Edited version of your written advice

Authorisation Number: 1012898343954

Date of advice: 21 October 2015

Ruling

Subject: Taxation treatment of sale proceeds from the sale of a building

Question 1

Will the proceeds or any gains from the sale of a building constitute a mere realisation of a capital asset assessable under section 104-10 of Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

If the answer to question 1 is no, will the proceeds be assessable under sections 15-15 or 6-5 of the ITAA 1997 or section 25A of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Not applicable.

This ruling applies for the following period

1 July 20xx to 30 June 20xx

Relevant facts and circumstances

1. X Pty Ltd as trustee for the Y Unit Trust (the Taxpayer) bought a building to be used for an intended purpose.

2. The sole shareholder and director of X Pty Ltd is Z.

3. The Taxpayer is part of a larger enterprise (Enterprise A). All the entities involved in Enterprise A are controlled by Z.

4. Besides Enterprise A, Z has Enterprise B. Both arm of the business is run by separate group of staff and separate IT system.

5. Entities of Enterprise A own a number of buildings from which the business of Enterprise A is run.

6. The Taxpayer undertook necessary due diligence to comply with the state government requirements to be able to use the building for the intended use. The valuations obtained also show prices based on the existing use and the intended use. The Crown lease variation document also shows the intended use as the reason for the variation. Again to secure the loan for refurbishment of the building, the Taxpayer provided five year revenue forecast from the intended use.

7. Evidence shows that the building was sold by the Taxpayer due to cash flow problem.

8. Although the building was sold by the Taxpayer but it was leased back from the buyer to continue operation for the intended use.

9. The Taxpayer's Income Tax Return (ITR) for the relevant year shows that the Taxpayer derived rental income from the building. The taxpayer submitted rental schedule with the ITR. The Taxpayer also claimed depreciation deduction for the relevant year.

10. The taxpayer's financial statements show that the building was the only asset it held in the relevant years. The building was shown as non-current asset in the financial statements.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income tax Assessment Act 1997 section 70-10

Income Tax Assessment Act 1997 section 104-10

Reasons for decision

Question 1

Summary

The proceeds or any gain from the sale of the building is a mere realisation of a capital asset assessable under section 104-10 of Part 3-1 of the ITAA 1997.

Detailed reasoning

Proceeds from the sale of a property can fall within one of the three categories:

• as ordinary income where the property is held as trading stock and is sold as part of a property development business; or

• as ordinary income where the property is not trading stock and is sold as a part of an isolated profit-making scheme or undertaking; or

• on capital account when the proceeds of sale are the mere realisation of a capital asset.

The courts have generally addressed the issue as to whether a particular asset disposed of was held on capital account or not as being the distinction between a mere realisation or change of investment and a transaction that is an act done in what is truly carrying on or carrying out of a business: California Copper Syndicate v. Harris (Surveyor of Taxes) (1904) 5 TC 159.

In London Australia Investment Co Ltd v. FCT (1977) 138 CLR 106, Gibbs J, when considering the criterion of whether a sale was a business operation carried out in the course of the business of profit-making, stated that:

To apply this criterion it is necessary "to make both a wide survey and an exact scrutiny of the taxpayer's activities": Western Gold Mines N.L v C. of T (W.A) (1938) 59 C.L.R. 729, at p 729, at p. 740. Different considerations may apply depending on whether the taxpayer is an individual or a company. In the latter case it is necessary to have regard to the nature of the company, the character of the assets realized, the nature of the business carried on by the company and the particular realization which produced the profit: Hobart Bridge Co. Ltd v F.C. of T. (1951) 82 C.L.R. 371, at p. 383, citing Ruhama Property Co. Ltd. v F.C. of T., at p. 154.

The leading Australian judgement on the distinction between capital and revenue expenditure is that of Dixon J in Sun Newspapers Ltd v. FCT (1938) 61 CLR 337 (Sun Newspaper). At pp 359, Dixon J said:

The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure or organisation set up or established for the earning of profit and the process by which such an organisation operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss.

