Edited version of your written advice

Authorisation Number: 1012735998637

Ruling

Subject: isolated commercial transactions

Question 1

Is the loss incurred in the purchase and sale of a luxury apartment deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Does the Commissioner agree with the quantum of the loss deductible under section 8-1 of the ITAA 1997?

Answer

Yes

This ruling applies for the following period

Income year ended 30 June 2014

The scheme commences on

1 July 2013

Relevant facts and circumstances

You are an Australian resident.

You have had a number of senior roles in large public groups.

These senior roles have given you extensive experience in the property industry.

In one of the roles you were responsible for the bulk of the property acquisitions and were consequently familiar with the dynamics that drove acquisitions of property.

You have extensive financial and business qualifications.

You and your wife maintain your current residence at W.

Prior to this you lived in a rental property at X and before that lived in a property you owned at Y.

In 20XX you attempted to purchase a new main residence but the sale fell through due to a building inspection issue.

In the years leading up to 20XX you controlled significant investments including public traded units and share, as well as investments in private companies.

In 20XX consistent with declining global economic conditions, these investments dropped significantly in value. In 20XX you found yourself in search of alternative ways to rebuild your wealth.

Having lost confidence in public traded shares and units due to the volatility in their price movements in a period of global economic weakness. You decided to draw on your expertise developed from xx years of experience working in the property industry and formed a view you could quickly rebuild your wealth by entering into a property based profit making venture.

In reviewing the price performance of the residential property market you formulated a list of criteria that needed to be met before you would acquire a property which would be readily saleable. Your criteria included:

a) age and amenities of the property - newer properties attracted a premium, particularly if they were part of a boutique, high-end/luxury development

b) location of the property, preferably with a 180 degree view of water and close to social amenities such as restaurants

c) proximity of the property to transport

d) expected future population demographics in the suburb

e) previous growth rate of high-end property prices in the suburb

f) other proposed high-end development in the vicinity.

On 20XX, you exchanged contracts for the purchase of the plan of a luxury residential apartment to be built at Z as part of the A complex. You decided to purchase this property as it met each of your criteria in that you would acquire it off the plan, it would be new, it was a high-end apartment in an exclusive development with water views and close to local amenities.

Under the purchase contract you agreed to pay a purchase price of $x million. At exchange, you paid a 10% deposit in the amount of $x (having arranged a deposit bond and sourcing a portion of your own capital). At the time of exchange, you understood that it would take approximately 30 months for the developer to complete the construction.

You chose to purchase the property in your own right as opposed to through a trust or some other business structure for the following reasons:

• You had significant tax losses in your personal capacity (approximately $x) which exceeded the losses in a previous investment vehicle (approximately $x) which you hoped to utilise after making a profit on the sale of the property.

• It simplified the financing arrangements in relation to seeking the initial deposit bond as the previous investment vehicle had no assets post GFC.

The purchase of the property was attractive to you as a profit making venture as it would enable you to make a relative small outlay to cover the deposit while not having the burden of maintaining the mortgage for the remainder of the purchase price until the property settled 30 months later. At the time of purchasing the property you did not have a salaried position and were working in a pro bono position. You did not have the resources to buy a property and take on a mortgage at the time of entering into the contract.

In or around 20XX, construction of the property completed. On X date you settled on the purchase of property. On completion, you paid consideration of $x with financing arrangements obtained from 2 facilities which were interest only facilities. This resulted in you not being required to take out mortgage insurance, thereby reducing the overall cost of financing.

You incurred additional expenditure associated with the purchase of the property, including:

a) stamp duty paid to the Office of State Revenue $x

b) interest on stamp duty paid to the Office of State Revenue $x

c) interest cost of the deposit bond $x

d) government transfer duty $x

e) legal fees incurred in relation to the purchase contract $x

Immediately following settlement of your purchase of the property you engaged lawyers to prepare a contract for the sale of the property. You appointed real estate agent A for the sale of the property. The property was advertised by real estate agent A for a price of around $x. You considered it typical that real estate agents provide conservative price guides in an attempt to entice potential purchasers to visit the property and entertain the idea of purchasing it. You in fact had hoped to secure a selling price of between $x and $x for the property.

You had based this expectation based of research you had conducted, including comparable sales in the local area.

On X date, you terminated the engagement with real estate agent A and appointed real estate agent B as the previous agent did not bring you any potential buyers during their tenure.

By X date real estate agent B indicated to you that it would be difficult to achieve a sale in your target range given the market feedback received from potential purchasers.

On X date you exchanged contracts for sale with a third party purchaser. The sale price of $x was well below what you had anticipated you would achieve for the sale of the property. This was the only formal offer that was put to you while the property was on the market. You were not prepared to incur further interest expense in respect of financing the property and your intention was always to sell it in 'as new' condition in order to maximise your return from the property.

