Edited version of private advice

Authorisation Number: 1051534962547

Date of advice: 27 June 2019

Ruling

Subject: GST and CGT and partitioning

Question 1

Are the interests to be disposed of by Entity A, Entity B, and / or Entity C (the Partnership) on partitioning of the corner of the Property CGT assets dealt with under Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Please be aware that the answer to Question 1 will have no bearing on whether or not the receipts on any future disposal of the townhouses will be considered to be ordinary income. That issue can only be determined at the time of the disposal as this is when all the facts necessary to decide that issue will be known.

Question 2

If the answer to question 1 is yes, do the interests to be disposed of come within the exception outlined in section 118-42 of the ITAA 1997?

Answer

Yes.

Please be aware that the answer to Question 2 will have no bearing on whether or not the receipts on any future disposal of the townhouses will be considered to be ordinary income. That issue can only be determined at the time of the disposal as this is when all the facts necessary to decide that issue will be known.

Question 3

Are Entity A and Entity B individually liable for goods and services tax (GST) in connection with the partition of the corner of the Property under section 9-40 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

No. Refer to Question 4.

Question 4

Is Entity C (the Partnership) liable for GST in relation to the partition of the Property under section 9-40 of the GST Act?

Answer

Yes.

Question 5

Do the answers to questions 1, 2, 3, or 4 change if Entity A and Entity B individually gift one of their townhouses to a family member after the partition of the Property?

Answer

No, the answers to question 1, 2, 3 or 4 do not change.

Relevant facts and circumstances

Registration and enterprise details

Entity A is not registered for GST.

Entity B is not registered for GST.

Entity C (You) is a partnership registered for GST from ddmmyyyy (the Partnership). The Partnership comprises of Entity A and Entity B (The Partners).

You entered into a Partnership Agreement on ddmmyyyy for the purpose of property development.

Entity A and Entity B are builders by trade and have only previously been involved in building activities as third party building contractors engaged by unrelated property developers.

The Partnership was carrying on a leasing enterprise in relation to various residential and commercial properties located on the corner of the Property.

Property details

The Partnership owns the following adjoining properties (legal title is held by the Partners, Entity A and Entity B as tenants in common in equal shares) (the Property):

·         Lot 1 (commercial property) (Lot 1):

o   Lot 1 was purchased by Entity B, Entity A and Entity D on ddmmyyyy. Entity D sold his share in Lot 1 to Entity B and Entity A on ddmmyyyy.

·         Lot 2 (residential property) (Lot 2):

o   Lot 2 was purchased by Entity B, Entity A and Entity D on ddmmyyyy. Entity D sold his share in Lot 2 to Entity B and Entity A on ddmmyyyy.

·         Lot 3 (residential property) (Lot 3):

o   Lot 3 was purchased by Entity B, Entity A and Entity D on ddmmyyyy. Entity D sold his share in Lot 3 to Entity B and Entity A on ddmmyyyy.

·         Lot 4 (commercial property) (Lot 4):

o   Lot 4 was purchased by Entity B, Entity A and Entity D on ddmmyyyy. Entity D sold his share in Lot 4 to Entity B and Entity A on ddmmyyyy.

·         Lot 5 (commercial property) (Lot 5):

o   Lot 5 was purchased by Entity E and Entity F, Entity A and Entity B's spouses on or around mmyyyy. Entity A and Entity B transferred Lot 5 to Entity B and Entity A on ddmmyyyy.

·         Lot 6 (commercial property) (Lot 6):

o   Lot 6 was purchased by Entity E and Entity F, Entity A and Entity B's spouses on or around ddmmyyyy. Entity E and Entity F transferred Lot 6 to Entity B and Entity A on ddmmyyyy.

The zoning for each Lot was residential zoning at acquisition and remains as such. There are no existing mortgages over the Lots.

Intention at time of purchase

At the time of acquisition of each Lot there was always an intention to develop the sites into residential premises.

Leasing details

Each Lot was made available for rent as follows:

·         Lots 1 to 4 were all made available for rent from the time Entity A, Entity B and Entity D purchased each Lot until the commencement of building activities.

