Edited version of private advice

Authorisation Number: 1052029578727

Date of advice: 19 September 2022

Ruling

Subject: CGT - GST and property

ISSUE 1: Income tax and Capital gains tax

Question 1: Will the proceeds from the sale of the Units be assessable under section 6-5 of the Income Tax Assessment Act 1997?

Answer: Yes.

Question 2: Will the cost base of the Land be the cost base of the Property when CGT event C1 occurred to the House?

Answer: Yes.

Question 3: Will the cost base of the Land be apportioned between the two subdivided lots on a reasonable basis?

Answer: Yes.

Question 4: Will the construction costs of each unit be included in the fourth element of the cost base of the subdivided lot on which it is constructed?

Answer: Yes.

Question 5: Are you entitled to the main residence exemption on the disposal of either of the Units?

Answer: No.

ISSUE 2: Goods and Services Tax

Question: Will your sale of the Units be subject to Goods and Services Tax (GST) under section 9-40 of the A New Tax System (Goods and Services Tax) Act 1999?

Answer: Yes.

GST is payable by you, being Person A and Person B, as a partnership. You will be required to register for GST as a partnership entity.

This ruling applies for the following periods:

Income year ended 30 June 20XX

Income year ended 30 June 20XX

Income year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Background

You, being Person A and Person B, obtained a home loan to purchase a property.

You are not registered for GST as a partnership or individually, nor have you been registered in the past.

You jointly purchased a property (the Property) after 20 September 1985 which consisted of a house (the House) that you planned to upgrade and retain as your family home, and land on which the House was located (the Land).

You moved into the Property several months after the settlement on the purchase of the Property occurred.

You sought quotes from various builders in relation to renovating and extending the House and engaged the services of Person X to extend and upgrade the House (activities to be undertaken on the House collectively referred to as the Works).

You moved into a rental property while the Works were being undertaken.

You experienced ongoing issues over a significant period of time with the Works not being progressed.

You determined that Person X had abandoned the Works leaving the House in an unliveable condition from exposure to the weather.

You left the rental property and relocated to another State.

You determined that if the Property was sold without the House, you would still have a significant debt. It was determined that engaging the services of another builder to rectify the state of the House would lift the value of the Property, but not sufficiently to be cost effective in relation to your existing debts and the additional costs that would need to be incurred to undertake the rectification activities.

Development of the Property

You decided that the House would be demolished and a duplex consisting of two units would be constructed on the Property, with the Land being subdivided into two lots with a unit located on each lot (collectively referred to as the Development) to realise the value of the outstanding loans, or around the value of the loans.

You borrowed more than $X to fund the Development in addition to contributing a significant amount of several hundred thousand dollars from your savings account.

You did not have any plans to live in either of the proposed units, nor did you have any plans to rent either of the units, with each subdivided lot and the unit located on it to be sold off the plan (each subdivided lot and the unit constructed on it to be referred to individually as Unit 1 or Unit 2, or collectively as the Units).

You engaged the service of Company A who lodged a Development application with the council for the demolition of the existing structures on the Property and construction of a dual occupancy with two lot Torrens title subdivision on the Property, which was approved by the council.

The House was demolished, with construction of the duplex commencing immediately after the demolition of the House and the clearing of the site had occurred.

The Construction Certificate was issued several months after the Development approval was approved.

You engaged the services of parties to undertake activities in relation to the demolition of the House, subdivision and construction of the duplex such as:

You engaged the services of a real estate agent to sell the Units by private treaty off the plan.

The contract for the sale of both Unit 1 and Unit 2 were entered into several months apart which included the following information:

•         Proposed lots in unregistered Plan

•         Each involved the vacant possession of garage and duplex

•         Sale price of each of the Units being more than $1 million

•         GST taxable supply - No, as sold by a vendor who is neither registered nor required to be registered for GST.

The Final Occupation Certification of the Units was granted during the year after the contracts of sale were entered, with the Plan of Subdivision of the Land being endorsed several months later.

Settlement on the sale of the Units occurred some months later.

