Edited version of private advice

Authorisation Number: 1052288325775

Date of advice: 7 August 2024

Ruling

Subject: CGT - trading stock

Question 1

Was the Property held as trading stock by the Taxpayer for a property development business which gave rise to capital gains tax (CGT) event K4 in the 2019 income year under section 104-220 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

If the answer to Question 1 is "Yes", is the capital gain arising under CGT event K4 disregarded under section 118-110 of the ITAA 1997?

Answer

Not applicable.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 2020

Relevant facts and circumstances

Background and development application process

1.    The Taxpayer held a house and land in an Australian state or territory (the Property).

2.    The Property is less than two hectares in size. The Property was owned by the Taxpayer.

3.    The Taxpayer's family trust acquired the property in the 19XX income year and was transferred to the Taxpayer personally circa 20XX.

4.    The Taxpayer occupied the dwelling on the Property as their main residence from the time it was acquired until 20XX, when the dwelling on the Property was demolished. During this time, the Property was their family home. The Taxpayer did not rent the Property or derive assessable income from it. They did not occupy any other dwelling as their main residence during this time.

5.    In 20XX, the Taxpayer, with the assistance of professional architects, made an application to the relevant City Council to construct an X-storey, Y-apartment development on the Property (Initial Application). The Initial Application was rejected by the relevant City Council due to the height of the proposed construction.

6.    Around June 20XX, the Initial Application was amended to an X-storey, Y-apartment development (Second Application). The Second Application was also rejected by the relevant City Council due to the height of the proposed construction.

7.    Around the 20XX financial year, the Taxpayer appealed the relevant City Council's decision in respect of the Second Application to the relevant Civil and Administrative Tribunal (CAT). The Taxpayer's appeal was successful, and CAT approved the plans for the Second Application, and the matter was remitted back to the relevant City Council. However, the relevant City Council refused to endorse the plans.

8.    In 20XX, after CAT approved the Second Application plans, the Taxpayer estimated the costs of the project to be approximately $X million. However, due to the on-going dispute in which the relevant City Council refused to endorse the plans, the development could not go ahead at that time.

9.    Around early 20XX, the Taxpayer engaged with a financial institution to potentially obtain finance for the Development, having been customer with the financial institution for many years and having enjoyed a strong relationship with them.

10.  Around the 20XX financial year, the Taxpayer appealed the relevant City Council's refusal to endorse the plans to CAT. CAT allowed the Taxpayer's appeal and the Second Application was allowed to proceed.

11.  The costs incurred by the taxpayer, with respect to the preparation and filing of the project plans to the relevant City Council, CAT costs and other associated project costs, were approximately $X.

Development application approved

12.  In 20XX, the relevant City Council wrote to the Taxpayer advising that, in light of the successful CAT proceedings, the relevant City Council extended the permit for the Second Application for an X-story, Y-apartment development (the Development) and endorsed these plans.

13.  The extension required the Development commence by XX XXXX 20XX and be completed by XX XXXX 20XX. The costs for the project were estimated at between $X million in 20XX, and a greater amount being $Y million by 20YY.

14.  The Taxpayer engaged multiple advisors and contractors regarding the Initial Application, Second Application and Development, including but not limited architectural, engineering, design and potential project management and construction services.

15.  The Taxpayer:

•         kept detailed business records regarding the Initial Application, Second Application and Development, including a ledger of costs;

•         undertook projections regarding the estimated costs of construction and the anticipated returns;

•         undertook feasibility analysis and due diligence with regard to projects; and

•         exerted a great amount of time and effort in respect of the Development, the Initial Application, Second Application and CAT proceedings.

Progress of development

16.  Around XXXX 20XX, The Taxpayer obtained approval for the demolition. Shortly after this time, the Taxpayer moved out of their dwelling on the Property.

17.  Around XXXX 20XX, the Taxpayer engaged demolition professionals to demolish the dwelling on the Property. The demolition of the dwelling on the Property commenced and was completed in XXXX 20XX.

Progress of development - planning and negotiating activities

18.  After the demolition of the dwelling on the Property, the Taxpayer engaged various professionals, undertook projections, undertook feasibility analysis and undertook due diligence in respect of the project; however, no further works were undertaken on the property, such as initial development works including formwork etc.

