House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Scott Morrison MP)

Chapter 1 - Travel related to use of residential premises

Outline of chapter

1.1 Schedule 1 to this Bill amends the ITAA 1997 to ensure that travel expenditure incurred in gaining or producing assessable income from residential premises is:

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not deductible; and

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not recognised in the cost base of the property for CGT purposes.

1.2 The amendments improve the integrity of the tax system by addressing concerns that some taxpayers have been claiming travel deductions without correctly apportioning costs, or have claimed travel costs that were for private purposes.

1.3 The amendments are not intended to affect deductions for institutional investors in residential premises, as the same integrity concerns do not arise for such investors. The amendments also do not affect deductions for travel expenditure incurred in carrying on a business, including where an entity carries on a business of providing property management services.

1.4 All legislative references in this Chapter are to the ITAA 1997 unless otherwise stated.

Context of amendments

1.5 Generally, section 8-1 allows income tax deductions for losses and outgoings that are incurred in the gaining or producing of assessable income, or are necessarily incurred in the carrying on of a business for the purpose of gaining or producing assessable income.

1.6 Prior to the amendments made by this Schedule, travel expenditure for, but not limited to, the inspection or maintenance of a rental property owned by a taxpayer, or travel expenditure to collect rent, was deductible as being incurred in gaining or producing assessable income under section 8-1. Deductible travel expenditure included car, airfare and accommodation costs. Where travel was for a mixed purpose, investors could only claim expenses to the extent they were incurred in relation to gaining income from the rental property.

1.7 In the 2017-18 Budget, the Government announced a package of measures designed to reduce pressure on housing affordability. This Schedule implements one of the reforms in the package to disallow travel deductions relating to residential investment properties. This is an integrity measure to address concerns that some taxpayers have been claiming travel deductions without correctly apportioning costs, or have claimed travel costs that were for private purposes. The amendments enhance community confidence in the tax system by ensuring tax deductions are better targeted.

Summary of new law

1.8 Schedule 1 amends the ITAA 1997 to ensure that travel expenditure incurred in gaining or producing assessable income from residential premises is not deductible unless incurred by certain institutional entities or by an entity in the course of carrying on a business.

1.9 Furthermore, travel expenditure which is prevented from being deducted by the amendments in this Schedule cannot form part of any element of the cost base and reduced cost base of residential premises for CGT purposes.

Comparison of key features of new law and current law

Detailed explanation of new law

1.10 These amendments deny deductions for travel expenditure incurred in gaining or producing assessable income from residential premises to address concerns that some taxpayers have been incorrectly claiming travel deductions.

1.11 The amendments do not prevent an entity from claiming such a deduction if:

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the entity is in an excluded class (refer paragraphs 1.26 to 1.34); or

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the losses or outgoings are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income (refer paragraphs 1.35 to 1.37).

Travel expenditure related to use of residential premises not deductible

1.12 The amendments provide that an entity cannot deduct a loss or outgoing incurred under the income tax law, to the extent that it is related to travel, if it is incurred to gain or produce assessable income from the use of residential premises as residential accommodation. [Schedule 1, item 2, paragraph 26-31(1)(a)]

Residential investment property

1.13 These amendments prevent travel expenditure related to residential premises being deducted. The term 'residential premises' is defined in the ITAA 1997 as having the same meaning as in the A New Tax System (Goods and Services Tax) Act 1999 (GST Act). The GST Act provides that 'residential premises' are land or buildings that are occupied as a residence or for residential accommodation or intended to be occupied, and are capable of being occupied, as a residence or for residential accommodation (regardless of the term of the occupation or intended occupation) and includes a 'floating home' (within the meaning of the GST Act). [Schedule 1, item 2, paragraph 26-31(1)(a)]

1.14 Due to its use in the GST law, this defined term is already the subject of considerable judicial scrutiny as well as interpretative guidance. Broadly, land or a building is residential premises if it provides, at a minimum, shelter and basic living facilities and is either occupied by a person (the first limb) or designed for occupation (the second limb).