Elaborating upon this concept, Dixon J then said at pp 359-360:

The business structure or entity or organization may assume any of an almost infinite variety of shapes and it may be difficult to comprehend under one description all the forms in which it may be manifested …But in spite of the entirely different forms, materials and immaterial, in which it may be expressed, such sources of income contain or consist in what has been called a 'profit-yielding subject' …As a general conceptions it may not be difficult to distinguish between the profit-yielding subject and the process of obtaining it. In the same way expenditure and outlay upon establishing, replacing and enlarging the profit-yielding subject may in a general way appear to be of a nature entirely different from the continual flow of working expenses, which are or ought to be supplied continually out of the returns or revenue.

Dixon J said (at p 363) that there were three matters to be considered:

(a) the character of the advantage sought

(b) the manner in which it is to be used, relied upon or enjoyed; and

(c) the means adopted to obtain it.

In Hallstroms Pty Ltd v. FCT (1946) 72 CLR 634, Dixon J added the following comments to his criteria in Sun Newspaper (at 648):

The contrast between the two forms of expenditure corresponds to the distinction between the acquisition of the means of production and the use of them; between establishing or extending a business organisation and carrying on the business; between the implements employed in work and the regular performance of the work in which they are employed; between an enterprise itself and the sustained effort of those engaged in it.

……

What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any secured, employed or exhausted.

However, in BP Australia Ltd v. FCT (1965) 9 AITR 615, the Privy Council cautioned (at 622):

The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances which may point in one direction, some in the other. ….It is a common sense appreciation of all the guiding features which must provide the ultimate answer. Although the categories of capital and income expenditure are distinct and easily ascertainable in obvious cases that lie far from the boundary, the line of distinction is often hard to draw in borderline cases; and conflicting considerations may produce a situation where the answer turns on questions of emphasis and degree.

In the present case, the Taxpayer bought the building to be used in connection with Enterprise A. Although Z, the sole shareholder and director of the Trustee, has another business through Enterprise B, Enterprise A has been kept separate from Enterprise B, including the staff involved and IT systems used. While the building was sold to meet urgent cash flow problem, entities involved in the operation of Enterprise A continue managing the business via a long term lease of the building from the buyer.

Therefore, the building is not a trading stock for the Taxpayer, which under section 70-10 of the ITAA 1997 means anything produced manufactures or acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course of a business. The Taxpayer is not in the business of refurbishing existing buildings for the intended use and selling them as going concerns. Nor was the building sold in the course of carrying on a business of selling buildings. It was more a profit yielding structure from which the Taxpayer was running the intended business. However, the fact that there was no repetition or recurrence of selling of buildings or selling of the buildings in the course of carrying on a business does not mean that the sale proceeds cannot be income. In FC of T v. The Myer Emporium Ltd (1987) 163 CLR 199, the Full High Court held that a receipt may constitute income if it arises from an isolated business operation or commercial transaction entered into otherwise than in the course of carrying on of the taxpayer's business, so long as the taxpayer entered into the transaction with the purpose of making a relevant profit or gain from the transaction.

Therefore, it is necessary to look at not only the business or the profit yielding structure but also the intention as well as the nature of the transaction and the nature of the asset realised that gave rise to the profit or loss.