Neither of you, nor any related parties:

•         have undertaken any similar activities in relation to property development in the past; or

•         have any intention to undertake any similar activities in relation to property development in the future.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

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 104-20

Income Tax Assessment Act 1997 Subsection 104-20(1)

Income Tax Assessment Act 1997 Subsection 104-20(2)

Income Tax Assessment Act 1997 Subsection 104-20(3)

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Subsection 108-55(1)

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Subsection 110-25(1)

Income Tax Assessment Act 1997 Section 110-55

Income Tax Assessment Act 1997 Paragraph 112-25(1)(a)

Income Tax Assessment Act 1997 Subsection 112-30(2)

Income Tax Assessment Act 1997 Subsection 112-30(3)

Income Tax Assessment Act 1997 Subsection 112-30(4)

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Subsection 118-20(2)

Income Tax Assessment Act 1997 Subsection 112-20(3)

Income Tax Assessment Act 1997 Section 118-110

Income Tax Assessment Act 1997 Section 118-120

Income Tax Assessment Act 1997 Section 118-150

Income Tax Assessment Act 1997 Paragraph 118-150(3)(a)

Income Tax Assessment Act 1997 Paragraph 118-150(3)(b)

Income Tax Assessment Act 1997 Section 118-160

Income Tax Assessment Act 1997 Section 118-190

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

A New Tax System (Goods and Services Tax Act) 1999 Section 9-5

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

A New Tax System (Goods and Services Tax Act) 1999 Section 9-40

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

A New Tax System (Goods and Services Tax Act) 1999 Section 40-65

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

A New Tax System (Goods and Services Tax Act) 1999 Section 184

A New Tax System (Goods and Services Tax Act) 1999 Section 188-10

A New Tax System (Goods and Services Tax Act) 1999 Section 188-25

Reasons for decision

ISSUE 1: Income tax and Capital gains tax

Legislative references are to the Income Tax Assessment Act 1997 unless otherwise specified.

Question 1: Will the proceeds from the sale of the two units be assessable under section 6-5?

Summary

Based on the facts provided, it is the Commissioner's position that your activities in relation to the demolition, land subdivision, construction, and sale of the Units on the subdivided lots constitute a profit-making undertaking or scheme. You have undertaken these activities in commercial like transactions with the intention of making profits.

Therefore, the proceeds from the sale of the Units will be assessable as ordinary income under section 6-5.

As the Units are also CGT assets, CGT event A1 occurred on the sale of both Unit 1 and Unit 2. However, any capital gain made from the event would be reduced by the amount included in your assessable income under section 6-5.

Detailed reasoning

Taxation treatment of property sales

Broadly profits from land development, subdivision, construction, and sale of Units on subdivided land can be treated for taxation purposes in the following three ways:

1.    As ordinary income under section 6-5 (revenue account) resulting from the carrying on a business of property development, and the sale of subdivided land and Units as trading stock; or

2.    As ordinary income under section 6-5 (revenue account) resulting from an isolated business or commercial 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; or

3.    As statutory income under the capital gains tax (CGT) legislation (capital account).

Whether the proceeds are treated as income or capital depends on the situation and circumstances of each case.

We will consider each of the ways you can make a profit as outlined above in relation to the gain made on the sale of the Units as follows:

Carrying on a business of property development

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

To determine whether an activity, or series of activities, amounts to a business, the activity needs to be considered against the indicators of a business established by case law.

In the High Court of Australia case of Hope v. Bathurst City Council (1980) 144 CLR 1; (1980) 29 ALR 577; (1980) 80 ATC 4386; [1980] HCA 16, a business was described in the following ways:

It is the words "carrying on'' which imply the repetition of acts and activities which possess something of a permanent character.

...activities engaged in for the purpose of profit on a continuous and repetitive basis.

Transactions were entered into on a continuous and repetitive basis for the purpose of making a profit...manifested the essential characteristics required of a business.

The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 which uses the following indicators to determine whether a taxpayer is carrying on a business:

•         whether the activity has a significant commercial purpose or character

•         whether there is repetition and regularity of the activity

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

•         whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at 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 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 situation

Based on the facts provided, you are not carrying on the business of property subdivision and development and the Development was not the commencement of the carrying of a business.

Isolated business transactions

Profits from isolated transactions will be assessable as ordinary income where the intention or purpose in entering into the transaction was to make a profit or gain and the transaction was entered, and the profit was made in the course of carrying out a business operation or commercial transaction.

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income sets out the Commissioner's view as to the application of the decision in Myer Emporium and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5.

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.

Paragraph 12 of TR 92/3 states that 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 TR 92/3 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.

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 (as discussed below) aligns itself with TR 92/3 and provides a list of factors which, if present may be an indication that a profit-making undertaking or scheme is being carried on.

Paragraph 42 of TR 92/3 provides that if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either:

a)    as the capital of a business; or

b)    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 or a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income although the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

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.

In determining whether activities relating to isolated transactions are a profit-making undertaking or are the 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 this case, it was your intention to use the Property as your main residence and to undertake some upgrades and renovations after it was purchased. However, after a significant period of delays and issues with the Builder in relation to them completing the Works on the House you decided to demolish the House, subdivide the Land and construct the duplex consisting of a unit on each subdivided lot, being the Development, for the purpose of selling the Units.

