Edited version of private ruling

Authorisation Number: 1011601308371

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Ruling

Subject: Property development - 3 units - trading stock or capital assets

Question 1

Are the 3 units (the properties) held by 3 individuals in partnership trading stock within the meaning of trading stock provided in section 70-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2010

Year ended 30 June 2011

The scheme commenced on

February 2010

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The Scheme

On 28 February 2010, 3 individuals (individually 'the partners' or as a group 'the partnership' or 'you') entered into a contract to purchase a partly developed property consisting of 3 residential units. The contract was negotiated 'on builders' terms' to enable completion of the project under the existing plan following extension of expiring council approvals and permits.

The construction works

At purchase, the property development project was at approximately 40% complete.

The following list provides some of the activities undertaken in completing the project:

a. Obtain necessary approvals

b. Obtain adequate construction works insurance on behalf of the builder

c. Complete frame and roof truss inspections

d. Complete roofing and guttering works

e. Complete the electrical pre wiring

f. Have the inside walls plastered

g. Complete all external suffeates/eaves with fibre cement sheeting and paint

h. Render, Granosite and paint all external walls

i. Fit-out all internal architraves, door jambs, doors, window reveals

j. Paint all internal areas

k. Have all wet areas wet sealed

l. Supply and install all 3 kitchens and 6 vanities/bathroom areas

m. Supply and install all laundry areas

n. Have all floor coverings - both tile and carpets installed

o. Have all windows security screens installed

p. Build internal shelving and rails for all storage space and install wardrobe and storage doors

q. Build in all pantries and install kitchen splash-backs and all shower screens

r. Supply and install all Ovens, range-hoods, air-conditioner fans, alarms and lighting

s. Have all window furnishings installed

t. Supply and install all hot water services and fit-out all plumbing fixtures

u. Attend to landscaping

v. Obtain final clearances for the onsite HSTP system

w. Liaise with surveyors for the strata titling (still waiting on council approvals)

x. List the properties for sale on the market and advertise accordingly

The majority of the labour for the building project has been undertaken by you.

Where necessary you sub-contracted qualified tradespersons.

Profitability

The purchase price you paid was the same price as had previously been offered by an independent third party purchaser.

You engaged a valuer to provide an appraisal to ensure the value paid was fair.

Original budgets and cost estimates were prepared as part of the due diligence process to ensure profitability of the project. The original budgets and cost estimates were favourable based on a worst case scenario and resulted in the project being undertaken.

The selling price was determined by an expert Real Estate agent. If the properties sell at the prices advised, you expect to realize a gross profit of approximately $300,000 - $350,000.

There has been no feedback from the agent or the buyers market that the prices are too high. However, you are mindful of current market conditions and will consider reducing the selling price if need be.

The current capital contribution of each party is approximately $230,000 each. You try to contribute in equal shares but this has varied from time to time as different resources are provided by each partner when required.

Intentions

Your intention when purchasing the property development was to complete the development and sell the units to make a profit.

If you are unable to sell the properties over the next 12 months, you may sell them to your respective self-managed superannuation funds for investment purposes.

Initially, you intended for a related entity to complete construction. However, as you were unable to obtain timely legal advice, you opted to complete construction yourselves.

A contingency plan included in your business plan provides that if, after an extended period and reduction in the selling price, you are unable to sell the units you may consider offering the properties for rental purposes.

You have no intention to use the premises for any partners' domestic needs.

On forming the partnership, your intention was to carry on a business of property development.

Business indicators

You have a written business plan.

Although you do not have a written partnership agreement you rely on common law partnership principles, where each partner is to share equally and be jointly and severally liable for any debts incurred. In the event of wind-up or dissolution of the partnership, assets are to be divided equally among the partners.

Each partner is involved in the decision making process.

Each partner is involved in the planning process, administration of projects and the financial management of the partnership.

Each partner uses their access to different resources to maximize their own strengths to provide a mutually rewarding outcome for all partners.

Each partner has been involved in the site works labouring and also the maintenance of the properties until sales are completed.

All partners have previous experience, education and knowledge of property development.

You utilise family building licenses.

