Edited version of private ruling

Authorisation Number: 1011670934049

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Ruling

Subject: Expenditure incurred after activity ceased and non commercial loss provisions

1. Are legal, accounting and other related expenses incurred after the cessation of your property development activity allowable as a deduction?

No.

2. Will deductions incurred after the cessation of your property development activity be subject to the non commercial loss provisions?

No.

Relevant facts and circumstances

You purchased a property in 1990 and retained ownership of the whole property until you commenced to sell the units under a strata plan.

The property was excavated in 1999 and you entered into a contract with a builder in the same year for the construction of a number of units on the site.

Construction was completed in mid 2001, after which a portion of the units were sold. Goods and Services Tax (GST) was remitted upon the sale of each of the four units and the GST registration was cancelled.

You included a capital gain in your 2001-02 income tax return and a further capital gain in your 2002-03 income tax return. The capital gain assessed was reduced by 50% in each case under the capital gains discount method. You retained ownership of the two remaining units and reside in one of them.

Some time later the body corporate pursued the statutory warranty from a government body for defective work in the construction of the building. The government body indemnified the owners for the faulty work and in turn took legal action against you, due to the insolvency of the builder and the insurer, in order to recover the monies outlaid. The legal action against you was possible because you were deemed to be the developer of the property.

You incurred legal, accounting and other costs incidental to the legal action in the 2008-09 and 2009-10 income years.

The matter was settled when you and government body entered into a deed whereby you agreed to pay them a sum of money without admission of liability. Each party agreed to pay their own costs.

You have retained no records of the disposal of any of the four units and have been unable to obtain any from your previous tax agent. You are also uncertain whether any or all of the gains on sale of the units have been declared and/or when each of the four disposals was declared.

Reasons for decision

Summary

Legal, accounting and other related expenditure incurred after the cessation of your property development activity as a result of legal action being taken against you, are not allowable as a deduction because you are not considered to be carrying on a business of property development or deriving income that is assessable as ordinary income.

As you are not carrying on a business, the non-commercial loss provisions do not apply.

Detailed reasoning

Question 1

Whether carrying on a business

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for any loss or outgoing that is incurred in gaining or producing your assessable income or is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. However you cannot deduct a loss or outgoing under this section that is capital, private or domestic in nature or is incurred in gaining or producing exempt income.

In order to determine whether expenses related to your property development activities but incurred after the cessation of the relevant activity, are allowable under section 8-1 of the ITAA 1997 it is necessary to first determine if your activities amounted to the carrying on of a business.

Taxation Ruling TR 97/11 provides the Commissioner's views on the indicators that are relevant as to whether a person is carrying on a business. Whilst this ruling is specifically aimed at determining if a business of primary production exists, the reasoning can be applied to businesses in general.

TR 97/11 notes that various court decisions over the years have held that the following indicators are relevant in considering whether a business has been carried on:

· 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 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.

No one indicator is decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922), and there is often a significant overlap of these indicators. For example, an intention to make a profit will often motivate a person to carry out the activity in a systematic and organised way, so that the costs are kept down and the production and the price obtained for the produce are increased.

The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the 'large or general impression gained' (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548) from looking at all the indicators, and whether these factors provide the operations with a 'commercial flavour' (Ferguson v. FC of T 79 ATC 4261; (1979) 9 ATR 873). However, the weighting to be given to each indicator may vary from case to case.

In your case it is apparent that the activity had a significant commercial purpose and that you were motivated by the prospect of profit to be derived from the development of the site. However, it is also apparent that:

· this was the first property development you had undertaken

· you have not undertaken any further property developments

· you held the property for many years before embarking on the development of the property

· you have retained no records of the transactions, and

· you kept some of the units for yourself.

You purchased the land on which the units were eventually built in 1990. You did not excavate the property until 1999 and did not engage a builder to erect the block of units until 1999. This is, by any measure, a long period of time in which to decide what you were going to do with the property and indicates that you had no clear intention in mind when you purchased it. As such your actions are not consistent with a person conducting a business of property development.

Since you have embarked on no other property developments in the following years further indicates that this was an isolated transaction and not indicative of a person actually carrying on a business. The fact that you retained two units for yourself is also not indicative of a person carrying on business. In a business, the units would comprise trading stock and to withhold a portion of the stock from sale is not consistent with the actions of a person carrying on a business.

You also have no accounting records of the sale of the units and do not appear to be certain if the capital gains returned in your 2001-02 and 2002-03 income tax returns represent any or all of the gains on sale of the units. Whilst we appreciate that your former tax agent may not have returned the records you provided him with in order to prepare the relevant income tax returns, we take the view that it would not be prudent for a person in business to rely upon a single set of records. Your lack of records is therefore considered to be unbusinesslike.

In our view the general impression of your property development activity is that it does not amount to the carrying on of a business.

Whether profit from an isolated transaction

Taxation Ruling TR 92/3 provides the Commissioner's views on whether profits on isolated transactions are assessable income.

In the ruling the term 'isolated transactions' refers to:

· transactions outside the ordinary course of business of a taxpayer carrying on a business, and

· transactions entered into by non-business taxpayers.

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

· the taxpayer had a profit-making intention when entering the transaction or operation, and

· the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

The intention of the taxpayer is determined by an objective consideration of the facts and the circumstances of the case.

Profit-making does not need to be the sole or dominant purpose for entering the transaction but there must be a significant purpose. The purpose must exist at the time the transaction or operation was entered into.

In view of the length of time that you had held the property, prior to commencing the excavation work which began the process of erecting the units, it is considered that you had no clear profit making intention at the time of purchase in 1990.

It is therefore considered that the profit derived from the sale of the units is not assessable under section 6-5 of the ITAA 1997 as an isolated transaction and that it has been correctly returned as a capital gain. Accordingly, the additional legal, accounting and other costs incurred after the cessation of the activity in connection with a claim for poor workmanship are by extension, also capital in nature.

Support for this view can be found in this observation by the Full High Court in Federal Commissioner of Taxation v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693 about the nature of profits from isolated transactions:

It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of the acquisition of acquiring for the purpose of profit making by sale. Then, if the asset is not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realisation. But it is quite another thing if the decision to sell is taken by way of implementation of an intention or purpose, existing at the time of acquisition, of profit-making by sale, at least in the context of carrying on a business or carrying out a business operation or commercial transaction.

Conclusion

You are not considered to be carrying on a business of property development and any profits from the sale of the units are not assessable as an isolated transaction under section 6-5 of the ITAA 1997. The deductions sought for legal, accounting and other related expenditure incurred in the 2008-09 and 2009-10 income years as a result of the settlement of an action for poor workmanship are therefore not deductible under section 8-1 of the ITAA 1997.

Question 2

Division 35 of the ITAA 1997 provides for the treatment of losses that are incurred from a non-commercial business activity for a particular year of income. However section 35-5(2) of the ITAA 1997 states that the Division is not intended to apply to activities that do not constitute carrying on a business.

As you are not considered to have carried on business as a property developer, the non commercial loss provisions do not apply to you.