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Ruling

Subject: Income or capital

Question 1

Will any gain in relation to the sale of the properties be assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: Yes

Question 2

Will any gain in relation to the sale of the properties be subject to Capital Gains Tax (CGT) under section 104-10 of the ITAA 1997?

Answer: No

This ruling applies for the following periods:

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

The scheme commences on:

1 July 2011

Relevant facts and circumstances

You are not carrying on a business.

The directors of the company are Mr and Mrs X (the directors). The directors formed the company for the purpose of purchasing a rental property to realise a gain on sale when they retired. At the time the scheme commenced they were both aged over 55 years.

Post September 1985 the company purchased a residential property.

A month later the company purchased the neighbouring property.

A month later the directors' son and daughter in law purchased a neighbouring property.

A few months later the directors purchased a further neighbouring property.

The Council finalised a Development Control Plan after the first properties were acquired. Under this plan, for properties to be used for the construction of residential apartment buildings the land size is required to be no less than 2500 square metres.

To be able to sell the properties as a development site, the fourth property was purchased and options over another two neighbouring properties were acquired some time later.

All properties have only been used for rental purposes since purchase, and will remain rented until sold.

Substantial funds were borrowed to acquire the properties and expenses exceed the rental income derived.

Advice was received from your real estate agent that to sell the properties for development under the Control Plan an architect should be approached to prepare a development application (DA) for residential apartments to be constructed on the properties.

The preparation and approval of the DA took two years and cost approximately $50,000.

You intend to sell all the properties with the houses intact, together with the approved plans for the construction of residential units, to a developer. You do not intend to take part in the development of the site.

The properties subject to the 'options' will be acquired directly by the developer.

As the sale proceeds from each property will exceed their cost you are seeking confirmation as to whether the profit will be assessable as income or subject to capital gains tax.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 118-20

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Taxation treatment of property sales

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

(1) As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of carrying on a business of property development, involving the sale of property as trading stock.

(2) As ordinary income under section 6-5 of the ITAA 1997, on revenue account, 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, which is the commercial exploitation of an asset acquired for a profit making purpose.

(3) As statutory income under the 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.

Note: section 118-20 of ITAA 1997 will reduce the capital gain where the amount is otherwise assessable e.g. under section 6-5 of ITAA 1997.

Carrying on a business

Section 995-1 of the ITAA 1997 states the term business includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11, which uses the following indicators to determine whether a taxpayer is carrying on a business:

(1) whether the activity has a significant commercial purpose or character;

(2) whether there is repetition and regularity of the activity;

(3) 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;

(4) whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit;

(5) the size, scale and permanency of the activity; and

(6) the volume of the operations and the amount of capital employed.

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 impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

Application to your circumstances

In your case, you are not carrying on a business.

You have not previously undertaken similar activities. The activity, the sale of four properties and two options with development approval for the construction of residential apartments, is outside the ordinary course of the activities from which you derive your income.

The transaction will not occur within the 'ordinary course of business' being carried on by you and would therefore not be assessable under section 6-5 of the ITAA 1997. The transaction may, however, be assessable as an isolated transaction.

Isolated transaction

The Commissioner's views on whether profits from isolated transactions are income are contained in Taxation Ruling TR 92/3

Isolated transactions are considered to be:

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

· transactions entered into by non-business taxpayers.

Paragraph 15 of TR 92/3 provides that if a taxpayer makes a profit from a transaction, that profit is income if the transaction is not in the course of the taxpayers business but:

· the intention or purpose of the 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 carrying out a business operation or commercial transaction.

Intention

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.

Where the decision to sell an asset is taken after its acquisition and there was no intention or purpose at the time of acquisition of acquiring for the purpose of profit-making by sale, the profit made is generally capital because it proceeds from a mere realisation. However, there will always be exceptions to this rule (TR 92/3).

Where the objection or purpose of profit-making by sale in the context of a commercial transaction existed at the time of acquisition, the profit would be treated as income.

Where the profit-making transaction involves the sale of property, it is usually, but not always, necessary that the purpose of profit-making existed at the time of acquiring the property.

