Edited version of your written advice

Authorisation Number: 1051392420908

Date of advice: 2 July 2018

Ruling

Subject: Am I in business? capital gains tax - mere realisation - property development – assessable income - profit making undertaking

GST and sale of new residential property as one off transaction

Issue 1

Am I in business? capital gains tax - mere realisation - property development – assessable income - profit making undertaking

Question 1

Will the profit from the sale of the property be as assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Issue 2

GST and sale of new residential property as one off transaction

Question 1

Is the sale of new residential property subject to Goods Services Tax (GST)?

Answer

Yes

This ruling applies for the following period:

Income year ended 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

You are 79 years old and are currently retired. You do minor repair and maintenance work under your ABN. You are registered for GST.

You purchased the property prior to 1985 for approximately XX pounds.

The property was zoned as residential at the time you purchased it. You are not aware of any changes to zoning of the property.

At the time you acquired the property, you were working on the railways as an employee.

You were not carrying on a business at the time you acquired the property.

You purchased the property with the intention of building your main residence. Footings were put in place for construction of the dwelling, however there was no road access to the property at that time and the project was abandoned.

You also owned the vacant block next to the property. You sold this block in 20xx as vacant land. The sale of this block took two years.

Due to slow moving land sales you were advised by a local real estate agent to build a dwelling on the property and market it for sale.

Prior to construction of the dwelling, the property was valued at approximately $XXX to $XXX.

In 20xx you entered into a contract with a builder to construct a residence on the property.

The contract for construction of the premises was $XXX including GST.

You also spent approximately $XX for construction of the driveway, landscaping and provision of services to the property.

Construction was completed in November 20xx. The external landscaping was completed in 20xx.

You did not undertake any of the construction work yourself. However, you did undertake some minimal landscaping activities.

You did not acquire any other land in relation to the development.

The property will be marketed and sold by a real estate agent.

The property is currently listed for sale for offers between $XXX and $XXX.

The property has never been occupied.

You funded construction of the premises with a $XXX interest only loan. You obtained an additional loan of $XX. You also withdrew funds from superannuation to fund the construction.

You stated in your application for private ruling that construction was only done to preserve the value of the land with no intention to make additional profit from the residential building.

Information provided with your application states that did not prepare any documents such as cash-flow or budgets in relation to the project because you had ‘no business intentions’.

You have not claimed the costs of holding the property or construction of the dwelling as tax deductions.

Other construction projects and property related transactions you have been involved with include:

● sale of vacant land adjacent to the property in 20xx.

● construction of premises on land in 20xx. This property is currently rented out.

● construction of premises on land in 20xx. This property is currently rented out.

● construction of a unit in 19xx. The unit is currently rented out.

● you built 5 other units and sold them in the period from 19xx to 19xx.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 section 9-5

A New Tax System (Goods and Services Tax) Act 1999 section 9-20

A New Tax System (Goods and Services Tax) Act 1999 Division 75

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Question 1

Will the profit from the sale of the property be as assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Summary

The sale of the property will not be a mere realisation of a capital asset. We do not consider that you are carrying on a business of property development, however, the nature of the activity indicates that the transaction is of a commercial nature.

Accordingly, profit from the sale will be assessable as income under section 6-5 of the ITAA 1997.

Detailed reasoning

Profits from a land subdivision can be treated in at least three ways for taxation purposes:

(1) As ordinary income under section 6-5 of the ITAA 1997, 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 1997, as a result of an isolated commercial transaction entered into by a non-business taxpayer or outside the ordinary course of business of a taxpayer carrying on a business.

(3) As capital gains under Part 3-1 and Part 3-3 of the ITAA 1997, from the mere realisation of a capital asset.

Business

‘Business’ is defined in the ITAA 1997 any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

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.

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

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.