The Property was not put on the market as a whole and you made a considered decision to undertake the Development to sell the Units and receive substantially more than if you had sold the Property or the Land. The activities involved with the Development were significantly more than if the Property had been sold as a whole, or if the Land had been subdivided with the subdivided lots of vacant land being sold.

The nature of the Property changed from being a residential house and land to two subdivided lots with a newly constructed unit located on each lot as a result of the Development.

You did not have any plans to live in either of the units, nor did you have any plans to rent either Unit 1 or Unit 2, with the intention to sell the Units. The House was demolished, and the Land was developed for the purpose of sale.

Your intention in relation to the Property changed when you decided to undertake the Development for the purpose of selling the Units. Your intention, or purpose, when you entered the scheme of developing, subdividing and selling the Units was to make a profit or gain.

It is viewed that there is a coherent plan for the activities to be undertaken and the actions involved with the Development were at a more complex level than would be required if the Land was just being subdivided given that your activities involve the construction of the units for the purpose of selling them.

While you engaged the services of professionals in relation to various aspects of the Development, you retained ultimate control as the final decision makers with respect to the Development.

Your activities were more of a commercial nature than a mere subdivision where land is subdivided and sold or the sale of one residential property. If you were to undertake the Development activities as part of a repetitious or recurring transaction, they would constitute the carrying on of a business. The Development activities you've undertaken involve substantially more than merely realising your asset to the best advantage.

The financial risk involved in the Development rested directly with you as the legal owners which involved you using a significant amount of borrowed funds and your savings to fund the activities. Therefore, the financial risks involved with the outcome of the sale of the Units was yours.

You received total sale proceeds for the sale of the Units that was substantially more than the market value of the Land/Property at the time the Development was commenced combined with the borrowed funds and savings amount used to fund the Development.

While you stood to profit from the overall development, in the event the Development failed, you were subject to any losses or resulting liabilities. You retained all the rewards and carried the risks from the Development. The assumption of the risks and the receipt of the subsequent rewards (or losses) is a strong indicator of a profit-making activity.

There was an intention to make a profit, rather than the sale being a capital transaction to realise the value of the Land. Based on the figures provided, the objective intention is that the Development was undertaken for the purpose of producing a profit.

Making an overall assessment on the factors set out in TR 92/3, it is the Commissioner's view that your activities in relation to the Development were more than the mere realisation of your asset, being an isolated transaction, which has the character of a business operation or commercial transaction.

Rather than selling the Property as it was, you made the decision to undertake the Development, incurring the additional expenses to receive amounts from the sale of the Units. By seeking to achieve a higher sale price by undertaking the Development it is viewed that you had a profit-making motive which can occur regardless of whether a profit or loss is ultimately made.

Although the Property was originally acquired for the purpose of being your residence, this intention is not definitive and based on the facts and your involvement in the Development, it has been concluded that the Development was entered into with the intention of profit in carrying out the commercial transaction.

Therefore, the net-profit arising from the sale of Unit 1 and Unit 2 will be assessable under section 6-5.

Capital gains tax

Section 102-5 includes a net capital gain in the assessable income of a taxpayer. Broadly, a net capital gain is the difference between a person's capital gains and capital losses for an income year. A capital gain or capital loss is made when a CGT event happens to a CGT asset under section 102-20.

Subsection 108-5(1) defines a CGT asset as any kind of property, or a legal or equitable right that is not property. Examples of a CGT asset are land and buildings.

CGT event A1 in section 104-10 happens if you dispose a CGT asset, or your ownership interest in a CGT asset. The time of the event is when you enter into the contract for the disposal. You make a capital gain if the capital proceeds from the disposal are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

Where a CGT asset is also treated as a revenue asset, the sale of that asset will give rise to both a capital gain and assessable income.

Section 118-20 operates to ensure that any capital gain made from the sale of the asset is reduced by the amount included in your assessable income under any other provisions outside of the CGT provisions to prevent double taxation as follows:

•         If the capital gain does not exceed the amount included in assessable income, the capital gain is reduced to zero under subsection 118-20(2); or

•         If the capital gain exceeds the amount included in assessable income, only the excess is treated as a capital gain under subsection 118-20(3).

Section 112-25 sets out what happens if a CGT asset is split into two or more assets. The splitting of assets is not a CGT event under subsection 112-25(2). However, the cost base or reduced cost base of each new asset is calculated in two steps under subsection 112-25(3) as follows:

1)    each element of the cost base and reduced cost base of the original asset at the time of the splitting or change is worked out; and

2)    each element is then apportioned in a reasonable way to each new asset.

The result is each corresponding element of the new asset's cost base and reduced cost base.

