Edited version of your written advice

Authorisation Number: 1012974066883

Date of advice: 23 February 2016

Ruling

Subject: Am I in business? - subdivision - property development - trading stock

Question 1:

Will the profit from the sale of units B and C be treated as ordinary income under section 6 -5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of the taxpayer carrying on a business of property development?

Answer:

No.

Question 2:

Will the profit from the sale of units B and C be treated as ordinary income under section 6-5 ITAA 1997 as a result of an "isolated transaction" carried out for profit and commercial in character?

Answer:

Yes.

Question 3:

Will the profit from the sale of units B and C be treated as statutory income under the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997?

Answer:

No.

Question 4:

Will units B and C be treated as trading stock under section 70-10 of the ITAA1997?

Answer:

No.

This ruling applies for the following periods

Income year ending 30 June 2016

Income year ending 30 June 2017

Income year ending 30 June 2018; and

Income year ending 30 June 2019

The scheme commences on

1 July 2015.

Relevant facts and circumstances

Documentation has been provided with the private ruling which should be read in conjunction with and forms part of the scheme of this decision.

Mr and Mrs A are the Directors of a company (the Company).

The Company is the Trustee of a trust (the Trust).

The Directors of the Company created the Trust with a view to eventually create further income to supplement their superannuation for retirement.

The Trustee purchased the property (the Property) with the contract of purchase being signed after 20 September 1985. A dwelling was located on the Property.

The Trustee's intention when the Property was purchased was to subdivide the Property and build a number of units.

The Property was leased around four months after settlement occurred, for a period of around five months.

A development application was lodged with the council around five months after the Property had been purchased in relation to the building of a number of grouped dwellings on the Property.

Approval for the development of the Property was granted around four months after the lodgement of the development application, which outlined the address of the units, being Units A, B and C.

The Trustee applied for the funding for the development of the Property, with the Directors going guarantors on the loan. The Property and the Director's private residence were used as security for the loan.

The original dwelling on the Property was rented out until finance for the construction of the units was approved, and it was then demolished.

The Trustee engaged the services of a project builder to undertake the necessary activities to build the units on the Property.

Upon commencement of construction of the units, the Trustee decided to rent out unit A and sell units B and C on the completion of the construction of the units.

Listing agreements were entered into with a real estate agent to sell units B and C prior to the completion of the construction of the units.

The construction of the units was completed around two years after the Property had been purchased, and unit A was rented out.

The cost for the acquisition and development of the property and the construction of the units was over $1,000,000.

Units B and C were put on the market for sale during the following month.

Extensions to the listing agreements for units B and C for additional listing periods were signed around three months after the original listing agreements had been signed.

An extension to the listing agreement for unit C for an additional listing period was signed around three months later.

The Directors decided to reduce the asking price for unit B, but continued to receive little interest from potential purchasers for the unit.

The Trustee received an offer for unit C around one month after the unit had been put on the market.

Around three months after the units had been listed, the Trustee decided to advertise unit B for rent as the Trust could not maintain the vacant properties for an extended period of time

Around one month after the offer on unit C had been received, a variation of the contract for the sale of unit C was signed by the Trustee and the potential purchasers of unit C to allow an extension of time for around 30 days. The varied sale contract expired because the potential purchasers failed to sell their property.

After the failed sale of unit C, a decision was made by the Trustee to reduce the asking price of unit C and to continue to actively advertise the unit for sale. However, no further offers were received.

Around four months after the units were listed, the Trustee received an application for rent for unit B and the unit was taken off the market.

The marketing for sale of unit C ended around eight months after the units had been listed on the market.

At present, both unit B and C are leased for between six and 12 months.

All of the units are being rented through the same real estate agent.

It is the Trustee's intention to retain unit A indefinitely for rental purposes and to sell units B and C when the market conditions improve.

For the purposes of this private ruling, units B and C will be sold within the period covered by this private ruling.

The Company has not undertaken any other activities of a similar nature to the construction of the three units and has no intention to carry out similar property developments in the future.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 70-10

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Legislative references referred to herein are from the Income Tax Assessment Act 1997 (ITAA 1997).

