PRIVATE AND CONFIDENTIAL

Letter of Advice

Letter of Advice To: Dr Cela

From: Blerina Zeqaj

Date: Monday, 10th August 2020

Reference: B1S2/2020

Subject: Request for advice on tax treatment of rental property owned by Dr Cela

Resolution: What amendments can be set out to the current tax situation and how to navigate
through the present tax rulings to ensure that Dr Cela’s tax treatment is correctly managed.

1|Pag
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August 10, 2020

PRIVATE AND CONFIDENTIAL

Ref: B1S2/2020

Dear Dr Cela,

Furthermore, to your request, I have prepared the following Letter of Advice in-depth for you to
review and see our advice about your current tax treatment. Please contact us immediately if
any of those facts and assumptions are not as discussed as they, may impact the advice
provided.

Summary of Advice.

Dr Cela has requested to prepare a letter of advice explaining the tax treatment for each year
1, 10 and 11 and whether she is entitled to use the rental property loss to reduce her taxable
income.

Since 1985 Dr Cela is a tax resident and has purchased an apartment near her home in
Hawthorn for her parents to retire in. Therefore, by doing so, it enabled her parents to sell
their current home, then live comfortably for the remaining decade on its proceeds and their
low superannuation balance.
Instead of paying for the apartment Dr Cela took out mortgage against the apartment and
subsequently charged her parents only 50% of the market rate of rent for the next decade.
Furthermore, after a decade, she plans to stop charging them rent and allow them to live in the
apartment until they pass away.

In summary, our recommendation is as follows:

 While you were a resident of Australia in the ordinary sense of the word for the years
that are being reviewed (Years 1, 10 & 11) you are considered a resident for income tax
purpose.

• Even that you have allowed your parents live in your property by giving them 50%
discount in rent we strongly recommend you have a legal contract in place and have a
real estate agent for purposes of achieving the maximum amount of deduction.

• We also recommend you apply to the ATO for a private ruling regarding your rental
property.

 Additionally, below, you will see further details regarding what your payments will be in
each of the income years as per our recommendation.
Justification of our decisions
Are you entitled to use negatively gear of the rental property loss and reduce
taxable income?

Generally, you can claim the rental property loss to reduce taxable income as long as they are
both 'fair and reasonable' in all the circumstances. Also, it will require a consideration of all the
details of the case to decide how much, if any, of the interest expense is deductible under
subsection 51(1)1

1. Where property is let to relatives the fundamental question is whether the

arrangements that have been put in place between you and your parents are consistent
with reasonable commercial practice FCT v Groser2.

1. Often questions arise about the extent which losses and outgoing incurred relating to
rent-producing properties are allowable as an income tax deduction.

2. Just because you are the owner of the property, you are not to be treated any
differently for income tax purpose from any other owner in a comparable arm's length
situation.

3. According to a case ruling, FCT v Kowal Case 3all rental income would be considered as
assessable income and all losses related to the rental property would be considered
deductible.

The fundamental resolution of the matter would depend upon the purposes of the taxpayer in
acquiring the property and in letting out to relatives. In your case, you own the property for
two reasons, the first was to provide your mother with a decent place to live, and the other
was to earn income from the investment, I reference this as an example of the FCT v Kowal
Case (1983)4 And in this case, the court specified that the investment was more likely to be his
incentive and found that second purpose or object was the predominant one and, in the result,
allowed income deductions for 80% of the losses and outgoings falling within sub-sections
51(1) and 67(1)5.

1 Income Tax Assessment Act 1997 (Cth) S 51(1).

2 FCT v Groser (1982) 65 FLR 121; 82 ATC 4478
3 FCT v Kowal, (1983) 84 ATC 4001; 15 ATR 125 38
4 FCT v Kowal, (1983) 84 ATC 4001; 15 ATR 125 38
5 Act 1997 (Cth) s 51(1) 6-1(1).
Referring to the case FCT v Groser6 which shows that if the rental income had been assessable,
it would allow no more than $104 in deductions under subsection 51 (1)7
The reason behind this being private or household plans for the use of prevailing over the reason
for creating assessable income.

Based on the information that you have provided us more likely you would fall under a similar
ruling as outline above, you would fall under a similar ruling as to the FCT v Kowal8,
case where it shows that you have purchased the property to provide your parents with a
good home at moderate cost and to earn assessable income.

6 FCT v Groser (1982) 65 FLR 121; 82 ATC 4478

7 Act 1997 (Cth) s 51(1)
8 FCT v Kowal, (1983) 84 ATC 4001; 15 ATR 125 38
Legislation were reviewed to determine if a person can reduce taxable
income.

Legislation
s I used to determine whether you're entitled to claim the losses of the property for
years mentioned I refer to s6-5, 67(1) of the Income Tax Assessment Act 1997 (ITAA
1997)9subsection (6- 5)1,2 & 4 (Legislation.gov.au, 1997)10
Income according to ordinary concepts (ordinary income)

(i) Your assessable income includes income according to ordinary concepts, which
is called ordinary income.

