Edited version of private advice

Authorisation Number: 1051806440550

Date of advice: 5 March 2021

Ruling

Subject: GST implications of developing land for the purpose of selling at a profit

Question 1

Are you (the property owners) considered to be carrying on a property development business?

Answer

No

Question 2

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

Answer

Yes

Question 3

Is the land trading stock?

Answer

No

Question 4

Are you carrying on an enterprise for Goods and Services Tax (GST) purposes and will the sale of townhouses (to be constructed) be subject to GST?

Answer

Yes

Question 5

Will you be required to register for GST?

Answer

Yes

Question 6

Will you be able to use the margin scheme to account for GST?

Answer

Yes. The margin scheme is an option for you to use to calculate the GST payable when you sell the townhouses.

Question 7

Can you claim GST input tax credits incurred in the construction of the townhouses be claimed in the period they are incurred?

Answer

Yes, if you plan to sell the townhouses and not hold them, then yes you can claim the input tax credits in the period they are incurred.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

September 20XX

Relevant facts and circumstances

The land in question was purchased by you as joint owners on XX XXX 20XX.

The land with an existing house was purchased for $XXX,000 with the initial intention of demolishing the existing house, sub dividing the block and building two new houses. One for the you to live in and the other for your child to live in.

The original house was leased out to tenants from xx/xx/xxx to xx/xx/xxxx.

A planning permit was issued by the relevant council on xx/xx/xxxx.

The existing house was demolished xx/xx/xxxx.

A building contract was signed xx/xx/xxxx, with you paying a 5% deposit in xx/xx/xxxx.

After the deposit was paid, the builder was uncontactable.

On xx/xx/xxxx you lodged a formal complaint with Consumer Affairs to cancel the contract as the builder had gone into liquidation.

Due to this bad experience you have not done anything with the block of land until now.

In the meantime, you have purchased another home which is your sole and principle residence and have no intention of moving from there. Your child has also purchased their own home.

Since xx/xx/xxxx you have decided to construct 2 townhouses on the land for sale.

As the original planning permit has expired, you require a new application to council. As yet no builder has been appointed.

You have no prior experience in property development and will have no involvement on a day-to-day basis for the management and construction of the houses.

You have no intention of undertaking any other subdivision activities or development projects in the future.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 995

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

A New Tax System (Goods and Services Tax) Act 1999 paragraph 40-75(1)

A New Tax System (Goods and Services Tax) Act 1999 section 9-70

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

A New Tax System (Goods and Services Tax) Act 1999 paragraph 75-5(1)

Question 1

Are you considered to be carrying on a property development business?

Summary

No, the Commissioner does not consider you to be in the business of property development. However, the Commissioner considers the development of the land and the sale of the 2 townhouses constitutes an isolated business transaction entered into by two non-business taxpayers for the purposes of making a profit. The profits on the sale of the townhouses will be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

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 an isolated business transaction entered into by a non-business taxpayer, or outside the ordinary course of business of a taxpayer carrying on a business, which is the commercial exploitation of an asset acquired for a profit making purpose;

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

Carrying on a business of property development

Section 995 of the ITAA 1997 states the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the particular facts.

Taxation Ruling TR 97/11 am I carrying on a business of primary production? (TR 97/11) provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. In the Commissioner's view, the factors that are considered important in determining the question of business activity are:

•         whether the activity has a significant commercial purpose or character

•         whether the taxpayer has more than just an intention to engage in business

•         whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

•         whether there is regularity and repetition of the activity

•         whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business

•         whether the activity is planned, organised and carried on in a businesslike manner such that it is described as 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 sporting activity.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

Application to your situation

Based on the information provided, you are not carrying on a business on buying and selling property, nor is this the commencement of you carrying on a business of buying, selling and developing land.

Therefore, any gain made on the disposal of the subdivided lots will not be assessable income under section 6-5 of the ITAA 1997 as ordinary income from the carrying on of a business.

Therefore, we will consider whether or not the proceeds from the subdivision of land, construction and sale of townhouses will be viewed as being received in relation to a profit-making undertaking or a mere realisation of a capital asset:

Question 2

Will the profit from the construction and sale of townhouses be assessable income under section 6-5 of the Income Tax Assessment Act 1997?

Summary

Yes. It is the Commissioner's view that the subdivision, construction of 2 townhouses and their sale will not be a mere realisation of capital assets. Therefore, as the disposal of the houses is viewed as an isolated business transaction, any profit made on their sale will be included in assessable income under section 6-5 of the ITAA 1997.

