Edited version of your private ruling

Authorisation Number: 1012541807201

Ruling

Subject: Commercial rental property lease surrender payment

Questions and Answers:

1. Is the surrender of lease payment made by your leasee to you assessable to the Trust on revenue account for taxation purposes (that is, is the Trust carrying on a business)?

No.

2. Is the surrender of lease payment made by your leasee to you assessable to the Trust on capital account under the capital gains tax (CGT) provisions for taxation purposes, and, if so, can the general 50% CGT discount under subdivision 115-A of the Income Tax Assessment Act 1997 (ITAA 1997) be applied to the net capital gain?

Yes.

This ruling applies for the following period:

Year ended 30 June 2013

The scheme commences on:

1 July 2012

Relevant facts and circumstances

You are the trustee for The Trust that owns one commercial property, which is used to generate rental income, as the Trust's primary source of income.

Post September 1985, the Trust acquired the commercial property, which comprised of a number of facilities and warehouses. Upon acquisition, you constructed another building, specifically for the needs of your tenant.

Recently, your tenant requested to surrender its interest under the lease. The Trust agreed.

In consideration for the Trust surrendering the lease, the tenant paid the Trust a surrender sum.

Since the property acquisition, the Trust has engaged and incurred considerable management fees to another entity, who manages the lease of the property, including collection of rents, attending to tenant queries (for example, repairs required) and advertising for tenants.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 115-25

Reasons for decision

Taxation Ruling TR 2005/6 is about lease surrender receipts and payments. Paragraphs 17 to 21 explain the tax consequences for a lessor who derives a lease surrender receipt.

In short, a lease surrender receipt of a lessor will constitute assessable income under section 6-5 of the ITAA 1997 if received in the ordinary course of carrying on a business of granting and surrendering leases.

Otherwise, the lease surrender receipt will constitute capital proceeds from the happening of CGT event C2 under section 104-25 of the ITAA 1997 in relation to ending of lessor's contractual rights under the lease agreement.

If CGT event C2 happens, subsection 115-25(3) of the ITAA 1997 does not exclude it from discount capital gain (when the capital gain results from the CGT event happening to a CGT asset that was acquired by the entity making the capital gain at least 12 months before the CGT event).

A view of the Commissioner about whether a rental property constitutes the carrying of a business or not is found in the Tax Office publication Rental properties 2011-12 (NAT 1729-6.2012), which, on page 4, states:

A person who simply co-owns an investment property or several investment properties is usually regarded as an investor who is not carrying on a rental property business, either alone or with the other co-owners. This is because of the limited scope of the rental property activities and the limited degree to which a co-owner actively participates in rental property activities.

For example, in the Federal Court of Australia case of Kennedy Holdings & Property Management Pty Ltd v. Federal Commissioner of Taxation 92 ATC 4918, it was ruled the company taxpayer, which co-owned one commercial rental property, was not carrying a business for income tax purposes because the freehold held in co-ownership was the income producing entity. In other words, the income was derived passively from the property rather than from any regular activity of the company.

Taxation Ruling IT 2423 is about whether rental income constitutes proceeds of a business for withholding tax purposes. It includes reference to the 1978 United Kingdom case of American Leaf Blending Co. Sdn Bhd v. Director-General of Inland Revenue (Malaysia) [1978] 3 All E.R. 1185, where the court decided the taxpayer company was carrying on a business because its "activity" comprised of it managing the rental of the factory area and warehouse of its former tobacco business to a number of tenants under a number of short term lease contracts, which also involved respective modifications and/or refurbishments of the property to suit the respective tenants. The fact that the taxpayer was a company strongly influenced the decision but was not, in itself, determinative.

In summary, whether a rental property owner is an individual, a trust or a company will not, in itself, necessarily determine whether they are carrying on a business of property rental or not.

In your case, the nature of the Trust rental activity is predominantly passive in nature. Apart from the initial management and modification of its commercial rental property, since the completion of the additional building, the Trust has engaged another entity to manage the lease of the property.

It follows the Trust is not carrying on a business of property rental and its lease surrender payment received represents capital proceeds for the happening of CGT event C2, for which it is entitled to discount capital gains under subdivision 115-A of the ITAA 1997.