Private ruling: Rental expenses
Published: April 2013
Ruling period: Year ended 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Are interest expenses from a loan used to purchase a rental property which is rented to beneficiaries of the trust at arm's length rates, deductible against the trust's rental income under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Are repairs and maintenance expenses deductible against the trust's rental income under section 8-1 of the ITAA 1997? | A2: Yes | Q3: Is depreciation of plant and equipment deductible against the trust's rental income under Division 40 of the ITAA 1997? | A3: Yes | Q4: Is a capital works deduction allowable against the trust's rental income under section 8-1 of the ITAA 1997? | A4: Yes | Q5: If the tax deductions in q 1 to 4 above are allowable and this creates a loss, can this loss be offset against other income of the trust? | A5: Yes

Relevant facts and circumstances: You are the trustee of a resident trust. The trust purchased a residential property for the main purpose of producing income. The trustee for the trust borrowed funds from a financial institution to acquire the property and signed an undertaking to pay the loan. The property is owned solely by the trust. The trustee has absolutely no financial interest in this property. The mortgage for the property is held by the trust, and any money loaned to the trustee (or owned by trustee) to cover the deposit or other purchasing costs was on-lent to the trust under a loan agreement between the trust and the trustee, with interest. All outgoings for the property were spent by bank accounts held by the trust. Shortly after the property was purchased and due to a change in circumstances, the beneficiaries, who are also the trustees of the trust, moved into the property. The property is rented out to the beneficiaries under an arms length agreement at prevailing commercial rates. The original capital of the trust was a transfer of shares acquired via a loan from the trustee, with interest. Since then, further monies have been loaned to the trust by the trustee at an agreed interest rate (documented in the trust minutes). The trust claimed interest expenses incurred on the loan from the trustee. Any monies transferred to the trust from the trustee increase the loan and any monies repaid to the trustee by the trust decrease it.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 25-10 | Income Tax Assessment Act 1997 Division 40 | Income Tax Assessment Act 1997 Division 43

Reasons for decision: Summary: 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 except where the outgoings are of a capital, private or domestic nature. Taxation Ruling TR 95/25 sets out the deductibility of interest expenses. Whether an interest expense has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. The 'use' test, established in Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153; [1926] HCA 58, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. The interest 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. Taxation Ruling IT 2167 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 arm's 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. 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 had to consider 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 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. In your case, the trust borrowed funds to be used to purchase a rental property which was intended to be rented out for the purpose of producing assessable income. The trustees, who are also beneficiaries, of the trust rent the property from the trust at normal commercial rates with a formal lease agreement in place. It is therefore considered that in the light of the Janmor Nominees decision the rent received by the trust will constitute assessable income and any losses or outgoings to the extent to which they are incurred in gaining or producing the rental income will be allowable deductions. As long as the property is being rented at a commercial rate, the trust will continue meeting section 8-1 of the ITAA 1997 to claim the interest expenses charged on the loan related to the rental property. Similarly, repairs and maintenance, depreciation and capital works deductions will be allowed against the trust's rental income. Where the expenses exceed the rental income derived under a commercial agreement, the net loss will be applied against the other assessable income of the trust.