Edited version of private advice

Authorisation Number: 1051824502075

Date of advice: 28 April 2021

Ruling

Subject: Trading stock

Question 1

Is the tax treatment of the acquisition and disposal of the property treated as a trading stock?

Answer

Yes

Question 2

Is the tax treatment of the acquisition and disposal of the property treated as a capital item?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2019

Year ended 30 June 2020

The scheme commences on:

1 July 2018

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You submitted a Private ruling application in your name on behalf of the partnership on 23 October 20XX.

The partnership has prior development history through a number of management development agreements and has lodged income tax returns for the years ended 30 June 20XX, 30 June 20XX and 30 June 20XX in relation to land development and subdivision.

The income tax return for the partnership for the year ended 30 June 20XX and was marked as a final return when lodged.

The Australian Business number (ABN) for the partnership was cancelled with an effective date of 30 June 20XX.

In December 20XX, Council forwarded Local Planning Scheme 3 (LPS 3) to the State Planning Commission (PC) for consent to advertise proposing the property remain with its current R12.5 zoning.

In October 20XX the PC granted consent to advertise LPS 3 subject to modification increase density to a significant degree throughout the area including the property being rezoned from Residential R12.5 (single house only) to R40 (grouped dwelling or multiple dwellings), allowing one lot to be subdivided into up to 3 lots, or units be built on the site.

The LPS 3 was advertised from December 20XX to March 20XX.

The Council considered submissions which had been made during advertising; and decided not to recommend supporting LPS 3 and advised the PC of this in July 20XX.

You consider it uncommon for Councils to not support Local Planning Schemes and in this instance by not supporting the scheme, the decision would then rest with the PC on what Scheme would be recommended to the Minister for Planning for approval.

The Minister and the PC have a clear mandate from the State Government to increase densities and was widely expected to support increased density like what it has proposed in the advertised version of the Scheme where it increased the density on what was advertised.

The contract of sale to purchase the property was executed on 13 December 20XX and settlement occurred on 30 January 20XX.

At that time the LPS 3 had been advertised, submissions had been considered and Council resolved not to support LPS 3 and the decision on LPS 3 was with the PC to make a recommendation to the Minister for Planning. There was no indication that the PC had changed their expectation on density increases and rezoning from the advertised version of the scheme.

The property was purchased with the intention to apply for subdivision, undertake subdivision activities including demolition of existing building and power and sewer modifications and sell the subdivided lots.

You obtained quotes dated 14 December 20XX to undertake feature survey and cost for providing services to undertake 2 and 3 lot subdivision applications.

Your intention to subdivide and make a provide is outlined in your email that outlines two options for subdivision of the block.

•         Option 1 proposes a subdivision into 2 blocks with an intention to make a profit of $XXX per block.

•         Option 2 with a proposed subdivision into three blocks shows land cost of $XXX, build cost of $XXX and being smaller blocks would return $XXX profit.

On 16 April 20XX the Local Planning Scheme was gazetted with no ability for this area to be subdivided.

As the property did not get rezoned, you placed the property on the market in July 20XX via a real estate agent to sell the property without any change to the property from the condition it was purchased.

As there was no interest from buyers you signed a listing agreement to sell the property through another agent on 3 September 20XX and entered into a contract to dispose of the property and settlement occurred on 12 December 20XX.

You believe the property was trading stock as the intention at the time of purchase was to develop the property and dispose of the property. There was no intention to hold the property.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 Section 70-10

Income Tax Assessment Act 1997 subsection 70-30(1)

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

Income Tax Assessment Act 1997 Section 104-220

Taxation Ruling (TR) 92/3

Taxation Determination (TD) 92/124

Taxation Determination (TD) 92/126

Taxation Ruling TR 97/11

Detailed reasoning

The proceeds from the sale of land can be treated as:

•         assessable ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) from carrying on a business of property development, subdivision and sale, or resale; or from an isolated business or commercial transaction; or

•         a mere realisation of a capital asset, assessable under Parts 3-1 and 3-3 of the ITAA 1997.

Section 6-5 of ITAA 1997 provides that the assessable income of an Australian resident for taxation purposes includes ordinary income derived directly or indirectly from all sources. Ordinary income has been held to include income from carrying on a business. Therefore, where an entity is carrying on a business of property development the income derived from carrying on that business will be included in its assessable income pursuant to section 6-5.