1.15 The courts have found that, for both limbs, whether premises are capable of being occupied as a residence or for residential accommodation is to be ascertained by an objective consideration of the character of the property. The purpose for which an entity may hold the property is not relevant.

1.16 The definition is broad and may include commercial residential premises, such as a hotel or boarding house. However, where travel expenditure is necessarily incurred in carrying on a business, the expenditure remains deductible under section 8-1 (refer paragraphs 1.35 to 1.37).

1.17 These amendments deny deductions for travel expenditure incurred in producing assessable income that is related to the use of residential premises as residential accommodation. In other words, the amendments disallow deductions for travel expenditure incurred in producing rental income from residential premises.

1.18 These amendments do not prevent an entity from deducting travel expenditure where they are not using residential premises as residential accommodation, but are using the premises for other income producing purposes. To the extent that the residential premises are used for other income producing purposes, travel expenditure relating to these purposes can continue to be deducted.

1.19 These amendments principally affect owners of residential rental properties. However, the amendments also affect entities that do not have a legal ownership interest in a property but have the right to use the property to produce income from the use of the residential premises as residential accommodation. This would include sublease arrangements (see example 3.2).

Travel expenditure

1.20 These amendments deny deductions for travel expenditure incurred to gain or produce assessable income from the use of residential premises as residential accommodation. This includes travel for activities undertaken to gain or produce rental income from an entity's residential investment property, such as, but not limited to, inspecting, maintaining, or collecting rent for the property. [Schedule 1, item 2, subsection 26-31(1)]

1.21 For the purposes of these amendments, the ordinary meaning of 'travel' applies. Travel expenditure would be expected to include motor vehicle expenses, taxi or hire car costs, airfares, public transport costs, and any meals or accommodation related to the travel.

1.22 The travel is not restricted to travel to the relevant property. For example, travel undertaken to attend an apartment building owner's corporation meeting or visit a real estate property manager to discuss the property is also not deductible.

1.23 The travel will not necessarily be undertaken by the taxpayer. For example, the taxpayer may incur a loss or outgoing related to their relative's travel if they reimburse or directly pay for their relative's travel and the travel is related to the rental property. Regardless of who undertakes the travel, these amendments deny deductions for travel expenditure incurred by a taxpayer to gain or produce assessable income from the use of residential premises as residential accommodation.

1.24 These amendments do not affect the ability of a taxpayer to deduct from their assessable income the cost of property management services under section 8-1, such as where the taxpayer engages a real estate agent to provide these services. As is the case prior to these amendments, the taxpayer is not able to deduct any expenditure (other than indirectly via the property manager's fees) for travel undertaken by the property management service provider as the taxpayer has not directly incurred this expenditure. Further, the payment of a property management service fee is not considered an expense related to travel, even if a component of the fee is a direct reimbursement of travel costs. [Schedule 1, item 2, subsection 26-31(1)]

1.25 However, the cost of the travel continues to be deductible to the property management service provider as it is an expense necessarily incurred in the course of carrying on their business for the purpose of gaining or producing assessable income (see paragraphs 1.35 to 1.37). Those travel costs would be expected to be passed on to the taxpayer as part of the real estate agent's fee for providing property management services.

Example 1.1 : Travel expenditure for inspecting property and visiting real estate agent not deductible

Michael owns an investment property and engages a real estate agent to manage his property which is located across town. The property is leased for residential accommodation and therefore considered residential premises within the meaning of the GST Act.

Every six months, Michael travels by car to inspect the property. He also meets with the real estate agent once a year to discuss potential rent increases and any other property management issues. Travel expenditure to inspect the property and meet with the real estate agent is for the purpose of gaining or producing rental income from the use of residential premises as residential accommodation.

Michael incurs fuel costs associated with this travel. The fuel costs are not incurred in carrying on a business. Michael cannot deduct such travel expenditure as it is related to travel and incurred to derive income from the use of residential premises for residential accommodation.

