Edited version of your written advice

Authorisation Number: 1012730993781

Ruling

Subject: CGT event K4

Question 1

Will the property become trading stock in your hands and trigger CGT event K4 under section 104-220 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Can you use the market value of the property at the time you decided to undertake the development as your cost in calculating the profit on the sale of each individual apartment?

Answer

Yes

This ruling applies for the following period(s)

Income year ended 30 June 2015

Income year ended 30 June 2016

The scheme commences on

1 July 2014

Relevant facts and circumstances

You purchased a commercial rental property.

Your tenant subsequently did not renew their lease.

The commercial rental market in the area has deteriorated.

You have been unable to find a tenant.

You engage an architect to prepare a feasibility study on the site.

You have decided to construct a multi-storey apartment on the property.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 70-10

Income Tax Assessment Act 1997 section 104-220

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Generally the profits from transactions involving the sale of real property will be assessable as ordinary income under section 6-5 of the ITAA 1997 where they are income from a business activity or profits from an isolated commercial transaction. In those instances where the profits of the sale would have been ordinary income any losses will generally be deductible. Alternatively, where the sale of real property is not part of a business or an isolated commercial transaction any profit or loss will be subject to the capital gain tax provisions.

Carrying on a business

The question of whether a business is being carried on is a question of fact and degree to be determined on a case by case basis. The courts have developed a series of indicators to determine the matter, which are summarised in Taxation Ruling TR 97/11. Although TR 97/11 specifically refers to primary production, the same principles apply to all businesses. Some indicators of carrying on a business which the courts have considered to be relevant include:

• whether the activity has a significant commercial purposes or character

• whether the taxpayer has more than just an intention to engage in business

• 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, and

• whether the activity is better described as a hobby, a form of recreation or sporting activity.

Applying the above indicators to your factual circumstances gives the overall impression that you will not be carrying on a business of property development, specifically noting the lack of repletion and regularity. Consequently the proceeds will not be assessable as income from a business activity.

Isolated commercial transactions

However the profits of any sale of property may still be assessable as ordinary income from an isolated commercial transaction. The Commissioner's view on whether profits on isolated transactions are assessable income under ordinary concepts is contained in Taxation Ruling TR 92/3. Profit from an isolated transaction is ordinary income where both:

• the intention and purpose for the taxpayer in entering into the transaction was to make a profit or gain and 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.

As was held in FC of T v The Myer Emporium Ltd (1987) 163 CLR 1999 the relevant intention is your intention taking into account objective consideration of all the fact and circumstances of the case.

It is a general principle that where a person purchases land not for the purpose of resale, and then sells the land either in its entirety or in separate lots that the party is merely realising their assets (see Californian Copper Syndicate v Harris (1904) 5 TC 159 and does not have a profit making purpose or intention. However this may not always be the case where there is an intervening act and a clear change in purpose for the use of the land such as in White v FCT (1968) 120 CLR 191 or Whitfords Beach v FCT 150 CLR 366; 82 ATC 4031.

In the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135, at 97 ATC 5152, Ryan J distinguished a mere realisation from a commercial transaction as follows:

Nor did the taxpayer undertake any works on, or development of, the land beyond what was necessary to secure the approval by the municipal authorities of the successive plans of subdivision and enhance the presentation of individual allotments for sale as vacant blocks. Had he constructed dwelling houses, internal fencing or other improvements, it would have been easier to impute to him an intention to carry on a business of land development and improvement.

In your circumstance we consider based on the above reasoning in Casimaty that the construction of a multi-story apartment complex clearly goes beyond the mere realisation of an investment property and will consequently result in an isolated commercial transaction, the net profits of which will be assessable as ordinary income under section 6-5 of the ITAA 1997.

Trading Stock and CGT event K4

Section 104-220 of the ITAA 1997 provides that CGT event K4 happens where you start holding as trading stock, a CGT asset you already owned but did not hold as trading stock.

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.

Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'. As discussed above we do not consider you have commenced a business of property development and therefore the land cannot become trading stock, consequently CGT event K4 will not occur.

Market value approach for isolated transactions

The withdrawal of Taxation Determination TD 92/161 was discussed in the National Tax Liaison Group minutes for the 17 June 2004 (available on our website https://www.ato.gov.au/Tax-professionals/TP/NTLG-minutes---17-June-2004/?page=49). The discussion involved a specific example:

A farmer who has owned farm land for 20 years decides, in 2004, to subdivide the land and sell the subdivided lots. Assume the subdivision and sale does not amount to the carrying on of a business and the therefore the land is not being held as trading stock. Also assume the subdivision and sale goes beyond the mere realisation of an asset in the most enterprising way, that is, it amounts to a commercial transaction such that the net profit is assessable under section 6-5 of the ITAA 1997.

In the meeting the ATO confirmed that in calculating the assessable net profit from the sale of the lots that the sale proceeds are reduced by the market value of the land at the time the land was ventured into the commercial transaction, namely 2004, and not by the original cost of the land when it was purchased in 1984 as per Whitfords Beach.

Consequently in calculating your assessable net profit, the sale proceeds of the apartments will be reduced by the market value of the property on the date when you decided to commence the activity to develop the property.

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