Edited version of your written advice

Authorisation Number: 1013068405739

Date of advice: 9 August 2016

Ruling

Subject: Income - assessable as revenue or capital gain

Question

Is the proposed sale of the Property a mere realisation of a capital asset and hence taxable on capital account under the capital gains tax (CGT) rules for the purpose of the taxation legislation?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2016

The scheme commences on

1 July 2015

Relevant facts and circumstances

You are a resident unit trust settled with a corporate trustee.

The unit holders are other trusts and a company.

You were established for the sole purpose of acquiring and developing a commercial property ('Property').

The proposed development consisted of a multi storey building with office suites. The majority of funds for the development would have been borrowings from financial institutions.

It was the unit holders' intention that once the proposed development was completed, they would enter into a partitioning agreement and subdivision, whereby each unit holder become the owner of a number of offices in accordance with their unit holdings and you would be wound up.

The unit holders would then rent the office spaces to third parties.

In 20XX you entered into a binding agreement to purchase the Property. The contract terms resulted in litigation which did not settle until some months later.

The settlement of the property was funded by a loan from a financial institution with the balance funded by the unit holders.

A planning permit for the development of the property was granted after the date of the purchase settlement.

The proposed development was abandoned due to the protracted litigation, changes in the bank lending policies requiring additional unit holders' funds to fund the project.

The unit holders have businesses and investments unrelated to the building trade. They do not have building experience nor have they previously been involved in other building activities.

If the proposed development had proceeded, a registered builder would have been engaged in the construction and completing of the proposed development project.

In 20YY you entered into a contract to sell the Property. The sale contract settled in 20ZZ.

You have made a gain from the sale of the Property.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Reasons for decision

Summary

The gain from the sale of the Property is considered to be assessable income under ordinary concepts. The sale of the Property with development approval is more than just mere realisation of the original asset purchased.

Detailed reasoning

The gain from the sale of a property may form part of a taxpayer's assessable income:

• as a profit made in the ordinary course of carrying on a business of property development

• as ordinary income as you conducted an isolated commercial transaction with a view to a profit under section , or

• as an assessable capital gain as a mere realisation of a capital asset.

We will examine each of the above to determine how your gain from the sale of the Property should be treated for tax purposes.

Carrying on a business of property development

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 provided.

Taxation Ruling TR 97/11 provides the Commissioner's view of the factors used to determine if you are in business for tax purposes.

In the Commissioner's view, the factors that are considered important in determining the question of business activity 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 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 out in a businesslike 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 a sporting activity.

No one indicator is decisive. The indicators must be considered in combination and as a whole. Whether a 'business' is carried on depends on the large or general impression.

Based on the information provided, it is considered that you are not carrying on a business of property development. Therefore, the proceeds from the sale of the Property are not considered to have been derived during the course of carrying on a business.

Profits from an isolated transaction

Taxation Ruling TR 92/3 discusses the treatment of profits and losses resulting from isolated transactions.

The term 'an isolated transaction' refers to those transactions outside of the ordinary course of business of a taxpayer carrying on a business and those transactions entered into by non-business taxpayers.

A profit from an isolated transaction is income according to ordinary concepts when both of the following elements are present:

(a) in entering into the transaction the taxpayer intended or expected to derive a profit which would have been assessable income, and

(b) the transaction was entered into in the course of carrying on a business or in carrying out a business operation or a commercial transaction.

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 transaction or operation involves the sale of the property, it is usually, but not always necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property.

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 (Federal Commissioner of Taxation v. Whitfords Beach Pty Ltd (1982) 150 CLR 355; 82 ATC 4031; 12 ATR 692). Whether a particular transaction has a business or commercial character depends on the circumstances of the transaction.

In determining whether an isolated transaction amounts to a business operation or commercial transaction, paragraph 13 of TR 92/3 outlines a number of factors that must be considered, as follows:

• the nature of the entity undertaking the operation or transaction. For example, if the taxpayer is a corporation with substantial assets rather than an individual, that may be an indication that the operation or transaction was commercial in nature

• the nature and scale of other activities undertaken by the taxpayer

• the amount of money involved in the operation or transaction and the magnitude of profit sought or obtained

• the nature, scale and complexity of the operation or transaction

• the manner in which the operation or transaction was entered into or carried out

• the nature of any connection between the relevant taxpayer and any other party to the operation or transaction

• if the transaction involves the acquisition and disposal of property, the nature of that property, and

• the timing of the transaction or the various steps in the transaction. For example, if the relevant transaction consists of the acquisition and disposal of property, the holding of the property for many years may indicate the transaction was not business or commercial in nature.

It is not necessary that a profit be obtained by a means specifically contemplated (either on its own or as one of several possible means) when the taxpayer enters into the transaction. It is sufficient that the taxpayer enters into the transaction with the purpose of making a profit in the most advantageous way and that a profit is later obtained by any means which implements the initial profit-making purpose. It is also sufficient if a taxpayer enters into the transaction with the purpose of making a profit by one particular means but actually obtains the profit by a different means.

Application to your circumstances

The following is an examination of the factors contained in TR 92/3 with regard to your circumstances.

(a) The nature of the entity undertaking the operation or transaction

You are a unit trust with a company as trustee. You were formed for the purpose of purchasing and developing the Property.

