Private ruling: General Deductions - Rent
Published: December 2013

Ruling: Q3: Will the proportion of the prepayment of Rent that is deductible for the taxpayer in a relevant year of income be determined in accordance with the formula in section 82KZMD of the Income Tax Assessment Act 1936 (ITAA 1936)? Advice Yes.

Relevant facts and circumstances: The taxpayer will be granted a Lease to use property which will enable the taxpayer to produce its assessable income. The taxpayer can choose to pay annual Rent payments on their Rent Payment Dates or prepay the annual Rent payments when the Lease is granted.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1936 Subsection 82KZL(1) | Income Tax Assessment Act 1936 Paragraph 82KZL(2)(b) | Income Tax Assessment Act 1936 Subsection 82KZMA(1) | Income Tax Assessment Act 1936 Subsection 82KZMA(2) | Income Tax Assessment Act 1936 Subsection 82KZMA(3) | Income Tax Assessment Act 1936 Subsection 82KZMA(4) | Income Tax Assessment Act 1936 Subsection 82KZMA(5) | Income Tax Assessment Act 1936 Section 82KZMD Does Part IVA apply to this advice? | Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtain a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies, the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable. | We have not considered the application of Part IVA to the arrangement you have asked us to provide advice on, or to an associated or wider arrangement of which that arrangement is part. | If you want us to provide advice on whether Part IVA applies, we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply. | For more information on Part IVA, go to our website (www.ato.gov.au) and enter 'part iva general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision: Summary: Each annual payment of Rent will be incurred in gaining or producing the taxpayer's assessable income for the purpose of paragraph 8-1(1)(a) of the ITAA 1997. Each annual payment of Rent will also not be outgoings of capital or of a capital nature for the purpose of paragraph 8-1(2)(a) of the ITAA 1997. As a result, each annual payment of Rent will be deductible for the taxpayer under section 8-1 of the ITAA 1997 when it is incurred. | Detailed Reasoning - Will the Rent be deductible under section 8-1 of the ITAA 1997?: Section 8-1 of the ITAA 1997 states that: 8-1(1) You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income. 8-1(2) However, you cannot deduct a loss or outgoing under this section to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature; or… Will the annual payments of Rent be incurred in gaining or producing the taxpayer's assessable income? The annual payments of Rent must be incurred "in gaining or producing the taxpayer's assessable income" (paragraph 8-1(1)(a) of the ITAA 1997) or "necessarily incurred in carrying on a business for the purpose of gaining or producing the taxpayer's assessable income" (paragraph 8-1(1)(b) of the ITAA 1997). Paragraph 8-1(1)(a) of the ITAA 1997 covers both business and non-business taxpayers. As a result, there is no need to consider paragraph 8-1(1)(b) of the ITAA 1997 if the taxpayer will satisfy paragraph 8-1(1)(a) of the ITAA 1997. The connection between a taxpayer's outgoings and the generation of assessable income was considered in Ronpibon Tin NL and Tongkah Compound NL v FC of T (1949) 78 CLR 47. The High Court stated at pages 56-57 that: For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end. The words "incurred in gaining or producing the assessable income" mean in the course of gaining or producing such income. And: In brief substance, to come within the initial part of the sub-section it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income. The Lease will allow the taxpayer to access the property to perform activities that will produce the taxpayer's assessable income. Without the Lease and the annual payment of the Rent, the taxpayer will not be able to perform the activities that will produce its assessable income. The Lease and the annual Rent payments allow the taxpayer to perform the activities in order to produce its assessable income. The occasion of the annual payments of the Rent will be found in what will be productive of the taxpayer's assessable income. Each annual Rent payment will be an outgoing incurred by the taxpayer in gaining or producing its assessable income for the purpose of paragraph 8-1(1)(a) of the ITAA 1997. Will the Rent be outgoings of capital or of a capital nature? In Sun Newspapers Ltd v FC of T (1938) 61 CLR 337 ( Sun Newspapers ) at page 359 Dixon J said: The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organisation set up or established for the earning of profit and the process by which such an organisation operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss. And at page 363: There are, I think, three matters to be considered [in determining whether expenditure is on revenue or capital account], (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play a part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment. Later in Hallstroms Pty Ltd v FC of T (1946) 72 CLR 634 at pages 646 and 647 Dixon J said as an introductory remark: …it may be useful to recall the general consideration that the contrast between the two forms of expenditure [income and capital] corresponds to the distinction between the acquisition of the means of production and the use of them; between establishing or extending a business organisation and carrying on the business; between the implements employed in work and the regular performance of the work in which they are employed; between an enterprise itself and the sustained effort of those engaged in it. And later at page 648: What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view... In Colonial Mutual Life Assurance Society Ltd v FC of T (1953) 89 CLR 428 at page 454 Fullagar J said: The questions which commonly arise in [determining whether expenditure is on revenue or capital account] are (1) What is the money really paid for? - and (2) Is what it is really paid for, in truth and in substance, a capital asset? These propositions have been applied in more recent cases. In FC of T v Citylink Melbourne Limited 2006 ATC 4404 ( Citylink Melbourne ), Crennan J (with whom Gleeson CJ, Gummow J, Callinan J and Heydon J agreed) stated at page 4427 that: The characterisation of an outgoing depends on what it is calculated to effect to be judged from a practical and business point of view .. [and] .. [t]he character of the advantage sought by the making of the expenditure is critical. In FC of T v Star City Pty Ltd (2009) FCR 39 at pages 51 and 52 Goldberg J said that: The primary judge correctly identified the relevant principles to apply in determining whether [the outgoing] was an item of revenue or of capital and in determining the character of the advantage sought and the characterisation of the [outgoing]. In particular, the primary judge observed that an examination of the character of the advantage sought was assisted by asking two questions: What was the [outgoing] really paid for; and, is what it was really paid for, in truth and in substance, a capital asset? Her Honour accepted that the answer to these questions…depended upon what the expenditure was calculated to effect from a practical and business point of view. Each annual payment of Rent will secure for the taxpayer the right to access the property to perform the activities for the period to which the Rent payment relates (no longer than twelve months). This advantage will not have any lasting quality beyond the period to which the Rent payment relates. Each annual payment of Rent will be a recurring expense of the taxpayer. The advantage sought will be used by the taxpayer to perform the activities so that it can produce regular income. Each Rent payment will represent an outgoing in carrying on the taxpayer's business rather than an outgoing to establish its business organisation or structure. Each annual payment of Rent will be on revenue account. | Summary: The prepayment will be incurred in gaining or producing the taxpayer's assessable income for the purpose of paragraph 8-1(1)(a) of the ITAA 1997. The prepayment will not be an outgoing of capital or of a capital nature for the purpose of paragraph 8-1(2)(a) of the ITAA 1997. As a result, the prepayment of Rent by the taxpayer will be deductible for the taxpayer under section 8-1 of the ITAA 1997 when the prepayment is made. | Detailed Reasoning - Will the prepayment be deductible under section 8-1 of the ITAA 1997?: Section 8-1 of the ITAA 1997 states that: 8-1(1) You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income. 8-1(2) However, you cannot deduct a loss or outgoing under this section to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature; or… Will the prepayment be incurred in gaining or producing the taxpayer's assessable income? For the same reasons given above (Issue 1, Question 1) in relation to whether the Rent will be incurred in gaining or producing the taxpayer's assessable income, the prepayment will be incurred in gaining or producing the taxpayer's assessable income for the purpose of paragraph 8-1(1)(a) of the ITAA 1997. Will the prepayment be an outgoing of capital or of a capital nature? The case law cited above (Issue 1, Question 1) in relation to whether the Rent will be outgoings of capital or of a capital nature is equally applicable to whether the prepayment will be an outgoing of capital or of a capital nature. In addition, in Sun Newspapers at page 362 Dixon J said: Recurrence is not a test, it is no more than a consideration the weight of which depends on the nature of the expenditure. And: But the idea of recurrence and the idea of endurance or continuance over a duration of time both depend on degree and comparison. As to the first, it has been said it is not a question of recurring every year or every accounting period; but "the real test is between expenditure which is made to meet a continuous demand, as opposed to an expenditure which is made once and for all"… By this I understand that the expenditure is to be considered of a revenue nature if its purpose brings it within the very wide class of things which in the aggregate form the constant demand which must be answered out of the returns of a trade or its circulating