ATO ID 2004/29: Allowable deduction: instalment sales contract - payment to vacate on default
Date of decision: 28 November 2003
Year of income: Year ended 30 June 2000 Year ended 30 June 2001 Year ended 30 June 2002
Business line: Private Groups and High Wealth Individuals

Issue
Is a deduction allowable under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the amount paid by the taxpayer to persuade a person to vacate a residential property, following their default under an instalment sales contract?

Decision
Yes. The amount paid to the defaulting purchaser is an allowable deduction under section 8-1 of the ITAA 1997 as it was incurred in carrying on the business of the taxpayer and it is not a loss or outgoing of a capital nature.

Facts
The taxpayer carries on a business of buying and selling residential properties. The properties are sold under instalment sales contracts with vendor finance. The instalment sales contract has the following features: The taxpayer did not use the properties for any other purpose prior to sale. The properties were sold for an amount that was in excess of the amount paid by the taxpayer to acquire the property. Each property was sold within six months of it being acquired by the taxpayer. The properties are trading stock for the purposes of subdivision 70-C of the ITAA 1997. During the year, a purchaser defaulted under an instalment sales contract. The interest paid was brought to account as assessable income under section 6-5 of the ITAA 1997 at the time of receipt. The forfeited deposit and instalments retained by the taxpayer will be brought to account under section 6-5 of the ITAA 1997 as ordinary income at the time of the default. The taxpayer paid an amount to the defaulting purchaser to persuade them to vacate the property. The taxpayer made this payment for the purpose of ensuring that the property was handed over in good condition and repair and to facilitate a quick re-sale of the property under an instalment sales contract. The property was then resold under an instalment sales contract.

Reasons for decision
Summary: Section 8-1 of the ITAA 1997 allows a deduction for all losses or outgoings to the extent to which they are incurred in gaining or producing assessable income or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, no deduction is allowed to the extent that the losses or outgoings are of a capital, private or domestic nature or are incurred in gaining or producing exempt income. In paragraph 9 of Taxation Ruling TR 95/33 the Commissioner states that an outgoing will be characterised as necessarily incurred in carrying on the business of the taxpayer for the purpose of earning the assessable income where the expenditure has the necessary connection with the operations or activities which more directly gain or produce assessable income. The judgment of Dixon J in Sun Newspapers Ltd v. FC of T (1938) 61 CLR 337 (1938) 5 ATD 87 (the Sun Newspapers Case) is a leading exposition of the matters that must be examined in order to differentiate whether an amount is capital or revenue in nature. Accordingly the following indicators, consistent with the matters raised by Dixon J, in the Sun Newspapers Case point towards an expense being capital in nature: The amount paid by the taxpayer to the defaulting purchaser to persuade them to vacate the property, is incurred in carrying on the taxpayer's business of selling residential properties under instalment sales contracts with vendor finance. The payment is not a loss or outgoing of a capital nature. Accordingly, a deduction is allowable under section 8-1 of the ITAA 1997 for the amount.

Legislative references: Income Tax Assessment Act 1997 subdivision 70-C 6-5 section 8-1
Case references: Associated Newspapers Ltd & Sun Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337 (1938) 5 ATD 87
Related public rulings and determinations: Taxation Ruling TR 95/33
Related ATO interpretative decisions: ATO ID 2004/25 | ATO ID 2004/26 | ATO ID 2004/27 | ATO ID 2004/28
Subject references: Capital expenditure Deductions & expenses Sale by instalments