Edited version of private advice

Authorisation Number: 1051535458919

Date of advice: 27 June 2019

Ruling

Subject: Mere realisation of a capital asset

Question

Is the gain made by the Trust in the 2018 income year from the sale of the Property taxed solely as a discount capital gain pursuant to section 115-5 of the Income Tax Assessment Act 1997 (ITAA 1997) and included in its net income for that year under section 102-5 of the ITAA 1997?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2018

Relevant facts and circumstances

In 2010, the Trust entered into a contract of sale to purchase the Property.

The Trust is part of a wider group (Group) involved in property building, development, and investment activities.

The purchase of the Property was financed through a mortgage from a financial institution and an additional amount from the Group.

In accordance with the terms of funding with the financial institution, valuations of the Property were undertaken in 2010, 2013 and 2016.

Sub-leases were entered into with a number of tenants from 2012 to 2017.

Numerous unsolicited approaches were made to the Group to acquire the Property during the period between acquisition and eventual sale. These were rejected as there was a desire to expand and retain a portfolio of well-located buildings and the Property was considered a good long-term asset at the time. The offers received were all greater than the relevant valuations of the Property at the time.

The Group's long-term investment strategy is to diversify its investments. Part of that strategy includes investment in assets which generate stable income.

In late 2017, the Group evaluated their portfolio of building assets and considered that the Property, while very well located, was inferior to the assets they were developing.

At this time further unsolicited offers were presented to the Group. One of these offers was accepted and the Trust entered into a contract for the sale of the Property in 2018. The sale proceeds were used to discharge the mortgage over the Property as well as invested into long-term building assets.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 subsection 104-10(4)

Income Tax Assessment Act 1997 Division 115

Income Tax Assessment Act 1997 section 115-5

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Summary

The gain made by the Trust on disposal of the Property is a discount capital gain included in the calculation of its net income pursuant to section 102-5.

Detailed reasoning

The determination of the appropriate tax treatment of the proceeds from the sale of property is a question of fact and degree determined on a case by case basis. The facts specific to each transaction must be discretely and closely examined.

Mere realisation v disposal in the course of business or profit-making undertaking

Generally, when you enter into an arrangement to sell your property, the key question to be determined is whether the ultimate sale is a 'mere realisation', or whether it is a disposal either in the course of business or as part of a profit-making undertaking or scheme.

Where the sale of property is considered a mere realisation of a capital asset, the receipts will be treated as a capital gain to which the capital gains tax (CGT) rules under Part 3-1 and Part 3-3 will apply. These receipts are not ordinary income.

A sale that is more than a mere realisation will be on revenue account. Proceeds from such a sale are assessable under section 6-5 as ordinary income.

The expression 'mere realisation' is used to distinguish a mere realisation from a business operation or a commercial transaction carrying out a profit-making scheme. Profits made on the realisation of capital assets can still be ordinary income if the activities go beyond a mere realisation and instead become a separate business operation or commercial transaction even though the taxpayer did not have a purpose of profit-making at the time of acquiring the asset.

In McClelland v FC of T 70 ATC 4115, for example, the Privy Council held that the question to be answered was whether the facts revealed a mere realisation of capital, albeit in an enterprising way, or whether they justify a finding that the taxpayer went beyond this and engaged in a trade of dealing in the asset, albeit on one occasion only.

Lord Justice Clark, in distinguishing between proceeds that is mere realisation of capital and ordinary income, stated in California Copper Syndicate v Harris (1904) 5 TC 159 at pp 165-166 that:

...What is the line which separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be determined being - is the sum of the gain that has been made a mere enhancement of values by realising a security, or is it a gain made in an operation of business in carrying out a scheme of profit-making?

In FC of T v Whitfords Beach Pty Ltd 82 ATC 4031, Gibbs CJ similarly said (at p.4034) that:

When the owner of an investment chooses to realize it, and obtains a greater price for it than he paid to acquire it, the enhanced price will not be income within ordinary usages and concepts, unless, to use the words of the Lord Justice Clerk in California Copper ...'what is done in not merely a realisation or charge of investment, but an act done in what is truly the carrying on, or carrying out, of a business'.

Having regard to the cases highlighted above, the Commissioner is of the view that the Trust has merely realised a capital asset. It is considered that the circumstances surrounding the sale of the Property indicate (with regard to the indicators discussed in Taxation Ruling TR 97/11) that there was no intention or purpose on the part of the Trust to do so as part of a business involving the acquisition of commercial office properties for resale, nor (with regard to Taxation Ruling TR 92/3) do the circumstances surrounding the sale of the Property indicate a purpose of profit-making from an isolated transaction which amounts to a business operation or commercial transaction.

Broadly, this position is primarily supported by the following facts:

·  the Trust's rejection of a number of unsolicited offers from unrelated third parties to purchase the Property for an amount which exceeded valuations of the Property at the time, on the basis that it was intended to be held long-term;

·  the Trust's decision to sell only eventuated following the receipt of yet another unsolicited approach from a number of parties willing to pay an amount significantly in excess of the most recent valuation received by the Trust as at that time;

·  the Property was held for about eight years during which time it was deriving rental income; and

·  proceeds from the sale were reinvested into other building assets to derive long-term rental income. These other buildings were considered superior to the Property.

CGT event A1 therefore happened to the Trust on the sale of the Property resulting in a capital gain pursuant to subsection 104-10(4) to the extent that the capital proceeds received on the sale exceed the cost base of the Property.

This capital gain meets each of the requirements of Division 115 and, for the purposes of determining the Trust's net capital gain for inclusion in its assessable income (and therefore net income) for the 2018 income year pursuant to section 102-5, is a discount capital gain pursuant to section 115-5.

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