Edited version of your private ruling

Authorisation Number: 1012374807662

Ruling

Subject: Capital Gains Tax

Capital Gains Tax

Question 1

Will the proceeds from the sale of a part of the property be assessable under the Part 3-1 Capital Gains and Losses of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period

1 July 2011- 30 June 2012

The scheme commenced on

7 July 2011

Relevant facts

A property was acquired through a structure where the ultimate owners were principals.

The principals divided the property into asset blocks.

Some of the blocks were held on capital account and some were on revenue account.

The principals developed some of the blocks for resale.

The principals also held significant investment portfolios.

The buildings on asset block (A) were retained and one building, of that block is the subject of this ruling. The buildings were capable of being redeveloped for a wide variety of uses.

An early application to the bank seeking finance for the purchase of the property commented on the principals' commercial capacity to develop the site and manage the tenants. Specifically in relation to asset block A, it was stated that the principals' intention was to refurbish the buildings relocating residual tenants and securing additional tenants as required.

Asset block A initially maintained its tenants under existing leases and the intent was to move other tenants into the property while development of other asset blocks was underway.

The buildings on asset block A were actively marketed for lease individually or in combination. One building was successfully rented quickly.

The remaining buildings were not rented and the principals decided to refurbish the remaining buildings in an attempt to draw tenants.

Capital expenditure was invested on the refurbishment.

Efforts continued to actively market the remaining buildings for lease. This met with some success. The buildings were never advertised for sale.

A real estate agent approached the principal about the sale of one building on asset block A and subsequently sold the property.

The building was sold after a long period of ownership. It had not generated any rental income for a significant part of the ownership period.

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 Part 3-1 Capital Gains and Losses

Reasons for decision

Question 1

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.

Where the profits from a property held by the trustee of a bare trust are determined to be a capital gain or revenue, then the character of the profit will be passed on with its distribution to the beneficial owners.

A gain from the disposal of property will be stamped with the character of income where:

1. it is made in the ordinary course of carrying on a business; that is, where "what ... is done is not merely a realisation or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business": California Copper Syndicate v Harris (1904) 5 TC 159 at pp.165-166; and London Australia Investment Company Limited v Commissioner of Taxation (1976-1977) 138 CLR 106;

2. it is made outside of the ordinary course of a taxpayer's business from an isolated (or "extraordinary") transaction entered into with the intention or purpose of making a profit. (This is the so-called first limb or strand of the decision in Commissioner of Taxation v The Myer Emporium Ltd (1987) 163 CLR 199 at pp.209-210); or

3. it is made from an isolated or one-off business venture or profit-making scheme: Commissioner of Taxation v Whitfords Beach Pty Ltd (1982) 150 CLR 355.

Did the sale of the building that is part of asset block A form part of the ordinary course of the taxpayer's business?

The building was purchased as part of the property.

The ultimate owners of the land (the principals) parceled the property into several asset blocks.

The principals proceeded to develop some of the asset blocks for resale.

In determining whether a receipt is on revenue or capital account, the authorities establish that it is necessary to conduct "a wide survey and an exact scrutiny of the taxpayer's activities": Commissioner of Taxation v Stone (2005) 222 CLR 289 at [19]; Federal Commissioner of Taxation v Montgomery (1999) 198 CLR 639 at 663 [69]; both citing Western Gold Mines NL v Commissioner of Taxation (WA) (1938) 59 CLR 729 at 740 per Dixon and Evatt JJ.

There is also authority that when determining whether a receipt has the character of income there will be occasions when it is appropriate to take into account the activities of the broader group of which the taxpayer is a part: Grollo Nominees Pty Ltd v Commissioner of Taxation (1997) 73 FCR 452 at 514-515 and GRE Insurance Ltd v Federal Commissioner of Taxation (1992) 34 FCR 160 at 164-165; and, if the taxpayer is a trustee, the nature of the trust and the content of the trustee's duties: Commissioner of Taxation v Radnor Pty Ltd (1991) 91 ATC 4689 at 4700.

Here, a wide survey and scrutiny of the broader group of which the principals are a part reveals a number of important matters.

Individually each principal conducted property development businesses. In addition they held significant property investment portfolios. These properties had a variety of clients on long term leases in geographically diverse locations.

