Edited version of private advice

Authorisation Number: 1051939714470

Date of advice: 4 March 2022

Ruling

Subject: Proceeds from the sale of land - capital v revenue

Question 1

Will any part of the proceeds or profit made on the sale of the Lots, constitute assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question

Will the gain from the sale of the Lots of Land be assessable treated as the mere realisation of a capital asset?

Answer

Yes

This ruling applies for the following period:

Financial year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Trust A is listed as a discretionary investment trust controlled by Individual A.

Trust B is listed as a discretionary trading trust previously operating a wholesale business. This business has now ceased.

Trust B is controlled by individual B who is Individual A's parent.

Trust A and Trust B (the Joint Owners) purchased a property (the Property) over two titles of land (the Lots) for $XXXX. The Property was purchased at the time under a single contract.

The Joint Owners registered a Partnership for the purposes of jointly purchasing the Property and receive the investment income.

You have stated that the Partnership is not in business and the Joint Owners did not enter into a partnership agreement.

At the time of purchase, a single residential dwelling and external garage occupied an area across both of the Lots.

You have provided a statement that the dwelling was condemned and that a decision to demolish was made when purchasing the Property.

You have stated that the Joint Owner's determined that demolishing the existing dwelling and garage could allow the dual titles of land to be utilised for the construction of separate dwellings in order to maximise investment yield.

A development application was submitted by Company X for a material change of use with the details of the proposed development two (2) dual occupancy dwellings.

Individual A is the sole shareholder and director of Company X. The main business activity of Company X is the construction of properties for third parties according to your statement.

The development application was approved.

The existing dwelling was demolished. Individual A attended to the administrative requirements, organising a third party to provide the demolition services.

The approved dwellings were never constructed by the Joint Owners.

The Owners received an offer to sell both Lots. Contracts for the Lots were entered and Lots settled shortly after this time.

You have stated that the Joint Owners did not actively market the sale of the property.

Prior to the sale of the Lots the Joint Owners had spent approximately $XXX on the Lots, including the costs for demolition.

You have stated that, at the time of the offer, the Joint Owners were worried about the effect that the uncertainty caused by COVID-19 may have on property and construction prices, therefor a decision was made to accept the offer.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Part 3-1 and Part 3-3

Reasons for decision

Summary

The limited activities undertaken by the Joint Owners to dispose of the Lots has led to the conclusion that they were not carrying on a business of property development and sale. As the Joint Owners did not have the requisite profit-making intent at the time of the purchase, the Lot sale is also not considered to be the result of an isolated commercial transaction. Consequentially, no part of the profits or proceeds from the Lot sale will be assessable under section 6-5 of the ITAA 1997.

The sale of the Lots sale is regarded as a mere realisation of a capital asset with any gain subject to the CGT provisions provided in Part 3-1 and Part 3-3 of the ITAA 1997.

Detailed reasoning

In generally, there are three ways by which the proceeds or gains from dealing in land gain be treated for income tax purposes:

•                Sale proceeds are treated ordinary income under section 6-5 of the ITAA 1997 where the land is held as trading stock and sold as part of carrying on a business of property development and sale.

•                Profits are treated as ordinary income under section 6-5, where land is not trading stock and is sold as part of an isolated commercial transaction entered into with a profit-making intention.

•                Gains are treated as statutory income under the CGT provisions in Part 3-1 and Part 3-3, where the land is neither trading stock nor the subject of an isolated profit-making scheme or undertaking and the proceeds of sale are the mere realisation of a capital asset.

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

'Ordinary income' is defined in section 6-5 of the ITAA 1997 to mean 'income according to ordinary concepts'. In general, a receipt will constitute income according to ordinary concepts if it is a receipt arising out of a taxpayer's employment or in the normal scope of a taxpayer's business. In limited circumstances, gains not within the ordinary scope of a taxpayer's business may form part of ordinary income

Where the sale of property is held to be a 'mere realisation' the sale is on capital account to which the CGT rules in Part 3-1 and Part 3-3 will generally apply. These proceeds are not ordinary income

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? (TR 97/11), 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.

Although an associated entity of one of the Joint Owners is involved in a building and construction business, the limited activity required to deal with the Property, draws a conclusion that the Lot sale proceeds are not derived from carrying on a business.

Profits from an isolated transaction

It is well settled law that a profit or gain made by a taxpayer outside the ordinary course of carrying on a business, but which arises from a transaction entered into by that taxpayer with the intention or purpose of making a profit or gain, will constitute assessable income, even where the transaction is an isolated one, "if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit..."(FC of T v. Myer Emporium Ltd (1987) 163 CLR 199 (Myer) at 209-210.

In Myer, at 163 CLR 213; 87 ATC 4369; 18 ATR 699-700, the Full High Court had this to say about the nature of profits from isolated transactions:

It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of acquisition of acquiring for the purpose of profit-making by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realisation. But it is quite another thing if the decision to sell is taken by way of implementation of an intention or purpose, existing at the time of acquisition, of profit-making by sale, at least in the context of carrying on a business or carrying out a business operation or commercial transaction.

