Computation of Rental Property Tax Laws

Question: Define the Determination of Residential Status and computation of Rental Property Income as per Australian Tax Laws. Answer: The determination of the residential status is crucial because the computation of the taxable income, application of the tax rates, rebates, and exemptions depends upon it. The nature of income that is to be included in the computation of the taxable income of a taxpayer is ascertained according to the residential status (Prince, 2013). For example, if a taxpayer is resident of Australia for a particular income year, then all types of income earned by the taxpayer either within or outside Australia shall be taxed in Australia. Further, the tax rates applied to charge tax on the taxable income also differ depending upon the residential status of the taxpayer. For example, in case of individual taxpayers, it could be observed that the Australian government has provided different income slab for residents and non residents. The taxpayers, who are resident of Australia for income year 2015-16, have been given first hand exemption for income up to $18200, whereas, the non-resident taxpaye rs are not allowed any exemption on the taxable income (Australian Taxation Office, 2016). The Income Tax Assessment Act (ITAA) 1936 incorporates the basic provisions regarding residential status. Further, various tax rulings have also been framed to clarify the basic provisions related to the residential status in more detail with the suitable examples (Wolters Kluwer, 2016). Residential status rules have been framed differently for different categories of taxpayers such as individuals, corporations, and others. In the current case, Juliette is an individual, for whom the residential status is to be determined, thus, the provisions and rules regarding the residential status of an individual have been analyzed. In this connection, it has been observed that the taxation ruling 98/17 contains detailed provisions in regard to determination of the residential status of individuals entering Australia (Australian Taxation Office, 2016). The tax ruling 98/17 is applied in determining the residential status of the Australian migrants, students coming to Australia for study, visitors on holiday, and workers coming to Australia in connection with employment (Australian Taxation Office, 2016). In this regard, it is important to note that this tax ruling is not to be applied in determination of the residential status of the people returning to Australia who earlier normally resided in Australia. The ruling prescribes that the residential status of the taxpayer is to be determined on year to year basis. Determination of the residential status each year is important because the circumstances could change from year to year leading to change in the residential status. Further, the tax ruling clarifies the meaning of term reside in a great detail with the statutory definition and ordinary meaning (Australian Taxation Office, 2016). The statutory definition of the term reside has been provided in section 6 of the Income Tax Assessment Act 1936 (Australian Taxation Office, 2016). The ordinary meaning has been explained in the ruling 98/17 by stating that person coming to Australia with an intention to live permanently and residing there for a considerable period of time will be deemed to be residing in Australia in ordinary parlance. However, it should noted here that the ordinary meaning of the term reside is resorted to only when the position as regards residential status of the individual is not clear from the statutory provisions. The statutory provisions in regard to determination of the residential status prescribe three types of tests, which are commonly known as the tests of residency (Australian Taxation Office, 2016). Those three types of tests of residency are domicile test, 183 day test, and superannuation test (Australian Taxation Office, 2016). All the tests of residency contain different parameters to adjudge that whether or not an individual is a resident of Australia. As per the domicile test, an individual is deemed to be resident for income tax purposes, if that individual has domicile in Australia. Domicile here implies the permanent place of abode, where the individual resides with the required amenities to live permanent. However, this provision will not apply in cases in which, the income tax authorities are satisfied otherwise (Lawrence, 2014). Further, it should also be remembered that if the individual satisfies the domicile test, that individual would be deemed to be resident of Australia without requiring any other test to pass or condition to comply with. The second statutory test of residency is 183 days test, which is based on the period of stay of the individual in Australia in the relevant income year. As per this test, if the individual stays for a period of 183 days in an income year in Australia, whether continuously or intermittently, that individual will be regarded as resident of Australia for income tax purposes (Australian Taxation Office, 2016). However, if individual does not have usual place of abode in Australia and there is no intention of the individual to settle in Australia for permanent, then the provisions of this test may not apply. This implies that even of an individual coming to Australia stays there for a period of 183 days or more in an income year, but the usual place of abode of the individual is outside Australia and there is no intention to live permanently in Australia, the individual will not be deemed as resident of Australia (Australian Taxation Office, 2016). The intention to live permanently is difficult to judge, therefore, the Australian taxation office has clarified in this regard detailing the circumstances that are considered to be indicative of the intention to live permanently. As per the rules framed in this regard, the two primary cut off criteria have been set to judge the intention of an individual such as individuals behavior and purpose of arrival (Wills, 1997). The purpose indicating an intention to live permanently may be anything such as education or employment, but it must be something more than mere travelling or visiting for casual reasons. The individuals behavior implies the action taken by the individual in respect of domestic and economic affairs, for example, selling off the investments, and letting out