Edited version of your private ruling

Authorisation Number: 1011956281449

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Ruling

Subject: Sale of property

Questions and Answers

1. Are the proceeds from subdividing the land, constructing and selling the dwelling assessable as ordinary income?

No

2. Are the proceeds from subdividing the land, constructing and selling the dwelling assessable as a capital gain?

Yes

3. Are you required to be registered for the goods and services tax (GST) when you sell the dwelling?

Yes

This ruling applies for the following periods:

Year ended 30 June 2010

Year ended 30 June 2011

The scheme commences on:

1 July 2009

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You and your spouse (You) in partnership purchased a property in 2004 with an area of less than 2 hectares which you used as your main residence.

You sought advice, working and drawings from a builder in 2005 in regard to subdividing the property and building two new residences. On completion of the new residences you would retain one as your main residence and sell the other one for profit.

The old residence was demolished a few years later by a builder.

You subsequently entered into a contract with the builder to build the two new residences.

You obtained finance from a financial institution for the funding of the building contract and other expenses.

On completion of the new residences in the 2009-10 income year, you entered into an agreement to sell the dwelling not used as your main residence (the new dwelling). The new dwelling was sold in the 2009-10 income year.

You and your spouse are not registered for GST either individually or as a partnership.

You and your spouse are not land developers. Neither of you have any formal qualifications, previous experience or knowledge of property development.

The construction and sale of the new dwelling was a one off transaction.

Your GST turnover for the sale of the new dwelling exceeds the registration turnover threshold which is currently $75,000.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5.

Income Tax Assessment Act 1997 Subsection 15-15.

Income Tax Assessment Act 1997 Subsection 102-5.

Income Tax Assessment Act 1997 Subsection 102-20.

Income Tax Assessment Act 1997 Subsection 104-10.

Income Tax Assessment Act 1997 Subsection 108-5.

A New Tax System (Goods and Services Tax) Act 1999 Section 9-20

A New Tax System (Goods and Services Tax) Act 1999 Section 23-5

A New Tax System (Goods and Services Tax) Act 1999 Section 188-10

A New Tax System (Goods and Services Tax) Act 1999 Section 195-1

Reasons for decision

Summary

The proceeds from the sale of the new dwelling will not assessable as ordinary income. The proceeds are capital proceeds and subject to the CGT provisions. You and your spouse are required to be registered for GST as a partnership as a result of the sale of the dwelling.

Detailed reasoning

Assessability of proceeds on sale of dwelling

Under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), your assessable income includes the ordinary income you derived directly or indirectly from all sources, during the income year. Additionally, section 15-15 of the ITAA 1997 includes profit arising from the carrying on or carrying out of a profit-making undertaking or plan. However, this provision does not apply to a profit that is assessable as ordinary income under section 6-5 of the ITAA 1997, or which arises in respect of the sale of property acquired on or after 20 September 1985.

Although the legislation does not define income according to ordinary concepts, a substantial body of case law has evolved to identify various factors that indicate the nature of ordinary income.

Taxation Ruling TR 92/3 discusses profits on isolated transactions. This ruling states that profits on isolated transactions may be income.

Profit from 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 or in carrying on a business operation or commercial transaction.

Some of the factors to consider when looking at whether an isolated transaction amounts to a business operation or commercial transaction are listed at paragraph 13 of TR 92/3. They are:

(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.

Profits on the sale of subdivided land can be income according to ordinary concepts within section 6-5 of the ITAA 1997, or as a profit making undertaking or plan within section 15-15 of the ITAA 1997, if the taxpayer's subdivisional activities have become a separate business operation or commercial transaction, or an isolated profit making venture.

Your case

The builder demolished the old residence and subdivided the property and built two new residences (dwellings).You used one of the dwellings as your main residence and the other was built for sale at a profit (new dwelling). The activities involved in the subdivision and sale of the dwelling do not amount to carrying on a business. You and your spouse are not land developers. Neither of you have any formal qualifications, previous experience or knowledge of property development. There has been no regularity of operations and this was a one-off transaction.

There is no indication that your subdivisional activities amounted to a separate business operation or commercial transaction, or that you were carrying on, or carrying out a profit-making undertaking or plan.