At paragraphs 56 and 57, TR 92/3 explains that a profit is income where it is made in any of the following situations:

● a taxpayer acquires property with a purpose of making a profit by whichever means prove most suitable and a profit is later obtained by any means which implements the initial profit-making purpose; or

● a taxpayer acquires property contemplating a number of different methods of making a profit and uses one of those methods in making a profit; or

● a taxpayer enters into a transaction or operation with a purpose of making a profit by one particular means but actually obtains the profit by a different means.

Paragraph 42 of TR 92/3 provides that if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either:

● as the capital of a business; or

● 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 or a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income although the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

In determining whether an isolated transaction amounts to a business operation or commercial transaction the following factors are relevant:

● 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 that property. 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

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

Capital gains tax – mere realisation

The mere realisation of a capital asset was described in Commissioner of Taxes v Melbourne Trust Limited [1914] AC 1001 (Melbourne Trust) as “liquidating or realising the old assets”.

In the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135, at 97 ATC 5152 (Casimaty), Ryan J described a salient characteristic of the mere realisation of land as follows:

… [to not] undertake any works on, or development of, the land beyond what was necessary to secure the approval by the municipal authorities of the successive plans of subdivision and enhance the presentation of individual allotments for sale as vacant blocks.

In distinguishing mere realisation from a commercial transaction, Justice Ryan further said:

Had he constructed dwelling houses, internal fencing or other improvements, it would have been easier to impute to him an intention to carry on a business of land development and improvement.

In circumstances where you acquire land before 20 September 1985, and a dwelling is constructed on the land after that date, the dwelling is considered to be a separate asset for capital gains tax (CGT) purposes. That is, the land will remain a pre-CGT asset and the dwelling will be a post CGT asset.

Application to your circumstances

Mere realisation

In your case, you purchased the land prior to the start of CGT with the intention of building your main residence. However you did not actually build a dwelling on the property until 20xx and you have never lived in the property.

The dwelling constructed on the property in 20xx will be a separate, post CGT asset for capital gains tax purposes.

The fact that you have opted to go to the time and expense of constructing a dwelling on the property for the purpose of sale indicates that there is something more involved in the transaction than merely “liquidating or realising the old assets” in line with the decision in Melbourne Trust.

As stated by the Court in the case of Casimaty, the construction of a dwelling, internal fencing or other improvements on land lends weight to an intention to carry on a business of land development and improvement, rather than the mere realisation of an asset.

It is not accepted that the construction of the dwelling was merely to ‘preserve the value of the land’, given it is rarely the case that land decreases in value, without some other factor which impacts on the value of the land.

Further, it is likely that you would still have realised a substantial gain if the property had been sold as vacant land.

Therefore, we do not consider the sale of the property to be the mere realisation of a capital asset.

Business

In your case, while it is clear that there has been some repetition of your activities in constructing dwellings, either for sale or for the purpose of renting out, your activity lacks other factors which would indicate that you are in the business of property development, such as:

● regularity. You have completed other building projects on land which you own, but you do not appear to be undertaking these projects on a regular basis

● size and scale. In your case, you have constructed one building for the purpose of sale. You have not advised if you intend to repeat this activity in the future (your response to request for information provided details of past projects undertaken by you but no reference to future projects)

● your level of personal involvement in the project. In your case, you have undertaken minor landscaping works, with the vast majority of the construction and landscaping undertaken by contractors and the property being marketed by a real estate agent

● an intention to engage in business. Your application states that you did not undertake financial analysis or claim costs of owning or building the property as tax deductions ‘due principally to the intention of the taxpayer’ and that you did not create any business documents such as cash flow projections or budgets, because you had no intention of engaging in business.

● indications that the activity is carried on in a manner which is similar to other businesses in the same industry, such as keeping business records or financial projections in relation to the project or the development of a business plan. In your case, you are not conducting your activity in a manner that we would consider to be similar to other property development businesses.

Therefore, we do not consider that you are carrying on a business of property development.

Commercial transaction

We consider that your construction of a dwelling on the property for the purpose of sale indicates that the property has been ventured into a commercial transaction.

