Edited version of private advice

Authorisation Number: 1052069115726

Date of advice: 9 December 2022

Ruling

Subject: CGT - property development

Question 1

Will the sale of apartment units on the property development be treated under the trading stock provisions in Division 70 of the ITAA 1997, on the basis that it is part of a property development business activity?

Answer

No

Question 2

Will proceeds from the sale of apartment units on the property development be assessed as income from an isolated profit making undertaking or activity?

Answer

No

Question 3

Will the sale of apartment units on the property development be treated under the capital gains provisions in Parts 3-1 and 3-3 of the ITAA 1997?

Answer

Yes

This ruling applies for the following period:

DD MM YYYY

The scheme commences on:

DD MM YYYY

Relevant facts and circumstances

1.    You acquired a property and used it as your main residence for many years.

2.    The cost of the land, building, and improvements was around $X.

3.    During the YYYY income year, under your personal name, you entered a contract with a builder to develop the property. The builder wasn't related to you. The estimated development cost was roughly $X.

4.    The property's market value when development started was roughly $X.

5.    The development completed around X years after you entered the building contract, for a final development cost of roughly $X.

6.    The development plans were for around X units (across X levels) and a basement carpark. We describe the plans (intended and completed) for each unit in Table 1.

Table 1: plans for the X apartment units

7.    You have never been involved in any other property development projects before this one.

8.    You registered for GST in the YYYY+1 income year.

9.    You set up a separate accounting function to record the transactions, account for the GST, monitor costs incurred, and ultimately determine any profit made on the sale.

10.  You didn't have a business plan for the project.

11.  Before the project started, you had been considering downsizing and perhaps investing in another property, as your personal circumstances changed.

12.  The property was rezoned in the YYYY-1 income year, making it possible to develop the property into an apartment complex.

13.  You discussed possibilities for developing the property with your friend Y, an architect. Y was interested in getting involved in developments and investing. But you were interested in developing the site as both a place to live and future income stream. Together, you came up with a plan to develop the property into apartments. You have said the plan would allow Y to invest in real estate, and you to build a family home, realise a regular income, and generate profit from the sale of three of the units.

14.  You later entered a joint venture agreement with X as trustee for a family trust. (Y controls the family trust.) Under that agreement, both parties contributed towards the project costs, and received units in the same proportion.

15.  The sale price for the units sold to X represented X% of the value of the land, plus X% of the budgeted construction cost for the development. The units was the consideration for paying for the land and contributing to the development costs.

16.  You have described the project timeline in some detail. Very broadly, the project took about X years from early in the YYYY-1 income year to early in the YYYY+2 income year. Your description includes:

•                     designs and planning (mostly by Y)

•                     discussions with city council officers

•                     preparing plans and reports (building design, traffic, landscape, acoustic, waste disposal)

•                     submitting plans to council

•                     strata planning

•                     engaging surveyors to assess costs

•                     seeking quotes from builders (and engaging one of them)

•                     dealing with and engaging other suppliers and contractors (bricklaying, concreting, electrical, plumbing, solar, kitchen/laundry appliances, airconditioning, plastering, landscaping).

17.  You and Y devoted a significant amount of time to the project. You've said that you were on site almost every day, usually more than once a day, met with Y and builders on site, and communicated by email or telephone practically daily. You estimate that you spent an average of X hours on the project each day. Y was also on site daily.

18.  You supplied documents showing the scale and extent of the project, including:

•                     progress claim certificates from the builder

•                     development application documents

•                     waste management plan

•                     design plans

•                     sample emails (between you, Y, city council officers, the builder, and some other contractors or suppliers).

Relevant legislative provisions

Income Tax Assessment Act 1997 section 4-10

Income Tax Assessment Act 1997 section 4-15

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 8-5

Income Tax Assessment Act 1997 section 70-5

Income Tax Assessment Act 1997 section 10

Income Tax Assessment Act 1997 section 70-25

Income Tax Assessment Act 1997 section 70-35

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 102-25

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 112-25

Income Tax Assessment Act 1997 section 118-20

Income Tax Assessment Act 1997 section 118-42

Income Tax Assessment Act 1997 section 124-190

Reasons for decision

Background relevant to all questions

19.  Your tax liability for an income year is worked out by formulas in Division 4. Taxable income, assessable income, and deductions are elements in those formulas: see sections 4-10 and 4-15. Assessable income includes income under ordinary concepts (section 6-5) and statutory income (section 6-10). Deductions include ordinary deductions under (section 8-1) and specific deductions (section 8-5).

