Edited version of your written advice

Authorisation Number: 1012912784886

Date of advice: 20 November 2015

Ruling

Subject: Income tax - Assessable income - Income vs capital

Question 1

Will any gain made from the sale of your land and buildings be a gain made from the mere realisation of a capital asset and a capital gain pursuant to subsection 104-10(4) of the Income Tax Assessment Act 1997 (ITAA 1997)? Will section 118-25 of the ITAA 1997 apply to disregard the capital gain?

Answer

The disposal of your land and buildings is a mere realisation of a capital asset and any gains made from the disposal will be a capital gain pursuant to subsection 104-10(4) of the ITAA 1997. As the land and buildings was not your trading stock, section 118-25 of the ITAA 1997 will not apply to disregard the capital gain.

Question 2

Will the proceeds from the sale of your land and buildings be assessable as ordinary income under section 6-5 of the ITAA 1997?

Answer

No.

Question 3

Will the proceeds from the sale of your land and buildings be assessable under section 15-15 of the ITAA 1997?

Answer

No.

Question 4

Will the proceeds from the sale of your land and buildings be assessable under section 25A of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

This ruling applies for the following periods:

Income year ended 30 June 20ZZ

The scheme commences on:

1 July 20YY

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

An entity acquired a vacant block of land and constructed buildings thereon which were subsequently tenanted.

Throughout the period of ownership of the land and buildings, the entity upgraded the buildings and expanded as required.

Due to family succession issues, lack of willingness to acquire further properties, develop significantly and manage the properties, the entity disposed of the land with the buildings thereon after undergoing various investigations to maximise the potential of the property.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 25A

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 15-15

Income Tax Assessment Act 1997 section 70-10

Income Tax Assessment Act 1997 section 70-30

Income Tax Assessment Act 1997 section 70-80

Income Tax Assessment Act 1997 section 70-110

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 subsection 104-10(4)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 subsection 118-25(1)

Reasons for decision

Question 1

Summary

The disposal of the land and buildings is a mere realisation of a capital asset and any gains made from the disposal will be a capital gain pursuant to subsection 104-10(4) of the ITAA 1997. As the land and buildings was not your trading stock, section 118-25 of the ITAA 1997 will not apply to disregard the capital gain.

Detailed reasoning

Section 6-5 of the ITAA 1997 provides that an amount is assessable income if it is income according to ordinary concepts (ordinary income).

As noted in Federal Commissioner of Taxation v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693 (Myer), as a business is carried on with a view to profit, a gain made in the ordinary course of carrying on a business is stamped with the character of income. Additionally, as noted in Colonial Mutual Life Assurance Society Ltd v. Federal Commissioner of Taxation (1946) 73 CLR 604; 8 ATD 137; 3 AITR 450, acts done in carrying on a business are not limited to acts in relation to a taxpayer's primary business.

In accordance with section 70-80 of the ITAA 1997, the proceeds from the sale of an item of trading stock disposed of in the ordinary course of business will also be ordinary income and are to be included in assessable income under section 6-5 of the ITAA 1997.

Under section 6-10 of the ITAA 1997, assessable income also includes some amounts that are not ordinary income but that are included in assessable income by provisions about assessable income (statutory income). These provisions are listed in the table in section 10-5 of the ITAA 1997.

The table in section 10-5 of the ITAA 1997 includes section 102-5 of the ITAA 1997. Under section 102-5 of the ITAA 1997, net capital gains are included in the assessable income of a taxpayer. A net capital gain as worked out in accordance with the method outlined in that section arises where capital gains made during the income year are more than the sum of capital losses made during the income year and unapplied net capital losses from earlier income years.

Pursuant to subsection 104-10(4) of the ITAA 1997, a capital gain is made from the disposal of a capital gains tax (CGT) asset if the capital proceeds are more than the asset's cost base. However, if at the time of the disposal the CGT asset is trading stock, subsection 118-25(1) of the ITAA 1997 will apply to disregard any capital gains from the disposal.

Section 108-5 of the ITAA 1997 defines a CGT asset as any kind of property; or a legal or equitable right that is not property. Land and buildings is listed as an example of a CGT asset in Note 1 to that section.