Example 1.2: Travel expenditure related to residential premises subject to a sublease arrangement not deductible

Chris is the owner of an investment property, which he has leased out to head tenant Billy. Billy decides to move out of the property but decides not to break the lease. Instead, Billy subleases the property to another tenant, Jared.

Billy collects rental income from Jared and incurs expenditure travelling to the property to inspect it every month. Billy is prevented from deducting such expenditure, which is related to travel and is incurred to gain or produce assessable income from the use of residential premises as residential accommodation.

Excluded classes of entity

1.26 These amendments do not prevent an entity from deducting a loss or outgoing related to travel incurred in relation to a residential investment property, if at any time during the income year in which the loss or outgoing is incurred, the entity is:

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a 'corporate tax entity' (within the meaning of the ITAA 1997);

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a 'superannuation plan' that is not a 'self managed superannuation fund' (within the meaning of the ITAA 1997);

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a public unit trust (within the meaning of section 102P of the Income Tax Assessment Act 1936 (ITAA 1936));

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a managed investment trust; or

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a partnership or unit trust if all of the members of the partnership or trust are entities included on this list (including this item).

[Schedule 1, item 2, subsection 26-31(2)]

1.27 The amendments do not apply to deductions for institutional investors in residential premises. Institutional investors usually operate under a corporate structure, are public unit trusts, managed investment trusts, or meet the description of being a 'superannuation plan' that is not a 'self managed superannuation fund' or are unit trusts or partnerships that are ultimately held by these entities. Generally, such investors are considered to have a low risk of incorrectly claiming travel deductions, as these entities are either outside the control of an individual, do not receive tax concessions which flow through to individuals or both. Furthermore, situations where apportionment of expenditure is required because there is a mixed purpose for travel are less likely to arise for such taxpayers.

1.28 Corporate tax entity is defined in section 960-115. It includes entities that are companies, corporate limited partnerships, corporate unit trusts and public trading trusts at the relevant time. It does not include a trust merely because the trustee of the trust is a corporate tax entity.

1.29 'Superannuation plan' and 'self-managed superannuation fund' are defined in subsection 995-1(1).

1.30 Public unit trust is defined in section 102P of the ITAA 1936. Broadly, a unit trust will be a public unit trust if the units in the trust are listed for quotation in the official list of a stock exchange, offered to the public in a public offer, held by more than 50 people or where a tax-exempt investment vehicle, such as a foreign superannuation fund, is a substantial unitholder (see subsections 102P(1) and (2) of the ITAA 1936). However, a trust is not a public unit trust if 20 or fewer people hold the beneficial interest in 75 per cent or more of the income or property of the trust, or if other integrity rules are not satisfied (see section 102P of the ITAA 1936).

1.31 Trusts are also excluded if they are managed investment trusts within the meaning of section 275-10. As part of its Housing Affordability package, the Government announced amendments to the tax law to enable managed investment trusts to invest in dwellings used to provide affordable housing and benefit, for example, from reduced rates of withholding tax. Excluding managed investment trusts removes any doubt that such trusts that comply with the widely held rules for managed investment trusts and engage in institutional investment in affordable housing are permitted deductions for travel expenditure.

1.32 In all cases these requirements ensure that trusts must be widely held and genuinely free from the control of any one member to benefit from this exclusion.

1.33 The final exclusion is for unit trusts or partnerships if all of the members of the entity (i.e. the unit holders or partners) are listed as excluded entities. This exclusion ensures that where all the benefit of deductions goes to excluded entities, the deductions continue to be available. This includes situations where the excluded entities receive the benefit of deductions through a chain of unit trusts or partnerships.

1.34 For example, a unit trust that owns residential premises is entitled to deduct travel expenditure for an income year if all of the units in the trust are held by another unit trust and all of the units in that unit trust are owned by excluded entities, such as companies.

