Edited version of private ruling

Authorisation Number: 1011640321749

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Ruling

Subject: Sale of property - capital or revenue

Question 1

Are the proceeds from sale of your properties assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Are the proceeds from sale of your properties subject to the capital gains tax (CGT) provisions in Part 3-1 and Part 3-3 of the ITAA 1997?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

Some years ago, but after 20 September 1985, you purchased the property as an investment.

You have not used this property for your own domestic use.

You rented the original house to tenants for them to use.

After several years renting the house, you decided to demolish the house and build two dwellings (the new premises) in its place.

Your intention at that time was to keep the new premises and rent them to tenants.

The construction was completed by you as owner builder, together with appropriate licensed tradesmen.

You have no other rental properties and have not conducted any other building or renovating projects.

You have not used the new premises for your own domestic use.

You rented both of the new premises to tenants for them to use.

You financed your original purchase of the property and construction of the new dwellings through home loans in your personal names, and not as business loans.

Rents received have been used to repay the home loan and cover other property related expenses.

Assumption

You provide courier services that amount to the carrying on of a business.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-5

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

Reasons for decision

Summary

It is the Commissioner's view that the sale of the properties is outside the ordinary course of business, and more accurately represents the mere realisation of capital assets owned as individuals, as joint tenants. The properties were not purchased with a profit-making purpose, but to hold as an investment, to generate long-term capital appreciation and returns of a capital nature.

As a mere realisation of a capital asset, the proceeds from sale are not assessable as ordinary income under section 6-5 of the ITAA 1997. The proceeds from sale of your properties are subject to the CGT provisions provided in Part 3-1 and Part 3-3 of the ITAA 1997.

Detailed reasoning

There are three ways in which profits from the sale of your properties can be treated for taxation purposes:

· as ordinary income under section 6-5 of the ITAA 1997, on revenue account, as income generated in the ordinary course of carrying on a business of buying/selling property

· as ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of an isolated commercial transaction, where net profits are included in assessable income, or

· as statutory income under the capital gains tax (CGT) regime in Part 3-1 and Part 3-3 of the ITAA 1997, on the basis that a mere realisation of a capital asset has occurred.

Carrying on 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

· the volume of the operations and the amount of capital employed.

A decision is dependant upon 'the large or general impression gained' and whether these indicators provide the activities with a commercial flavour after considering the indicators in combination and as a whole (paragraph 16 of TR 97/11).

The receipt of income from leasing an asset for use by others does not, of itself, amount to the carrying on of a business. Taxation Ruling IT 2423 at paragraph 5 provides:

"A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations. An individual who derives income from the rent of one or two residential properties would not normally be thought of as carrying on a business. On the other hand if rent was derived from a number of properties or from a block of apartments that may indicate the existence of a business."

You advise you are carrying on a business providing courier services. The questions in this case do not require the Commissioner to decide whether your courier services activities amount to 'carrying on of a business' and accept the assumption in proceeding with this case.

Due to the facts that:

· rental, property development, and property sales activities are not of the type normally required in carrying on a courier services business; and

· the scope of your rental, property development, and property sale is limited to one property;

these activities are not sufficient to amount to 'carrying on a business' and are considered to be 'outside the ordinary course of' your courier services business or transactions entered into by you as individuals and not as partners in business.

Isolated business transactions

Taxation Ruling TR 92/3 provides the Commissioners view on whether profits from isolated transactions are assessable as ordinary income and explains the term 'isolated transactions' refers to those transactions outside the ordinary course of business, and those transactions entered into by non-business taxpayers.

TR 92/3 states profit from an isolated transaction is generally income when both the following elements are present:

(a) the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain, and

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

The profit-making purpose (where a taxpayer acquires an asset with the intention to resell it quickly and make a profit on the deal) must exist at the time of entering into the transaction. It need not be the dominant purpose, but must be a significant purpose or intention.

