Edited version of your private ruling

Authorisation Number: 1051516242151

Date of issue: 31 May 2019

Ruling

Subject: Income tax - assessable income - income vs capital

Question

Should the acquisition and sale of the joint venture interests in the Property be treated as a capital transaction and the profit on sale be included as a net capital gain in the relevant parties' assessable incomes in accordance with section 102-5 of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

XX June 20XX

Relevant facts and circumstances

Overview

1.    Three friends, Individuals A, B and C, wanted to acquire a vacant parcel of land (the Property). They established a joint venture (the JV) to facilitate their joint acquisition of the Property. The three friends shared a common intention in relation to both the JV and the acquisition of the Property.

2.    They assert this common intention comprised three parts. First, the JV would acquire the Property. Second, the JV would work to have the Property rezoned. Third, the JV would construct on the Property a shopping centre to generate an ongoing source of rental income.

The JV

3.    The JV commenced on XX June 20XX and a written JV agreement was executed the same day.

4.    The partners in the JV were three trusts, each associated with one of the three friends. The partners in the JV were:

Trust A: a 51% JV participating interest;

Trust B: a 24.5% JV participating interest; and

Trust C: a 24.5% JV participating interest.

5.    The written JV agreement records that:

-   the purpose of the JV was to acquire the Property with the intention of developing, owning and managing a shopping centre;

-   the JV partners appointed Individual A to manage the day to day affairs of the JV;

-   the JV partners would beneficially own all JV assets in proportion to their JV participating interests as tenants in common;

-   the JV partners would receive any income of the JV in proportion to their JV participating interests; and

-   the JV partners would pay the JV costs in proportion to their JV participating interests.

6.    The JV maintained financial statements. The financial statements described the three trusts as partners. The JV obtained a tax file number and an Australian business number. It registered for goods and services tax and lodged partnership income tax returns. On XX May 20XX, Company A was incorporated to act as nominee for the JV.

The Property

7.    The Property was zoned 'rural'.

8.    The Property was located in an area long identified as having potential for urban development. The three friends considered the location and other characteristics of the Property meant it was well placed to be developed as a commercial or retail site if that urban development occurred.

Acquisition of the Property

9.    On XX June 20XX, Individual A (on behalf of the JV) entered into a contract of sale with an unrelated party to acquire the Property. The amounts payable under the contract were due and payable as instalments over a number of years.

10.  On XX September 20XX, Company A, as nominee for the JV, obtained title to the Property after payment of the final instalment. The JV partners each contributed finance consistent with their JV participating interests.

11.  The only real asset of the JV was the Property. The JV partners beneficially owned the Property in the same proportions as their JV participating interests.

Sale of JV interests in the Property

12.  On XX March 20XX, Trusts B and C sold the whole of their interests in the JV and Trust A sold most of its interest in the JV.

13.  The purchaser was an unrelated party. The sale was achieved under the Partnership of Trusts Reconstitution Deed. The purchaser acquired a 97% interest in the JV and the one continuing partner, Trust A, maintained a 3% interest in the JV.

14.  The original JV partners (Trusts A,B and C) were each paid certain amounts for transferring their JV interests.

Events leading to the sale of JV interests in the Property

15.  On XX August 20XX, the JV and an arm's length third party entered into a deed. In this deed, the JV provided the arm's length third party first and last right of refusal to lease areas of the Property upon its eventual development by the JV.

16.  The deed records that the JV intended to have the Property rezoned and to construct a shopping centre. The deed placed obligations on the JV to use reasonable endeavours to obtain the planning approvals necessary to construct a shopping centre on the Property.

17.  It was submitted the 2008 Financial Crisis made borrowing funds more difficult. It became apparent to the JV that changed lending parameters meant it could not alone borrow the funds required to complete a development of the Property.

18.  The JV tried to find additional JV partners to help develop the Property. No new partner was found. The JV determined to put the Property up for sale.

19.  Following a sales campaign, an arm's length third party offered to buy the Property in July 20XX. Negotiations relating to the offer continued for 18 months. Those negotiations concluded in a contract of sale under which the JV partners agreed to sell the Property.

20.  The sales agreement contained a condition enabling the JV to re-acquire part of the Property proposed as the site for a XX. The three friends assert this provided a way for the JV to achieve, on a smaller scale, its original aim of developing the Property to produce an income stream. Rather than developing the whole of the Property, this condition would have enabled the JV to re-acquire and develop only the XX site in order to produce an ongoing stream of income.

21.  The sales agreement also contained a condition that made settlement subject to and conditional on the relevant head government document guiding the use and development of the land being approved within two years.

22.  This head government document was not approved within two years and the third party withdrew its offer to purchase the Property.

23.  Individual A subsequently had conversations with a property developer (the Purchaser) that led to an offer to buy the Property. A contract of sale was entered into and settlement was scheduled to occur within 365 days.

24.  Settlement did not occur. The contract of sale was cancelled by mutual agreement and rescission. On the same day, the JV partners and the Purchaser executed the Partnership of Trusts Reconstitution Deed.

25.  The partnership reconstitution resulted in Trusts B and C selling the whole of their interests in the JV to the Purchaser, and Trust A selling 94% of its interest in the JV to the Purchaser, thereby retaining a 3% interest in the JV.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Part 3-1

Reasons for decision

Question

Should the acquisition and sale of the joint venture interests in the Property be treated as a capital transaction and the profit on sale be included as a net capital gain in the relevant parties' assessable incomes in accordance with section 102-5 of the Income Tax Assessment Act 1997?