Travel expenditure incurred in carrying on a business

1.35 These amendments ensure that deductions for travel expenditure incurred in carrying on a business remain deductible under section 8-1. This means deductions continue to be available for an entity that carries on a business of property investing or a business of providing retirement living, aged care, student accommodation or property management services. [Schedule 1, item 2, paragraph 26-31(1)(b)]

1.36 Whether a business is being carried on depends on the facts of the particular case. For example, some indicators that the courts have considered relevant are whether the activity has a significant commercial purpose or character, whether there is repetition and regularity of the activity and whether the activity is better characterised as a hobby or recreational pastime.

1.37 An entity that is considered to be carrying on a business of providing retirement living, aged care or student accommodation may incur travel expenditure in carrying on its business. For example, a retirement village operator may incur travel expenditure in having an employee travel from a head office to a retirement village to inspect the property or carry out maintenance. This travel is for the purpose of gaining or producing assessable income from the use of residential premises as residential accommodation. Such entities can continue to deduct travel expenditure necessarily incurred in carrying on their business (refer section 8-1).

Example 1.3 : Travel expenditure incurred in carrying on a business deductible

Mirela operates a business of leasing holiday flats in Coffs Harbour. She undertakes various tasks such as cleaning, laundry, greeting guests and topping up provisions on a daily basis.

Mirela uses a car to travel between the flats and her garage at home where she keeps her equipment and stock. She uses the logbook method to calculate her travel expenditure.

Her travel expenditure is incurred in the course of carrying on a business for the purpose of producing assessable income and therefore remains deductible.

Example 1.4 : Travel expenditure in a mixed use property

Anna owns multiple workshops across Australia as part of her business operations. She owns a two-storey brick shop-house in Melbourne. The building comprises a workshop on the ground floor and an apartment on the first floor.

The apartment is rented out separately to a couple, Leon and Michelle. Therefore, Anna derives assessable income from both her workshop and the apartment.

The apartment satisfies the definition of residential premises within the meaning of the GST Act.

Anna travels from her home town in Canberra to her property in Melbourne for the purpose of carrying out maintenance to the floor of the workshop. This maintenance activity is solely related to gaining or producing assessable income from the workshop.

Anna incurs airfare costs associated with this travel. Anna will be able to deduct her travel expenditure as it relates to gaining or producing assessable income in the course of carrying on her business from her workshop, not from gaining or producing assessable income from the use of her apartment as residential accommodation.

Anna takes a second trip from her home town in Canberra to her property in Melbourne for the purpose of carrying out maintenance to the wall of her apartment. This maintenance activity is solely related to gaining or producing assessable income from the apartment. Anna incurs airfare costs associated with this travel. This time Anna will not be able to deduct her travel expenditure as it relates to gaining or producing assessable income from the use of her apartment as residential accommodation.

Ensuring non-deductible travel expenditure is excluded from the cost base for capital gains tax purposes

1.38 This Schedule includes amendments to the CGT rules that ensure that losses and outgoings, which are prevented from being deducted by the amendments in this Schedule do not form part of any element of the cost base and reduced cost base of a residential investment property. This has the effect that the travel expenditure is never included in any of the elements of the cost base or reduced cost base (refer section 110-37). [Schedule 1, items 3 and 4, subsections 110-38(4A) and 110 55(9J)]

1.39 This ensures that the expenses that are no longer recognised on a taxpayer's revenue account are also prevented from being recognised on their capital account.

Non-deductible travel expenditure also not deductible as black hole expenditure

1.40 Travel expenditure is not deductible under section 40-880 (which makes certain business related capital expenditure, known as 'black hole expenditure', deductible) to the extent that it is not deductible under these amendments (refer paragraphs 40-880(5)(g) and (h)).

Consequential amendments

1.41 Schedule 1 includes consequential amendments adding references to the new rules to the guidance material in section 12-5 (which contains a list of provisions about deductions). [Schedule 1, item 1, table item headed 'travel expenses' in section 12-5]

1.42 This Schedule also includes consequential amendments adding notes to assist users of the legislation. [Schedule 1, items 3 and 4, note to subsections 110-38(4A) and 110-55(9J)]

Application and transitional provisions

1.43 The amendments apply to any loss or outgoing incurred on or after 1 July 2017. [Schedule 1, item 5]