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Ruling

Subject: Expense deductibility

Question 1

Are property development expenses incurred in relation to a proposed land subdivision and aged care development an allowable deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2010

The scheme commences on:

1 July 2006

Relevant facts and circumstances

You were advised that a property, suitable for a land subdivision and development, was for sale.

You undertook some feasibility analysis in respect to undertaking a land subdivision and development on the property.

You made an initial offer to conditionally acquire the property.

The initial conditional offer was not accepted and over the next 18 months further negotiations in relation to the property continued.

A further conditional offer to acquire the property was made and the offer was accepted.

The Trust was established during the 2009 income year.

The corporate Trustee of the Trust had directors both of whom have worked in the industry and have extensive experience.

The initial unit holders of the Trust were corporate trustees of discretionary trusts established for the benefit of the family.

A contract of sale was entered into in respect of the property with the purchaser being the Trustee of the Trust in its capacity as Trustee of that Trust.

There were several conditions precedent in the contract of sale and in particular a special condition specifying that the contract is subject to and conditional upon the purchaser obtaining all relevant approvals for the re-zoning of the property.

An initial non-refundable deposit was paid by the Trustee on signing the contract.

The Trustee registered for GST during the 2009 income year.

The Contract of Sale included a provision in respect to GST requiring that any GST payable in relation to the property would be calculated using the margin scheme.

Extensive works were undertaken in relation to the proposed development of the property and the following expenses were incurred:

· deposits payable under the contract of sale, and

· legal fees related to the contract of sale;

· third party consultant's fees relating to the proposed development.

Some expenses were incurred in relation to employing consultants to devise and/or assist with the various development schemes that were considered.

The development schemes considered varied.

The majority of expenses were paid to a small number of main consultants with the balance paid to a number of minor consultants.

All expenses were paid to third parties that are not related in any way to the directors of the Trustee or to the unit holders in the Trust.

All expenses were paid for by the Trustee.

All feasibility analyses prepared in relation to the scheme indicated a significant potential profit.

The proposed development of the property did not proceed due to additional requirements being introduced, after the contract of sale that prohibited the conditions precedent in the contract of sale being satisfied by the approval date.

The contract was rescinded during the 2010 income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Summary

The expenses incurred in relation to a proposed land subdivision and developments are an allowable deduction under section 8-1 of the ITAA 1997.

Detailed reasoning

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income or are necessarily incurred in carrying on a business for the purposes of gaining or producing such income, except where the outgoings are of a capital, private or domestic nature.

Taxation Ruling TR 92/4 provides the Commissioner's view on whether losses on isolated transactions are deductible. Although TR 92/4 refers to subsection 51(1) of the ITAA 1936 that ruling is also applicable to section 8-1 of the ITAA 1997.

The note to section 1-3 of the ITAA 1997 provides that:

Note: A public or private ruling about a provision of the Income Tax Assessment Act 1936 is taken also to be a ruling about the corresponding provision of this Act, so far as the 2 provisions express the same ideas: see section 357-85 in Schedule 1 to the Taxation Administration Act 1953.

Paragraphs 49 and 50 of TR 2006/10 provide the following advice in relation to public rulings on rewritten legislation.

The status of public rulings following a rewrite of the law

49. If the Commissioner has made a public ruling about a relevant provision and that provision is re-enacted or remade, the public ruling is taken to be about the re-enacted or remade provision, insofar as the new law expresses the same ideas as the old law. However, if the law is substantively changed, the part of the public ruling dealing with the changed law ceases to apply.

50. Therefore entities can continue to rely on existing legally binding rulings which deal with the old law if the old law expresses the same ideas as the new law. If the old law has been replaced by a new law which does not express the same ideas, then the part of the public ruling on that old law does not apply in relation to the new law. That is, that part of the public ruling will not apply to schemes entered into on or after, or extending beyond, the date of effect of the new law.

This rationale also applies to Taxation Ruling TR 92/3.

Paragraph 1 of TR 92/4 provides that the term 'isolated transaction' refers to:

(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.

Paragraph 3 of TR 92/4 provides that it should be read with Taxation Ruling TR 92/3 which provides the Commissioner's view on whether profits on isolated transactions are income.

Paragraph 4 of TR 92/4 provides that a loss from an isolated transaction is generally deductible if:

(a) in entering into the transaction the taxpayer intended or expected to derive a profit which would have been assessable income; and

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

In very general terms, a transaction has the character of a commercial transaction if it would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions.

The intention of the taxpayer is determined by an objective consideration of the facts and circumstances of the case. Profit-making does not need to be the sole or dominant purpose for entering into the transaction, but it must be a significant purpose. The purpose must exist at the time the transaction or operation was entered into and in the case of property, it is usually but not always necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property.