Detailed reasoning

Isolated business transactions

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 Income Tax: whether profits on isolated transactions are income (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 as ordinary income.

Paragraph 1 of TR 92/3 outlines that isolated transactions are:

a) those transactions outside the ordinary course of business of a taxpayer carrying on a business; and

b) those transactions entered into by non-business taxpayers.

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.

If a transaction or operation is outside the ordinary course of a taxpayer's business, the intention or purpose of profit-making must exist in relation to the transaction or operation in question.

Paragraphs 41 and 42 of TR 92/3 outline that where a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset 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 operation or commercial transaction carrying out a profit-making scheme, as the case may be.

For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character. Whether a particular transaction has a business or commercial character depends very much on the circumstances of the case.

Paragraph 13 of the ruling outlines the following factors which may be relevant when considering whether an isolated transaction amounts to a business operation or commercial transaction:

•         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 the property, and

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

The direction provided within TR 92/3 and in case law indicates that profits in this context are more likely to be considered ordinary income if they are made in the ordinary course of carrying on a business. Further, ordinary income may be derived from an isolated transaction which becomes commercial in nature, or as a result of profits on a transaction in which the initial intention was to make a profit on sale.

In addition to the above factors, for the purposes of determining whether the activities undertaken in relation to real property and development equate to a profit-making undertaking or scheme, Miscellaneous Taxation Ruling MT 2006/1 (MT 2006/1) aligns itself with TR 92/3 and provides a list of factors which, if present may be an indication that a business or profit-making undertaking or scheme is being carried on. 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. These factors are as follows:

•         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 determining whether activities relating to isolated transactions are a profit-making undertaking 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.

Application to your situation

In the context of considering the above authorities and factors when determining whether your activities would be viewed as a profit-making undertaking, the following general observations of your situation can be made:

•         You purchased the property in 20XX with the intention of demolishing the existing house and building 2 new homes, one for yourselves to live in and another for your child to live in.

•         After a bad experience with your builder you abandoned your vision of building your own home and one for your child and purchased a home elsewhere where you intend to reside indefinitely.

•         The property has sat vacant since 20XX.

•         In 20XX you decided to now develop the property by sub dividing the block and building 2 townhouses on it for sale.

•         There has been a change in the purpose for which the property was held from developing for personal use to developing for sale.

A balanced view of these observations, with no one feature being determinative in isolation, reasonably leads to a conclusion the intention for holding the property has changed to one of a profit-making undertaking.

The simplest way you could have divested yourselves of the property would have been to dispose of it without seeking any subdivision approvals and without actually undertaking the associated works. The acts of seeking approvals and undertaking of the subdivision work and building 2 houses must in some way contribute towards a finding that the overall activity constitutes something more than a 'mere realisation' of a capital asset.

The property to be subdivided, the construction of town houses and the selling thereof, is considered to be a profit-making venture which is on a sufficient scale to characterise it as a commercial or profit-making undertaking. As a consequence, the proceeds from the sale of the townhouses will be considered to be ordinary income and therefore assessable under section 6-5 of the ITAA 1997.

Capital gains tax

The capital gains tax (CGT) provisions are contained in Part 3-1. Broadly, the provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own.

CGT event A1 under section 104-10 happens if you dispose a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property.

A capital gain will be made if the cost base of the asset is less than the capital proceeds in accordance with section 102 of the ITAA 1997.

Section 118-20 contains anti-overlap provisions which operate to reduce any capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 as a result of the sale, for example, as ordinary income under section 6-5.

Application to your situation

Making an overall assessment on the factors set out in TR 92/3, it is the Commissioner's view that the subdivision, construction of 2 townhouses and their sale will not be a mere realisation of capital assets.

Therefore, as the disposal of the houses is viewed as an isolated business transaction, any profit made on their sale will be included in your assessable income under section 6-5 of the ITAA 1997.

Any capital gain made on the disposal of the houses will be reduced to the extent that the profit from the sale of the houses is included in assessable income under section 6-5 of the ITAA 1997.

Question 3

Is the land treated as trading stock?

Summary

No

Detailed reasoning

Taxation determination TD 92/128 Income tax: property development: if land is acquired for development, subdivision and sale but after some initial development the project ceases and is recommenced in a later income year, how is a profit on the sale of the land treated for income tax purposes? states;

Land can only be treated as trading stock if a business of trading in land is actively being carried on. There must be present the continuity of activity which characterises a business, refer to the remarks of Jacobs and Aickin JJ. in F C of T v. St. Hubert's Island Pty Ltd (1).