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

Paragraph 16 of TR 92/3 summarises the relevant authorities providing that 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.

The relevant intention or purpose of the taxpayer (of making a profit or gain) referred to in Myer 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 (paragraph 38 of TR 92/3).

The relevant purpose must include the purpose of profit-making by the very means by which the profit was in fact made. Such a purpose can be found where the means is but one alternative contemplated by the taxpayer Steinberg v Federal Commissioner of Taxation (1975) 134 CLR 640 at 670 (per Mason J), at 699-700 (per Gibbs J) and at 704-5 (per Stephen J).

It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose (paragraph 40 of TR 92/3 and Federal Commissioner of Taxation v Cooling (1990) 22 FCR 42 at 57.

This issue was considered by the Full Federal Court in Westfield Limited v FC of T. At 91 ATC 4243; 21 ATR 1408, Hill J (with whom Lockhart and Gummow JJ agreed) said:

'...where a transaction falls outside the ordinary scope of the business, so as not to be a part of that business, there must exist, in my opinion, a purpose of profit-making by the very means by which the profit was in fact made. So much is implicit in the decision of the High Court in Myer.'

His Honour limited this broad statement when he pointed out:

'There may be a case, the present is not one, where the evidence establishes that the taxpayer has the purpose or intention of making a profit by turning an asset to account, although the means to be adopted to generate that profit have not been determined: Steinberg v Federal Commissioner of Taxation (1972-75) 134 CLR 640; 75 ATC 4221; 5 ATR 594...

His Honour then said:

While a profit-making scheme may lack specificity of detail, the mode of achieving that profit must be one contemplated by the taxpayer as at least one of the alternatives by which the profit could be realised. Such was the case in Steinberg. But, even if that goes too far, it is difficult to conceive of a case where a taxpayer would be said to have made a profit from the carrying on, or carrying out, of a profit-making scheme, where, in the case of a scheme involving the acquisition and resale of land, there was, at the time of acquisition, no purpose of resale of land, but only the possibility (present, one may observe, in the case of every acquisition of land) that the land may be resold....

The joint owner's primary intent at the time of purchase was to hold the property for the purpose of generating rental income with the expectation of long-term capital growth. Despite the Property being held for a relatively short time, the sale at this time was not anticipated at the time of purchase. It is accepted that the uncertain circumstances associated with the COVID pandemic was the reason the Joint Owners abandoned their intention to hold the property for long term investment purposes.

As the intention or purposes of the taxpayer in entering into the transaction or operation was for investment purposes rather that to make a profit, the first element/condition (profit-making purpose) of paragraph 16 of TR 92/3 is not satisfied.

Of the two elements/conditions of paragraph 16 of TR 92/3, both must be satisfied in order for a profit from an isolated transaction (where a business is not being carried on) to be classified as income. Therefore, it is not necessary to discuss further the second element/ condition (business operation or commercial transaction) of paragraph 16 of TR 92/3. The profits from the sale of the Lots are not considered to be derived from an isolated commercial transaction.

Mere Realisation

Proceeds from the sale of property more often represent the mere realisation of capital assets, with gains subject to the CGT provisions in Part 3-1 and Part 3-3 of the ITAA 1997.

Paragraph 36 of TR 92/3 states the courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. The expression 'mere realisation' is used to contradistinguish a business operation or a commercial transaction carrying out a profit-making scheme.

The full federal court decision in Statham & Anor v FC of T 89 ATC 4070 court was satisfied that the owners did not enter into the business of selling land and said there was nothing surprising in the fact that the owners applied themselves in an enterprising way to the realisation of a capital asset, in a manner calculated to maximise their receipts. But the fact that this occurred does not necessarily make the proceeds either profits from an undertaking or scheme, or income from a business. The court said:

It is well established... that the mere realisation of an asset at a profit does not necessarily render the profit taxable. The profit must arise from the carrying on of a business or a profit-making undertaking or scheme. The mere magnitude of the realisation does not convert it into such a business, undertaking or scheme; but the scale of the realisation activities is a relevant matter to be taken into account in determining the nature of the realisation, ie in determining whether the facts establish a mere realisation of a capital asset or a business or profit-making undertaking or scheme.

The mere realisation of profit in this case does not convert the activities of the Joint Owners into a business or a profit-making undertaking (as held in Statham).

The limited activities of the Joint Owners in disposing of the Lots has led to the conclusion discussed previously that they were not carrying on a business of property development and sale. In the absence of a profit-making intent by the Joint Owners at the time of the Property purchase, the subsequent unexpected sale of Lots is also not considered a profit-making undertaking or isolated commercial transaction.

Therefore, in applying the principle held in Myer as stated above, the Property is deemed to be a capital asset and not a revenue asset, and it is the Commissioner's view that the disposal of the Lots would more accurately represent the mere realisation of a capital asset.

As a mere realisation of a capital asset, any gain or proceeds from the disposal of Properties, will not be assessable as ordinary income under section 6-5 of the ITAA 1997. The gain will be subject to the CGT provisions provided in Part 3-1 and Part 3-3 of the ITAA 1997.

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