Edited version of your written advice

Authorisation Number: 1012782424353

Ruling

Subject: Rental property overseas

Question 1

Will the Commissioner allow you to return your foreign sourced income on a calendar income year basis?

Answer

No.

Question 2

Are the travel expenses an allowable deduction?

Answer

Yes.

Question 3

Are you entitled to deduct rental expenses incurred while your investment properties remain unrented?

Answer

Yes.

Question 4

Are you entitled to a deduction for the portion of telephone expenses incurred in flat A which are directly related to your income earning activities?

Answer

Yes.

Question 5

Are you entitled to a deduction for expenses relating to flat A such as water rates, electricity and building levies incurred while in Australia?

Answer

No.

Question 6

Are you entitled to a deduction for the income producing portion of expenses relating to flat A such as water rates, electricity and building levies incurred while staying there?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2014

The scheme commences on

1 July 2013

Relevant facts

You are a resident of Australia for taxation purposes.

You and your spouse built several flats overseas. You own these flats as tenants in common in equal shares.

Several flats are rented to tenants, one flat is owned by a relation and the remaining flat (flat A) is used by you to stay in when you go to country B.

The flats have never been used by family or friends. The flats are rented at market rate.

The remaining flat is used by you as your sole base of operations, that is, as an office, as well as accommodation whilst managing and servicing your rental properties.

You have received rental income from the flats for several years. The flats are located in a residential area of city C, close to transport, schools and other community facilities.

You pay tax on the rental income derived in country B with the relevant tax authorities. Country B tax year is a calendar year.

You travelled to country B to attend to your rental properties in the 2013-14 financial year. Your spouse did not accompany you on the trip.

You incurred cost for the airfare.

The purpose of the trip was predominantly to find tenants for the vacant flats and to inspect, supervise, manage and generally look after the investment properties.

You also visited family and friends while on this trip. You would occasionally meet friends and family outside business hours.

When you arrived, some of your flats were vacant.

You advertised your flats via various means including through real estate agents.

You requested a rental market appraisal from these agents; however you decided to reduce the average market rent for the vacant flats to attract prospective tenants and rent the flats as soon as possible. Several enquiries were received through the agents from prospective tenants but you did not secure any tenants as a result.

You interviewed at least eight serious tenants while in country B.

You were successful in finding suitable tenants for all vacancies and all flats are currently occupied.

While in country B you organised for repairs to be carried out on the properties and carried out some of these repairs yourself. Painting, plumbing, minor adjustments of sliding and hinged doors and windows, cleaning and kitchen cabinet repairs were carried out.

You paid for water and building levies on the flats while they remain vacant.

When you return to Australia, your relation and a long term tenant show prospective tenants the vacant investment property if necessary. Your relation inspects the properties regularly and reports to you via the phone/fax maintained in the vacant flat. The tenant also communicates with you on a regular basis on matters relating to the properties.

You have a manager in country B who organises and issues the regular monthly levies like cleaner, elevator maintenance, central heating, common areas maintenance and common bills payments.

You have kept documentation in relation to the properties and you kept a travel diary for the trip.

You do not employ an accountant in country B to lodge your foreign tax return. You do it yourself to save money.

You reconcile the books after the end of the calendar year. You find it difficult and a long process to reconcile the foreign tax with the Australian tax rules. You have a health condition and the current tax requirements cause a significant amount of stress.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 6-5

Reasons for decision

Foreign sourced income

Section 6-5 of Income Tax Assessment Act 1997 (ITAA 1997) provides that an Australian resident must include assessable income they derive from both Australian and overseas sources.

Generally for income tax purposes an individual is required to disclose in his or her Australian income tax return the amount of foreign income derived during the Australian financial year.

It is acknowledged that where an individual's foreign source accounts have been prepared on a basis other than the year ended 30 June, difficulty can be experienced in dissecting the income for the purposes of returning on a strict Australian income year basis.

In certain circumstances and for reasons of practical administration it has been accepted that the foreign source income may be shown by the taxpayer in his or her Australian return on the relevant foreign income year basis.

Income Tax Ruling IT 2498 Income Tax : foreign tax credit system : currency translation of foreign income : trading stock and depreciable plant : basis of returning foreign income : capital gains/losses discusses when this administrative concession may apply.

Individuals who are required to prepare foreign source income accounts on a basis other than a year ending on 30 June and who can demonstrate difficulties in dissecting the income/expenses for the purposes of returning on a strict Australian income year basis in relation to a year of income may be permitted to return the foreign source income in his or her Australian return for that year of income on the relevant foreign income year basis.

In your case you receive rental income from your flats in country B. Rent is mainly paid directly into your bank account and occasionally a tenant may pay you directly with cash. It is therefore easy to calculate your monthly rental income. Similarly, your rental expenses can also be easily determined monthly. Although a tenant may sometimes incur a rental expense on your behalf, as this amount is deducted from their monthly rent paid, it is not difficult to calculate your monthly expenses. The amount of your monthly levies and other amounts paid should also be relatively easy to calculate monthly.

Applying the guidelines from IT 2498, it is not considered that your foreign sourced income is difficult to dissect. The monthly rental income and expenses can easily be calculated.