19.  Around late 20XX and early 20YY, the number of dwellings the Taxpayer envisaged building on the Property was reduced due to the increasing costs of the original planned Development.

20.  The Taxpayer had been travelling towards the end of the 20XX calendar year, which further delayed the project, although they were undertaking analyses continuously throughout this time. The Taxpayer had various consultants assisting during this time (prior to COVID-19 impacting Australia from the 20XX calendar year), and delays were experienced due to having to reconsider options because of costs. There were a number of surveys done by surveyors, and costs significantly increased due to factors noted above, such as appeals to CAT. The Taxpayer had to manage and adjust this operation to increase the ultimate possible return.

21.  After the successful CAT appeals, the relevant City Council endorsing the plans in XXXX 20XX and the demolition of the property in XXXX of 20XX, the Taxpayer with the assistance of numerous professionals estimated the costs of the project to be $X by 20YY.

22.  After the project costs were revised, the Taxpayer undertook further cost analysis in respect of changing the development to make it more feasible. This included changing the style of the development and changing the project from a multi-dwelling development to a single- or double-dwelling development.

23.  After the demolition in XXXX 20XX, the Taxpayer continued to obtain quotes and advice for various aspects of the project, including with respect to building surveyance work, environment or sustainability work, geotechnical services and structural and civil engineering.

24.  After receiving updated quotes in 20XX for the various works involved in the Development, which were increased from the earlier 20XX estimates, the Taxpayer undertook work to explore alternative options to make the Development more feasible.

25.  The Taxpayer engaged architects to prepare alternative plans for the Development, which provided for single-dwelling and multi-dwelling options for the Development.

26.  In XXXX 20XX, the Taxpayer entered into a contract to complete a re-establishment of title survey completed for all boundary lines of the Property.

Activities between 20XX and 20XX

27.  As COVID-19 impacted Australia in the 20XX calendar year, particularly the building and construction industry, external finance was becoming more difficult to obtain.

28.  The Taxpayer's area of residence went into various COVID-19 lockdowns at times between XXXX 20XX and XXXX 20XX.

29.  The Taxpayer preferred to meet with consultants in person rather than via technology-based means of communications, and their ability to consult effectively during the pandemic was limited. Once the pandemic restrictions eased, the Taxpayer arranged for numerous meetings with consultants regarding the project.

30.  The Taxpayer was diagnosed with incurable disease in XXXX 20XX. The Taxpayer's analysis was still ongoing when they received this diagnosis.

31.  The Taxpayer had not undertaken any similar activity or developments of this nature previously. The Taxpayer did not hold an Australian Business Number.

32.  The Taxpayer passed away in late 20XX. Unfortunately, given the Taxpayer's passing in late 20XX, ultimately no construction of any new dwelling development on the Property had commenced nor been completed.

33.  The Property, sitting as vacant land, is currently available for sale.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 70-10

Income Tax Assessment Act 1997 section 104-220

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Summary

No, the Property is not considered to be held as trading stock by the Taxpayer for a property development business. It is the Commissioner's view that the activities undertaken by the Taxpayer were preliminary and preparatory in nature and did not amount to carrying on a business of property development. Accordingly, CGT event K4 did not occur.

Detailed reasoning

CGT event K4, and trading stock

Subsection 104-220(1) of the ITAA 1997 provides that CGT event K4 happens if:

(a) you start holding as trading stock a CGT asset you already own but do not hold as trading stock; and

(b) you elect under paragraph 70-30(1)(a) to be treated as having sold the asset for its market value.

Subsection 70-10(1) of the ITAA 1997 provides that trading stock includes:

(a) anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and

(b) live stock.

The Commissioner's views on when land is treated as trading stock are discussed in Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'? (TD 92/124). TD 92/124 states that:

1. Land is treated as trading stock for income tax purposes if:

•         it is held for the purpose of resale; and

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

2. Both the required purpose and the business activity 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 sale of the land.

Am I in business?

