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Subject: Subdivision - isolated transactions - ordinary income

Question:

Is the profit from my development and sale of a newly constructed dwelling on my subdivided property assessable income?

Answer:

Yes.

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts

You purchased a property with your husband after 20 September 1985 and resided at the dwelling.

Your husband passed away and you currently reside at the dwelling.

You intend to demolish the current dwelling and erect a number of units and reside in one of the units and sell the remainder.

A revised plan has been proposed which now includes demolishing the existing dwelling and constructing a lesser number of units.

The development will be financed through a mortgage.

You are undertaking this venture as you anticipate that you will be unable to afford to maintain the property.

You have arranged for a local property developer to prepare and submit revised plans for approval by the Local Council

Your only asset is the dwelling and you currently receive an aged pension.

You require information about any tax liabilities that you may incur as a result of the proposed development.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Assessable income

A taxpayer is liable to tax on their taxable income derived during the income year. Taxable income is calculated by subtracting allowable deductions from the taxpayer's assessable income.

Income is generally assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997).

Under section 6-5 of the ITAA 1997, assessable income is made up of ordinary income and statutory income. Exempt income is not included in assessable income, even when it is also ordinary or statutory income.

Under subsection 6-5(1) of the ITAA 1997, ordinary income means income 'according to ordinary concepts'. This phrase is not defined under the legislation, but a large body of case law has developed to identify the factors that indicate if an amount is income according to ordinary concepts. Each fact situation must be examined to determine if the particular payment can be characterised as income according to ordinary concepts.

Carrying on a business

Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the particular facts.

Taxation Ruling TR 97/11 provides the Commissioners 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;

§ Whether the activity is better described as a hobby, a form of recreation or sporting activity.

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

We have reviewed your information and applying TR 97/11 we have determined that you were not carrying on a business of property development in the 2012 income year.

We have found that your activity does not display the character of an operating business structure as this is your first property development and you have not stated an intention to complete any other further developments.

The scale of your development is small and your level of personal involvement is minimal and as such you are not in the business of property development.

Isolated transactions: profit and loss

Taxation Ruling TR 92/3 states the Commissioner of Taxation's views on whether profits on isolated transactions are assessable income.

An 'isolated transaction' is defined as:

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.

TR 92/3 represents the Commissioner's application of the High Court's decision in Federal Commissioner of Taxation v.The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987)18 ATR 693.

Generally, a profit from an isolated transaction will be income when both of the following are present:

a) The intention or purpose of 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 intention of the taxpayer is determined by an objective consideration of the facts and circumstances of the case.

Profit-making does not need to be the sole or dominant purpose for entering the transaction. Profit-making must be a significant purpose. The purpose must exist at the time the transaction or operation was entered into.

If the transaction or operation is in the course of the taxpayer's business, then the profit from the transaction will be income provided that any gross receipt from the transaction is not income.

If the transaction or operation is not in the course of the taxpayer's business the taxpayer must have:

a) a profit-making purpose; and

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

If a taxpayer not carrying on a business, makes a profit, that profit is income if:

a) the taxpayer had a profit-making intention when entering the transaction or operation; and

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

A transaction may be characterised as a business operation or commercial transaction if the transaction is business or commercial in character.

Some of the factors that may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are:

§ the nature of the entity undertaking the operation or transaction. For example, if the entity is a corporation with substantial assets rather than an individual, this may be an indication that the operation or transaction was commercial in nature.

§ The nature and scale of the activities undertaken;

§ The amount of money involved in the transaction and the size of the profit that was sought or obtained;

§ The nature, scale and complexity of the operation or transaction;

§ The manner in which the operation or transaction was carried out. For example, whether professional agents and advisers were used and whether the operation or transaction was in a public market

§ The nature of any connection between the taxpayer and any other party to the operation or transaction. For example, the relationship may suggest that the operation was essentially a family dealing;

§ The nature of any property disposed of. For example, if the property has no use other than as a subject of trade, it is easier to infer the transaction was commercial in nature;

§ The timing of the transaction or the various steps involved. For example, if the transaction involves the acquisition and disposal of property, then holding the property for many years may indicate the transaction was not business or commercial in nature.

You must have intended to make a profit when you entered into the transactions and made the profit in carrying out business operations or commercial transactions.

Your intention is to make a profit when you start the development to achieve this you have mortgaged your main residence to finance the development.

We consider that your property development constitutes business operations or commercial transactions.

We considered the factors at paragraph 13 of TR 92/3.

You intend to subdivide a block into an area for development and as such the transactions are commercial in nature and the profit of this will be assessable as ordinary income.

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