Edited version of private ruling

Authorisation Number: 1011708856445

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Ruling

Subject: Income - property development

Question 1

Are the proceeds from the sale of the units assessed under the capital gains tax provisions in the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Are the proceeds from the sale of the units assessed as ordinary income under section 6-5 of the ITAA 1997?

Answer

Yes

Question 3

Are the units considered to be trading stock in accordance with section 70-10 of the ITAA 1997?

Answer

No

Question 4

If the proceeds from the sale of the units are assessed under the capital gains tax provisions as the realization of a capital asset, is the entity carrying on an enterprise for GST purposes and is registration for GST required?

Answer

Not applicable

This ruling applies for the following periods:

1 July 2010 - 30 June 2011

1 July 2011 - 30 June 2012

1 July 2012 - 30 June 2013

The scheme commences on:

1 July 2010

Relevant facts and circumstances

The private company (the company) was incorporated prior to September 1985 with the purpose of holding the family residence.

At no time has the company been used for carrying on a business. This structure was chosen as an asset protection measure and for succession planning purposes to avoid the imposition of death duties when assets passed to future family generations.

The directors/shareholders (the owners) have always been family members, the current owners have held shares in the company since earlier than September 1985.

The family residence was acquired in the year of incorporation.

Until recent years the entire property was used as the residence of the owners. Recently, the property has been vacant.

The owners now wish to move back to the family property but would like to live in a smaller, more modern home that is easier to maintain and live in.

The company proposes to construct a number of apartments that maximize the land value and position, and use the proceeds of the sale of the units to fund the cost of the owner's residential apartment.

There is excess value held in the family property. The company intends to maximize the sale proceeds to enable the cost of a smaller, more suitable home to be constructed.

The owners and the company have no experience in one off property development and will have minimal personal involvement in the operation. The company has appointed a project manager to the project.

Borrowed funds will finance the development.

The current value of the property is $A. The total cost of the project is $B. The final value of the units is expected to be $C. The expected market value of each unit was provided

The site plans were provided and form part of the ruling.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 70-10

Income Tax Assessment Act 1997 Subsection 70-10(a)

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.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Question 1 and 2

Taxation Ruling TR 92/3 sets out the Commissioners view on whether profits made from isolated transactions are ordinary income. 'Isolated transactions' refers to:

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

· those transactions entered into by non-business taxpayers.

Whether a profit from an isolated transaction is income according to ordinary concepts depends very much on the circumstances of the case. However, where a taxpayer who does not carry on a business makes a profit from an isolated transaction, 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.

Intention or purpose

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 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.

The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. Where a transaction or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the land or property.

Where the taxpayer is a company, the purposes of those who control it are its purposes (Paragraph 39 of TR 92/3).

Making a profit or gain

The term 'profit or gain' is not defined and consequently it takes its ordinary meaning. It refers to concepts commonly used in the commercial world and can encompass a 'profit or gain' of an income or capital nature. (see Paragraph 385 of MT 2006/1).

Carrying out a commercial transaction

Paragraph 13 of TR 92/3 lists factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction. Relevant factors include:

· 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;

· if the transaction involves the acquisition and disposal of property, the nature of that property; and

· the timing of the transaction or the various steps in the transaction.

In addition to the above factors, for the purposes of determining whether the activities undertaken in relation to real property and development equate to a profit-making undertaking or scheme, Miscellaneous Taxation Ruling MT 2006/1 aligns with TR 92/3 and provides a list of factors which, if present may be an indication that a business or profit-making undertaking or scheme is being carried on. If several of these factors are present it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows:

· there is a change of purpose for which the land is held;

· additional land is acquired to be added to the original parcel of land;

· the parcel of land is brought into account as a business asset;

· there is a coherent plan for the subdivision of the land;

· there is a business organisation - for example a manager, office and letterhead;

· borrowed funds financed the acquisition or subdivision;

· interest on money borrowed to defray subdivisional costs was claimed as a business expense;

· there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and

· buildings have been erected on the land.

No single factor is determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

Paragraph 284 to 287 of MT 2006/1 provides an example of a subdivision of land that amounts to an enterprise by way of constituting an isolated profit-making scheme or transaction. This example reads as follows:

284. Prakash and Indira have lived in the same house on a large block of land for a number of years. They decide that they would like to move from the area and develop a plan to maximise the sale proceeds from their land.

285. They consider their best course of action is to demolish their house, subdivide their land into two blocks and to build a new house on each block.

286. Prakash and Indira lodge the necessary development application with the local council and receive approval for their plan. They arrange for:

· their house to be demolished ;

· the land to be subdivided ;

· a builder to be engaged ;

· two houses to be built ;

· water meters, telephone and electricity to be supplied to the new houses ; and

· a real estate agent to market and sell the houses.

287. Prakash and Indira carry out their plan and make a profit. They are entitled to an ABN in respect of the subdivision on the basis that their activities go beyond the minimal activities needed to sell the subdivided land. The activities are an enterprise as a number of activities have been undertaken which involved the demolition of their house, subdivision of the land and the building of new houses.

Application to your situation

As described in your ruling application, the company has owned the residence since earlier than September 1985. The current shareholders/directors (the owners) have held shares in the company since earlier than September 1985 and the property has been used as a main residence for an extensive period.

There is an intention to make a profit

The proposed plan is to realize the excess value held in the family property to enable the owners to acquire a smaller, more suitable home to be constructed. The site will be developed into a number of units, with the company to retain one unit as a main residence for the owners.

Based on the financial information provided, from the carrying out of the transaction the company will retain a unit and create equity of approximately $X million in the unit. This represents significant value adding to the asset to be retained by the company as a result of carrying out the project. It is considered that a significant purpose in entering into the transaction to make a profit or gain.

The transaction is commercial in nature

Based on your factual situation, it is considered that the transaction is commercial in character due to the magnitude of profit, significant value adding expected to be achieved and the amount of capital risked carrying out the project.

The nature and scale of the operation will provide significant value adding to the property as discussed above. The activities are planned, organised and coherent.

The value of capital risked to complete the project is significant. The current value of the property is $A. The total cost of the project is $B; the company proposes to finance the project by borrowing 100% of the funds required.

The facts set out that the transaction is beyond that of a mere realisation of a capital asset, albeit in an enterprising way. The expected revenues from the sale of the units represent a significant portion of the construction costs though would not be sufficient to cover the costs in full. There will be significant development undertaken on the property which will result in significant value adding to the asset to be retained by the company.

On a weighing of the facts of your case we find that this transaction will be entered into, and any profits made, in the course of carrying out an isolated profit making transaction. Accordingly, the proceeds will be considered ordinary assessable income under section 6-5 of the ITAA 1997.

Question 3

Trading stock

Subsection 70-10(a) of the ITAA 1997 states that trading stock is anything produced, manufactured or acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course of business. Your activity does not amount to the carrying on of a business. As a result the units would not be considered trading stock.

Question 4

Not applicable