Dee Why property investor loses battle with ATO over split rental income with estranged wife

A Sydney property investor has failed in his bid to convince a court that his estranged wife should pay half of his tax bill after claiming that they jointly owned a retail commercial property and thus should split the rental income.

The bid appears to have failed principially due to lack of evidence - with tax experts warning of the importance of keeping relevent documentation.

Sydney investor Barrie Harbutt had submitted a tax return claiming only half the rental income on a commercial property based in Dee Why on Sydney’s Northern beaches over 2003, 2004 and 2005 and leased to two retail businesses.

He bought the property on Pittwater Road for $800,000 in 1990.

He attempted to convince the Administrative Appeals Tribunal (AAT) of his claim despite being the sole owner and receiving all the rent.

But the ATO formed a different view, and apportioning all the rental income to Harbutt.

As a consequence, he made a smaller net loss to offset against his income under negative gearing rules and hence had a higher tax bill.

Having assessed both Harbutt’s financial affairs and that of his wife, the ATO made the assessment that Harbutt was “liable to tax on the entire net rental income from the property, and Mrs Harbutt became liable to tax on none of it”.

Harbutt had argued that he was a in a “tax law partnership” with his wife and claimed that they always intended to own the property jointly, despite being separated.

He said his wife had access to his bank account regularly withdrew funds but failed because he had no evidence to support this claim nor was their evidence of a partnership agreement between Harbutt and his wife.

In his ruling, AAT deputy president Stephen Frost criticised Harbutt’s lack of evidence but suggested that the argument put forward by Harbutt did have merit.

“In circumstances where a person is the registered proprietor of a rental property, receives the rental income for that property into an account in his name alone, and pays the expenses for the property from that same bank account, a presumption is created that the income from the property belongs to that person alone, and that any deductions are allowable to that person alone,” said Frost.

But he also added that while a statement that income is shared with someone else, “is a self-serving statement which, while it should not be rejected out of hand, is to be approached critically and must be subjected to careful scrutiny”.

Frost said that if he accepted Harbutt’s assertion that 50% of the income from the property belongs to his wife, then his tax liability would be significantly reduced and there would a corresponding increase in his wife’s tax liability.

“That circumstance would make any evidence that Mrs Harbutt might be able to give about the existence of a tax law partnership absolutely critical. Unfortunately there is no such evidence. Mr Harbutt explained that he and his wife are currently separated. But it is not the case that they have lost contact with each other. He knows where she lives,” he added.

Harbutt was not helped in his claim by his correspondence with the ATO – included in the judgement  - telling the tax commissioner his wife knew nothing of his court proceedings and that they were “none of her business”.

Commenting on the case, Chan & Naylor director Ken Raiss told SmartCompany that proper documentation is "absolutely critical,”

“We always tell our clients to start paperwork from day one," he said.

Tax lawyer Robert Richards of Robert Richards & Associates told the Australian Financial Review the Australian Tax Office's view that legal ownership is supreme was wrong and comments made by the AAT in its judgement might work against the ATO.

This simple little case looks as if the Tax Office has won,” said Richards,.

“[But the AAT] seems to indicate that the rule as to legal ownership is not conclusive.”

The case is the exact opposite of the common scenario where property investors take advantage of favourable negative gearing rules that allow them to deducting net tax losses on rental properties against their income and reduce their tax bill.