Having regard to the above, proceeds from the sale of property will be treated in one of three ways:

a. where property that is held as trading stock is sold as part of a business of property development, the gross proceeds from the sale of the property will be ordinary income; or

b. where property is sold as part of an isolated profit making scheme or undertaking, the net proceeds from the sale of the property will be ordinary income; or

c. where the sale of property is a mere realisation of a capital asset and not the sale of trading stock as part of a business of property development or a sale made as part of an isolated profit making scheme or undertaking, the proceeds will, form part of the calculation of any capital gain made on the sale.

Trading stock

Trading stock is defined widely in section 70-10 of the ITAA 1997 to include anything produced, manufactured or acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course of a business.

It follows from this definition that an asset will only be trading stock if both the required purpose and the business activity are present.

Required purpose

The expression 'held for purposes of manufacture, sale or exchange' requires that an item's current use or purpose, and not its original use or purpose, be one of the requisite purposes. Inherent in the definition of trading stock is the notion that an item's use or purpose may change as can its characterisation for income tax purposes.

Sections 70-30 of the ITAA 1997, which deals with starting to hold as trading stock an item that you already own, and 70-110 of the ITAA 1997, which deals with items that are still owned but that cease to be held as trading stock, reinforce this notion.

When assessing whether an item is held for the purposes of resale, the previous activities of the taxpayer; the taxpayer's controlling mind and the activities of related entities are relevant factors: R and D Holdings Pty Ltd v. Deputy Commissioner of Taxation [2006] FCA 981; (2006) 2006 ATC 4472; (2006) 64 ATR 71 (R and D Holdings).

Business activity

Property cannot be trading stock unless it is an asset of a business of trading in property of that kind: Federal Commissioner of Taxation v. St Hubert's Island Pty Ltd (in liq) (1978) 138 CLR 210; 78 ATC 4104; (1978) 8 ATR 452 (St Hubert's Island).

As explained in Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'? (as amended by TD 92/124A), land will be treated as trading stock for income tax purposes if it is held for the purpose of resale and a business activity which involves dealing in land has commenced.

Whether an asset is sold or exchanged in the ordinary course of a business is to be determined by reference to what it is that the relevant entity normally does. The business of a single member of a group or a special purpose vehicle will be seen in the context of the business activities of the wider group: Grollo Nominees Pty Ltd v. Federal Commissioner of Taxation (1997) 73 FCR 452; (1997) 97 ATC 4585; (1997) 36 ATR 424.

Isolated profit making scheme or undertaking

Guidance in determining whether profits from isolated transactions are ordinary income and the ATO view as to the application of the decision in Myer is provided in Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income.

In TR 92/3 the term 'isolated transactions', in the case of a business taxpayer, refers to those transactions outside the ordinary course of business. A transaction may be outside the ordinary course of business because it takes place in the course of business but it is not within the ordinary course of that business or because it does not take place in the course of business.

As explained in TR 92/3, a profit from an isolated transaction will generally be income when both the intention or purpose of 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.

Intention to make a profit

In Westfield Ltd v. Federal Commissioner Of Taxation [1991] FCA 86; 91 ATC 4234; 21 ATR 1398 the Full 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 his business activity will be of an income nature. This would eliminate the distinction between income and a capital profit.

The Court said that if the transaction or operation which gives rise to the profit is part of the ordinary business of the taxpayer then a profit-making purpose is imprinted on the transaction. The same applies if the transaction is an ordinary incident of the business activity of the taxpayer, even though it is not directly its main business activity. But in cases where a transaction is not part of the taxpayer's ordinary business activity or a necessary incident of 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 relevant intention or purpose of the taxpayer of making a profit or gain can be discerned from an objective consideration of the facts and circumstances of the case: August v. Federal Commissioner of Taxation [2013] FCAFC 85; (2013) 2013 ATC 20-406; (2013) 94 ATR 376.

The intention or purpose of an entity taxpayer is to be ascertained by reference to the intention or purpose of its controllers at the relevant time: Federal Commissioner of Taxation v. Whitfords Beach Pty Ltd (H.C.) (1982) 150 CLR 355; 82 ATC 4031; 12 ATR 692 (Whitford's Beach).

If a transaction or operation is outside the ordinary course of a taxpayer's business, the intention or purpose of profit making must exist in relation to the transaction or operation in question: Federal Commissioner of Taxation v. Spedley Securities Limited 88 ATC 4126; 19 ATR 938.