·         Lots 5 and 6 were made available for rent from the time Entity E and Entity F purchased them. They were not made available for rent after they were transferred to Entity A and Entity B in mmyyyy because construction of the properties was scheduled to commence shortly after they were transferred.

Each Lot ceased being rented as follows:

·         Lot 1 ceased being rented ddmmyyyy.

·         Lot 2 ceased being rented ddmmyyyy.

·         Lot 3 ceased being rented ddmmyyyy.

·         Lot 4 ceased being rented ddmmyyyy.

·         Lots 5 and 6 ceased being rented in mmyyyy because construction of the properties was scheduled to commence shortly after they were transferred.

Entity A and Entity B both declared the rental income received from the Lots in their personal tax returns.

Development details

The Partnership is redeveloping the Property by demolishing the existing buildings and constructing 18 residential townhouses.

The development commenced on or around mmyyyy and is expected to be complete on or around mmyyyy with an estimated cost of $X.

Lots 1,2,3,4,5 and 6 are to be amalgamated into one property with legal title to the Property held by Entity A and Entity B as tenants is common. Once the building works, being the construction of new residential townhouses, are completed the townhouses will be registered as lots in a strata plan.

Each townhouse will be a distinct lot in a strata plan.

At the time that the strata plan is created, the Partnership (legal title held by the Partners) will own the 18 residential townhouses, with Entity A and Entity B having an equal interest in the Property pursuant to the Partnership Agreement.

A partition will occur whereby:

·         Entity A will become the sole owner of 8 townhouses.

·         Entity B will become the sole owner of 8 townhouses.

·         The Partnership will retain ownership of two townhouses as tenants-in-common in equal shares.

The partition will involve, the Partnership making an in specie distribution of Partnership property as follows:

·         A transfer of townhouses numbered 1 to 6 (inclusive), 13 and 14 to Entity B.

·         A transfer of townhouses numbered 7 to 12 (inclusive), 17 and 18 to Entity A.

The development will be a once-off arrangement.

Entity A and Entity B will hold the completed residential townhouses indefinitely for the purpose of rental income.

After partition Entity A intends to gift one townhouse to his son and Entity B intends to gift one townhouse to his parents. The gifting is made as an expression of love. There will be a transfer of the beneficial interest in the townhouses, the transfer is made voluntarily, the transfer arises by way of benefaction and there is no material benefit or advantage received by way of return. The gifting is not a product of any prior legal obligation or any income producing activities. The recipients are not involved in any aspects of the development of the Property and intend to retain the townhouses and lease them to derive rent.

There is no written business plan for the development.

The following tasks will be jointly undertaken by Entity A and Entity B for the Partnership:

·         Manage the property development.

·         Engage contractors / subcontractors to carry out development works where required, for example engaging subcontractors to undertake excavation works.

·         Submit any plans or building applications.

·         Supervise contractors / subcontractors at the building site.

Entity A and Entity B will undertake some of the building works themselves for the Partnership, for example internal fitouts, joinery, gyprock and painting, being trades in which Entity A and Entity B have prior experience.

The Partnership has contacted and engaged contractors to carry out various parts of the development works.

Consultants / contractors are paid using the proceeds received by the Partnership from a Bank loan. All consultants or contractors provide quotes for their services, based on which, Entity A and Entity B can choose to engage their services for the Partnership.

The Partnership will maintain a general ledger of all expenses incurred in the course of developing the residential townhouses.

No research or study on the profitability of the development was conducted.

Entity A and Entity B are leveraging their skill and experience in the building industry to build the residential townhouses, with the aim of producing increased rental returns from the lots.

The expected market value of the property once the development is completed is $X exclusive of GST.

The Partnership has claimed input tax credits in relation to the development.

Loan details

The Partnership received approval for a joint loan from the Bank. The development has been funded using the development loan from the Bank and the residential townhouses will be constructed using the loan. Entity A and Entity B have agreed between themselves to finance this loan in equal proportions. To the extent that further capital contributions are required, they will be provided in accordance with clause X of the Co-Ownership Agreement.

On ddmmyyyy the Bank confirmed settlement of your loan with the borrower being the Partnership.

