Private ruling: Treatment of retirement village residency arrangements
Published: March 2015
Ruling period: Year ending 2015 | Year ending 2016 | Year ending 2017 | Year ending 2018 | Year ending 2019 | Year ending 2020 | Year ending 2021 | Year ending 2022 | Year ending 2023 | Year ending 2024 | Year ending 2025 | Year ending 2026 | Year ending 2027 | Year ending 2028 | Year ending 2029 | Year ending 2030
Date scheme commenced: 1 July 2014.

Ruling: Q1: Is a repayment of the entry payment made under the Type 1 Lease Agreement to a resident following termination of that agreement, deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) where the new resident, referred to under that lease agreement, enters into a Type 3 Loan-Lease Agreement? | A1: Yes. | Q2: Is a repayment of the entry payment made under the Type 2 Lease Agreement to a resident following termination of that lease agreement deductible under section 8-1 of the ITAA 1997 where the new resident, referred to under that lease agreement, enters into a Type 3 Loan-Lease Agreement? | A2: Yes. | Q3: If the answers to question 1 and question 2 are 'No', are those payments deductible under section 25-110 of the ITAA 1997? | A3: Not applicable as the answers to question 1 and question 2 are 'Yes'. | Q4: Is the loan amount of the entry payment that is received from a resident under the Type 3 Loan-Lease Agreement assessable income under section 6-5 of the ITAA 1997? | A4: No. | Q5: 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 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 Type 3 Loan-Lease Agreement? | A5: 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 1 July 20XX there were two different types of lease agreements with residents at the retirement village (Type 1 Lease Agreement and Type 2 Lease Agreement). 3. Since July 20XX, the entity has entered into Type 3 Loan-Lease Agreements with new residents as former residents terminate their lease agreements at the village. The entity no longer enters into any Type 1 Lease Agreements or Type 2 Lease Agreements with new residents. 4. Over time, it is expected that all of the Type 1 Lease Agreements and Type 2 Lease Agreements will be terminated and only Type 3 Loan-Lease Agreements will be in place with residents. 5. All of the current leases with residents were entered into after 19 April 2000. Type 1 Lease Agreement 6. The Type 1 Lease Agreement is for residential property as described on the front page of the lease agreement. 7. The term of the Type 1 Lease Agreement is 99 years from the commencement date unless terminated in accordance with the agreement and the lease is non-assignable. 8. Under the Type 1 Lease Agreement, an entry payment is required to be paid by the resident to the entity on or before the commencement date. 9. On termination of the Type 1 Lease Agreement, the entry payment is required to be repaid to the resident on or before the exit entitlement date. 10. Any entry payments received by the entity under a Type 1 Lease Agreement have been included in the assessable income of the entity in the relevant income year. 11. The applicant has stated that the Type 1 Lease Agreement is not a 'finance lease' as defined in the accounting standards or statements of concepts made by the Australian Accounting Standards Board (AASB). 12. The signing page of the lease agreement requires the resident(s) to acknowledge whether or not they have obtained independent legal advice in relation to the contract. 13. The applicant has stated that the entity recommends that new residents seek independent legal advice prior to entering into a lease agreement with the entity. Type 2 Lease Agreement 14. The Type 2 Lease Agreement is for a residential unit as described on the front page of the lease agreement. 15. The term of the Type 2 Lease Agreement is 99 years from the date specified on the front page of the lease, unless it is earlier terminated and the lease is non-assignable. 16. Under the Type 2 Lease Agreement, an amount is required to be paid by the resident to the entity on or before the commencement date. 17. The entity must pay certain amounts to the resident in accordance with a specific clause of the Type 2 Lease Agreement. 18. In the event that there is no amount received from an incoming resident, a clause prescribes an estimate of the value of the ingoing contribution. 19. Any entry payments received by the entity under a Type 2 Lease Agreement have been included in the assessable income of the entity in the relevant income year. 20. The applicant has stated that the Type 2 Lease Agreement is not a 'finance lease' as defined in the accounting standards or statements of concepts made by the AASB. Type 3 Loan-Lease Agreement Lease Agreement 21. The Type 3 Loan-Lease Agreement is for residential property as described on the front page of the Lease Agreement. 