Paragraph 46 of TR 92/3 confirms that where a taxpayer enters into a transaction outside the ordinary course of carrying on a business or as an individual, it is necessary to consider whether it is a commercial transaction. Paragraph 13 of TR 92/3 provides some aspect that may be relevant in reaching this conclusion as follows:

(a) the nature of the entity undertaking the operation or transaction;

(b) the nature and scale of other activities undertaken by the taxpayer;

(c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

(d) the nature, scale and complexity of the operation or transaction;

(e) the manner in which the operation or transaction was entered into or carried out;

(f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

(g) if the transaction involves the acquisition and disposal of property, the nature of that property; and

(h) the timing of the transaction or the various steps in the transaction.

If an isolated transaction is outside the ordinary course of a business being carried on or by individuals, the intention or purpose of making profits must exist in relation to the specific transaction in question.

Mere realisation of a capital asset

The proceeds of sale of property more often represent the mere realisation of capital assets, which will fall for consideration under the CGT provisions in Part 3-1 and Part 3-3 of the ITAA 1997. Section 108-5 of the ITAA 1997 provides that a CGT asset is any kind of property, or a legal or equitable right that is not property.

CGT event A1 under section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you dispose of each subdivided block. You will make a capital gain if the capital proceeds from the disposal are more than the cost base of each block. You will make a capital loss if those capital proceeds are less than the reduced cost base of each block.

In applying this to the facts of your case, the relevant transaction(s) include not only the sale of the new premises and sub-divided land, but also the original purchase, the subdivision and construction of the new premises.

When entering the purchase transaction of the house and land, your intention was not to resell the property quickly, but to hold it as an investment that would increase in value over the long term. Without a profit-making intent your activities would not ordinarily be regarded as revenue-based income.

The following facts also support a conclusion that the property related activities and transactions were not isolated commercial transactions:

· You provided the original house to tenants for them to use in exchange for rental receipts.

· When you decided to demolish the old house and build the new premises you planned to hold on to the properties, as before, for investment purposes.

· When construction was complete the new premises were leased to tenants for their use.

· The new premises have been rented for approximately 12 months prior to sale.

· You have not used the premises as your business premises.

· Both the old house and the new premises were residential premises, not commercial properties.

· You do not have any other rental properties.

· You have not conducted any other property development activities.

It is the Commissioner's view that the sale of the properties is outside the ordinary course of business, and more accurately represents the mere realisation of capital assets owned as individuals, as joint tenants. The properties were not purchased with a profit-making purpose, but to hold as an investment, to generate long-term capital appreciation and returns of a capital nature.

As a mere realisation of a capital asset, the proceeds from sale are not assessable as ordinary income under section 6-5 of the ITAA 1997. The proceeds from sale of your properties are subject to the CGT provisions provided in Part 3-1 and Part 3-3 of the ITAA 1997.

Further issues for you to consider

Split or changed assets

Special cost base rules apply if a CGT asset is split into two or more assets but only if the taxpayer remains the beneficial owner of the new assets after the change.

Section 112-25 of the ITAA 1997 provides the method to calculate the cost base and reduced cost base of each new asset as follows:

1. Work out each element of the cost base and reduced cost base of the original asset at the time when the CGT asset is split.

2. Apportion each element to each new asset in a reasonable way. The result is each corresponding element of the new asset's cost base and reduced cost base.

Taxation Determination TD 97/3, which is about the subdivision of land, states:

1. The disposal of a subdivided block is treated as the disposal of an asset in its own right, and not as a disposal of part of an asset (the original land parcel).  

2. We consider that the effect of registering separate new titles under the subdivision is, for Part IIIA purposes, to divide the original land parcel into two or more assets (viz., the subdivided blocks). The subdivided blocks are then treated as separate assets under the capital gains provisions. They are taken to have been acquired by the owner of the original land parcel when that original parcel was acquired.

At paragraph 5, TD 97/3 provides 3 examples of the allocation of cost base and reduced cost base to each new block.

The acquisition date for the subdivided blocks remains the date you originally acquired the original parcel of land.