The Bank required a copy of the Partnership Agreement for the loan which was provided ddmmyyyy.

In an email to the Bank dated ddmmyyyy the following was confirmed:

·         The borrowing entity is the Partnership.

·         The six lots will be consolidated into one lot prior to strata subdivision

Co-ownership Agreement

Entity A and Entity B have entered into a Co-ownership Agreement (the Deed) that records who will hold rights to occupy each townhouse before the conversion process and who will own each townhouse after registration of the strata plan of subdivision for the Land.

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 9-40

A New Tax System (Goods and Services Tax) Act 1999 Section 23-5

A New Tax System (Goods and Services Tax) Act 1999 Section 184-1

A New Tax System (Goods and Services Tax) Act 1999 Division 188

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 106-5

Income Tax Assessment Act 1997 Section 118-42

Income Tax Assessment Act 1997 Section 124-10

Income Tax Assessment Act 1997 Section 124-190

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Question 1

Capital gains tax (CGT)

The term 'CGT asset' is defined in subsection 108-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) to be:

(a) any kind of property; or

(b) a legal or equitable right that is not property.

Subsection 108-5(2) of the ITAA 1997 states that to avoid doubt, CGT assets include:

(a) part of, or an interest in, an asset referred to in subsection (1);

(b) goodwill or an interest in it;

(c) an interest in an asset of a partnership;

(d) an interest in a partnership that is not covered by paragraph (c).

Examples include land and building, debts owed to a taxpayer, and a right to enforce a contractual obligation.

Generally you make a capital gain or a capital loss if a CGT event occurs to a CGT asset you own.

In this case, the interests in the Property are clearly interests in a kind of property and therefore meet the definition of a CGT asset under paragraph 108-5(2)(a) of the ITAA 1997. If the Property is an asset of the partnership, the interests would also meet the part of the definition contained in paragraph 108-5(2)(c) of the ITAA 1997.

For CGT purposes it makes no difference whether the Property, which is legally owned by Entity A and Entity B as tenants in common, is an asset of the partnership or not as section 106-5 of the ITAA 1997 states that any capital gain/loss from a CGT event happening in relation to a partnership's CGT asset is made by the partners individually.

Question 2

Section 160ZZPG of the Income Tax Assessment Act 1936 (ITAA 1936) contained roll-over relief which applied where land on which a building or buildings were erected was subdivided into strata units or strata units and common property and immediately before and after the subdivision a taxpayer had a particular asset in relation to the land. Section 160ZZPG of the ITAA 1936 was repealed and replaced by sections 118-42 and 124-190 of the ITAA 1997.

Section 118-42 of the ITAA 1997 states that if:

(a) you own land on which there is a building; and

(b) you subdivide the building into stratum units; and

(c) you transfer each unit to the entity who had the right to occupy it just before the subdivision;

a capital gain or capital loss you make from transferring the unit is disregarded.

Under section 124-190 of the ITAA 1997 a roll-over is available if:

(a) you own property (the 'original asset') that gives you a right to occupy a unit in a building;

(b) the building's owner subdivides it into stratum units; and

(c) the owner transfers to you the stratum unit (the 'new asset') that corresponds to the unit you had the right to occupy just before the subdivision.

The cost base of the new stratum unit is worked out according to subsections 124-190(2) and 124-10(3) of the ITAA 1997.

Essentially the operation of sections 118-42, 124-190 and 124-10 of the ITAA 1997 results in the CGT attributes of the 'original asset' (the property from which the right to occupy was derived) being rolled over to the 'new asset' (the stratum unit).

That is, the first element of the cost base of the new stratum unit includes the cost base of the original asset.

Taxation Ruling TR 97/4 Income tax: capital gains: roll-over relief for buildings subdivided under strata title law into stratum units and common property sets out the Commissioner's view on tenants in common subdividing a building and transferring their interests so that each tenant in common becomes a registered proprietor of a stratum unit.

Roll-over relief is only available if, before the conversion process, the tenants in common entered into an agreement or understanding granting each tenant in common exclusive occupation (including an exclusive right of possession) of a particular unit.

