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Ruling

Subject: Taxation treatment under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) and 21A of the Income Tax Assessment Act 1936 (ITAA 1936) of a lease incentive (fit-out contribution).

Question 1:

Will the Applicant be required to include an amount equal to the Developer's Fit-out Contribution in its assessable income pursuant to section 6-5 of the ITAA 1997, provided that it will be wholly used towards the cost of the fit-out works?

Answer:

No

Question 2:

Will the Fit-out Contribution or the provision of the Developer's Fit-out be considered a non-cash business benefit under section 21A of the ITAA 1936?

Answer:

Yes

Question 3:

Where the Fit-out Contribution or the provision of the Developer's Fit-out is considered a non-cash business benefit under section 21A of the ITAA 1936, will the amount of income derived by the Applicant be reduced to Nil under subsection 21A(3) of the ITAA 1936?

Answer:

Yes

This ruling applies for the following periods:

1 October 2011 to 30 September 2030

The scheme commenced on:

1 October 2011

Relevant facts and circumstances

The Applicant is requesting a private ruling in relation to the tax treatment of a lease incentive (Fit-out Contribution) offered by the Developer, under section 6-5 of the ITAA 1997 and 21A of the ITAA 1936.

The Applicant has supplied the following relevant background facts:

· The Applicant executed an Office Agreement for Lease (the Agreement) with The Developer for a building on 21 June 2012.

· As part of the Agreement, the Developer has agreed to provide the Applicant with the Fit-out Contribution.

As defined under the Agreement, the term "Fit-out" means:

· the fit-out work to be carried out by The Developer within the building;

· the integrated services including the work, materials, systems and equipment necessary to accommodate the services required by the fit-out works; and

· the ancillary signage works.

The Fit-out Contribution will be used towards the costs of the fit-out works.

To the extent that the aggregate costs of the fit-out works exceed the Fit-out Contribution, the Applicant will pay the excess amount to the Developer after the costs are verified by an independent certifier.

The ownership of the fit-out will be determined in accordance with the Agreement. the Developer will own the fit-out that is paid for out of the Fit-out Contribution and the Applicant will own the fit-out that is paid by the Applicant.

The Agreement also provides that to the extent that the Fit-out Contribution amount exceeds the aggregate costs of the fit-out works, the Developer must pay the residual balance of the Fit-out Contribution amount, at the election of the Applicant:

· a lump sum cash payment; and/or

· a rent abatement over 5 years.

In this case, all of the fit-out will be owned by the Developer.

In relation to the proportion of the fit-out works belonging to the Developer:

The title to the fit-out remains with the Developer from its installation in the building

The Applicant must obtain the Developer's approval to alter, remove and dispose of the fit-out; and

If the Applicant disposes of an item of fit-out, the Applicant must remit any proceeds from the disposal (if there are any such proceeds) to The Developer

The ruling is to apply for 19 years; this covers the period of the lease, including the execution date of the agreement (i.e. 21 June 2012).

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 21A of the Income Tax Assessment Act 1936

Reasons for decision

Question 1:

Section 6-5 of the ITAA 1997 sets out the basic rules relating to ordinary income. Under the general principles, a benefit is not income within the ordinary meaning of that term unless it consists of cash or is capable of being converted into cash.

According to the Lease Agreement entered into between the Applicant and the Developer for the building, the Developer will provide the Applicant with a lease incentive in the form of a Fit-out Contribution.

Based on the information provided by the Applicant, if the fit-out contribution is wholly used towards the cost of the fit-out, the fit-out will be owned by the Developer and the Applicant will have the use of the fit-out for the duration of the lease.

Federal Commissioner of Taxation v. Cooke and Sheldon 80 ATC 4140 considered the question of cash convertibility of a benefit. In that case the Full Federal Court decided that the benefit of the free holiday provided to the taxpayer was not income because it could not be converted into cash or transferred to anyone else.

As the benefit of using the fit-out during the term of the lease is not convertible to cash, it is considered that it does not have an income character according to ordinary concepts. Accordingly, such a benefit will constitute a non-cash benefit. Therefore, the incentive provided to the Applicant in the form of fit-out contribution by the Developer is not assessable income pursuant to section 6-5 of the ITAA 1997.

Question 2:

Subsection 21A(1) of the ITAA 1936 provides that any non-cash business benefit (which is not convertible to cash) that is provided to a taxpayer in the context of a business relationship, shall be treated as convertible into cash for the purpose of determining the income of a taxpayer.

Subsection 21A (5) of the ITAA 1936 defines a 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.

As the lease agreement between the Developer and the Applicant constitutes a business relationship between the two parties, the fit-out contribution provided by the Developer is considered to be a non-cash business benefit pursuant to section 21A of the ITAA 1936.

Question 3:

Subsection 21A(2) of the ITAA 1936 specifies the manner in which the amount of the aforesaid income is to be determined. Essentially, the arm's length value of the non-cash benefit is included in the assessable income of the taxpayer. This amount is reduced by any amount paid as consideration for the benefit by the taxpayer.

Subsection 21A(2)(b) of the ITAA 1936 provides that if a benefit is not convertible to cash, in determining the arm's length value of the benefit, any conditions that would prevent or restrict the conversion of the benefit to cash shall be disregarded.

Subsection 21A(3) of the ITAA 1936 provides that where the non-cash benefit is income derived by a taxpayer in a year of income and if the taxpayer had, at the time the benefit was provided, incurred and paid unreimbursed expenditure in respect of the provision of the benefit equal to the amount of the arm's length value of the benefit, a once-only deduction would have been allowable to the taxpayer in respect of the deductible percentage of the expenditure.

Taxation Ruling IT 2631 addresses the treatment of free fit-outs provided as lease incentives. Paragraph 25 and 26 state that the tax consequences will depend upon the ownership of the lease. That is, if a landlord has the ownership of the fit-out, then the only benefit to the tenant is the use of the fit-out during the term of the lease. The value to the tenant in this instance will be equal to a reduction in rent. Payments for the use of the fit-out, as with rental payments, would generally have a revenue character and be fully deductible. Accordingly, such benefit will be effectively tax-free by the operation of subsection 21A(3).

Therefore as the Developer will have the ownership of the fit-out and the only benefit to the Applicant equivalent to a reduction in rent, the Fit-out Contribution will be effectively tax-free pursuant to subsection 21A(3).