Taxation Determination TD 97/3 expresses the view that where an owner of a parcel of land acquired after 19 September 1985 subdivides the land, the original parcel of land is divided into two or more assets (the subdivided lots) which are then treated as separate assets for CGT purposes. The separate assets are taken to have been acquired by the owner when the original parcel of land was acquired. A disposal of a lot is not, therefore, a part disposal of the original parcel.

Application to your situation

In your case, no CGT event occurred when the Land was subdivided into two lots. The two subdivided lots will be treated for CGT purposes as separate CGT assets, that were each acquired when the Property was acquired in 20XX. However, you need to calculate the cost base and reduced cost base of each new subdivided lot which is treated as separate CGT assets following subdivision.

When CGT event A1 occurred on the sale of each of the Units, you need to determine whether any capital gain or loss was made from CGT event A1 for each of the Units sold. Any capital gain made from the event would be reduced by the amount included in your assessable income under section 6-5 by operation of section 118-20.

Question 2: Will the cost base of the Land be the cost base of the Property when CGT event C1 occurred to the House?

Summary

CGT event C1 occurred when the House was demolished with the cost base of the Land being the cost base of the Property at the time of the event.

Detailed reasoning

Demolition of a dwelling

Under subsection 108-55(1) a building or structure and land acquired on or after 20 September 1985 will not be separate CGT assets unless the balancing adjustment provisions apply.

CGT event C1 in section 104-20 happens when an asset you own is lost or destroyed, such as the demolition of a dwelling. The note to subsection 104-20(1) makes it clear that CGT event C1 can apply to part of a CGT asset.

Taxation Determination TD 1999/79 Income tax: capital gains: does the expression 'lost or destroyed' for the purposes of CGT event C1 in subsection 104-20(1) of the Income Tax Assessment Act 1997 apply to: (a) a voluntary 'loss' or 'destruction'? (b) intangible assets? outlines that destroyed relates to both voluntary and involuntary actions and that the asset must be wholly destroyed for CGT event C1 to occur.

The time of the event is when the destruction occurred if you do not receive any compensation for the loss or destruction under subsection 104-20(2).

When a CGT event has happened to only part of the taxpayer's asset, the taxpayer will be required to apportion the cost base or reduced cost base between the land and the dwelling using the apportionment rules set out in subsections 112-30(2), (3) and (4).

ATO Interpretative Decision ATO ID 2002/633 Income Tax Capital gains tax: demolition of a dwelling: CGT event C1 outlines that when no capital proceeds are received in relation to the demolition of a dwelling no amount is apportioned to the cost base or reduced cost base of the dwelling.

Therefore, upon demolition of a dwelling the cost base of the dwelling and land is wholly attributable to the land when no capital proceeds have been received in relation to the demolition under the application of subsections 112-30(2) to 112-30(4).

You make a capital gain when CGT event C1 occurs if the capital proceeds from the loss or destruction are more than the asset's cost base. You make a capital loss if the capital proceeds are less than the asset's reduced cost base under subsection 104-20(3).

However, where the capital proceeds from the demolition are nil, the cost base attributable to the demolished asset is also nil, and a capital gain or capital loss will not be made in relation to the demolition of the asset.

Costs incurred to demolish a house can be included in the fourth element of cost base of the land as they are capital expenditure incurred where the purpose or the expected effect of which is to increase or preserve the asset's value or which relate to removing the asset under subsection 110-25(5).

Main residence exemption

A capital gain or capital loss you make from a CGT event that happens in relation to a CGT asset that is a dwelling is disregarded if the conditions in subsection 118-110(1) are satisfied. CGT event C1 is a relevant CGT event for the main residence exemption based on subsection 118-110(2).

If the demolished asset (dwelling) was your main residence prior to it being demolished, the entitlement of the full or partial main residence exemption under section 118-110 will end unless the exemption is extended by meeting the conditions of certain provisions as discussed below.

Application to your situation

In your case, you owned the Property which was a CGT asset consisting of the House and Land. The House and Land were not separate CGT assets as the balancing adjustment provisions did not apply.

You did not receive any proceeds from the demolition of the House, so they will be nil, with the cost base attributed to the House also being nil. Therefore, you did not make a capital gain or capital loss upon the demolition of the House when CGT event C1 occurred.

Given you did not make any capital gain or capital loss from CGT event C1, there's no use applying the main residence exemption as there's no gain or loss to disregard. Any entitlement to the main residence exemption ended when CGT event C2 happened to the House upon its demolition.

The cost base of the Land will be the cost base of the Property at the time of the CGT event.

Costs incurred to demolish the House will be included in the fourth element of the cost base or reduced cost base of the Land.

Question 3: Will the cost base of the Land be apportioned between the two subdivided lots on a reasonable basis?

