Private ruling: Income Tax ~~ Deductions ~~ lease expenses
Published: September 2013
Ruling period: 1 July 20XX to 30 June 20YY
Date scheme commenced: The date the ruling is made.

Ruling: Q1: Will the lease payments made by the Taxpayer be treated as deductible for tax purposes in the year such payments are incurred pursuant to Division 8 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes

Relevant facts and circumstances: The Taxpayer as the lessee will operate the Real Estate Asset subject to a lease on behalf of the lessor. Periodic lease payments will be set, via a quarterly Lease Payments Schedule, at a level to be the expected operating revenue of the Real Estate Asset less the operating costs that the Taxpayer as lessee is responsible to cover. Where the actual positive cash flow generated by the Real Estate Asset is below the Lease Payments Schedule in any quarter, the shortfall will constitute a deferred lease payment and will be required to be paid to the lessor in future quarters when there is sufficient operating cash flow to do so. Where the actual positive cash flow generated by the Real Estate Asset is above the Lease Payments Schedule and any required deferred lease payments in any quarter, the Taxpayer and the lessor will share 50:50 in such outperformance. The payment of the lessors' 50% share is referred to as an incentive fee. By this arrangement, there will be an incentive for the Taxpayer to maximise operational performance of the Real Estate Asset.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 8-1(1) | Income Tax Assessment Act 1997 Subsection 8-1(2) Question 1 | Summary | The payments under the lease (lease payments) made by the Taxpayer will be treated as deductible for tax purposes in the year such payments are incurred pursuant to Division 8 of the ITAA 1997. | Detailed reasoning | Paragraph 8-1(1)(a) of the ITAA 1997 states that you can deduct from your assessable income any loss or outgoing to the extent that it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. | On the facts provided, the Commissioner accepts that: | · lease payments incurred by the Taxpayer will be an outgoing | · the Taxpayer is carrying on a business in operating the Real Estate Asset on behalf of the lessor, and | · the operating revenue derived by the Taxpayer from the Real Estate Asset is assessable income. | Therefore, all that needs to be considered by the Commissioner is whether these lease payments will be necessarily incurred by the Taxpayer in operating the Real Estate Asset for the purpose of gaining or producing its assessable income. | Relevantly, paragraph 9 of Taxation Ruling TR 95/33 Income tax: subsection 51(1) - relevance of subjective purpose, motive or intention in determining the deductibility of losses and outgoings outline the Commissioner's view on the meaning of "necessarily incurred" for the purposes of the former subsection 51(1) of the Income Tax Assessment Act 1936 (which was rewritten as subsections 8-1(1) and 8-1(2) of the ITAA 1997): 9. The test in the second limb of subsection 51(1) requires that the relevant outgoing be characterised as necessarily incurred in carrying on the business of the taxpayer for the specified purpose. In other words, the expenditure in question must have the necessary connection with the operations or activities which more directly gain or produce assessable income if it is to meet the statutory criterion of being a loss or outgoing necessarily incurred in gaining or producing assessable income (see Hill J in FC of T v. Roberts & Smith 92 ATC 4380 at 4386; (1992) 23 ATR 494 at 502). | To be permitted to carry on its business in operating the Real Estate Asset, the Taxpayer must pay the lease payments incurred by it as the lessee to the lessor. The lease payments (including the deferred lease payments) are incurred at the time that they are legally due under the lease. | Therefore, the Commissioner is of the view that these lease payments will be necessarily incurred by the Taxpayer in operating the Real Estate Asset. | Next, the Commissioner needs to determine whether or not there is sufficient connection between the lease expenses incurred by the Taxpayer and the "gaining or producing of its assessable income." | The Commissioner at paragraphs 40 to 47 of Taxation Ruling TR 2002/15 Income tax: deductibility of payments incurred on moneys raised through the issue of perpetual notes (by reference to the High Court decisions in DCT (WA) v. Boulder Perserverance (1937) 58 CLR 223 and FC of T v. The Midland Railway Co of Western Australia Ltd (1951) 85 CLR 306) considers the principle of distinguishing between the expenses of deriving income and the application of income derived. | More specifically, the Commissioner is of the view that periodic payments can be considered tax deductible under section 8-1 of the ITAA 1997 provided they are not contingent on the net profit/taxable income made by the taxpayer in the previous financial year. | From the facts provided, the incurring of these lease payments by the Taxpayer is contingent on the quarterly operating revenue exceeding the quarterly operating costs and any deferred lease payments balance carried forward from previous quarterly periods. In other words, the lease payments are contingent on the positive quarterly cash flows generated by the Taxpayer in operating the Real Estate Asset, not the business's net profit/taxable income for the previous financial year. | Therefore, the consideration of this principle does not preclude these lease payments from being tax deductible under section 8-1 of the ITAA 1997. | Before reaching a conclusion about the tax deductibility of these lease payments, the negative limbs within subsection 8-1(2) of the ITAA 1997 will need to be considered. | (a) To the extent that they are an outgoing of capital or of a capital nature: The Commissioner is of the view that these lease payments are clearly periodic operating expenses incurred by the Taxpayer in operating the Real Estate Asset for the duration of the lease and are not an outgoing of capital or of a capital nature. | (b) To the extent that they are of a private or domestic nature: The Commissioner accepts that these lease payments are clearly not of a private or domestic nature. | (c) To the extent that they are incurred in relation to producing exempt or non-assessable non-exempt income: The Commissioner accepts that the lease payments will not be incurred in relation to producing exempt income or non-assessable non-exempt income. | (d) A provision of the ITAA 1997 prevents them from being deducted: On the facts provided, the Commissioner is of the view that there is no such provision within the ITAA 1997. | In conclusion, as the first positive limb in paragraph 8-1(a) of the ITAA 1997 has been satisfied and none of the negative limbs in subsection 8-1(2) of the ITAA 1997 apply, the Commissioner is of the view that the lease payments made by the Taxpayer will be treated as deductible for tax purposes in the year such payments are incurred pursuant to Division 8 of the ITAA 1997.