Edited version of private advice

Authorisation Number: 1051915736481

Date of advice: 4 November 2021

Ruling

Subject: Sale of property

Question 1

Will the proceeds from the sale of property A and property B (the Site) be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of carrying on a business of property development, involving the sale of land as trading stock?

Answer

No.

Question 2

Will the proceeds from the sale of the Site be assessable under section 6-5 of the ITAA 1997 as an isolated commercial profit-making transaction?

Answer

Yes.

Question 3

Will the profit from the sale of the Site be assessable under the capital gains tax provisions as a mere realisation of a capital gains tax asset?

Answer

No.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July xxxx

Relevant facts and circumstances

Entity A and entity B formed an investment platform to acquire property in xxxx and undertake a project.

Entity B is associated with entity C, which is involved in construction, development and property investment. The vast majority of their investments are long term in nature, however they did participate in land subdivision in xxxx.

Entity A, which has a 50% interest in the project, is associated with entity D which has a history of purchase of existing buildings as long-term rental investments, purchase of sites for redevelopment to subsequently be held as long-term investments as well as some properties purchased for redevelopment and sale.

A joint venture agreement (the agreement) between entity A and entity B (the parties), was finalised and executed on xxxx, however the parties were effectively operating under the provisions of the agreement while in draft. The effective date under the agreement is xxxx.

The objectives as stated in the agreement are to:

•         carry on the Project;

•         develop the project and the property in accordance with the Project Plan; and

•         maximise the value of the Joint Venture and the Project.

An ABN was obtained and the parties lodge tax returns as a tax law partnership and are registered for GST.

The joint venture was initially established for the purpose of purchasing property C, comprising xxxx square metres of land and buildings.

The contract for the acquisition of property C settled on xxxx for a purchase price of approximately $xxxx.

A neighbouring property, property B, was subsequently purchased by the parties on xxxx for a purchase price of $xxxx. The property comprised a single existing residence on xxxx square metres of land. This house was leased to residential tenants from xxxx to xxxx.

Subsequently, the parties purchased property A, an adjacent parcel of land, in xxxx for a purchase price of approximately $xxxx. This site measures xxxx square metres.

Property A and property B combined are referred to as the Site. The Site is approximately xx% of the total area owned by the parties.

The combined Site and property C are referred to as the Land.

All properties were purchased as tenants in common.

The project has been funded by equity from the two parties. There was no bank funding for the purchase of the Land.

Since the purchase of property C, the parties have taken action to remediate property A, which was a condition of the purchase, before the land could be used for any purpose. This work commenced in xxxx and was completed in xxxx and cost $xxxx. The parties carried out the work in conjunction with entity E.

Since xxxx, property B has been used as the site office relating to the work on property A. No demolition has occurred on property B.

Property A has remained vacant since purchase and no portion of the property has been rented. The building and other item were demolished to allow for the remediation work.

There has been no intention to subdivide any part of the Land. During the period of ownership, submissions have been made to the relevant authority regarding potential development on the Land.

At the time of the purchase of the Land the intention was to increase the value of the Land while minimising costs, enter into leases initially with short term tenants, achieve development approval in a given timeframe to build and enter into commitment for long term leases. At the time of original purchase, it was envisaged that by xxxx, additional funds would be needed but it was also foreseen as a possibility that the Land could be sold. In xxxx, additional funds were obtained.

The parties entered into a period of exclusivity of discussions with a developer. However, no agreement was reached and the discussions concluded in xxxx.

By xxxx, the parties were in the process of negotiating the lease for a portion of the Site. In xxxx, they executed terms with entity F for a term of xx years.

Remediation work added a further $xxxx cost to the Site and there have also been some management and holding costs, some of which have been offset by rental income. The total cost for the Site including purchase is approximately $xxxx.

Under the agreement, a development manager was appointed.

The Land has not been on the market for sale. Various proposals have been sought and assessed, however, as the proposals did not align with the required outcomes they were not progressed.

In xxxx, the parties were approached by entity G regarding the potential sale of the Site. The approach was unsolicited and an offer was subsequently made. The proposed price for the sale of the Site is $xxxx. It is proposed the contract for the sale of the Site will be executed in the year ended xxxx, although it may not settle until the xxxx income year.

The Site will not be subdivided.

Under the agreement, nothing prohibits the owners agreeing to sell the property or vary the project at any time.

No development application has been made.

There is no proposal to sell property C.

The parties are not planning on purchasing any other property or assets.

Under the agreement, all costs and profits are shared equally between the parties.

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 70-10

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

Reasons for decision

Generally, an amount received in relation to subdividing 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.

Whilst it is not free from doubt, it is considered that the parties are not carrying on a business for tax purposes. Although some related entities have previously carried on property development activities and some aspects are business-like, based on the information provided and the above factors, we do not consider that any proceeds from the current activities and sale of the Site would be derived in the course of carrying on a business.

Trading stock

The term 'trading stock' is defined in subsection 70-10(1) of the ITAA 1997 to include:

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

Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'? (TD 92/124) confirms that it is the Commissioner's view that land will be 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.

TD 92/124 explains that 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. 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. Therefore, if land is held for the purpose of development, subdivision and sale by a taxpayer carrying on a business of property development it will be trading stock of that business.

In your case, there was not a definite and continuous cycle of operations designed to lead to the sale of the land, nor were you considered to be undertaking a business activity which involved dealing in land, therefore the site would not be regarded as the sale of trading stock.

