Edited version of private ruling

Authorisation Number: 1011829338197

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: Sale of property

Question 1

Will the proceeds from the sale of the house and land be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice/Answers

Yes.

Question 2

Will the proceeds from the disposal of the house and land be subject to the capital gains tax (CGT) provisions in Part 3-1 of the ITAA 1997?

Advice/Answers

Yes.

Question 3

If the proceeds from the disposal are subject to the CGT provisions in Part 3-1 of the ITAA 1997, will section 118-20 of the ITAA 1997 apply to reduce any capital gain made?

Advice/Answers

Yes.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You operate a business as a partnership with your spouse.

The partnership is registered for GST.

You hold a builder's licence although you have not formerly built any houses. The business does not build houses.

You and your spouse purchased a vacant block of land.

You borrowed to fund the acquisition and later borrowed to complete the construction of the house.

When you signed the contract to purchase the land, you intended to build a spec house on it for resale. This house was to be constructed by you. However, a short time later, you changed your minds and decided to build a house for yourselves.

The plans originally drawn up for the spec house were changed when you decided to build for yourselves. The changes included making the house smaller as you could not afford the house in the original plans.

You obtained building approval as owner builders and started construction. The house was completed to lock-up stage, and you stayed in the house while it was being built. Your spouse stayed at your original residence during this time.

The building was completed and contracts for the sale of the property have recently been exchanged.

You and your spouse decided to sell the house and stay in the original residence for personal reasons. The original residence was then put on the market as you and your spouse now intend to move to another area.

During construction, you did not claim GST on materials or claim interest on the loan as you considered it to be a private dwelling and not part of your business.

You have no history of building and selling spec homes. You have never built a new home as a builder and have only ever done renovations.

At the time that you purchased the land, you had no intention to purchase further land for development purposes. You still have no such intention at the present time.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5
Income Tax Assessment Act 1997 Section 104-10
Income Tax Assessment Act 1997 Section 118-20

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Profits from the sale of property can be treated for taxation purposes in the following ways:

(a) As ordinary income under section 6-5 of the ITAA 1997 as a result of carrying on a business of property development and involving the sale of property as trading stock. Ordinary income is defined as income according to ordinary concepts.

(b) As ordinary income under section 6-5 of the ITAA 1997 as a result of an isolated business transaction which, although outside the ordinary course of business of a taxpayer, is entered into for the commercial exploitation of an asset acquired for a profit making purpose, that is, the profit is derived in the course of carrying out a business operation or commercial transaction.

(c) As statutory income under the CGT provisions of Part 3-1 of the ITAA 1997.

Case law on profits from sale of assets

The principle that profits made in the ordinary course of carrying on a business constitute income and is not of a capital nature was confirmed in FC of T v. The Myer Emporium Ltd (1987) 87 ATC 4363; (1983) 163 CLR 199; 18 ATR 693 (Myer). The High Court also held that a profit arising from an isolated transaction which, although not made within the ordinary course of the taxpayer's business, was entered into with the purpose of making a profit and in the course of the taxpayer's business might well constitute income.

In McCurry & Anor v. FC of T 98 ATC 4487; (1998) 39 ATR 121 (McCurry), the Federal Court considered the case of two brothers who purchased land with an old house on it. They removed the old house and borrowed money in order to build three townhouses. These were completed in June 1987 and August 1987.

The units were advertised for sale just before they were completed but could not be sold. The taxpayer and other family members moved into two of the townhouses. The units were put up for sale again in July 1988 and sold in December 1988 but the family remained in two of them as tenants.

The taxpayer's denied that they had undertaken a profit making venture and that even if there had been such a venture, that venture had been abandoned as two of the units had been used as homes for the taxpayer's family.

Davies J stated:

In my opinion, the taxpayers entered into a profit-making undertaking or scheme which was a business or commercial dealing in the sense I have described when they acquired the property at Addison Avenue. Their venture was a trading venture and from this venture they made the profit which had been anticipated. Perhaps strictly, as the purpose of the venture was the purpose of the taxpayers, I should say that I am not satisfied the profit-making, by development and sale of the units, was not their predominating objective.

It has been submitted on behalf of the taxpayers that, if they undertook a profit-making venture, which they denied, that venture was abandoned. For twelve months from the time that they purchased the newsagency, units 2 and 3 were used as homes for the McCurry family. Unit 1 seems to have been used partly as a storeroom for the newsagency and partly as a residence by one or other of the boys when visited at weekends by his partner from Sydney. I draw the conclusion, however, that the taxpayers' scheme was not totally abandoned and that the units were not irrevocably committed to another activity. Profit-making by the sale of the units always remained an option for the brothers, notwithstanding that, for some period, when it was convenient to do so, the units were used for another purpose.

