Edited version of your written advice

Authorisation Number: 1012911686405

Date of advice: 18 November 2015

Ruling

Subject: Property development

Question 1

Is any gain made on the sale of Property A assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

If a loss is made on the sale of the Property A, will it be on revenue account and deductible under section 8-1 of the ITAA 1997?

Answer

Yes.

Question 3

Will capital gains provisions apply to the sale of the Property B?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2015

Year ended 30 June 2016

The scheme commences on:

1 July 2014

Relevant facts and circumstances

Your intention was to acquire a large property zoned commercial.

The initial plan for the property was to build a multi-storey complex with multiple tenants. Due to the financial risk that this would have imposed, a second plan was made to purchase the block, sub-divide the property, build commercial buildings and sell the properties.

Ultimately, you were unable to acquire the property.

You entered into a contract for the purchase of another piece of land.

The land that was acquired consisted of two adjacent blocks - Property B which was zoned residential and Property A which was zoned commercial.

Property B had a residential property constructed on it, which was subject to a residential rental contract. You intended to retain this property as an investment property however you received an offer to sell it. The property was sold for a loss.

You approached the purchase and development from a commercial perspective, with the intention to make a profit, by engaging a property consultant and architect including drawing up proposals and plans, and obtaining council approval.

Shortly after settlement detailed construction plans were drawn up and submitted to council for the final approval of the development of commercial premises as soon as possible following settlement. Cash flow projections were prepared which showed your intention to sell the land for a profit, and income tax payable included in the projections.

Property A will be leased once construction of the building is completed.

At this stage you propose to sell the property to a related entity and assign the property lease to them a short time after completion of construction and any remediation/remedial works are settled.

At the time of sale, a valuation of the property will be obtained from an independent valuer and that valuation will form the basis of the sale price.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 subsection 100-25(2)

Income Tax Assessment Act 1997 section 104-5

Reasons for decision

Under section 6-5 of the ITAA 1997, your assessable income includes the ordinary income you derived directly or indirectly from all sources, during the income year.

Although the legislation does not define income according to ordinary concepts, a substantial body of case law has evolved to identify various factors that indicate the nature of ordinary income. 

In FC of T v The Myer Emporium (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693 (Myer Emporium), the Full High Court expressed the view that profits made by a taxpayer who enters into an isolated transaction with a profit making purpose can be assessable income.

Taxation Ruling TR 92/3 considers the assessability of profits on isolated transactions in light of the principles outlined in Myer Emporium. According to Paragraph 1 of TR 92/3, the term isolated transactions refers to:

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

• those transactions entered into by non-business taxpayers.

Paragraph 6 of TR 92/3 provides that a profit from an isolated transaction will generally be income when both the following elements are present:

• your intention or purpose 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.

Paragraph 4 of Taxation Ruling TR 92/4 states that a similar test applies to the deductibility of losses incurred from isolated transactions under section 8-1 of the ITAA 1997.

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 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

Application to your circumstances

Property A

In your case, you acquired the property with the intent to develop it and sell it for a profit, engaged a property consultant, obtained council approval and prepared cash flow projections.

It is considered that an isolated transaction was entered into, and a profit or loss will be made, in carrying out a commercial transaction. Therefore if the sale of the property results in a profit, this profit would be assessable under section 6-5 of the ITAA 1997 and if the sale of the property results in a loss, this loss would be deductible under section 8-1 of the ITAA 1997.

Property B

Division 100 of the ITAA 1997 explains that you make a capital gain or a capital loss if a CGT event happens to a CGT asset. Subsection 100-25(2) of the ITAA 1997 specifically includes land and buildings as CGT assets. Disposal of a CGT asset is CGT event A1 (section 104-5 of the ITAA 1997).

You acquired the property B which contained a residential property and it was being used as a rental property. The property continued to be a rental property until it was sold. We accept that the acquisition of property B was incidental to your commercial transaction of property development; the property was intended to be held on capital account.

This property is a CGT asset. The sale of the property would be CGT event A1. The capital loss on the disposal of this property would need to be included in the calculation of your net capital gain for the relevant income year. If you are unable to utilise your capital loss in a particular financial year, you carry the unused portion of your capital loss over to the next financial year. This capital loss can be carried forward until such a time that you have made a capital gain which you can offset it against.