Edited version of your written advice

Authorisation Number: 1012746195222

Ruling

Subject: NRAS deductions and definition of income of a trust estate

Question 1

Is the rent payable to the owners of properties subject to the National Rental Affordability Scheme (NRAS) under a head lease agreement fully deductible?

Answer

No.

Question 2

Can your trust estate income include refundable tax offsets and State Government NRAS contributions?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2013

Year ended 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

Year ending 30 June 2020

The scheme commences on:

1 July 2012

Relevant facts and circumstances

You are a discretionary trust and a member of a NRAS consortium. The members of the consortium include an entity that is the eligible participant and that has obtained NRAS certificates in relation to the subject properties. Investors who own the rental properties and lease them to you under a head lease agreement and you then sub-lease the properties to tenants who meet the NRAS income requirements.

You receive NRAS rental income from the tenants pursuant to sub-lease agreements. You also receive State Government NRAS contributions and are entitled to NRAS tax offsets. You pay rent to the investors pursuant to the head lease agreements.

Your trust deed defines income as the net income of the trust as defined in section 95(1) of the ITAA 1936, but is subject to Clause X of the trust deed that states the trustee may adopt another definition of the 'income of the trust fund'.

Accordingly, your trustee has defined net income as defined in section 95 together with refundable tax offsets to which the trust is entitled pursuant to subdivision 380-A of the ITAA 1997 and State Government NRAS contributions referred to in section 380-35 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1936 section 95

Income Tax Assessment Act 1936 section 97

Income Tax Assessment Act 1997 subdivision 380-A

Income Tax Assessment Act 1997 section 380-35

Reasons for decision

Is NRAS rent payable fully deductible?

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income.

However sub-section 8-1(2) of the ITAA 1997 states you cannot deduct a loss or outgoing to the extent it is of capital or of a capital nature, of a private or domestic nature, or incurred in producing exempt income or non-assessable non-exempt (NANE) income.

Expenses incurred in respect of a rental property are generally considered to be incurred in gaining or producing assessable income and, subject to the operation of sub-section 8-1(2) of the ITAA 1997, are therefore deductible.

Apportionment of expenditure is necessary where it (the expenditure) serves both an assessable income producing end and some other end: (Ronpibon Tin NL v FC of T (1949) 8 ATD 431). While derivation of assessable income by way of rent is one objective achieved by participation in the NRAS, the receipt of government incentives, including state government NANE income is another.

Expenses are not deductible to the extent they are incurred in gaining NANE income (paragraph 8-1(2)(c) ITAA 1997). Accordingly rental expenses incurred in respect of an NRAS rental property must be apportioned, limiting a claim for any deduction to the portion of costs relating to the derivation of assessable income.

Generally this apportionment of expenses would be made using the following formula to calculate the percentage of deductible expenses:

Expenses x (assessable rental income / [assessable rental income + NANE income])

Application to your circumstances

The rent payable by you to the owners of the leased properties subject to the NRAS will not be fully deductible. The deductible portion can be calculated by applying your expenses in accordance with the formula above.

Income of a trust estate

Section 97 of the Income Tax Assessment Act 1936 (ITAA 1936) states that a beneficiary (not under any legal disability and presently entitled to a share of trust income) shall include their share of attributable net income in their assessable income.

Net income, in relation to a trust estate, as defined in section 95 of ITAA 1936 means:

the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions, except deductions under Division 393 of the Income Tax Assessment Act 1997 (Farm management deposits) and except also, in respect of any beneficiary who has no beneficial interest in the corpus of the trust estate, or in respect of any life tenant, the deductions allowable under Division 36 of the Income Tax Assessment Act 1997 in respect of such of the tax losses of previous years as are required to be met out of corpus.

Draft Taxation Ruling TR 2012/D1 Income tax: meaning of 'income of trust estate' in Division 6 of Part III of the Income Tax Assessment Act 1936 and related provisions (TR 2012/D1) states at paragraph 7:

There is no set or static meaning of the expression 'income of the trust estate' as used in Division 6. The meaning in the case of a particular trust will depend principally on the terms of that trust and the general law of trusts.

However, appendix 1 to TR 2012/D1 (at paragraphs 66 to 68) provides some understanding as to the extent to which the terms of a trust deed and the general trust law define what is included in the income of a trust estate. It says:

66. In Forrest v. Commissioner of Taxation , the Court was of the view that the settlor's intention of creating a fixed trust of income other than capital gains would have been defeated if a widely-drawn power to characterise receipts as income or capital was construed as an unfettered discretionary power.

67. The Court held that on the facts of that case, and having regard to the settlor's objective intention ascertained from the provisions of the deed read as a whole, the trustee had no more than an administrative power to honestly classify receipts according to law.

68. The decision highlights that in any trust where those entitled (or potentially entitled) to benefit from 'income' and 'capital' are not the same in all respects it is important to consider whether a trustee power should be interpreted more narrowly than its drafting, considered in isolation, may suggest.

While the decision in Forrest v. Commissioner of Taxation is most concerned with the distinction between income and capital, it does highlight that trustees do not have 'unfettered discretionary power' when it comes to categorising receipts.

Distributable income

TR 2012/D1 also places limitations on the 'distributable income' of a trust estate.

A definition of 'distributable income' can be found in FC of T v Bamford & Ors; Bamford & Anor v FC of T [2010] HCA 10. Paragraph 45 of the judgment refers to the analysis by Sundberg J in Zeta Force Pty Ltd v Commissioner of Taxation (1998) 84 FCR 70 at 74-75. It states (in part):

The words 'income of the trust estate' in the opening part of s 97(1) refer to distributable income ….

Paragraph 14 of TR 2012/D1 states (in part):

Where the distributable income of a trust (as defined in the trust instrument or by the trustee acting in accordance with a power granted under the trust instrument) is equated to the trust's net income … amounts received that might ordinarily be considered income but which are not assessable (for example, ordinary income that is exempt) … will be treated for trust purposes as accretions to or depletions of trust capital

A further example of this type of income would be NANE income, such as State Government NRAS contributions.

Appendix 1 of TR 2012/D1 (at paragraph 106) provides further guidance. It states:

However, despite such definitions of income, the Commissioner's view is that, an amount which is included in the net income of the trust but which is not represented by a net accretion to the trust fund (for example, notional income amounts) cannot generally form part of the distributable income of that trust estate.

Application to your circumstances

In your case, we first look to the terms of your trust deed.

Your trust deed defines income as the net income of the trust as defined in section 95(1) of the ITAA 1936, but is subject to Clause X of the trust deed that states the trustee may adopt another definition of the 'income of the trust fund'.

Your trustee has defined the income of the trust as net income as defined in section 95 plus refundable tax offsets to which the trust is entitled pursuant to subdivision 380-A of the ITAA 1997 plus State Government NRAS contributions referred to in section 380-35 of the ITAA 1997. However, regardless of this definition and in accordance with paragraphs 14, 66 to 68 and 106 of TR 2012/D1, it is considered that tax offsets and NRAS contributions would not part of the distributable income of the trust (income of the trust estate).