Edited version of your written advice

Authorisation Number: 1012716133134

Ruling

Subject: Income from property

Question 1

Will the profit from the sale of the land be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Are you a small business entity for the 2013-14 financial year under Division 152 of the ITAA 1997?

Answer

No

Question 3

Will the land qualify as an active asset under section 152-35 of the ITAA 1997?

Answer

No

Question 4

Will the Commissioner exercise his discretion under subparagraph152-35(2)(b)(ii) of the ITAA 1997 to treat the cessation of business as the end of the active asset test period?

Answer

No

This ruling applies for the following period(s)

Income year ended 30 June 2014

The scheme commences on

1 July 2013

Relevant facts and circumstances

You are a private company established in 20xx.

You were established for the dual purpose of:

• purchasing, developing and leasing commercial property

• purchasing, developing and disposing of commercial property

You are part of a large group of unrelated entities.

You acquire property A in 20xx and sold it in 20xx.

You acquired property B in 20xx, developed it in 20xx, and continue to lease the property.

You acquire the land in 20xx. You original intended to develop the land into an office building to sell.

Building plans were completed and approved by council in 20xx.

In 20xx you decided that the development would run at a loss if your proceeded with the development.

You decided to hold the land until the market improved.

In 20xx your director's marriage broke down.

Over the next x years you were focused on finalising consent orders and agreeing to the split of assets.

In 20xx the consent orders were stamped and the placed the property on the market.

You sold the land in 20xx.

You consequently held the land for x years.

You derived a small amount of income from the land as neighbouring business have used it as on overflow car park on rare occasions.

You turnover is $x in 2013 and $x in 2014.

You have provided the turnover of you and your connected entities as $x in 2013 and $x in 2014.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 118-20

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 subparagraph 152-35(2)(b)(ii)

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 subsection 328-110(1)

Reasons for decision

Summary

The Commissioner does not consider that your activities amount to the carrying on of a business, either of developing properties for resale or deriving rental income. However as the property was purchased with the intent of making a profit from resale, the Commissioner considers that the profits on the sale of the land will still be assessable as an isolated commercial transaction notwithstanding the fact that the proposed development did not proceed. As you are not carrying on a business the land will not be an active asset, nor will you be a small business entity.

Detailed Reasoning

Generally the proceeds from transactions involving the sale of real property will be assessable as ordinary income under section 6-5 of the ITAA 1997 where they are income from a business activity or profits from an isolated commercial transaction. In those instances where the profits of the sale would have been ordinary income any losses will generally be deductible. Alternatively, where the sale of real property is not part of a business or an isolated commercial transaction any profit or loss will be subject to the capital gain tax provisions.

Carrying on a business

The question of whether a business is being carried on is a question of fact and degree to be determined on a case by case basis. The courts have developed a series of indicators to determine the matter, which are summarised in Taxation Ruling TR 97/11. Although TR 97/11 specifically refers to primary production, the same principles apply to all businesses. Some indicators of carrying on a business which the courts have considered to be relevant include:

• whether the activity has a significant commercial purposes or character

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

• whether there is regularity and repetition of the activity

• whether the activity is of the same kind, and carried on in a similar manner, to that of ordinary trade in that line of business

• whether the activity is planned, organised and carried on in a businesslike manner such that it is described as 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 sporting activity.

While some of the above indicators may suggest a business activity, the Commissioner considers when viewed on balance the majority of the indicators suggest that you did not commence a business of property development. We note specifically the lack of repetition and regularity regarding the activities you carry on, and that the development never proceeded, consequently you have never progressed beyond a mere intention to carry on a business activity. Consequently the profits will not be ordinary income by virtue of being a receipt of a business of property development. However the profits from the sale of the property may still be assessable as ordinary income from an isolated commercial transaction.

Isolated commercial transactions

However the profits of any sale of property may still be assessable as ordinary income from an isolated commercial transaction. The commissioner's view on whether profits on isolated transactions are assessable income under ordinary concepts is contained in Taxation Ruling TR 92/3. Profit from an isolated transaction is ordinary income where both:

• the intention and purpose for 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 in carrying out a business operation or commercial transaction.

