Edited version of your written advice

Authorisation Number: 1012827669158

Date of advice: 22 June 2015

Ruling

Subject: CGT - subdivision - isolated transaction

Issue 1

Question 1

Will the proceeds from the sale of the houses be assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will the sale of the houses trigger CGT event A1, disposal of an asset under section 104-10 of the ITAA 1997?

Answer

Yes

Question 3

Under section 118-20 of the ITAA 1997, are you entitled to reduce any capital gains made by the disposal of the houses by any amount which is included in your assessable income under 6-5 of the ITAA 1997

Answer

Yes

Issue 2

Question 1

Is goods and services tax (GST) applicable on the sale of the houses that were constructed on the land and subdivided by the owners supply?

Answer

Yes, GST is applicable on the sale of the houses that were constructed on the land and subdivided by the owners because the sale of the houses is a taxable supply under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999.

This ruling applies for the following period

Year ending 30 June 2014

The scheme commences on

1 July 2013

Relevant facts and circumstances

In 20XX, E (you) and N purchased a vacant land. The property was bought to be sold in the future or developed if money can be borrowed.

C provided a loan to E for the purchase of the property. The loan was a private agreement and there was no written contract or document in place to evidence this loan.

In 20XX E and N decided to build houses on the vacant land. The reason for constructing the houses was for rental purposes and then selling them if the market was there.

There was some difficulty in raising finance for the construction of the houses. C decided to become a partner of the land and agreed to offset the loan he gave to E for ownership of one a portion of the land. Under this agreement, E, N and C were registered as owners of the land, each owning a portion of the land.

Construction of the houses was financed by a bank and the loan was under the name of the owners. All houses were constructed at the same time shortly after finance was approved.

Construction of the houses started in late 20XX and finished early 20XX. The subdivision of the land into strata titles was done after the construction and was completed in June 20XX. Surveyors conducted the subdivision. The new titles for the subdivided land were registered under the names of the owners.

The owners sold some of the houses in the first half calendar of the relevant year and no GST was charged. No rental income was derived from these houses. The houses were sold in order to reduce the debt.

One house is being used for rental purposes.

The owners have not accounted the subdivided land as a business asset and have not claimed the loan as a business expense.

The owners are not registered jointly as a partnership for GST.

E and C have previously built houses as joint owners and the houses are currently being rented.

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 section 104-10

Income Tax Assessment Act 1997 section 112-25

Income Tax Assessment Act 1997 section 118-20

A New Tax System (Goods and Services Tax) Act 1999 section 9-5

A New Tax System (Goods and Services Tax) Act 1999 section 9-20

A New Tax System (Goods and Services Tax) Act 1999 section 23-5

A New Tax System (Goods and Services Tax) Act 1999 Division 188

Reasons for decision

Issue 1

There are three ways profits from a land subdivision 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 land 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 capital gains tax (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.

Ordinary income

In your situation, the Commissioner is satisfied you are not carrying on a business of property development. The repetition, scale and volume of your activity is not of the same nature as is ordinarily carried on by a property developer that is carrying on a business.

Profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium). 

Taxation Ruling TR 92/3 considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income.

TR 92/3 defines the term 'isolated transactions' as:

• transactions outside the ordinary course of business of a taxpayer carrying on a business; and

• transactions entered into by non-business taxpayers. 

It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayers business but:

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

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

Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case.  Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of subdivided land can be assessed as ordinary income within section 6-5 of the ITAA 1997. TR 92/3 lists the following factors to be considered:

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.

In the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135 (Casimaty), the legal principles in relation to the subdivision of land were discussed at length. In concluding his judgment that the subdivision of the taxpayer was a mere realisation of a capital asset, Justice Ryan said, at 97 ATC 5152:

Nor did the taxpayer undertake any works on, or development of, the land beyond what was necessary to secure the approval by the municipal authorities of the successive plans of subdivision and enhance the presentation of individual allotments for sale as vacant blocks. Had he constructed dwelling houses, internal fencing or other improvements, it would have been easier to impute to him an intention to carry on a business of land development and improvement. [Emphasis added]

In addition to the above general factors, Miscellaneous Taxation Ruling MT 2006/1 provides a list of specific factors relevant to isolated transactions and sales of real property. If several of the factors are present, it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows:

n there is a change of purpose for which the land is held;

n additional land is acquired to be added to the original parcel of land;

n the parcel of land is brought into account as a business asset;

n there is a coherent plan for the subdivision of the land;

n there is a business organisation - for example a manager, office and letterhead;

n borrowed funds financed the acquisition or subdivision;

n interest on money borrowed to defray subdivisional costs was claimed as a business expense;

n there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and

n buildings have been erected on the land.