The principals could develop all the blocks for resale. They state that is was never their intention to develop the buildings for resale but to increase the rental income derived from the investment property business of each principal. The buildings were refurbished to improve their rental attractiveness and they were actively marketed for lease until an offer to buy one building was made. The other buildings are generating rental income for the investment portfolio. Throughout the period the building was owned it was held on capital account. We conclude that the building formed part of the principal's ordinary business of investment properties not of property development.

Did the building that is part of asset block A form part of the trading stock of the taxpayer?

Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'? provides the Commissioner's view of land considered to be trading stock when it states:

1. Land is treated as trading stock for income tax purposes if:

·it is held for the purpose of resale; and

·a business activity which involves dealing in land has commenced.

2. Both the required purpose and the business activity must be present before land is treated as trading stock. The business activity is taken to have commenced when a taxpayer embarks on a definite and continuous cycle of operations designed to lead to the sale of the land.

The building was acquired as part of asset block A. The buildings were not held for the purpose of resale but the stated purpose of deriving rental income. Initially it was the principal's intent to use the buildings on asset block A to house residual tenants as other parts of the property were developed. The buildings were actively marketed for rent with progressive success after they were refurbished on capital account. However one building remained untenanted. The principals had embarked on a definite and continuous cycle of operations to obtain tenants for this building. There was no attempt to advertise the building for sale and the decision to sell was only seriously considered after a real estate agent approached the principals. The building was never held for the purpose of resale and did not form that part of the principals' business operations that consisted of the sale of redeveloped land. The building was not trading stock of the principals' development business.

We conclude that asset block A was purchased as part of the principals' business of leasing properties for a profit. The sale of one building was an isolated transaction in the business of using the buildings on asset block A to generate rental income.

The Commissioner in Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income states his view at paragraph 35:

35. A profit from an isolated transaction is therefore generally assessable income when both of the following elements are present:

(a) The intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain.

(b) The transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

At the time the building that is part of asset block A was purchased, was there a profit making purpose?

The property owned by the principals was structured similarly to other development done by the principals

However in an application for finance to purchase the property, the principals recognised that part of the property had buildings that could be used for rental purposes. They therefore effectively quarantined that part of the property in asset block A.

The principals continued with existing leases and elected to use the space to later house the residual tenants, ousted when the other asset blocks were developed.

The rental income was declared as income in the relevant income tax returns.

At the time the property was purchased, the intent of the principals was to add the asset block A to their existing investment properties for the purpose of generating profits through rental income. The buildings on this block were the only buildings that were not earmarked for demolition and development that is one facet of the principals' business. Asset block A was not acquired for the purpose of profit making through development and resale.

Was the building that is part of asset block A disposed of as part of a profit making scheme by the very means by which the profit was made?

The opportunity existed to develop the buildings in asset block A for resale but the principals instead decided to continue with their existing rental use. To this end, they arranged for the buildings to be actively marketed for rent and, to make them commercially more attractive for this purpose, refurbished. These costs were accounted for as capital expenditure.

The nominee company disposed of the building in asset block A after being approached by a real estate agent in a manner of making a profit which was not contemplated at the acquisition of, or whilst it was owned by, the principals. The sale of the building was a transaction which fell outside of the ordinary scope of the principals' business of property investment and also of property development for sale. We conclude there was never a purpose of profit-making by the means in which the profit was made when the building was sold.

The building was sold after a long period of ownership. We conclude that the sale of the property was the realization of a portion of a larger asset that was originally purchased and quarantined through a joint venture with the intent of generating profit from it through rental income as part of an investment portfolio in property held by the principals. At the outset the building was deriving rental income but failed to continue to do so under a new lease arrangement, despite efforts to market it as a stand alone or in conjunction with the other buildings. Refurbishment did not improve its rental ability but did eventually attract a buyer.

We conclude that the building was sold for a profit but not as part of a profit making scheme.

The building was held on capital account and its sale was a mere realisation of an asset. The profits from its sale will be statutory income under Part 3-1 of the Capital Gains and Losses of the ITAA 1997. Section 10-5 of the ITAA 1997 identifies statutory income captured by section 102-5 of the ITAA 1997 as assessable income that is not ordinary income. The net capital gain is calculated on the profit and included in assessable income by virtue of section 102-5 of the ITAA 1997.