Private ruling: Assessability of income
Date of advice: 30 September 2015
Published: September 2015
Ruling period: Year ended 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Is the amount of prepaid rent assessable in the year of receipt where there is no provision for a pro-rata refund if the lease is terminated during the period covered by the pre-paid rent? | A1: Yes.

Relevant facts and circumstances: You purchased an investment property You entered into a XX week tenancy agreement with unrelated third parties as tenants. The tenants voluntarily paid a lump sum amount of rent, being for the entire XX week lease period spanning two financial year periods to the managing agent. The tenants suggested this prepayment as proof of their capacity to pay rent. You did not prepay any expenses relating to your rental property, all expenses will be returned in the period to which they relate. A portion of the lump sum has been placed in your managing agent's trust account. You received the remaining balance of funds into your bank account. The tenancy agreement between you and the tenant is silent about whether there is an obligation for any of the rent to be refunded if the lease is terminated early. You contend that you have a legal obligation to refund any overpaid rent to the tenants in the event that the lease is terminated early, under Section 47 of the Residential Tenancies Act 2010 , which states: 47 Tenant's remedies for repayment of rent and excess charges (1) Requests to landlord. A tenant may make a written request to the landlord that the landlord repay to the tenant any rent, or other amounts, paid by the tenant that are not required to be paid under this Act or the residential tenancy agreement. (2) A request may be made during or after the termination of a residential tenancy agreement. (3) A landlord must, within 14 days of a written request by a tenant, repay to the tenant the amount of any rent or other amount paid in excess of the amount payable by the tenant under this Act or the residential tenancy agreement. (4) Tribunal orders. A tenant may apply to the Tribunal for an order for the repayment of rent or any other amount paid by the tenant if a written request by the tenant for payment is not complied with by the landlord within 14 days. (5) The Tribunal may order that rent or any other amount be repaid to the tenant if it finds that the rent or amount was not required to be paid by the tenant under this Act or the residential tenancy agreement.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 6-5(2)

Reasons for decision: Summary: Subsection 6-5(2) of the Income Taxation Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year. Ordinary income is defined as income according to ordinary concepts. Factors like periodicity, recurrence, regularity or services performed have been identified by the courts as indicating that an amount is income according to ordinary concepts. However an amount received in a lump sum can also be ordinary income depending on the nature of the lump sum payment. If the purpose of the lump sum payment is to provide a substitute for an income stream then that lump sum may take on the character of those payments it is intended to replace. In the circumstances here the issue is whether this lump sum was intended to replace future rental income and whether it amounted to a lump sum payment of prepaid rent. We can take some guidance on this issue from Taxation Ruling TR 2002/14 which deals with the characterisation of receipts on the granting of occupancy rights in the context of retirement villages. Although this ruling applies to the taxation of retirement village operators the principles discussed in determining whether an amount is pre-paid rent are relevant here. Where: • a person is prepared to make a lump sum payment in exchange for the right to occupy a dwelling for a fixed term • the person is entitled to receive a pro-rata refund for the unexpired portion of the term (if any); and • the intention of the parties is that the lump sum payment in advance is for the use and enjoyment the dwelling for the fixed term, the payment should generally be accounted for as rent in advance and be brought to account over the period for which the payment is made. For example if you are paid a lump sum of $12,000 in lieu of a monthly rent of $100 under a 10 year lease and the tenant is entitled to a pro-rata refund of this lump sum should the lease be broken early you would return the rent as income of $1,200 each year over the term of the lease in accordance with the principles laid down in Arthur Murray (NSW) Pty Ltd v. Federal Commissioner of Taxation 114 CLR 314; 14 ATD 98; (1965) 9 AITR 673. However, amounts representing rent in advance that are non-refundable are assessable in full on receipt (Paragraph 23 of TR 2002/14). In Case B51, 70 ATC 253, the taxpayer received three years rent in advance, but without provision for any abatement. The Taxation Board of Review held that the amount was in fact rent, but that it had 'come home' to the taxpayer and was assessable in full in the year of receipt In your case it is clear that the lump sum payment is as consideration for rent under the lease; however, the residential tenancy agreement does not indicate that any rent paid in advance may be refundable. You contend that you do have an obligation to refund any overpaid rent to the tenant under Section 47 of the Residential Tenancies Act 2010 , however, this section provides for the repayment of rent and excess charges "…that are not required to be paid under this Act or the residential tenancy agreement." The prepaid rent covers the period of the lease only. As the lease is a contract of liability and obligation by the tenant to pay that amount over the term of the contract, it cannot be considered to be an amount 'in excess' of the tenancy agreement. As such, this section is not considered to apply to your situation. It follows that as there is no provision in your tenancy agreement for a pro-rata refund of rent to the tenant if the lease is terminated early, the whole of the prepayment amount is assessable in the year of income in which it was received.