Edited version of private ruling

Authorisation Number: 1011743513194

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Ruling

Subject: Property development - revenue or capital.

Question 1:

Is the profit received from the sale of a number of residential units assessable as ordinary income?

Answer:

No.

Question 2:

Is the profit received from the sale of a number of residential units assessable as capital gains?

Answer:

Yes.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commenced on:

1 July 2009

Relevant facts

An opportunity arose to purchase a number of blocks of land (the properties).

The entity purchased the properties as tenants in common.

The entity's intention was to build a unit on the each block of land for investment purposes.

No research was undertaken in relation to the profitability of purchasing and developing the properties for sale.

No business plan was undertaken to develop the properties.

The purchase of the properties was settled and some time after the settlement as it became apparent to the entity that the land could be subdivided, with the intention of constructing further units on each block of land for investment purposes.

The entity engaged a number of entities to carry out the planning, design and construction of the units on the properties.

Financed for the construction of the units was provided by a financial institution.

The properties were subdivided.

During construction of the units the entity decided to sell the finished units rather than maintaining the initial intention of holding the properties of investment purposes. The decision to sell the units was due to financial pressure which may have impacted on the members of the entity's financial wellbeing.

The entity placed the units on market for sale while the construction of the units was still in progress.

The units were rented through an agent whilst listed for sale.

The entity received rent of the leased units.

The properties were rented from a short period of time before they were sold.

The units were sold by a member of the entity.

The units were sold a number of years after the land was purchased.

All costs in relation to the development of the units were paid by the entity.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5.
Income Tax Assessment Act 1997 section 10-5.
Income Tax Assessment Act 1997 subsection 995-1.
Income Tax Assessment Act 1997 Section 102-5.

Reasons for decision

There are three ways profit from property sales can be treated for taxation purposes: 

1) As ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), as a result of carrying on a business of property development.  

2) As ordinary income under section 6-5 of the ITAA 1997, as a result of an isolated business transaction entered into by a non-business taxpayer or outside the ordinary course of business of a taxpayer carrying on a business.  

3) As statutory income under the capital gains tax (CGT) legislation, (sections 10-5 and 102-5 of the ITAA 1997), on the basis that a mere realisation of a capital asset has occurred.

Carrying on a business of property development
Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the facts.

Taxation Ruling TR 97/11 provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. These factors are:

· 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 business-like manner such that it is described as 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 sporting activity.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. 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 from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

In applying these factors to the entity's situation, the entity has no prior history of being involved in property development. The entity's initial intention was to hold the properties as a long term investment and rent them out. The entity did not have a business plan and the development was a once off arrangement. The entity's involvement in the development is limited to obtaining finance and the subsequent sale of the properties. The entity engaged consultants and builders to organise plans, permits and the overall construction of the development. The size and scale of the development is relatively small and the expected profit will be modest.

Therefore it is considered that the entity is not carrying on a business of property development and the income derived from the selling of the units is not ordinary income.

Isolated transactions

The Commissioner's view on whether profit from isolated transactions is assessable as ordinary income is found in Taxation Ruling TR 92/3. 'Isolated transactions' are:

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

· those transactions entered into by non-business taxpayers.

TR 92/3 states profits on an isolated transaction will be ordinary income when:

· the intention or purpose of a taxpayer in entering into the transaction was to make a profit or gain; and

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

The intention of the taxpayer is determined by an objective consideration of the facts and circumstances (paragraph 38 of TR 92/3). Further, paragraph 40 of TR 92/3 indicates that a profit making purpose need not be the sole or dominant purpose for entering into the transaction. It is sufficient if profit making is a significant purpose.

Paragraph 41 of TR 92/3 indicates that you must have the requisite purpose at the time of entering into the relevant transaction or operation. If the transaction involves the sale of property, it is usually necessary that you have the purpose of profit making at the time of acquiring the property.

If a taxpayer not carrying on a business and 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.

A transaction may be characterised as a business operation or commercial transaction if the transaction is business or commercial in character.

Paragraph 13 of TR 92/3 lists some matters which may be relevant in 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 that property; and

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

In applying these factors to the entity's circumstances, the entity does not carry on a business of property development. At the time of purchasing the properties the entity did not intend to enter into the transaction to make a profit. The entity intended to hold properties for long term investment. The properties were rented for a period after they constructed. However, due to financial pressure of holding the units, they were sold a number of years after the acquisition of the land.

The entity has not been involved in property development before and the development was a once off arrangement. The entity's involvement in the development was limited to obtaining finance and the sale of the units. The entity engaged consultants to organise and plan the project and builders to carry out the construction of a number of units. The size and scale of the project is relatively small.

Based on the facts and circumstances noted above we have determined that the profit from the sale of the units by the entity is not assessable as income from an isolated transaction. The acquisition and sale of the units do not amount to a business operation or commercial transaction but from the sale of an investment property. Therefore, any profit or gain from the sale of the units will not be assessable as ordinary income under section 6-5 of the ITAA 1997.

Conclusion

It is considered any gain or loss the entity makes on the disposal of units is on capital account and the gain or loss will subject to CGT provisions.