Private ruling: Retirement Village Residence Contracts
Date of advice: 29 September 2015
Published: September 2015
Ruling period: Year ending 30 June 2015 to 30 June 2030
Date scheme commenced: During the income year ended 30 June 2015

Ruling: Q1: Is the former Residence Contract ("RC") properly characterised as a lease premium arrangement for income tax purposes? | A1: Yes | Q2: Are Entry Fee receipts, received from a Resident by the Retirement Village Operator ("RVO") under the former RC, of a revenue nature in the hands of RVO which constitute assessable income pursuant to section 6-5 of the Income Tax Assessment Act 1997 ("ITAA 1997") in the year of derivation? | A2: Yes | Q3: Do net payments, made to an outgoing Resident by the RVO under the former RC, constitute an allowable deduction pursuant to section 8-1 of the ITAA 1997 in the year RVO is liable to make payment? | A3: Yes | Q4: Is the new RC properly characterised as a loan/lease arrangement for income tax purposes? | A4: Yes | Q5: Are receipts and repayments of the Loan Amount (the interest-free loan from the resident to the RVO, under the new RC, capital in nature and accordingly not assessable income in the hands of the RVO on receipt pursuant to section 6-5 of the ITAA 1997, nor deductible outgoings of the RVO on repayment pursuant to section 8-1 of the ITAA 1997? | A5: Yes | Q6: Are receipts of Pre-Paid Rent for the grant of the lease, received from a Resident by the RVO under the new RC, of a revenue nature in the hands of the RVO which constitute assessable income pursuant to section 6-5 of the ITAA 1997 in the year of derivation? | A6: Yes | Q7: Is the Deferred Management Fee ("DMF") payable by a Resident to the RVO on exit under the new RC assessable income of the RVO pursuant to section 6-5 of the ITAA 1997 in the year of derivation? | A7: Yes | Q8: Are Capital Gain Share payments made to a Resident by the RVO, under the new RC, an allowable deduction of the RVO pursuant to section 8-1 of the ITAA 1997? | A8: Yes

Relevant facts and circumstances: This description of facts is based on the ruling application, former and new RCs and other documentation attached to the application. The documents form part of this description. The RVO owns and operates a retirement village which includes units and apartments. The retirement village has no Stata Title arrangements. Rather all Residents are 'non-owner residents' as that term is defined in the Retirement Villages Act 1986 (Vic). The RVO has entered into arrangements with its residents under the former RC. Recently the RVO has amended certain terms and conditions in the residential contracts. The contractual changes apply to all new RC which will be entered into with the New Residents. As at the date of the private ruling application, no contracts have been entered into under the new RMC. The Former RC The Former RC is in the form of a non-assignable lease agreement. Clause A of the former Resident Contract provides that the resident is required to make the following payments to the RVO at the time of entry: • Entry Fee • Chattels fee • One month's Maintenance Charge Pursuant to clause B of the former RC, upon termination of the Resident's Contract, and receipt of a New Entry Fee from a New Resident, the RVO was required to pay the Resident: • X% of any capital gain; and • an amount equal to Y% of the lesser of the outgoing Resident's Entry Fee and the New Entry Fee paid by the New Resident. On departure the Resident was also obliged to make payments to the RVO of amounts stated in clause C of the former R&MC. In the event that a capital loss was made, the capital loss was to be borne by the Resident. The New RC The RVO has introduced the new RC for both units and apartments. It is proposed that under clause A of the new RC, the Resident pays the following amounts to the RVO at the time of entry: • the Loan Amount (pursuant to the Loan Agreement); • Pre-Paid Rent (non-refundable); • Chattels Fee; and • One month's Maintenance Charge Pursuant to clause B of the new RC, upon termination of the contract, and the Resident's departure from the retirement village, the RVO must repay the Loan Amount to the Resident at the earliest of either: • # months from the date the resident provides vacant possession of the Resident's Premises ("# Month Date"); and • The RVO receiving the New Entry Fee from the New Resident. In the event that a capital gain is made, residents living in units will also be entitled to a share of any capital gain, whereas residents living in apartments will not be entitled to share in any capital gain. Additionally, where a capital loss is made, the capital loss will be borne by the Resident. On departure, the Resident is obliged to make payments of amounts stated in clause C of the new RC on the earliest of the # Month Date, or the owner receiving the New Entry Fee from the New Resident. Clause A of the new RC almost replicates that of clause A of the former RC, with the exception that a new clause has been included to ensure that the Resident must pay a DMF. The DMF is calculated with reference to the period of residency (up to a capped amount). Additionally, the new RC allows payments between the Resident under clause A and the RVO under clause B to be set-off against each other. In effect, the contractual changes to the new RC removes the contingency contained in the former RC of the resident's entitlement to payment being contingent on a New Entry Fee being received by a New Resident. The new RC provides a fixed/ascertainable date for the RVO to refund and pay exiting entitlements to residents upon permanent departure from the retirement village.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 and | Income Tax Assessment Act 1997 section 8-1.

