Private ruling: Main residence – lease – deduction – apportionment
Date of advice: 27 February 2018
Published: July 2018
Ruling period: Year ended 30 June 20XX.
Date scheme commenced: 1 July 20XX.

Ruling: Q1: Are you able to claim a deduction for the private main residence portion of a lease under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) if the property is considered to be ‘wholly and exclusively’ used in a primary production business under Self-Managed Superannuation Funds Ruling 2009/1 - Self-Managed Superannuation Funds: business real property for the purposes of the Superannuation Industry (Supervision) Act 1993 (SMSFR 2009/1)? | A1: No

Relevant facts and circumstances: Your Self-Managed Superannuation Fund (SMSF) purchased a rural property (the Property). From settlement you leased the Property from your SMSF and commenced your primary production business. You occupy the dwelling located on the Property as you main residence. You operate a primary production business on the property. The dwelling (and area used for private purposes) is less than 2 hectares. You meet the conditions in SMSFR 2009/1 to treat the whole property as business real property. You believe this ruling, SMSFR 2009/1, enables you to treat the private main residence portion of the lease as a deduction to the primary production business under section 8-1 of the ITAA 1997.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1

Reasons for decision: Summary: Business real property is defined in subsection 66(5) of the Superannuation Industry (Supervision) Act 1993 (SISA), which states that business real property of a person means any freehold or leasehold interest in real property which is used wholly and exclusively in a business carried on by a person but does not include any interest held in the capacity of beneficiary of a trust estate. The definition requires business real property to be used wholly and exclusively in one or more businesses, whether carried on by the SMSF or not. To satisfy the wholly and exclusively business use requirement, the real property must be used entirely in one or more businesses, to the exclusion of all other activities. Property that meets the definition of business real property includes land on which a business is conducted (for example, shop, factory or office) and land that is subject of a business (for example, land held by a property developer for development or redevelopment, or in the process of being developed or redeveloped). SMSFR 2009/1 sets out the Commissioner’s view on what constitutes business real property for the purposes of the SISA. Two conditions must be satisfied before an SMSF or any other entity related to or dealing with an SMSF can be said to hold real property: ● the SMSF or other entity must hold an eligible interest in real property, that is an interest identified in paragraph (a), (b) or (c) of the business real property definition; and ● the underlying land must satisfy the business use test in the definition, which requires the real property to be ‘used wholly and exclusively in one or more businesses’ carried on by an entity. Paragraph 32 of SMSFR 2009/1 (with example at para 218) contains a special rule for dealing with the concept of ‘wholly and exclusively’ in relation to primary production businesses. This special rule ensures that the threshold can be met where a part of the real property on which the business is carried on contains a residential dwelling. The ‘wholly and exclusively’ threshold will be met if: a. The area containing the dwelling and used primarily for domestic or private purposes does not exceed two hectares; and b. The domestic or private use is not the predominant use of the property. 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, or relate to the earning of exempt income. It is necessary to consider the essential character of the expenditure incurred to determine whether there is a sufficient connection with the assessable income earned. The essential character of an expense is a question of fact to be determined by reference to all the circumstances. Expenditure may have been incurred, in part, for a purpose other than the production of assessable income. If this is the case, the expenditure must be apportioned and a deduction allowed only to the extent that the expenditure was incurred for the income producing purpose. The appropriate method of apportionment will depend on the facts of each case and the method must be both 'fair and reasonable' in all the circumstances ( Ronpibon Tin NL & Tongkah Compound NL v. FC of T (1949) 78 CLR 47; (1949) 8 ATC 431). For example, in Fletcher v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613 ( Fletcher’s case ), the High Court suggested a 'common sense' or 'practical' weighing of all the factors and in that case found that it was 'fair and reasonable' to limit the amount of the deduction to the amount of the assessable income actually received in that year. In your case you believe that because you meet the requirements under para 32 and 218 of the SMSFR 2009/1 you are entitled to treat the whole lease payment for the property as an expense under section 8-1 ITAA 1997 in your primary production business tax return. This is not the case, this only allows a related party of the SMSF to lease a primary production property from the SMSF and live in the dwelling as their main residence (while conducting a primary production business). To recognise whether private or domestic expenses are deductible you need to refer to section 8-1of ITAA of 1997. As you lease the property for your primary production business, and that property has a dwelling on it, and you reside in that dwelling as your main residence, the private component of the lease needs to be apportioned between the part of the lease that is for the business and the part of the lease that is for the main residence dwelling. Consequently, you will not be able to claim a deduction under section 8-1of ITAA of 1997 for the entire lease amount as a deduction to your primary production business, as no deduction is available for private component that relates to your main residence. | Detailed Reasoning - Other relevant comments: We have not considered whether you are in business or whether you meet the requirements in SMSFR 2009/1 for the property to be considered wholly and exclusively used in the primary production business.