Edited version of your written advice

Authorisation Number: 1013043257048

Date of advice: 29 June 2016

Ruling

Subject: Property - development - Am I in business? - isolated transaction

Question 1:

Will the profit from the sale of the units 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 the units 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 gain made on the disposal of the units be assessable under Parts 3-1 or 3-3 of the ITAA 1997?

Answer:

Yes. However, section 118-20 of the ITAA 1997 will apply to reduce the capital gain to the extent that the profit from the sale of the units is otherwise included as assessable income under section 6-5 of the ITAA 1997.

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 2016.

Relevant facts and circumstances

You purchased the property (the Property) after 20 September 1985. A house is located on the Property.

The Property was rented out shortly after settlement occurred and continued to be rented out until the present time, with the exception of a short period between tenants.

The zoning of the Property at the time it was purchased allowed for one dwelling to be built on the Property.

You purchased the Property for it to be a long-term hold with a view that your family would move into it at a later date.

The local Council proposed the amendment of the rezoning of the area in which the Property is located to provide residential development potential without the requirement for an overarching Structure Plan.

The zoning amendment was approved and as a result the zoning of the Property changed to R80/100 which allowed high density multiple dwellings to be constructed on the Property.

As a result of the rezoning, you now have the opportunity to construct multiple dwellings on the Property and intend demolishing the existing house on the Property, constructing units on the Property, and selling some of them to fund your retirement (the Project).

Subject to approval, you intend constructing sole occupancy units of which you will sell one unit every year for a number of years (the Sale Units), with any constructed unit/s being rented out after they are constructed until they are sold. You will keep the remaining units as long-term rental properties. The Property will be a built-strata subdivision.

At present, you intend selling some of the units and keeping some of the units, but that will be dependent on the market.

You have not lodged any applications or permits at this point, but anticipate lodging the relevant applications/permits within the next two months.

You have engaged the services of a Construction Company and Surveyors to complete the Design Approval.

The market value of the Property prior to the development activities is $xxx,xxx.

It is estimated that the costs involved with the construction of the units will be $x,xxx,xxx.

You will fund the activities with equity from you home through a bank loan.

It is estimated that the sale price of the units will be $xxx,xxx per unit.

You will engage the services of a real estate/s to sell the sale units.

You purchased a property and many years later you demolished the existing house and constructed two town houses which you rent out and still own.

You will not undertake any similar activities similar to the current construction and sale of the sale units in the future.

For the purposes of this ruling the following will occur:

• You will demolish the existing house on the Property

• You will engage the services of others to undertake the activities related to the Project

• You will engage the services of real estate agent/s to sell some of the units

• You will keep some of the units for long term rental purposes; and

• You have not undertaken any similar activities in the past and have no intention to undertake any similar activities 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 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

Summary

You are not carrying on a business of property development because your activities do not display the salient indicator of a business, which are transactions entered into on a continuous and repetitive basis. However, any profit or loss from the sale of the units will still be accounted for on revenue account as an isolated commercial transaction because you are constructing the units for the primary purpose of making a profit on their sale.

Detailed reasoning

Legislative references referred to herein are from the 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 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.

Application to your situation

You purchased the Property with the intention of keeping it for long-term hold with the view of it becoming your family home. The Property was rented out shortly after settlement occurred and has continued to be rented out, with the exception of a short period of time between tenants.

The area in which the Property is located has been rezoned and you intend demolishing the existing house on the Property and constructing units on the Property, some of which you will sell and others you will keep for long-term rental.

We will consider each of the ways you can make a profit as outlined above in relation to the gain made on the sale of the units 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 with the intention that it would be your family's main residence. However, the Property has been used as a rental property.

You now intend demolishing the existing house and constructing units on the Property for the purpose of keeping some of the units and selling some of the completed units, the Project. The units and the subdivision of the Property will occur under a Strata subdivision.

You will engage the services of other parties in relation to the Project.

You have previously purchased a dwelling, which you demolished and constructed townhouses in its place which you have used for long-term rental income and still own. You do not have any intention to undertake any similar activities in the future.

After reviewing the information and documentation provided, it is the Commissioner's view that the activities involved with the Project are not those of an entity carrying on a business of developing property. Also, there is nothing to suggest that the undertaking of the activities in relation to the Project was the beginning of a continuing business of property development.

The activities undertaken in relation to the Project 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 will be undertaken by another party/ies 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 the units 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.

Miscellaneous Taxation Ruling MT 2006/1 provides a list of specific factors relevant to isolated transactions and sales of real property. If several of the factors are present, it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows:

• there is a change of purpose for which the land is held;

• additional land is acquired to be added to the original parcel of land;

• the parcel of land is brought into account as a business asset;

• there is a coherent plan for the subdivision of the land;

• there is a business organisation - for example a manager, office and letterhead;

• borrowed funds financed the acquisition or subdivision;

• interest on money borrowed to defray subdivisional costs was claimed as a business expense;

• there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and

• buildings have been erected on the land.

