Edited version of your private ruling

Authorisation Number: 1012598357056

Ruling

Subject: Preliminary costs for proposed land subdivision business

Questions and Answers:

1. Will your costs incurred to acquire your call option and to obtain a development approval (i.e., a right to develop land) fall into the cost base of a capital gains tax (CGT) asset or multiple CGT assets or, in general, be capital in nature?

No.

2. Will your costs to acquire your call option and to obtain a development approval (i.e., a right to develop land) be revenue in nature?

Yes.

3. If you obtain the development approval and purchase the land, will your costs to acquire your call option and to obtain a development approval form part of the cost of your trading stock and thus be deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes.

4. If you do not acquire the land, will your costs to acquire your call option and to obtain a development approval be deductible under section 8-1 or section 40-880 of the ITAA 1997 or form part of a CGT cost base?

No.

This ruling applies for the following periods:

Year ended 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

The scheme commences on:

1 June 2012

Relevant facts and circumstances

You are a unit trust established to carry on a business of land development and subdivision. You are interested in the acquisition and development of a piece of land but have not yet acquired the land.

You purchased an option from the landowner, which provides you with the option to acquire the land from the landowner should you wish to do so once you have finalised your feasibility study and secured the necessary government approvals. If you exercise your call option, the option fee you paid will form part of the deposit for the purchase of the land.

You have also incurred costs pertaining to the feasibility study of the land and acquiring the necessary government development approval, mainly through paying third party consultants.

You must obtain this approval before you can apply for development finance, which is required to purchase the land.  

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 70-25

Income Tax Assessment Act 1997 Section 40-880

Income Tax Assessment Act 1997 Section 110-25

Reasons for decision

Summary

Since your requisite purpose at the time of incurring the relevant expenses is a business purpose connected to the acquisition of trading stock, your relevant expenses will be revenue in nature.

It follows if your acquire the relevant land, your relevant expenses will form part of the cost of your trading stock, which will be deductible on revenue account when you acquire the land (trading stock) and thus commence your business activity.

Otherwise, if you do not acquire the relevant land, because you will not have commenced a business in relation to the relevant expenses, the expenses will be incurred at a point too soon for deductibility under section 8-1 of the ITAA 1997. Further, because the relevant expenses are revenue in nature, they will not form part of a CGT cost base or be deductible under section 40-880 of the ITAA 1997.

Detailed reasoning

Trading stock

Section 70-10 of the ITAA 1997 defines 'trading stock' to mean anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and livestock.

Section 70-15 of the ITAA 1997 tells you in which income year to deduct under section 8-1 an outgoing incurred in connection with acquiring an item of trading stock. It states:

If the item becomes part of your trading stock on hand before or during the income year in which you incur the outgoing, deduct it in that income year.

Otherwise, deduct the outgoing in the first income year:

a) during which the item becomes part of your trading stock on hand; or

b) for which an amount is included in your assessable income in connection with the disposal of that item.

Taxation Determination TD 92/124 explains 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. 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. It is not necessary that the acquisition of land be repetitive. A single acquisition of land for the purpose of development, subdivision and sale by a business commenced for that purpose would lead to the land being treated as trading stock.

In the decision of Federal Commissioner of Taxation v. Kurts Development Ltd (1998) 86 FCR 337; (1998) 39 ATR 493; 98 ATC 4877 (Kurts Development ), infrastructure and external costs were allocated to the value of trading stock. In discussing the allocation of external costs, the court in Kurts Development used a 'but for' test. In that case the question was whether the external costs were properly characterised as part of the cost price of the individual subdivided lots. They were all expenses which had to be incurred in order to create the individual subdivided lots and, but for that expenditure, those lots would not have been created. For that reason the external costs were also part of the cost price of the individual lots. (ATO Interpretative Decision ATO ID 2003/150 discusses this case).

Revenue vs Capital

Section 70-25 of the ITAA 1997 states an outgoing you incur in connection with acquiring an item of trading stock is not an outgoing of capital or of a capital nature.

Taxation Determination TD 92/126 and Taxation Determination TD 92/127 provide where land is purchased on revenue account for subdivision but the developed is abandoned, the subsequent sale of the land remains on revenue account.

As previously stated, TD 92/124 explains both the required purpose and the business activity must be present before land is treated as trading stock.

These tax determinations is consistent with Taxation Ruling TR 92/3, about isolated commercial transactions, which, in general, provides the nature of the transaction is determined by the requisite purpose at the time of entering into the relevant transaction or operation.

Deductibility of expenses

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

It is not necessary, however, that the expenditure in question should produce assessable income in the same year in which the expenditure is incurred (Taxation Ruling TR 2004/4).

Taxation Ruling TR 2004/4 considers the decision of the High Court in Steele v. Deputy Commissioner of Taxation (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 (Steele's Case) and provides guidance about when interest incurred in a period prior to the derivation of relevant assessable income will be not be incurred 'too soon' to preclude deductibility in relation to holding an income earning asset. The principle in Steele's Case was used to allow the deductibility of certain holding costs in ATO ID 2001/478 (borrowing expenses on purchase of vacant land and the construction of a house for future income producing purposes), ATO ID 2001/479 (holding expenses on vacant land held for future income producing purposes) and ATO ID 2002/1096 (letting fees incurred prior to property being available for rent).

To the contrary, the Commissioner has ruled on a number occasions that certain costs related to acquiring income earning assets are incurred at a point to soon, such as in ATO ID 2001/535 (deductibility of the cost of accommodation when inspecting potential properties for purchase), ATO ID 2002/768 (legal expenses for preparing a loan agreement) and ATO ID 2003/324 (property investment seminar expenses for future investment properties).

When a business commences

Paragraph 98 of Taxation Ruling TR 2001/14 (which is about non-commercial business losses) states for a taxpayer start to carry on a business activity, broadly, this requires the taxpayer to have:

n made a decision to commence the business activity;

n acquired the minimum level of business assets to allow that business activity to be carried on; and

n actually commenced business operations.

In the case of Whitfords Beach Pty Ltd v. FC of T 83 ATC 4277; (1983) 14 ATR 247, which was about a land subdivision, it was determined the taxpayer commenced carrying on a business on the day when new shareholders purchased the shares in the company and thus acquired control of the land in order for the land (the company owned) to be subdivided. This was also the same day relevant parties were appointed to undertake the actions required to develop and sell the land.

Section 40-880

Section 40-880 of the ITAA 1997 is a provision of last resort which, in general, subject to its exclusions, allows a deduction over five income years for certain business capital expenditure incurred after 30 June 2005 which is not otherwise taken into account or denied a deduction by some other provision. Paragraph 40-880(2)(c) is about the deductibility of certain business capital expenditure you incur if it is in relation to a business proposed to be carried on.

Application of law on your case

In your case, your various costs are revenue in nature since they are connected with the acquisition of trading stock (per section 70-25, TD 92/124, TD 92/126, TD 92/127 and TR 92/3).

If you obtain the development approval and purchase the land, your various cost will be deductible under section 8-1 of the ITAA 1997 in the income year you acquire the trading stock (per section 70-15) since you will commence carrying on a business in that income year.

However, if you do not purchase the land and do not proceed with the development, your various costs will not be deductible under sections 8-1 because they will be incurred at a point too soon since you would have not commenced carrying on a business in relation to the relevant land.

Further, your various costs would not form part of a CGT cost base or be deductible under section 40-880 of the ITAA 1997 because the costs are not capital in nature.