Taxation treatment of property sales

 There are three ways profits from property sales can be treated for taxation purposes:

1. As ordinary income under section 6-5, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock; or

2. As ordinary income under section 6-5, on revenue account, as a result of an isolated business transaction entered into by a non-business taxpayer, or outside the ordinary course of business of a taxpayer carrying on a business, which is the commercial exploitation of an asset acquired for a profit making purpose; or

3. As statutory income under the capital gains tax (CGT) legislation, sections 10-5 and 102-5, on the basis that a mere realisation of a capital asset has occurred.

Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case.

We will consider each of these in relation to your situation as follows:

Carrying on a business of property development 

Section 995 of the ITAA 1997 states the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

To determine whether an activity, or series of activities, amounts to a business, the activity needs to be considered against the indicators of a business established by case law.

In the High Court of Australia case of Hope v. Bathurst City Council (1980) 144 CLR 1; (1980) 29 ALR 577; (1980) 80 ATC 4386; [1980] HCA 16, a business was described in the following ways:

It is the words "carrying on'' which imply the repetition of acts and activities which possess something of a permanent character.

…activities engaged in for the purpose of profit on a continuous and repetitive basis.

Transactions were entered into on a continuous and repetitive basis for the purpose of making a profit…manifested the essential characteristics required of a business.

For a one-off land subdivision to be considered to be of a business or commercial nature, it is usually necessary that a taxpayer has the purpose of profit-making at the time of acquiring the property.

The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 (TR 97/11) which uses the following indicators to determine whether a taxpayer is carrying on a business: 

• 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;

• 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.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

Application to your situation

In this case, the Property was purchased by the Trustee of the Trust with the intention of demolishing the existing dwelling, subdividing it, and building a number of units on it.

After reviewing the information and documentation provided, it is the Commissioner's view that the activities of the Trustee are not those of an entity carrying on a business of developing and selling land.

The activities undertaken do not display the salient indicator of a business, which are transactions entered into on a continuous and repetitive basis. The building of the units was undertaken by builder and the activity is in relation to a relatively small one off project that was not carried on in a manner similar to other property development businesses.

Therefore, any gain made on the disposal of units B and C will not be assessable income under section 6-5 as ordinary income from the carrying on of a business.

Isolated business transactions

Profits from isolated transactions will be assessable as ordinary income where the intention or purpose 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 out a business operation or commercial transaction

Taxation Ruling TR 92/3 (TR 92/3) sets out the Commissioner's view of the general principles and factors that have been considered in determining whether an isolated transaction is of a revenue nature.

Paragraph 1 of TR 92/3 outlines that isolated transactions are:

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.

The ruling outlines at paragraph 6 that whether a profit from an isolated transaction will be ordinary income will depend on the circumstances of the case, however a profit from an isolated transaction will be ordinary income when:

a) the intention or purpose of a 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 operation or commercial transaction.

TR 92/3 outlines that the relevant intention or purpose of the taxpayer, of 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.

If a transaction or operation is outside the ordinary course of a taxpayer's business, the intention or purpose of profit-making must exist in relation to the transaction or operation in question.

The transaction may take place in the course of carrying on a business even if the transaction is outside the ordinary course of the taxpayer's business.

Paragraphs 41 and 42 of the ruling outline that where a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction, the activity of the taxpayer constitutes the carrying on of a business operation or commercial transaction carrying out a profit-making scheme, as the case may be.

 Whether a particular transaction has a business or commercial character depends very much on the circumstances of the case. Paragraph 13 of the ruling outlines the following factors which may be relevant when considering whether an isolated transaction amounts to a business operation or commercial transaction: 

• the nature of the entity undertaking the operation or transaction

• the nature and scale of other activities undertaken by the taxpayer

• the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained

• the nature, scale and complexity of the operation or transaction

• the manner in which the operation or transaction was entered into or carried out

• the nature of any connection between the relevant taxpayer and any other party to the operation or transaction

• if the transaction involves the acquisition and disposal of property, the nature of the property, and

• the timing of the transaction or the various steps in the transaction.

