Edited version of your written advice

Authorisation Number: 1012725491245

Ruling

Subject: Rental property arrangements

Questions

Does the net rental income derived by a trust in relation to a residential rental property that will be leased on a market value basis to the directors of the trustee company form part of the assessable income of the trust?

Answer:

Yes

Will Part IVA of the ITAA 1936 be applied to deny some or all of the deductions otherwise allowable in deriving rental income?

Answer:

No

This ruling applies for the following periods

Year ended 30 June 2015

The scheme commenced on

1 July 2016

Relevant facts

You are the corporate trustee of a discretionary trust of which A and B are beneficiaries. A and B are also your directors and shareholders.

The trust derives its income from dividends and the rental of properties.

The trust purchased land with the intention of building residential premises to derive rent from unrelated parties. A and B intended to remain in their current main residence.

You used the land as security to borrowed a percentage of the value of the land from a commercial bank to purchase it and the deposit; the balance of the purchase price was provided from the trust's cash reserves and existing lines of credit.

During the process of drafting plans for the new residential building the possibility of having ancillary accommodation on the land arose and the intention is to build this as well and rent it to B's relative at market value.

With the drafting of the building plans nearing completion, A and B have determined that they would like the opportunity to live in the building upon its completion.

In this regard, A and B will be the tenants of the property under a 12 month lease with an option to renew.

Rent will be based on market rates and the rental will be managed by the real estate agent that manages the current residential rental property owned by A. Their children will also reside at the property and their current main residence will be rented to unrelated tenants using the same real estate agent as manages the rental property of A.

The intention is to carry out the rental arrangement indefinitely or until the property is sold.

The trust will have the cash flow to finance the arrangement without needing additional payments from the beneficiaries/tenants.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 section 177A

Income Tax Assessment Act 1997 section 177F

Income Tax Assessment Act 1997 section 177C

Income Tax Assessment Act 1997 paragraph 177D(b)).

Income Tax Assessment Act 1997 paragraph 177D(b)).

Reasons for decision

Under section 6-5 of the ITAA 1997, the assessable income of the trust estate consists of all the statutory and ordinary income earned by the trust property.

Returns in the nature of capital invested, such as rent, are income according to ordinary concepts and will be assessable income unless they are expressly or impliedly excluded by a provision of the ITAA 1997.

Taxation Ruling IT 2167 looks at the situation of rental properties and whether the income is assessable. Paragraphs 4 and 5 of IT 2167 states

4. The second point to be made is that, ordinarily, where a taxpayer grants a lease or licence of property, whether wholly or in part, whether at arms-length or otherwise, the amount received as rent or in respect of the licence is assessable income. This is illustrated by the decision in FCT v Kowal, 84 ATC 4001: 15 ATR 125.

5. It is necessary to make the qualification "ordinarily" because some cases may arise, particularly where the arrangements are not at arm's length, where an amount described as or said to be rent is not of income nature and, therefore, not assessable income. In FCT v Groser, 82 ATC 4478: 13 ATR 445, for example, the taxpayer permitted his invalid brother to live in a house which the taxpayer owned. The taxpayer arranged to receive his brother's invalid pension so that he could use the moneys to provide for the brother's maintenance. It was arranged that $2 per week would be deducted for rent of the taxpayer's house. The Court held that the weekly amounts of $2 were not assessable income. They were a contribution to the funds out of which the taxpayer proposed to maintain his brother. The arrangements were simply not of a kind which produced a receipt of income as that term is normally understood.

Paragraph 5 of IT 2167 looks at the situations where the receipts are either way below arm's length or have been calculated using a methodology that is not analogous to a weekly rental.

Federal Commissioner of Taxation v. Janmor Nominees Pty Ltd (1987) 75 ALR 15; (1987) 15 FCR 348;19 ATR 254;87 ATC 4813 also considered the situation whether the rent received from a residential property rented by a trust to associates at a market rate constitutes assessable income. The Full Court held that the rental receipts did constitute assessable income to the trust.

You have stated that you will rent the property to A and B for a commercial rent, through a real estate agent, in the same manner that you would a non-director/beneficiary. Accordingly, the rental income earned from the investment property will form part of the assessable income of the trust estate.

Application of Part IVA 

Part IVA of the ITAA 1936 is a general anti-avoidance provision that can apply in certain circumstances. Part IVA gives the Commissioner the power to cancel a 'tax benefit' (or part of a 'tax benefit') that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies.

In broad terms, Part IVA will apply where the following requirements are satisfied:

• there is a scheme (see section 177A)

• a taxpayer has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme (see section 177C) and

• the dominant purpose of a person who entered into or carried out the scheme, or any part of the scheme, was to enable the relevant taxpayer to obtain a tax benefit in connection with the scheme, or to enable the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (paragraph 177D(b)).

The application of Part IVA depends on a careful weighing of all the relevant facts and surrounding circumstances of each case.

In your case, what you are proposing is a 'scheme' capable of attracting the operation of Part IVA. However, when considered in conjunction with the factors in paragraph 177D(b) of the ITAA 1936, all these factors either point against the application of Part IVA or are neutral. Therefore, Part IVA will not apply to this arrangement.