As explained in the authorities I have mentioned, the crucial issue is whether the property generating the profit was acquired in a business operation or commercial transaction for the purpose of profit-making by the means which in fact gave rise to the profit, in other words, whether there was a profit-making scheme or undertaking and profit was derived from the carrying out of that scheme. It matters not that there may be an interruption to or interregnum of the scheme if the profit ultimately is derived from the activity which was planned and carried out to give rise to it. This is not a case such as Kratzmann v FC of T 70 ATC 4043; (1970) 44 ALJR 293 or Eisner v FC of T 71 ATC 4022; (1971) 45 ALJR 110, where the profit-making scheme was abandoned and profit was derived otherwise than in accordance with the scheme. In the present case, the profit that was derived was in contemplation at the time of the acquisition of the land.

Profits from carrying on a business

Taxation Ruling TR 97/11 lists the following key factors in determining whether a taxpayer carries on a business for tax purposes:

· Whether the activity has a significant commercial purpose or character

· 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 and

· The size, scale and permanency of the activity.

TR 97/11 points out that no one indicator is decisive and they must be considered in combination and as a whole. The conclusion is drawn on the basis of the evidence and facts as to whether these indicators provide the operations with a commercial flavour.

Profits from isolated transactions

Myer is authority for the principle that profits arising from an isolated business or commercial transaction constitute ordinary income if the taxpayer's purpose or intention in entering into the transaction was to make a profit, notwithstanding that the transaction was not part of its daily business activities.

Taxation Ruling TR 92/3 sets out the Commissioner's view of the principles that have been considered in determining whether an isolated transaction is of a revenue nature. It states that a profit from an isolated transaction is generally income when both of the following elements are present:

(a) the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain and

(b) the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

The relevant intention or purpose of the taxpayer in making a profit or gain is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case. 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.

For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character. In very general terms, 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 repetitious or recurring transactions or operations.

Paragraph 14 of TR 92/3 states:

14. It is not necessary that the profit be obtained by a means specifically contemplated (either on its own or as one of several possible means) when the taxpayer enters into the transaction. It is sufficient that the taxpayer enters into the transaction with the purpose of making a profit in the most advantageous way and that a profit is later obtained by any means which implements the initial profit-making purpose. It is also sufficient if a taxpayer enters into the transaction with the purpose of making a profit by one particular means but actually obtains the profit by a different means.

Paragraph 44 of TR 92/3 states:

44. It is not our view, nor has it ever been, that all receipts or profits of a business are income. For example, when a taxpayer derives a profit from a transaction outside the ordinary course of carrying on its business and the taxpayer did not enter that transaction with the purpose of making a profit, the profit is not assessable income.

Capital gains tax

CGT event A1 under section 104-10 of the ITAA 1997 happens if you dispose of a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property.

Section 118-20 of the ITAA 1997 reduces a capital gain made from a CGT event to the extent that the gain is otherwise assessed under another provision of the legislation.

Taxation Determination TD 92/135 states that where the sale of a dwelling gives rise to income under the ordinary income provisions of the ITAA, that income remains assessable even if a main residence exemption is available for CGT purposes.

The main residence exemption is a CGT exemption only and does not extend to exempt from tax ordinary profits or business income.

The following example is given in TD 92/135

A builder constructs a spec home in which he and his family reside while construction proceeds on another spec home. Any profit on sale which gives rise to income is fully assessable to the builder even if a main residence exemption is available for CGT purposes.

Applying the above guidelines to your circumstances

In this particular case, the purchase of the land for the purposes of building a spec house for resale was not part of the business activity carried on by the partnership. The partnership business does not build houses.

There is also no indication that a separate business activity of land development commenced with the purchase of the land. There was an absence of repetition and the purchase of the land was an isolated transaction. The profit from the sale therefore can not be said to be from the carrying on of a business.

The profit from the sale will, however, constitute ordinary income under the guidelines of TR 92/3 discussed above as a profit from an isolated transaction, as the purchase of the land for the purposes of building a spec house for resale would indicate that the intention at that time was to make a profit or gain, and the building of a spec house for resale would be considered to be a commercial transaction.

Applying the principles of the McCurry case as discussed above, you did not totally abandon your scheme prior to the sale of the house and land. The intention at the time of the purchase was to construct a house on the land and sell the property. This is what actually occurred, within a relatively short period after the purchase of the land. Although the house plans were changed and the house was smaller, the scheme essentially remained the same. Although the intentions in relation to the property might have changed, the house and land were not irrevocably committed to another activity and profit-making by the sale of the house and land always remained an option.

As discussed in McCurry, the fact that there is some interruption to the scheme, which in this case would be the fact that you resided in the property for a period prior to the sale, does not matter if the profit ultimately is derived from the activity which was planned and carried out, which is what has occurred in this case. The profit that was made was in contemplation at the time of the acquisition of the land.

The capital proceeds from the sale will therefore be assessable under section 6-5 of the ITAA 1997 as a profit from an isolated transaction. CGT event A1 under section 104-10 of the ITAA 1997 will also happen as a result of the sale of the house and land. The house and land are considered to be a single asset.

Any capital gain made from the CGT event will be reduced to zero under section 118-20 of the ITAA 1997 by the gain assessed under section 6-5 of the ITAA 1997. The main residence exemption may apply to any capital gain remaining after the reduction if the relevant conditions in Subdivision 118-B of the ITAA 1997 are satisfied.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).