Ormiston and Commissioner of Taxation

[2005] AATA 978

Administrative

Appeals

Tribunal

 

DECISION AND REASONS FOR DECISION [2005] AATA 978

ADMINISTRATIVE APPEALS TRIBUNAL        No VT2004/231-234

TAXATION         APPEALS        DIVISION
Re		SIMON ORMISTON

Applicant

And COMMISSIONER OF TAXATION

Respondent

DECISION

Tribunal: Mr B.H. Pascoe, Senior Member

Date5 October 2005

PlaceMelbourne

Decision:The Tribunal varies the decision under review to the extent of allowing the objection decisions in respect of the years ended 30 June 1999, 2000, 2001 and 2002 in part by allowing as deductions in each of the years the following amounts:

Year ended 30 June 1999              $12,021

Year ended 30 June 2000              $17,909

Year ended 30 June 2001              $17,931

Year ended 30 June 2002              $17,528

The Tribunal certifies that the proceedings have terminated in a manner favourable to the applicant.

(sgd) B.H. Pascoe

Senior Member

INCOME TAX – property purchased for rental purposes – renovation over five years – property not available for rent – expenditure on interest, annual charges and repairs – whether allowable deductions – whether connection between expenditure and prospective income.

Income Tax Assessment Act 1997

Steele v Deputy Commissioner of Taxation (1999) 197 CLR 459

REASONS FOR DECISION

5 October 2005  Mr B.H. Pascoe, Senior Member

1.      These applications are to review decisions of the Commissioner of Taxation (the respondent) to disallow objections against amended assessments of income tax for the years ended 30 June 1999 to 30 June 2002 inclusive (the relevant years).  The amended assessments were issued to disallow expenditure claimed as rental property related deductions.

2.      At the hearing the applicant Mr S. Ormiston was self‑represented.  The respondent was represented by Mr C. Sievers of counsel.  Evidence was given by Mr Ormiston.

3.      In his income tax returns lodged for the relevant years, Mr Ormiston claimed the following deductions as being related to rental.  No rental income was shown in any of the four years.

30 JUNE 1999       30 JUNE 2000     30 JUNE 2001     30 JUNE 2002

INTEREST            $11,482               $16,650             $16,677             $15,890

RATES AND              $395                  $759                $717               $1,193

LAND TAX

DEPRECIATION         $700                  $910                $728                $582

INSURANCE                   ‑                  $309                $298                $343

REPAIRS AND         $3,850                $2,069                $340  ‑

MAINTENANCE

WATER CHARGE       $144                  $191                $239                $102

SUNDRY                  $118                  $185                $222                $298

EXPENSES

TOTAL                 $16,689               $21,073             $19,221             $18,408

4.      Mr Ormiston said that he decided to purchase an investment property in early 1998 as a long term investment to provide rental income and increase in value.  In May 1998 he attended an auction of a house in Murrumbeena (the investment property).  He said that the investment property was owner-occupied and “in a liveable but dated condition.”  The property was passed in at auction but, after subsequent negotiation, Mr Ormiston purchased the investment property for $215,000 in July 1998.  Settlement was on 28 October 1998.  Mr Ormiston said that he financed the deposit through a redraw facility on the borrowings secured on his house owned jointly with his de-facto partner.  He then borrowed $240,000 from the Commonwealth Bank of Australia to cover the purchase price, stamp duty, conveyancing costs and materials to make repairs and improvements.  As the bank required his residence to be used as collateral security, the loan and the purchase of the investment property were in the names of himself and his partner as tenants in common.  Mr Ormiston said that his partner did not wish to be involved in the investment and executed a declaration of trust stating that her interest was held for the benefit of Mr Ormiston.

5.      Mr Ormiston said that, shortly after taking possession of the investment property he arranged an inspection by two local real estate agents for their estimate of the potential rental.  Both estimated a rental of between $220 and $260 per week with an increase of approximately $50 per week if some “cosmetic improvements” were made.  He said that he decided to undertake some improvements prior to letting the investment property.  As he had developed skills in renovating his own residence he sought to do most of the work himself.  Initially, he expected the work to take up to twelve months but felt that the delay was warranted to obtain a higher rental and a better class of tenant.

6.      Mr Ormiston said that, soon after commencing work on the investment property, he decided that it would be prudent to restump the house.  This delayed work on other areas of the investment property and resulted in more work and time than initially contemplated in repairing lath and plaster internal walls and external walls.  Initially he worked on the investment property most weekends and some evenings.  He accepted that he had not properly scheduled the amount of work and time required.

7.      Mr Ormiston said that his relationship with his de‑facto commenced to deteriorate from late 1999 and they separated in October 2001.  As a result of these personal problems, a change of employment and reduced enthusiasm for the prolonged renovations, little was accomplished during the 2001 and 2002 years.  He said that he did not have sufficient financial resources to contract out the work and was unable to take out further borrowings.  Until the work was completed the investment property was unable to be rented.

8.      As a result of legal action following the end of the de‑facto relationship, Mr Ormiston said that it was necessary to sell the investment property to free the residence, now occupied by his former de‑facto partner, from the security of the loan and to rationalise their joint affairs.  The investment property was sold in August 2003.  The work commenced by Mr Ormiston was still incomplete but he understood that the purchasers were able to complete the renovations and move into the house within five to six weeks of settlement.  In the nearly five years of his ownership, the investment property had remained unoccupied.

