Edited version of your private ruling

Authorisation Number: 1012538065133

Ruling

Subject: Rental property

Question 1

Are you entitled to a deduction for all or part of the weekly option fees you pay under the option deeds?

Answer

No.

Question 2

Are you entitled to a deduction for the decline in value of the depreciating assets in the properties?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts and circumstances

You have entered into option agreements for properties.

Under each agreement:

· you have acquired an option to purchase the property from the legal owner at some time in the future but prior to the expiration of the option's term for a set price

· the owner of the property remains the legal owner

· you have the right to rent the property to a tenant as if you were the actual owner

· you receive any rental income from the property

· you must maintain insurance on the property and its contents

· you must pay and/or reimburse all outgoings for the property including rates, water, insurance and management costs

· you have the right to assign or nominate another purchaser in your place to purchase the property

· if you default on paying the weekly option fee the option will be terminated.

You paid an upfront fee to enter each option. You also pay an on-going weekly fee for the term of the option or until settlement. Both the upfront fee and a portion of the weekly fee are credited to the purchase price of the property if you exercise the option.

If you do not exercise the option to purchase the property, you will lose the option fee and all other monies paid.

You use the services of a property manager to manage the properties.

The weekly rent for each property is less than the weekly option fee.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 40-25

Income Tax Assessment Act 1997 Section 40-40

Income Tax Assessment Act 1997 Section 108-5

Reasons for decision

Summary

No deduction is allowable for the weekly option fee as it forms part of the purchase price of the option and is capital in nature. You are entitled to a deduction for depreciation on plant and equipment in the properties.

Detailed reasoning

Weekly option fee

Section 8-1 of the ITAA 1997 states you can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income, or

(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

However, you cannot deduct a loss or outgoing of a capital, private or domestic nature or where it relates to the earning of exempt income or a provision of the taxation legislation excludes it.

In your situation you are not the legal owner of the properties. However, the option agreements confer on you ownership rights (to receive rental income) and responsibilities (maintenance of the property, costs and insurances). Thus, it is considered that you are considered to be the economic or beneficial owner of the property.

Under the option agreements, you receive rental income which forms part of your assessable income. Outgoings incurred to obtain that rental income are deductible except where the outgoing is of a capital, private or domestic nature.

The guidelines for distinguishing between capital and revenue outgoings were laid down in Sun Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 23; (1938) 1 AITR 403. There it was pointed out that expenditure in establishing, replacing and enlarging the profit-yielding (ie business) structure itself was capital and is to be contrasted with working or operating expenses. The test laid down contained the following three elements, although none in itself is decisive:

(a) the nature of the advantage sought

(b) the way in which it is to be used or enjoyed, and

(c) the means adopted to get it.

Regarding the first two elements, the lasting or recurrent character of the advantage and the expenditure is important. The courts have held that, in the absence of special circumstances, expenditure is capital in nature where it is made to bring into existence an asset or an advantage (tangible or intangible) for the enduring benefit of the taxpayer (British Insulated & Helsby Cables v. Atherton (1926) AC 205). In addition it is the nature of the advantage sought by the taxpayer that is relevant.

The third element involves consideration of whether the outlay is a periodic one covering the use for the asset or advantage during each period, or whether the outlay is calculated as a single final provision for the future use or enjoyment of the asset or advantage.

Parts 3-1 to 3-5 of the ITAA 1997 discuss the tax rules regarding capital gains and losses. Section 108-5 of the ITAA 1997 defines a capital gains tax (CGT) asset as:

(a) any kind of property, or

(b) a legal or equitable right that is not property.

Note 1 to the section includes options as an example of a CGT asset.

The advantage conferred by the option agreement is the ability to purchase a property at an agreed price at some stage in the future. This advantage is considered of an enduring benefit to you - the ability to acquire an income producing asset.

The weekly option fees are considered to be part of the purchase price of the option as the option would be terminated if you failed to pay. Thus, the weekly option fees maintain the enduring benefit (ie the continued existence) of the option.

As the weekly option fees contribute to the enduring benefit of the option, they are capital in nature and not deductible under section 8-1 of the ITAA 1997. This cost will form part of the cost base when calculating your capital gain or loss.

Depreciation

Section 40-25 of the ITAA 1997 allows a deduction for the decline in value (depreciation) of a depreciating asset you hold, to the extent the asset is used for a taxable purpose.

The table in section 40-40 of the ITAA 1997 identifies who is the holder of a depreciating asset. Item 6 of the table provides that the economic owner is the holder of a depreciating asset where they:

(a) possess the asset, or an immediate right to possession

(b) have a right, the exercise of which would make them the legal owner (for example, an option to acquire the asset), and

(c) it is reasonable to expect the economic owner will become the holder by exercising that right.

You use the plant and equipment in the properties for rental purposes. You have a right to obtain legal title to them, through the option agreement. During the period the property is rented it is reasonable to expect that you would exercise this right.

You are considered to be the holder of the properties' depreciating assets under item 6 of the table in section 40-40 of the ITAA 1997. Therefore you are entitled to a deduction for the decline in value of the plant and equipment under Division 40 of the ITAA 1997.