22. The term of the Lease agreement is 99 years from the commencement date unless terminated in accordance with the agreement and is non-assignable. 23. Under the Lease Agreement, an entry payment is required to be paid by the resident to the entity on or before the commencement date. The entry payment consists of a loan amount and an amount for prepaid rent that is non-refundable (other than in the cooling-off period and the settling-in period). 24. On or before the exit entitlement date, the loan amount is required to be repaid to the resident in accordance with the Loan Agreement. 25. In the event that there is no new resident, a clause prescribes the calculation methodology for determining the amounts under certain clauses. 26. The signing page of the Lease Agreement requires the resident(s) to acknowledge whether or not they have obtained independent legal advice in relation to the contract. 27. The applicant has stated that the entity recommends that new residents seek independent legal advice prior to entering into a Lease Agreement with the entity. Loan Agreement 28. Under the Loan Agreement, the loan amount is advanced by the new resident to the entity on or before the commencement date. The loan amount is unsecured and interest free. 29. Other than in certain circumstances, the loan amount is required to be paid back to the resident. 30. However, the loan amount must be repaid to the resident no later than the expiration of five years from the date the resident vacates the premises. 31. The Loan Agreement is non-assignable or transferrable. Reasons and benefits of standardising the resident leasing arrangements 32. The applicant has provided the following reasons for the entity moving to one single based lease agreement (Type 3 Loan-Lease Agreement): • provides a single fee model for the majority of the entity's retirement village business, which assists in marketing the retirement villages to potential residents and significantly simplifies administration • conforms with industry wide standards - this type of arrangement is the most accepted form of occupancy arrangement amongst 'for profit' retirement village operators • simplifies the management and administration of different accounting policies applicable to the different lease agreements in terms of accounts preparation and auditing • removes the uncertainty surrounding the different taxing points and difficulties of compliance • reduces the sales and marketing training required for sales staff • reduces the administration for sales staff that act as a key point of contact for incoming and outgoing residents • reduces the uncertainty for residents with regard to the financial returns that will accrue in the absence of active markets or in times of reduced demand • the greater level of certainty is a key sales benefit and is expected to increase sales in respect of the retirement village, and • the entity has been entering into the Type 3 Loan-Lease Agreements with new residents since July 20XX. 33. The applicant has further provided the following reasons for adopting the Type 3 Loan-Lease Agreement structure rather than continuing with the Type 1 Lease Agreements and Type 2 Lease Agreements: • The interest-free loan non-assignable lease is better understood by various parties in the retirement village industry, including residents, their legal advisers, and financial planners. This improves the marketability of the premises and facilitates sales. • The time period from the commencement of marketing the premises until sale is expected to reduce. • Time and cost efficiencies are expected in dealing with the residents' legal advisers as the interest-free loan non-assignable lease is better understood. 34. In comparison to the Type 1 Lease Agreement and Type 2 Lease Agreement, the applicant has provided the following two disadvantages of the Type 3 Loan-Lease Agreement: • the possible inclusion of the loan amount in the net debt calculation for the entity (however, in most cases these 'resident loans' are excluded from the calculations of net debt), and • the inclusion of a limited timeframe to sell the premises which inherently has the risk of vacancy or selling at a capital loss (this being mitigated by the existence of an internal sales function and effective management of capital maintenance and refurbishment - further this term could be included in any form of lease agreement with residents, and is not a disadvantage that is unique to switching to the Type 3 Loan-Lease Agreement). 35. The applicant has also provided the following two advantages of the Type 1 Lease Agreement and Type 2 Lease Agreement: • the lease agreements are encapsulated in a single document rather than a separate loan agreement and lease agreement, and • the liability to repay amounts under these lease agreements is not recognised in the entity's financial statements for accounting purposes.

