Edited version of private advice

Authorisation Number: 1052119457495

Date of advice: 17 May 2023

Ruling

Subject: Subdivision - income vs capital

Question 1

Will the sale of the property constitute the mere realisation of a capital asset?

Answer

Yes.

Question 2

Will the supply of new residential premises be a taxable supply under section 9-5 of the A New Tax Systems (Goods and Services Tax) Act 1999?

Answer

No.

This private ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You are not registered for GST.

You acquired a residential property.

At the time of acquisition, a single residential premises was situated on the property.

The intention at the time of acquisition was to demolish the existing premises, subdivide the property into two separate lots and construct two new premises to be retained indefinitely as rental properties.

The strategy of constructing two premises was part of a long-term goal of increasing your long term wealth and securing your financial future:

•         Constructing two premises on the same parcel of land at the same time would provide cost efficiencies by splitting both the construction costs and land costs over two properties. This would result in increased equity in the property

•         The increased equity would allow you to acquire further real estate assets (potentially including a main residence) while still retaining ownership of the property. This is due to the fact that you could use the property as security for future borrowings; and

•         Rental income would be generated from two residential premises rather than a single premises. Given the split of the underlying costs between the premises, this increased the rental yield percentage for the property. Your goal was to have the property in a cashflow positive position as soon as possible.

As soon as practicable after acquisition, the existing dwelling was demolished and two new premises were constructed. The property was subdivided into two separate lots.

Subdivision approval was received. The construction contract was signed soon after.

After construction was complete, both premises were leased to tenants.

Both premises continue to be leased at the present point in time.

You are currently residing in rented accommodation with family. The overriding plan has been to eventually acquire another dwelling to occupy as a family home.

To finance the purchase of the main residence, you had planned on using the premises as security for the borrowing. However, the recent economic situation has changed the lending criteria being used by banks in assessing the serviceability of debts.

The mortgage broker retained by you has advised that to secure a loan to purchase your desired main residence, you will need to sell both of the rental properties and clear all existing loans.

The proceeds from the sale of the premises will be used to purchase a new main residence. A small amount of the proceeds may be retained to top up accessible savings.

You do not own any other properties and have not previously been involved in subdivision or development activities.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

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 23-5

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

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

Reasons for decision

Question 1

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) discusses the application of the principles outlined in the Myer Emporium case and 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 provides:

16. If a taxpayer not carrying on a business makes a profit, that profit is income if:

(a) The intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain: and

(b) The transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

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. It is also 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.

Whether a particular transaction has a business or commercial character depends on the circumstances of the case. Paragraph 13 of the ruling 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.

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

The expression 'mere realisation' is used to distinguish a gain made on an asset compared to income or gains derived from a business operation or an isolated transaction carrying out a profit-making scheme. Classifying an asset as a 'mere realisation' depends on the facts and circumstances of each case. The proceeds from the sale of a mere realisation of capital assets will be assessed under the capital gains tax provisions contained in Parts 3-1 and 3-3 of the ITAA 1997.

Application to your circumstances

In this case we do not consider the proceeds from the disposal of the properties will be assessable under 6-5 of the ITAA 1997. The factors, set out above, are not present when we consider the original intention and the use of the properties since they were constructed. We accept that the transaction is a mere realisation and therefore the proceeds from any sale will be assessed under the capital gains tax provisions.

Question 2

In this ruling,

•         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

GST is only payable on taxable supplies. Section 9-5 outlines the requirements of a taxable supply and 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.

One-off sales of new residential premises may be a taxable supply if all the requirements of a taxable supply are met. In your case, the requirement to be carrying on an enterprise and whether you are required to be registered for GST are matters that require greater examination in determining whether GST is applicable to the sale of the Premises.

Enterprise - an adventure or concern in the nature of trade

The term "enterprise" in section 9-5 includes an activity or activities "in the form of an adventure or concern in the nature of trade". 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) explains the phrase "in the form or an adventure or concern in the nature of trade" for the purposes of acquiring an Australian Business Number but is also applicable to the definition of enterprise for GST purposes:

244. 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. The fact that the asset is sold at a profit does not, of itself, result in the activity being commercial in nature.

