Edited version of private advice

Authorisation Number: 1051845202443

Date of advice: 2 June 2021

Ruling

Subject: Property development

Question 1

Will the profit from the sale of the properties be assessable under section 6-5 of the Income Tax Assessment Act 1997 as a profit-making commercial undertaking?

Answer

Yes.

Question 2

Will the sale of the properties be a mere realisation of a capital gains tax asset?

Answer

No.

Question 3

Is the sale of the properties a taxable supply under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

No, the sale of the properties is not a taxable supply under section 9-5 of the GST Act. No GST liability arises.

Question 4

Are required to make any adjustments under Division 129 of the GST Act to GST credits previously claimed for development expenses?

Answer

No, you are not required to make any adjustments for the GST previously claimed for development expenses.

Relevant facts and circumstances

Entity A purchased properties next to each other. The total land area of both properties is xxxx square metres.

The contract date to purchase both properties was xxxx.

The date of settlement for the properties was xxxx.

Entity A was set up on xxxx for the single project of property development or investment depending on the environment and circumstances of the market.

Entity A registered for GST and intended to undertake a development work, then sell at a profit.

Entity A has claimed GST credit on planning expenses.

A planning permit was applied for on xxxx and granted on xxxx. The planning permit was lodged by a Town Planner.

Entity A rented out the properties from day one to derive rental income.

The tenants of each property were obtained through a real estate agent and were not known or related to entity A.

The weekly rent is $xxxx.

Due to the pandemic impact, entity A changed their intention with respect to the level of development of the land.

Entity A is going to sell the residential properties with a planning permit.

The costs of development total $xxxx. The costs include contribution levy, design, landscaping, council planning, removing trees, surveyor fees and electricity connection.

Part of the costs were self-funded. Further funds were supposed to be from a loan from a financial institution, however this loan was not approved.

The zoning of the land has not changed since purchase and no application has been lodged in relation to the rezoning of the land.

The properties were placed on the market on xxxx. Entity A is hoping to sell the properties in the 20XX-XX income year.

Entity A has architecturally designed a facility, with development approval. Entity A also has a tenant ready with an initial xx year net lease and commencement rental income of $xxxx per annum. The purchaser may have the option to keep the lease agreement with the tenant or withdraw the lease agreement.

Entity A has not been involved in any other property development before.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 995-1

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 40-65

A New Tax System (Goods and Services Tax) Act 1999 Section 195-1

A New Tax System (Goods and Services Tax) Act 1999 Division 129

Reasons for decision

Generally, an amount received in relation to developing land would be assessable either as:

•         ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as business income,

•         ordinary income under section 6-5 of the ITAA 1997 as an isolated commercial transaction with a view to a profit, or

•         statutory income under the capital gains tax (CGT) provisions contained in Part 3-1 of the ITAA 1997 as a mere realisation of a capital asset.

Ordinary income

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Carrying on a business of property development

Section 995-1 of the ITAA 1997 states the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? outlines some factors that indicate whether or not a business of primary production is being carried on. These factors equally apply to other types of businesses. The question of whether a business is being carried on is a question of fact and degree. In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators should be considered in conjunction with the other factors.

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.

Profits from an isolated transaction

Profits arising from an isolated commercial transaction will be ordinary income if the 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 a taxpayer's business (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693).

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income provides guidance in determining whether profits from isolated transactions are ordinary income and therefore assessable under section 6-5 of the ITAA 1997.

The term isolated transaction refers to:

• those transactions outside the ordinary course of business of a taxpayer carrying on a business; and
• those transactions entered into by non-business taxpayers.

If a taxpayer not carrying on a business makes a profit from an isolated transaction or operation, that profit is assessable ordinary income if both of the following elements are present:

• the intention or purposes of the taxpayer in entering into the transaction or operation was to make a profit or gain; and
• the transaction or operation was entered into and the profit was made in carrying out a business operation or commercial transaction.

Profit-making does not need to be the sole or dominant purpose for entering into the transaction. A profit-making purpose must exist at the time the transaction or operation was entered into. Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case.

In this situation, the contract date to acquire the properties was in xxxx. Entity A intended to undertake development work, then sell at a profit. Entity A later changed their intention and are hoping to sell the property with the development application.

To decide if any profit made is ordinary income, we need to consider if the transactions are made in a commercial manner.

TR 92/3 lists the following factors which are relevant in determining whether an isolated transaction amounts to a business operation or commercial transaction:

a.    the nature of the entity undertaking the operation or transaction;

b.    the nature and scale of other activities undertaken by the taxpayer;

c.     the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

d.    the nature, scale and complexity of the operation or transaction;

e.    the manner in which the operation or transaction was entered into or carried out;

f.      the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

g.    if the transaction involves the acquisition and disposal of property, the nature of that property; and

h.    the timing of the transaction and the various steps in the transaction.