Similarly, TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'? states;

1.    Land is treated as trading stock for income tax purposes if:

-        it is held for the purpose of resale; and

-        A business activity which involves dealing in land has commenced.

2.    Both the required purpose and the business activity must be present before land is treated as trading stock. The business activity is taken to have commenced when a taxpayer embarks on a definite and continuous cycle of operations designed to lead to the sale of the land.

3.    It is not necessary that the acquisition of land be repetitive. A single acquisition of land for the purpose of development, subdivision and sale by a business commenced for that purpose would lead to the land being treated as trading stock.

As you are not considered to be in business the land held is not trading stock.

Question 4

Are you carrying on an enterprise for Goods and Services Tax (GST) purposes and will the sale of townhouses (to be constructed) be subject to GST?

Summary

Yes you are considered to be carrying on an enterprise for GST purposes and the sale of the townhouses will be subject to GST.

Detailed reasoning

The term 'enterprise' is defined for GST purposes in section 9-20 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) and includes, among other things, an activity or series of activities done:

•         in the form of a business (paragraph 9-20(1)(a)) or

•         in the form of an adventure or concern in the nature of trade (paragraph 9-20(1)(b)).

The phrase 'carry on' in the context of an enterprise includes doing anything in the course of the commencement or termination of the enterprise.

Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number (MT 2006/1) provides the Tax Office view on the meaning of 'enterprise' for the purposes of entitlement to an Australian Business Number (ABN).

Goods and Services Tax Determination GSTD 2006/6 Goods and services tax: does MT 2006/1 have equal application to the meaning of 'entity' and 'enterprise' for the purposes of the A New Tax System (Goods and Services Tax) Act 1999? provides that the discussion in MT 2006/1 equally applies to the term 'enterprise' as used in the GST Act and can be relied on for GST purposes.

In the form of a business

Paragraphs 170 to 179 of MT 2006/1 discuss factors to consider when determining whether an activity or series of activities are done in the form of a business.

In your case, and as discussed above, we consider the facts do not support you are carrying on an enterprise in the form of a business.

We will consider whether your activities are an activity in the form of an adventure or concern in the nature of trade.

In the form of an adventure or concern in the nature of trade

Paragraph 244 of MT 2006/1 explains that an adventure or concern in the nature of trade includes a commercial activity that does not amount to a business, but which has the characteristics of a business deal.

Paragraph 245 of MT 2006/1 refers to 'the badges of trade' with paragraphs 247 to 257 discussing the various 'badges of trade' that may be taken into account when determining whether assets have the characteristics of 'trade' and held for income producing purposes, or held as an investment asset or for personal enjoyment.

While an activity such as the selling of an asset may not of itself amount to an enterprise, account should be taken of the other activities leading up to the sale to determine if an enterprise is carried on.

Paragraph 262 of MT 2006/1 acknowledges that the question of whether an entity is carrying on an enterprise often arises where there are 'one-offs' or isolated real property transactions. Paragraph 263 continues stating that the issue to be decided is whether the activities being conducted 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 252, 253 and 266 of MT 2006/1 provide the following commentary:

252. Improving 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.

253. Trade involves operations of a commercial character. As assets can be sold for reasons other than trade, the circumstances behind the sale need to be considered. For example, a quick resale may have occurred as a result of sudden financial difficulties.

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.

Examples 28 and 29 at paragraphs 271 to 276 of MT 2006/1 provide examples which we consider to be on foot with yours.

Examples of subdivisions of land that are enterprises

Example 28

271. Stefan and Krysia discover that the local council has recently changed its by-laws to allow for smaller lots in the area. They decide to take advantage of the by-law change. They purchase a block of land with the intention to subdivide it into two lots and to sell the lots at a profit. They carry out their plan and sell both lots of land at a profit.

272. Stefan and Krysia are entitled to an ABN in respect of the subdivision on the basis that their activities are an enterprise being an adventure or concern in the nature of trade. Their activities are planned and carried out in a businesslike manner.

Example 29

273. Tobias finds an ocean front block of land for sale in a popular beachside town. He devises a plan to enable him to afford to live there. He decides to purchase the land and to build a duplex. He plans to sell one of the units and retain and live in the other. The object of his plan is to enable him to obtain private residential premises in an area that would otherwise be unaffordable for him.