Summary

The cost base of the Land will be apportioned on a reasonable basis between the two subdivided lots. However, no CGT event occurred when the Land was subdivided into two lots.

Detailed reasoning

Subdivision of land

When a block of land is subdivided, the original land parcel is split into two or more separate assets under paragraph 112-25(1)(a).

Subdivision itself is not considered to be a CGT event as subdividing does not change ownership of the subdivided lot with the acquisition date of each subdivided lot being the same acquisition date as that of the original land. Therefore, a capital gain or capital loss is not made at the time of the subdivision.

However, the original cost base needs to be apportioned between the new assets, being the subdivided lots, on a reasonable basis.

Taxation Determination TD 97/3 Income tax: capital gains: if a parcel of land acquired after 19 September 1985 is subdivided into lots ('blocks'), do Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 treat a disposal of a block of the subdivided land as the disposal of part of an asset (the original land parcel) or the disposal of an asset in its own right (the subdivided block)? provides that the Commissioner will accept any reasonable method of apportioning the cost base between the new lots on an area basis if all the land is of a similar size and market value or on a relative market value basis if this is not the case.

The costs of subdivision should be apportioned between the lots. If the lots are of unequal market value the Commissioner considers that costs such as survey, legal fees and application fees associated with the subdivision should be apportioned in accordance with relative market value of the lots.

However, any costs solely related to one lot should be attributed to that lot, such as the costs of connecting electricity and water to the lot which is to be sold, should be attributed solely to that lot.

The costs incurred in relation to the subdivision of land are capital expenditure incurred to increase the value of the land. Therefore, those costs can be included in the fourth element of each of the subdivided lots in accordance with subsection 110-25(5) as discussed below.

Application to your situation

The Land was subdivided into two subdivided lots, resulting in two separate parcels of land. Each subdivided lot is viewed as being separate CGT assets that were each acquired when the Property was acquired in 20XX for CGT purposes.

The cost base of the Land at the time the subdivision occurred will be apportioned between the two subdivided lots on a reasonable basis in accordance with TD 97/3.

Any subdivision costs solely attributable to either subdivided lot will be included in the fourth element of their respective cost base or reduced cost base. Costs incurred jointly for both subdivided lots will be apportioned between the two subdivided lots on a reasonable basis.

Question 4: Will the construction costs of each unit be included in the fourth element of the cost base of the subdivided lot on which it is constructed?

Summary

The costs for the construction of a unit on each subdivided lot will be included in the fourth element of the cost base of the respective subdivided lot on which the unit is constructed.

Detailed reasoning

Cost base of subdivided lots

The elements included in the cost base or reduced cost base of a CGT asset are provided in section 110-25.

Under subsection 110-25(5) the fourth element of the cost base of a CGT asset is capital expenditure the taxpayer incurred:

•         for the purpose or the expected effect of which is to increase or preserve the asset's value, or

•         that relates to installing or moving the asset.

The reduced cost base of a CGT asset in section 110-55 has the same five elements as the cost base, except for the third element which relates to balancing adjustments for certain depreciating assets.

Expenditure incurred in erecting a building or other structure or improvement on land which was acquired on or after 20 September 1985 will be included in the fourth element of the cost base of the land with them being viewed as a single CGT asset.

Application to your situation

In your case the two subdivided lots are separate CGT assets with a separate cost base or reduced cost base.

You incurred costs to construct a unit on each of the subdivided lots. Any costs incurred in relation to the construction of the units will be included in the fourth element of the cost base or reduced cost base of the respective subdivided lot on which they are constructed.

Question 5: Are you entitled to the main residence exemption on the disposal of either of the units?

Summary

Based on the facts provided you are not entitled to the main residence exemption as:

•         The main residence exemption ended when the House was demolished and CGT event C1 occurred; and

•         There are no conditions that would enable the exemption to be extended to the subdivided lot on which either unit is located as you did not reside in either unit after they were constructed.

Detailed reasoning

Main residence exemption

Generally, any capital gain or capital loss that arises from a CGT event that happens to a dwelling that is a taxpayer's main residence is disregarded under section 118-110. However, to obtain a full exemption from CGT:

•         the dwelling must have been the taxpayer's main residence for the entire period they owned it (section 118-110)

•         the dwelling had not been used to produce assessable income (section 118-190); and

•         the dwelling is located on less than two hectares of land.