Paragraphs 14-17 of TR 92/4 relevantly provide that:

14. We consider that a profit from an isolated transaction is generally income when both of the following elements are present (FC of T v. The Myer Emporium Ltd (1987) 163 CLR 199 at 213; 87 ATC 4363 at 4369; 18 ATR 693 at 699-700):

(a) the intention or purpose of the 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 or in carrying out a business operation or commercial transaction.

15. Our views on the above elements are set out in detail in TR 92/3 and apply equally in considering whether a loss on an isolated transaction is deductible.

16. Consequently, a loss from an isolated transaction is generally deductible under subsection 51(1) if:

(a) in entering into the transaction the taxpayer intended or expected to derive a profit which would have been assessable income; and

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

17. As emphasised in TR 92/3, whether a profit on an isolated transaction is income depends very much on the circumstances of the particular case. The same is true in determining whether a loss incurred on an isolated transaction is deductible under subsection 51(1).

Paragraph 13 of TR 92/3 provides that the following matters may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction:

(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.

Was the proposed development an 'isolated transaction'?

Isolated transactions are those transactions that are outside the ordinary course of business of a taxpayer carrying on a business, or those transactions that are entered into by non-business taxpayers (paragraph 1 of TR 92/3).

The transaction did not take place in the course of carrying on a business

From the time that it was known that the property was for sale to the time when the second offer was accepted and the Trust was established, feasibility analysis, an initial offer and 18 months of negotiations were undertaken with respect to the potential land subdivision and development at the property.

The Trust was established immediately on the signing of the contract to purchase the property, specifically for the purpose of developing the property and this has been the Trust's sole activity during the period in question.

The expenses were paid to third parties that are not related in any way to the directors of the Trustee or to the unit holders in Trust.

The expenses were paid for by the Trustee.

The trust has not undertaken any activity since the time of the rescission of the sale contract.

It is considered that the Trust was established specifically for the purpose of developing the property and this is the only activity undertaken by the Trust during the relevant period, therefore, the Trust is not carrying on a business of property development.

Expectation to produce assessable income

As no assessable income was actually derived from the attempted land subdivision and development and following the principles found in TR 92/3 and TR 92/4, it is necessary to establish that:

1) in entering into the transaction there was an expectation to produce assessable income; and

2) the transaction was entered into, and the loss was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

Prior to the second offer being accepted a feasibility analysis was undertaken. The intention was to develop and sell the site although part may have been retained for long term investment.

All feasibility analyses prepared in relation to the scheme indicated a potential profit.

An initial non-refundable deposit was paid by the Trustee on signing the contract.

The Trustee registered for GST during the 2009 income year.

The Contract of Sale included a provision in respect to GST requiring that any GST payable in relation to the property would be calculated using the margin scheme.

Professional consultants were engaged to prepare plans for the development and significant amounts were spent on the professional consultants.

The professional consultants were independent, unrelated 3^rd parties.

All feasibility analyses prepared in relation to the scheme indicated a potential profit.

The scheme was undertaken in a systematic and business-like manner.

The scheme was pursued for a number of years and all possible development alternatives were considered before it was abandoned as a result of changes made to the planning provisions that were beyond the control of the taxpayer.

It is therefore considered that in entering into the proposed land subdivision and development there was an intention to subdivide and develop property with the expectation of making a profit on the sale of the property. The fact that the proposed subdivision and development did not proceed does not change that expectation to produce assessable income.

Business operation or commercial transaction

In terms of the relevant factors outlined in TR 92/3 as to whether an isolated transaction amounts to a business operation or commercial transaction, the following comments are made in relation to the scheme:

· the entity in question was a trust, settled for the purpose of undertaking the property development;

· the nature of transaction was to convert land into residential and other related uses. The scale of the transaction was intended to be significant;

· the expenditures and revenues were forecast to be significant. The magnitude of the profit would have been significant;

· the nature, scale and complexity of the transaction were specialist, significant and extremely complex. In the end, the contingency of planning approval brought an end to the project;

· the transaction was conducted in an extremely professional manner. Consultants and specialists were commissioned at all times;

· the trust was settled in order to conduct the transaction. The directors of the Trustee have extensive experience.

· the property was located in a site suitable for the project proposed by the taxpayer, but subject to the relevant approvals;

· the steps in the project were spelt out clearly by the consultants.

The overall impression derived from the weighing up of these factors is that the taxpayer was undertaking a business operation or commercial transaction.

It is concluded that the expenses incurred in relation to a proposed land subdivision and development are an allowable deduction under section 8-1 of the ITAA 1997 as:

· the transaction was an isolated transaction which was a business operation or commercial transaction; and

· the entering into of the transaction was for the purpose of making a profit or gain.