Edited version of your written advice

Authorisation Number: 1051498035285

Date of advice: 25 March 2019

Ruling

Subject: Income tax implications of the demolition and rebuild of apartment building

Question 1

Will the demolition and rebuilding of the site trigger a CGT event for the unit holders?

Answer

Invalid question as a unit holder is not a rulee

Question 2

If the unit holder holds their interest in the original site and the replacement apartments as their main residence will they be able to ignore any capital gain under Division 118 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Invalid question as a unit holder is not a rulee

Question 3

Will the demolition and rebuilding of the site trigger a CGT event for the strata corporation?

Answer

No. A capital gain or loss does not arise until there is a disposal of the property

Question 4

Will the strata corporation be assessable on any capital gain from the disposal of the new apartments?

Answer

No.

Question 5

If so, will these assessable amounts be a receipt on capital account?

Answer

Invalid question as it is not regarding a relevant provision

Question 6

Will there be any other income tax or capital gains tax consequences for the strata corporation?

Answer

Invalid question as it is not regarding a relevant provision

This ruling applies for the following periods:

Financial year ending 30 June 2019

Financial year ending 30 June 2020

The scheme commences on:

XXX 2019

Relevant facts and circumstances

The strata corporation owns the property that consists of a strata-titled low storey apartment building with apartments together with airspace rights above the building. The strata plan was deposited before 19 September 1985. The strata corporation does not and has not earned any income from the common property.

The corporation comprises unit holders which include:

● individual owner-occupiers

● individual investors

● one self-managed super fund investor.

The corporation has identified an opportunity to redevelop the site to build a larger, better-designed and more valuable apartment building. The intended scope of the project is as follows:

(a) the existing apartment building on the site will be demolished

(b) a new taller apartment building will be rebuilt on the site

(c) a number of apartments of the redeveloped property will have the same essential specifications as is existing (ie bedroom and bathroom count) and will be given to the existing owners as replacements for their current apartments

(d) the ground floor of the redeveloped property will be used for car parking

(e) the replacement apartments will be positioned on the lower levels of the redeveloped property

(f) to fund the project, the remaining floors of the redeveloped property will be developed and sold as residential apartments.

It is anticipated that the finance would come from a banking institution or a capital building company that would profit share. Both providers will finance a project that is fully costed and all pre-sold (ie all new apartments pre-sold before demolition begins).

There is expected to be a profit from selling the new apartments.

The developer of the site will be the corporation, and it will contract a third party builder at commercial rates to build the redeveloped property. The corporation has never previously undertaken a project such as this and is not in the business of developing or redeveloping property. They expect that this will be the only property development project that it will undertake.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-5

Income Tax Assessment Act 1997 subsection 104-20(1)

Income Tax Assessment Act 1997 subsection 104-20(3)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 116-25

Reasons for decision

Summary

An event does not occur for capital gains tax purposes when the apartment building is demolished as no capital proceeds are received at this time. Any income from the sale of the additional apartments will not be assessable to the strata corporation itself.

Detailed reasoning

CGT event on demolition of the building

A capital gain or capital loss is made when a CGT event happens to a CGT asset you own under section 102-20 of the ITAA 1997. CGT asset is defined in section 108-5 of the ITAA 1997 and includes any kind of property. CGT assets include part of or an interest in property or ‘a legal or equitable right that is not property’.

The most common event is CGT event A1 which happens when a person disposes of a CGT asset to someone else. CGT event A1 under section 104-5 of the ITAA 1997 occurs when a disposal contract is entered into, or if there is no contract, when an entity stops being an asset's owner.

CGT event C1 will happen when a CGT asset is demolished or destroyed (subsection 104-20(1) of the ITAA 1997). The time of the event is when the destruction occurs. Paragraph 4 of Taxation Determination TD 1999/79 confirms that CGT event C1 can happen on the voluntary destruction of an asset where for example, a taxpayer might demolish a building in the course of redeveloping a property.

Subsection 104-20(3) of the ITAA 1997 provides that you make a capital gain from CGT event C1 if the capital proceeds from the loss or destruction are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced coat base. Section 116-25 of the ITAA 1997 provides that the market value substitution rule does not apply to CGT event C1.

If you do not receive any capital proceeds upon the demolition of the apartment building, the combined effect of these provisions is that no amount is apportioned to the cost base or reduced cost base of the apartment building. As the capital proceeds from the demolition were nil and the cost base attributed to the apartment building is also nil, the strata corporation will not make a capital gain or capital loss upon the demolition of the apartment building. A capital gain or capital loss does not arise at the time of the demolition of the apartment building as capital proceeds will not be received at this time. It is possible for the transaction to be regarded as being on revenue.

Profits from 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.

2. As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of entering into a profit-making undertaking or scheme (including an isolated transaction).

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

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 case)).

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. Paragraph 1 of TR 92/3 defines the term ‘isolated transactions’ as:

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

● those transactions entered into by non-business taxpayers’.

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.

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 (TR 92/3 paragraph 6):

● 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.

Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits can be assessed as ordinary income within section 6-5 of the ITAA 1997.

Taking all of the available facts into consideration, the proceeds received from the sale of the additional apartments would be derived in the course of a one-off commercial transaction. The proceeds that the strata corporation will receive from the development of the apartment building are ordinary income and assessable under section 6-5 of the ITAA 1997.

Apartments owned by the strata corporation

A strata scheme is a legally recognised arrangement whereby a building and the land upon which it is erected is subdivided into lots, or lots and common property. The lots (commonly called units) have a separate title, which can generally be bought and sold without restriction. Common property is that part of a strata plan not comprised of any proprietor’s lot and includes the stairways, lifts, passages, common gardening areas, and any other fixtures intended for common use.

The ownership of common property varies under different State Acts and Territorial Ordinances. In this state the ownership of common property is vested in the proprietors as per the schedule of unit entitlements and profits will be distributed on the basis of unit entitlement.

Taxation Ruling TR 2015/3 provides the Commissioner’s view on income tax and ‘matters relating to strata title bodies constituted under strata title legislation’. Where a strata title body distributes to apartment holders out of profits, it constitutes dividends which are assessable and can be franked (paragraph 33 of TR 2015/3).

When a disposal of an asset held under a strata title arrangement occurs in an isolated profit making transaction, each unit holder would receive income in line with their interest in the asset. Any income/loss would then be included in the assessable income of each lot holder.

The strata corporation itself will not be assessable on any income from the disposal of the new apartments.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).