The main residence exemption is attached to the dwelling and relates to CGT events that occur to it. An extension of the main residence exemption to land is limited to the following situations:

•         To adjacent land up to two hectares when the land is sold with the dwelling that was the main residence under section 118-120

•         If a dwelling that was your main residence is accidently destroyed, such as by fire, and you dispose of the land on which the dwelling was located on under section 118-160; or

•         If you build a dwelling on land you already own, the land usually does not start to qualify for the main residence exemption until the dwelling becomes your main residence. You can make a choice under section 118-150 to enable the land to be viewed as your main residence only when the relevant conditions are met, such as:

-       The newly constructed dwelling becomes your residence as soon as practicable after the dwelling is built, repaired or renovated (paragraph 118-150(3)(a), and

-       The newly constructed dwelling continues to be your main residence for at least three months (paragraph 118-150(3)(b).

The main residence exemption will cease if CGT event C1 occurs to the dwelling when it is demolished and none of the provisions to extend the main residence exemption are available.

Application to your situation

You jointly purchased the Property and did not move into the House until some months after settlement had occurred. Therefore, as you had not moved into the House as soon as practicable after settlement had occurred you would have only ever been entitled to a partial main residence exemption if the other conditions for the main residence exemption had been met.

However, the House was demolished and a CGT event C1 occurred as it ceased to exist, being totally destroyed. At that point just the Land was left.

The main residence exemption was connected to the House and once it was demolished your eligibility to any main residence exemption ended unless the exemption could be extended to the Land.

However, in your case the main residence exemption cannot be extended to the Land as:

•         The House that had been your main residence was not sold with the Land as it had been voluntarily demolished

•         The Land was not sold as vacant land after the House had been accidentally demolished; and

•         The Land was subdivided and sold with a newly constructed unit located on each subdivided lot, with you not meeting the relevant conditions under section 118-150 to make the choice to extend the exemption as you never resided in either unit.

Therefore, you have not met the conditions to be entitled to any main residence exemption on the disposal of your ownership interests in the Units.

ISSUE 2: Goods and Services Tax

Question: Will your sale of the Units be subject to GST under section 9-40 of the A New Tax System (Goods and Services Tax) Act 1999?

Summary

The sale of the Units is viewed as being a taxable supply and your activities are an enterprise. As your GST turnover meets the registration turnover threshold, you are required to register for GST.

Detailed reasoning

This is to explain how we reached our decision. This is not part of the private ruling.

For this question,

•         unless otherwise stated, all legislative references are to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)

•         all legislative terms of the GST Act marked with an asterisk are defined in section 195-1 of the GST Act.

•         all reference materials, published by the Australian Taxation Office (ATO), that are referred to are available on the ATO website ato.gov.au

Section 9-40 provides that GST is payable on taxable supplies. Section 9-5 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 the indirect tax zone; 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.

In your case, the sale of the Units were made for consideration and were connected with the indirect tax zone.

Therefore paragraphs 9-5(a) and 9-5(c) are satisfied. The sale of the Units is not a GST-free supply. Further it is not an input taxed supply under section 40-65 as the Units are new residential premises.

We will now consider the remaining elements of section 9-5 - namely, whether the sale of the Units is in the course or furtherance of an enterprise you carry on (paragraph 9-5(b)), and whether you are registered or required to be registered for GST (paragraph 9-5(d)).

The sale of the Units is made in the course or furtherance of an enterprise you carry on

Subsection 9-20(1) provides, amongst other things, that an enterprise is an activity, or series of activities, done:

(a)  in the form of a business; or

(b)  in the form of an adventure or concern in the nature of trade.

The definition of 'carrying on' an enterprise can be found in section 195-1:

carrying on an enterprise includes doing anything in the course of the commencement or termination of the enterprise.

This definition ensures that activities done in the course of the commencement or termination of the enterprise are included in determining whether the activities of the entity amount to an 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.

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. Such transactions are of a revenue nature. However, the sale of the family home, car and other private assets are not, in the absence of other factors, adventures or concerns in the nature of trade.

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.

Paragraph 264 of MT 2006/1 discusses two seminal cases in this area: Statham & Anor v Federal Commissioner of Taxation 89 ATC 4070 (Statham) and Casimaty v FC of T 97 ATC 5135 (Casimaty). Paragraph 265 of MT 2006/1 extracts the key elements of both cases and provides a list of factors that can be used to assist in determining whether isolated property transactions are an adventure or concern in the nature of trade or a mere realisation of a capital asset:

265. From the Statham and Casimaty cases a list of factors can be ascertained that provide assistance in determining whether activities are a business or an adventure or concern in the nature of trade (a profit-making undertaking or scheme being the Australian equivalent, see paragraphs 233 to 242 of this Ruling). 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 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 addition to the above, paragraphs 266 and 267 of MT 2006/1 provides that there may be other relevant factors outside this list that are present on the facts of a given case, and that no individual factor is determinative to the question of whether an enterprise is present:

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.