A deduction is allowed under section 8-1 of the ITAA 1997 for losses or outgoings necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, a deduction is not allowed under section 8-1 of the ITAA 1997 to the extent that the loss or outgoing is of a capital nature. Other relevant provisions of the Income Tax Assessment Act 1936 (ITAA 1936) or the ITAA 1997 may allow deductions for expenditure incurred in the course of carrying on a business that are not deductible under section 8-1.

The basic distinction between the sale of property as part of a business, or alternatively, as an isolated 'profit making' undertaking or scheme is that the latter will generally be a one-off event and not carried out in an overly organised or systematic manner. Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) provides guidance to determine whether profits from isolated transactions are ordinary income. In Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199 the

High Court stated at 211:

...a receipt may constitute income, if it arises from an isolated operation or commercial transaction entered into otherwise than in the ordinary course of the carrying on of the taxpayer's business, so long as the taxpayer entered into the transaction with the intention or purpose of making a relevant profit or gain from the transaction.

In contrast to the sale of land being an isolated business or commercial transaction, or from carrying on a business, the sale may be the mere realisation of a capital asset. The Commissioner accepts that where the activities undertaken by an entity are no more than the mere realisation of a capital asset, any realised gain on the transaction will be a capital gain under the capital gains tax (CGT) provisions in the ITAA 1997. 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.

The CGT provisions are contained in Parts 3-1 and 3-3 of the ITAA 1997. 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 of the ITAA 1997 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. The inclusion in assessable income of the profit or gain on the sale of a CGT asset does not mean that a CGT event does not happen in relation to the asset. However, section 118-20 of the ITAA 1997 operates to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. Therefore, while a CGT event will occur when an asset is sold (CGT event A1), any capital gain will be reduced by the amount included as ordinary assessable income under section 6-5 of the ITAA 1997.

Carrying on a business of property subdivision and development

The question of whether a business is being carried on is a question of fact and degree to be determined on a case by case basis.

Subsection 995-1(1) of the ITAA 1997 defines 'business' to include 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'. This definition simply states what activities may be included in a business; it does not provide any guidance for determining whether the nature, extent, and manner of undertaking those activities amount to the carrying on of a business.

Profits made on the sale of land can be considered ordinary income under section 6-5 of the ITAA of 1997 if the activities become a separate business operation.TR 92/3[1], paragraph 11 states:

The transaction may take place in the course of carrying on a business even if the transaction is outside the ordinary course of the taxpayer's business.

Further, Gibbs CJ in Whitfords Beach [2] provided the following commentary,

On the day that the shares were transferred.... 'the taxpayer was transformed from a company which held land for the domestic purposes of its shareholders to a company whose purpose was to engage in a commercial venture with a view to profit.' (page 4039)

The purpose of those controlling the taxpayer company was to engage in a business venture with a view to profit: 'Counsel for the taxpayer submitted that it was not permissible to blur the distinction between the company and its shareholders. That of course is true, but in deciding whether what was done was an operation of business, it is relevant to consider the purpose with which the taxpayer acted, and, since the taxpayer is a company, the purposes of those who control it are its purposes.' (page 4039)

Paragraph 13 of Taxation Ruling TR 97/11[3] states that the courts have held that the following indicators are relevant to whether or not a person is carrying on a business (although TR 97/11 specifically deals with carrying on a primary production business, the principles discussed in that Ruling can apply to any business):

a)    does the activity have a significant commercial purpose or character?

b)    does the taxpayer have more than a mere intention to engage in business?

c)    is there an intention to make a profit or a genuine belief that a profit will be made? Will the activity be profitable?

d)    is there repetition and regularity in the activity?

e)    is the activity of the same kind and carried on in a similar way to that of the ordinary trade in that line of business?

f)     is the activity organised in a businesslike manner?

g)    what is the size or scale and permanency of the activity?

h)    is the activity better described as a hobby, a form of recreation or a 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 circumstances

The following considers the above indicators for your circumstances:

Significant commercial purpose or character

The significant commercial purpose or character indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of other indicators. It is particularly linked to the size and scale of the activity, the repetition of the activity and the profit indicators.