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

The question of whether a business is being carried on is a question of fact and degree and depends on the impression of a taxpayer's activities considered as a whole. Over the years, the Courts have developed a series of indicators to determine if a business is being carried on. The Commissioner's views on relevant factors used to determine if an entity is carrying on a business are set out in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? (TR 97/11). Although TR 97/11 is about primary production, the indicia of carrying on a business developed by the Courts are discussed in this ruling, and apply to this case:

•         Whether the activity has a significant commercial purpose or character

•         Whether the taxpayer has more than just an intention to engage in business

•         Whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

•         Whether there is regularity and repetition of the activity

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

•         Whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

•         The size, scale and permanency of the activity

•         Whether the activity is better described as a hobby, a form of recreation or sporting activity

In this case it is contended that the Taxpayer had commenced a business of property development in the 20XX income year. However, the critical question is whether the activities undertaken by the Taxpayer were merely preliminary or preparatory to the carrying on of such a business; or whether the business had actually commenced.

Preparatory activities - When does a business commence?

The Commissioner has expressed views on when a business has commenced in Taxation Ruling TR 2001/14 Income tax: Division 35 - non-commercial business losses (TR 2001/14). Although TR 2001/14 is about non-commercial losses, the principles discussed apply in this case.

Paragraph 69A of TR 2001/14 discusses that for a taxpayer to have started to carry on a business activity, this requires the taxpayer to have:

•         committed to the activity - that is, they had purpose, intention and made the decision to commence the business activity (Goodman Fielder Wattie Ltd v. FC of T 91 ATC 4438 at 4447 (Goodman Fielder Wattie); Softwood Pulp and Paper Ltd v FC of T 76 ATC 4439 (1976) 7 ATR 101 at [4451] (Softwood); John Fairfax & Sons Pty Ltd v. Federal Commissioner of Taxation (1959) 101 CLR 30);

•         acquired the minimum level of business assets to allow that business activity to be carried on; and

•         actually commenced business operations.

A mere intention or desire to carry on a business is insufficient (Southern Estates Pty. Ltd. v. Federal Commissioner of Taxation [1967] HCA 16; (1967) 117 CLR 481 per Brennan J; McTiernan J and Barwick CJ at 488 on appeal - endorsed by Brennan J in Inglis v. FC of T 80 ATC 4001 at [4004-4005]; (1979) 10 ATR 493 (Inglis) at 496-497; Calkin v. CIR [1984] 1 NZLR 440 (Calkin); J & R. O'Kane & Co. v. Inland Revenue Commissioners (1920) 12 TC 303 at [347]).

Per paragraph 97 of TR 2001/14, the actual date of commencement of a business activity is a question of fact, and the nature of the activity said to amount to a business is critical to determining whether that business has actually commenced (Goodman Fielder Wattie).

In this case, for the business to have commenced, it must be shown that the Taxpayer had committed to the activity, embarking on a definite and continuous cycle of operations designed to lead to the development, subdivision and sale of the land (Whitfords Beach Pty Ltd v. FC of T 83 ATC 4277; (1983) 14 ATR 247 (Whitfords Beach) and Puzey v. Commissioner of Taxation (2003) 53 ATR 614)).

In Inglis,per Davies J (with whom St. John J agreed at [4007-4008]), a lack of certainty as to the use, where there are multiple options for the future use of an asset (in that case the land), was a factor that weighed against a conclusion that a business (of primary production) was carried on at a particular time. In that case, the land may have been used for private purposes, primary production, or alternatively, sale contracts could proceed to allow a family company to undertake a primary production activity.

In Softwood, activities relating to the establishment of a paper production operation were considered to be preliminary to carrying on a business. Menhennitt J found that "the taxpayer never committed itself to go on with the project, never made a final definitive decision to do so." An important fact in the reasoning provided by Menhennitt J was that the taxpayer lacked the capital required to undertake the proposed activity (see also Goodman Fielder Wattie at [4448]).

Whitfords Beach examined the issue of the commencement of a business activity and the factors to consider when determining the commencement of a business activity. These factors were a consideration of the taxpayer's purpose and the taxpayer's activities. Bowen CJ, Morling and Fitzgerald JJ said, at ATC 4282; ATR 253:

'Of course, it does not follow that all the activities engaged in by the taxpayer were necessarily in the course of that business or that some of them were not merely preparatory to it. In order to determine when the taxpayer's relevant business commenced and when its land or the various parts of it were committed to or ventured in that business, it is necessary to have regard both to the taxpayer's purposes and to its activities.'