As was held in FC of T v The Myer Emporium Ltd (1987) 163 CLR 1999 the relevant intention is your intention taking into account objective consideration of all the fact and circumstances of the case.

It is a general principle that where a person purchases land not for the purpose of resale, and then sells the land either in its entirety or in separate lots that the party is merely realising their assets (see Californian Copper Syndicate v Harris (1904) 5 TC 159 and does not have a profit making purpose or intention. However this may not always be the case where there is an intervening act and a clear change in purpose for the use of the land (see White v FCT (1968) 120 CLR 191, Whitfords Beach v FCT 150 CLR 366).

Commercial character of the transaction

In your case, you have provided that your intention in purchasing the land was to develop an office building and to sell for a profit. Therefore as you purchased the land for the purpose of resale the question in your case is whether or not your transactions can be considered commercial in character.

Paragraph 13 of TR 92/3 outlines some factors which 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.

We note the following in relation to the above factors, in your circumstances:

• You are a company; you have provided that you are part of a large group of entities that carry on similar activities.

• It is clear from the submitted documents including draft agreements, development information and correspondence that the development proposed was of both of a commercial and highly complex nature.

• Even though you may have decided in 20xx that due to the market conditions not to proceed with the development it is clear that when the property was purchase the magnitude of the profit sought and the related outlays were to be significant.

Applying the above factors we consider that if the development of the land had proceeded it would have clearly amounted to carrying out a business operation or a commercial transaction.

Commissioner's view where development doesn't proceed

In your circumstance, due to the prevailing market conditions in 2009, you made a decision not to go forward with the proposed development. At paragraph 56 of TR 92/3 the Commissioner provided that the following situations give rise to assessable income on profits of the sale of land:

• Where the taxpayer acquires property with a purpose of making a profit by which ever means prove most suitable and a profit is later obtained by any means which implements the initial profit-making purpose.

• Where a taxpayer acquires property contemplating a number of different methods of making a profit and uses one of those methods in making a profit.

Further in Taxation Determination TD 92/126 the Commissioner provides that where a taxpayer acquires land for the purpose of development, subdivision and sale but that subdivision doesn't proceed, any profit on the sale of the land will be assessable income. Even though the profit will be assessable income, the land is not treated as trading stock because a business of trading in land was not commenced.

Even though your proposed development did not involve subdivision it is considered that the above principles from TD 92/126 still apply. Consequently as any potential profits on the sale of the office block would have resulted in assessable income any sale of the vacant undeveloped land will also be on revenue account and give rise to assessable income.

Small business entity

Subsection 328-110(1) of the ITAA 1997 provides you are a small business entity if you meet the following for the current year:

(a) you carry on a business in the current year; and

(b) one or both of the following applies:

(i) you carried on a business in the income year (the previous year) before the current year and your aggregated turnover for the previous year was less than $2 million;

(ii) your aggregated turnover for the current year is likely to be less than $2 million

The Commissioner has determined that you do not carry on a business of developing property or deriving rental income. Consequently you will not be a small business entity.

Active asset test and Commissioner's discretion

The active asset test is contained in section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997). The active asset test is satisfied if:

• you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the test period detailed below, or

• you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of least 7.5 years during the test period.

The test period:

• begins when you acquired the asset, and

• ends at the earlier of

• the CGT event, and

• when the business ceased, if the business in question ceased in the 12 months before the CGT event (under subparagraph 152-35(2)(b)(ii) of the ITAA 1997 the Commissioner can allow a longer period than 12 months).

Section 152-40 of the ITAA 1997 provides the meaning of active asset. A CGT asset is an active asset if it is used or held ready for use in the course of carrying on a business. As we have previously determined that we do not consider you are carrying on a business, the land will not be an active asset, consequently the Commissioner will not exercise the discretion under subparagraph152-35(2)(b)(ii) of the ITAA 1997 to change the active asset test period.

As the Commissioner has already determined the profits of the sale of land will be on revenue account, a contrary determination that the land was held ready for the use of a business activity of developing and selling property would further support the conclusion that the profits will be assessable as ordinary income and have no practical application.