This is evidenced by the following factors:

● the complexity of the project. Building a dwelling and associated landscaping is a far more complex undertaking than merely placing the property on the market for sale.

● the fact that you sold a vacant block located adjacent to the property in the year before deciding to construct the dwelling. While you did experience some delay in selling the other property you eventually achieved success in selling the vacant lot in the same vicinity, within a reasonably close period of time, such that it could be assumed that you would be successful in marketing this property as a vacant block (albeit the sale may occur within a longer timeframe than desired)

● your previous experience in constructing dwellings, for the purpose of sale or the generation of rental income. Most notably, the construction and sale of 5 units between 19xx and 19xx

● the substantial expenditure you have incurred in order to construct the dwelling (plus associated landscaping and services)

● the manner in which the project has been funded, including a substantial ‘interest only’ loan and access to superannuation funds

● the fact that the property has been placed on the market for sale as soon as construction was completed indicates that there is no other purpose that the property has been constructed for, other than as the object of trade, which supports a finding that the transaction is commercial in nature.

As indicated in TR 92/3, where an asset which was originally purchased for personal enjoyment is later ventured into a commercial or business transaction, profit from the sale of the asset will be assessable as income, rather than as a capital gain. This is the case even where the asset is a pre CGT asset for capital gains tax purposes.

Conclusion

The sale of the property will not be a mere realisation of a capital asset. We do not consider you to be carrying on a business of property development, however, the construction of the dwelling and sale of the property is considered to be a commercial transaction. The proceeds of the sale are therefore assessable as ordinary income.

Issue 2

GST and sale of new residential property as one off transaction

Question 1

Is the sale of new residential property subject to Goods Services Tax (GST)?

Detailed reasoning

You are liable to remit GST on any taxable supplies you make.

Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that you make a taxable supply if you make the supply for consideration; the supply is made in the course or furtherance of an enterprise that you carry on; the supply is connected with the Indirect Tax Zone and you are registered or required to be registered.

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed.

The supply of new residential property is not GST-free or input taxed under any provision of the GST Act.

In this case, when the taxpayer sells the new residential property they will be making the supply for consideration and the supply is connected with the Indirect Tax Zone and he is registered for GST. However, it is necessary to ascertain whether the supply will be made in the course or furtherance of an enterprise that the taxpayer carries on.

Carrying on an enterprise

Enterprise is defined in subsection 9-20(1) of the GST Act, which states:

An enterprise is an activity, or series of activities, done;

(a) in the form of a business; or

(b) in the form of an adventure or concern in the nature of trade; or

(c) on a regular or continuous basis, in the form of a lease, licence or other grant of an interest in property; or

(d) ………………

Miscellaneous Taxation Ruling MT 2006/1: The New Tax System: the meaning of an entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number (MT 2006/1) provides guidance on the meaning of ‘entity’ and ‘enterprise’ for the purposes of the A New Tax System (Australian Business Number) Act 1999 (ABN Act).

Goods and Services Tax Determination GSTD 2006/6 provides that the principles in MT 2006/1 have equal application to the meaning of ‘entity’ and ‘enterprise’ for the purposes of the GST Act.

The taxpayer has previously been engaged in property development activities as he has developed two residential properties for leasing purposes since 20xx. An adventure or concern in the nature of trade includes an isolated or one-off transaction that does not amount to a business but which has the characteristics of a business deal. It should be determined whether the development activities carried out by the taxpayer in relation to the property in question is an isolated or one-off transaction.

Isolated transactions and sales of real property

Paragraphs 262-302 of MT 2006/1 refer to isolated transactions and sales of real property. Paragraphs 262 and 263 of MT 2006/1 state:

262. The question of whether an entity is carrying on an enterprise often arises where there are ‘one-off’ or isolated real property transactions.

263. The issue to be decided is whether the activities are an enterprise in that they are of a revenue nature as they are considered to be activities of carrying on a business or an adventure or concern in the nature of trade (profit making undertaking or scheme) as opposed to the mere realisation of a capital asset.