capital and that actual recurrence of the specific thing need not take place or be expected as likely. The main difference between the payment of the annual Rent and the prepayment of those annual Rent payments is that the prepayment will bring forward the payment of otherwise periodic Rent. Despite this, the nature of the expenditure will not change. The prepayment will secure the same advantage for the taxpayer: access to and use of the property in order to derive its assessable income. The prepayment will be in substitution for a continuous demand for annual Rent. The annual Rent payments form part of the constant demand which must be answered out of the taxpayer's assessable income. The prepayment of Rent will not constitute a premium paid for the grant of the Lease. The grant of the Lease is not conditional on the prepayment being made. Further, the prepayment of Rent is refundable on a pro-rata basis if the Lease is terminated as a result of default by the Landlord, or the property is substantially damaged or destroyed and not reinstated by the Landlord. | Summary: The conditions in subsection 82KZMA(1) of the ITAA 1936 will be met and section 82KZMD of the ITAA 1936 will apply to set the amount and timing of deductions for the prepayment. As a result, the proportion of the prepayment of Rent that is deductible in a relevant year of income will be determined in accordance with the formula in section 82KZMD of the ITAA 1936. | Detailed Reasoning - Detailed reasoning: Subsection 82KZMA(1) of the ITAA 1936 states that: Section 82KZMD sets the amount and timing of deductions for expenditure that a taxpayer incurs in a year of income (the expenditure year ), if: (a) apart from that section, the taxpayer could deduct the expenditure for the expenditure year under: (i) section 8-1; or (ii) … of the Income Tax Assessment Act 1997 ; and (b) the requirements in subsections (2),(3), (4) and (5) are met. Subparagraph 82KZMA(1)(a)(i) of the ITAA 1936 For the reasons given above (Issue 2, Question 1) the prepayment will be deductible under section 8-1 of the ITAA 1997 when the prepayment is made. The requirement in subsection 82KZMA(2) of the ITAA 1936 Subparagraph 82KZMA(2)(a)(i) of the ITAA 1936 requires the taxpayer to 'carry on a business'. The performance of the activities will constitute a business carried on by the taxpayer. As a result, the taxpayer will meet the requirement in subsection 82KZMA(2) of the ITAA 1936. The requirement in subsection 82KZMA(3) of the ITAA 1936 Subsection 82KZMA(3) of the ITAA 1936 requires the prepayment to be: · incurred in carrying on a business (subparagraph 82KZMA(3)(a)(i) of the ITAA 1936), and · incurred under an agreement (paragraph 82KZMA(3)(b) of the ITAA 1936), and · incurred in return for the doing of a thing under the agreement that is not to be wholly done within the expenditure year (paragraph 82KZMA(3)(c) of the ITAA 1936). The prepayment of Rent will be incurred by the taxpayer in carrying on a business and will also be incurred under an agreement. As a result, subparagraph 82KZMA(3)(a)(i) of the ITAA 1936 and paragraph 82KZMA(3)(b) of the ITAA 1936 will be met. Paragraph 82KZL(2)(b) of the ITAA 1936 will deem the prepayment of Rent to be incurred in return for the making available or continued making available of the property over the term of the Lease. As a result, the prepayment of Rent will be incurred in return for the doing of a thing that is not to be wholly done within the expenditure year. The requirement in subsection 82KZMA(4) of the ITAA 1936 Subsection 82KZMA(4) of the ITAA 1936 requires that the prepayment of Rent "must not be excluded expenditure". 'Excluded expenditure' is defined by subsection 82KZL(1) of the ITAA 1936. The prepayment of Rent does not fall within any of the limbs of the exhaustive definition of 'excluded expenditure'. The requirement in subsection 82KZMA(5) of the ITAA 1936 Subsection 82KZMA(5) of the ITAA 1936 requires that the prepayment 'must not meet a pre-RBT obligation'. A 'pre-RBT obligation' is defined by subsection 82KZL(1) of the ITAA 1936. The definition has four limbs, all of which must be satisfied. The first limb of the definition of a pre-RBT obligation is a contractual obligation that 'exists under an agreement at or before 11.45 am (by legal time in the Australian Capital Territory) on 21 September 1999'. The prepayment is not capable of meeting a pre-RBT obligation because the obligation to make the prepayment did not exist under an agreement at or before 11.45 am on 21 September 1999. Conclusion Ordinarily, the prepayment of Rent would be deductible under section 8-1 of the ITAA 1997 when it is made. However, as subsection 82KZMA(1) of the ITAA 1936 will be satisfied in respect of the prepayment of Rent, section 82KZMD of the ITAA 1936 will set the amount and timing of deductions for the prepayment of Rent.

Will the annual payment of the Rent be deductible for the taxpayer under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) when it is incurred? | Will a prepayment of Rent by the taxpayer be deductible for the taxpayer under section 8-1 of the ITAA 1997 when the prepayment is made?