(ii) If you are an Australian resident, your assessable income includes the * ordinary
income you * derived directly or indirectly from all sources, whether in or out of
Australia, during the income year.

(iiii) In working out whether you have derived an amount of * ordinary income, and
(if so) when you derived it, you are taken to have received the amount as soon as it is
applied or dealt with in any way on your behalf or as you direct11

Furthermore, ATO has provided guidelines for determining whether you are entitled to use the
rental property loss to reduce your taxable income in Taxation Ruling IT 216712.
However, there are examples of relevant cases such as the FCT v Groser13 and FCT v Kowal14
that shows several instances as to how the law interprets your current situation.

Taxation Ruling No. IT 2167 Income Tax: rental properties - non-economic rental,
holiday home, share of residence, etc.in the case states that cases, family trust cases
(TR IT 2167) ordinarily, where a taxpayer grants a lease or licence of property,
whether wholly or in part, whether at arm’s length or otherwise, the amount
received as rent or in respect of the licence is assessable income.

If the property is let to relatives at less than commercial rent other considerations
arise. Unless the arrangements are comparable to those in FCT v Groser referred to
earlier, the rent would represent assessable income.

9 1997 (ITAA 1997)

10 Legislation.gov.au. (1997).
11 Income Tax Assessment Act 1997 (Cth) S 6 (5).
12 IT 2167
13 FCT v Groser (1982) 65 FLR 121; 82 ATC 4478
14 FCT v Kowal, (1983) 84 ATC 4001; 15 ATR 125 38
 In FCT v Kowal, 84 ATC 4001: 15 ATR 125 case such circumstance is illustrated
where the Court found that the taxpayer had two purposes or objects in mind in
acquiring the relevant property. One was to provide his mother with a good home at
a moderate cost. The other was to earn assessable income. The Court further found
that the second purpose or object was the predominant one15.

Referring to the cases above both had a different outcome the decisions differed according to
the facts of each case.

15 IT 2167
What is your tax payable for the years in question and
what can we do to improve it?

I have calculated your tax payable using the current 2019 tax rate this would be based
on your current circumstances. I have also stated what improvements can we make to
reduce your taxable income. This all will depend on your choice on which option you
would like to go.
Tax payable = (Assessible income – Deductions) × Tax rate (45%)

1. If you were to pay tax for the years 1, 10 and 11 based only on your assessable income
at $300,000 your taxable income would be at $108,097 + medicate levy 2% +
surcharge 1.5% at $10500 = Total of $118,597

2. If you charge your parents at the full market rate than you will be entitled to claim
deductions from all of your expenses and net rental losses. For the first year, you
totally tax payable including Medicare levy + surcharge would be $116,925.55. Second
Year your tax payable will be $118,966 and the third year $104,192.

Year 1 $294,700
Year 2 $300,700
Year 3 $270,300

4. After studying all aspects of your case to improve your tax situation we came to the
result that you should consider applying for a private binding ruling from the ATO and
we strongly recommend you to get privet health insurance as you save around $4,500
per year and Medicare levy and surcharges you would save approximately $1500.00
per year by having private healthcare hospital cover.

5. If the ruling was to your favour and you would be able to claim 100% percent, of your
expenses your taxable income for years 1, 10 and 11 will be reduced as follow:

Year 1: $284,500
Year 10: $285,500
Year 11: $270,000
If you decide to apply for privet ruling you will require to justify to ATO that negatively
gearing properties at the amount you have claimed the loss is deductible under subsection
51(1).

To assess this appropriately we would need to justify all reasons the purchase of the
investment property and the expenses incurred after the purchase. I would also suggest that
we included deprecations of fixtures and fittings appropriately along with any other forms of
deprecation/expenses that can be associated with the cost of this property.
 Conclusion

As stated earlier, verdicts in these types of cases will depend upon the information and facts of
each case. It is difficult to provide sufficient information in regard to a taxpayer’s
circumstance during the process of submitting a tax return. Should you wish to provide any
additional relevant information or facts that might affect our interpretation of the law and rules
governing the determination of taxable income, we may need to revise our advice.

We assume that in these circumstances and as a working rule that income deductions for
losses, outgoings and deprecation that are about the investment property could be permissible
on the amount of return received.

Should you wish to proceed with my services regarding this matter, I would be more than
happy to represent in the future.

Should you have further queries, please don’t hesitate to contact me.

Yours Faithfully,

Blerina Zeqaj

The Accounting Professionals

111 Smith Street Melbourne Vic
PO Box 128 Melbourne Vic 3000
Bibliography
Books. K Sadiq et al, Principles of Taxation Law 2019 (Thomson Reuters, 2019)

Case Law.
Federal Commissioner of Taxation v. Kowal. [1983] 75 (G.N. Williams J.) Available at:
https://www.ato.gov.au/law/view/document?LocID=%22JUD%2F84ATC4001%22

[Accessed 10 Aug. 2020].