Whitfords Beach involved a change of intention and the undertaking of activities which showed a business had clearly commenced. This followed a transfer of share ownership, a change in the directors and a change in the articles of association on 20 December 1967. On the same day, Whitfords Beach embarked on clear course of action which can be said to be the commencement of the business, including contracting general managers to undertake the subdivision and development of the land. Wilson J at [4053] adopted the words from the Federal Court where Deane J stated:

It is plain the effect of the transactions and events of 20 December 1967 was completely to transform the sub-stratum of the taxpayer. At the commencement of that day, the taxpayer was a company whose only significant asset was land which had been acquired for the purpose of safeguarding the interests of its shareholders as owners of the Whitford's Beach shacks and which, under the Articles of Association was, when subdivision became possible, to be allocated among the shareholders with any surplus to be dealt with as the company might, in general meeting, decide. At the end of that day, the taxpayer had set out upon a projected course of activity in relation to that land which involved procuring changes of zoning, the development of the subject land as a residential subdivision and the eventual sale, over a period of many years, of the subdivided lots....

Paragraph 99 of TR 2001/14 explains the Commissioner's view that the question of when a business activity commences is like the question of whether a business is being carried on at all; and depends on the 'large or general impression gained' (Martin v. FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551).

Paragraphs 100 to 105 of TR 2001/14 also provide the following:

100. The chain of events leading to the commencement or start-up of a business activity often begins with a mere intention to establish the business activity. This is developed by researching the proposed business and, in some instances, by experiment. This process culminates in a final decision on whether to commence business. Not all businesses commence in such an orderly fashion of course.

101. The intention and purpose of the taxpayer in engaging in the activity is relevant to when a business commences. However, a mere intention to commence a business activity is not enough: Goodman Fielder Wattie. The taxpayer must have more than an intention to commence business. There must be activity. In Esso Australia Resources Ltd v. FC of T 97 ATC 4371 at 4382; (1997) 36 ATR 65 at 77-78 Sundberg J stated:

'While the taxpayer may have had the intention ultimately to engage in production, that is not sufficient in itself to constitute a business activity.'

Sundberg J went on to say that 'commitment' was missing on the facts of the case. See also Brennan J in Inglis v. FC of T 80 ATC 4001 at 4004-4005; (1979) 10 ATR 493 at 496-497.

102. Whitfords Beach Pty Ltd v. FC of T 83 ATC 4277; (1983) 14 ATR 247 is one of the few cases that has examined the issue of the commencement of a business activity and the factors to consider when determining the commencement of a *business activity. These factors were a consideration of the taxpayer's purpose and the taxpayer's activities. Bowen CJ, Morling and Fitzgerald JJ said, at ATC 4282; ATR 253:

'Of course it does not follow that all the activities engaged in by the taxpayer were necessarily in the course of that business or that some of them were not merely preparatory to it. In order to determine when the taxpayer's relevant business commenced and when its land or the various parts of it were committed to or ventured in that business, it is necessary to have regard both to the taxpayer's purposes and to its activities.' (emphasis added)

103. Most business activities have a structure that provides the framework of the business, or their 'profit yielding subject'. It is usually a collection of capital assets. What the particular capital assets are will depend on the particular business activity. In Calkin v. CIR [1984] 1 NZLR 440 Richardson J said at 446-447:

'Clearly it is not sufficient that the taxpayer has made a commitment to engage in business: he must first establish a profit-making structure and begin ordinary business operations.' (emphasis added)

104. For a business activity to commence, an appropriate business structure should also be in place. As to what this structure will consist of, and its size, this will be a question of fact and degree, and depend on the nature of the business activity. A suitable structure might even be established by the execution of certain documents, where independent contractors with the necessary capital assets are engaged. Even though the taxpayer may have no physical assets themselves, their rights as against the independent contractor secure use of such assets, and those rights can properly be said to be capital assets in the taxpayer's hands. However, each case will need to be determined on its own facts and having regard to industry norms.

105. As noted in Inglis, the level of activity is important. The extent of activity will also determine whether a business activity has commenced and is in its start-up phase. Activity will support the taxpayer's claims to have commenced a business activity. Brennan J in Inglis made it clear that there must be activity when he said at ATC 4004; ATR 496:

'The carrying on of a business is not a matter merely of intention. It is a matter of activity. Yet the degree of activity which is requisite to the carrying on of a business varies according to the circumstances in which the supposed business is being conducted. Little activity may suffice for carrying on a business that does not call for much activity, as in Thomas and in Ferguson.' (emphasis added)

Brennan J went on to say at ATC 4005; ATR 497:

'At the end of the day, the extent of activity determines whether the business is being carried on. That is a question of fact and degree.' (emphasis added)

The level of activity that is required will clearly vary from case to case. Based on the decision in Calkin two different types of activity are relevant:

•        acquisition of the minimum level of 'business assets'; and

•        the commencement of 'business operations'.