The proceeds from the sale of the new dwelling will therefore not be ordinary income and not assessable under sections 6-5 or section 15-15 of the ITAA 1997.

Capital gains tax

Section 102-20 of the ITAA 1997 provides that a capital gain or capital loss arises if a capital gains tax event (CGT event) happens to a capital gains tax asset (CGT asset). This applies to CGT assets acquired on or after 20 September 1985.

A CGT asset is any kind of property, or a legal or equitable right that is not property, real estate is a CGT asset (section 108-5 of the ITAA 1997).

The most common CGT event happens if you dispose of an asset to someone else, the disposal of a CGT asset causes a CGT event A1 to happen. You dispose of an asset when a change of ownership occurs from you to another entity. The time of the event is when you enter into the contract for the disposal or if there is no contract when the change of ownership occurs (section 104-10 of the ITAA 1997).

You make a capital gain if the capital proceeds from the disposal are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

In your circumstance the dwelling is a CGT asset and the sale of the dwelling resulted in CGT event A1 happening.

Therefore, any proceeds received from the sale of the new dwelling are treated as capital proceeds.

Goods and Services Tax (GST)

Under section 23-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) you are required to be registered for the GST if:

(a) you are carrying on an enterprise; and

(b) your GST turnover meets the registration turnover threshold which is currently $75,000.

Who is making the supply of the new property?

Based on the facts provided, the new property is owned as joint tenants by two individuals (you and your spouse), thus we first need to examine whether the property will be provided by each individual separately or by a partnership for GST purposes.

The term 'you' applies to 'entities' generally. An entity is defined in section 184-1 of the GST Act to include (amongst others) an individual and a partnership.

Co-owners of property are considered partners in a partnership for tax law purposes where they are in receipt of ordinary or statutory income jointly. Therefore, the entity will be the partnership of Mr and Mrs Cronan.

For further information on tax law partnerships and co-owners of property, please refer to Goods and Services Tax Ruling GSTR 2004/6: tax law partnerships and co-owners of property (available at www.ato.gov.au).

Is the partnership carrying on an enterprise?

The definition of an enterprise in section 9-20 of the GST Act includes (amongst other things) an activity or series of activities, done:

· in the form of a business

· in the form of an adventure or concern in the nature of trade; or on a regular or continuous basis, in the form of a lease, license or other grant of an interest in property.

The meaning of enterprise is considered in Miscellaneous Taxation Ruling MT 2006/1: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number, and Goods and Services Tax Determination GSTD 2006/6: does MT2006/1 have equal application to the meaning of 'entity' and 'enterprise' for the purposes of the GST Act. The principles outlined in the ruling and determination have been applied in your circumstances.

Paragraph 10 of GSTD 2006/6 provides that 'an activity or series of activities' means any act or series of acts that an entity does. The acts can range from a single act or undertaking, to groups of related activities, to the entire operations of the entity. Therefore, an enterprise can incorporate a single or one-off transaction such as the subdivision, building and sale of real property.

The term business ordinarily would encompass a trade that is engaged in, on a regular or continuous basis, while an adventure or concern in the nature of trade may be an isolated or one-off transaction and includes a commercial activity that does not amount to a business but which has the characteristics of a business deal.

You advised that you have never been involved in property development before and that your activities represent a one off transaction on the original property that you have purchased and used as your principal place of residence. In the absence of other facts, it is considered that your activities are not carried out in the form of a business if these activities are part of a one off transaction on the original property and not the beginning of an ongoing property development business.

As your activities of development and sale of new dwelling is an isolated transaction, it is necessary to determine whether the development and sale of the new dwelling will have a commercial flavour that goes beyond the mere realisation of an investment asset or private asset.

In the form of an adventure or concern in the nature of trade

Paragraph 13 of GSTD 2006/6 explains that an adventure or concern in the nature of trade includes a commercial activity that does not amount to a business but which has the characteristics of a business deal. Isolated transactions with a commercial flavour are included in this category. Such transactions are of a revenue nature.