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, property B has been owned since xxxx and property A has been owned since xxxx. After carrying out some activities, the parties have decided to sell the Site.

Although the parties are not currently in the business of property development, 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:

1. the nature of the entity undertaking the operation or transaction;
2. the nature and scale of other activities undertaken by the taxpayer;
3. the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;
4. the nature, scale and complexity of the operation or transaction;
5. the manner in which the operation or transaction was entered into or carried out;
6. the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;
7. if the transaction involves the acquisition and disposal of property, the nature of that property; and
8. 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.

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 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.

Numerous cases have considered the assessability of profits or proceeds from the sale of land including the following cases:

Case E20, 73 ATC 160, which involved two builders, claimed that certain properties were purchased out of the funds of the partnership as an investment to derive rents and that other properties were acquired to build houses thereon and let them. These claims were rejected and it was held that the profits from the sale of properties sold pursuant to a forced sale were assessable. The properties were acquired with the intention of committing them to whatever profit-making purpose commended itself to the taxpayers at the appropriate time so that the profit was assessable as ordinary income.

Statham & Anor v. FC of T 89 ATC 4070 20 ATR 228 (Statham's case) where the property was subdivided and sold after a business of raising cattle had failed. The taxpayer relied on the local council to carry out the subdivision work and the local real estate agents handled the advertising and sale of the lots. The Full Federal Court held that what occurred was the realisation, by the most advantageous means, of the asset which the owners had on their hands when they abandoned the intention of farming the subject property.

Casimaty v FC of T 97 ATC 5135; (1997) 37 ATR 358 (Casimaty's case) where due to the growing debt and the ill health of the taxpayer, primary production land was progressively subdivided and sold off over a period of 18 years. There was no coherent plan conceived for the subdivision of the whole property. The taxpayer had acquired and had continued to hold and use the residence and conduct the business of a primary producer on the property. Therefore, there was no change of purpose of object for which the property had been held. In his judgment, Ryan J in the Federal Court held that the profits resulted from the mere realisation of a capital asset and as such the profits were not assessable as ordinary income.

Richardson v FC of T 97 ATC 5098, in which the taxpayer was an engineer who operated a building and project management business through a company (IR Pty Ltd). The company was also the trustee of a family trust of which the taxpayer was a beneficiary. As part of the construction of a building for another company, IR Pty Ltd (as trustee of the family trust) sold a parcel of land and purchased another for the same consideration. The parcel of land was then used as a rental property until sold. The profit made on disposal was ordinary income of the trust as the family trust had a purpose or intention of profit-making when entering into the relevant transactions and the acquisition was made as part of the trust's business of deal making.

McCurry & Anor v FC of T 98 ATC 4487, in which two brothers bought a block of land in 1986 for $32,000. They subsequently borrowed $80,000 to enable them to construct three townhouses. They could not sell the townhouses and, in mid-1987, they and members of their family moved into two of the townhouses. The third townhouse was used partly as a storeroom for a news agency business purchased by the family and partly as accommodation for visitors. The townhouses were sold in December 1988, but the family remained in two of them as tenants. The court found that profit-making by sale (rather than the receiving of rental income) was the dominant factor. Accordingly, the net profit arising from sale of the property was ordinary income.

As displayed in the above cases, a taxpayer can embark on a profit-making scheme after property was acquired for a different purpose.

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, the parties acquired the properties referred to as the Site in xxxx and xxxx. At the time of purchase, the intention was to increase the value of the Land and initially enter into short term tenants, achieve development approval in a few years to build a development and enter into long term leases.

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

• an agreement was entered into;
• there is a coherent plan for the use and development of the Land;
• the original intention was to keep the Land for long term lease;
• there has been a change in the purpose of owning the Site;
• the parties have not been involved in property development or subdivision, however associated entities have been involved in property development activities in the past;
• the purchase of the properties was funded by equity from the parties;
• a significant amount of capital has been invested since purchase;
• additional funds have been obtained to meet the funding commitments;
• the total monetary outlay is significant;
• there is an intention to profit from the development of the Land;
• the transactions have been undertaken in a commercial, organised, professional and deliberate manner;
• submissions have been made to the relevant authority regarding potential development on the Land;
• the parties have worked with relevant entities to undertake the various activities;
• work has been carried out which was a condition of the purchase of property A;
• the building and other item have been demolished;
• an unsolicited offer has been made for the purchase of the Site; and
• the activities undertaken are more complex than to sell the Site with minimal activity as a mere realisation of a CGT asset.

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

Although the Site was purchased with the intention to be developed and used for long term leasing, the intention in relation to the Site changed when a purchaser approached the parties.

It is acknowledged that some work was a condition of purchase and there has been no subdivision, however the plans under the agreement go beyond the required remediation works.

The decision to enter into the agreement and to develop the Site shows a choice to engage in exposure to the risks of the development, including the profits, losses and its general success for the purpose of maximising the potential profit.

It is acknowledged that you didn't advertise the property for sale, however, with the various activities completed, it cannot be said that minimal development work has been undertaken as in Statham's case and Casimaty's case. There has been a coherent plan and a profit-making purpose in the activities.

Although the parties may not be carrying on a business of property development, they are nevertheless involved in a commercial profit-making undertaking. The activities 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 Site 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 property is 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 activities and sale of the Site is more than a mere realisation of a capital asset.

As highlighted above, the disposal of the Site 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 Site will be reduced to the extent that the profit from the sale of the property is included in your assessable income under section 6-5 of the ITAA 1997.

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