Private ruling: Treatment of the retirement village residency arrangements
Date of advice: 6 October 2016
Published: December 2016

Ruling: Q1: Is an Exit Entitlement payment made to an outgoing resident following termination of an Old Lease deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), where the new resident enters into a New Lease? | A1: Yes | Q2: If the answer to Question 1 above is no, is a deduction allowable for those outgoings under section 25-110 of the ITAA 1997? | A2: Not applicable. | Q3: Is the loan amount of the entry payment that is received from an incoming resident under a New Lease assessable income under section 6-5 of the ITAA 1997? | A3: No | Q4: Under section 177F of the Income Tax Assessment Act 1936 (ITAA 1936), will the Commissioner make a determination to cancel a tax benefit, where that tax benefit has been obtained, or would but for that section, be obtained in connection with a scheme to which Part IVA of the ITAA 1936 applies with the applicable scheme being the adoption of the New Lease? | A4: No.

Relevant facts and circumstances: The scheme that is the subject of this ruling has been ascertained from the private ruling application. Background 1. The entity owns and operates a retirement village. 2. Until recently there were various different types of lease agreements with residents at the retirement village (Old Lease Agreements). 3. Since then the entity has entered into New Leases with new residents as former residents terminate their leases at the village. The entity no longer enters into any Old Leases with new residents. 4. Over time, it is expected that all of the Old Leases will be terminated and only New Leases will be in place with residents. 5. As the entity acquired the village after 19 April 2000, the Commissioner's view in Taxation Ruling TR 94/24 does not apply to any of the existing Old Leases. Old Leases 6. The Old Leases are for a period of 40 or more years from the commencement date unless terminated in accordance with the agreement. 7. The Old Leases include assignable and non-assignable leases. 8. Under the Old Leases, an incoming resident is required to make an entry payment to the entity on or before the commencement date. 9. On termination of the Old Leases which are non-assignable, the entity is required to repay the entry payment (reduced by a number of costs and charges) to the resident when a new resident enters into a lease for the premises, and an additional payment. 10. Where the Old Leases are assignable leases, the outgoing resident is required to pay the entity an amount for the costs and charges as well as an additional payment out of the proceeds received for assigning the lease to a new incoming resident. 11. Any entry payments received under an Old Lease was included in the assessable income of the relevant entity in the relevant income year. 12. An Old Lease is not a 'finance lease' as defined in the accounting standards or statements of concepts made by the Relevant Standards Board. New Lease 13. The term of the New Lease is a number of years from the commencement date unless terminated in accordance with the agreement and is non-assignable. 14. Under the New Lease, the incoming resident is required to make an entry payment to the entity on or before the commencement date. The entry payment consists of a Loan and an amount for prepaid rent that is non-refundable (other than in the cooling-off period and the settling-in period). 15. On or before the exit entitlement date, the entity is required to repay the Loan to the resident in accordance with the Loan. 16. In the event that there is no new resident, a clause prescribes the calculation methodology for determining the amounts under certain clauses. 17. The New Lease includes a clause where incoming residents are advised to seek independent legal advice prior to entering into the New Lease. Loan 18. The New Resident advances the Loan to the entity on or before the commencement date. The Loan is unsecured and interest free. 19. Other than in certain circumstances, the entity is required to repay the Loan to the resident. 20. The Loan must be repaid to the resident no later than the expiry of a certain number of years from when the resident vacates the premises. 21. The Loan is non-assignable or transferrable. Reasons and benefits of standardising the resident leasing arrangements 22. The change to a New Lease simplifies the entity's contractual arrangements and therefore enables the entity to obtain commercial efficiencies. Assumptions All leases are substantially the same in all material aspects as those provided to the ATO for the purposes of the private ruling.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 177F | Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 8-1