Federal Commissioner of Taxation v Groser [1982] (Jenkinson J.) Available at:

https://www.ato.gov.au/law/view/document?LocID=%22JUD
%2F82ATC4478%22

[Accessed 10 Aug. 2020].

FLETCHER & ORS v FC of T [1991] 1 (Mason CJ, Brennan, Deane, Dawson, Toohey, Gaudron and
McHugh JJ) Available at:
https://iknow.cch.com.au/document/atagUio543223sl16762784/fletcher-ors-v-fc-of-t

[Accessed 11 Aug. 2020].

Legislation. Legislation.gov.au. (1936). Income Tax Assessment Act 1936. [online] Available
at:
https://www.legislation.gov.au/Series/C1936A00027 [Accessed 11 Aug.
2020].
Legislation.gov.au. (1997). Income Tax Assessment Act 1997. [online]
Available at:
https://www.legislation.gov.au/Details/C2017C00336
[Accessed 11 Aug. 2020].

Medicare levy Act 1986.110 [online] Available at:

https://www.legislation.gov.au/Details/C2017C00172
[Accessed 11 Aug. 2020].

Taxation Ruling IT 2167 [online] Available at:

https://www.ato.gov.au/law/view/document?docid=ITR/IT2167/NAT/ATO/00001
 Appendix

Assessable $
Income 320,400.00

Year 1 If she charged her parence 100%rent with deduction of 100%

$
Rental income 20,400.00
$
Interest expenses 17,500.00
$
Other expenses 8,200.00
negative gear -5,300
$
Taxable income 294,700.00

Assessable $
Income 330,400.00

Year 10
$
Rental income 30,400.00
$
Interest expenses 17,500.00
$
Other expenses 12,200.00
$
700.00
$
Taxable income 300,700.00

Year11
$
Rental income -
$
Interest expenses 17,500.00
$
Other expenses 12,200.00
$
(297,000.00)
Taxable income $
 270,300.00

Resident tax rates 2019–20 Year 1

Tax on this income
0 – $18,200 Nil
$18,201 – $37,000 19c = $3,572
$
$37,001 – $90,000 32.5c = 17,225.00
$
$90,001 – $180,000 37c = 33,300.00
$
$180,001 -$ 294,700 45c = 51,614.55

$
Total 105,711.55
$
Plus Medicare levy 2% + surcharge 1.5 11,214.00

Total tax payable 116,925.55

Resident tax rates 2019–20 Year 10

Tax on this income
0 – $18,200 Nil
$18,201 – $37,000 19c = $3,572
$
$37,001 – $90,000 32.5c = 17,225.00
$
$90,001 – $180,000 37c = 33,300.00
$
$180,001 -$ 294,700 45c = 54,314.55

$
Total 108,441.55
Plus Medicare levy 2% + surcharge 1.5 10,524.50
Total tax payable 118,966

Resident tax rates 2019–20 Year 11

Tax on this income
0 – $18,200 Nil
$18,201 – $37,000 19c = $3,572
$
$37,001 – $90,000 32.5c = 17,225.00
$
$90,001 – $180,000 37c = 33,300.00
$
$180,001 -$ 294,700 45c = 40,634.55
Total 94,731.55
Plus Medicare levy 2% + surcharge 1.5 9,460.50
Total tax payable 104,192
Resident tax rates 2019–20 Year 1
Tax on this income
0 – $18,200 Nil
$18,201 – $37,000 19c = $3,572
$
$37,001 – $90,000 32.5c = 17,225.00
$
$90,001 – $180,000 37c = 33,300.00
$
$180,001 -$ 294,700 45c = 51,614.55

$
Total 105,711.55
$
Plus Medicare levy 2% + surcharge 1.5 11,214.00
Total tax payable 116,925.55

Resident tax rates 2019–20 Year 10

Tax on this income
0 – $18,200 Nil
$18,201 – $37,000 19c = $3,572
$
$37,001 – $90,000 32.5c = 17,225.00
$
$90,001 – $180,000 37c = 33,300.00
$
$180,001 -$ 294,700 45c = 54,314.55

$
Total 108,441.55
Plus Medicare levy 2% + surcharge 1.5 10,524.50
Total tax payable 118,966

Resident tax rates 2019–20 Year 11

Tax on this income
0 – $18,200 Nil
$18,201 – $37,000 19c = $3,572
$
$37,001 – $90,000 32.5c = 17,225.00
$
$90,001 – $180,000 37c = 33,300.00
$
$180,001 -$ 294,700 45c = 40,634.55

Total 94,731.55
Plus Medicare levy 2% + surcharge 1.5 9,460.50
Total tax payable 104,192