Edited version of your written advice

Authorisation Number: 1051473785040

Date of advice: 17 January 2019

Ruling

Subject: Deductibility of land tax arrears incurred on a rental property.

Question 1

Is the fixed charge tax deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Is the penalty tax deductible under section 8-1 of the ITAA 1997?

Answer

No

Question 3

Is the interest charged by the ACT Revenue Office on land tax and fixed charge deductible?

Answer

Yes

Question 4

Is the interest on the loan taken out deductible to the extent to which it was used to pay the fixed charge, land tax and interest under section 8-1 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

The scheme commences on:

21 July 20XX

Relevant facts and circumstances

The taxpayers own a property.

It was the family home until they relocated and it was subsequently rented.

The taxpayers were unaware of an obligation to pay land tax.

Some years later the relevant authority, who had only recently become aware of the fact that the property was rented issued a land tax assessment to the taxpayers.

The assessment was for an amount which was paid by the taxpayers.

On objection it was subsequently reduced and a refund was paid.

This comprises:

(i) Land tax arrears

(ii) Fixed charge

(iii) Penalty

(iv) Interest

The taxpayers took out a mortgage on the property in order to pay the debt by the due date.

Interest was neither paid nor imposed in respect of the penalty tax imposed by the Z.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 26-5

Reasons for decision

You can claim a deduction for local government rates and levies for the period your property is rented or is genuinely available for rent. The fixed charge is merely a component of the amount of rates you pay for a standard property.

The fixed charge is deductible under section 8-1 of the ITAA 1997 if and to the extent to which it is incurred in gaining or producing the assessable income or in carrying on a business for that purpose. The deduction is not allowed to the extent to which it is of a capital, private or domestic nature or incurred in gaining or producing exempt income.

Any penalty component of the land tax assessment is not deductible as per section 26-5 of the ITAA 1997. You are not entitled to a deduction, otherwise allowable under section 8-1 of the ITAA 1997, for a penalty imposed in accordance with a State law. This is so, no matter how that penalty is described.

Interest on land tax and the fixed charge

Interest is deductible in the income year that the land tax assessment notifying the interest amount payable is issued. As the interest on late lodgement is not a penalty, it is not excluded from being deductible under section 26-5 of the ITAA 1997.

As the relevant land tax legislation gives a power of remission to the state revenue authority, any interest amount is purely hypothetical until the power of remission has been exercised. The amount of interest, if any, can never be quantified until the land tax authority has issued their assessments. At this point a liability for interest arises. Prior to this point such a liability is purely speculative. Interest is deductible in the income year that the land tax assessment notifying the interest amount payable is issued. The interest component is to compensate for the time value of money and is therefore not a penalty.

Deductibility of interest on the loan

The interest on the loan taken out to pay the liability which was raised is considered an allowable deduction under section 8-1 of ITAA 1997 to the extent that the portion of interest accrued on the loan relates to tax deductible items. These items namely being the fixed charge, land tax and interest imposed on the fixed charge and land tax.

The interest incurred on the loan was incurred in gaining or producing the assessable income as the funds were borrowed to clear a liability resulting from income producing activities. Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith states at paragraph 3 that the interest expense must have a sufficient connection with the operations or activities which more directly gain or produce the taxpayer's assessable income and not be of a capital, private or domestic nature. It also states interest on borrowed funds will not be deductible simply because it can be said to preserve assessable income producing assets. The borrowing was incurred as part of income producing activities.

Relevant years

Taxation Ruling TR 97/7 summarises various propositions of the Courts about when a loss or outgoing is 'incurred' for the purposes of section 8-1 of the ITAA 1997. The ruling states (at paragraph 5), 'As a broad guide, you incur an outgoing at the time you owe a present money debt that you cannot escape.' The Courts have described this in various ways: as having a 'presently existing liability'; as being 'definitively committed' or 'completely subjected' to the outgoing in spite of the fact that it remains unpaid. Another requirement is that the amount of the liability is ascertained or reasonably capable of estimation. Deductibility under section 8-1 also depends on the outgoing being 'properly referable' to the income year in which the deduction is sought (Coles Myer Finance Pty Ltd v. Federal Commissioner of Taxation (1993) 176 CLR 640; 93 ATC 4214 at 4222; (1993) 25 ATR 95 at 105).

In the present circumstances, you incurred a liability to pay land tax under the provisions of the state legislation at the start of each calendar year for which the land tax was payable. You were 'definitively committed' or 'completely subjected' to the debt at that time, even though unaware of it. As the liability to pay land tax was ascertainable in the year to which the assessment giving rise to the liability relates, land tax payable was incurred in that year (Case B5 70 ATC 24; 15 CTBR (NS) Case 67). The Federal Court confirmed this principle, in the context of payroll tax, in Layala Enterprises Pty Ltd (in liq) v. Federal Commissioner of Taxation (1998) 86 FCR 348; 98 ATC 4858; (1998) 39 ATR 502.

Conclusion

A deduction is allowable for the fixed charge, land tax and relevant interest; however a deduction is not allowed for the penalty. The land tax expenses are deductible in the year to which the liability relates, even though payment may have occurred in a subsequent year. Additionally, interest will be deductible in the years that they were incurred, i.e. the years following on from the years where the land tax was originally assessed.