20.  Income under ordinary concepts isn't defined, but case law has established guidelines to characterise whether receipts have the character of ordinary income. TR 2006/3[1] at paragraphs 84 and 85 lists some propositions taken from case law to help characterise whether amounts are income. To loosely paraphrase a couple of those propositions, receipts are likely to be income if they're receipts from business activity, or an isolated profit-making activity, and don't have a capital character.

21.  Statutory income refers to amounts which aren't characterised as ordinary income, but are made assessable by other tax provisions. Capital gains are an example of statutory income. Part 3-1 calculates gains and losses from CGT events. Your net capital gain for an income year (worked out under a method statement in section 102-5) is included in your assessable income. (Losses can be carried forward and applied to reduce capital gains in future years in some circumstances.) There are some special rules relevant to capital gains in Part 3-3.

22.  These reasons will address whether your proceeds from selling apartment units are:

•                     included in your ordinary income as receipts from carrying on a business activity (Question 1)

•                     included in your ordinary income as receipts from an isolated-profit making activity (Question 2)

•                     relevant to working out a potential net capital gain or loss for the income year under Part 3-1.

Question 1

Will the sale of apartment units on the property development be treated under the trading stock provisions in Division 70 of the ITAA 1997, on the basis that it is a property development business activity?

Summary

23.  No. The trading stock rules only apply to the sale of items held in the course of carrying on a business. We don't think you held the units in the course of carrying on a business. We think your project had a mixed character. The sales were incidental to building residences for your family to live in or rent out. We think the project had a significant personal or private (rather than commercial or profit-making) character.

Detailed reasoning

Trading stock is held for sale in the course of a business; Division 70 includes earnings and outgoings from trading stock in taxable income calculations.

24.  Broadly, the effect of the trading stock rules in Division 70 is that if items are held as trading stock, outgoings and earnings are assessed or deducted on revenue account, not treated on capital account. This is explained in section 70-5. It says this means:

•                     gross outgoings are deductible under section 8-1

•                     gross earnings are assessable as income under section 6-5

•                     the difference in the value of trading stock on hand at the start and end of the year is either assessable or deductible.

Section 70-25 says the cost of trading stock isn't capital.

Section 70-35 says you compare the value of trading stock on hand at the start of the year with the value of trading stock on hand at the end of the year: if it increases, the excess is assessable; if it decreases, the reduction is deductible.

25.  Section 70-10 says trading stock includes anything produced, manufactured, or acquired that's held for the purposes of manufacture, sale, or exchange in the ordinary course of a business.

26.  The ATO has guidance about when land is treated as trading stock. TD 92/124[2] says land is treated as trading stock if the taxpayer:

•                     holds it for the purpose of resale, and

•                     has started a business activity which involves dealing in land.

It also says that:

•                     the business activity and required purpose must be present before land is treated as trading stock

•                     the business activity is taken to have commenced when a taxpayer embarks on a definite and continuous cycle of operations designed to lead to the land being sold

•                     it isn't necessary that the acquisition be repetitive: a single acquisition of land by a business commenced for that purpose would mean the land is trading stock.

27.  Before we can decide whether the units you sold were your trading stock, we need to decide whether you held the units in the ordinary course of a business. In other words, were you carrying out a business for the development and sale of real property?

Determining whether you carry on business is a question of impression, considering and weighing a list of relevant indicators.

28.  Determining whether an activity can be characterised as a business is an impressionistic process, testing the facts against a list of indicators. ATO guidance in TR 97/11[3] extracts relevant indicators (factors, considerations) from caselaw.

•                     The indicators include commercial purpose/intention, profitability, repetition and regularity, whether it's conducted in a businesslike manner, size and scale, and whether it can be described as a hobby. See TR 97/11 at paragraphs [13], [18], and [26].

•                     The indicators must be weighed, but all cases turn on their own facts. [12]

•                     No single indicator is decisive. [15]

•                     The weight given to each indicator may vary from case to case. [16]

•                     The indicators must be considered in combination, as a whole, and the decision depends on the general impression. [16]

We apply a fuller list of indicators in Table 2.

