Private ruling: Tainted Rental Income
Date of advice: 10 September 2018
Published: November 2018
Ruling period: 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Does the Controlled Foreign Company of which the taxpayer is a shareholder derive tainted rental income? | A1: No.

Relevant facts and circumstances: The controlled foreign company (CFC), is a Country X incorporated company, and is a Country X resident for tax purposes. It lodges and pays company tax in Country X at the relevant corporate tax rate. The CFC owns substantial tracts of land, in some cases with attached structures. The CFC is majority owned by the taxpayer, with the minority being owned by a separate Country X company. The taxpayer is registered in Australia. The taxpayer is owned by individuals who are resident in Country X. Its directors are Country X residents and Australian residents. The taxpayer’s sole asset is the majority shareholding in the CFC. Prior to 20XX the CFC had not issued any dividends to its shareholders, including the taxpayer. The first dividend was issued in 2017. All income of the CFC is generated through the leasing and property management of properties in Country X. All leased properties have a large component of property management expenses associated with them representing a substantial proportion of the CFC’s total gross income. The lease rate charged by the CFC higher than its competitors due to the extra property management expenses. The agreement provides the following property management services as part of the serviced leases entered with tenants: a. Gardening b. Maintenance c. Catering d. Cleaning e. Security, through CCTV and on-site security guards f. Electricity g. Water h. Environmental management and protection i. Waste management j. Fire services k. Workplace health and safety l. Community management and liaison, including necessary corporate social responsibility (CSR) compliance. m. Building design services n. Necessary infrastructure, such as roads, dams, power stations, landscaping and fences o. All necessary government permits for everything available on site, including building, explosives and nuclear storage All services are supplied to an international quality standard The CFC employs a large team of employees. Many leases are for a very long term – 20 to 40 years In addition to the provision of the above services, the CFC also provides catering services. There are two systems of catering: a. Bachelor accommodation and meals, where catering is included in the rental rate. b. General accommodation where meals are provided separately and billed at cost recovery rates (a per meal rate to cover the cost of ingredients only), with the cost of food preparation, service and cleaning incorporated into the rental charge for general accommodation. The CFC has a dedicated full time catering team preparing and serving meals for the site management and facility management team 24/7. Where the sites provide specific facilities, the CFC provides staffing for these facilities, as part of the lease fee, for example.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 317

Reasons for decision: Summary: The CFC does not receive tainted rental income as it is can be established that a substantial part of the income it earns under the lease agreements entered with arms-length third parties is attributable to the provision of labour-intensive property management services in connection with the land, being services provided by directors or employees of the company. | Detailed Reasoning - Detailed Reasoning: In determining whether the company received tainted rental income, it is necessary to examine whether it was that a substantial part of the income is attributable to the provision of labour-intensive property management services in connection with the land, being services provided by directors or employees of the company. There are three definitions that are important in seeking to determine this question. They are: ● What is the meaning of labour-intensive? ● What are property management services? ● What does substantial mean in relation to the income received from the argued labour-intensive property management services? | Detailed Reasoning - Contextual Approach: This ruling adopts the contextual approach to interpretation used by Australian Courts. For example the Full Federal Court in Chaudhri v FCT 2001 ATC 4214 at 4216; (2001) 47 ATR 126 at 128 said: ‘The guiding principle of statutory interpretation may be summed up as being the ascertaining of the meaning of the words which Parliament has used by reference to the context in which they appear, where ‘context’ has the wide meaning which extends to the legislative history, the parliamentary intention and the mischief to which a particular provision has been directed as well as narrower meaning which would dictate reading the words to be construed by reference to the immediately surrounding or otherwise related provisions.’ | Detailed Reasoning - “Labour-intensive”: Labour-intensive is not defined in the legislation. Nor was it referred to expressly in the Explanatory Memorandum. However it would appear that the insertion of this phrase was meant to guide the analysis towards differentiating between labour-intensive activities and capital-intensive activities. Capital-intensive activities would be more passive in their operation, meaning income would be generated through purchasing assets and deriving income from the use of those assets. Labour-intensive activities would be where the director’s and employees own services are being utilised. Rent received from the provision of the land and buildings would be considered to be income from a capital-intensive activity. However, the section would contemplate entities receiving rent through the use of the property. Therefore, given the use of the wording ‘labour intensive’, the focus should be whether there are other activities that relate to the income received and the formation of that income. The CFC’s broader activities would come within the definition of labour-intensive. These activities include: ● Gardening ● Maintenance ● Catering ● Cleaning ● Security through use of on-site guards ● Environmental management and protection ● Waste management ● Workplace health and safety ● Building design services These sorts of activities, while requiring certain capital assets to assist, would require significant manual labour input to complete, and would fall into the definition of labour-intensive. The completion of this activity would give rise to that part of the payment receivable under the agreements for the provision of these services. Analysing the facts as a whole, it can be established that a part of the activities undertaken by the CFC can be characterised as being “labour-intensive”. | Detailed Reasoning - “Property Management Services”: Property management services is defined in the legislation in section 317: “Property management services” includes any of the following services: (a) Cleaning (b) Secretarial (c) Catering Unlike labour-intensive, ‘property management services’ is specifically defined in the legislation. The terms included in the list are quite general. Therefore activities such as following are likely to come within the definition above: ● Gardening ● Landscaping ● Maintenance ● Catering ● Pool and gymnasium cleaning ● Electrical services (including supply of electricity from site power stations) ● Air-conditioning maintenance, and fuel depot services, ● Various work place health and safety ● Environmental management services ● Analysing the facts as a whole, it can be established that a part of the activities undertaken by the CFC can be characterised as being “property management services”. | Detailed Reasoning - Meaning of “Substantial”: In the CFC’s situation, it receives a large proportion of its income for providing labour-intensive, property management services in connection to the leases. Further, the provision of those services is integral to its whole business operation, and allows it to distinguish its market offer from its competitors. Without providing those services as part of the lease arrangements it enters, the CFC would not derive its assessable income. In these circumstances, we consider that a “substantial” amount of the income derived by the CFC is attributable to the provision of “labour-intensive” “property management services”. | Detailed Reasoning - Conclusion: The Controlled Foreign Company, of which the taxpayer is a shareholder, receives income from a lease of land, where a substantial part of the income is attributable to the provision of labour-intensive property management services. Therefore, it will not be considered to be in receipt of tainted rental income for the purposes of the ITAA 1936.