(b) The nature and scale of other activities undertaken by the taxpayer

Your unit holders consist of trusts and a company. Their other investments and business activities are unrelated to the building trade and they have not been involved in property development previously.

(c) The amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained

The Property was purchased for XX and expected development costs were $XX. The Property sold for $XX with the development approval. The development approval added to the value of the property when it was marketed and sold.

(d) The nature, scale and complexity of the operation and transaction

The operation involved the purchase of a commercial property and developing it into office suites. Then the Property was then to be subdivided and ownership transferred to the unit holders according to their unit holdings.

The acquisition of a development approval is not a simple transaction. It involves obtaining information as to the extent that the property can be developed, having plans drawn up and liaising with council to have the proposal approved. A development approval being attached to a property that is acquired saves the purchaser a lot of time and effort and they know with certainty what they can build on that property.

(e) The manner in which the operation or transaction was entered into or carried out

The transaction was carried out in a commercial or business-like manner. You acquired the Property, acquired development approval and then sold it.

You borrowed money to fund part of the purchase resulting in the property becoming encumbered.

(f) The nature of any connection between the relevant taxpayer and any other party to the operation or transaction

There was no relationship between you or your unit holders and other parties to the operation.

(g) If the transaction involves the acquisition and disposal of property, the nature of that property

The property was a commercial warehouse and not vacant land. A development application for a multi storey building containing office suites was obtained for the Property. The property was sold with the development approval by a real estate agent.

(h) The timing of the transaction or the various steps in the transaction

A binding agreement to purchase the Property was entered into in 20XX but due to litigation regarding the purchase price did not settle until 20YY. The development application was approved later. A sales contract was entered into in 20YY and settled in 20ZZ.

TR 92/3 paragraph 38 states that the intention or purpose of the taxpayer in making a profit or gain is not the subjective intention or purpose of the taxpayer. Rather it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case. It is considered that an assessable profit can arise when a taxpayer makes a profit by a different means than the particular means that arose when the transaction was entered into (paragraph 57 of TR 92/3). The Commissioner has considered Westfield Limited v. FC of T (1991) 21 ATR 1398; 91 ATC 4234; (1991) 99 ALR 510 (1991) 28 FCR 333 but has followed Moana Sand Pty Limited v. Federal Commissioner of Taxation 88 ATC 4897; (1988) 19 ATR 1853 (Moana Sand's Case) in coming to this view in TR 92/3. In Moana Sand's Case the taxpayer purchased land for two purposes: to sell the surplus sand and hold the land to sell at a profit. The land was compulsorily acquired by a government authority. It was found by the Federal Court that 'the sale was the fulfilment of the taxpayer's ultimate purpose in relation to the land'.

Paragraph 40 of TR 92/3 states that it is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering the transaction. It is sufficient if profit-making is a significant purpose.

It is considered that your property development activities were carried out as part of a commercial transaction with the intent to make a profit or gain, albeit not carried through to full conclusion. You, as a unit trust, were created expressly for the purpose of the proposed property develop and were to be wound up upon the development being completed. Obtaining the development approval is not a simple process.

Your actions demonstrate there was an intention to enter into a commercial transaction to make a gain or profit from developing the Property. A gain would have been made where the developed Property was subdivided and ownership transferred to the unit holders. An actual gain was made through the sale of the Property shortly after the development application was approved by council.

Therefore, the gain is considered to be income according to ordinary concepts and is assessable under section 6-5 of the Income Tax Assessment Act 1997.

Mere realisation of a capital asset

The commercial nature, scale and manner of the transactions indicate the presence of an intention to make a profit or gain rather than a mere realisation of an asset. Considering the matters set out in paragraph 13 of TR 92/3 you have carried out a commercial transaction and therefore, the gain from the sale of the property would be treated as income according to ordinary concepts.

This situation is similar to AAT case Case 12/2000 2000 ATC 210. In this case, a taxpayer acquired property on the Gold Coast intending to develop it as a hotel and shopping centre. The taxpayer established a trust in which he was the sole unit holder. The taxpayer then transferred ownership of the property to the trust, realising a profit of over $2 million. Sometime later, the trust sold the hotel for a profit of over $45 million. The taxpayer claimed both of these amounts as capital profits.

The taxpayer contended that the profits arose from the forced sale of an asset that they acquired with the intention of retaining for long term investment purposes, and that the sums were therefore the realisation of a capital asset. The Commissioner contended that the amounts constituted income in the ordinary sense of the term, or they represent the profits arising from the carrying out of a profit making scheme, and therefore should be included in the taxpayer's assessable income.

The AAT decided in favour of the Commissioner. It was decided that the transactions had the character of the 'realisation of a contemplated premeditated sale'. The 'profit on sale is one that was contemplated by the applicant as at least one of the alternative objects or purposes for which the scheme was propounded'. The profit was found to constitute income.

A mere realisation is just happening to make a profit from what was already there with little improvement to it. Acquiring a property with the intention of developing it and selling it with the development approval for a multi storey office suite development is not a mere realisation of an asset. Originally the plan was for this to development to be conducted by a builder experienced in this type of activity.

On the basis of the above discussion, the proceeds from the sale of the property with the development approval is more than the realisation of an asset and the profit from the transaction are included under section 6-5 of the ITAA 1997.