You purchased all necessary insurances for the project. Construction work insurance was purchased on the builders' behalf and now the buildings are insured and awaiting body corporate information to finalise the policy.

Relevant legislative provisions

Income Tax Assessment Act section 70-10

Income Tax Assessment Act section 995-1

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Summary

Trading stock is anything produced, manufactured or acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course of business.

Considering the indicators of carrying on a business, your current activities give the general impression that you are carrying on business of property development.

As the properties are not capital held for use by the partners or partnership, and are being held for the purpose of sale, in the ordinary course of your property development business, they are trading stock as given meaning under section 70-10 of the ITAA 1997.

Detailed reasoning

Section 70-10 of the ITAA 1997 provides that trading stock includes anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business.

On 28 February 2010, you entered into a contract to purchase land and three partly constructed units with a lapsing development permit. For the land and units to be treated as trading stock both the purpose provided by the section, and the business activity must be present.

The question of whether the activities of a group of individuals amounts to carrying on a property development business, or is more accurately described as engaging in a isolated business operation or commercial transaction; or merely acting to increase the value of a capital investment, is a question of fact.

The ITAA 1997 provides the definition of 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee (section 995-1 of the ITAA 1997). However, this does not address whether a business is being 'carried on'.

Taxation Ruling TR 97/11 discusses factors which are indicative of carrying on of a business. The relevance of the indicators has been determined by courts of law, over time, in relation to many different industries.

No one indicator is decisive. The facts and circumstances in your case must be weighted against all the indicators to gain an overall impression of the nature, extent and manner of completing activities considering your intentions and purposes in undertaking them.

The indicators of the carrying on of a business from paragraph 13 of TR 97/11 are:

§ whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators;

§ 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 repetition and regularity of the activity;

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

§ whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at 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 a sporting activity.

Are you carrying on a business of property development?

Purpose and prospects of profit

On learning the partly constructed property was for sale, you realised it was likely there was a profit to be made in completion and sale of the units.

Although, you initially entered into the purchase contract as agents for your superannuation fund, you were unable to get advice about the legalities involved, so you adopted the alternative strategy, to complete the project yourselves.

To ensure the activities were capable of making a profit you prepared budgets and cost estimates which took into account:

§ the purchase price negotiated,

§ a valuation obtained by an independent valuer,

§ prices of building materials, labour, finance costs etcetera,

§ use of existing equipment, knowledge and connections to minimise costs, and

§ current selling prices for similar residences.

The estimates were favourable based on a worst-case sale price so the project was undertaken. You advise that if the properties sell at the prices advised by the selling agent, you will expect to make a gross profit of approximately $300,000 to $350,000.

Intention of the taxpayer

You decided to complete the project yourselves in partnership and intended the activities to be the carrying on of a property development business. You entered into the contract on builders' terms and drew up a business plan which provides:

§ your primary goal is to develop and sell properties and make money.

§ that you will need to sell the current properties to finance future projects.

You did not enter into the activities for private or domestic purposes, and will not offer the properties for rental purposes until all other sale options have been exhausted and after an extended period.

Significant commercial purpose or character

Paragraph 29 of TR 97/11 clarifies that this indicator is closely linked to the other indicators and is a generalisation drawn from the interaction between them. Activities are more likely to amount to the carrying on of a business where the activity is being operated for commercial reasons, in a commercially viable way.

From the facts the following strongly suggest a 'significant commercial purpose or character' in your activities:

§ intention, when engaging in the activities, to make a profit from completing construction of the units for sale

§ significant profits expected

§ preparation of budgets and cost estimates which indicate the project and profits expected are realistic and reasonable

§ identified potential markets and various advertising methods to reach those markets

§ not required to meet your domestic needs

Activity carried on in a manner that is characteristic of the industry

A business is characteristically carried on in a systematic and organised manner rather than on an ad hoc basis.

As with your activities, within the building and construction industry tradesmen and women often undertake building projects as sole traders or in partnership with friends and family in the industry as small businesses. It is not uncommon to enter different projects with different partners. For these small businesses, projects are often carried out one at a time so as each project can help finance the next. The real estate market being well established as the method of advertising and selling the end product.