Where the taxpayer is a company, the purposes of those who control it are its purposes (Whitfords Beach at 150 CLR 370; 82 ATC 4039; 12 ATR 701).

Carrying out a commercial transaction

For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character. 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, Miscellaneous Taxation Ruling MT 2006/1 and TR 92/3 provide guidance and a list of 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.

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.

The terms 'profit making undertaking or scheme' and 'an adventure or concern in the nature of trade' include a commercial activity that does not amount to a business but which has the characteristics of a business deal.

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 270 of MT 2006/1 states that in isolated transactions, where land is sold that was purchased with the intention of resale at a profit (which would be ordinary income) the Commissioner considers these activities to be an enterprise. This would be so whether the land was sold as it was when it was purchased or whether it was subdivided before sale. An enterprise would be carried on in this situation because the activities are business activities or activities in the conduct of a profit making undertaking or scheme and therefore an adventure or concern in the nature of trade.

Application to your circumstances

In applying the principles of TR 92/3 to your case, the following facts have been considered:

· You have not been involved in any property development activity in the past and this is your first project.

· The company was established to purchase the rental properties with the aim of producing a profit on sale and this is its only activity.

· The company purchased the options on neighbouring properties to enable the council requirements for development to be met, and prepared and lodged the development application at a cost of approximately $50,000.

· You estimate the profit from the sale of the four blocks and the development approval to be around $xxx,xxx.

· The properties are all neighbouring properties and were purchased in a short space of time by entities with a close family relationship. This indicates a common and co-ordinated purpose in the acquisition of the properties.

· The last property was purchased after the finalisation of the 'control plan'.

· The scale of the development is six properties, of which four are owned by the related entities and two properties over which the company holds options.

· You purchased the properties with the purpose of making a profit on their sale. Although the properties have been rented in the interim, the purpose at the time of purchase was to make a profit on their sale as opposed to deriving a future gain from a long term investment. This indicates a purchase for profit making purpose.

· You will not be acting as the developer, but have obtained professional assistance to prepare and obtain council approval for the development.

· The use of professional agents and advisers in this process, the purchase of options to satisfy the requirements for a development, and the company structure indicate commercial activity.

· There have been substantial borrowings to fund the acquisitions and the properties are all in a negative situation which indicates the properties were purchased with the intention of obtaining a profit from the sale, as opposed to an income stream from an investment. Due to the ongoing negative return over a number of years, there appears no use other than as the subject of trade.

On balance, it would seem that the project is an undertaking on a sufficient scale to take it well beyond the realms of a mere realisation of an asset and characterize it as a commercial undertaking.

In particular, the timing of the acquisitions, the proximity of the properties, and the relationship of the related parties indicates the purchase of the properties was a co-ordinated exercise and that there was an intention of amalgamation in some form. This may have been speculative initially, however on the facts appears to be the dominant purpose of the acquisitions.

As a consequence, the proceeds from the sale of the land will be considered to be ordinary income and therefore assessable under section 6-5.

Capital gains tax (CGT)

A taxpayer can only make a capital gain or capital loss if a CGT event happens. A CGT event A1 happens when there is a disposal of a CGT asset section 104-10.

There are some circumstances where, even though a CGT event has occurred, a CGT liability does not arise due to an exemption or exception that applies to disregard any capital gain or capital loss that may arise from a CGT event (section 100-30).

The anti-overlap provisions found in section 118-20 deals with reducing capital gains if an amount is otherwise assessable. A capital gain you make from a CGT event is reduced if, because of the event, a provision of this Act includes an amount, for any income year, in your assessable income.

Application to your circumstances

As the proceeds of the sale will be assessable as ordinary income under section 6-5, the anti-overlap provisions found in section 118-20 take effect to reduce your capital gain by the amount that is otherwise assessable under section 6-5.

Conclusion

The facts indicate the properties were acquired for the purpose of trade and that the transaction is commercial in nature.

The above facts are not determinative on their on, but when considered in combination show that an isolated transaction was entered into and the profit was made in carrying out a commercial transaction.

Therefore, any profit made on the sale of the properties would be assessable income under section 6-5 of ITAA 1997.