Private ruling: Rental property – income – timing of assessability of prepaid rent
Date of advice: 18 December 2017
Published: May 2018
Ruling period: Year ended 30 June 201Y | Year ended 30 June 201Z
Date scheme commenced: 1 July 201X

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. | Q2: Are you able to split the rental income and declare it according to the financial year to which it relates? | A2: No.

Relevant facts and circumstances: You are a non-resident living in a foreign country with only a rental property in Australia. Your tenant has paid you 12 months’ rent upfront from part of which relates to the next financial year. After interest and associated costs are taken into consideration you expect to make minimal or no income.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 6 - 5(3) Summary | Amounts representing rent in advance that are non-refundable are assessable in full in the year of receipt. | Detailed reasoning | Subsection 6-5(3) of the Income Taxation Assessment Act 1997 (ITAA 1997) explains that the assessable income of a non-resident taxpayer includes ordinary and statutory income derived from an Australian source 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. | We can take some guidance on this issue from Taxation Ruling TR 2002/14 Income tax: taxation of retirement village operators (As at 26 November 2014). Although this ruling applies to the taxation of retirement village operators the principles discussed in determining whether an amount is prepaid 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 in advance (Paragraph 23 of TR 2002/14). | It is accepted 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. | It could be argued 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 one year 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 201Y-1Z financial year, being the year of income in which it was received.