Edited version of private advice

Authorisation Number: 1052217317021

Date of advice: 16 February 2024

Ruling

Subject: Taxable supply of residential premises

Question 1

Will you make a taxable supply pursuant to section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) when you sell part of a duplex residence known as Unit B?

Answer

No. The supplies are not taxable supplies as all of the conditions of a taxable supply are not met, nor are you required to be registered for GST.

This ruling applies for the following period:

1 January 2024 to 30 June 2028

The scheme commenced on:

1 January 2024

Relevant facts and circumstance

You purchased the underlying property in XXXX and continue to occupy it as your main residence since purchase.

The original land size is over XXX square meters while the original dwelling occupied YYY square meters.

The original dwelling was over XX years old and had a continuing leaking problem, so you decided to demolish the original dwelling entirely and rebuild into a duplex.

Your intention was for you and your children to occupy one side, and other family members to occupy another side. This arrangement had the advantage that your family could help look after the children while you were working during the day.

You moved out from the original property for construction from AAA.

The construction completed recently, with two equal sized subdivided dwellings built.

You moved into unit A and you are considering selling unit B.

As at your application date, the mortgage balance of the original property is approximately $BB and the construction loan balance of rebuilding is approximately $CC. Given the recent increase of interest rates, the family is under financial stress and is considering altering the original family plan of keeping both subdivided dwellings for family use. In particular, you are considering whether to sell one of duplex dwellings, and you will continue to occupy only one of the dwellings as the family's main residence.

The current repayments on your loan are $D per month as per correspondence from a bank that you provided dated x date. The interest rate is currently E percent. You did not plan for such a sudden and high increase in interest rates.

You originally purchased the property for $FF in 20XX.

You estimate that your mortgage repayments are now over 80 percent of your family's total income.

The loan was initially interest only and you applied for this aspect of your loan as you knew that cashflow may be an issue early in the construction phase.

You listed Unit B for sale on X date but after a few weeks no offers were received, you decided to lease it instead to get some cashflow to ease the financial pressure you are experiencing.

You decided to lease Unit B for 12 months. You are planning to put Unit B back on the market.

You did not have a business plan and you based your costs on the estimate that your builder gave you.

The builder has been the sole consultant that you used in the construction process.

You do not have any experience in property development. HH is a bank officer and II is a sales representative.

You expect the sale price to be approximately $X million.

Detailed Reasoning

In this section of the ruling all references to legislation are to the A New Tax System (Goods and Services Tax) Act 1999 unless otherwise specified.

Under section 40-65, a sale of residential premises is input taxed unless they are new residential premises. Subsection 40-75(1) defines 'new residential premises' amongst other things as premises that have not been previously sold or subject to a long term lease. As the premises in question are newly constructed and occupancy certification recently issued, they are new residential premises.

Accordingly, we need to determine if they will be supplied by way of a taxable supply. Subsection 40-75(2) establishes that they are not new residential premises if they have been rented continuously for a period of 5 years since they were constructed. The facts indicate that Unit B was rented to tenants quite recently and as a result it is still new residential premises.

To determine whether you are making a taxable supply of new residential premises, section 9-5 contains the key elements of a taxable supply and must be applied to determine the answer to the question set out above.

Section 9-5 provides that you make a taxable supply if:

a)    you make the supply for consideration; and

b)    the supply is made in the course or furtherance of an enterprise that you carry on; and

c)    the supply is connected to the indirect tax zone (Australia); and

d)    you are registered or required to be registered for GST.

However, the supply will not be a taxable supply to the extent the supply is GST-free or input taxed.

In this case, Unit B is not currently on the market so we have made the assumption that the sale of the property will be made for arm's length consideration.

This would satisfy paragraph 9-5(a). Unit B is located in the indirect tax zone (Australia). This satisfies paragraph 9-5(c). Assuming the property will not be rented continuously for a five year period by the time it is sold, there are no other factors that would make the sale input taxed and the facts provided do not indicate any possible GST-free treatment.