In determining whether activities relating to isolated transactions are an enterprise or are the mere realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. This may require a consideration of the factors outlined above; however there may also be other relevant factors that need to be weighed up as part of the process of reaching an overall conclusion. No single factor will be determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

Application to your situation

While it had been your intention to move your family into the Property, it had been used for rental purposes. Your intention in relation to the Property has changed from it being used for passive rental purposes with the intended demolition of the existing house and the construction of the units for multiple purposes, being private in relation to the units you will keep for long-term rental and profit making in relation to the units you will sell (the Sale Units).

The construction of the Sale Units will not be undertaken for the purpose of private or rental purposes, but solely for the purpose of sale. Although your initial intention when you acquired the Property may have been for private purposes, as outlined in paragraph 42 of TR 92/3, when a taxpayer's intention in relation to an asset changed and the taxpayer decides to venture into a profit-making scheme with the characteristics of a commercial transaction, the activity of the taxpayer will constitute the carrying out of a profit-making scheme.

The estimated market value of the Property prior to the Project is $xxx,xxx. The costs involved with the construction of the units will be $x,xxx,xxx. It is estimated that the Sale Units will be sold for $xxx,xxx each.

The undertaking of the Project will significantly improve the Property, increasing its value to a combined value of the units which would be significantly higher than the value of the Property prior to the Project being undertaken.

There is a coherent plan of subdivision and a demonstrated intention to profit as you are constructing the units with the intention of selling the Sale Units specifically for the purpose of making a profit.

The manner in which the Project has been entered into and will be carried out on your behalf has the nature of a commercial transaction. The development of the units is not a simple and uninvolved development and your actions demonstrate that the development and sale of the Sale Units will be undertaken on the basis that it will be profitable and that a gain will be made on the disposal of the Sale Units.

The purpose of the Project was to enable you to sell some of the Units to fund your retirement. Given the nature and scale of what you will be doing, you will be carrying out a profit making scheme, whether you intend to be or not.

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 objective evidence sourced from the information and documentation provided establishes that your intention in entering into the transaction to build the Sale Units will be for the purpose of making a profit or gain from their sale from an isolated transaction. Accordingly, the proceeds from the sale of the Sale units will be assessable as ordinary income under section 6-5 and not as statutory income under the capital gains tax provisions.

You did not acquire the property for resale at a profit. However, you are now venturing into a profit making scheme. Your purpose in carrying out the Project is to enable you to sell some of the units to use for your retirement.

If you had sold the property as it is, any gain would be a mere realisation. However, in your case you are going beyond what is required to merely realise the value of the Property. In particular:

• You would be able to sell the Property for a profit without undertaking the Project

• The construction of the units will enhance the value of the Property

• You have approached the Project in a businesslike way; and

• You intend to make a profit from the sale of the Sale Units.

Accordingly, the Project will have the characteristics of a commercial transaction. As you will be carrying out an isolated commercial transaction with a view to a profit, the profit made will be ordinary income under section 6-5 of the ITAA 1997.

Note: As some of the units will be kept as long-term rentals, they will be capital in nature. Any gain made on their disposal will be determined in accordance with the general taxation provisions.

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.

You make a capital gain or loss as a result of a CGT event happening to a CGT asset. CGT assets include real estate acquired on or after 20 September 1985.

You make a capital gain if the capital proceeds from the sale of a CGT asset are greater than the cost base of that asset, for example, if you receive more for an asset than you paid for it.  

You make a capital loss if the reduced cost base of an asset is greater than the capital proceeds resulting from the sale of the asset, for example, if you receive less for an asset than you paid for it.

Where an asset is split into 2 or more assets, and you are the owner of both the original asset and the 'new' asset or assets, section 112-25 provides that the split is not a CGT event and the cost base is apportioned to each 'new' asset in a reasonable way.

The inclusion of the profit or gain on the sale of a CGT asset as ordinary income does not mean that a CGT event does not happen in relation to the asset. However, section 118-20 of the ITAA 1997 operates to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. Therefore, while a CGT event will occur when an asset is sold (CGT event A1), any capital gain will be reduced by the amount included as ordinary assessable income under section 6-5 of the ITAA 1997.

Application to your situation

In your case, no CGT event will occur when the Property is subdivided and all of the subdivided lots will be treated for CGT purposes as if they had both been acquired when the Property was acquired, in 20yy.

Making an overall assessment on the factors set out in TR 92/3, it is the Commissioner's view that the sale of the Sale Units will not be a mere realisation of a capital asset.

Therefore, as the disposal of the Sale Units is viewed as an isolated transaction, any profit made on its sale will be included in your assessable income under section 6-5.

CGT event A1 will occur on the sale of the Sale Units. However, any capital gain made on the disposal of the Sale Units will be reduced to the extent that the profit from the sale of the units is included in your assessable income under section 6-5.

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