Paragraph 29 of TR 97/11 provides that a way of establishing that there is a significant commercial purpose or character is to compare the activities with those of a taxpayer who is carrying on a similar activity that is a business.

Any knowledge, previous experience or skill of the taxpayer in the activity, and any advice taken by the taxpayer in the conduct of the business should also be considered but are not necessarily determinative.

You have had previous experience with a number of developments under various structures including the partnership structure through management development agreements.

The Commissioner considers that your activities exhibit a significant commercial purpose or character and this indicator suggests you were carrying on a business of land development.

Intention to engage in business

In Inglis, Brennan J stated:

The carrying on of a business is not a matter merely of intention. It is a matter of activity....At the end of the day, the extend of activity determines whether a business is being carried on. That is a question of fact and degree.

You purchased the property with the intention of applying for subdivision, undertake subdivision activities including demolition of existing building and power and sewer modifications and sell the subdivided lots.

You obtained quotes to undertake feature survey and cost for providing services to undertake 2 and 3 lot subdivision applications.

You did not intend to hold the land.

The Commissioner considers that you committed the land to subdivision from the time of purchase of the property.

Is there an intention to make a profit or a genuine belief that a profit will be made?

Stronger evidence of an intention to make a profit occurs when you have conducted research into your proposed activity, consulted experts or received advise on the running of the activity and profitability of it before setting up the business.

You obtained quotes from Landsurveys dated 14 December 20XX to undertake feature survey and cost for providing services to undertake 2 and 3 lot subdivision applications that demonstrates research into your proposed activity.

Your email of dated 17 December 20XX outlines the options for subdividing the block is also indicative of your intent to make a profit on the sale of the subdivided blocks.

The Commissioner regards that you have intentions to make profit from the activity as you have consulted experts and received advice on the costings of feature surveys and costs of providing services to undertake the subdivision. These are positive indicators of carrying on a business of land development.

Is there repetition and regularity of the activity?

It is often a feature of business that similar sorts of activities ae repeated on a regular basis. The repetition of activities by the same person over a period of time on a regular basis helps to determine whether there is the 'carrying on' of a business.

The Commissioner notes that you have previous experience in land developments in an enterprising, advantageous and businesslike way. Your email of 17 December 20XX shows option 2 to be the construction of 3 strata title villas which is similar to previous land development projects undertaken.

The Commissioner considers these to be positive indicators of carrying on a business for the purpose of land development.

Is the activity organised in a businesslike manner?

A business is characteristically carried on in a systematic and organised manner rather than on an ad hoc basis. An activity should generally conform with ordinary commercial principles to amount to carrying on a business.

You stated you obtained quotes from Landsurveys dated 14 December 20XX to undertake feature survey and cost for providing services to undertake 2 and 3 lot subdivision applications.

No other work was carried out as you were waiting on the results of the rezoning process.

What is the size or scale of the activity?

The size or scale of the activity is not a determinative test, and a person may carry on a business in a small way. However, if the scale of the activities results in more than is required for your own domestic needs combined with an intention to profit from the activities and a reasonable expectation of doing so, a business may be carried on despite the scale.

Is the activity better describe as a hobby or a form of recreation of sporting activity?

You have not provided any information that support that the activity is better described as a hobby, a form or recreation or a sporting activity.

The Commissioner considered that your activities are not a hobby, or a form of recreation and this indicator is not relevant.

TR 92/3 does not provide further detail on the time at which the Commissioner considers that a transaction has been "entered into" to constitute the carrying on of a business or business operation or commercial transaction.

In Whitfords Beach[4], Bowen CJ, Morling and Fitzgerald JJ stated that:

it does not follow that all activities engaged in by the taxpayer were necessarily in the course of that business or that some of them were not merely preparatory to it. In order to determine when the taxpayer's relevant business commenced and when its land or the various parts of it were committed to or venture into that business, it is necessary to have regard both to the taxpayer's purposes or its activities.

In TD 92/124, at paragraph 2, the Commissioner considers that a 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".