As such, to determine whether the sale of the property is a taxable supply will depend on whether the supply is made in the course or furtherance of an enterprise that you carry on under paragraph 9-5(b). Additionally, that answer will determine whether you are registered or required to be registered for GST under paragraph 9-5(d). The analysis below focuses on these two paragraphs of the definition.

In the course or furtherance of an enterprise

The term 'enterprise' is defined in section 9-20. Subsection 9-20(1) states:

An enterprise is an activity, or series of activities, done:

a)         in the form of a *business; or

b)         in the form of an adventure or concern in the nature of trade; or

c)         on a regular or continuous basis, in the form of a lease, licence or other grant of an interest in property.

An asterisk indicates a defined term in section 195-1.

The phrase 'carrying on' an enterprise is defined in section 195-1 to include doing anything in the course of the commencement or termination of the enterprise.

Under the first limb of the definition, paragraph 9-20(1)(a), an issue to be decided is whether you conducted an activity or series of activities that amount to a business, or is in the form of a business of property development. Under the second limb, paragraph 9-20(1)(b), we need to assess whether your activities are a one off, adventure in the nature of trade in dealing with the units as the activities of construction and eventual sale potentially are in the commencement and termination of a property development enterprise.

Finally, under paragraph 9-20(1)(c), the definition of 'enterprise' states that leasing, licencing or other grants of land can amount to an enterprise.

It is noteworthy that subsection 9-20(2) provides

an 'enterprise' does not include (GSTA, s 9-20(2)):

... an activity, or a series of activities, done:...

(b) as a private recreational pursuit or a hobby; or

(c) by an individual... or a partnership (all the members of which are individuals), without a reasonable expectation of profit or gain...

Given that you leased to a third party at market value rent, this is considered to be an enterprise as it is leasing or licencing real property on a regular or continuous basis and is not excluded because there is an expectation of profit or gain in performing those activities. Despite this, you may not be required to be registered given that you are making input taxed supplies of residential rent which in turn are likely excluded from the calculation determining whether you are required to be registered. Registration is discussed more fully below.

The next issue is whether the activities of developing and selling Unit B amount to an enterprise. The Commissioner, in Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number (MT 2006/1) provides guidance on the meaning of the term 'enterprise' for GST purposes.

According to MT 2006/1, a business generally includes a trade that is engaged in on a regular or continuous basis, while an adventure or concern in the nature of trade includes a commercial activity that does not amount to a business but which has the characteristics of a business deal. Isolated or one-off transactions will fall into this category.

The use of the words 'in the form of' before 'business' or 'an adventure or concern in the nature of trade' has the effect of extending the meaning of enterprise beyond entities carrying on a business or an adventure or concern in the nature of trade. Despite this, the focus is still on making an assessment of the factors indicating a business.

Whilst there is no single test of whether a business is being carried on, Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? (TR 97/11), provides the main indicators of carrying on a business.

These indicators include:

•         a significant commercial activity;

•         the purpose and intention of the taxpayer or taxpayers in engaging in the activity;

•         an intention to make a profit from the activity;

•         the activity is or will be profitable;

•         repetition and regularity of activity; and

•         the activity is organised and carried on in a businesslike manner.

These factors in turn are derived from a number of common law cases. The principles are explained in Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income. These principles are considered later in these reasons.

These cases indicate that the question whether a business is being carried on is a question of fact and the conclusion generally depends on weighing up all the relevant factors set out above. You purchased the property with a house on it that was over 50 years old and had defects making occupation less comfortable. Your intention was to build a dual occupancy structure allowing one unit to be your residence (Unit A) and the other as a residence for your close relatives to reside (Unit B).

During the construction phase, you did not register for GST and have not claimed any input tax credits or deductions. Based on your acquisition price and potential sale price and costs, there is no apparent prospect of the activity being profitable unless you sold both Units A and B. In terms of assessing the scale of your activity, it is a one suburban block subdivision on which you constructed a duplex house. On this basis, there is low repetition and it is a relatively small scale activity.

