Edited version of your written advice

Authorisation Number: 1051453990787

Date of advice: 15 November 2018

Ruling

Subject: Capital gains tax - sale of property - income v capital

Question:

Will the profit made on the sale of Lot B be assessable under section 6-5 of the Income Tax Assessment Act 1997?

Answer:

Yes

This ruling applies for the following periods:

Income year ending 30 June 2019

Income year ending 30 June 2020

The scheme commences on:

1 July 2018

Relevant facts and circumstances

You, being Company A, are the trustee of the Trust.

The Trust is a discretionary trust.

Person A is your director.

A meeting was held between members of the local council (the Council), and Person A and Person B (t on your behalf (the Applicant) in relation to the proposed subdivision of Lot A and Lot B (two into two lots). The following information was sourced from the record of the meeting:

● site details – Lot A and Lot B;

● zone – low density residential;

● the key issues identified by the Applicant were parking access and servicing for the commercial character building, alterations to the building, streetscape works and tree removal;

● aim of discussions to provide initial advice on nominated major issues relevant to the development proposal to assist in the timely processing of applications;

● the site currently consists of two lots on one title. The site contains a commercial character building overlayed over Lot B. The site also contains a shed;

● it is proposed to remove the shed and reconfigure the lot boundaries to create two square lots which will result in the commercial building being retained on a new corner lot and one new lot fronting a street being created;

● it was considered that the proposed demolition of the shed was supportable as it would not result in a loss of commercial character to the streetscape;

● only Lot A is mapped as being with the Commercial character building overlay, and that the commercial character building extends over the boundary with Lot B, which is not mapped under the overlay;

● the Applicant enquired if the portion of the building extending over the boundary could be demolished, leaving Lot B clear of any buildings or structures;

● it was the Council’s view that the removal of part of the building at Lot B was likely to result in the demolition of some of the building that was in the overly and that the Council did not support any demolition of the commercial character building where it is not demonstrated to comply with the commercial character building (demolition) overlay code;

● a number of alternative development proposals were discussed which included constructing a separate dwelling unit at the rear of the building, with shared parking access which the Council had advised was an option; and

● the proposal to refurbish the commercial character building for on-going commercial use was discussed and the Council advised there were criteria with respect to expected design outcomes under the overlay code.

You entered into a contract to purchase a property (the Property) which consisted of two lots on the one title as follows:

● Lot A, which has a commercial building, a garage/shed and trees were located on it; and

● Lot B, which is vacant land.

The Property was zoned Low Density Residential (LDR) when it was purchased.

The Property was purchased for the following purposes:

● for it to be formally subdivided, with Lot B to be sold as vacant land; and

● Lot A to be renovated and leased out.

Settlement on the purchase of the Property occurred a number of months after the contract was entered into.

The reconfiguration of the Property as discussed with the Council prior to the Property being purchased was determined to be financially unviable, so the existing layout of the Property was maintained.

The Property was rundown and neglected and required significant expenditure to make the building located on Lot A suitable for commercial rental purposes. Significantly overgrown trees were located on the Property were removed after the Property was purchased. The shed/garage was removed because it was in poor condition and contained asbestos.

Renovations were undertaken to convert the building located on Lot A for commercial usage, currently consisting of a number of shops.

The services of a real estate agent (Company XYZ) were engaged to lease and manage the shops on Lot A.

An agreement was entered into with another real estate agent (Company ABC) as the selling agent for Lot B. Onsite signage and the internet were used in relation to the sale of Lot B, however during the time it was on the market only verbal offers had been received with the most offered being less than the sale amount sought.

A lease agreement for one of the shops located on Lot A was entered into.

Lot B was taken off the market a number of months after it had been put on the market.

Multiple and persistent tenancy issues were experienced.

Your representative was approached by a real estate agent who advised that there may be demand in the current market for the acquisition of Lots A and B together.

It is anticipated that you will sell Lot A, with a shop being leased and the remaining shop/s being vacant, and Lot B as vacant land together on one sale contract.

Lot A has not been put on the market, however an unsolicited offer of $XXX,XXX was received a number of months ago.

