Claiming tax deductions for capital appreciation payments made to residents may be a long standing approach for some retirement village operators.

Whether or not a deduction can be claimed for capital appreciation payments to residents will depend on whether or not the payments are deductible under section 8-1 of the Income Tax Assessment Act 1997 (Cth) (ITAA97).

One argument is that the payments are “… necessarily incurred in carrying on a business for the purposes of gaining or producing…assessable income.”

In response to the question of “aren’t capital appreciation payments capital in nature”, is the argument that the payments are not of a capital nature and therefore, deductibility is not prohibited by section 8-1(2) of the ITAA97.

Also, the payments may be claimed to be “blackhole expenditure” and therefore deductible under section 40-880 of ITAA97.

Recent case on this issue

The recent Administrative Appeals Tribunal (AAT) case of The Retirement Village Company and Commissioner of Taxation gives insight into the Australian Taxation Office’s (ATO) view on claiming deductions for capital appreciation payments to outgoing residents.

This case involved an operator who had acquired an existing village and the proceeded to claim tax deductions for capital appreciation payments to residents that were residents when the operator took over the village.

The ATO argued that capital appreciation payments to residents were not deductible as they were payments that were made “in relation to the acquisition of the village and are capital in nature”. This argument was based on the view that the operator agreed to assume the liability of the outgoing operator to repay the ingoing contribution to the residents and to pay any share of capital appreciation due to the residents when they vacated the village.

In this case, the AAT found in favour of the retirement village operator and held that the payments to residents were deductible as they were “necessarily incurred in carrying on a business for the purposes of gaining or producing …assessable income”.

The ATO has lodged an appeal against the decision of the AAT and the appeal is due to be heard in July 2011.

This outcome of the appeal will impact operators who have been claiming deductions for capital appreciation payments for villages that have been purchased, and may open the door for operators that have not been claiming deductions to do so.

What's next?

The ATO’s appeal against the AAT’s decision is due to be heard in July.

When the Federal Court appeal has been determined, the ATO may release a decision impact statement which outlines the Commissioner's position in relation to the decision and how the law will be administered as a consequence of the decision.

We will provide further updates on the Federal Court appeal and the Commissioner’s position when they become available.

In preparation for the outcome of the appeal, we recommend reviewing arrangements and income tax returns to ascertain whether deductions have been claimed and whether or not to consider amending tax returns as a result of this important case.