Edited version of your private ruling

Authorisation Number: 1011935981742

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Ruling

Subject: Residency, rental losses, business expenses and non-commercial losses

Questions

Are you an Australian resident for income tax purposes for the year ended 30 June 2011?

Answer

Yes.

Are you entitled to claim the losses that you incurred from your investment property in the calculation of your taxable income for the 2010-11 financial year?

Answer

Yes.

Will your rental property losses be offset against your exempt income?

Answer

Yes.

Are you entitled to claim the loss that you incurred from your business in the calculation of your taxable income for the 2010-11 financial year?

Answer

No.

Will you be entitled to offset any capital loss from the sale of your rental property against your future taxable income?

Answer

No.

Can any CGT loss be carried forward until it is absorbed by any capital gains that you derive?

Answer

Yes.

Are you entitled to claim a deduction where you pay a reasonable amount to a related person for the services she provided during your absence from Australia?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 2011
The scheme commenced on

1 July 2010

Relevant facts

The arrangement that is the subject of the 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:

· your application for private ruling;

· additional information provided; and

· your 2009-10 income tax return

You have been working in another country as an employee.

The project you are working on is funded by an aid agency.

You have an aid visa.

You state that you cannot estimate the length of your stay as it is dependent on independent assessment, but that you intend to return to Australia to spend the rest of your life here after you finish your work there.

You state that the salary you earn from this employer is exempt from Australian tax.

You have lived outside Australia for more than 320 days during the 2010-11 financial year.

You have been renting in the overseas country until recently when accommodation was provided by your employer.

You have no assets in the other country except for your day-to-day living account with your bank.

You have a permanent place of residence in Australia where your family resides.

No members of your family accompanied you overseas, as:

· there is no certainty in your employment tenure there;

· your children are studying in Australia

· your spouse also works in Australia; and

· you do not consider the overseas country to be safe for your family as it has regular security issues.

You are a citizen of Australia.

You have no social or sporting connection with the overseas country.

You have other Australian income, including rental income from an investment property you own in Australia. This property is negatively geared and you have been incurring losses since you purchased the property.

You also have a business in Australia.

You collect GST from your clients and submit BAS to the ATO on a monthly basis.

Due to your overseas employment, the business has not taken off and you have been earning very little revenue. Since your relocation overseas, the work of the business has continued to be carried out in Australia primarily by a relative.

The work involves organising the paperwork, raising a few invoices, maintaining the computer and the files and updating the computerised monthly accounts.

The relative has also liaised with your investment property manager and tradesmen a few times.

You have paid your relative a lump sum amount in cash for the services provided, which was used for private purposes.

Some of the business related expenses have ceased, but a small amount (of business expenses) still continue.

Your business has made the following net profits in two of the four years since commencement: and losses in the other two.

Prior to your relocation overseas, you had sufficient taxable income to offset the losses you incurred from your business and your investment. However, during the 2009-10 financial year your taxable income was not sufficient to absorb all these losses. Your taxable income shown on your 2009-10 notice of assessment was zero.

During the 2010-11 financial year, the situation will be similar, that is, your losses from the investment and the business will exceed your taxable income from salary earned from your employer.

The current market value of your investment property is less than the money you owe and you expect to make a loss on sale.

Your adjusted taxable income for the 2010-11 financial year, which includes your foreign exempt income, is greater than $250,000.

The business failed the assessable income test, the profits test, the real property test and the other assets test in the 2010-11 financial year.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1),

Income Tax Assessment Act 1997 subsection 8-1,

Income Tax Assessment Act 1997 subparagraph 35-10,

Income Tax Assessment Act 1997 subparagraph 35-55 and

Income Tax Assessment Act 1997 section 26-35.

Reasons for decision

Residency

An Australian resident is defined in subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) to be a person who is a resident of Australia for the purposes of the Income Tax Assessment Act 1936 (ITAA 1936).

The terms 'resident' and 'resident of Australia', in regard to an individual, are defined in subsection 6(1) of the ITAA 1936. The definition provides four tests to ascertain whether a taxpayer is a resident of Australia for income tax purposes. These tests are:

1) residence according to ordinary concepts (primary test)

2) domicile and permanent place of abode test (first statutory test)

3) 183 day rule (second statutory test)

4) Commonwealth superannuation test (third statutory test)

The first two tests are the most applicable in deciding whether a person remains an Australian resident for taxation purposes in the case where the person leaves Australia temporarily and is not actually living in Australia during the year of income.

In your case, you do not qualify as an Australian resident for taxation purposes under ordinary concepts as you are not actually living in Australia during the period of appointment in the overseas country.

However, under the domicile and permanent place of abode test, a person will be a resident of Australia if he or she has an Australian domicile, unless the Commissioner of Taxation is satisfied that the person has established a permanent place of abode outside of Australia.

Taxation Ruling IT 2650 states at paragraph 10 that, 'In determining a person's domicile for the purposes of the definition of "resident" in subsection 6(1), it is necessary to consider the person's intention as to the county in which he or she intends to make his or her home indefinitely.'

You will retain an Australian domicile if, under the employment contract, you are to return to Australia at the end of the overseas appointment.

Where the taxpayer's domicile is in Australia, it is necessary to consider whether or not the taxpayer has established a permanent place of abode outside of Australia.

The leading case on whether a permanent place of abode is outside Australia is FC of T v. Applegate 79 ATC 4307; (1979) 9 ATR 899. The Federal Court said that in respect of the definition of 'resident', a permanent place of abode does not have to be everlasting or forever.