In this case, Entity A and Entity B legally own, as tenants in common, the Property which is to be subdivided into stratum units. Prior to the conversion process they have entered into an agreement that sets out which entities hold rights to occupy particular units in the building. After the conversion the ownership of each unit will be held by the entity/ies which held the right to occupy the unit immediately prior to the strata title conversion.

It is accepted that the requirements for access to the CGT concessions for a strata title conversion under sections 118-42, 124-190 and 124-10 of the ITAA 1997 will be met.

Note:

Please be aware that the answers to Questions 1 and 2 have no bearing on whether or not the receipts on any future disposal of the townhouses will be considered to be ordinary income. That issue can only be determined at the time of the disposal as this is when all the facts necessary to decide that issue will be known.

This was made clear in the case August v. Commissioner of Taxation [2013] FCAFC 85. That case involved properties which had been renovated after purchase then rented for 7 to 9 years before being sold. Mr August claimed that his intention on their purchase had been to hold them for long term investment. However, the Federal Court at first instance concluded that despite what Mr August claimed was his intention, based on all the surrounding facts and circumstances, there had actually been an intention that the properties be developed, tenanted and sold for a profit. Consequently, the gain made on the sale of the properties was ordinary income. On appeal, the Full Federal Court upheld the trial judge's finding.

Question 3 and 4

In this reasoning, please note:

·         all legislative references are to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)

·         all legislative terms of the GST Act marked with an asterisk are defined in section 195-1 of the GST Act

·         all reference materials referred to are available on the Australian Taxation Office (ATO) website ato.gov.au

Section 9-40 which is about the liability for GST on taxable supplies provides:

You must pay the GST payable on any * taxable supply that you make.

Section 9-5 provides that you make a taxable supply if:

(a) you make the supply for consideration

(b) the supply is made in the course or furtherance of an enterprise that you carry on

(c) the supply is connected with the indirect tax zone (Australia), and

(d) you are registered, or required to be registered for GST.

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

Entity

The term 'you' applies to an entity, and it is an entity that makes a taxable supply and is liable for GST on a taxable supply it makes. An 'entity' includes an individual and a partnership.

It is first necessary to determine which entity is liable for GST if the partition of the Property is a taxable supply. That is, whether Entity A and Entity B are individually liable, or the partnership Entity C.

A partnership for GST purposes is defined by reference to section 995-1 of the Income Tax Assessment Act 1997:

partnership means:

(a) an association of persons (other than a company or a limited partnership) carrying on business as partners or in receipt of ordinary income or statutory income jointly; or

(b) a limited partnership.

The first limb of the definition in paragraph (a) reflects the definition of partnership contained in State and Territory partnership Acts. This reflects the general law definition of a partnership.

The second limb of the definition in paragraph (a) extends 'partnership' for taxation purposes to include persons in receipt of income jointly, for example where two or more persons derive income from real estate that they own as joint tenants or as tenants in common. We refer to this type of partnership as a tax law partnership.

Entity A and Entity B entered into a Partnership Agreement in accordance with the laws of the relevant state on ddmmyyyy for the purpose of property development, and the partnership, Entity C (you) (the Partnership) registered for GST from ddmmyyyy.

On ddmmyyyy you provided a copy of the Partnership Agreement to the Bank to enable the Partnership to obtain finance for the property development, which includes construction of 18 townhouses by the Partnership.

You have lodged activity statements and claimed input tax credits under the ABN of the Partnership.

It is our view that the partnership of Entity C is the entity for GST purposes that is undertaking the development enterprise and is liable to pay the GST on any taxable supply that the Partnership makes.

Supply by partitioning of new residential premises

Goods and Services Tax Ruling GSTR 2009/2 Goods and Services tax: partitioning of land considers the GST consequences of partitioning property among joint tenants and tenants in common, in particular a partition of land by a general law partnership.

It is the Commissioner's view that in making an in specie distribution of land, or a supply of an interest in land by way of a partition, the partnership makes a supply to the partners.

For the purposes of the GST Act it is the partnership and not the partners that makes an in specie distribution of the whole of the relevant partnership property to the acquiring partner, notwithstanding how the legal title to the property is held by the partners. In this case, legal title to the Property is held by Entity A and Entity B.