In Westfield Ltd v. FCT (1991) FCA 86; ATC 4234; 21 ATR 1398 (Westfield), the taxpayer secured an option over property in May 1987. The option was extended several times until May 1980 while the taxpayer pursued plans for developing the property into a shopping centre. In January 1980, the taxpayer abandoned those plans. Another company became interested in developing a shopping centre on the property, intending to capitalise on the work already done by the taxpayer in that regard. To prevent this, the taxpayer secured another extension of the option to buy the property, until April 1981. The taxpayer exercised the option and bought the property in April 1981 with a view to build a shopping centre going ahead in some form. At the time the property was bought, the taxpayer had already entered into negotiation with AMP with a view of some form of participation by AMP in the project. The land was sold to AMP in 1982 for $735,000. The taxpayer was subsequently engaged by AMP to design and construct the shopping centre. The Full Court of the Federal Court held that the proceeds of the sale were not ordinary income. The Court said that although a profit or gain made in the ordinary course of carrying on a business constitutes income, it does not follow that every profit made by a taxpayer in the course of carrying on a business constitutes income. In the word of Hill J:

33……..To so express the proposition is to express it too widely, and to eliminate the distinction between an income and a capital profit.

……

34…….In a case where the transaction, which gave rise to the profit, is itself a part of the ordinary business (e.g. a profit on the sale of shares made by a share trader), the identification of the business activity itself will stamp the transaction as one having a profit-making purpose. Similarly, where the transaction is an ordinary incident of the business activity of the taxpayer, albeit not directly its main business activity, the same can be said.

The Court observed in Westfield that the resale of the land was not part of the taxpayer's ordinary business activity or a necessary incident of it, because the taxpayer's business activity was the construction of the shopping centres which were then leased out or managed by the taxpayer on either their own land, the land of others or on a joint venture land. Accordingly, the Court further observed that where a transaction occurs outside the scope of ordinary business activities, it is necessary to find that the transaction was commercial and also that there was, at the time the transaction was entered into, the intention or purpose of making a profit. The Court found that in this case, although at the time the land was acquired it was open to the taxpayer to sell it, the taxpayer's intention was to develop the land itself. The taxpayer therefore lacked the necessary profit-making purpose at the time of acquisition. Further, the sale of the land to achieve participation in the development of a shopping centre was not part of a profit-making scheme and did not therefore reflect the necessary profit-making purpose. Obtaining the contract to construct and manage the centre was not, of itself a scheme of profit making. It was a scheme of deriving income from performance of work under the building and management contracts.

In the present case, it is very clear from the very beginning that the Taxpayer acquired the building for the purpose of the intended use. The valuations that the Taxpayer obtained included the scenario of converting the building for the intended use. The Crown lease was also varied to allow the Taxpayer to use the building for the intended use. The State Government gave approval to the Taxpayer subsequent to carrying out a number of compliance activities to make the building suitable for such use.

Again, the five year forecast of estimated revenue that the Taxpayer provided to the bank to secure the loan for refurbishment of the building further demonstrates the mutual understanding between the parties that the Taxpayer intended to carry on the intended business by refurbishing the building.

While the above facts demonstrate that initial acquisition of the building was not for profit making purposes, the manner in which it was held during and following the refurbishment also indicates that the Taxpayer treated the building as passive investment during its ownership period. In the Taxpayer's financial statements, the building is shown as non-current asset. In its ITRs, the Taxpayer declared rental income and submitted a rental schedule. The Taxpayer also claimed depreciation deduction.

All these show that the Taxpayer was genuinely holding the building as a profit yielding structure or as a passive investment.

Therefore, selling the building was not an ordinary incident of the Taxpayer's business nor was it done in the course of carrying on its ordinary business. Again, there was no profit-making intention by selling the building at the time it was acquired, refurbished or used in the intended business. The decision to sell the building was to overcome urgent cash flow problem of the larger business operation of Z.

The sale proceeds of the building is therefore a mere realisation of a capital asset and assessable to the Taxpayer as a statutory income under section 6-10 of the ITAA 1997 as per section 104-10 of Part 3-1 of the ITAA 1997.

Question 2

Section 15-15 of the ITAA 1997 has no application to a profit arising from the sale of a property acquired after 19 September 1985.

Section 25A of the ITAA 1936 has no application to the sale of property acquired after 19 September 1985.

Section 6-5 of the ITAA 1997 does not apply since the proceeds of the sale of the building, as shown above, are a mere realisation of a capital asset.