You estimate that if the two lots were sold together the sale price would be $X,XXX,XXX to $X,XXX,XXX and if sold separately would be as follows:

● Lot A is between $XXX,XXX and $X,XXX,XXX; and

● Lot B of between $XXX,XXX and $XXX,XXX.

The Property has not been put on the market at this point.

Neither you, nor any related entities, have undertaken any property development and/or subdivision activities in the past, or have any plans to undertaken any similar activities in the future.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 15-15

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Subsection 104-10(3)

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Disposal of real property

The profits or gains made from the disposal of real property can be assessed for income tax purposes in a number ways, such as:

● Ordinary income under section 6-5 of the ITAA 1997, resulting from:

● carrying on a business; or

● an isolated or commercial transaction that was entered into with a profit-making intention; or

● Statutory income pursuant to the capital gains tax (CGT) provisions in Parts 3-1 and 3-3 of the ITAA 1997 (section 6-10 of the ITAA 1997).

Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case.

We will consider each of these in relation to your situation as follows:

Carrying on a business

Subsection 995-1(1) of the ITAA 1997 defines ‘business’ as ‘including any profession, trade, employment, vocation or calling, but not occupation as an employee’.

Taxation Ruling TR 97/11 provides the Commissioner’s view of the factors used to determine if you are in business for tax purposes. In the Commissioner’s view, the factors that are considered important in determining the question of business activity are:

● whether the activity has a significant commercial purpose or character

● whether the taxpayer has more than just an intention to engage in business

● whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

● whether there is regularity and repetition of the activity

● whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business

● whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

● the size, scale and permanency of the activity, and

● whether the activity is better described as a hobby, a form of recreation or sporting activity.

No one factor is decisive. The indicator must be considered in combination and as a whole. Whether a ‘business’ is carried on depends on the large or general impression.

Isolated business transactions

Profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium). 

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income.

TR 92/3 defines the term ‘isolated transactions’ as:

● transactions outside the ordinary course of business of a taxpayer carrying on a business; and

● transactions entered into by non-business taxpayers.

It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose. In transactions or operations that involve the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquisition.

Therefore if a taxpayer acquires an asset with the intention of using it for a certain purpose he can later decide to use the asset for a different purpose. If he uses the asset in a business operation or commercial transaction the profit from the activity is income even though the taxpayer did not have that purpose in mind at the time of acquiring the asset.

If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayer’s business but:

● the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain, and

● the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of subdivided land can be assessed as ordinary income within section 6-5 of the ITAA 1997.

Generally, a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of a repetitious or recurring transactions or operations.

Paragraphs 51 to 58 of TR 92/3 outline that if the taxpayer makes a profit by the exact means it contemplated at the time of entering into the transaction, the profit is clearly income. Where evidence establishes that the taxpayer has the purpose or intention of making a profit, although the means to be adopted to generate that profit have not been determined, the mode of achieving the profit must be one contemplated by the taxpayer as at least one of the alternatives by which the profit could be realised.

For income tax purposes, a one-off profit-making undertaking will be treated as a revenue transaction.

Capital gains tax

The capital gains tax (CGT) provisions are contained in Parts 3-1 and 3-3 of the ITAA 1997. Broadly, the provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own.

CGT event A1 happens if you dispose a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property. However, any capital gain or capital loss made on the disposal of a CGT asset will be disregarded if the asset was acquired before 20 September 1985.

The capital gain can be reduced by the 50% CGT discount if the conditions listed in Division 115 are met.

Section 118-20 of the ITAA 1997 contains anti-overlap provisions which operate to reduce any capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 as a result of the sale, for example, as ordinary income under section 6-5 of the ITAA 1997.

Application to your situation

The Property was purchased for the stated purpose of subdividing it, with Lot B to be sold as vacant land and building located on Lot A to be renovated and leased out.

The building located on Lot A has been renovated and consists of a number of shops, with a number being currently leased out, with the remaining being vacant.

You attempted to sell Lot B without success, with it being marketed for a number of months.

You have made the decision to sell the Property as is in one sale contract without subdividing the two lots as originally planned.

Neither you, nor any related entities, have undertaken any property development and/or subdivision activities in the past, or have any plans to undertaken any similar activities in the future.