Reasons for decision: Summary: The former RC is properly characterised as a lease premium arrangement for income tax purposes. | Detailed Reasoning - Detailed reasoning: The former RC makes reference to the nature of the ownership or tenure being in the form of a lifetime licence, which confers exclusive and vacant possession upon the Resident. Paragraph 24 of Taxation Ruling TR 2002/14 ("TR 2002/14") clarifies that the label 'licence fee' in a commercial retirement village arrangement could be a mischaracterisation. Usually, these arrangements involve leases rather than licences and the tax treatment will depend on the proper characterisation of the particular arrangements. Paragraph 29 of TR 2002/14 provides that: where an 'interest-free loan' is not repayable unless or until another resident enters into an 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. Clause B of the former RC makes it clear that the payment of a Resident's exit entitlement is contingent upon a New Resident paying a New Entry Fee. On the basis that the former RC confers exclusive and vacant possession of the premises as against all and the owner, it can be concluded that the arrangement is in fact a lease. | Summary: An entry fee received under the former RC constitutes assessable income pursuant to section 6-5 of the ITAA 1997 in the year of derivation. | Detailed Reasoning - Detailed reasoning: Paragraph 25 of TR 2002/14 provides that the amount received for the grant of a lease, whether it be termed a lease premium or otherwise, is on revenue account and constitutes assessable income of the operator in the year in which it is derived. As identified in question 1 above, the former RC constitutes a lease premium arrangement. Therefore, the Entry Fee receipts received from a Resident are assessable under section 6-5 of the ITAA 1997, in the year of derivation. | Summary: Net payments made to an outgoing Resident under the former RC constitute an allowable deduction pursuant to section 8-1 of the ITAA 1997 in the year of payment. | Detailed Reasoning - Detailed reasoning: Clause C of the former RC makes it clear that the Resident must pay certain amounts on departure following the receipt of the New Entry Fee from the New Resident by the RVO. Clause B of the former RC then details the amounts that the RVO must pay to the Resident upon exit following the receipt of the New Entry Fee from the New Resident. Clause B specifically provides that these two amounts can be offset against each other, so that a net amount is paid to a Resident upon termination of a lease. Paragraph 26 of TR 2002/14 provides that where an amount paid by an incoming resident is properly characterised as a lease premium and included in the assessable income of the operator, the amount payable by the operator to the resident upon termination of a lease agreement is an allowable deduction in the year in which the operator becomes liable to make that payment. On the basis that Entry Fees received from Residents are included in the assessable income of the RVO (as discussed in question 2 above), it necessarily follows that amounts paid by the RVO to a Resident on departure will be an allowable deduction in accordance with section 8-1 of the ITAA 1997. Such amounts will be deductible in the year in which the RVO incurs the loss or outgoing - hence, in the year that the RVO pays the amount in accordance with clause B of the former RC. | Summary: The new RC is characterised as a loan/lease arrangement for income tax purposes. | Detailed Reasoning - Detailed reasoning: Under clause A of the new RC, the Resident is required to pay the following amounts at the time of taking up residence at the retirement village: • the Loan Amount pursuant to the Loan Agreement; • the Pre-Paid Rent; • the Chattels Fee; and • one month's Maintenance Charge. Clause A of the new RC provides that no interest is payable to the Resident in relation to the Entry Fee (which is defined to be the Pre-Paid Rent plus the loan amount). Clause B of the new RC provides that the RVO must pay to the Resident the Loan Amount pursuant to the Loan Agreement at the earliest of either: • # Month Date; and • The Owner receiving the New Entry Fee from the New Resident. Clause C of the new RC details the payments due by the resident to the RVO on departure, including payment of the DMF. Pursuant to paragraph 28 of TR 2002/14, an arrangement between a resident and village operator will be characterised as a loan where: • An amount of money (sometimes referred to as an 'interest-free loan') is paid to a retirement village operator by an incoming resident; and • The operator has an obligation to pay the same amount to the resident upon termination of the lease. Further, paragraph 29 of TR 2002/14 states that where repayment of an interest-free loan is contingent upon a new resident being found, the arrangement is not properly characterised as a loan, as the essential element of a loan, being the obligation to repay, is absent. The new RC contains a sunset clause (clause B), which provides a fixed time for the repayment of the entire Loan Amount pursuant to the Loan Agreement. Therefore the repayment of the loan under the new RC is not contingent upon a new resident being found. Further, clause B of the new RC states that the payment due from the RVO to the Resident under clause B must, where possible, be offset against the payment due from the Resident to the owner under clause C. Paragraphs 27 and 204 of TR 2002/14 provide that the village operator being able to set off certain fees and charges (e.g. DMF) does not change the character of the loan. Therefore, in view of the above guiding principles extracted from TR 2002/14, it can be concluded that the new RC can be properly characterised as a loan/lease arrangement for income tax purposes. | Summary: Receipts and repayments of the Loan Amount by the RVO under the new RC are capital in nature, and therefore not assessable nor deductible. | Detailed Reasoning - Detailed reasoning: Paragraph 28 of TR 2002/14 provides that where the relevant arrangement