Summary

Yes. The JV acquired and held the Property for the purpose of its development and the production of an income stream. Your sale of an interest in the JV amounts to the mere realisation of a capital asset. The proceeds from this sale are not ordinary income but instead fall to be considered for tax purposes only in working out your net capital gain.

Detailed Reasoning

Sale of JV partnership interests

1.    The principal asset of the JV was the Property and the three original JV partners beneficially owned the Property as tenants in common in proportion to their JV participating interests.

2.    Paragraph 7 of Taxation Ruling IT 2540 Income tax: capital gains: application to disposals of partnership assets and partnership interests (IT 2540) confirms that a partnership does not own property in its own right. Paragraph 9 of IT 2540 explains that a partner needs to account for their own interests in the partnership assets when they dispose of an interest in the partnership.

3.    Consequently, the Partnership of Trusts Reconstitution Deed effected a sale by each of the three original JV partners of interests they held in the Property.

4.    Proceeds from real property sales are usually treated for taxation purposes in one of the following three ways:

          (A)        as ordinary income on revenue account, where the taxpayer was carrying on a business and the property was sold in the ordinary course of that business;

          (B)        as ordinary income on revenue account, where the property was sold as part of an isolated transaction in carrying out a business operation or commercial transaction, and the taxpayer's purpose in entering into the isolated transaction was to make a profit; or

         (C)        as statutory income on capital account, where the property sale was the mere realisation of a capital asset.

Was the JV carrying on a business or carrying out a business operation or commercial transaction

5.    The Commissioner has decided the sale of interests in the Property occurred in the course of the JV carrying out a business operation or commercial transaction. Therefore, it has not been necessary for the Commissioner to decide whether or not the JV was also carrying on a business.

6.    Paragraph 12 of Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) confirms it is sufficient for a transaction to have a business or commercial character for it to be characterised as a business operation or commercial transaction.

7.    The Commissioner considers the sale of interests in the Property occurred in the course of carrying out a business operation or commercial transaction because:

-   the JV was established as a vehicle for the acquisition and ownership of the Property

-   the JV maintained financial statements

-   the JV obtained a tax file number and an Australian business number

-   the JV registered for goods and services tax and lodged partnership income tax returns

-   Company A was incorporated to act as nominee for the JV

-   the original JV partners obtained finance to fund the acquisition of the Property and incurred expenses incidental to holding the Property, and

-   significant sums of money were involved.

8.    The relevant question therefore is whether the JV intended to profit from the acquisition and sale of the Property; note that the proceeds from an isolated transaction are only ordinary income when there is both a business operation or commercial transaction and the taxpayer's purpose in entering into the isolated transaction was to make a profit (see paragraph 6 of TR 92/3).

JV's purpose for acquiring the Property

9.    Paragraph 9 of TR 92/3 notes that if 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 property.

10.  The question is whether the JV acquired the Property for the purpose of profit-making by sale.

11.  The written JV Agreement records that the JV was established to acquire the Property with the intention of building and retaining ownership of a shopping centre.

12.  The deed entered into with a third party identifies that the JV intended to develop and hold the Property.

13.  The original JV partners assert their intention when acquiring the Property was to develop it to enable the production of an ongoing income stream. Upon determining a sale was necessary, the JV sought to maintain development rights of the XX site. This provided a way for the JV to achieve, on a smaller scale, the asserted original aim of developing the Property to produce an income stream.

14.  Another consideration is the submitted impact of the 2008 Financial Crisis. The effect of this event on the economy, and lending parameters in particular, cautions against inferring an intention in 2006 from behaviour that occurred after 2008. The Commissioner makes this observation given the JV first made efforts to sell the Property in 2010.

15.  The Commissioner is satisfied the Property was acquired by the JV solely for the purpose of its development and the production of an income stream. The deed involving an arm's length third party was the most significant item of evidence the Commissioner relied on to reach this conclusion.

16.  The Commissioner notes this conclusion also means that the Property would not have been trading stock in the event the JV had been carrying on a business.

A mere realisation

17.  Having established the JV acquired the Property with the intention of holding it to produce an ongoing income stream, the question is whether the eventual sales went beyond a mere realisation.

18.  The statement of the law which established the distinction between realisation of land and the venturing of it into a business or into some other profit making endeavour comes from Williams J. in Scottish Australian Mining Co. Ltd. v. F.C. of T. (1950) 81 C.L.R. 188 at p. 195:

The crucial question is therefore whether the facts justify the conclusion that the appellant embarked on such a business or undertaking or scheme in 1924. The facts would, in my opinion, have to be very strong indeed before a court could be induced to hold that a company which had not purchased or otherwise acquired land for the purpose of profit-making by sale was engaged in the business of selling land and not merely realizing it when all that the company had done was to take the necessary steps to realize the land to the best advantage, especially land which had been acquired and used for a different purpose which it was no longer business-like to carry out.

19.  The facts do not indicate the JV or the original JV partners did anything more than seek to realise the Property to its best advantage. The JV undertook no significant activity in relation to the Property after deciding it would be difficult if not impossible to develop the Property as originally intended.

Conclusion

20.  The Commissioner considers the disposal of your interests in the JV (effectively the Property) was the mere realisation of a CGT asset. As a result, you need to include any net capital gain arising from that disposal in your assessable income pursuant to section 102-5 of the Income Tax Assessment Act 1997.

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