Both are necessary to be able to conclude that a business has commenced.

Application to your circumstances

The Taxpayer's contentions are that in the 20XX income year, they commenced carrying on a business of property development and sale in respect of the Property, and therefore the Property became trading stock to the Taxpayer. In summary, the following factors were provided in support of this conclusion:

•         The Taxpayer had substantial personal involvement in the planning process of the development, the Initial Application and Second Application;

•         The Taxpayer's personal effort and commitment to the overall project was significant, including noting the difficulties that they had before CAT with the planning process;

•         The scale of the project that ultimately proceeded was significant and extended well beyond the Taxpayer's personal needs. The project had a significant commercial character;

•         The Taxpayer pursued the project with the intention of deriving profit from the activity and the activity was planned, organised and carried on in a businesslike manner; and

•         The Taxpayer kept detailed business records and undertook feasibility analysis in an organised, businesslike manner.

Taking all available facts into consideration, and on weighing the relevant facts, the Commissioner's view on balance is that no business activity had ever commenced during the Taxpayer's ownership period of the Property, including when the dwelling on the Property was demolished. The key factors leading to this conclusion are as follows:

•         There were several different types of developments being contemplated by the Taxpayer, with varying numbers of lots and storeys across the various building plans. Information provided explains that, after successful CAT proceedings, the relevant City Council extended a permit for the Taxpayer to develop an X-storey, Y-apartment development. However, further information provided shows that the Taxpayer was still undertaking feasibility and planning activity, through architects, who provided the Taxpayer with various other plans for developments in XXXX and XXXX 20XX (noting this activity occurred post-demolition of the Taxpayer's home dwelling on the Property). These other plans varied in style, number of apartments, number of storeys, facilities, etc.

o   Accordingly, as these different options were still being contemplated, no subdivision of the land ever occurred.

o   Accordingly, as these different options were still being contemplated, and therefore feasibility was still being considered, it cannot be said that a development had been committed to.

•         No actual development works had commenced or occurred on the Property once the dwelling was demolished.

•         The various feasibility studies undertaken, and engagements for quotes with service entities such as engineers, architects, builders, etc. by the Taxpayer are properly characterised as activities aimed at establishing the economic feasibility of the development, to determine if it should go ahead.

o   The information provided shows that various entities engaged by the Taxpayer were not contracted; they were merely approached for quotes for services, which would inform the Taxpayer's decision-making.

o   The information provided shows that the only service engagement form signed by the Taxpayer was for a survey for re-establishment of the Property's land title.

o   However, the Commissioner acknowledges that clearly the Taxpayer had pursued and paid for various other services, for example the building plans from architects.

•         All discussions with the various service providers were merely preliminary and were to inform or establish feasibility and a potential budget.

•         Although the Commissioner acknowledges the Taxpayer's relationship with the financial institution, it is unknown if the Taxpayer had the finance necessary to undertake the development.

o   Further, given that the Taxpayer was still contemplating different development options in XXXX and XXXX 20XX, it is considered that the Taxpayer would also be engaging with lenders because his finance requirements would be unknown and varying.

The activities undertaken during the Taxpayer's ownership period of the Property are considered to be mere preliminary and preparatory work. While clearly there was an intention to develop on the land after demolishing the dwelling previously used as the Taxpayer's residence, the facts demonstrate that the Taxpayer had not fully committed to the commencement of a business and had not embarked on a definitive and continuous cycle of operations designed to lead to the development, subdivision and sale of the Property.

That these activities undertaken are, in nature, preliminary and preparatory to the carrying on of a business is consistent with, and supported by, the decisions in Softwood, Inglis and Goodman Fielder Wattie.

On balance, and considered as a whole, the activities undertaken by the Taxpayer are best characterised as preliminary or preparatory activities aimed to put him in a position to undertake the proposed development, subdivision and resale; and that a business of property development had not commenced.

Therefore, CGT event K4 did not occur to the Property in the 2019 income year.

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