requires the resident to make a loan, the receipt and repayment of the loan are on capital account. As outlined in question 4 above, the new RC is properly characterised as a loan/lease arrangement for income tax purposes. The new RC provides certainty in terms of the time of repayment as well as the amount of repayment of the Loan Amount to the Resident, so that the receipts and repayments are capital in nature. Therefore, any receipts and repayments of the Loan Amount by the RVO are on capital account, and accordingly the receipt of the ingoing loan will not be assessable income under section 6-5 of the ITAA 1997, nor will the repayment of the loan be deductible under section 8-1 of the ITAA 1997. | Summary: Receipts of Pre-Paid Rent by the RVO for the grant of the lease under the new RC are of a revenue nature and assessable pursuant to section 6-5 of the ITAA 1997 in the year of derivation. | Detailed Reasoning - Detailed reasoning: The new RC provides that "Pre-Paid Rent" means the non-refundable amount payable by the Resident to the RVO on or before the Commencement Date of the contract. This amount forms part of the entry costs that a resident must pay. Clause D of the new RC provides that in consideration of the payment of the Pre-Paid Rent, the RVO grants a licence of the Resident's Premises from Commencement Date for the term of the Contract. Clause A also makes reference to the fact that the Pre-Paid Rent is one of the costs payable by the resident on entry, either on or before Commencement date, and Clause E then confirms that exclusive and vacant possession of the Resident's premises will be provided. Paragraph 23 of TR 2002/14 provides that: To the extent that a village operator receives amounts that are in form rent in advance, and non-refundable, the rent is assessable in full on receipt. Where the rent is fully abatable, it is assessable over the term of the lease, in accordance with the Arthur Murray principle. Paragraphs 124-126 of TR 2002/14 draw a distinction between a payment required as consideration for the granting of the lease, and a payment for the actual use and enjoyment by the lessee of the land. On the basis that the Resident obtains exclusive and vacant possession of the premises once the Pre-paid Rent and Chattels Fee is paid, it can be concluded that the Pre-Paid Rent is paid in respect of the grant of a lease rather than a licence. Under the new RC, the Pre-paid Rent is a one-off payment, forming part of the entry costs for the purpose of securing the right to exclusively occupy the Resident's Premises as opposed to being a payment of rent intended for the use of the premises. Accordingly, the amount received as Pre-paid Rent is assessable in full pursuant to section 6-5 of the ITAA 1997 in the year of receipt. | Summary: DMF payable by a Resident to the RVO on exit under the new RC are assessable pursuant to section 6-5 of the ITAA 1997 in the year of derivation. | Detailed Reasoning - Detailed reasoning: Clause C of the new RC details the costs payable by a resident on departure, and deals specifically with the DMF. The new RC provides that DMFs will accrue over the period of possession (up to a capped amount). It is important to note that Clause C provides that costs are payable by the resident upon the earliest of either: • The # month date; and • The owner receiving the New Entry Fee from the New Resident. Paragraph 39 of TR 2002/14 provides that: …the village operator cannot properly demand payment of the fee until the resident ceases to reside in the accommodation unit to which the contract relates. That is a condition precedent to the making of a demand for payment. Until the condition precedent is satisfied, the fee does not mature into a recoverable debt. Accordingly, the deferred management fee payable by an outgoing resident is derived by a village operator in the year in which the operator becomes entitled to demand payment of the fee from the outgoing resident. Paragraph 96 of TR 2002/14 explains that DMFs may be calculated as a set percentage, for each year of occupancy, of a resident's original entry price or the entry price paid by a new resident often limited to a maximum amount (e.g., 25% of the original entry price). The deferred management fee may also be the greater of a set percentage per year of occupancy of either the original entry price paid by the outgoing resident or the entry price payable by the new resident. On the view that the new RC should be properly characterised as a loan/lease arrangement in accordance with TR 2002/14, it follows that the DMF calculated in accordance with Clause C of the new RC is specifically referrable to the period of occupancy. Accordingly, the RVO will be assessed on the DMF pursuant to section 6-5 of the ITAA 1997 in the year in which it becomes entitled to demand payment of the fee from the outgoing resident. | Summary: Capital Gain Share payments made to a Resident by the RVO are allowable deductions to the RVO pursuant to section 8-1 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Clause B of the new RC provides that where the New Loan amount is higher than the Loan Amount paid by the Resident, an amount equal to the Capital Gain Share is payable to the Resident. The new RC defines a Capital Gain Share as X% of the amount by which the New Loan Amount exceeds the Loan Amount. Paragraph 50 of TR 2002/14 provides that: Where a village operator, in addition to repaying the deposit or loan received by a village operator upon the grant of a lease, makes a payment to an outgoing resident (or to their legal personal representatives) that represents a share of any increase in the entry price payable by a new resident (that is, the difference between the entry price paid by the outgoing resident and the entry price payable by the new resident), such payments are deductible under section 8-1. In view of the above, a Capital Gain Share payment made to a Resident (living in a unit), constitutes a deductible outgoing in accordance with section 8-1 of the ITAA 1997 in the year in which the payment is made.