Private ruling: Income tax consequences for security bonds and related interests not earned
Published: November 2011
Ruling period: 1 July 2010 to 30 June 2015
Date scheme commenced: 1 July 2010

Ruling: Q1: Whether the security bonds and interests would form part of X Pty Ltd's assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) if these amounts are returned to its tenant at the end of the tenancy period? | A1: No.

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 taxpayer, X Pty Ltd, is a developer of real estate and is in the business of renting those properties that it develops. As part of the rental arrangement, the tenants are required to pay a bond which the taxpayer lodges in an interest bearing account. The account is in the name of the taxpayer as trustee for the tenant. The taxpayer supplies the bank with its tax file number. The term deposit accounts mature annually and the interest is added to the principal amount. The accounts are closed when the tenancy ceases and the bond money plus the interest is returned to the tenant. The standard lease agreement, provided by the taxpayer to the ATO, states: If you comply with this lease then the bond will be refunded to You at the end of the term or when You vacate the premises, whichever happens last - provided You have vacated and made good the promises. If a tenant defaults in their financial responsibilities, the taxpayer retains all or some of the bond, including the interest if necessary. The lease agreement states: We can use part or all of the bond to cover money due to Us because of any breach of this lease by You. On the undertaking of returning the interest earned on the bond amount, the lease agreement states: We must account to You for interest earned on such a deposit but We are entitled to retain any such interest and deal with it as money paid by You to Us to form part of the bond.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision: Summary: Under subsection 6-5(1) of the ITAA 1997, Your assessable income includes income according to ordinary concepts, which is called ordinary income. The term, 'ordinary income' is not a defined term and depends on its ordinary meaning. Numerous case law on the topic has identified factors which may be relevant in determining whether an amount is income according to ordinary concept. These include: · whether the amount has the characteristics of periodicity, recurrence or regularity · whether it is convertible into money or money's worth · whether it is associated with business activities or services rendered, as distinct from the mere sale of property, and · whether it is solicited, as distinct from a windfall In the present case, the taxpayer is in the business of property development and rent. It is receiving the rental income on a regular basis and on a regular interval. The rental income is convertible into money. It is solicited and not a windfall. Therefore, the rental income is assessable income for the taxpayer according to ordinary concept. Under subsection 6-5(2) of the ITAA 1997: If you are an Australian resident, your assessable income includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year. The word 'derived' is a defined term under subsection 995-1(1) of the ITAA 1997 which directs us back to subsection 6-5(4) of the ITAA 1997. Subsection 6-5(4) of the ITAA 1997 defines it as: In working out whether you have derived an amount of ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you directs. In the present case, the bond and the interest amounts are returned to the tenant, as per the term of the lease agreement, at the end of the lease period or when the leased premises is vacated, provided there is no breach of the lease agreement. In this case, the interest and the bond amounts are not derived by the taxpayer as the amounts cannot be dealt with in any way on the taxpayer's behalf or as it directs. However, if there is a breach of the lease, the lease agreement gives the taxpayer the right to use part or the full amount of the bond to rectify the situation. At the same time, the taxpayer would be entitled to retain the interest earned on the bond and deal with it as money paid by the lessee to the taxpayer to form part of the bond. In that situation, the taxpayer has derived the amounts as ordinary income as it is able to deal with the amounts, and hence become part of the taxpayer's assessable income.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.