Edited version of private advice

Authorisation Number: 1052046370685

Date of advice: 19 October 2022

Ruling

Subject: Rental - discretionary trusts and beneficiaries

Question 1

Is the rental income derived in respect of a residential property (the Property) owned by the discretionary trusts (the Taxpayers), as tenants in common in equal shares, leased to beneficiaries of the Taxpayers at commercial rates and on commercial terms assessable income of the Taxpayers under section 6‐5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Are the expenses incurred by the Taxpayer in respect of the Property, owned by the discretionary trusts (the Taxpayers), as tenants in common in equal shares, leased to beneficiaries of the Taxpayers at commercial rates and on commercial terms, deductible to the Taxpayers under section 8‐1 of the ITAA 1997?

Answer

Yes

This ruling applies for the following period

Year ended 30 June 20XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The Taxpayers acquired a property (the Property) as tenants in common in equal shares.

The Property was redeveloped, and a new residential building was constructed.

The Taxpayers have each borrowed funds from related companies to fund the investment. The loans from the related companies are on terms compliant with section 109N for the purposes of Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936).

The beneficiaries of the Taxpayers, entered into a residential rental agreement to jointly lease the property from the Taxpayers and have been living at the Property.

The tenancy agreement includes standard lease terms and conditions. The commercial rent will be reviewed and adjusted from time to time to reflect any changes in the market rates.

The Taxpayers sought a valuer to determine the market rent. Copy of the valuation report is provided.

As per the Rental Agreement, the rent will be direct debit.

The Taxpayers acquired the Property with the view that the Property will increase in capital value over the long term.

Relevant legislative provisions

Income Tax Assessment Act 1936subsection 95(1)

Income Tax Assessment Act 1997section 6-5

Income Tax Assessment Act 1997section 8-1

Reasons for decision

Unless otherwise stated, all legislative references are to the Income Tax Assessment Act 1997.

Summary - question 1 and question 2

Rental income derived by the Taxpayers is assessable income and expenditure incurred in deriving that income is deductible, so long as the outgoing is not of a private, capital or domestic in nature and the deduction is not denied by another section of the Act.

Detailed reasoning

Section 6-5 provides that assessable income of an Australian resident taxpayer includes the ordinary income it derived directly or indirectly from all sources during the income year.

Ordinary income does include income received by a taxpayer as a result of renting out a rental property.

The net income of a trust is the total assessable income of the trust calculated as if the trustee were a resident taxpayer in respect of that income, less all allowable deductions: subsection 95(1) of the Income Tax Assessment Act 1936 (ITAA 1936).

Where a taxpayer grants a lease of property, the amount received in respect of such a lease will ordinarily be assessable income to the taxpayer.

Section 8-1 allows allowable deductions for expenses incurred by a taxpayer in relation to their gaining of assessable income. This is subject to the expense not being of a capital or private or domestic nature, not prevented from being deducted by the Act or relating to the gaining or producing of exempt income.

Taxation Ruling TR 93/32 - Income tax: rental property - division of net income or loss between co-owners (TR 93/32) discusses issues concerning rental properties and the division of net income or loss between co-owners. Paragraph 8 of TR 93/32 states:

Ownership conveys an entitlement to exercise the maximum legally permissible rights over what is owned. Generally, a legal interest in land is achieved by the owner being registered proprietor of the legal title to the land. Where there is more than one person with a concurrent interest in the same land, those persons are co-owners of the land.

The ATO view on the tax treatment of the purchase of a residence by a family trust and the subsequent leasing of it to family beneficiaries in the trust is set out in Taxation Ruling IT 2167 - Income Tax: rental properties - non-economic rental, holiday home, share of residence, etc. cases, family trust cases (IT 2167).

It discusses arms length and non-arms length letting of a residence. Generally, the approach to be followed is based on whether the rent charged by the owner represents a normal commercial rent. Where property is let at a commercial rent then, apart from the effect of any express statutory provision to the contrary, expenses incurred in letting the property under an arms length arrangement is fully deductible. That is, the arrangement is treated no differently for income tax purposes from any other owner in a comparable arms length situation.

Paragraphs 29 and 30 of IT 2167 state:

Purchase of a residence by a family trust and the subsequent leasing of it to family beneficiaries in the trust.

29. Situations under this heading are designed to obtain an income tax deduction for losses and outgoings which would otherwise be characterized as private or domestic expenditure. By way of illustration, a family trust may be established to acquire what is in fact the private residence of the beneficiaries of the trust. Financial arrangements for the purchase of the residence by the trustee may be highly geared. The trustee will let the residence to one or both parents at a commercial rental and the family would occupy the residence as the family home. The trustee lodges a return of income disclosing the rental as assessable income and claiming income tax deductions for the losses and outgoings attributable to the residence. Income from other sources is channelled into the trust to absorb the losses arising from the rental of the residence to the parents.

30. In situations such as this it is apparent that, had the parents acquired the residence in their own right, the losses and outgoings attributable to the residence would not have been allowable as income tax deductions - they would have been private or domestic expenditure. In cases of this nature that have arisen, the deductions claimed by the trustee have been reduced. A case in point has been heard by a Taxation Board of Review and is currently awaiting decision. In the meantime it should not be accepted in cases of this nature that the rent payable by the parents is assessable income of the trustee or that the losses and outgoings attributable to the residence are allowable as income tax deductions.

In Federal Commissioner of Taxation v Janmor Nominees Pty Ltd (1987) 75 ALR 15; (1987) 15 FCR 348;19 ATR 254;87 ATC 4813 (Janmor Nominees) the court considered whether the rent received from a residential property purchased by the trust with money borrowed by the trust and rented to associates at a market rate constituted assessable income. The Full Federal Court held that the rental receipts constituted income according to ordinary concepts of the trust. The payment of interest by the trust was an outgoing incurred in the course of gaining or producing the assessable income of the Trust.

Janmor Nominees was made after Taxation Ruling IT 2167 was issued in 1986.

A Note was added to IT 2167 on 8 August 2013, noting the effect of the decision in Janmor Nominees in altering the position taken in that Taxation Ruling. The Note states:

Note: Where a residence is purchased by a family trust and is leased to beneficiaries in the trust at commercial rates (paragraph 29), the rent paid by the beneficiaries is assessable income of the trustee and losses and outgoings attributable to the residence are deductible, unlike the view expressed in paragraph 30. This reflects the decision of the Federal Court in FCT v. Janmor Nominees Pty Ltd 87 ATC 4813; (1987) 15 FCR 348. The priority given to updating/rewriting this ruling to correctly reflect the law depends on the ATO resources available to do so when weighed against other ATO priorities (Note added on 8 August 2013).

In this instance, the expenses incurred will be deductible to the extent that the property is used to produce assessable income. A loss or outgoing is not deductible where it is incurred to gain or produce benefits for other persons.

In the Taxpayers case, they:

• acquired the Property as tenants in common in equal shares;
• have each borrowed funds on arm's length commercial loan terms from related entities to fund the Property;
• rented out the Property at commercial rates and on commercial terms to use the Property under a residential rental agreement with the related parties for the purpose of producing assessable income;
• the rent will be directly debited and reviewed on regular basis.
• acquired the Property with the view that the Property will increase in capital value over the long term;

While the decision in Janmor Nominees was made with respect to subsection 25(1) and subsection 51(1) of the ITAA 1936, it is also equally applicable with respect to section 6-5 and section 8-1.

It is therefore considered that the rent received by the Trusts will constitute assessable income under section 6-5 and any losses or outgoings to the extent to which they are incurred in gaining or producing the rental income and are not of a capital or private nature will be allowable deductions under section 8-1.