9.      It was submitted by Mr Ormiston that his intention had been and continued to be to bring the investment property to a state where it could be let and generate income for the future.  He maintained that this would have been accomplished in a lesser time and he would have retained the investment property for rental purposes if it had not been for personal difficulties during the period.  He sought to rely on the decision of Steele v Deputy Commissioner of Taxation (1999) 197 CLR 459. Mr Ormiston said that the clarification of the expenses between capital, revenue and depreciable items was done by his tax agent on whom he relied.

10.     It was submitted for the respondent that the dominant intention of Mr Ormiston in incurring the interest and other expenses was to protect the capital value of the investment property and to allow him to engage his interest in home renovation.  Any intention to produce a rental income some time in the future was said to have been a secondary purpose.  It was submitted that, at no time, was the investment property available for rental although the ultimate purchaser was able to move in after a very short period, some of the work done was not required to put the investment property into a state to be let, the work done was inefficient, non commercial and unplanned and substantial interest was incurred with no prospect or attempt to offset such expenditure with rental income.  As such, it was argued that there was not a sufficient connection between the incurring of expenditure and the production of future rental.  Mr Sievers submitted that the period between the incurring of the expenditure and the possible future derivation of rental income was simply too long to establish an appropriate connection.  Mr Sievers questioned how long the work would have continued and the property remained vacant if it had not been for the relationship break up and the consequent necessity for sale.  The decision in Steele was sought to be distinguished on the facts.

11.     The facts of this case leave the issue of deductibility of interest and other expenditure very much in the balance.  On one hand, it is difficult to understand how a relatively young man with limited financial resources who makes a decision to purchase a fully geared investment property in October 1998 was unable to have the investment property available for rental by August 2003, nearly five years later.  That large time gap and the failure within it to accomplish his alleged intention of deriving rental income from a simple suburban house can indicate a lack of necessary connection between the expenditure and potential future income.  In Steele, the taxpayer intended a motel development involving re-zoning, finding appropriate partners and management and a substantial investment in a large development.  The time gap in such a project is understandably long.  Here, notwithstanding Mr Ormiston’s explanation of lack of planning and foresight and personal problems the time delay is difficult to understand.

12.     On the other hand, what other purpose could be said for the borrowing of the money, incurring substantial interest and other costs and the substantial investment of time.  The respondent suggested either engaging in a hobby of home renovation or to protect the capital value of the investment property.  If the latter, it would be reasonable to extend the motive to realisation of a profit on a subsequent sale of an improved property.  Such a profit would be, in whole or in part, taxable income.  While it is common for taxation on profits on sales of assets to be referred to as “capital gains tax’,” there is no tax by that name, solely the inclusion of all or part of a profit in assessable income.

13.     On balance, I am prepared to accept the evidence of Mr Ormiston that his intention at the time of purchase of the investment property and thereafter until shortly before the sale, was to derive long term rental from the investment property.  Consequently, I am prepared to accept, also, that his initial expectation was to have the investment property available for rental after modest renovations within a maximum of two years.  The delay was caused by his inexperience, lack of proper planning and problems in his personal life.

14.     As such, the interest on funds borrowed should be an allowable deduction under s 8-1 of the Income Tax Assessment Act 1997 (“the Act”) on the authority of Steele’s case.  It follows, also, that other necessary recurring expenditure of rates, land tax, insurance and water charges were deductible under s 8‑1 of the Act.  On the other hand, I am unable to see how any amounts described as repairs and maintenance can be deductible.  Such would be deductible only where the need for repairs or maintenance resulted from the use of the investment property to produce assessable income.  It is difficult to see how any such expenditure between the dates of purchase and being available for rental could be an allowable deduction.  No assets were actually used for the purpose of producing assessable income nor installed ready to use for such purpose in the relevant years so that no deduction for depreciation is allowable.  The claim for “sundry expenses” appear to be amounts related to renovations and I cannot be satisfied that they constituted allowable deductions.

15.     The result of the foregoing is that the decision under review should be varied to the extent of allowing the following amounts as deductions:

Year ended 30 June 1999:
Interest  $11,482
Rates and Land Tax               $395
Water Charges  $144

$12,021

Year ended 30 June 2000:

Interest  $16,650
Rates and Land Tax               $759
Insurance  $309
Water Charges  $191

$17,909

Year ended 30 June 2001:

Interest  $16,677
Rates and Land Tax               $717
Insurance  $298
Water Charges  $1239

$17,931

Year ended 30 June 2002:

Interest  $15,890
Rates and Land Tax            $1,193
Insurance  $343
Water Charges  $102

$17,528

I certify that the fifteen [15] preceding paragraphs are a true copy of the reasons for the decision herein of

Mr B.H. Pascoe, Senior Member

(sgd)       Elite Aloni

Clerk

Date of Hearing:  4 August 2005

Date of Decision:  5 October 2005

Advocate for the applicant:          Self-represented

Counsel for the respondent:        Mr C. Sievers

Solicitor for the respondent:        Australian Taxation Office, Legal Services Branch