

Division 43 of the ITAA 1997 allows for a deduction of certain capital expenditure on assessable income producing buildings.

As stated above the application of paragraphs 29 and 30 of Taxation Ruling IT 2167 would deny a deduction as the house is not being use to produce assessable income (a requirement under section 43-140 of the ITAA 1997).

However in addition to this section 43-170 of the ITAA 1997 states:

43-170(1)

A part of capital works, other than a *hotel building or an *apartment building, is taken not to be used for the *purpose of producing assessable income if that part is for use mainly for, or in association with, residential accommodation by you or an *associate.

43-170(2)

Subsection (1) does not apply to use by an *associate under an *arrangement:

(a) to which you and the associate are parties; and

(b) that is of a kind that the parties could reasonably be expected to have entered into if they had been dealing with each other at arm's length; and

(c) that was not entered into for the purpose of obtaining a deduction under this Division.

43-170(3)

If property that constitutes the whole or part of capital works, other than a *hotel building or an *apartment building, is part of an individual's home, the property is taken to be used, or for use, wholly or mainly for or in association with residential accommodation.

The meaning of 'you' is explained in section 4-5 of the ITAA 1997 and states:

If a provision of this Act uses the expression you, it applies to entities generally, unless its application is expressly limited.

An entity as defined in section 960-100 of the ITAA 1997 to include a trust, however subsection 960-100(2) states:

The trustee of a trust, of a *superannuation fund or of an *approved deposit fund is taken to be an entity consisting of the person who is the trustee, or the persons who are the trustees, at any given time.

As a trustee of the Trust, Individual A is the 'you' referred to in subsection 43-170(1) of the ITAA 1997. Because Individual A uses the house as their own residential accommodation section 43-170 of the ITAA 1997 will apply to deny a deduction.

Given the building is a four bedroom house and is being used as a home under subsection 43-170(3) of the ITAA 1997 the whole house is to be taken as being used, or for use, wholly or mainly for or in association with residential accommodation even if part of it is used in the farming business.

It is noted that Individual A as a beneficiary is also an associate of the other trustee as defined in subsection 318(3) of the ITAA 1936, but section 43-170 of the ITAA 1997 does not require a determination as to in what capacity the house is provided. The fact that Individual A is a trustee will deny the deduction.

Question 4

Are 100% of the electricity expenses incurred in respect if the house deductible under section 8-1 of the ITAA 1997?

Summary

No, as some of the electricity costs were incurred in providing accommodation to Individual A.

Detailed reasoning

For 100% of an expense to be deductible under section 8-1 of the ITAA 1997 the expense needs to have been incurred wholly in earning assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

The courts have considered the meaning of 'incurred in gaining or producing assessable income'. In Ronpibon Tin NL Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431 (Ronpibon Tin) the High Court stated that:

   For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end. The words "incurred in gaining or producing the assessable income" mean in the course of gaining or producing such income.

As explained above in our answer to Issue 2 Question 1 the house is not being used to produce assessable income (either as a rental accommodation or to an employee in respect of their employment) it is being provided to a beneficiary of the Trust as their home.

As there is only one electrical account for the entire property the portion of that account that relates to the provision of the electricity to the house is not deductible.

Note: had we concluded in Issue 1 Question 1 that the house was provided in respect of employment then the electricity provided as part of the use of that house would also have been in respect of employment. However there would have been a corresponding fringe benefit in respect of that electricity which is treated separately from the housing benefit under the FBTAA (see ATO ID 2004/276).

Question 5

If the answer to question 4 is no, are electricity expenses incurred in respect of the house deductible to the extent that the expenses relate to the farming enterprise under section 8-1 of the ITAA 1997?

Summary

Although the amount has not been quantified, a deduction would be available to the extent that the electricity expenses were incurred in producing the assessable income of the farming enterprise.

Detailed reasoning

Under section 8-1 of the ITAA 1997 a deduction can be claimed for an expense incurred in producing assessable income.

In our answer to Issue 2 Question 4 we concluded that the portion of the electricity expenses in respect of the private use of the house are not deductible.

However a deduction would be allowable to the extent that the electricity was used to produce assessable income.

Ronpibon Tin expressed the view that '... there are at least two kinds of items of expenditure that require apportionment'. These were generally: those items that are capable of dissection; and those that cannot be dissected but should be apportioned on the basis that they serve more than one object indifferently.

As there is only one electrical account the expense serves more than one object. One is to provide a home to a beneficiary the other is in respect of running the farm. You will need to apportion this account to determine the extent to which electricity relates to producing the assessable income of the farming enterprise.

Question 6

Is the taxpayer entitled to claim a deduction for rates in respect of the house at under section 8-1 of the ITAA 1997?

Summary

The portion of rates that relate to the provision of the house is not deductible.

As explained in the answer to Issue 2 Question 5 you will need to determine to what extent the rates can be attributable to the producing the assessable income of the farming enterprise. The portion that can be attributed to the farming enterprise is the amount that would be deductible under section 8-1 of the ITAA 1997.