Paragraphs 262 to 302 of MT 2006/1 specifically consider isolated transactions and sales of real property. Paragraph 263 of MT 2006/1 states that the issue to be decided is whether the activities are an enterprise, in that they are of a revenue nature, as opposed to the mere realisation of a capital asset.

Certain factors listed at paragraph 265 of MT 2006/1 can be used as indicators of whether or not there is an activity done in the form of a business or in the form of an adventure or concern in the nature of trade. These factors include whether:

· 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 for council approval for the subdivision, and

· buildings have been erected on the land.

In determining whether activities relating to isolated transactions are an enterprise or the mere realisation of a capital asset, it is necessary to examine the facts and circumstances of each case. No single factor will be determinative. Rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

Paragraphs 258 to 260 of MT 2006/1 provide that certain type of assets, such as rental properties, business plant and machinery, the family home, family cars and other assets are considered as investment assets. These assets are purchased with the intention of being held for a reasonable period of time, as income-producing assets or for the pleasure or enjoyment of the person. The mere disposal of these investment and private assets does not amount to trade. Assets can change their character from investment to trade, however these assets cannot be held at the same time for both purposes.

From the facts given, we consider that your development and sale of the new dwelling is in the course of an enterprise and more than the mere realisation of a capital asset because:

· There is a change in purpose for which the land (property) is held. Your original purpose of using the original property as a principal residence has changed to that of subdividing and constructing a new dwelling for sale.

· You had a coherent plan for subdivision and development of the original property and later the sale of the new dwelling. You had plans to subdivide and construct the new residential properties, and had sought approval from council for the subdivision. You borrowed funds to finance the construction and other expenses. All planning and construction and finishing work were completed by professionals and trade contractors. The new dwelling was sold after its completion.

· The development of the land for the new property is beyond that necessary for council approval of the land, and the development cost of the new property is substantial.

· You erected a new residential building on the new property.

From the above, these activities indicate a commercial approach and there is a clear intention of profit making. Accordingly, the activities undertaken by you in the development of the new property have the characteristics of activities that would constitute an adventure or concern in the nature of trade. Therefore, you are considered to be carrying on an enterprise as defined in section 9-20 of the GST Act.

Is the partnership required to be registered for GST?

As you are not registered for GST, it needs to be established whether or not you are required to be registered for GST in relation to the sale of the new property that you have constructed.

Section 188-10 of the GST Act provides that your GST turnover meets the registration turnover threshold if:

(a) your current GST turnover is at or above $75,000 and the Commissioner is not satisfied that your projected GST turnover is below $75,000; or

(b) your projected GST turnover is at or above $75,000.

Your current GST turnover is the sum of the values of all supplies made in a particular month plus the previous 11 months. Your projected GST turnover is the sum of the values of all supplies made in a particular month plus the next 11 months.

In calculating current GST turnover and projected GST turnover, the following supplies (amongst others) are not included in the calculation:

(a) supplies that are input taxed (which includes financial supplies, residential rent and sale of residential premises).

(b) supplies that are not for consideration.

(c) supplies that are not made in connection with an enterprise that you carry on.

(d) supplies that are not connected with Australia.

In working out your projected GST turnover, paragraph 188-25(a) of the GST Act requires that you disregard any supply made or are likely to be made, by you by way of transfer of ownership of a capital asset of yours.

Goods and Services Tax Ruling GSTR 2001/7: meaning of GST turnover, including the effect of section 188-25 on projected GST turnover discusses the meaning of capital assets. Paragraph 33 of GSTR 2001/7 provides that an asset which is acquired and used for resale in the course of carrying on an enterprise is not a capital asset for the purposes of paragraph 188-25(a) of the GST Act.

Paragraphs 34 to 36 of GSTR 2001/7 further provide that a revenue asset is an asset whose realisation is inherent in, or incidental to, the carrying on of a business. If the means by which you derive income is through a disposal of an asset, the asset will be of a revenue nature rather than a capital asset, even if this disposal is a one-off transaction. Where an asset is held by an entity over a period of time, its character may change from capital to revenue (that is, trading) or from revenue (trading) to capital. For the purposes of section 188-25 of the GST Act the character of an asset must be determined at the time of expected supply.