This indicates that you are not in the business of buying and selling properties, nor has a business of buying and selling commenced as a result of the purchase and sale of the Property.

Based on the information provided, it is viewed that the Property was acquired with the intention of making a profit through the resale of Lot A, and to keep Lot B for the purpose of renting out the building located on that lot.

The facts of your situation support that the purchase of Lot B for the purpose of reselling it would characterise it as a profit making intention.

While any profit made on the sale of the Property will not be made in the way originally planned, with the Property being subdivided and Lot B being sold as vacant land, it was always your intention to sell Lot B from the time the Property was purchased.

Therefore, in your situation the sale of the Property relates to a CGT event in relation to the sale of Lot A, and a revenue transaction in relation to the sale of Lot B.

The proceeds received from the sale of the Property will be revenue in nature to the extent that they relate to Lot B. The remaining sale proceeds relating to Lot A will be capital in nature and will need to be apportioned on a reasonable basis to account for the capital and revenue portion of the sales proceeds.

Note: CGT event A1 will occur when the Property is sold. A separate calculation will need to be undertaken to determine whether a capital gain or capital loss has arisen on the sale of both Lot A or Lot B, with any capital gain made on the sale of Lot B being reduced to the extent that an amount is included in your assessment under section 6-5 of the ITAA 1997 in relation to its sale.

Further issues for you to consider

The following information is provided as written guidance. A taxpayer who relies on guidance will remain liable for any tax shortfall if the guidance is incorrect or misleading and they make a mistake as a result (unless a time limit imposed by the law precludes the liability). However, they will be protected against the shortfall penalty and interest on the tax shortfall provided they relied on that guidance reasonably and in good faith.

To provide guidance on how to apportion the capital proceeds received from the sale of the Property we offer the following information:

Capital proceeds - Apportionment rule – modification 2

Sections 116-30 to 116-110 of the ITAA 1997 provide modifications to and special rules about capital proceeds.

If you receive a payment in connection with a transaction that relates to one CGT event and something else, the capital proceeds from the event are so much of the payment as is reasonably attributable to the event in accordance to subsection 116-40(2) of the ITAA 1997.

The capital proceeds in respect of the sale of the Property must be apportioned on a reasonable basis between the interests in Lot A and Lot B.

Whichever method is used, the whole of the Property must be valued so that the apportionment percentage can be determined and applied to the extent that it relates to Lot A or Lot B.

Taxation Determination TD 98/24 Income tax: capital gains: what are the CGT consequences of a CGT event happening to post-CGT real property if the property comprises separate CGT assets under Subdivision 108-D in Part 3-1 of the Income Tax Assessment Act 1997 (the 1997 Act) or if the property is sold with depreciable assets? (TD 98/24) outlines that when making a reasonable apportionment of the capital proceeds to the separate assets it is expected that each party would generally have regard to, and be able to justify, their reasonable apportionment based on the relevant market values of the separate assets at the time of the making of the contract.

Taxpayers are not required to get an independent valuation to justify the apportionment, but must take adequate steps to in working out the proper value of a particular asset (Taxation Determination TD 9 Capital Gains: How do you apportion consideration received on the disposal of a composite asset?) Taxpayers who make their own estimates must be able to justify them. If an asset is disposed of under a contract, it is preferable that parties allocate the overall proceeds in the contract as follows:

Property disposed of under contract

If the property is disposed of under a contract, the Commissioner will accept a contractual allocation of the capital proceeds between the relevant assets, provided that the allocation was arrived at by parties acting at arm ' s length. In the absence of an agreed allocation in a contract, a subsequent agreement by such parties will also be accepted by the Commissioner (TD 98/24). In either of these cases, the Commissioner does not require additional evidence that the allocation reflects market values.

If there is no agreed allocation, the Commissioner’s view is that each party needs to make their own “reasonable apportionment” of the capital proceeds to the separate assets. In making this apportionment, the Commissioner expects that each party would generally be able to justify it on the basis of the relevant market values of the assets at the time the contract is made. Written-down values will not necessarily be regarded as market values (TD 98/24). In certain cases an independent valuation may be appropriate, although it is not mandatory (TD 9).