The expedited three week settlement was at your request in order to maximise your return from this venture. At this point you used consideration received from the property sale to repay the interest bearing finance provided by your bank.

During the holding period from your purchase of the property to the sale in 20XX, you incurred various costs amounting to approximately $x comprising:

a) interest on loan $x

b) strata levies/water/electricity $x

c) advertising and marketing (real estate agent A) $x

d) advertising and marketing (real estate agent B) $x

e) hire of furniture for marketing of apartment $x

f) legal fees on sale $x

g) interest received on sale deposit $(x)

h) real estate agent B commission on sale $x

The combination of the above costs as well as the loss on the sale of the property had left you a loss in the amount of $x from this transaction.

During the marketing campaign for the property two other units in the complex were put up for sale. It is your understanding that those properties were owned by the developer of the complex and had not been sold off the plan prior to the completion of the construction of the complex. The developer, eager to complete this project, was keen to dispose of these unsold luxury units and reduced his asking price in order to expedite a sale. These other properties were of a similar size and nature to the property you purchased. Consequently this impacted your ability to sell the property at your target price as there were more apartments in this boutique complex for sale than you had anticipated there would be when you entered into this venture.

Based on feedback from the agents and your own assessment you formed the view that you would not be able to achieve a price in excess of $x for the property in the market and you did not wish to hold the property for longer than necessary. Consequently, you accepted the only formal offer that real estate agent B had been able to secure from a buyer who could complete a purchase.

Your intention when purchasing the property was to acquire it direct from the developer who would be predisposed to secure an off the plan sale in order to meet their pre-sale requirements for construction to commence. You then proposed to on sell it immediately following the settlement of the purchase contract. You did not wish to hold the property for any extended period of time as you formed the view that a new property in this location would earn a larger premium and the longer you held the property, the greater the negative impact upon your return on the funds invested.

You also did not form the view to offer the property for rent, as the expected yield would not justify the investment and would generate a poor return. It would also reduce the potential sale value of the property as it would no longer be an as new condition property.

In 20XX, just prior to exchanging contracts for the purchase of the property, you had calculated that you could sell the property immediately upon its completion, some 30 months later, for approximately $x to $x, representing a gross profit margin of approximately $x to $x on the purchase price being a 9-12% increase in value per annum over the 30 month period.

Prior to the purchase, you researched the performance of the high-end property market and found it had been a strong performer in terms of price growth.

The financing you obtained for the purchase of the property, was structured to allow you to repay the borrowing with no penalty provision. As you planned to sell the property on completion this was important.

In addition, your expectation at the time of purchasing the property in x was that interest rates were declining and would continue to do so as evidenced by information provided by the Reserve Bank of Australia. You calculated that this would allow for potential buyers in the future to access more economical finance which would give rise to increases in value of real estate and allow you to profit on the immediate resale of the property on completion of construction.

Consistent with your initial intention, you did sell the property shortly after completion of the purchase. As a result of the market condition at the time of the sale, the anticipated profit did not arise and you incurred a loss on the disposal.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Generally the proceeds 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.

Isolated commercial transactions

Profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business, see FC of T v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693 (Myer). 

Taxation Rulings TR 92/3 and TR 92/4 consider the principles outlined in Myer and provide guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income or losses on isolated transactions are deductible under section 8-1 of the ITAA 1997.

TR 92/3 should be read in conjunction with TR 92/4.

TR 92/3 defines the term 'isolated transactions' as:

• transactions outside the ordinary course of business of a taxpayer carrying on a business, and

• transactions entered into by non-business taxpayers. 

If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayers business but:

• the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain, and

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

Profit making intention or purpose

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.

Paragraph 7 of TR 92/3 provides the Commissioner's view that the relevant intention or purpose of the taxpayer in making a profit of 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.

Further the taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction involves or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit making at the time of acquiring the property.

The case of McCurry v. Commissioner of Taxation [1998] FCA 512; (1998) 98 ATC 4487; (1998) 39 ATR 121 involved the construction and subsequent sale of three units and whether the profits on the sales were assessable as ordinary income. The case turned primarily on whether the taxpayer had constructed the units for the purpose of making a profit on resale or alternatively to be held as rental investments. Justice Davies held the following in relation to discerning the purpose of acquiring property, at 121,127:

In a case such as this, where the Court must examine the purpose of a transaction, the Court is entitled to have regard not only to the evidence which the taxpayers give of what they had in mind but also to the surrounding facts and to the events which actually occurred. Those events, by hindsight, can throw light upon the considerations which the taxpayer had at the time when the dealing was initiated.