You did not undertake all the building activities yourselves; however, it is common practice in the building and construction industry to sub-contract work to professionals to complete.

Repetition and regularity of the activity

A continuing business involves a pattern of transactions which are repetitive and systematic and are overall moved by profit. However, it is not every occasion where a single acquisition, development, and sale, will amount to an 'isolated transaction'. As stated by Bowen CJ and Franki J in Ferguson v. FC of T (1979) 37 FLR 310 at FLR 314; 79 ATC 4261 at ATC 4264-4265; (1979) 9 ATR 873 at ATR 876-877:

Repetition and regularity of the activities is also important. However, every business has to begin, and even isolated activities may in the circumstances be held to be the commencement of carrying on business.

It is necessary to consider whether the activities may be more accurately described as an isolated business operation, project, or commercial transaction.

Taxation Ruling 92/3 discusses isolated transactions and at paragraph 6 explains that the term refers to:

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

b) those transactions entered into by non-business taxpayers.

Items acquired, developed or manufactured and held for the purposes of an isolated transaction do not meet the definition of trading stock in section 70-10 of the ITAA 1997.

As this is your first and only project as partners your activities do not show repeat or regular sales. However, as discussed above it is not uncharacteristic for single projects to come to completion prior to commencement of the next in small property development business within the industry.

In your business plan you discuss future projects and you have stated that unless the current project makes a loss you will continue in partnership on further projects, but are more likely to consider renovation projects as the local government costs involved are significantly less and as such, they are more profitable.

Organisation in a businesslike manner and the use of system

As part of the purchase of the partly constructed units, you purchased the vendors building plan, approvals and permits. Through your purchase, you were able to organise the extension required for completion of the development. You are able to utilise the trade licences of sub-contractors and family members as required and have purchased business and building insurances as required.

You have a written business plan and have registered as a partnership for taxation purposes. Although you do not have a written partnership agreement, this is not a compulsory legal requirement as you can rely on common law principles.

Each partner is involved in decision making; and planning, administration, and the financial management of the partnership. You have engaged a professional accountant to provide advice and assist in meeting your taxation obligations and to provide managerial and financial accounting reports and advice.

Each partner has contributed private capital to the partnership, and also building materials and equipment for the project. You try to have each partner contribute in equal shares but this has varied from time to time. Due to the private contributions of each partner, the partners have not needed to obtain third party finance in the partnership's name.

Your actions in assessing the viability of the project prior to purchasing were business-like and professional.

Size and scale of your activities

As this is your first purchase and build project together, you have been undertaking the one project only. You have confirmed in your business plan that the process you will undertake is to complete each project and utilise the profits from sale to help finance your next project.

At this stage your operation is small. However, a person may still be carrying on a business even though carried on in a small way (TR 97/11 paragraph 77).

Hobby or form of recreation

None of your activities are suggestive of the activities being better described as a hobby or form of recreation.

Conclusion on carrying on a business

After considering the facts in your case against the indicators of carrying on a business, the general impression gained as to the nature, extent and manner of undertaking the activities and considering your intentions and purposes in undertaking them is that the activities amount to the carrying on of a residential property development business.

Holding land and buildings for use, not sale

Land and buildings are regularly acquired and improved by owners for purposes other than re-sale, such as private or domestic use, use as a business premises or for use by third parties for payments of rent.

In these circumstances the land and buildings are capital assets providing an enduring, long-term benefit or advantage to the owners.

You are not, and have no intention to, use the units for private or domestic purposes, or as a business premises. Although, you have included the possibility of renting as a contingency in your business plan, this would only be considered after an extended period of attempting to sell and exhausting all other selling options.

If this were to occur the units would be being held for use and would not meet the definition of trading stock under section 70-10 of the ITAA 1997.

Conclusion

In light of the above, the Commissioner is satisfied that you acquired and held the properties for the purpose of sale in the ordinary course of your property development business.

As such, both conditions necessary under section 70-10 of the ITAA 1997 are present and the properties are treated as trading stock of the partnership.

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