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: Detailed Reasoning - Detailed reasoning: Section 8-1 of the ITAA 1997 provides that a deduction is allowable from assessable income for any 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. It enters into and terminates lease agreements of premises with residents in those retirement villages in the ordinary course of its business. 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 Type 1 Lease Agreement. | Detailed Reasoning - Characterisation of the arrangement: Taxation Ruling TR 2002/14 Income tax: taxation of retirement village operators provides the Commissioner's view on various aspects of the taxation implications for entities involved in retirement villages. TR 2002/14 draws distinctions between various types of arrangements. In the present context, the most relevant of those arrangements are the lease premium (non-assignable) arrangement and the interest-free loan-lease (non-assignable) arrangement. Under a lease premium (non-assignable) arrangement, a resident is granted a long term lease, generally for a period of 99 years of a dwelling in the retirement village, conditional upon immediate payment to the operator of an amount described as a 'lease premium' or lease 'deposit' equal to the market value of the dwelling. Upon termination of the lease, the operator is obliged to make a payment to the outgoing resident (or personal representative) equivalent to the entry price paid by the new resident. The outgoing resident may be required to pay a deferred management fee. The operator is entitled to offset the amount of the deferred management fee payable by the resident against the amount the operator is required to pay to the outgoing resident (paragraph 88 of TR 2002/14). Under a loan-lease (non-assignable) arrangement, a resident is granted a long term lease, generally for a period of 99 years, of a dwelling in the retirement village, conditional upon immediate payment to the operator of an 'interest-free loan' equal to the market value of the dwelling. Upon termination of the lease, the operator is obliged to repay the loan to the outgoing resident (or personal representative) and the outgoing resident may be required to pay a 'deferred management fee' to the operator. The deferred management fee is offset against the amount repayable to the outgoing resident. The outgoing resident may or may not participate in the capital gain or capital loss between the original loan of the outgoing resident and the replacement loan of the incoming resident (paragraphs 90 and 91 of TR 2002/14). Where an agreement is properly characterised as a lease premium agreement, the amount paid by the incoming resident is assessable income of the operator in the year in which it is derived and the amount payable by the operator to the resident on termination of the lease agreement is an allowable deduction in the year in which the operator is liable to make the payment (paragraphs 25 and 26 of TR 2002/14). Where an agreement is properly characterised as an interest-free loan, the receipt and repayment of the loan are on capital account and are neither assessable nor deductible respectively. Where the entry price will be repaid to the resident on termination of the lease, the proper characterisation of the entry price is that it is a loan in form and not a lease premium. However, where the operator is required to make a payment to the outgoing resident calculated by reference to the new resident's entry price, the proper characterisation of the entry price is that it is a lease premium and not a loan because it cannot be regarded as other than a payment that is required to be made in consideration for the granting of the lease (paragraphs 119 and 121 of TR 2002/14). Further, if an interest-free loan is not repayable unless or until another resident enters into another agreement to occupy the accommodation unit vacated by the outgoing resident, the arrangement is not properly characterised as a loan and will be regarded as a lease premium. The fact that the repayment of the loan is contingent upon a new resident being found, an event that may not happen, means an essential element of a loan - the obligation to repay - is absent (paragraph 29 of TR 2002/14). | Detailed Reasoning - Type 1 Lease Agreement characterisation: An entry payment is required to be paid by a resident that enters into the agreement on or before the commencement date. The entity must repay the entry payment to the resident on or before the exit entitlement date. The sale of the premises is required before the entry payment is repaid. Accordingly, as the repayment of the entry payment is contingent on the sale of the premises, the proper characterisation of the arrangement is a lease premium arrangement (paragraph 29 of TR 2002/14). | Detailed Reasoning - Type 3 Loan-Lease Agreement characterisation: The Lease Agreement requires a new resident to pay an entry payment consisting of an ingoing contribution that has two components: a loan component and a prepaid rent component that is non-refundable (other than during the cooling-off period and settling-in period). The loan amount is subject to a separate Loan Agreement. The loan is an unsecured and interest-free loan to the entity. Under the Lease Agreement, the entity must repay the loan amount in accordance with the Loan Agreement on or before the exit entitlement date to the resident. Other than where certain events occur, the loan is to be repaid before a certain date. However, notwithstanding certain clauses of the Loan Agreement, the loan must be repaid to the resident no later than the expiration of five years from the date that the premises were permanently vacated by the resident. Accordingly, although the repayment of the loan amount can occur as a result of a new entry payment being received by the entity from a new resident, ultimately the repayment of the loan amount is not contingent on the sale of the premises to a new resident as there are specified dates by which the loan amount must be repaid, whether