No single factor is determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

Application to your circumstances

In your case, you acquired vacant land with the intention of either holding it for future sale or for development, if finance was able to be obtained. When finance was obtained you constructed X houses and subdivided the land, selling X of the houses and retaining one house as a rental property.

In accordance with the direction provided in TR 92/3 and MT 2006/1 we consider that the activity amounts to more than the mere realisation of an asset to its best advantage. There is a coherent plan in place to carry out a sequence of actions that will result in a profit and there is a level of development of the land beyond that necessary to secure council approval for a subdivision and buildings have been erected on the subdivided land.

On a weighing of the facts of your case we find that the subdivision and construction of the dwellings will constitute an isolated profit-making scheme. Accordingly, your share of the profits from the disposal of the houses will be considered ordinary assessable income under section 6-5 of the ITAA 1997.

Capital gains tax

Capital gains tax (CGT) is the tax that you pay on certain gains you make. You may make a capital gain as a result of a CGT event, happening to an asset in which you have an ownership interest. The most common CGT event, CGT event A1 (section 104-10 of the ITAA 1997), occurs when you dispose of your ownership interest in a CGT asset to another entity.

Under section 112-25 of the ITAA 1997, the subdivision of land does not result in a CGT event. As such, you are not making a capital gain or capital loss at the time of the subdivision. You make a capital gain or loss at the time you enter into the contract for the disposal of the subdivided land and house or when there is a change in ownership. Therefore you will not make a capital gain or loss on the house you intend to keep and rent, until they it is sold or the ownership interest changes. You will, however make a capital gain or loss on the three houses sold at the time the contract for sale is entered into for each house.

Section 118-20 of the ITAA 1997 primarily exists to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. In the absence of such a provision, it is conceivable that a receipt properly characterised as ordinary income and which has also been derived as a result of a CGT event could result in the receipt being taxed twice.

Therefore, whilst CGT event A1 will occur due to the sale of the houses, any capital gain will be disregarded to the extent of any amount already included as ordinary assessable income under section 6-5 of the ITAA 1997.

Issue 2

GST is payable on a taxable supply. You make a taxable supply under section 9-5 of the GST Act if:

a) you make the supply for consideration; and

b) the supply is made in the course or furtherance of an enterprise that you carry on; and

c) the supply is connected with Australia; and

d) you are registered or required to be registered for GST.

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed.

All of the above requirements must be satisfied for a supply to be a taxable supply under section 9-5 of the GST Act.

From the information received, the owners of the land satisfy paragraphs 9-5(a) and 9-5(c) of the GST Act when they sell the houses constructed on the subdivided blocks of vacant land as they made the supply for consideration and the supply is connected with Australia as the houses on the subdivided blocks are located in Australia.

For GST purposes, the houses built are new residential premises. There is no provision in the GST Act that makes a supply of new residential premises in Australia GST-free or input taxed.

We will now consider whether the sale of the houses were made in the course or furtherance of an enterprise that the owners carry on (paragraph 9-5(b) of the GST Act) and whether the owners were required to be registered for GST as they are currently not registered for GST (paragraph 9-5(d) of the GST Act).

Paragraph 9-5(b) of the GST Act

The definition of an enterprise in subsection 9-20(1) includes (amongst other the things) an activity or series of activities done:

• in the form of a business;

• in the form of an adventure or concern in the nature of trade.

Miscellaneous Taxation Ruling MT 2006/1 provides guidance on what constitute an enterprise for the purposes of eligibility for registration for an Australian business number (ABN). Goods and Services Tax Determination GSTD 2006/6 extends the application of MT 2006/1 to GST.

The term business ordinarily would encompass a trade that is engaged in, on a regular or continuous basis, while an adventure or concern in the nature of trade may be an isolated or one-off transaction and includes a commercial activity that does not amount to a business but which has the characteristics of a business deal. Isolated transactions with a commercial flavour are included in this category. Such transactions are of a revenue nature.

In regard to isolated or one-off transaction, paragraphs 262 and 263 of MT 2006/1state:

Isolated transactions and sales of real property

262. The question of whether an entity is carrying on an enterprise often arises where there are 'one-offs' or isolated real property transactions.

263. The issue to be decided is whether the activities are an enterprise in that they are of a revenue nature as they are considered to be activities of carrying on a business or an adventure or concern in the nature of trade (profit making undertaking or scheme) as opposed to the mere realisation of a capital asset. ...

From the facts received, Eugene and Christopher were previously engaged in property development since they jointly constructed 4 houses and these houses are being rented. However, the owners have not, in a partnership, been engaged in property development and subdivision previously. In this instance, we consider the owners' subdivision of the land, construction and sale of the houses to be a 'one-off' or isolated real property transaction.

Paragraphs 262 to 302 of MT 2006/1 specifically consider isolated transactions and sales of real property. Paragraph 263 of MT 2006/1 states that the issue to be decided is whether the activities are an enterprise, in that they are a revenue nature, as opposed to the mere realisation of a capital asset.