In contrast, paragraph 36 of TR 92/3 notes that the courts have often said that a profit on the mere realisation of an investment is not ordinary income, even if the taxpayer goes about the realisation in an enterprising way. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment.

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. The profit from the activity is income even though the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

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.

Taxation Determination TD 92/127 Income tax: property development: if land is acquired for development, subdivision and sale but the development is abandoned and the land sold in a partly developed state, how is a profit on the sale of the land treated for income tax purposes? is relevant. Under TD 92/127 the net profit on the sale of the land is ordinary assessable income.

In addition to the above, 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 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number 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.

The factors listed in paragraph 265 of MT 2006/1 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.

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.

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

Application to your circumstances

In this case, entity A acquired the neighbouring properties with the intention to undertake development work, then sell at a profit.

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

• entity A engaged a town planner to lodge the planning permit;
• a planning permit was applied for and granted;
• the property has an architecturally designed facility, with development approval;
• entity A has found an operator to move into the property;
• costs incurred for the development are $xxxx;
• electricity connection and removing trees has been done;
• there is a coherent plan for the development of the property;
• entity A has changed their intention with respect to the level of development of the land;
• entity A has not been involved in property development business activities in prior years;
• there is an intention to profit from the development and
• the transactions have been undertaken in a commercial manner.

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 remains as a profit-making undertaking. Although the intention in respect to the level of development of the property has changed, there still remains a profit-making undertaking.

The acts of applying for a planning permit and have a facility development approval with a tenant contributes towards a finding that the overall activity constitutes something more than a mere realisation of a capital asset.

Although entity A will not be doing the physical development work, entity A has undertaken the organisation and management of the activities. It is viewed that entity A's activities have the characterisation of a commercial or profit-making undertaking which go beyond a mere realisation of a capital asset.

Based on the facts of this situation, the project is considered to be a profit-making commercial undertaking and the profits from the sale of the properties is considered to be ordinary assessable income under section 6-5 of the ITAA 1997.

Capital gains tax

Under section 6-10 of the ITAA 1997, assessable income also includes statutory income. Capital gains are included as assessable income under section 102-5 of the ITAA 1997.

Section 102-20 of the ITAA 1997 states that a capital gain or capital loss is made only if a CGT event happens to a CGT asset. The properties are a CGT asset (section 108-5 of the ITAA 1997).

CGT event A1 happens if you dispose a CGT asset.

Section 118-20 of the ITAA 1997 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.

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 development of the land is more than a mere realisation of a capital asset.

As highlighted above, the disposal of the properties is an isolated transaction and any profit made on the sale is included in your assessable income under section 6-5 of the ITAA 1997.

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

GST - taxable supply

Section 9-40 of the GST Act provides that you are liable for GST on any taxable supplies that you make.

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 with Australia; and

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

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

Under section 40-65 of the GST Act the sale of residential premises is input taxed to the extent that the property is residential premises to be used predominantly for residential accommodation (regardless of the term of occupation). However, the sale is not input taxed to the extent that the residential premises are:

• Commercial residential premises; or
• New residential premises other than those used for residential accommodation (regardless of the term of occupation) before 2 December 1998.

Section 195-1 of the GST Act explains that Residential premises means land or a building that:

(a)  is occupied as a residence or for residential accommodation; or

(b)  is intended to be occupied, and is capable of being occupied, as a residence or for residential accommodation

(regardless of the term of the occupation or intended occupation) and includes a floating home.

You purchased the properties as existing residential premises with a view of developing a site. You rented the premises from day one to earn income while you obtained relevant planning permits.

The sale of the properties meet the definition of residential premises and as a result the sale of the premises is input taxed under section 40-65 of the GST Act. As a result, no GST liability arises on the sale of the premises.

GST credits

Under Division 129 of the GST Act, an entity needs to make an adjustment if there is a change in the extent of creditable purpose in relation to an acquisition made in the course of your enterprise for which you claim GST credits.

The 'creditable purpose' of an acquisition changes if either:

• there is a difference between how you planned to use the acquisition and how you actually use it
• the way you used the acquisition has changed over time.

In your situation, you incurred $xxxx in development cost expenses in relation to your enterprise of developing and selling it for a profit. This was always your intention.

We do not consider that the costs incurred in your development enterprise are in any way connected with the input taxed supply of residential rent. Your enterprise for which the costs were incurred was the development enterprise and sale, which if proceeded to completion would have been a taxable supply. Your intention to continue with the development enterprise only changed as a result of COVID-19 impacts.

As the extent of creditable purpose of your acquisitions did not change you are not required to make any adjustments in relation to GST credits claimed for the expenses incurred in your development enterprise. That is the costs for which the GST credits were claimed were never used in relation to input taxed supplies of residential rent.

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