Partnership property may be converted into the separate property of a partner by the partnership transferring the property to the acquiring partner. For the acquiring partner to enjoy absolute ownership of the land, the partnership must also distribute the remaining beneficial (and legal) interest in the land held by the partner as a partner in the partnership to the partner in their own right. The partnership would therefore make an in specie distribution of the whole of the land to the acquiring partner.

Section 40-65 provides that sales of residential premises are input taxed (ie there is no requirement to pay GST or entitlement to claim GST credits) to the extent the property is residential premises to be used predominantly for residential accommodation. However, the supply is not input taxed to the extent that the residential premises are 'new residential premises'.

Section 40-75 provides the meaning of 'new residential premises' which include those premises that:

·         have not previously been sold as residential premises, or

·         have been built, or contain a building that has been built, to replace demolished premises on the same land.

An in specie distribution of an interest in land, comprising of residential premises, by a partnership to a partner would constitute the first sale of new residential premises in their entirety. The partnership, in this instance, supplies the whole of the interests in the residential premises. The in specie distribution of the new residential premises by the partnership to the partner therefore will be a taxable supply if all the requirements of a taxable supply are satisfied.

For consideration

The Commissioner considers that an in specie distribution of partnership property by a partnership to a partner is a supply made by the partnership.It is the Commissioner's view that an in specie distribution of partnership property by a partnership to a partner is made for consideration.

The consideration is the reduction in each Partner's interest in the Partnership to that extent. In other words, at the same time as partitioning, the Partnership disposes of 100% interest in each unit to the respective partner, being Entity A or Entity B.

Therefore, the requirement that the supply is made for consideration under paragraph 9-5(a) will be satisfied.

Made in the course or furtherance of an enterprise that you carry on

As outlined above, you are a Partnership conducting a property development enterprise.

The partners Entity A and entity B have entered into a Co-Ownership Agreement that outlines an agreement to partition (clause X) so that Entity A will become the sole owner of eight townhouses and Entity B will become the sole owner of eight townhouses. To complete the development as per the Co-Ownership Agreement, the Property will be partitioned such that each partner has sole ownership over 8 townhouses.

For the purposes of the GST legislation a general law partnership is an association of persons carrying on business as partners. Therefore, the existence of a partnership implies that all of its activities are in the course of its business activities and thus in the course or furtherance of an enterprise carried on by the partnership.

Therefore, the requirement that the supply is made in the course or furtherance of an enterprise that you carry on under subsection 9-5(b) will be satisfied.

Connected with the indirect tax zone (Australia)

The supply of the Property is in Australia and therefore the requirement that the supply is connected with the indirect tax zone (Australia) under subsection 9-5(c) will be satisfied.

Registration for GST

You, the Partnership, are registered for GST.

Further, as the in specie distribution is in the course of the Partnership enterprise the Partnership is required to be registered for GST pursuant to section 23-5 as its GST turnover will meet the registration turnover threshold.

Therefore the requirement that you are registered or required to be register for GST under subsection 9-5(d) is satisfied.

Conclusion

If you proceed to effect a partition and distribute Partnership property to each partner, the Partnership will make a supply satisfying all the requirements of a taxable supply under section 9-5. The Partnership will be liable for GST on the supply of each townhouse.

The Partnership will be required to remit 1/11 of the GST inclusive market value of each townhouse.

Question 5

The subsequent gifting of a townhouse by Entity A or Entity B to a family member will not change the answer to question 1 or 2. The subsequent gifting has no impact on whether the interests in the Property prior to the strata title conversion were CGT assets. Also, the requirements for access to the CGT concessions for a strata title conversion will be met and this is not changed by the subsequent gifting.

You should note that a subsequent gifting would be a CGT event. We have not considered the income tax consequences of a subsequent gifting apart from whether it impacts the answers to questions 1 and 2.

For GST purposes the subsequent gifting of a townhouse by Entity A or Entity B to a family member will not change the answer to question 3 or 4. These subsequent supplies have no impact on the previous supplies made by the Partnership to Entity A and Entity B.

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