The facts indicate that the level of commercial activity is on the lower end of the scale. Your initial purpose or intention in this arrangement was to keep the property in its entirety. You retained an expert but only to the extent of hiring a builder who conducted the development on your behalf and a real estate agent to conduct the sales. This factor, of itself, does not point to an enterprise. It is noteworthy that you both are not employed in any sector related to building or construction. This factor suggests it is less likely to be a business-like venture.

On balance, we consider the abovementioned factors do not indicate you are conducting a business of property development in the form of a business or as a profit making undertaking or scheme. It is not large scale; you do not have a business plan for developing the property as your original intent was to live in one unit and allow relatives to live next door. Your principal driver for entry into the sale of Unit B is the change in market conditions increasing your costs.

As the transaction volume may be described as one-off, we also need to consider the extended definition of enterprise under paragraph 9-20(1)(b) and whether these activities fall in the form of an adventure or concern in the nature of trade. MT 2006/1 provides guidance on the meaning of this expression.

An 'adventure or concern in the nature of trade' refers to transactions that have a commercial nature which are entered into for a profit making purpose.

As the above factors are also relevant to one off transactions, we conclude that you are not engaged in an enterprise either on the basis of activities you conduct in the form of a business or that you were engaged in an adventure in the nature of trade. This means that paragraph 9-5(b) is not met in relation to whether you are conducting a property development either in the form of a business or as an adventure in the nature of trade.

Registration

The final factor of to be considered is whether you are registered or required to be registered under paragraph 9-5(d). We consider that the registration turnover threshold set out in section 23-5 is relevant.

Section 23-5 states that you are required to be registered for GST if:

a)    you are carrying on an enterprise; and

b)    your GST turnover meets the registration turnover threshold (currently $75,000).

As discussed above, your activities do not fall within the scope of 'carrying on an enterprise' of property development but your activities related to leasing the property may amount to an enterprise. Consequently, as a lessor of real property, you meet paragraph 23-5(a) above, and the next issue to be considered is whether the rents you receive are 'GST turnover' and if so, exceed the $75,000 registration turnover threshold.

Division 188 is about the 'meaning of GST turnover'. Section 188-10 is relevant for working out whether an entity's GST turnover meets, or does not exceed, a turnover threshold.

Under subsection 188-10(1) an entity's GST turnover meets a particular turnover threshold when:

a)    the entity's current GST turnover is at or above the turnover threshold, and the Commissioner is not satisfied that the entity's projected GST turnover is below the turnover threshold; or

b)    the entity's projected GST turnover is at or above the turnover threshold.

Section 188-15 defines 'current GST turnover' and that subject to certain exclusions the current GST turnover at any time during a particular month is the sum of the values of all the supplies that an entity made, or are likely to make, during the current month and the preceding 11 months.

Section 188-20 defines 'projected GST turnover' and subject to certain exclusions the projected GST turnover at a time during a particular month is the sum of the values of all the supplies that an entity made, or are likely to make, during that month and the next 11 months.

For both the current and projected GST turnover, the exclusions include supplies that are input taxed. Subsection 40-35(1) includes that a supply of premises by way of lease is input taxed if the supply is of residential premises, where the premises are to be used predominantly for residential accommodation.

The lease of the residential premises is an input taxed supply under section 40-35 and the rental will be excluded from the calculation of the current and projected GST turnover.

A final issue to consider is whether the sale of the premises will be included in the current and projected GST turnover. It is relevant to also consider the projected GST turnover as you are looking to make a sale of the property within the next year.

Guidelines on GST turnover are also available in Goods and Services Tax Ruling GSTR 2001/7 Goods and services tax: meaning of GST turnover, including the effect of section 188-25 on projected GST turnover (GSTR 2001/7). GSTR 2001/7 includes the following guidelines:

Supplies to be disregarded under section 188-25

29. Section 188-25 modifies the effect of section 188-20 by excluding certain supplies made when working out your projected GST turnover. Section 188-25 requires you to disregard the following when calculating your projected GST turnover:

•         any supply made, or likely to be made, by you by way of transfer of ownership of a capital asset of yours; ...