In the course of carrying on a business

A transaction may take place in the course of carrying on a business even if the transaction may not be within the ordinary course of that business: Myer.

Business operation or commercial transaction

Where a taxpayer carrying on a business enters into a transaction or operation that is not in the course of that business, it is necessary to consider whether the transaction is part of a business operation or commercial transaction.

For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character: Whitfords Beach.

Whether a transaction has a business or commercial character depends on the circumstances of the case: Myer.

The scale of a development may make it impossible for the transaction to be a mere realisation of an asset: Whitfords Beach.

Even if an operation or transaction lacks repetition or recurrence, it may be a business operation or commercial transaction: Whitfords Beach.

In very general terms, a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations.

Some factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are the following:

a. the nature of the entity undertaking the operation or transaction: Ruhamah Property Co. Ltd. v. Federal Commissioner of Taxation (1928) 41 CLR 148 (Ruhamah Property); Hobart Bridge Co. Ltd. v. Federal Commissioner of Taxation (1951) 82 CLR 372 (Hobart Bridge); Federal Commissioner of Taxation v. Radnor Pty Ltd 91 ATC 4689; 22 ATR 344;

b. the nature and scale of other activities undertaken by the taxpayer: Western Gold Mines N.L. v. Commissioner of Taxation (W.A.) (1938) 59 CLR 729;

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: Edwards v. Bairstow [1956] AC 14; Hobart Bridge; and

h. the timing of the transaction or the various steps in the transaction: Ruhamah Property.

Mere realisation

The distinction between a mere realisation of a capital asset and a transaction that is an act done in carrying on a business or carrying out a business operation or commercial transaction is not always clear and is a question of fact.

The issue was summarised in Californian Copper Syndicate v. Harris (Inspector of Taxes) (1904) 5 TC 159 at 165 where Lord Justice Clerk said:

It is quite a well settled principle in dealing with questions of assessment of Income Tax, that where the owner of an ordinary investment chooses to realise it, and obtains a greater price for it than he originally acquired it at, the enhanced price is not profit assessable to Income Tax. But it is equally well established that enhanced value obtained from realisation or conversion of securities may be so assessable, where what is done is truly the carrying on, or carrying out, of a business. What is the line which separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be determined being - Is the sum of gain that has been made a mere enhancement of values by realising a security, or is it a gain made in an operation of business in carrying out a scheme of profit-making?

The determination of whether an amount is from a mere realisation or from a business operation is an objective test that requires a close examination of all relevant circumstances.

In London Australia Investment Co Ltd v. Federal Commissioner of Taxation (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 Ruhamah Property Co. Ltd. v F.C. of T. at p. 154.

The mere realisation of a capital asset will not give rise to ordinary income even where the realisation is carried out in an enterprising way to secure the best price.

In Scottish Australian Mining Co Ltd v. Federal Commissioner of Taxation (1950) 81 CLR 188 (Scottish Australian Mining) the taxpayer purchased land for the purposes of carrying on a coal mining business. Once the mine was exhausted, the taxpayer subdivided the land at considerable expense. Roads were constructed on the land and part of the land was set aside for public institutions and parklands. The taxpayer made considerable profits from the sale of a large area of land in the subdivision. The High Court held that the sale of the land was a mere realisation of an asset as the company had not purchased the land for the purpose of profit making by sale and had merely taken the necessary steps to realise the land to the best advantage.

Similarly, in Statham and Anor v. Federal Commissioner of Taxation (1988) 20 ATR 228; 16 ALD 723; 89 ATC 4070 (Statham) it was found that a mere realisation of assets had been effected even though the owners had applied themselves in an enterprising way to the realisation with the consequence that proceeds from the sale of land were not assessable income. The Full Federal Court held at 4077 that what occurred was:

the mere realisation, by the most advantageous means, of the asset which the owners had on their hands when they abandoned the intention of farming the subject property.

The Commissioner had argued that the following factors had indicated a business or at least a profit-making scheme or undertaking: the fact that the owners sought to subdivide land which was originally zoned as rural, the substantial sum spent on subdivisional costs, the owners' engagement in the activity over a long period of time, and the fact that the subdivision was large by local standards.