the property on rent before leaving for Australia and taking residence in Australia with all the required amenities (Wills, 1997). Ascertaining the individuals intention and purpose is a subjective matter requiring careful interpretation and application of the provisions and rules. There have been observed various disputes involving the issue of determination of the intention and purpose of an individuals visit (Wills, 1997). The courts pronouncements have set out various principles in regard to ascertainment of the residential status of an individual. For example, in the case of FC of T v. Penchey 75 ATC, it has been held that employee staying in Australia in connection with employment for a short period will not be deemed to be resident (Australian Taxation Office, 2016). The third test of residency is the superannuation test, which provides explicitly that if the provisions of superannuation act 1976 apply to an Australian government employee, then that individual shall be deemed to be resident (Australian Taxation Office, 2016). Further, it is also to be noted in this regard that if an individual is declared resident as per the superannuation test, then the spouse and children under 16 years of age would also be deemed as resident of Australia. However, the superannuation test is applied only in case of Australian government employees and not in other usual cases (Australian Taxation Office, 2016). Applying the above provisions in the current case of Juliette, the residential status in her case for the income year 2014-15 and 2015-16 has been determined as under: Residential Status of Juliette for the Income Year 2014-15 It has been observed in case of Juliette that she does not have a permanent place of abode in the income year 2014-15 in Australia, which implies that as per domicile test, she is not resident of Australia (Australian Taxation Office, 2016). Further, Juliette is also not an employee of the Australian government, which implies that superannuation test of residency also, does not apply in her case. Now the determination of the residential status of Juliette depends upon the test of 183 days stay. For this purpose, the days of her stay in Australia in the income year 2014-15 comprising the period from July 01, 2014 to June 30, 2015 is produced below: Income Year: 2014-15 Month Feb Mar April May June Total Days 28 0 0 31 30 89 From the above, it is clear that Juliette stayed for a period total period of 89 days in the income year 2014-15, which is less than the limit of 183 days. This implies that Juliette is not an Australian resident for the income year 2014-15 (Australian Taxation Office, 2016). Residential Status of Juliette for the Income Year 2015-16 The circumstances for Juliette changed in the income year 2015-16 as she got married with an Australian young man and also took out a permanent place to reside in Australia. These circumstances indicate her intention to live permanently in Australia, which is a significant factor to determine the residential status under the provisions of the income tax in Australia (Wills, 1997). Further, the total period of her stay also exceeded the prescribed limit of 183 days in the income year 2015-16, as shown in the table given below: Income Year: 2015-16 Month July August Sep Oct April May June Total Days 31 31 30 16 16 31 30 185 Thus, based on this analysis, it has been articulated that Juliette is to be regarded as Australian resident for the income year 2015-16 (Australian Taxation Office, 2016). Requirement-2 (a) As per the provisions of the Income Tax Assessment Act 1936, a person earning income by way renting the property has to pay taxes on the rental income. The computation of rental property income is carried in the rental property statement, which shows the particulars of the rental income along with the expense claimed and allowed (Australian Taxation Office, 2016). In the current case, George is running business of letting out the property since the year 1995. In this regard, the rental property statement for the income year 2015-16 has been presented as below: Rental Property Statement Amount ($) A. Rental Income Rent received for the current income year 13,900.00 B. Rental Deductions Agent Commission for management ($13,900*5%) 695.00 General repairs and maintenance 6,000.00 Repainting the front fence which consists of painted wooden pickets 2,500.00 Fixing the broken front door which was damaged by vandals 1,000.00 Total 10,195.00 C. Decline in the Value of Assets Stove ($900/12) 75.00 Hot water service ($2000/12) 166.67 Carpets (3500/10) 350.00 Furniture and fittings (5000/13.33)+(1200/13.33*.5) 420.11 Total 1,011.77 D. Capital works deduction Replacing the damaged fibro roof with longer lasting colorbond 187.50 ($15000*2.5%*0.50) Net Rental Income or Loss (A-B-C-D) 2,505.73 Requirement-2 (b) The rental property statement given in requirement-2 (a) above has been divided into four main parts such as rental income, rental deductions, decline in the value of asset, and capital works deductions. The first part of the statement shows all types of rental income earned by the taxpayer in the income year. The guidelines set out in regard to the rental property income prescribe that the rental income not only includes rental receipts, but other incomes directly associated with the let out of properties are also clubbed with that (Australian Taxation Office, 2016). For example, the other income associated directly with the letting out of the property may be fees collected from the tenants for the cleaning and maintenance services. In the current case, the rental property income includes only the rent receipts amounting to $13,900. The second part of the rental property statement lists out the rental expenses, which are allowed straightforward in the same year in which these were incurred. Certain expenses such as advertisement, insurance, general repair and maintenance, agent commission, and interest on loan are allowed to the taxpayer in the same income year in which these are incurred (Australian Taxation Office, 2016). However, there are certain expenses, which are not allowed to be deducted while computing the taxable income from letting business. These expenses include acquisition costs, expenses not borne by the owner, travel expense incurred for inspection of the property, and expenses incurred in disposing off the property (Australian Taxation Office, 