29.  TR 97/11 at paragraph 30 says it may help to know whether the taxpayer has:

•                     drawn up a business plan

•                     where not an expert, sought expert advice from relevant authorities in the field

•                     where not an expert, obtained technical literature on the activity

•                     established whether the techniques/strategy is suitable

•                     investigated capital requirements

•                     conducted research to confirm that profits can be expected

•                     ensured the size and scale is sufficient for a commercial enterprise

•                     complied with any legal requirements

•                     has an intention to make a profit, shown by a business plan.

30.  The ATO website has similar guidance for determining whether you're in the business of renovating properties. This page (property renovating as a business or profit-making activity)[4] says there are many factors to consider, and their importance varies depending on circumstances. It lists relevant questions about the property renovating activities.

•                     Are they regular and repetitive?

•                     What is their size and scale?

•                     Are they planned, organised, and carried on in a business-like manner?

•                     Are they carried on for the purpose of making a profit?

•                     Do you rely on the income you receive to meet regular expenses?

•                     Are they of a similar kind and carried on in a similar manner to the activities of other property renovating businesses?

We don't think you were carrying on a business of property development because the project had mixed purposes, and a significant private and personal character.

31.  Balancing the relevant indicators, we don't think you were carrying on a property development business.

•                     The project had mixed purposes: you built apartments for yourself and family members to use as private residences, to rent out to third parties and some family members, and to sell to friends and relatives.

•                     You only sold three of the X units, and those sales were to your company and Y's trust.

•                     The family and friend connections give the project a private and personal character.

•                     You didn't have a business plan in the sense that you set out to make a profit: all your planning was directed at technical challenges to do with the project.

•                     While you devoted considerable time and effort to the project, and went about it in an organised way, we don't think your efforts were directed at making a profit.

Table 2: indicators relevant to determining whether you're carrying on a business

Conclusion on Question 1

32.  The units you sold weren't trading stock. We've concluded you weren't carrying on a property development business. This means the units weren't held in the course of a business. The trading stock rules in Division 70 don't apply to the sale of these apartment units..

Question 2

Will proceeds from the sale of apartment units on the property development be assessed as income from an isolated profit making undertaking or activity?

Summary

33.  No. We don't think you sold the units as part of an isolated profit-making activity for similar reasons we don't think you were carrying on a property development business. The sales were incidental to building residences for your family to live in or rent out. We think the project had a significant personal or private (rather than commercial or profit-making) character.

Detailed reasoning

Proceeds from an isolated profit-making transaction are assessable income. Very broadly, a transaction will be 'profit-making' if it has a commercial character, and would be a business activity if it was performed regularly.

34.  Proceeds from selling property which aren't held as trading stock in the course of carrying on a business might still be assessable as ordinary income.

35.  Income from an isolated transaction may be ordinary income if the taxpayer entered the transaction to make a profit. The ATO gives guidance about this in TR 92/3[5]. At paragraph 6, it says profit from an isolated transaction is generally income when

•                     the intention or purpose in entering the transaction was to make a profit or gain, and

•                     the transaction and profit were in the course of carrying on a business or in carrying out a business operation or commercial transaction.

36.  For taxpayers not carrying on business, a profit is income if:

•                     the taxpayer's intention or purpose in entering the profit-making transaction or operation was to make a profit or gain, and

•                     the transaction or operation was entered into, and the profit made, in carrying out a business operation or commercial transaction. [16]

37.  TR 92/3 also makes some extra propositions, which we'll paraphrase.

•                     Whether a profit from an isolated transaction is income depends on the circumstances. [6]

•                     Purpose is determined objectively not subjectively. [7]

•                     It's enough if profit-making is a significant purpose; it doesn't need to be sole or dominant. [8]

•                     The taxpayer must have the purpose when entering the relevant transaction. For the sale of property, it's usually (but not always) necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property. [9]

•                     In very general terms, a transaction has a business or commercial character if it would be carrying on business except it wasn't recurring or repetitive. [49]

38.  TR 92/3 lists indicators relevant to determining whether an isolated transaction is a business operation or commercial transaction. The factors (to some extent) overlap with the test of whether a taxpayer is in business. We'll paraphrase the list from paragraph 13:

•                     nature of the entity undertaking the transaction

•                     nature and scale of the taxpayer's other activities

•                     amount of money involved

•                     magnitude of profit sought or obtained

•                     nature, scale, and complexity of the operation or transaction

•                     manner entered into or carried out

•                     connections between the taxpayer and other parties

•                     the nature of the property acquired and disposed

•                     timing of the transaction.