Taxation Ruling IT 2650, sets out the factors that are used to determine a taxpayer's permanent place of abode. These are summarised at paragraph 5 in the Ruling as:

(a) the intended and actual length of the taxpayer's stay in the overseas country;

(b) any intention either to return to Australia at some definite point in time or to travel to another country;

(c) the establishment of a home outside Australia;

(d) the abandonment of any residence or place of abode the individual may have had in Australia;

(e) the duration and continuity of the taxpayer's presence in the overseas country; and

(f) the durability of association that the individual has with a particular place in Australia.

In your case, your remuneration is paid by the Australian employer and you have assets in Australia, including a home which is lived in by your family and investment property.

You also operate a business in Australia.

By comparison, you have not demonstrated that a permanent place of abode has been established in the overseas country.

Accordingly, you remain an Australian resident for tax purposes under subparagraph (a)(i) of the definition of "resident" in subsection 6(1) of the ITAA 1936.

Losses from investment property (rental losses)

A rental property is negatively geared if it is purchased with the assistance of borrowed funds and the net rental income, after deducting other expenses, is less than the interest on the borrowings.

The overall taxation result of a negatively geared property is that a net rental loss arises. In this case, you may be able to claim a deduction for the full amount of rental expenses against your rental and other income (such as salary, wages or business income) when you complete your tax return for the relevant income year. Where the other income is not sufficient to absorb the loss it is carried forward to the next tax year.

However, carried-forward losses are offset first against any net exempt income and only then against assessable income. Losses must also be utilised in the order in which they were incurred.

Non-commercial losses

Losses from activities that do not meet any of the four tests under Division 35 of the ITAA 1997, or the exception in subsection 35-10(4) of the ITAA 1997, will be subject to the loss deferral rule in subsection 35-10(2) of the ITAA 1997, unless the Commissioner exercises a discretion under paragraph 35-55(1)(b) of the ITAA 1997 that it would be unreasonable to defer the loss.

For the 2009-10 and following income years, the introduction of the income requirement test means that individuals with an income for non-commercial loss purposes in excess of $250,000 for that year will not get access to the four tests.

You have satisfied the income requirement in subsection 35-10(2E) of the ITAA 1997 for the income year.

As you have not met one of the four tests, to be able to claim your losses in that year you have to be granted the Commissioner's discretion under section 35-55 of the ITAA 1997 or meet one of the exclusions.

As you have not requested the Commissioner's discretion under either subparagraph 35-55(1)(a) (special circumstances) or subparagraph 35-55(1)(b) (nature of your activity) of the ITAA 1997, or met one of the exclusions, you will have to defer your business loss from the 2010-11 financial year.

However, the amount of the loss that is deferred to future years is reduced by any net exempt income you have derived in the current or future years that has not already been offset against carry forward tax losses.

Capital losses

You may make a capital gain or capital loss when you sell (or otherwise cease to own) a rental property that you acquired after 19 September 1985.

You will make a capital gain from the sale of your rental property to the extent that the capital proceeds you receive are more than the cost base of the property. You will make a capital loss to the extent that the property's reduced cost base exceeds those capital proceeds.

You cannot deduct a capital loss from your income, but in most cases it can be used to reduce any capital gain you make in the same year or future years.

Business deductions - wages

In relation to an employee, section 8-1 of the ITAA 1997 allows a deduction for any loss or outgoing incurred in gaining or producing their assessable income to the extent that it is not of a private, domestic or capital nature.

In Wells v. FC of T 2000 ATC 2077; (2000) 45 ATR 1145 (Wells Case) the taxpayer was an employee of a bank. As a Business Development Manager he arranged loans on behalf of his employer. He was paid on a retainer plus commission basis.

The taxpayer employed a company which in turn employed his wife to perform all the necessary paperwork required for the loans.

The Administrative Appeal Tribunal allowed a deduction for the expense on the basis that there was a real connection between the services provided by his wife and the taxpayer's increased commissions. It also held that no part of the payment was a private expense.

In your case, you are able to generate business income due to the assistance provided by a relative. As such, there is sufficient connection between the assistance provided by the relative and the business income to conclude that the payments are incurred in gaining or producing your assessable income.

However, as the lump sum you paid your relative was also used to fund a trip for your relative for private purposes, some portion of the payment may be characterised as private in nature.

Section 26-35 of the ITAA 1997 limits the amount otherwise deductible for a payment made to a relative to so much of the amount as the Commissioner considers reasonable. If the amount paid to your relative is equivalent to an arm's length payment, that is what you would pay an unrelated party to do the work, the whole payment may be considered to be a reasonable amount.

As such, you are entitled to a deduction under section 8-1 of the ITAA 1997 for a reasonable amount of wages paid to your relative for assisting you with the work of your business in your absence.

Where the amount of assessable income is disproportionate to the level of expenses, it may be necessary to examine the circumstances surrounding the expenditure and the taxpayer's purpose or intention in incurring the expenditure to determine whether it is wholly deductible. Expenditure may have been incurred, in part, for a purpose other than the production of assessable income. If this is the case, the expenditure must be apportioned to the extent that the expenditure was incurred for the income producing purpose. Taxation Ruling TR 95/33 outlines the Commissioners view on the importance of subjective purpose, motive or intention in determining the deductibility of losses and outgoings.

The appropriate method of apportionment will depend on the facts of each case and the method must be both 'fair and reasonable' in all the circumstances (Ronpibon Tin NL & Tongkah Compound NL v. FC of T (1949) 78 CLR 47; (1949) 8 ATC 431). For example, in Fletcher v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613, the High Court suggested a 'commonsense' or 'practical' weighing of all the factors and in that case found that it was 'fair and reasonable' to limit the amount of the deduction to the amount of the assessable income actually received in that year.