Therefore to determine whether this transaction had a profit making intention or purpose the Commissioner must consider whether an objective consideration of the facts and circumstances at the time of entering into the contract in 20XX support your stated intention that you purchased the property solely for the purpose of making a profit on resale.

One of the key consideration is the financial capacity of the taxpayer at the time of making the transaction, in the Federal Court case of Casimaty v. Federal Commissioner of Taxation [1997] FCA 1388; (1997) 37 ATR 358; 97 ATC 5135, reference was made to Turner v Last (HM Inspector of Taxes) (1965) 42 TC 517, per Cross J at 522-523. In that case the court upheld the taxpayer's assessment to tax of the profits on the sale of farming land despite the taxpayer's contention that the whole of the land had been purchased with the intention of farming, on the ground that the inference that the taxpayer in fact intended to resell the land at a profit could reasonably be drawn from evidence that the taxpayer's financial position before the purchase would not allow him to hold the land indefinitely.

Application to your circumstances

The Commissioner notes the following facts and circumstances in relation to the initial purchase of the property at X date:

• you had significant tax losses in your personal capacity which you intended to utilise upon making a profit

• you did not have a salaried position at the time of purchasing the property, as you were living off your previous investments having accepted a pro bono position

• you did not have the capacity to service a mortgage for the entirety of the purchase price of the property

• you had previously attempted to purchase a new main residence worth $x which was worth significantly less than your previous main residence at X ($x) and the property at Y ($x)

• the property had a different character to the other properties you have resided in, which were all located in New South Wales

• you have provided that you sought confirmation from a real estate agent you have previously dealt with that you could expect to make a profit from the sale of the property. That real estate agent has provided a signed written statement confirming that conversation took place.

The Commissioner notes the lack of contemporaneous documentary or otherwise evidence that supports the position that the property was purchased for a profit making purpose. While none of the above factors in of themselves would definitively suggest that the property was purchased for the dominant purpose of making a profit on resale, the Commissioner accepts that on balance you have discharged the burden of proof that your objective factual circumstances support the proposition you had a profit making intention when entering into the contract in 20XX. While not definitive by itself the Commissioner has been persuaded that your individual financial circumstances in 20XX were such that you could not afford to hold the property for a significant period making it unsuitable as a rental investment or as a residence.

Business operation or commercial transaction

Whether an isolated transaction is commercial in character will depend on the circumstances of each case.  Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits can be assessed as ordinary income within section 6-5 of the ITAA 1997.

In Myer the High Court did not provide any guidelines or criteria that would establish whether any given transaction was a commercial transaction. However the High Court did refer to previous circumstances where the courts have held isolated transactions produced assessable income:

• A syndicate purchased a mining property for the purpose of resale at a profit, rather than deriving income from mining operations on the property, and later sold the property at a profit (Californian Copper Syndicate (Limited and Reduced) v. Harris (1904) 5 TC 159) (Californian Copper).

• A company engaged in exploiting a particular invention by granting licences under patents acquired additional patents in relation to the invention and, as always contemplated, sold those patents at a profit (Ducker v. Rees Roturbo Development Syndicate Ltd [1928] AC 132).

• A partnership purchased a complete spinning plant with a view to resale at a profit, having no intention of using the plant to derive income from spinning, and later sold the plant at a profit (Edwards v. Bairstow [1956] AC 14) (Bairstow).

• A company which owned beachfront land suffered a change in ownership and then procured changes of zoning, developed the land as a residential subdivision and sold the vacant subdivided lots for a profit of several million dollars (FC of T v. Whitfords Beach Pty Ltd (1982) 150 CLR 355; 82 ATC 4031; 12 ATR 692).

In TR 92/3 the Commissioner provides his view on the factors that would suggest whether a transaction has a commercial or business nature, largely being the same factors that determine whether a business activity has commenced, excluding repetition or regularity. These are listed at paragraph 13 and 49 of TR 92/3 as follows:

a) the nature of the entity undertaking the operation or transaction ( Ruhamah Property Co. Ltd. v. F C of T (1928) 41 CLR 148 at 154; Hobart Bridge Co. Ltd. v. FC of T (1951) 82 CLR 372 at 383; FC of T v. Radnor Pty Ltd 91 ATC 4689; 22 ATR 344). For example, if the taxpayer is a corporation with substantial assets rather than an individual, that may be an indication that the operation or transaction was commercial in nature. However, if the taxpayer acts in the capacity of trustee of a family trust, the inference that the transaction was commercial or business in nature may not be drawn so readily;

b) the nature and scale of other activities undertaken by the taxpayer ( Western Gold Mines N.L. v. C. of T. (W.A.) (1938) 59 CLR 729 at 740);