Applying these indicators: your development wasn't an isolated profit-making transaction, because your personal and private connections were significant.

39.  Applying these indicators, we don't think you sold the three apartments as part of an isolated profit-making transaction. Our reasons are similar to why we don't think the development was a business activity. We don't characterise your building project as a profit-making plan or transaction. We think it had mixed purposes, and personal and private connections are significant when characterising it. You sold the three apartments to a related company and your friend's trust. Those sales were incidental to other purposes: building family residences and rental properties. We apply and discuss the relevant factors in more detail in Table 3.

Table 3: indicators relevant to determining whether you carried out a profit-making undertaking

Conclusion on Question 2

40.  We've concluded that you didn't sell the apartment units as part of an isolated, profit making activity. They were sold as part of a project which has a significant private and personal character. While you approached the project in an organised way, the sales were incidental to other purposes, not making a profit.

Question 3

Will the sale of apartment units on the property development be treated under the capital gains provisions of the ITAA 1997?

Summary

41.  Yes. Apartment units are CGT assets. CGT event A1 happened when you sold them to other entities. Capital gains and losses will be worked out under the capital gains provisions. You may need to consider rules relevant to splitting assets or strata title arrangements.

Detailed reasoning

42.  The capital gains provisions calculate gains and losses from CGT events, and include the net capital gain in assessable income. We'll quickly summarise a few relevant rules in Part 3-1.

•                     Net capital gains for an income year are calculated and included in assessable income under section 102-5.

•                     Capital gains and losses from individual CGT events are generally calculated by comparing capital proceeds from CGT events to the asset's cost base. Capital proceeds and cost base are worked out under Divisions 110, 112, and 116.

•                     One CGT event is CGT event A1. This happens if you dispose of a CGT asset to another entity. You dispose of a CGT asset if a change of ownership occurs from you to another entity, but not if you stop being the legal owner but continue to be the beneficial owner. See section 104-10. (Another is CGT event E2 - transferring a CGT asset to an existing trust: see section 104-60.)

•                     CGT assets are defined to include any kind of property, or legal or equitable rights that aren't property, and land and buildings are examples: see section 108-5.

•                     When multiple CGT events happen, section 102-25 says that you apply the one most specific to your situation. (ATO ID 2003/559[6] discusses whether CGT event A1 or CGT event E2 is most specific where a taxpayer transfers CGT assets to an unrelated trust.)

•                     There's a rule which reduces capital gains for amounts already included in assessable income: see section 118-20.

•                     There are other rules which might affect arrangements which split real property into multiple titles. See, for example, section 112-25 about split assets (and TD 97/3[7]), section 118-42 about transferring stratum units, and section 124-190 about rollovers for stratum units.

43.  At least one CGT event (CGT event A1) will have happened when you sold the apartment units. Real property, including apartments in a complex, are clearly CGT assets. Beneficial ownership changed from you to a family trust (legal ownership changed to the trustee). That's a disposal from you to another entity, which means CGT event A1 happened.

44.  It's possible that other CGT events may have happened, such as transferring property to a trust: CGT event E2. In that case, you would need to consider which CGT event is the most specific to your circumstances. ATO ID 2003/559 seems relevant to this question.

45.  Your capital gain or loss from those sales would be determined applying the capital gains rules in Part 3-1. You may need to consider how some specific rules apply to any strata title or subdivision arrangements for the property.

[1] Taxation Ruling TR 2006/3 Income tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business.

[2] Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'?

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

[4] ATO (June 2020), Property renovating as a business or profit-making activity (QC 18014) accessed at Home> General> Property> In detail> Property renovating as a business or profit-making activity on 7 November 2022.

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

[6] ATO Interpretative Decision ATO ID 2003/559 Income Tax Disposal of a CGT asset to a trust: application of CGT event A1 or CGT event E2.

[7] 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)?

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