267. No two cases are likely to be exactly the same. For instance, while the conclusions reached in the Statham and Casimaty cases were similar, different facts and factors were considered to reach the respective conclusions.

Application to your situation

In your case you acquired the Property and used the Property as your principal place of residence for a period until you moved to a rental property to commence renovations on the Property. After delays and issues with the renovation you decided to demolish the House and construct two new duplex premises on the Property. You did not have any plans to live in or rent either of these new premises. You sold these premises off the plan. We consider that as a result, the purpose for which the land was held or applied changed from that which it was originally held and used for (being for a private purpose used as your principal place of residence) to being held for the purposes of a property development venture.

An example similar to your situation is illustrated in Example 31 (paragraphs 284 to 287) of MT 2006/1:

Example 31

284. Prakash and Indira have lived in the same house on a large block of land for a number of years. They decide that they would like to move from the area and develop a plan to maximise the sale proceeds from their land.

285. They consider their best course of action is to demolish their house, subdivide their land into two blocks and to build a new house on each block.

286. Prakash and Indira lodge the necessary development application with the local council and receive approval for their plan. They arrange for:

•         their house to be demolished;

•         the land to be subdivided;

•         a builder to be engaged;

•         two houses to be built;

•         water meters, telephone and electricity to be supplied to the new houses; and

•         a real estate agent to market and sell the houses.

287. Prakash and Indira carry out their plan and make a profit. They are entitled to an ABN in respect of the subdivision on the basis that their activities go beyond the minimal activities needed to sell the subdivided land. The activities are an enterprise as a number of activities have been undertaken which involved the demolition of their house, subdivision of the land and the building of new houses.

Similar to what is illustrated in Example 31 of MT 2006/1, we consider the activities you engaged in constituted a level of development of the Property beyond that necessary to secure council approval for the subdivision. While you neither brought the Property into account as a business asset nor acquired additional land, you formulated a coherent plan to execute your changed purpose for which the land was held. As set out in the facts, you have:

• arranged for the existing house to be demolished
• engaged a developer with responsibility for various activities including:

-       designing the development and specifying lot sizes

-       obtaining all approvals for the works

-       determining how to undertake the development and the development timeline

• engaged professionals such as a surveyor to complete the subdivision of the Property
• obtained development consent
• arranged finance such that the source of funding will be repaid to the extent from the proceeds of sale of properties
• entered into a building contract for the construction of two residential premises
• entered into an agreement with a real estate agent for the sale of the premises.

These facts show that the extent of your development of the Property went beyond a 'mere' realisation' of the asset in its original form. You arranged for the subdivision of the Property and the construction of two premises on it and sold the Property in this newly developed state to maximise your return on the sale of the Property in the form of the two Units. The nature of your activities in arranging for the subdivision and development of the Property demonstrate you had a profit-making intention.

Therefore, your activities fall within the scope of an enterprise as defined in section 9-20, being a series of activities done in the form of an adventure or concern in the nature of trade.

Is the above enterprise undertaken by a partnership?

Given that the above enterprise involves both you, being Person A and Person B, it needs to be discussed whether you are undertaking this enterprise as a partnership, rather than as two individuals. A partnership is a separate entity for GST purposes.

Section 9-5 has a primary step requiring identification of the entity making the supply as it states that "you make a taxable supply if...".

'You' is defined in section 195-1 as:

if a provision of this Act uses the expression you, it applies to entities generally, unless its application is expressly limited.

Note: The expression you is not used in provisions that apply only to entities that are not individuals.

'You' appears in paragraph 9-5(a): 'you make a supply' and 'you' is also connected to any identifiable enterprise and in the course or furtherance of whose enterprise are the supplies being made under paragraph 9-5(b). Additionally, 'you' is tied to the entity that is registered or required to be registered.

Section 184 sets out the definition of 'entity'. Subsection 184(1) provides an entity is any of the following:

(a)  an individual;

(b)  a body corporate;

(c)   a corporation sole;

(d)  a body politic;

(e)  a partnership;

(f)    any other unincorporated association or body of persons;

(g)  a trust;

(h)  a superannuation fund.

'Partnership' is defined in section 195-1 as having the same definition provided in section 995-1 of the Income Tax Assessment Act 1997. Section 995-1 of that Act provides that a 'partnership' is, among other things, an association of persons carrying on a business as partners or in receipt of ordinary income or statutory income jointly.

The supplies are the sale of real property being Lots 1 and 2, 448 Princes Highway, Gymea, New South Wales 2227. The suppliers are the parties and they are making the supply in a single contract per lot.

In your case, when carrying on the enterprise identified above, you took a loan jointly to fund the construction of the Units and you jointly appointed the builder to build the residential premises situated on the Units. You jointly owned the Units prior to their sale and you were both listed as vendors on the contracts of sale for the Units, indicating that you were jointly supplying each Unit to the respective purchaser.

