Edited version of your written advice

Authorisation Number: 1013054664615

Date of advice: 26 July 2016

Ruling

Subject: Business - property development - isolated transactions, business or mere realisation

Question 1

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

Answer

No.

This ruling applies for the following periods:

Income year ending 30 June 20YY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You acquired a dwelling (the Property), with settlement taking place during the 20XX financial year.

The sale contract shows that the purchase price of the Property was around $500,000.

The sale contract included the following special conditions, which were initialled by all parties:

6. The owners will rent the property for three (3) months from settlement at $X amount per week

7. This offer is not subject to a final inspection and is being sold as a development block. The owners have the right to remove any fixtures, structures and parts of the house that they choose.

8. this house will not be habitable once the owners move out after renting the property for 3 months and the purchaser is aware of this and will make no claims against the sellers/tenants after the owners move out

The purchase of the Property was funded by a loan from a bank.

The loan application included a question on your financial objectives for seeking credit. The loan applications states that your financial objectives for seeking credit was to 'Increase wealth via a unit development'.

The Property was rented to the vendor for a period after purchase, at the request of the vendor, and in accordance with special condition of the sale contract.

You applied for another amount $X, which was obtained to fund the construction of the units. This loan was used to refinance the balance of your original loan of amount for the construction of units on the Property.

In the loan application, under the section 'description of property offered as security', described Property 2 as '(Inv) to develop and sell'.

Demolition of the dwelling located on the Property began soon afterwards.

You entered into a Cost plus building contract with a builder (the Builder). The stated amount for the building of the units was around $500,000, and excluded landscaping and application fees.

The building contract includes the following special conditions at clause 25. Of particular note is the following clause:

N.B. Owners to choose a settlement agent to apply for the strata titles once they are in order for dealing.

The Builder, was an unrelated third party.

The Property was subdivided into a number of strata titles - (the X Units).

In March 20YY, the construction of the X Units was completed.

They X Units were sold to third parties as newly constructed and unoccupied residential premises as follows.

The proceeds from the sale of the X Units were greater than the associated costs.

During construction you were registered for Goods and Services Tax (GST) and applied the margin scheme to the sale.

You have not previously taken on this kind of development, however your associates did acquire a block of land. A residential dwelling was constructed and completed. The property was not held for investment, and was sold with settlement occurring around two years after the purchase.

After the sale of the X Units you acquired a property which is currently tenanted at $X per week.

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

Question 1

Summary

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 X 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

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 of the ITAA 1997, 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 of the ITAA 1997, 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.

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 as established by case law.

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

You purchased the Property as a development site (as stated in the sale contract). The Property purchase price was around $500,000, and further finance was obtained to undertake the activities relating to the demolition of the dwelling, the subdivision of the Property, and the construction of the X Units, bringing your total borrowings to around $X. You subsequently sold the subdivided properties for a profit, which indicates that the activity had a substantial purpose and character.

This is the first time that you have completed a multi-unit development activity, and it is considered this single occasion development does not show the repetition and regularity that would be associated with a property development business. Although your associates did complete a previous single dwelling development, the circumstances are considered to be distinguished enough that this is not considered to be the level of repetition that would indicate that a business was being carried on.

You have conducted your activity of property development in a business-like manner by seeking advice, employing professionals, conducting your activities in a timely manner, registering for GST and lodging activity statements. You also appear to have made a substantial profit in a short period of time (although we do not have a complete account of income and expenses).

Although the size and scale of this activity is substantial, the activity lacks permanence, and was actually concluded with sale of the X Units.

The activity is not better described as a recreational activity.

In the weighing up of the facts, the overall impression gained is that your activity of property development would not be considered to be a business.

Although your activity does show some indicators that a business was being carried on, the lack of repetition and regularity, along with the lack of permanence of the activity does not support that a business of property development was carried on.

Question 2

Summary

As you had a significant intention to sell the X Units and make a profit, the proceeds will be assessable as ordinary income from an isolated profit making transaction. Accordingly, the proceeds of the sale of the X Units are not viewed as a mere realisation of a capital asset.

Detailed reasoning

Isolated profit making transaction

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 (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium). 

Taxation Ruling TR 92/3 considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income.

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.

The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property.

Intention

The relevant intention or purpose of the taxpayer (of making a profit or gain) is not the subjective intention. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case. 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.

The case of McCurry and Anor Vs the FC of T 1998 ATC 4487 (McCurry) is relevant. The judge found that the actions of the taxpayer should be used as a guide to their intentions, and that their actions indicated there was always an intention to sell at a profit:

"That which a person does is a guide to that which he had in mind to do. There are three particular facts from which I draw an inference that the predominant factor influencing the taxpayers in their project was that of making a profit… most of the moneys were borrowed moneys … it was likely that, at some stage, the property would have to be sold to repay to the Bank … the units were first put on the market shortly prior to their completion, the intention being to realise the profit which had been foreseen …. no step whatever was taken to secure tenants for the property."

Application of the law to your facts

In your case, you purchased the Property, which had an existing dwelling located on it, knowing at the time of purchase that the dwelling was uninhabitable. The sale contract for the Property makes it clear that it was not in contemplation at the time of purchase that the dwelling would be able to be used as a rental property after the vendors vacated the dwelling.

After the vendors vacated the Property, the demolition of the dwelling commenced in a shortly after, followed by the obtaining of further finance for construction of the X Units and signing of a building contract for the construction of the X Units.

As soon as the dwelling became vacant you took steps to undertake the demolition of the dwelling, subdivision and the building of the X Units, and very early in this process you formed the intention to sell the units on completion.

While you state you originally entered into the purchase of the Property for the purpose of earning rental income, your actions indicate that the intention to engage in demolition, subdivision and sale became a significant purpose within a short period of time, and in actual fact the long term rental of the dwelling located on the Property at the time of purchase was not feasible.

The project was been carried out over a short period of time, with the purchase, subdivision, construction, and sale of the X Units being completed in a year and a half. This was a coherent plan of construction and subdivision. The manner in which the project was entered into and carried out has the nature of a commercial transaction. The development of the X Units is not a simple and uninvolved development and your actions demonstrate that the development and sale of the units was undertaken with a view to profit.

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 purchase the Property and build the X Units was for the purpose of making a profit or gain from their sale from an isolated transaction. Therefore, the proceeds from the sale of the units will assessable under section 6-5 of the ITAA 1997 as ordinary income from an isolated profit making transaction.

Question 3

Summary

Although capital gains tax (CGT) event A1 will happen when you dispose of the X Units, anti-overlap provisions apply to reduce the capital gain by the amount already included in your return under section 6-5 of the ITAA 1997.

Detailed reasoning

Capital gains tax

The 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 of the ITAA 1997 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 of the ITAA 1997 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 92/3, it is the Commissioner's view that the sale of the units is not a mere realisation of capital assets.

Accordingly, while CGT event A1 under section 104-10 will occur on the disposal of the X Units, the disposal will be viewed as an isolated transaction, and any capital gain arising from the disposal will be reduced to the extent that the profit from the sale of the X Units is included in your assessable income under section 6-5 of the ITAA 1997.

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