c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

d) the nature, scale and complexity of the operation or transaction;

e) the manner in which the operation or transaction was entered into or carried out. This factor would include whether professional agents and advisers were used and whether the operation or transaction took place in a public market;

f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction. For example, the relationship between the parties may suggest that the operation or transaction was essentially a family dealing and not business or commercial in nature;

g) if the transaction involves the acquisition and disposal of property, the nature of that property (Edwards v. Bairstow ; Hobart Bridge 82 CLR at 383). For example, if the property has no use other than as the subject of trade, the conclusion that the property was acquired for the purpose of trade and, therefore, that the transaction was commercial in nature, would be readily drawn; and

h) the timing of the transaction or the various steps in the transaction (Ruhamah Property 41 CLR at 154). For example, if the relevant transaction consists of the acquisition and disposal of property, the holding of the property for many years may indicate that the transaction was not business or commercial in nature.

Application to your circumstance

In relation to the above factors we note the following:

a) The property was acquired in your individual capacity as opposed to by a business structure. However we acknowledge that in your personal circumstances you had significant professional expertise, and that purchasing in your own right was commercially practical as you had significant tax losses and that financing arrangements would be simplified.

b) You have not carried on any business activities or similar profit making schemes which would add support to the argument that this transaction is commercial in nature.

c) Both the total purchase price of the property ($x) and the profits sought ($x to $x) are significant and suggest the transaction had a commercial nature.

d) The transaction involved the researching for, financing, purchasing and resale of a single luxury unit.

e) The way in which the transaction was structured suggests a commercial nature. You paid a 10% deposit sourced equally through a deposit bond and your own capital. This enabled you to lock in the purchase with a relatively small outlay. Upon completion you borrowed against two separate facilities on an interest only basis, as to avoid mortgage insurance. You engaged professionals to market the property, and when these professionals failed to bring you a buyer you appointed others.

f) You were not related to either the developer or the purchaser. All transactions were entered into at arm's length.

g) While the property was a residential property it was a high-end luxury apartment in a highly sought after location. Additionally it was an off the plan purchase which gives it a different character to that of a traditional purchase of real estate, in that the nature of the property is significantly different between the time of entering into the contract and settlement.

h) The contract was entered into to purchase the property in 20XX, however, once the construction was finished and the property settled you immediately listed it for sale. You sold the property approximately X months after it was listed for sale. During that period you replaced your real estate agent after they failed to find you a buyer.

No one of the above individual factor will be in of itself indicative of a commercial transaction or business operation. While some of the factors, notably the lack of similar activities and the fact that the transaction involved the sale of a single unit does not support the argument that this transaction was commercial. Further the passive and speculative nature of the transaction would ordinarily suggest a capital investment giving rise to a capital loss as opposed to a revenue loss.

However when viewed on balance the Commissioner considers that the transaction is of a commercial nature having regard to the factors in TR 92/3, noting specifically that the property in question was an off the plan purchase of a high-end luxury apartment, the way in which the transaction was structured including the financing, the amount of money involved and the timing of the steps within the transaction.

Further as stated above Myer did not establish any guidelines that would definitively establish whether any given transaction was commercial in nature but instead relied upon pre-existing common law authorities as examples of transactions that were commercial in nature. It is considered that two of these authorities Bairstow and California Cooper Syndicate strongly support the argument that this transaction is commercial in nature. Both of the above authorities involved the purchase of a type of property normally used for a set purpose (mining land and a spinning plant), but were in fact purchased solely for the purpose of resale as opposed to the normal business activity associated with the properties. In each instance the sale of the properties was held to be assessable as ordinary income.

This is analogous to your circumstance where you acquired a residential unit off the plan with the sole intention of making a profit from the resale of that property as soon as it settled. Such a property would normally be used as a residence or a rental investment, however it's accepted that an objective consideration of your facts support your stated intention that you purchased the property solely for the purpose of resale, and you through your actions after construction have acted consistently with that intention.

Further it is necessary to draw the distinction between this transaction and the more traditional forms of property investments that would be capital in nature. Essentially in your situation you have speculated that the property upon its final construction would be worth significantly more than the off the plan purchase price. The character of the off the plan initial purchase is different to the character of the completed property that you eventually settled on, and it would not be unreasonable to expect that the completed property would be worth more than what was essentially a right to purchase the property. This is distinguishable from a situation where you buy and sell pre completed property as in those situations generally for you to achieve any significant increase in value would involve holding that property for a significant period of time, as that property retains its character.

As the properties were purchased with the sole intention of making a profit and it is concluded that the transactions are commercial in nature, any profits from the resale of the properties will be assessable under section 6-5 of the ITAA 1997 and any losses will be deductible under section 8-1 of the ITAA 1997.

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