Paragraphs 264 and 265 of MT 2006/1 refer to factors that indicate whether the activities undertaken are an adventure or concern in the nature of trade and state:

264. The cases of Statham & Anor v. Federal Commissioner of Taxation (Statham) and Casimaty V.FC of T (Casimaty) provide some guidance on when activities to subdivide land amount to a business or a profit-making undertaking or scheme. In these cases, farm land was subdivided and sold. Minimal development work was undertaken to meet council requirements and to improve the presentation of certain allotments. On the particular facts of these cases the courts held that the sales were a mere realisation of a capital asset.

265. From the Statham and Casimaty cases a list of factors can be ascertained that provide assistance in determining whether activities are a business or an adventure or concern in the nature of trade……….If several of these factors are present, it may be an indication that a business or an adventure or concern in the of trade is being carried on. These factors are as follow:

● 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 applying the above factors to the property development activities carried on by the taxpayer, we note the following:

There is a change of purpose for which the land is held

The taxpayer acquired the vacant land XX years ago and has now decided to construct a new residential property for sale. The taxpayer also sold another land adjacent to the property in question.

We are of the view that there has been a change of purpose for which the land is held when the taxpayer decided to construct a new residential property on the vacant land for sale.

Borrowed funds financed the acquisition or subdivision;

The taxpayer has obtained loan facilities to finance the construction of the new residential property and other development activities. They have also used funds from his superannuation.

The funds obtained to finance the property development indicate that a substantial amount has been expended on the construction of the new residential property for sale. The borrowing of funds to finance the construction is relevant to consider whether the activities have a commercial flavour and the nature of the asset changes to one of trade.

There is a level of development of the land beyond that necessary to secure council approval and buildings have been erected on the land

Improving a property beyond preparing an asset for sale, to bring it into a more marketable condition and gain a better price suggests an element of trade and demonstrates that the transaction has been undertaken in a commercial manner with an intention to profit from the sale of the residential property.

The taxpayer has obtained advice from the local real estate agent on how to maximise the profit from the sale of the property. Building a residential property on the land is a clear indication of an anticipated profit from the sale of the property.

Therefore, the taxpayer’s activities in respect of the construction of residential building on the land have been planned and carried out in a businesslike manner and there is a coherent plan for the property development.

Furthermore, the taxpayer has been engaged in a number of property development activities in the past as he has built residential properties for either lease or sale.

To recapitulate, paragraph 265 of MT 2006/1 provides a list of factors to determine whether activities are a business or an adventure or concern in the nature of trade. Paragraph 265 of MT 2006/1 further mentions that if several of these 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.

Moreover, no single factor will be determinative; it will be a combination of factors that will lead to a conclusion as to the characters of the activities. Whilst each case is affected by its own particular facts, the determination of whether an enterprise exists for GST purposes is generally the result of a process of weighing all the relevant indicators.

Paragraph 266 of MT 2006/1 states:

266. 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.

In applying the above principles mentioned in MT 2006/1 and based on the facts provided it is our view that the activities of developing a new residential property for sale would be considered as carrying on an isolated transaction in the form of an adventure or concern in the nature of trade. Therefore, the taxpayer would be selling the property in the course or furtherance of an enterprise that the taxpayer would be carrying on.

Furthermore, the taxpayer has been carrying on an enterprise of renting residential properties and registered for GST. Therefore, the sale of new residential property will be subject to GST and the taxpayer is liable to pay GST to the Australian Taxation Office (ATO) on the sale of this property.

Additional Information

Division 75 of the GST Act grants the option of applying the margin scheme in some circumstances to reduce your GST liability on taxable supplies.

The margin scheme provides some relief in relation to property transactions and allows for a reduced amount of GST to be paid. It applies to the supply of freehold interest in land, strata units and long-term leases, including those held on 1 July 2000.

The margin scheme cannot be used if a property is acquired through a taxable supply where GST was calculated without using the margin scheme.

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