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Ruling

Subject: Company - property development - income or capital - losses

Question 1:

Can the losses from your property related transactions during the financial year ended 30 June 2005 be carried forward to a later income year as revenue losses under section 36-17 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: Yes.

Question 2:

Can the losses from your property related transactions during the financial year ended 30 June 2006 be carried forward to a later income year as revenue losses under section 36-17 of the ITAA 1997?

Answer: Yes.

This ruling applies for the following periods:

1 July 2005 to 30 June 2006.

The scheme commences on:

1 July 2004.

Relevant facts and circumstances

You are a company established with the specific intention that you would carry on a business of property development.

You purchased some properties and prepared development application approvals for construction of buildings. Due to lengthy delays and rising costs you sold the properties.

Over time you entered into contracts for several properties that had potential for development. In some cases properties were sold at a loss and in other cases you forfeited the deposits.

At the time of forming you had a Business Plan Overview and you had researched the best locations for increase in value of properties. However, you made a number of losses.

You are now seeking a ruling on the characterisation of these losses.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 36-17

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 8-1(1)

Income Tax Assessment Act 1997 subsection 8-1(2)

Income Tax Assessment Act 1997 Division 36

Income Tax Assessment Act 1997 section 36-10

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

Section 6-5 of the ITAA 1997 includes in a taxpayer's assessable income, where the taxpayer is an Australian resident, all ordinary income derived by the taxpayer both in and out of Australia during an income year. Ordinary income is defined as income according to ordinary concepts.

Deductions

Subsections 8-1(1) and 8-1(2) of the ITAA 1997 state:

(1) You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

(2) However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital nature; or

(b) it is a loss or outgoing of a private or domestic nature;

(c) it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt; or

(d) a provision of this Act prevents you from deducting it.

Division 36 of the ITAA 1997 provides for the deduction of tax losses incurred in earlier income years.

Section 36-10 of the ITAA 1997 provides that the tax loss for an income year is the excess of deductions over the sum of assessable income and net exempt income.

Section 36-17 of the ITAA 1997 states that if a company has deductions that exceed its assessable income and net exempt income in an income year, the company has a loss which it can carry forward and use as a deduction in a future income year. However, the company can only deduct the tax loss if it satisfies either the continuity of ownership test (COT) or the same business test (SBT).

Generally speaking, a receipt will constitute income according to ordinary concepts if it is a receipt arising out of a taxpayer's employment or business activities. Whether or not a transaction occurred in the course of carrying on a business is to be determined on the basis of objective facts, having regard to all the circumstances of a particular case.

Taxation Ruling TR 97/11 deals with the question of whether a taxpayer is carrying on a business of primary production. However, the principles enunciated in this ruling are equally applicable to the question of whether a business is being carried on in other contexts. It states at paragraph 13 of TR 97/11 that common indicia of the carrying on of a business are:

· whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators

· whether the taxpayer has more than just an intention to engage in a business

· whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

· whether there is repetition and regularity

· 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

· whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at 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 a sporting activity.

TR 97/11 also notes that no single indicator is decisive. Further, it states that the indicators must be considered in combination and as a whole. Whether a business is being carried on by a taxpayer depends on the large or general impression gained from looking at all the indicators, and whether these indicators provide the operation with a commercial flavour. The application of the indicators in TR 97/11 to your circumstances is discussed below.

Whether the activity has a significant commercial purpose or character.

A way of establishing that there is a significant commercial purpose or character is to compare the activities with those of a taxpayer who is carrying on a similar activity that is a business.

In essence, this indicator concerns itself with whether the activity is carried on for commercial reasons and in a commercially viable manner. As noted in paragraph 29 of TR 97/11, it is closely linked to other indicators and is a generalisation drawn from the interaction of other indicators.

In this case, it is considered that the purchase and intention to develop the properties has a commercial character, having regard to the following:

· your intention was to develop the properties or at least re-sell for a profit

· you had invested in several properties over a period of time

· you had invested large sums of money and undertaken council approvals, and

· the activity was undertaken by a company which also indicates a commercial purpose.

Whether the taxpayer has more than just an intention to engage in business

This indicator deals with the question of whether a taxpayer's activities are merely preparatory to the carrying on of a business, or represents commencement of an activity. Again, this indicator concerns itself with whether the activities could be better described as a hobby or pursuit of a recreational or sporting activity, and whether there is an intention to make a profit. In this case, your primary intention was generate income. A company was formed, large sums of money were involved and time and effort were also needed to submit planning approvals and locate properties that were considered suitable. This indicates more than an intention to carry on a business.

Whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity.

The activity does not need to make an immediate profit but demonstrate that it will be able to make a profit sometime in the future. You had a Business Plan Overview and had carried out research as to which area could generate the most profit for this type of activity. You took action when holding the property was costing money as the approvals were not granted.

Whether there is repetition and regularity of the activity.

Paragraph 55 of TR 97/11 states:

It is often a feature of a business that similar sorts of activities are repeated on a regular basis. The repetition of activities by the same person over a period of time on a regular basis helps to determine whether there is the 'carrying on' of a business.

You have purchased several properties over the period. For this type of business, property development, this would indicate repetition and regularity of the activity.

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.

Paragraph 63 of TR 97/11 states that 'an activity is more likely to be a business when it is carried on in a manner similar to that in which other participants in the same industry carry on their activities'. In this case, you have acquired several properties to ensure that a much better development proposal could be undertaken.

Whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit.

A company was set up to conduct the business. The properties were purchased by the company and prior to commencement there was a Business Plan Overview. Research was undertaken to find the best locations and time and effort was spent trying to gain DA approvals.

Size, scale and permanency of the activity.

The larger the scale of the activity the more likely it will be that the taxpayer is carrying on a business even though a person may carry on a business in a small way. In this case you have made attempts to purchase several properties and spent large sums of money in doing so.

Whether the activity is better described as a hobby, a form of recreation or sporting activity.

This indicator is concerned with the distinction between activities that are undertaken primarily for pleasure and are in reality the enthusiastic pursuit of a hobby or other pastime rather than a business. In this case, the purchase and proposed development of properties was not carried out as a hobby.

On the basis of the consideration of the above indicators, taken as a whole, it is considered that you are carrying on a business of property development. A company was formed, planning was undertaken, large sums of money were spent and time and effort was applied in seeking DA approval.

As you are considered to be carrying on a business, business expenses incurred will be allowable deductions in your income tax return. Also, losses on sale of business assets will be included as losses on income account and not as capital losses.

Therefore, any losses from your previous development activities can be carried forward to later income years on revenue account under Division 36 of the ITAA 1997.