Edited version of private ruling

Authorisation Number: 1011511043110

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Ruling

Subject: Timing of sales

Questions and answers

1. Is the purchase price component on the sale of residential properties under the terms contract arrangement assessable when the purchase contract is signed?

No.

2. Is the purchase price component on the sale of residential properties under the terms contract arrangement assessable when the contract is completed?

Yes.

3. Is the purchase price component on the sale of residential properties under the terms contract arrangement assessable when each instalment is received during the term of the contract?

No.

4. If the purchaser defaults, is the purchase price component received under the terms contract assessable in the year in which the purchaser defaults?

Yes.

5. Are the repayments received under the terms contract prior to any default considered a return of capital?

No.

This ruling applies for the following period:

1 July 2006 to 30 June 2014

Relevant facts:

The Trust is in the business of purchasing run down residential properties, renovating, and then selling them with a view to make a profit.

The Trust sells the properties under a "terms contract arrangement". This arrangement involves the purchaser agreeing to pay off the purchase price, plus interest, over a period of several years. Payments are received regularly and include a portion of the purchase price, an interest component and reimbursement of other costs including rates and insurance.

The title to the properties remains with the Trust until the purchase price has been fully repaid and the contract fulfilled.

If a purchaser defaults on the regular payments, and the contract is terminated under specific clauses due to the default, the property ownership remains with the Trust, and all payments up to the date of default are retained by the Trust and forfeited by the purchaser.

The Trust is seeking a ruling on the timing and assessability of these payments.

Relevant legislative provisions:

Subsection 6-5(2) of the Income Tax Assessment Act 1997

Subsection 70-80(1) of the Income Tax Assessment Act 1997

Reasons for decision

Instalments under the "terms contract arrangement"

Under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997), a taxpayer is required to include in assessable income the ordinary income it derives during the income year.

Subsection 70-80(1) of the ITAA 1997 provides that the proceeds from the disposal of trading stock are to be included in assessable income as ordinary income.

Taxation Ruling TR 97/15 at paragraph 23 states that:

It is an accepted principle of income tax law that the method under which a taxpayer accounts for its business or income producing activities for the purposes of income tax must 'give a substantially correct reflex of the taxpayer's true income'

Paragraph 28 of TR 97/15 says it is clear that the sale price of trading stock is derived as income of the seller when the sale price becomes a presently existing debt.

Paragraph 89 of Taxation Ruling TR 97/9 states:

The derivation of income from the sale of goods should be contrasted with the derivation of income from the sale of real property. It was held in Gasparin [Gasparin v. FC of T (1994) 50 FCR 73] that income from the sale of land was not derived until settlement had taken place. We [the ATO] do not think that von Doussa J's decision was based on the fact that legal ownership in the land would not be transferred until settlement. The explanation for the judgement rather lies in the realisation that a vendor in a real property transaction will not have performed all that is needed to become entitled to a payment prior to settlement. At settlement, transfers are effected which put the purchaser in a position to become registered as owner. As such, the vendor does not earn the income from the sale until settlement.

Under the instalment sales contracts in question, whilst the relevant contracts provide for the payment of instalments over a number of years, as in Gasparin v. Federal Commissioner of Taxation (1994) 50 FCR 73; 94 ATC 4280; (1994) 28 ATR 130 (Gasparin), the income from the sale of the properties has not been derived until settlement of the contracts. Until settlement, the vendor has not done all that is required in order to derive the payments in respect of the sale of the properties. At settlement, the vendor will transfer the title to the property and have done all that is necessary for the income to have 'come home'. Until that point in time, the properties remain part of the trading stock of the vendor, and no income from the sales has been derived under subsection 6-5(2) of the ITAA 1997.

In the Trust's situation, the repayments under the "terms contract arrangement" will not be assessable until the Trust has done all that is necessary for the income to "come home". According to ATO ID 2004/27, the vendor has not done all that it has needed to do to be entitled to payment until settlement. Settlement generally occurs upon the swapping of the title to the property for the purchase price. In this regard, settlement in your case will occur after the property has been paid in full, and legal title has been transferred to the purchaser.

Therefore, the income from the purchase price component will be assessable in the year in which settlement occurs.

With regards to the interest component, the interest is assessable in the year in which it is received because the Trust has done all that is necessary to be entitled to the payment.

Purchaser defaults on instalments

The monies retained by the taxpayer where the purchaser has defaulted on the contract are considered to be 'profit' made in the ordinary course of carrying on the business of buying and selling residential properties, and are therefore ordinary income for the purposes of subsection 6-5(1) of the ITAA 1997 (L'Estrange v. FC of T 78 ATC 4744; (1978) 9 ATR 410).

In Gasparin, where the residential properties were trading stock, it was considered that when a contract of sale came to an end, the forfeited deposit payment became a receipt of the business at that time.

According to ATO ID 2004/28, the monies retained will be derived for the purpose of subsection 6-5(2) of the ITAA 1997 at the time the purchaser defaults under the contract. This is the point at which the taxpayer has done everything necessary to earn the amount.

Therefore, when a purchaser defaults, the income from the purchase price component will become assessable in the year in which the purchaser defaults.

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