Your circumstances are not within the administrative concession offered in IT 2498 and therefore you are unable to include the foreign sourced rental income in your Australia tax return on a calendar year basis.

Your health and specific circumstances are acknowledged, however the Commissioner does not consider that having rental properties overseas or your other individual circumstances are sufficiently difficult to allow you to declare your overseas rental income on a calendar year basis.

Allowable deductions

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income. 

A number of significant court decisions have determined that for an expense to be an allowable deduction:

• it must have the essential character of an outgoing incurred in gaining

assessable income or, in other words, of an income-producing expense

(Lunney v. FC of T; (1958) 100 CLR 478,

• there must be a nexus between the outgoing and the assessable income so

that the outgoing is incidental and relevant to the gaining of assessable

income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47 (Ronpibon's case)), and

• it is necessary to determine the connection between the particular outgoing

and the operations or activities by which the taxpayer most directly gains or

produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v.

FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

To determine whether expenses are deductible, the essential character of the expenditure must be considered. It is necessary to determine whether there is a sufficient nexus between the expenditure and your current income-earning activities. The intention or purpose in incurring an expense can be an element in determining whether the whole or part of the expense is an allowable deduction. 

Travel expenses

Taxation Ruling TR 98/9 Income tax: deductibility of self-education expenses incurred by an employee or a person in business discusses the apportionment of overseas travel expenses where there is a dual purpose for the travel. Although this ruling deals with deductions of self-education expenses, the principles are relevant in your circumstances.

As highlighted in TR 98/9, if the purpose of the travel was for income earning purposes, the existence of an incidental private purpose does not affect the characterisation of the related expenses as being incurred in gaining assessable income. However where there are two equal purposes of the travel, 50% of the expenses would be deductible.

In your case, although you visited family and friends while in country B, it is accepted that the main purpose of your trip was to attend to your rental properties. It is considered that there is a sufficient connection to your income producing activities. Therefore your airfare expenses are wholly deductible under section 8-1 of the ITAA 1997.

Deduction for vacant rental properties

An existing property will be considered to be held for income-producing purposes if the property is being rented, or available for rent.

Where a property is not actually being rented it will be considered to be 'held' for the purpose of producing assessable income where it is genuinely available for rent as evidenced by the taxpayer undertaking active and bona fide efforts to let the property at a commercial rental. This would include such activities as listing the property with a real estate agent, placing advertisements in newspapers and not restricting availability (for example, by making the property unavailable for rent during holiday periods) to ensure the taxpayer's private use and enjoyment of the property (Tax Ruling IT 2167 Income Tax: rental properties - non-economic rental, holiday home, share of residence, etc. cases, family trust cases).

Case law provides guidance on what is considered to be an active and bona fide effort.

In Case P116 82 ATC 590 the Board of Review held that the owners could only claim expenses in relation to the period of actual letting occupancy of a cottage in the Blue Mountains as lettings were only made by word of mouth to persons known to the owners.

In Inglis & Anor v. FC of T 87 ATC 2037 the taxpayer was similarly restricted in claiming because advertising had only been done by word of mouth and in a major daily newspaper. The property was not placed with an agent and no other activities were undertaken to obtain further tenants for the property. It was held that insufficient effort had been made for the whole of the relevant period.

By contrast in Case V133 88 ATC 847 the taxpayers were allowed expenses in relation to the whole period of availability for a property on the New South Wales coast because active and bona fide attempts were made to let the property. In the 1983 and 1984 income years the taxpayers had spent approximately $2,000 in advertising and promoting the property. They had paid for display advertisements to be inserted in newspapers including specialised newspapers such as The Land and Open Road and daily newspapers. They had advertised in specialised journals such as Qantas News. The property was listed with several agents. They had written to major employers to encourage them to take block bookings for their employees.

In your case it is considered that a genuine and bona fide effort was being made to rent the flats. The flats were not being used by yourself or family members for holidays. As the flats were genuinely available for rent, the expenses associated with the three vacant flats are an allowable deduction.

Flat used by you

Flat A remains vacant at all times other than when you are in country B. You stay at this property for the duration of your stay in country B.

As you do not derive any assessable income from this flat, no deduction in relation to the holding expenses relating to this flat are deductible under 8-1 of the ITAA 1997 while you are in Australia. However telephone calls made from the phone in this flat by your relation during the time you are not in country B that concern your rental properties are sufficiently related to your income earning activities and therefore the cost of such calls is an allowable deduction.

You travelled to country B for the main purpose of maintaining and managing your rental properties. However, considering the length of time spent in country B and after reviewing your diary, it is not considered that your rental property activities took up 100% of your time. Therefore, it is considered that only a portion of your associated accommodation expenses incurred while in country B is an allowable deduction.

As your accommodation expenses are not fully deductible, you will need to apportion the expenses using a reasonable basis. Apportionment is a question of fact and involves a determination of the proportion of the expenditure that is attributable to deductible purposes. The Commissioner believes that the method of apportionment must be fair and reasonable in all the circumstances.

As much of your trip relates to income producing activities, you are entitled to a deduction for your accommodation costs while in country B that directly relate to this income producing purpose. Therefore a portion of your rates, electricity and building levies incurred while in country B are an allowable deduction.