Edited version of your written advice

Authorisation Number: 1013089183821

Date of advice: 13 September 2016

Ruling

Subject: Property - deductions - carrying on a business - isolated transaction

Question:

Will you and your spouse be entitled to claim deductions for interest and holding costs arising in relation to Lots A and B in the 2015-16, 2016-17 and 2017-18 income years?

Answer:

No. It is viewed that you and your spouse's activities are an isolated transaction. Therefore, the costs arising in relation to those activities will be included in the calculation to determine whether you have made a profit or loss on the sale of each of the lots.

This ruling applies for the following periods

Income year ending 30 June 2016;

Income year ending 30 June 2017; and

Income year ending 30 June 2018.

The scheme commences on

1 July 2015.

Relevant facts and circumstances

After 20 September 1985, you and your spouse paid a deposit of around $XX,000 for the purchase of a vacant block of land (Lot A). The sale price of Lot A was $XXX,XXX, excluding Goods and Services Tax (GST).

Around the same time that the deposit on Lot A had been paid, you and your spouse paid a $X,000 deposit on an option to purchase another vacant block of land (Lot B). The sale price of Lot B was $XXX,XXX, excluding GST, being half the price of Lot A.

Lots A and B are part of a new housing estate development (the Estate), which is located near a city.

The Estate is being undertaken in numerous stages and includes plans for a new shopping centre which is expected to be completed in 2017, and which will include a supermarket, professional suites and an education centre.

The blocks of land involved with the Estate development have been sold as follows:

• Stage 1 - All blocks of land have been sold, including Lot A;

• Stage 2 - Currently being sold, including Lot B: and

• Stage 3 - are expected to be sold in 2017.

You and your spouse formed a partnership (The Partnership) over twelve months after the deposits on the two lots had been paid.

In the month after the Partnership was formed, you and your spouse paid the settlement amount on the purchase of Lot A.

You and your spouse expect to partner with a housing construction company (the Housing Company) to build a house on each block for sale.

The Housing Company has provided an estimate to construct a house to suit the lot size, being a single storey brick and colour bond home with a total area of less than 300 square metres, for a cost of $XXX,000, inclusive of GST.

Due to a substantial delay in the settlement on Stage 2 due to continual rain, it is expected that the Stage 2 blocks will be ready for settlement in late 2016.

It is expected that you and your spouse will pay the balance of the amount owing on Lot B in late 2016.

For the purposes of this ruling the following will occur:

• You and your spouse will pay the settlement amount in relation to the purchase of Lot B during the ruling period;

• You and your spouse will not personally undertake any activities to develop Lots A and B until the 2017-18 income year;

• You and your spouse will incur interest and holding costs in relation to Lots A and B;

• The two lots will be offered for sale as House and Land packages under the Housing Company's banner once all of the blocks of land involved with the three stages of the Estate have been sold, and the shopping centre is in operation; and

• You and your spouse will partner with the Housing Company and will sell Lots A and B as House and Land Packages in the 2018-19 income year.

You and your spouse have not previously undertaken any similar activities in the past.

You and your spouse do not intend to commence a property development business

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Taxation treatment of property sales

Legislative references referred to herein are from the Income Tax Assessment Act 1997 (ITAA 1997).

There are three ways profits from property sales can be treated for taxation purposes:

1. As ordinary income on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock.

Expenses incurred in relation to activities that are being undertaken as a result of carrying on a business will be deductible in the income year in which the expenses are incurred; or

2. As ordinary income on revenue account, 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, which is the commercial exploitation of an asset acquired for a profit making purpose.

The net profit arising in relation to an isolated transaction involving the sale of property will be determined by reducing the sale proceeds by the cost of the land and other expenses necessarily incurred to complete the activity. This will be determined when the relevant property is disposed of; or

3. As statutory income under the capital gains tax legislation on the basis that a mere realisation of a capital asset has occurred.

Expenses incurred in relation to the asset will be included in the cost base of the asset under the capital gains tax legislation to determine whether a capital gain or capital loss has been made on the sale of the property.

Whether the expenses are treated as a deduction, used in determining the net profit, or form part of the asset's cost base depends on the situation and circumstances of each particular case.

We will consider these in relation to your situation as follows:

Carrying on a business of property development 

Section 995-1 of the ITAA 1997 states the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

To determine whether an activity, or series of activities, amounts to a business, the activity needs to be considered against the indicators of a business established by case law.

In the High Court of Australia case of Hope v. Bathurst City Council (1980) 144 CLR 1; (1980) 29 ALR 577; (1980) 80 ATC 4386; [1980] HCA 16, a business was described in the following ways:

It is the words "carrying on'' which imply the repetition of acts and activities which possess something of a permanent character.

…activities engaged in for the purpose of profit on a continuous and repetitive basis.

Transactions were entered into on a continuous and repetitive basis for the purpose of making a profit…manifested the essential characteristics required of a business.

The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 (TR 97/11) which uses the following indicators to determine whether a taxpayer is carrying on a business: 

• whether the activity has a significant commercial purpose or character;

• whether there is repetition and regularity of the activity;

• whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business;

• whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at 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. 

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 impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

Application to your situation

In this case, you and your spouse paid deposit amounts to purchase Lots A and B.

You and your spouse paid the balance of the amount owing for Lot A in late 2015 and expect to pay the settlement on the purchase of Lot B in late 2016.

You and your spouse intend building houses on the lots in partnership with the Housing Company and will sell the lots as House and Land packages under Housing Company's banner.

