Effective assignments
Commonly, clients consider splitting rental property income by
assigning or directing that income to be paid to their family
members (i.e. in lower marginal tax brackets) in order to minimise
the total amount of tax paid. Unfortunately, special rules exist
that may render these arrangements ineffective for tax purposes.
Seven year itch
The advantage of effectively assigning the right to income from
property (i.e. instead of transferring the property itself) is
that the income will no longer be the assignor’s income which
means the assignor will not be taxed on the income. The problem is
that income from property (e.g. a rental property), cannot be
effectively assigned for tax purposes unless the assignment is
made for at least seven years. If the income is assigned for
less than seven years the assignment is treated as void for tax
purposes under section 102B of the Income Tax Assessment Act
1936 (ITAA 1936) (i.e. the assignor will be assessed on the income and not
the assignee).
An assignment of income between associated persons will only be
effective if:
- consideration at market value is paid
for the assignment of income; or
- the assignment is for at least seven
years.
Any consideration paid for the assignment of income will be
included in the assessable income of the assignor in the year in
which the right is transferred and, in some circumstances, may
lead to an even larger overall tax bill.
Assignment CGT
Assigning the right to income from property will also result in
the disposal of a CGT asset for tax purposes and may give rise to
a capital gain or loss upon transfer of the right to receive
income.
Ineffective assignments
Great caution must be undertaken if assigning income. This is
because the assignment is not effective if the assignor will, or
may, terminate the assignment before seven years.
To satisfy the seven-year requirement, the right to income must
be one which subsists for more than seven years. For example, if
the assigned income is the right to receive income from leases,
and the leases are themselves for a term less than the nominated
seven-year period, then the transfer will fail.
In addition, an assignment made through a sublease may also
fail. Hill J in Davis v. FCT (1989) 20 ATR 548, held that
many subleases have clauses which allow the sublease to be
terminated prior to the seven-year period if certain circumstances
involving default by the lessee occur. Hill J said that he was
conscious of the fact that no assignments of income under a lease
will ever be effective having regard to section 102B(1) of ITAA
1936 because in practice all leases will contain provisions
equivalent to default clauses.
It follows from the above that assigning income for tax
purposes, for no consideration, will be practically impossible
when the property is subject to any sort of lease. The only way to
split or transfer the income is to transfer the income-producing
property itself with the resultant CGT implications.
This is an excerpt of an article that
appeared in Thomson’s InTax
magazine (September 2007); Australia’s best independent monthly
tax magazine. InTax provides concise reports of the latest
tax news, plus the practical implications of tax developments in
an easy-to-read magazine format. To find out more, phone Thomson
Customer Service on 1300 304 197.
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