2016). Further, in regard to the repair and maintenance expenses, it has been observed that the expense should on revenue account to be able claim it in the year of incurrence (Australian Taxation Office, 2016). The repair and maintenance expense on capital account are either not allowed or allowed as capital works deduction over the number of years. The repair and maintenance expenses on capital account includes replacement of entire structure or unit of the property, repairs carried out at the time of acquiring the property, and similar nature repairs and maintenance involving heavy amount. Claims in regard to agent fees and commission should also be dealt with caution because there are certain restrictions on allowance of such expenditure. For example, commission paid to agent for assisting in disposal of property and acquisition of property is not allowed for deduction from the rental income. Although, these expenses are not allowed while computing rental income but these are added to t he cost of the property and adjusted at the time of computing capital gains on disposal of the property (Australian Taxation Office, 2016). However, the commission paid to the agent for managing the business of letting is allowed to be deducted from the rental income. Considering the above discussed guidelines, total expenses amounting to $10,195 have been claimed in the rental property statement. These expenses comprise of commission paid to agent for managing the property renting affairs amounting to $695 and repairs on revenue account amounting to $9,500 ($6000+$2,500+$1,000). The repairs claimed on revenue account include general repair and maintenance amounting to $6,000, repainting the front door amounting to $2,500, and fixing broken door amounting to $1000. Further, the repair of the damaged roof amounting to $15,000 has been excluded considering it to be of capital nature. The third part of the rental property statement deals with the deductions for decline in the value of assets. In letting out the property, the tenant not only uses the building, but the assets such as air conditioners, stove, and other items of furniture and fittings are also used (Australian Taxation Office, 2016). Assets other than building being used by the tenants are commonly called plant on which depreciation for decline in the value is allowed. Since, the assets deteriorate with the use over the period of time, therefore, the cost of assets is allowed for deduction in the form of depreciation. The depreciation is worked out based on the estimated useful life of the asset. There are two methods such as diminishing value method and prime cost method, which the taxpayer can use to compute deprecation on the assets (Australian Taxation Office, 2016). It is to be noted here that depreciation is only allowed on plant and not on other assets such as building or some other asset fixed to the earth (Australian Taxation Office, 2016). However, there is a separate deduction in the name of deduction for capital works, which allowed on building and other construction work. Further, it is also pertinent to note that the depreciation and deduction for capital works is allowed proportionate to the number of days the asset is held in the income year. This implies that if the asset is held for half of the year, the depreciation or deduction for capital works will be reduced to fifty percent (Australian Taxation Office, 2016). Taking into account the above guidelines, total depreciation amounting to $1,011.77 has been claimed in the current case. This amount includes depreciation of $75.00 on stove, $166.67 on hot water service, $350.00 on carpet, and $420.11 on furniture and fittings. The taxpayer has applied prime cost method in computing the depreciation in the current case on all the assets. The depreciation on stove has been computed by dividing the cost of stove of $900 by effective life of 12 years. In the way, the depreciation on the hot water service and carpet has been calculated by dividing their respective costs with their respective effective lives. However, in respect of furniture and fittings, there has been observed an addition of $1200 in December 2015. Therefore, the depreciation on the furniture and fittings comprises of depreciation on the existing cost and an additional part on the new purchases. Since, the new furniture and fittings were purchased in the December month, which is six month from the start of the income year; therefore, the depreciation has been reduced to 50% on the new purchase. Further, as per the guidelines, if the effective life is in fractions, it is to be taken in fractions only and not to be rounded off, thus, the effective life of the furniture and fittings has been taken as 13.33 years. The fourth part of the rental property statement covers the capital works deductions. The guidelines in this regard stipulate that the construction expenditure which is not allowable as repairs in the same income year, can be claimed as capital works deductions. The capital works deduction is allowed over a period of 25or 40 years depending upon the nature of capital expenditure (Australian Taxation Office, 2016). Categories of expenditure covered in the capital works deduction are building construction, alterations, and structural improvements. Further, there are restrictions on the amount that can be claimed as deduction under capital works. The amount of deduction here depends upon the nature of expenditure and the date of expenditure incurrence. Primarily, there are two rates such as 2.5% and 4%, which can be applied in computing the deduction for capital works. The category of 4% deduction covers the special properties such industrial building or complexes, while rest of the pro perties are covered under category of 2.5% deduction (Australian Taxation Office, 2016). In the current case, considering the nature of capital work, a deduction at the rate of 2.5% on the replacement of the damaged roof has been claimed. The capital work of replacement of the damaged roof carried in the month December, thus, the total allowable deduction has been reduced to 50%. References Australian Taxation Office. (2016). Individual income tax rates for prior years. Retrieved August 20, 2016, from https://www.ato.gov.au/Rates/Individual-income-tax-for-prior-years/?page=1#Tax_rates___resident. Wolters Kluwer. (2016). 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