As the owners' activity of land development leading to the subdivision, construction and sale of the houses is an isolated transaction, it is necessary to consider whether the subdivision and sale of the houses is a transaction with a commercial flavour that is in the form of an adventure or concern in the nature of trade.

In the form of an adventure or concern in the nature of trade

Paragraph 265 of MT 2006/1 outlines factors that indicate whether activities undertaken on a one-off are an 'adventure or concern in the nature of trade' and states:

265. From the Statham and Casimaty cases a list of factors can be ascertained that provide assistance in determining whether activities are a business or an adventure or concern in the nature of trade… If several of these factors are present it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows: …

• there is a change of purpose for which the land is held;

• additional land is acquired to be added to the original parcel of land;

• the parcel of land is brought into account as a business asset;

• there is a coherent plan for the subdivision of the land;

• there is a business organisation - for example a manager, office and letterhead;

• borrowed funds financed the acquisition or subdivision;

• interest on money borrowed to defray subdivisional costs was claimed as a business expense;

• there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and

• buildings have been erected on the land.

In determining whether activities relating to isolated transactions are an enterprise or the mere realisation of a capital asset, it is necessary to examine the facts and circumstances of each case. No single factor will be determinative. Rather it will be the combination of factors that will lead to a conclusion as to the character of the activities.

Applying the information received to the factors in paragraph 265 of MT2006/1

From the facts received:

• The land was originally purchased either to be sold in the future or to be developed. Sometime later it was decided to subdivide the land and build X houses and these houses would be rented. After the construction, X houses were sold and the remaining house is being rented.

• No additional land was acquired.

• The land has not been brought into account as a business asset by the owners.

• There was a coherent plan for the subdivision and construction of the houses.

• You borrowed funds to finance the subdivision and construction of the houses.

• No costs have been claimed as a business expense.

• Houses were erected on the land as part of the subdivision.

From the above we consider there is a significant commercial component in the activities carried on the land and the extent of the activities is not merely the realisation of capital assets. Accordingly, the subdivision, construction and sale of the houses are activities of carrying on a business or an adventure or concern in the nature of trade as opposed to the mere realisation of a capital asset. The owners' activities amount to carrying on a property development enterprise.

Accordingly, the owners have sold the houses in the course of a property development enterprise that they carry on under paragraph 9-5(b) of the GST Act.

Paragraph 9-5(d) of the GST Act

Under section 23-5 of the GST Act, you are required to be registered if:

a) you are carrying on an enterprise, and

b) your GST turnover meets the registration turnover threshold (currently $75,000).

Under sections 188-15 and 188-20 of the GST Act, GST turnover refers both to 'current annual turnover' and 'projected turnover'. Current annual turnover is turnover for a particular month and the preceding 11 months and projected turnover is turnover for a particular month and the next 11 months. In both cases, the calculation is based on the GST exclusive value of supplies made (sections 188-10 and subsection 9-75(1) of the GST Act). Section 188-10 of the GST Act provides guidance on how to determine when an annual turnover meets or exceeds the registration threshold.

Under section 188-25 of the GST Act, when calculating your projected annual turnover, you do not include any supplies made or likely to be made by transfer of ownership of capital assets, or as a result of ceasing to carry on an enterprise or substantially and permanently reducing the size and scale of an enterprise.

From the information received, the owners were required to be registered for GST when selling the houses because:

• as discussed above, the owners are carrying on a property development enterprise;

• the sale of the houses is trading stock and not capital asset and therefore the sale price are included when calculating the current and projected GST annual turnover. As the sale price of each house is above $75,000, the GST annual turnover would be above the GST registration threshold.

Paragraph 9-5(d) of the GST Act is therefore satisfied.

For more information on GST turnover refer to Goods and Services Tax Ruling GSTR 2001/7 which is available from the legal database of www.ato.gov.au

Summary

As all the requirements in section 9-5 of the GST Act are satisfied, the owners' sale of the houses that constructed on the subdivided vacant land as outlined is a taxable supply and therefore is subject to GST

Other information

A supply of residential rent for residential accommodation is an input taxed supply under section 40-35 of the GST Act. The income received from the input taxed supply is not included when calculating the GST current or projected annual turnover (sections 188-15 and 188-20 of the GST Act).

Under section 40-75 residential premises have been built and have not been used for making input taxed supply for a period of at least 5 years since the premises were last built are new residential premises. In this case the sale of the new residential premises is not input taxed and will be subject to GST if the supplier is registered or required to be registered for GST.

The sale of a property from which rental income has been derived is a sale of capital asset and therefore the sale price will not be included when calculating the GST projected turnover of the enterprise under section 188-25 of the GST Act.