This follows the comments by the Court in Whitfords Beach where it was held that the "taxpayer's business of developing, subdividing and selling the land commenced as soon as the intention to take steps for that purpose in relation to the entire land was formed and activities directed to that end were commenced...".[5]

It is not necessary that the acquisition of land be repetitive. While ordinarily the carrying on a business of development will involve repeated acts of buying and selling, this is not an essential feature of trading, and a taxpayer can commence a business prior to any acts of subdivision.[6]

There are generally six stages in the development process, as set out by Emmett J in FCT v Kurts Development Ltd:[7]

1.    Rezoning

2.    Subdivision approval

3.    Engineering and design process

4.    Construction process

5.    Plan sealing process

6.    Registration of titles

From analysis of the facts the Commissioner considers that you embarked on a cycle operations of property development with the intention to lead to the subdivision and sale of the land, at the time you obtained quotes from Landsurveys dated 14 December 20XX to undertake feature survey and cost for providing services to undertake 2 and 3 lot subdivision applications. At this point of time you've commenced taking steps in the development process as set out by (Emmett J in FCT v Kurts Development Ltd[8]) for the purpose of developing, subdividing and selling the land.

Therefore, the Commissioner considers that it is reasonable to conclude that you were carrying on a property development business at the time, when you purchased the land.

Conclusion

The Commissioner is satisfied that your activities, as reflected in the indicators above, go beyond the mere realisation of a CGT asset.

Therefore, the Commissioner considers that the indicators reflect that a land development business was commenced by you when you purchased the land. You engaged a Landsurveys to undertake feature survey and costings for providing services to undertake 2 and 3 lot subdivision applications. The Commissioner considers that you were carrying on a business of land development at this time.

As the Commissioner considers that a business of land development has commenced, it was not necessary to consider whether your activity would generate profits from an isolated transaction as assessable income as described in TR 92/3[9] are income and section 15-15 of the ITAA 1997.

Trading stock issues applying to your circumstances

The trading stock provisions in Division 70 of the ITAA 1997, apply to your land. Section 70-10 of the ITAA 1997 discusses the meaning of trading stock. It states:

Trading stock includes:

a)  anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and

b)  live stock.

In considering whether property is trading stock, Taxation Determination TD 92/124 Income Tax: property development: in what circumstances is land treated as 'trading stock'? (TD 92/124) 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 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 stated in paragraph 3 of TD 92/124, it is not necessary that the acquisition of land be repetitive. That is, the development of one specific property can constitute a property development business, in which case the sale of the property is within the ordinary course of that business and the property is trading stock (R & D Holdings Pty Ltd v DCT [2006] FCA 981 (R & D Holdings) and FCT v St Hubert's Island Pty Ltd (In Liq) [19781 HCA 10; (1978) 138 CLR 210 (St Hubert's Island))

Land that is not initially acquired for subdivision, development and sale, but is later 'held' for that purpose will also be trading stock.

Land can be trading stock before it has been turned into the condition in which it is intended to be ultimately sold - that is, land intended to be sold after subdivision is still trading stock before it is subdivided (R & D Holdings; St Hubert's Island). It is only when the land is subdivided, so that different parts of the land become an identifiable and segregated parcel of land subject to separate title or titles, separate from the other parts of the land that each plot of land becomes an individual article of trading stock (Barina Corporation Ltd v FC of T 85 ATC 4186).

Application to your circumstances

The partnership of XXX and XXX carried on a business of property development. The land held by the partnership for the purposes of development and sale in its business is trading stock as defined in section 70-10 of the ITAA 1997.

Conclusion

Weighing all of the evidence together, on balance it is more likely that you are in business and therefore the land will be classed as trading stock for the entity.

[1] Taxation Ruling TR 92/3: Income Tax: whether profits on isolated transactions are income.

[2] Whitfords Beach Pty Ltd v FC of T (1983) 14 ATR 247, 253.

[3] Taxation Ruling TR 97/11: Income Tax: am I carrying on a business of primary production.

[4] Whitfords Beach Pty Ltd v FC of T (1983) 14 ATR 247, 253.

[5] Whitfords Beach Pty Ltd v FC of T 83 ATC 4277, 4283.

[6] FCT v St Hubert's Island Pty Ltd (in liq) (1978) 138 CLR 210, Jacobs at [11].

[7] 98 ATC 4877 at 4880-4881.

[8] 98 ATC 4877 at 4880-4881.

[9] Taxation Ruling TR 92/3, paragraph 6.

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