As discussed above, your activities of developing and selling the new property constitute the carrying on of an enterprise. At the time of the intended sale, the nature of your asset (the new property) is changed from a capital to a revenue (trading) asset. The sale of the new property does not constitute the transfer of a capital asset and paragraph 188-25(a) of the GST Act does not apply. You are deriving income from the disposal of a revenue (trading) asset even if the disposal is part of a one-off transaction.

Therefore, the sale of the new property is not excluded from the calculation of your projected GST turnover. Hence, the value of the sale must be included in the calculation of your current and projected GST turnovers.

Ceasing or reducing the size or scale of an enterprise

Further, in working out your projected GST turnover, paragraph 188-25(b) of the GST Act requires that you disregard any supply made or are likely to be made, by you solely as a consequence of ceasing to carry on an enterprise, or substantially and permanently reducing the size or scale of an enterprise.

Paragraphs 46 and 47 of GSTR 2001/7 discuss isolated transactions. GSTR 2001/7 states at paragraphs 46 and 47:

46. An enterprise may consist of an isolated transaction or a dealing with a single asset. For example, an enterprise may consist solely of the acquisition and refurbishment of a suburban shop for resale at a profit. Where an entity engages in acquiring a single asset for resale at a profit, the activity will be an enterprise under paragraph 9-20(1)(b), because it is an activity in the form of an adventure in the nature of trade. As discussed in paragraph 35 of this Ruling, the disposal of that single asset is not the transfer of a capital asset. Consequently, that supply is not excluded from your projected GST turnover.

47. The disposal of that single asset, or the completion of that isolated transaction, is also not a transfer solely as a consequence of ceasing to carry on an enterprise. In such circumstances the enterprise ceases as a consequence of the disposal of the single asset, rather than the single asset being disposed of in consequence of the ceasing to carry on the enterprise.

Therefore, your sale of the new dwelling will not satisfy paragraph 188-25(b) of the GST Act, and the consideration received from the sale of the new property is included in the calculation of your projected GST turnover.

Accordingly, prior to the sale of the new dwelling, you should be registered for GST because your projected GST turnover would be above the GST registration turnover threshold of $75,000.

Summary

Based on the information received, you will be required to be registered for GST as:

(a) you are carrying on an enterprise when you develop the land and construct the new dwelling; and

(b) your GST turnover for the sale of the new dwelling exceeds the registration turnover threshold which is currently $75,000.

We note that you may choose to backdate your GST registration to the date when you commenced your enterprise.

Additional information

Sale of new residential property

The sale of the new residential property is not GST-free under any provisions of the GST Act or any other legislation. The sale of the new residential property is a taxable supply where the supplier is registered or required to be registered for GST.

Margin scheme

Where you make a taxable supply of real property by selling a freehold interest in land, or selling a stratum unit, or granting or selling a long-term lease, you may be eligible to apply the margin scheme in working out the amount of GST on the supply. For further information on the margin scheme, refer to the: GST and the margin scheme guide (NAT 15145), and the list of relevant public rulings/publications which are available on our website at www.ato.gov.au

Claiming input tax credits

Once you are registered for GST, you are liable for the GST on all taxable supplies that you have made, or will make. However, you will be entitled to claim input tax credits (ITCs) for any creditable acquisitions that you have made, or will make, provided you hold the relevant tax invoices.

Section 11-20 of the GST Act provides that you make a creditable acquisition if:

1. you acquire anything solely or partly for a creditable purpose; and

2. the supply of the thing to you is a taxable supply; and

3. you provide, or are liable to provide, consideration for the supply; and

4. you are registered, or required to be registered.

You acquire a thing for a creditable purpose to the extent that you acquire it in carrying on your enterprise. However, you do not acquire the thing for a creditable purpose to the extent that:

· the acquisition relates to making supplies that would be input taxed; or

· the acquisition is of a private or domestic nature.

Therefore, you are entitled to claim ITCs on the GST included in the costs incurred on creditable acquisitions to the extent that relate to the sale of the new property where your GST registration is backdated to a date before you made the creditable acquisitions.