Consequently, we consider that you are undertaking the enterprise identified above as a partnership.

You are required to be registered for GST

As you are not registered for GST, it remains to be determined whether you are required to be registered for GST.

Section 23-5 provides you are required to be registered if:

(a)  you are carrying on an enterprise; and

(b)  your GST turnover meets the registration turnover threshold.

For the reasons discussed above, we consider you are carrying on an enterprise and so paragraph 23-5(a) is satisfied.

The next issue to consider is whether your GST turnover meets the registration turnover threshold. The registration turnover threshold is currently $75,000 for all entities except non-profit bodies. This is the threshold that applies to you.

The meaning of GST turnover is contained in Division 188.

Section 188-10 provides that your GST turnover will meet the registration turnover threshold if:

(a)  your current GST turnover is at or above the registration turnover threshold ($75,000) and the Commissioner is not satisfied that your projected GST turnover is below the registration turnover threshold, or

(b)  your projected GST turnover is at or above the registration turnover threshold.

Your 'current GST turnover' is defined in section 188-15 and is the sum of your turnover for the current month and the previous 11 months other than:

(a)  supplies that are input taxed

(b)  supplies that are not for consideration

(c)   supplies that are not made in connection with an enterprise that you carry on.

Your 'projected GST turnover' is defined in section 188-20 and is the sum of your turnover for the current month and the next 11 months other than:

(a)  supplies that are input taxed

(b)  supplies that are not for consideration

(c)   supplies that are not made in connection with an enterprise that you carry on.

Section 188-25 requires you to disregard the following when calculating your projected GST turnover:

(a)  any supply made, or likely to be made, by you by way of transfer of ownership of a capital asset of yours; and

(b)  any supply made, or likely to be made, by you solely as a consequence of:

          (i)       ceasing to carry on an enterprise; or

         (ii)       substantially and permanently reducing the size or scale of an enterprise.

Goods and Services Tax Ruling GSTR 2001/7 Goods and services tax: meaning of GST turnover, including the effect of section 188-25 on projected GST turnover (GSTR 2001/7) discusses the meaning of the term 'capital asset'.

Paragraphs 31 to 36 of GSTR 2001/7 state:

31. The GST Act does not define the term 'capital assets'. Generally, the term 'capital assets' refers to those assets that make up 'the profit yielding subject' of an enterprise. They are often referred to as 'structural assets' and may be described as 'the business entity, structure or organisation set up or established for the earning of profits'.

32. 'Capital assets' can include tangible assets such as your factory, shop or office, your land on which they stand, fixtures and fittings, plant, furniture, machinery and motor vehicles that are retained by you to produce income. 'Capital assets' can also include intangible assets, such as your goodwill.

33. Capital assets are 'radically different from assets which are turned over and bought and sold in the course of trading operations'. An asset which is acquired and used for resale in the course of carrying on an enterprise (for example, trading stock) is not a 'capital asset' for the purposes of paragraph 188-25(a).

34. 'Capital assets' are to be distinguished from 'revenue assets'. A 'revenue asset' is 'an asset whose realisation is inherent in, or incidental to, the carrying on of a business'.

35. If the means by which you derive income is through the disposal of an asset, the asset will be of a revenue nature rather than a capital asset even if such a disposal is an occasional or one-off transaction...

36. Over the period that an asset is held by an entity, its character may change from capital to revenue or from revenue to capital. For the purposes of section 188-25 the character of an asset must be determined at the time of expected supply.

Also, on the distinction between capital assets and revenue assets, paragraph 260 of MT 2006/1 states:

260. Assets can change their character but cannot have a dual character at the same time.

We acknowledge that for a period of time, being the time you acquired the Property and used the Property as your main residence (prior to the change of use), the Property would be classified as a 'capital asset'. However, as per the principles set out in GSTR 2001/7, we consider that the nature of the asset has changed to that of a revenue asset when you made the decision in mid-20XX to demolish the House and subdivide the Property into two lots and construct the Units.

Given the above, the turnover from the sales of the developed lots would not be excluded when calculating your projected GST turnover and given the sales prices for each respective Unit, your turnover will meet the registration threshold.

As you are carrying on an enterprise and your GST turnover meets the registration turnover threshold, you are required to register for GST.

As the enterprise is conducted by you in the form of a partnership, you will need to register for GST as a partnership entity.

In conclusion, given the facts of this case, your sales of the Units satisfy all of the elements of section 9-5 and are neither GST-free nor input taxed. Therefore, the sales will constitute a taxable supply as defined for GST purposes. GST is payable on the sale of the Units.

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