Edited version of your written advice

Authorisation Number: 1051293234482

Date of advice: 11 October 2017

Ruling

Subject: Property Subdivision - Revenue or Capital

Question 1

Will any gain or loss you make on the sale of the units be taxable under the capital gains tax provisions?

Answer

Yes

This ruling applies for the following periods:

1 July 2013 to 30 June 2014

1 July 2014 to 30 June 2015

1 July 2015 to 30 June 2016

1 July 2016 to 30 June 2017

The scheme commences on:

1 July 2013

Relevant facts and circumstances

Taxpayer One and Taxpayer Two (the Taxpayers) purchased a house and land at a location after 20 September 1985. The property was purchased as joint tenants. The house was the Taxpayers main residence from the date of purchase.

Some years later, the Taxpayers began to investigate selling the house and purchasing a smaller single level home without steps or stairs in the area, due to their advancing years.

The Taxpayers did not find a suitable property, and decided to build a smaller single level residence on the land of their current residence.

The Taxpayers approached their neighbour, a local builder (the Builder), with the intention that the Builder would build the Taxpayers a new unit and buy the remaining land. The Builder would only agree to build a new unit for the Taxpayers if they would also agree to finance the Builder to build three more units on the remaining land and then sell them to the Builder’s relatives (the Buyers).

The Builder is not related to the Taxpayers.

The Taxpayers entered into a contract the Builder’s company (the Company). Under the agreement, the Company would (a) Construct a single level townhouse (Unit Four) in the backyard of the property, (b) Demolish the old residence at the property, (c) Construct three new units (Units One, Two and Three) on the vacant land and (d) assist in having the land subdivided into four lots.

The Taxpayers agreed to finance the project, pay all costs related to the building and demolition, including a builder’s margin of 20% and to sell units One, Two and Three to the Builder’s relatives. The Company would pay a notional interest at 7% on the money used to fund the construction into the final sale price.

The agreement used a value for the land (based on recent land sales) and allocated it between the proposed subdivided blocks as:

The Taxpayers signed contracts to sell the three new units “off the plan” to the Buyer’s relatives.

Construction of Unit Four began and an occupancy permit was issued.

The old house was demolished and the construction of units One, Two and Three began after this point. The construction of the units was then completed.

Subsequent to this, Taxpayer Two passed away. Some construction costs were incurred after their death.

The subdivision of the property was completed.

At a specified point in time, the final selling price of the units was determined. Deeds of variation were drawn up. The final price was the cost of construction, plus the 20% builder’s margin, including GST plus 7% interest on the money.

The sale of two of the units settled on a specified date, while the third one settled on a different date.

An independent retrospective valuation of the land was undertaken, providing a value and apportioning it between the house at 21% of the value and the land at 79%.

Neither Taxpayer One nor Taxpayer Two have ever been involved in property development or any building venture prior to the current scheme. The Taxpayers involvement with the development was limited to paying the invoices issued by contractors and the Company.

The project was financed from the Taxpayers personal funds. There were no borrowings involved.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Part 3-1

Reasons for decision

Summary

The gains the Taxpayers make on the sale of the units will be taxable under the capital gains tax provisions. There was no profit making intent in the scheme and the building and sales represent a realisation of a capital asset while retaining the Taxpayers main residence.

Detailed reasoning

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, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock;

2. As ordinary income under section 6-5 of the ITAA, on revenue account, as a result of entering into a profit-making undertaking or scheme;

3. As statutory income under the capital gains tax legislation.

Carrying on a business of property development

Taxation Ruling TR 97/11 is about carrying on a business. Whether an entity is carrying on a business has been considered extensively by the courts, using the following indicators:

1. the nature of the activities, particularly whether they have the purpose of profit making;

2. the repetition and regularity of the activities;

3. organisation in a businesslike manner, including 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;

4. the volume of the operations; and

5. the amount of capital employed.

In deciding whether a person is carrying on a business, the above indicators are weighed up. However equal weighting may not be given to each indicator. The indictors that carry the strongest weighting are repetition and regularity of activities, organisation in a businesslike manner and volume of operations.

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.

'Isolated transactions' refers to:

● those transactions outside the ordinary course of business of a taxpayer carrying on a business; and

● those transactions entered into by non-business taxpayers.

Whether a profit from an isolated transaction is income according to the ordinary concepts and usages of mankind depends very much on the circumstances of the case. However, where a taxpayer who does not carry on a business makes a profit from an isolated transaction, that profit is income if:

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

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

Intention

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.

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 taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. Where a transaction 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 land or property.

Carrying out a commercial transaction

Paragraph 13 of TR 92/3 lists factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction. Relevant factors include:

● 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;

● if the transaction involves the acquisition and disposal of property, the nature of that property; and

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

In addition to the above factors, for the purposes of determining whether the activities undertaken in relation to real property and development equate to a profit-making undertaking or scheme, Miscellaneous Taxation Ruling MT 2006/1 aligns itself with TR 92/3 and provides a list of factors which, if present may be an indication that a business or profit-making undertaking or scheme is being carried on. Relevant factors include:

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

● there is a coherent plan for the subdivision of the land; and

● there is a level of development of the land beyond that necessary to secure council approval for the subdivision.

No single factor is determinative rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

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. Where an amount is included in your income as ordinary income, it will not also be treated as a capital gain.

Application of the law to your facts

The Taxpayers purchased the house and land with the intent of it using it as their main residence, and it was their main residence for more than nearly thirty years. Following the demolition of the old house and the building of the new units, Unit Four became the Taxpayers main residence. At all times the Taxpayers have held the land with the intention of living on it.

The scheme of demolish, build and sell the additional units was a way for the Taxpayers to build a new dwelling suitable for an older people to live in, while not moving away from the area that had been the Taxpayers home for the nearly thirty years. By conducting the development in this fashion the Taxpayers were able to retain ownership of the new townhouse while realising the increase in the capital value of the remaining land.

There is little about the nature of the contract the Taxpayers entered into with the Company that would suggest a profit motive to the scheme. The Taxpayers gain on the sale of Units One, Two and Three was limited to unlocking the increase in the capital value of the land at the time the contract was entered into, and the notional seven percent interest for the use of the Taxpayers funds over the period the building was happening.

The Taxpayers sought no legal or accounting advice before entering into the agreement and did not structure it in a businesslike fashion. Generally the Taxpayers relied on the personal nature of their relationship with the Builder in engaging them as builder and relying on their advice.

The development was carried out on a small scale, and a sizeable portion of the spending related to building the Taxpayers own new townhouse. Little of the Taxpayers behaviour could be characterised as businesslike, and the drawn out timing of the scheme is not indicative of a profit motive.

Consequently the Taxpayers did not engage in a profit making undertaking. Any gain that the Taxpayers make on the sale after subtracting their costs will be taxable as a capital gain, and eligible for the 50% discount.

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