The court was satisfied that the owners did not enter into the business of selling land. There was nothing surprising, the court said, in the fact that the owners applied themselves in an enterprising way to the realisation of a capital asset, in a manner calculated to maximise their receipts. But the fact that this occurred does not necessarily make the proceeds either profits from an undertaking or scheme, or income from a business. The court said at p 4075:

It is well established that the mere realisation of an asset at a profit does not necessarily render the profit taxable. The profit must arise from the carrying on of a business or a profit- making undertaking or scheme. The mere magnitude of the realisation does not convert it into such a business, undertaking or scheme; but the scale of the realisation activities is a relevant matter to be taken into account in determining the nature of the realisation, ie in determining whether the facts establish a mere realisation of a capital asset or a business or profit-making undertaking or scheme.

In circumstances where there is an absence of profit-making intention, the likelihood of any profit made on the eventual sale of an asset being ordinary income is greatly diminished. The reasons prompting the sale may be a relevant consideration.

In Casimaty v. Federal Commissioner of Taxation (1997) 97 ATC 5135; (1997) 37 ATR 358, the taxpayer acquired a farming property. The next year, the taxpayer purchased more land on which he erected a homestead and for many years conducted a farming business. Due to growing debt and ill health, the taxpayer subdivided and sold off a large part of the property. Most of the subdivisions required the taxpayer to construct roads, provide water and sewerage facilities and to fence the boundaries. Although the subdivisions were numerous and ultimately were a large part of the original property, the court held that the sales from the subdivisions occurred as part of the mere realisation of a capital asset of the taxpayer. The court was primarily influenced by the fact that the taxpayer continued to use the property as a farm and a residence. The court said that it did not detect any change in the purpose for which the property was acquired. The taxpayer did not undertake any works or developments on the land beyond that which was necessary to secure approval for each subdivision.

Application to your circumstances

In your case, at the time of disposal, the land and buildings were tenanted and you were deriving rental income from numerous tenants; you had derived rental income since construction of the buildings. This indicates that your primary activity was that of renting the land and buildings.

Your business is to keep the land and buildings let and maintained to its best commercial advantage. This suggests that a rental activity business was contemplated and intended by the entity.

Your focus has been on property investment and management. This suggests a purpose of long term investment with regard to your land and buildings.

The factors in your case indicate that at the time of disposal the land and buildings was not held for the purpose of resale in a business of property development. They indicate that the nature of your business was renting your premises and the land and buildings was the profit yielding structure from which you generated your income. Accordingly, the land and buildings was not your trading stock for the purposes of section 70-10 of the ITAA 1997 at the time of disposal.

You were motivated to dispose of the land and buildings because of family succession issues and a lack of willingness to undertake significant development.

You conducted several investigations before eventually selling. This suggests that you were seeking to maximise any profit from the sale, as established in Australian Scottish Mining, merely taking steps to realise an asset to its best advantage will not preclude it from being a mere realisation. Likewise, in Statham it was decided that what occurred was the mere realisation by the most advantageous means despite all the activities undertaken to achieve the sale.

As the disposal was not part of a business operation or commercial transaction and there was no profit making intention in relation to the disposal, the proceeds from the disposal of the land and buildings will not be ordinary income.

The disposal of the land and buildings is instead a mere realisation of a capital asset and any gains made from the disposal will be a capital gain pursuant to subsection 104-10(4) of the ITAA 1997. As the land and buildings was not your trading stock, section 118-25 of the ITAA 1997 will not apply to disregard the capital gain.

Question 2

Summary

The proceeds from the sale of the land and buildings will not be assessable as ordinary income under section 6-5 of the ITAA 1997.

Detailed reasoning

As outlined above in question 1, the land and buildings was not your trading stock. Further, you did not dispose of it with the intention of making a profit or gain as part of a commercial transaction of business operation. Accordingly, proceeds from the disposal are not assessable as ordinary income under section 6-5 of the ITAA 1997.

Question 3

Summary

The proceeds from the sale of the land and buildings will not be assessable under section 15-15 of the ITAA 1997.

Detailed reasoning

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.

Question 4

Summary

The proceeds from the sale of the land and buildings will not be assessable under section 25A of the ITAA 1936.

Detailed reasoning

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