Edited version of your written advice

Authorisation Number: 1012737950104

Ruling

Subject: Part IVA

Question

Is the scheme (the sale of a residential rental property to a family trust whereby the trust takes out a loan to partly fund the purchase) subject to the provisions of Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2015

The scheme commences on:

1 July 2014

Relevant facts and circumstances

You and your spouse bought a property on a double block after 19 September 1985. The property was originally built by a relative and there is an intention (because of this family connection) that the property be retained for future generations. The property was split at a date (Lot X and Lot Y) and a new dwelling was constructed on Lot Y whilst the property's original dwelling remained on Lot X. Shortly after you and your spouse moved into the new property on Lot Y. This dwelling was the sole principal residence of you and your spouse until its sale.

From shortly after it was vacated by you and your spouse, the dwelling at Lot X was rented to external clients. There is currently no outstanding loan in relation to the purchase of the property.

An as yet unincorporated and unnamed company intends to take out a loan in its capacity as trustee of an unnamed family discretionary trust (the Trust) to purchase the property from you and your spouse shortly. The loan will cover the majority of the purchase price. The sale of the property will be effected at market valuation and it is expected that there will be a capital gain made on the disposal by the clients. The remaining % of the purchase price will come from an interest free loan from you and your spouse.

The beneficiaries of the trust will be you, your spouse and your children.

It is expected that, to begin with, the property will be negatively geared and that this investment property will be the only asset/business activity of the trust. However, in the future (the next 1-3 years), it is anticipated that the trust will be used as the family's 'investment vehicle' and it will purchase shares. Further, it is anticipated there will be positive distributions made to the beneficiaries in the next five to ten years mainly due to expected rental income growth as the property is located in the inner city (an area expected to be become more popular).

You or your spouse operate a business. You are risk adverse and wish to protect assets (particularly the property due to the family connection) from business failure, relationship breakdowns and/or other unforeseen circumstances.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 Part IVA

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997

Under section 8-1 of Income Tax Assessment Act 1997 (ITAA 1997), interest on a loan taken out to purchase an income producing property is generally deductible if it is not private, domestic or capital in nature. In this case, the trust will incur loan interest expenses associated with the purchase of an income producing property so the interest will be deductible to the trust under section 8-1 of the ITAA 1997.

Part IVA of the Income Tax Assessment Act 1936

Part IVA of the ITAA 1936 applies to a scheme where, having regard to a number of objective factors or matters, it would be concluded that one of the scheme participants who entered into or carried out the scheme or any part of the scheme did so for the dominant purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme.

A 'scheme' is defined in subsection 177A(1) of the ITAA 1936. That definition is widely drawn and includes any agreement, arrangement, understanding, promise, undertaking, scheme, plan or proposal. The factual arrangement described above (i.e. the taking out of the loan to cover the majority of the purchase price, purchase of the property from you and your spouse, and the continuing rental of the property to external clients) will constitute a 'scheme'.

Under section 177C of the ITAA 1936 a tax benefit received in relation to a scheme will include an amount for a deduction being allowable where that deduction would not have been allowable, or might reasonably be expected not to have been allowable if the scheme had not been entered into.

Part IVA was amended in 2013 to insert section 177CB of the ITAA 1936 which applies in relation to schemes entered into after 15 November 2012. Under subsection 177CB(3) when postulating what might reasonably be expected to have occurred in the absence of a scheme, the alternative must represent a reasonable alternative to the scheme in the sense that it could reasonably take the place of the scheme.

In this case, a reasonable alternative to the proposed scheme would be for the trust to purchase an investment property from an unrelated party. You and your spouse could also sell the property to an unrelated third party.

Under this alternative postulate, the trust would still be entitled to a deduction for the interest expense on the rental property acquired, and you would still be in receipt of funds, being the proceeds from the sale of the property. Therefore, there is no tax benefit under the scheme.

Accordingly Part IVA of the ITAA 1936 will not apply.