The direction provided within TR 92/3 and the above cases indicates that profits in this context are more likely to be considered ordinary income if they are made in the ordinary course of carrying on a business. Further, ordinary income may be derived from an isolated transaction which becomes commercial in nature, or as a result of profits on a transaction in which the initial intention was to make a profit on sale.

Application to your situation

In this case, it was the Trustee's intention to develop and subdivide the Property and build the units. Upon commencement of construction of the units, the Trustee decided to rent out unit A and sell units B and C on the completion of the construction of the units.

The cost to purchase of the property and construct the units was over $1,000,000.

Based on the information provided, the activity will be an isolated activity and is not one of a series of activities done in the form of a property development business.

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.

The intention in relation to the Property changed when the units were being constructed and it was determined that two of the units would be sold, making the activities a profit making undertaking or scheme. There was a demonstrated intention to profit and the transaction has been undertaken in a commercial manner.

In this case, the Commissioner is satisfied that the proceeds from the sale of units B and C will be those from an isolated transaction as the Trustee is not carrying on a business of property development. The construction work was completed by a builder engaged by the Trustee, the activities lack repetition and regularity of activities of a person conducting a business operation and the activity comprises of only three units.

While units B and C have been taken off the market and are currently being rented out, this would be viewed as an expense mitigation activity. The Trustee's previous intention to sell units B and C still remains even though the units have not been sold due to the market conditions. Therefore, it cannot be viewed that the Trustee has abandoned their intention to sell the units and the Trustee's intention to make a profit on the disposal of the units remains.

Consequently, the proceeds from the sale of units B and C will be a profit from an isolated transaction under the guidelines of TR 92/3 as discussed above, and will be included as ordinary income.

As the income derived is not in the course of carrying on a business of property development and is an isolated profit making undertaking the net profit from the sale of the properties are assessable under section 6-5.

Capital gains tax

The capital gains tax (CGT) provisions are contained in Part 3-1 of the ITAA 1997. Broadly, the provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own.

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

Section 118-20 contains anti-overlap provisions which operate to reduce any capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 of the ITAA 1997 as a result of the sale, for example, as ordinary income under section 6-5 of the ITAA 1997.

Application to your situation

Making an overall assessment on the factors set out in TR 93/2, it is the Commissioner's view that the subdivision, development and sale of units B and C will not be a mere realisation of a capital asset.

Accordingly, whilst CGT event A1 under section 104-10 will occur on the disposal of the units However, as the disposal of the units are viewed as an isolated transaction, any capital gain arising from this CGT event will be reduced to nil as any profit will be assessable under section 6-5.

Trading stock

Section 70-10 defines trading as anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business.

Taxation Determination TD 92/128 states land can only be treated as trading stock if a business of trading in land is actively being carried on. There must be present the continuity of activity which characterises a business.

Taxation Determination TD 92/126 states if, in an isolated commercial transaction, land is acquired for the purpose of development, subdivision and sale, even though net profit made on the sale of the land is assessable as ordinary income, the land is not treated as trading stock because a business of trading in land was not commenced.

TR 92/3 and Taxation Ruling TR 92/4 discuss the tax treatment of 'profits' and 'losses' from isolated transactions. Here, the terms 'profits' and losses' infer the tax treatment of an isolated transaction only occurs on completion of the transaction.

This treatment follows TD 92/126, which states "net profit" made on the sale of the land from an isolated transaction is assessable income and "in calculating the profit on the sale of the land the cost of the land is deducted from the proceeds of sale." This treatment is confirmed in Taxation Ruling TR 2000/8. Paragraph 87 of TR 2000/8 states:

…if an investor's activities amount to an isolated business transaction that is not the carrying on of a business, outgoings are only deductible on completion of the transaction. It is then that the final profit, or loss, is calculated for income tax purposes (see Commercial and General Acceptance Ltd v. FC of T 77 ATC 4375; (1977) 7 ATR 716).

Application to your situation

In this case, it is viewed that a business of property development was not being carried on because the scale of the activities was simply too small for there to be repeated acts of selling.

Accordingly as the activities were part of an isolated transaction, and not as part of carrying on a business, it follows the units were not trading stock.

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