Edited version of your written advice

Authorisation Number: 1013065868970

Date of advice: 3 August 2016

Ruling

Subject: Capital gains tax

Question 1

Is the sale of your property assessable as ordinary income?

Answer

No.

Question 2

Is the sale of your property assessable as a capital gain?

Answer

Yes.

Question 3

Are you entitled to the 50% CGT discount?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2015

The scheme commences on:

1 July 2014

Relevant facts and circumstances

You purchased a residential property.

This property was purchased with the intention to retain it as a rental property.

The property was rented for a number of years.

While renting the property, you saw an opportunity to increase the profitability of the rental be demolishing the current property and constructing a boarding house in its place, to then be held and rented out.

You got an appraisal done on the property in regards to what rental income you could expect to receive and applied to the bank for a loan, to fund the construction of the boarding house. You stated the purpose on the loan was to construct the boarding house, which once completed would be held as an asset indefinitely.

You engaged a real estate agent to manage the property and the agent began advertising for tenants.

You were made an offer by an unrelated party wanting to purchase the property. At the same time the real estate agent had not managed to find any tenants and had advised you that it may be more difficult than they had originally anticipated to fill the property. As a result you were under some financial stress with the lack of cash flow to assist with the repayment of the loan for the construction of the property.

Due to the cash flow pressures and difficulty finding tenants you accepted the offer and sold the property.

Your intention on acquisition and at all subsequent times was to hold the property for its rental return.

You registered for GST and claimed GST associated with the construction costs during the construction process on the basis that the property would be rented as a boarding house upon completion and its rent would exceed $75,000 per annum.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1997 Subsection 995-1

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Division 115

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

Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

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 a trust is 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.

Based on the information provided, it is not viewed that you are carrying on a business of buying and selling property, or that this is the commencement of you carrying on a business of buying and selling land.

Therefore, any gain made on the disposal of the property will not be assessable income under section 6-5 as ordinary income from the carrying on of a business.

Isolated transactions

The Commissioner's view on whether profits from isolated transactions are assessable as ordinary income is found in Taxation Ruling TR 92/3. 'Isolated transactions' are:  

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

• those transactions entered into by non-business taxpayers.

TR 92/3 states that profits from an isolated transaction will be ordinary income when: 

• the intention or purpose of a 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 operation or commercial transaction.

The intention of the taxpayer is determined by an objective consideration of the facts and circumstances (paragraph 38 of TR 92/3). Further, paragraph 40 of TR 92/3 indicates that a profit making purpose need not be the sole or dominant purpose for entering into the transaction. It is sufficient if profit making is a significant purpose.

Paragraph 41 of TR 92/3 indicates that you must have the requisite purpose at the time of entering into the relevant transaction or operation. If the transaction involves the sale of property, it is usually necessary that you have the purpose of profit making at the time of acquiring the property.

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

• the taxpayer had a profit-making intention when entering into the transaction or operation, and

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

A transaction may be characterised as a business operation or commercial transaction if the transaction is business or commercial in character.

Paragraph 13 of TR 92/3 lists some matters which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction:

1. the nature of the entity undertaking the operation or transaction;

2. the nature and scale of other activities undertaken by the taxpayer;

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

4. the nature, scale and complexity of the operation or transaction;

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

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

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

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

Applying the criteria to your circumstances

At the time of purchasing the property you did not intend to develop the property and it was rented for a number of years as a residential property. You then saw an opportunity to increase the profitability of the rental by demolishing the residential property and constructing a boarding house in its place. Your intention has always been to hold the property for its rental return.

Based on the facts and circumstances noted above, we have determined that the profit from the sale of the property is not assessable as ordinary income from an isolated transaction. The acquisition, the development and sale of the property does not amount to a business operation or commercial transaction. Therefore, any profit or gain from the sale of the boarding house will not be assessable as ordinary income under section 6-5 of the ITAA 1997.

Conclusion
It is considered any gain or loss the trust makes on the disposal of the boarding house is on capital account and the gain or loss will be subject to the CGT provisions.

50% CGT discount

Under Division 115 of the ITAA 1997, a discount of 50% can be applied to a capital gain if a CGT event happens after 11:45am on 21 September 1999 and the CGT asset was acquired at least 12 months before the CGT event.

In your case, you acquired a property and sold it more than 12 months later. Consequently, as you owned the property for at least 12 months you are entitled to apply the 50% CGT discount to your capital gain.