or not there is a sale of the premises. The characterisation of the Type 3 Loan-Lease Agreement is therefore an interest-free loan-lease (non-assignable) arrangement. | Detailed Reasoning - Deductibility of repayment amounts under the Type 1 Lease Agreement: As outlined above, the Type 1 Lease Agreement is characterised as a lease premium arrangement. The entry payment that is received by the entity is assessable income to it in the year of income that it derives that amount (paragraph 25 of TR 2002/14). The repayment of the entry payment under the Lease Agreement is an allowable deduction to the entity in the year that the entity becomes liable to pay that amount (paragraph 26 of TR 2002/14). The deductibility of the repayment of the entry amount under the Type 1 Lease Agreement is not affected where the new resident enters into a Type 3 Loan-Lease Agreement (which is characterised as an interest-free loan-lease (non-assignable) arrangement). The arrangement that the entity entered into with a resident under a Type 1 Lease Agreement is separate and distinct from an arrangement that the entity enters into with a resident under a Type 3 Loan-Lease Agreement. | Detailed Reasoning - Question 2: Is a repayment of the entry payment made under the Type 2 Lease Agreement to a resident following termination of that lease agreement deductible under section 8-1 of the ITAA 1997 where the new resident, referred to under that lease agreement, enters into a Type 3 Loan-Lease Agreement? | Detailed Reasoning - Detailed reasoning: As discussed in question 1, it is necessary to ascertain the character of the payment made under the Type 2 Lease Agreement. An entry payment is required to be paid by a resident that enters into the agreement on or before the commencing date. A clause of the Type 2 Lease Agreement requires the entity to repay the resident certain amounts within certain time periods. The applicant contends that as the entity is only required to pay a single amount calculated by reference to a number of elements, it cannot be said that the entity has an obligation to repay the full amount of the entry payment to the outgoing resident upon termination of the occupancy arrangement. The obligation to repay the entry payment is not a legal obligation that is distinct and separate from other payments or receipts provided for under the agreement. The applicant has referred to paragraphs 142 and 143 of TR 2002/14 which effectively states that the essence of a loan of money is the payment of a sum on condition that at some future time an equivalent amount will be repaid. Further, the obligation to repay the principal sum is an essential feature of a loan transaction - where the principal amount is not repayable (whether or not there is a provision for the payment of interest), an essential feature of a loan is absent. The clause of the Type 2 Lease Agreement clearly states that the entry payment specified is payable to the resident, notwithstanding that other amounts are included or excluded as provided for under the agreement from the final payment that is made to the resident. This is not dissimilar to the effect an offset clause has in other lease agreements. It cannot therefore be said that there is not an obligation to repay the principal sum. However, as the repayment of the entry payment is contingent on an incoming resident paying the entry payment when entering a lease of the premises, the proper characterisation of the arrangement is a lease premium arrangement (paragraph 29 of TR 2002/14). For the reasons provided in question 1, the repayment of the entry payment is an allowable deduction to the entity in the year that the entity becomes liable to pay that amount (paragraph 26 of TR 2002/14). The deductibility of repayment of the entry payment amount is not affected where the incoming resident enters into a Type 3 Loan-Lease Agreement (which is characterised as an interest-free loan-lease (non-assignable) arrangement). The arrangement that the entity entered into with a resident under a Type 2 Lease Agreement is separate and distinct from an arrangement that the entity enters into with a resident under a Type 3 Loan-Lease Agreement. | Detailed Reasoning - Question 3: If the answers to question 1 and question 2 are 'No', are those payments deductible under section 25-110 of the ITAA 1997? | Detailed Reasoning - Detailed reasoning: Not applicable as the answers to question 1 and question 2 are 'Yes'. | Detailed Reasoning - Question 4: Is the loan amount of the entry payment that is received from a resident under the Type 3 Loan-Lease Agreement assessable income under section 6-5 of the ITAA 1997? | Detailed Reasoning - Detailed reasoning: Subsection 6-5(2) of the ITAA 1997 provides that an Australian resident'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 question 1, the Type 3 Loan-Lease Agreement is characterised as an interest-free loan-lease (non-assignable) arrangement. Loans under these types of arrangements are on capital account (paragraph 28 of TR 2002/14), and consequently loan amounts received are not ordinary income. Accordingly, the loan amount of the ingoing contribution that the entity receives from a resident under a Type 3 Loan-Lease Agreement will not be assessable income of the entity under section 6-5 of the ITAA 1997. | Detailed Reasoning - Question 5: Under section 177F of the ITAA 1936, will the Commissioner make a determination to cancel a tax benefit, where that tax benefit has been 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 Type 3 Loan-Lease Agreement? | Detailed Reasoning - Detailed reasoning: On an objective consideration of the relevant facts and circumstances, the Commissioner will 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 Type 3 Loan-Lease Agreement.

Is a repayment of the entry payment made under the Type 1 Lease Agreement to a resident following termination of that agreement, deductible under section 8-1 of the ITAA 1997 where the new resident, referred to under that lease agreement, enters into a Type 3 Loan-Lease Agreement?