Edited version of your written advice

Authorisation Number: 1012755013304

Ruling

Subject: Capital gains tax

Question 1

Will the proposed future sale of the remaining two units (C and D) be assessed to under the CGT provisions of the ITAA 1997?

Answer: Yes

This ruling applies for the following period

Year ending 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts and circumstances

You purchased a block of land for an amount in the 2009-10 income year.

You intended to construct units on the land, sell two of the units and retain two units for the purpose of earning rental income.

Due to the processes of seeking finance and obtaining council approval for your development application, construction did not start straight away.

Construction of the units was completed in the 2013-14 income year at significant cost to you.

You sold two of the units ( A and B) during the 2013-14 financial year.

You currently lease units C and D via an agent and report rental income from these units.

You propose to sell the remaining two units at some time in the future but you do not know when and you have no plans to sell at present.

The development was a one-off event and you have no intention to conduct any further development.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1997 Section 102-5

Reasons for decision

There are three ways profit from property sales can be treated for taxation purposes:

(1) As ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), as a result of carrying on a business of property development.  

(2) As ordinary income under section 6-5 of the ITAA 1997, 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.  .

(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.

Carrying on a business of property development

The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the facts.

Taxation Ruling TR 97/11 provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. These factors are:

• whether the activity has a significant commercial purpose or character

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

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

• 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 business-like 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.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impression gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

Isolated transactions

Taxation Ruling TR 92/3 deals with isolated transactions and at paragraph 16 states that:

If a taxpayer not carrying on a business makes a profit, that profit is income if:

(a)   the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain; and

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

Paragraph 40 of TR92/3 states that it is not necessary that the intention or purpose of profit making be the sole or dominant intention for entering into the transaction, although it must be a significant purpose.

Some factors relevant in determining whether a transaction is an isolated transaction include:

• the nature of the entity undertaking the operation or transaction;

• the nature and scale of other activities undertaken by the taxpayer;

• the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

• the nature, scale and complexity of the operation or transaction;

• the manner in which the operation or transaction was entered into or carried out;

• the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

• if the transaction involves the acquisition and disposal of property, the nature of that property; and

• the timing of the transaction or the various steps in the transaction.

The cases of Casimaty v. Commissioner of Taxation 97 ATC 5135; (1997) 37 ATR 358 (Casimaty) and McCorkell v FC of T Re 39 ATR 1112; 98 ATC 2199 demonstrate that in circumstances where there is an absence of profit making intention when land is acquired, the likelihood of any profit made on the eventual sale of land being income according to ordinary concepts is greatly diminished.

In Casimaty, Ryan J also discussed Stevenson v FC of T 91 ATC 4476; (1991) 29 FCR 282, under the periscope of established principles found in other cases. Here, the fact that the taxpayer 'not only obtained finance but he risked it' was mentioned as a fact that could, together with other factors, distinguish a business case from 'where an area of land is merely divided into several allotments'.

Application to your circumstances

In applying the factors in TR 97/11 to your circumstances, it is considered that you are not carrying on a business of property development.

In reviewing whether your land development activities amount to a profit making undertaking or plan, the relevant factors in your case can be summarised as follows:

• there is not a complex structure involved;

• you had not previously undertaken any other property developments and you do not intend to enter into further developments;

• the property was purchased for investment or development purposes and, in the case of units C and D, for the purpose of earning rental income;

• the property was held in its original state for a period of time only due to delays in funding and the development application process;

• the works on the Land went beyond what is necessary by the municipal authorities to sell the land;

• you owned the Land and obtained finance for the development, putting significant funds at risk;

• the scale of the development was small; and

• your involvement in the subdivision process included obtaining and risking funding, involvement in the development application process, appointing contractors to undertake the work and engaging a real estate agent for the subsequent sale of the land.

In the circumstances here, whilst you intended to derive rental income from Units C and D, you had the clear and significant intention of making a profit through selling units A and B within a short time frame. The terms of the sales of units A and B meant you were assured of making a profit by entering into the sale contracts soon after construction, for a price in excess of the cost.

In the case of the remaining two units, the facts are distinguished in that it was your intention to hold Units C and D for an indefinite period for the purpose of earning rental income and this intention is supported by the facts. Consequently, any gains from the future disposal of these units will amount to a realisation of a capital asset.

Accordingly, any profit on the future sale of units C and D will fall for consideration under the CGT provisions in Part 3-1 of the ITAA 1997.