30. Your projected GST turnover does not include supplies that fall within the description in either paragraph 188-25(a) or paragraph 188-25(b) listed above. Your supply does not have to satisfy the descriptions in both paragraph (a) and paragraph (b). When you make a supply that is capable of satisfying the description in both paragraphs, the supply is excluded only once...

Given our finding above that the sale of the property is not pursuant to activities in the course of a development enterprise, and as it is capital in nature, it would be excluded from the projected turnover calculation of the leasing enterprise. As the sale is excluded from projected turnover, you are not required to be registered for GST as the GST turnover is less than $75,000 for the leasing enterprise as paragraph 23-5(b) is not satisfied. As the sale is excluded from projected turnover, you are not required to be registered for GST as the GST turnover is less than $75,000 for the leasing enterprise as paragraph 23-5(b) is not satisfied.

Conclusion

The original property was not intended to be acquired for the primary purpose of resale at a profit and that intention did not change. Even though the supply will be made for consideration and is located in the indirect tax zone (Australia), it is not made in the course or furtherance of a development enterprise you carry on. Additionally, despite being engaged in a rental enterprise, you are not required to be registered for GST as the sale proceeds and the rental are excluded from the GST turnover calculation. Consequently, you will not be making a 'taxable supply' as defined when you sell Unit B.

GST at Settlement

On or after 1 July 2018, if you supply potential residential land you are required to notify your purchaser in writing as to whether or not they have a withholding obligation. As you are not required to be registered for GST, the supplies are not taxable supplies of potential residential land. Consequently, you should notify the purchasers they do not have a withholding obligation. Detailed information can be found in Law Companion Ruling LCR 2018/4 Purchaser's obligation to pay an amount for GST on taxable supplies of certain real property.

Question 2

Will the Capital Gains Tax main residence exemption under subdivision 118-B of the Income Tax Assessment Act 1997 (ITAA 1997) apply to the proposed sale of 18 Jenkins Street DUNDAS NSW 2117?

Summary

The main residence exemption is not available in respect of any capital gain or loss that you make from the disposal of the block because the land will be sold separately from a main residence: see subsection 118-120(1) of the ITAA 1997.

Detailed Reasoning

Main Residence Exemption

The meaning of the term 'dwelling' is defined in subsection 118-115 of the ITAA 1997 to include a unit of accommodation that is a building and consists of wholly or mainly of residential accommodation. Broadly, Subdivision 118-B of the ITAA 1997 allows taxpayers to ignore a capital gain or loss made from a capital gains tax (CGT) event that occurs with regards to a dwelling that is their main residence (main residence exemption).

Section 118-190(1)(b) of the ITAA 1997 highlights that if a dwelling has been used for assessable income producing purposes (such as renting) it will only be subject to partial exemption for the period it was lived in as your main residence.

The basic rules that must be satisfied for a taxpayer to be eligible for the main residence exemption are provided in section 118-110 of the ITAA 1997.

Specifically, subsection 118-110(1) of the ITAA 1997 provides that a capital gain or loss from a CGT event in relation to a taxpayer's main dwelling, or ownership interest in it, is disregarded if:

a)    the taxpayer is an individual

b)    the dwelling was the individual's main residence throughout the ownership period, and

c)    the interest did not pass to the individual as a beneficiary in, and was not acquired as a trustee of, a deceased estate.

Demolition of Existing Property

A CGT event C1 happens if a CGT asset you own is lost or destroyed, section 104-20 of the ITAA 1997. Taxation Determination TD 1999/79 Income tax: capital gains: does the expression 'lost or destroyed' for the purposes of CGT event C1 in subsection 104-20(1) of the Income Tax Assessment Act 1997 apply to: (a) a voluntary 'loss' or 'destruction'? (b) intangible assets? (TD 1997/79) paragraph 4, confirms that CGT event C1 can happen on the voluntary destruction of an asset where for example, a taxpayer might demolish a building in the course of redeveloping a property.