Reasons for decision: Summary: Summary The Exit Entitlement payment made by the entity to an outgoing resident following the termination of an Old Lease is deductible under section 8-1 of the ITAA 1997. Detailed reasoning Section 8-1 of the ITAA 1997 provides that a deduction is allowable from assessable income for a loss or outgoing to the extent that it is incurred in gaining or producing assessable income or is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, the loss or outgoing is not deductible to the extent that it is capital or of a capital nature, private or domestic nature, is incurred in gaining or producing exempt income or non-assessable non-exempt income, or a provision prevents the deduction. The entity is in the business of owning and managing retirement villages. In the ordinary course of this business the entity enters into and terminates lease agreements of premises with residents in those retirement villages. It is therefore necessary to determine the nature of the arrangements it has with its residents to ascertain the character of the payments that are made under the Old Leases. Character of the arrangement Taxation Ruling TR 2002/14 : Income tax: taxation of retirement village operators (TR 2002/14) sets out the Commissioner's view on various income tax matters for entities involved in retirement villages, see in particular paragraphs 25-26, 28-29, 88-90, 119 and 121. Old Leases As stated in the Relevant facts and circumstances above, the outgoing resident or the entity is required to pay an additional payment to the other. However, the entity is not obliged to repay the outgoing resident an amount until a new ingoing contribution is received. This is consistent with the assignable lease arrangement and the non-assignable lease arrangement as described in TR 2002/14 at paragraphs 88 and 89. Further, as the entity is not obliged to repay an amount to the outgoing resident, the arrangement is not a loan arrangement as described at paragraphs 90 and 121 of TR 2002/14. As the payment is not a loan, in the circumstances of the entity and outgoing residents, the arrangement is a lease premium arrangement in accordance with the guidance in paragraph 29 of TR 2002/14. New Lease The New Lease requires a new resident to make an entry payment consisting of: • a Loan, and • pre-paid rent of an amount that is non-refundable (other than during the cooling-off period and settling-in period). The Loan is an unsecured and interest-free loan to the entity. Under the New Lease the entity must repay the Loan on or before the Exit Entitlement Date. The Exit Entitlement Date is the earlier of a specified number of days after the entity receives a New Entry Payment, or where no entry payment has been received, at a specified time, the specified time. Accordingly, although the Loan may be repaid as a result of a new entry payment, the repayment of the Loan is ultimately not contingent on the sale of the premises to a New Resident. The New Lease is therefore an interest-free loan-lease (non-assignable) arrangement. | Detailed Reasoning - Deductibility of amounts paid under the Old Leases: As outlined above, the Commissioner considers that the Old Leases are lease premium arrangements. The entry payment that the entity receives under each Old Lease is assessable income of the entity in the year of income that it derives that amount (paragraph 25 of TR 2002/14). Therefore, the entity is entitled to a deduction for an Exit Entitlement payment made to an outgoing resident under an Old Lease under section 8-1 in the year of income that the entity becomes liable to make the Exit Entitlement payment (paragraph 26 of TR 2002/14). The deductibility of the Exit Entitlement payment is not affected where the New Resident enters into a New Lease (which is characterised as an interest-free loan-lease (non-assignable) arrangement). The Old Lease arrangement that the entity entered into with a resident is separate and distinct arrangement from the New Lease. | Detailed Reasoning - Question 2: Summary Not applicable. It is not necessary to address the application or otherwise of section 25-110 of the ITAA 1997 in the event the answer to Question 1 is no. The answer to Question 1 is yes for the reasons set out in the Detailed reasoning for Question 1 above Detailed reasoning See Summary above. | Detailed Reasoning - Question 3: Summary The Loan part of the entry payment that the entity receives from an incoming resident under a New Lease is not assessable income of the entity under section 6-5 of the ITAA 1997. Detailed reasoning Section 6-5 of the ITAA 1997 includes ordinary income in assessable income. Subsection 6-5(2) of the ITAA 1997 provides that an Australian resident entity's assessable income includes the ordinary income it derives directly or indirectly from all sources, whether in or out of Australia, during the income year. As outlined in the Detailed reasoning for Question 1 , the New Lease is an interest-free loan-lease (non-assignable) arrangement. Loans made under such arrangements are on capital account (paragraph 28 of TR 2002/14), and therefore do not give rise to ordinary income. Accordingly, the Loan that the entity receives from a new incoming resident under a New Lease will not constitute assessable income of the entity under section 6-5 of the ITAA 1997. | Detailed Reasoning - Question 4: Summary The Commissioner will not make a determination under section 177F of the ITAA 1936 to cancel a tax benefit, where that tax benefit was obtained, or would but for section 177F of the ITAA 1936 be obtained, in connection with a scheme to which Part IVA of the ITAA 1936 applies with the applicable scheme being the adoption of the new Loan-Lease Agreement. Detailed reasoning On an objective consideration of the relevant facts and circumstances, the Commissioner accepts that entry into the scheme or schemes was designed on a commercial basis and will therefore not make a determination under section 177F of the ITAA 1936 to cancel a tax benefit as it cannot reasonably be concluded that the entity entered into the scheme with the dominant purpose of enabling the entity to obtain a tax benefit in connection with adoption of the New Lease.