274. Tobias carries out his plan. He purchases the land, and lodges the necessary development application with the local council. The development application is approved by the council, Tobias engages a builder and has the duplex built. He sells one unit, and lives in the other.

275. Tobias is entitled to an ABN. His intentions and activities have the appearance of a business deal. They are an enterprise.

276. Further, there is a reasonable expectation of profit or gain (see paragraphs 378 to 405 of this Ruling) as his plan has enabled him to be able to keep and live in one of the units.

Therefore, in weighing up all of the facts of your case, and in line with our ruling the profits are assessable as ordinary income, we consider that your activities amount to an enterprise.

GST Treatment

Section 9-5 of the GST Act provides that you make a taxable supply if:

(a) you make the supply for consideration; and

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

(c) the supply is connected to the indirect tax zone (Australia); and

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

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

Sale of a new residential premises is neither GST free nor input taxed.

In your case, the sale of the townhouses will be made for consideration and are located in Australia. The sale of the Property will be made in the course or furtherance of an enterprise that you carry on as explained above. Since your GST turnover from the sale of the townhouses is expected to be over the GST turnover threshold (which is currently $75,000), you will be required to be registered for GST.

Therefore, the sale of the townhouses will satisfy the requirements of section 9-5 of the GST Act and will be subject to GST.

Question 5

Will you be required to register for GST and be liable for GST on the sale of the townhouses?

Summary

Yes

Detailed reasoning

GST registration

Section 23-5 of the GST Act provides that you are required to be registered for GST if you are carrying on an enterprise and your GST turnover meets the registration turnover threshold, currently $75,000.

We have already established that you are continuing to carry on an enterprise of subdivision.

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 a partnership. A partnership for GST purposes is defined by reference to section 995-1 of the ITAA 1997.

Partnership means:

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

b),,,,,

In your case, you are an association of persons that is not in business, but that will nevertheless be in receipt of ordinary income jointly, being the proceeds from the sale of the townhouses.

Relevantly, your GST turnover will exceed the registration turnover threshold if your projected turnover is at or above $75,000. In your case the sale of the townhouses will be revenue assets and therefore included in your turnover. As these amounts are expected to exceed $75,000 your projected turnover will exceed the registration turnover threshold and you (the partnership) will be required to be registered for GST.

Question 6

Are you able to use the Margin Scheme to account for GST?

Summary

Yes, the margin scheme is an option for you to use to calculate the GST payable when you sell the townhouses.

Detailed reasoning

If you make a taxable supply of real property, the GST payable under the basic rule in section 9-70 of the GST Act is 1/11^th of the sale price. However, under subsection 75-5(1), if you make a taxable supply of real property by selling a freehold interest in land you may apply the margin scheme, if you and the recipient have agreed in writing that the margin scheme is to apply, at or before making the supply.

Under the margin scheme, the GST payable on the supply of real property is 1/11^th of the margin for the supply. The margin for the supply is the amount by which the consideration received for the property exceeds the consideration for the acquisition of the real property.

Eligibility to use the margin scheme depends on when you bought the property and when you are selling the property. Your eligibility can be affected by the eligibility of the person from whom you bought the property.

Based on the information you have provided namely you purchased the property on xx/xx/xxxx, and the house was an existing house and therefore not subject to GST, you may be eligible to use the margin scheme provided you agree in writing with the purchaser that the margin scheme is to apply.

Further information about GST and the margin scheme can be found on the ato web site, ato.gov.au by searching QC 18646.

Question 7

Can you claim GST input tax credits incurred in the construction of the townhouses in the period they are incurred?

Summary

Yes, if you plan to sell the townhouses and not hold them, then yes you can claim the input tax credits in the period they are incurred.

Detailed reasoning

An entity that is registered or required to be registered for GST is liable for the GST payable on the taxable supplies that it makes. An entity is also entitled to input tax credits for creditable acquisitions made in carrying on its enterprise.

Goods and services tax ruling GSTR 2009/4 Goods and services tax: new residential premises and adjustments for changes in extent of creditable purpose, states at paragraph 24;

If an entity constructs new residential premises and the entity plans, as evidenced by an objective assessment of the facts and circumstances, to only sell those premises by way of a taxable supply as part of its enterprise, the acquisitions made in constructing the premises will be for a creditable purpose. Assuming all of the other requirements in section 11-5 are satisfied, the acquisitions will be creditable acquisitions and the entity will be entitled to input tax credits.

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