We consider that one-off and isolated property transactions can fall within something done in the nature of trade. This is particularly so in the circumstances where the property was purchased, developed (although this may not be necessary) with the intention to resell at a profit. Paragraph 237 of MT 2006/1 provides:

The term 'profit making undertaking or scheme' like the term 'an adventure or concern in the nature of trade' concerns transactions of a commercial nature which are entered into for profit-making, but are not part of the activities of an on-going business. Both terms require the features of a business deal....

Alternatively, in some circumstances, one-off property transactions are a mere realisation of a capital asset and therefore not considered to be supplied as part of an adventure in the nature of trade.

MT 2016/1 provides detailed guidance and examples on isolated property transactions:

270. In isolated transactions, where land is sold that was purchased with the intention of resale at a profit (which would be ordinary income) the Commissioner considers these activities to be an enterprise. This would be so whether the land was sold as it was when it was purchased or whether it was subdivided before sale. An enterprise would be carried on in this situation because the activities are business activities or activities in the conduct of a profit making undertaking or scheme and therefore an adventure or concern in the nature of trade.

Enterprise - in the form of a lease

The term "enterprise" in section 9-5 also includes an activity or activities "an activity, or a series of activities, done on a regular or continuous basis, in the form of a lease, licence or other grant of an interest in property'". The leasing of residential premises is, therefore, a supply made in the course of an enterprise.

Requirement for registration

Under section 23-5, you are required to be registered for GST if you carry on an enterprise and your GST turnover is at or more than $75,000. GST turnover includes both current turnover and projected turnover.

Your current GST turnover is the value of all the supplies (that is gross income less GST) you make for the current month and the previous 11 months. Your projected turnover is the value of all the supplies (that is gross income less GST) you make for the current month and the next 11 months.

You are required to register if your current turnover is at or below $75,000 but the Commissioner is not satisfied that your projected turnover is at or below $75,000. Therefore, your projected turnover must be at $75,000 or more before you are required to register.

There are exclusions to both current and projected GST turnovers, such as input taxed supplies, which includes the lease residential premises. Section 188-25 provides that certain supplies are excluded in working out your projected turnover. You do not include supplies in relation to a sale of a capital asset or any sale that is likely or made solely as a consequence of ceasing or substantially and permanently reducing the size or scale of an enterprise.

Assets that are the subject of an adventure or concern in the nature of trade are included in both the current and projected GST turnovers provided they don't fall within other exclusions, as they are not capital assets but revenue assets.

Application to your circumstances

Your supply of the premises will clearly satisfy paragraphs 9-5(a) and (c). The sale of premises located in Australia will be for consideration and connected to the indirect tax zone. The sale of new residential premises is not input taxed or GST-free.

We consider that the sale of the premises will be made in the course of an enterprise. The sale of the premises will be the sale of a capital asset or a supply made solely as a consequence of ceasing to carry on an leasing enterprise. We do not consider that the sale of the premises will be made as part of an adventure or concern in the nature of trade.

An objective assessment of the circumstances surrounding the sale shows that your intention was to carry out an enterprise of leasing the residential premises which you need to cease in order to repay debt, to facilitate the purchase your desired residential premises. As a result, you cannot continue to maintain the leasing enterprise as you are not able to obtain the finance to purchase the desired property for your residence. This is evidenced by contemporaneous documents.

You have leased both premises on the property since 2020 and continue to do so. Further the term "carrying on an enterprise" includes anything done in the course of commencement or termination of the enterprise. We consider that the purchase of the property, demolition of the existing premises, subdivision and construction of two new residential premises has sufficiently progressed the leasing enterprise to the point where it falls within the definition of the commencement of a leasing enterprise.

Given the circumstances and evidence provided, we also consider that it is not appropriate to characterise the sale of the premises as part of an adventure or concern in the nature of trade. The circumstances do not show that you intended to purchase the property with aim to resale at a profit. Changed lending criteria now requires the sale of the premises.

This characterisation has important implications in relation to the calculation of your GST turnover. As you are carrying on a leasing enterprise, the sale of the premises will be excluded in the calculation of your projected GST turnover and as it is a sale of a capital asset or a supply made solely as a consequence of terminating the leasing enterprise. Moreover, the input taxed rental proceeds from the lease of the original residential premises would always be excluded in the calculation of both current and projected GST turnover despite the characterisation of the enterprise. The means that you will not have a GST turnover at or above $75,000.

As you are not registered nor required to be registered for GST, the sale of the premises will not meet all the requirements of a taxable supply and therefore, GST will not be applicable to the sale of the premises.

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