The following statements have been made in the private ruling application:

• It is your intention to partner with the Building Company and build two homes for sale.

• It is your intention to keep both blocks for a number of years until the Estate is further along in its development with a substantial number of houses being built and inhabited, and the new approved Shopping Village completed and open for business providing services to the local community.

• It is your view that in a number of years the Estate will be populated with all stages of the Estate being completed, with the shopping centre being in business, and this will maximise your return on developing both blocks as House and Land packages.

• Currently House and land packages in Stage 2 are currently being sold for $XXX,000 to $XXX,000, with houses in Stage 1 just starting to be built and no shopping centre. It is your view that when Stage 3 is under development, and the shopping centre is in operation, this price range should increase to $XXX,000 to $XXX,000, with the median price being $XXX,000 GST inclusive.

• If you keep both blocks until the Estate is a busy community, it is your conservative estimate that you will earn a profit on both blocks, with total profits after sale and development as House and Land packages of approximately $XXX,000.

From the information provided, and in applying the business indicators to your circumstances, we make the following observations:

• you and your spouse have not previously undertaken any similar activities in the past

• you and your spouse do not intend to commence a property development business

• this is a one-off activity that is unlikely to be repeated; and

• there is nothing to suggest that the development of the lots will be the beginning of a continuing business of property development.

Therefore, the large and general impression gained after examining you and your spouse's activities against the business indictors identified in TR 97/11, is that you and your spouse are not considered to be carrying on a business of property development.

Isolated transaction

Paragraph 234 of Miscellaneous Taxation Ruling MT2006/1 (MT 2006/1) distinguishes between a business and an adventure or concern in the nature of trade (or profit-making undertaking or scheme). It provides that the term 'business' would encompass trade engaged in, or on, a regular or continuous basis. However, it goes on to say that an adventure or concern in the nature of trade may be an isolated or one-off transaction that does not amount to a business deal but has the characteristics of a business deal.

The question of whether an entity is carrying on an enterprise often arises where there are one-off property transactions. The decision to be made is whether the activities are an adventure or concern in the nature of trade as opposed to the mere realisation of a capital asset.

Taxation Ruling TR 92/3 (TR 92/3) sets out the Commissioner's view on whether profits made from isolated transactions are ordinary income. '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.

Whether an activity/ies is viewed as an isolated transaction depends very much on the circumstances of the case. However, where a taxpayer who does not carry on a business makes a profit from an isolated transaction, that profit is income if:

a) the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain; and

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

The relevant intention or purpose of the taxpayer (of 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 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.

Application to your situation

It has been stated that you and your spouse's intention was to purchase the two lots, partner with the Housing Company, and sell the lots as House and Land packages under the Housing Company's banner.

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.

Based on the information provided, the activity will be an isolated activity and is not one of a series of activities done in the form of carrying on of a business of buying and selling property.

Taking your situation into consideration, it is the Commissioner's view that you and your spouse have ventured into a profit-making scheme when the two lots were purchased with the intention of selling them as House and Land packages.

There is a demonstrated intention to profit from the purchase and sale of the lots as House and Land packages given that you intend keeping both lots until the Estate is further advanced in anticipation of maximising your return on the lots.

You are engaging the services of professionals, being the Housing Company, which you will partner with in relation to these activities.

The nature of the lots is being changed from vacant blocks of land to House and Land packages, which is increasing the value of the lots. It cannot be viewed that you are merely realising your assets given that the nature of the lots has changed.

If you and your spouse undertook the same activities in the future, or had undertaken similar activities in the past, your activities would generally be viewed as carrying on a business of buying and selling property as the activities would be viewed as being commercial in nature, which were recurring.

Taking the factors as outlined in MT 2006/1 and TR 92/3 in consideration, it is viewed that you and your spouse's activities in relation to Lots A and B are an isolated transaction.

Capital gains tax

The capital gains tax (CGT) provisions are contained in Part 3-1. Broadly, the provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own.

CGT event A1 under section 104-10 happens if you dispose a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property.

A capital gain will be made if the cost base of the asset is less than the capital proceeds in accordance with section.

The capital gain can be reduced by the 50% CGT discount if the conditions listed in Division 115 are met.

Section 118-20 contains anti-overlap provisions which operate to reduce any capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 as a result of the sale, for example, as ordinary income under section 6-5 of the ITAA 1997.

Application to your situation

Making an overall assessment on the factors set out in TR 92/3, it is the Commissioner's view that the purchase and sale Lots A and B will not be a mere realisation of capital assets.

CGT event A1 will still occur on the disposal of the two lots. The capital gain for the event is worked out by comparing the cost base of the asset with the capital proceeds for its disposal. If the conditions under Division 115 are met, the capital gain can be reduced by 50% by applying the CGT discount.

Any capital gain made on the disposal of the two lots will be reduced to the extent that the profit from the sale of Lots A and B are included in your assessable income under other taxation provisions.

Conclusion

Based on the information provided, it is not the Commissioner's view that you and your spouse are carrying on a business in relation to the purchase and sale of the two lots as House and Land packages. Accordingly, expenses such as interest and holding costs incurred in relation to these activities cannot be claimed as a deduction in the income year the expenses are incurred.

Nor is it the Commissioner's view that the purchase and sale of the two lots will be a mere realisation of your assets.

Therefore, the expenses you and your spouse incur in relation your activities involved with the purchasing and sale of the two lots will be included in the calculation to determine the net profit you and your spouse have made on the sale of the two lots, which will be done when each of the lots is sold.