Edited version of private ruling

Authorisation Number: 1011774372554

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Ruling

Subject: Am I in Business-property development

Question 1:

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

Answer: No.

Question 2:

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

Answer: Yes.

This ruling applies for the following period:

Year ending 30 June 2011
Year ending 30 June 2012
Year ending 30 June 2013

The scheme commenced on:

1 July 2009

Relevant facts

The entity was established as a holding entity for the property for asset protection purposes.

The entity purchased an investment property.

The property is a weather board house.

The property is zoned residential.

The property was rented just after it was purchased.

The intention of the entity was to hold the property for long term investment as the entity believed this would provide a secure income stream for retirement purposes and the rental income could be utilised to cover the ongoing operating costs including finance costs.

The entity's initial intention also was not to develop the property. However, a few months after purchasing the property the entity decided to develop the property into a number of units.

The entity did not undertake any detailed research into the profitability of the development as the entity believed that due to the capital appreciation of the property over time the project should be profitable.

The entity has engaged a number of consultants to undertake the planning and development of the property:

The property has not been subdivided.

The development plans were approved by the local council.

The entity has obtained initial quotes for the development.

The entity will appoint a builder to undertake the development.

It is not the entity's desire to sell any of the units after completion of the development, but due to financial pressure the entity may sell a number of the units to reduce the debt level in relation to the project.

The entity has never operated nor conducted a business of development, nor any other business for that matter.

Consultants invoice the entity for their services and expenses are paid from a cash management account held by the entity.

The entity does not hold any licences or qualifications in relation to the development or construction industry.

The development is a once off arrangement.

The entity intends to engage a real estate agent in relation to the sale of the units.

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 an entity is 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 is to hold the property as a long term investment and rent the property out. The entity did not undertake any detailed research into the profitability of the development as the entity believes the value of the property would appreciate over time. The development is a once off arrangement. The entity's involvement in the development is limited to purchasing the property and paying for the development costs. The entity has engaged consultants to organise the plans and permits for the development and is expecting to appoint a builder to undertake the overall construction of the development. The size and scale of the development is relatively small.

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:

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

(b) those transactions entered into by non-business taxpayers.

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

(a) the intention or purpose of a 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 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 is 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 the following factors 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.

Applying the criteria to your circumstances

The entity does not carry on a business of property development. The entity was established for asset protection purposes. At the time of purchasing the property, the entity did not intend to develop the property as the entity's intention was originally to purchase the property as a long term investment to provide an income stream for beneficiaries of the entity in retirement.

The entity's intent to retain a number of units at the completion of the redevelopment and utilise the rental income to cover the ongoing operating and finance costs. The property had been rented just after it was purchased. However, due to financial pressure the entity may have to sell a number of the units to reduce the debt level in relation to the project. While the existing structure at the site will be demolished and a block of new units will be built on site, the scale of the activity is considered relatively small.

The entity has no prior history of being involved in property development and the current development is a once off arrangement. The entity's involvement in the development is limited to purchasing the property, as the entity has engaged consultants to organise plans, permits and are seeking to engage a builder to carryout the re-development work. All costs in relation to the redevelopment will be paid out of a cash management account and the units which may be sold will be listed with a local real estate agent.

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 ordinary income from an isolated transaction. The acquisition, the development and sale of a number of units do not amount to a business operation or commercial transaction. Therefore, any profit or gain from the sale of a number of 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 a number of units is on capital account and the gain or loss will subject to the CGT provisions.