Subsection 104-20(3) of the ITAA 1997 provides that you make a capital gain from CGT event C1 if the capital proceeds from the loss or destruction are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base. Section 116-25 of the ITAA 1997 provides that the market value substitution rule does not apply to CGT event C1.

The effect of the cost base rules in subsections 112-30(2) and (3) of the ITAA 1997 and the capital proceeds rule in section 116-25 of the ITAA 1997 is that no capital gain or capital loss arises when CGT event C1 happens on the demolition of a dwelling if no capital proceeds are received for it.

This is explained in ATO Interpretive Decision ATO ID 2002/663 Income Tax Capital gains tax: demolition of a dwelling: CGT event C1. As no capital proceeds were received for the demolished dwelling, and as no amount is apportioned to the cost base or reduced cost base of the dwelling, you did not make a capital gain or capital loss under a C1 event.

Subdivision and CGT

Section 112-25(2) of the ITAA 1997 provides that subdividing the land is not a CGT event itself if you keep ownership of the subdivided land. You do not make a capital gain or loss at the time of the subdivision, only when you sell the subdivided blocks. Where a property acquired as one asset is subdivided, the resulting subdivided blocks are treated under 112-25(1) of the ITAA 1997, as though they were separate assets on separate titles.

Taxation Determination 97/3 Income tax: capital gains: if a parcel of land acquired after 19 September 1985 is subdivided into lots ('blocks'), do Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 treat a disposal of a block of the subdivided land as the disposal of part of an asset (the original land parcel) or the disposal of an asset in its own right (the subdivided block)? (TD 97/3) sets out that, for the purposes of CGT, the date you acquire the subdivided blocks will be the same date as you originally acquired the land. Subdividing land does not result in a CGT event as long as the ownership of the subdivided block(s) does not change. The acquisition date of the two subdivided blocks will therefore be the same date you originally purchased the property before subdivision in 20XX.

Choice of main residence

Subsections 118-150(1) and (2) of the ITAA 1997 state if you build a dwelling on land in which you have an ownership interest in, you can choose to apply the main residence exemption to the new dwelling as if it were your main residence from the time you acquired the ownership interest. You can only make the choice for the newly constructed dwelling on the land to be your main residence as soon as practicable after the work is finished as per paragraph 118-150(3)(a) of the ITAA 1997. The new dwelling must continue to be your main residence for at least 3 months, per paragraph 118-150(3)(b) of the ITAA 1997.

Paragraphs 118-150(4)(a) and (b) of the ITAA 1997 outline the time limit in which the choice to make the new dwelling can operate is the shorter of the 4 years before the dwelling becomes your main residence, and the period starting when you acquired your ownership interest in the land and ending when the dwelling becomes your main residence.

Once you have made the choice, subsection 118-150(6) of the ITAA 1997 states that no other dwelling can be treated as your main residence during the period referred to in subsection (4), except where you are in the process changing main residences. Under section 118-140 of the ITAA 1997, you can only have one main residence for the same period, except where a new property has been purchased before you have sold your old one, and you intend to move into it. When this occurs, you can treat both as your main residence for up to 6 months.

Disposal of Dwelling

Pursuant to subsection 104-10(1) of the ITAA 1997, when you dispose of a dwelling, CGT event A1 which relates to the disposal of a CGT asset will occur. The time of the event is when you enter into the contract for the disposal or if there is no contract, when the change of ownership occurs. Subsection 104-10(2) of the ITAA 1997 states that a taxpayer will dispose of a CGT asset if a change of ownership occurs from the taxpayer to another entity.

Application to this circumstance

You reside at Unit A and state that you have no intention to occupy Unit B. You further explain that you are intending to put it back on the market in the first quarter of 20XX. As you do not reside in YYYY, and are not intending to reside in it within 6 months, the property will not meet the criteria outlined above to be your main residence, and a capital gain or loss from CGT event A1 will occur on the sale/transfer of this property.

As you acquired the original property after 20 September 1985, and it has been subdivided into a separate asset, XXXX, which is not and will not be your main residence, any capital gain or capital loss made on its disposal is not disregarded under the Main Residence Exemption.