Edited version of your written advice

Authorisation Number: 1013127074036

Date of advice: 25 November 2016

Ruling

Subject: Am I in Business - Renovation and Sale

Question 1

Was the renovation and sale of the dwelling undertaken as part of a business of property development?

Answer

No.

Question 2

Was the renovation and sale of the dwelling an isolated profit making transaction?

Answer

Yes

This ruling applies for the following periods:

1 July 2011 to 30 June 2012

1 July 2012 to 30 June 2013

1 July 2013 to 30 June 2014

1 July 2014 to 30 June 2015

The scheme commences on:

1 July 2011.

Relevant facts and circumstances

The Taxpayer purchased the dwelling on a date in 201X. At the time the Taxpayer purchased the dwelling they intended that it would become their residence.

Due to health issues, on a date in 201X the Taxpayer decided that the dwelling was no longer suitable to become their residence. Instead they took steps to sell the property again, approaching a real estate agent who told them it could be sold again at a profit.

The Taxpayer consulted with an advisor, who told them that by spending a significant amount renovating the dwelling they would be able to increase their profit on the sale.

The Taxpayer consulted with architects and builders to establish what would be required to renovate the dwelling to a high enough standard. The Taxpayer prepared detailed plans of the development they wished to undertake. The Taxpayer prepared a budget of a significant amount of money to complete the works. The Taxpayer engaged architects, builders and other advisors to undertake the renovation of the property.

A loan account was established with a bank to fund the purchase of the property. The same loan account was used to fund the additional money that was spent on the renovations, and the ongoing costs of holding the property. Funds from this account were only used for the development. The facility had a maximum limit of an amount and was secured by a mortgage over the dwelling, the Taxpayer's own home and the Taxpayer's personal guarantee. The Taxpayer capitalised interest payments against this facility.

The Taxpayer completed the renovations in August 201Y. The Taxpayer placed the dwelling on the market, with an indicative asking price of a large amount. The property did not sell until a date in 201Z, for an amount considerably less than the asking price, after an extended marketing campaign. Settlement did not take place until a date in 201Z.

The Taxpayer made a loss on the sale of the dwelling. This loss includes selling for less than the purchase plus renovation costs, and the marketing and holding costs (including interest) from the extended selling period.

The Taxpayer determined that the extended selling period was due to there being no buyers in the price range that they marketed it at. In turn the Taxpayer established that this was due to flood zone restrictions affecting the appeal of the property. The Taxpayer has begun legal action to recover damages for negligent advice.

The Taxpayer had planned to undertake further renovation projects, however due to the loss and the ongoing legal action they have been unable to proceed with this.

On a date in 201Z the Taxpayer engaged in advising a third party in how to best realise value from a real estate project. The Taxpayer received gross fees of an amount that they plan to include as revenue in a tax return. The Taxpayer is also registered for GST and remitted GST of an amount on the fees.

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 8-1 of the Income Tax Assessment Act 1997

Section 104-10 of the Income Tax Assessment Act 1997

Reasons for decision

Issue 1

Questions 1 and 2

Summary

The Taxpayer was not engaged in a business of property renovation.

The Taxpayer's property renovation is regarded as an isolated commercial transaction for tax purposes. Any profits resulting from the scheme will be taxable at the time the scheme is complete, and any losses will be able to be offset against other income.

Detailed reasoning

The renovation and sale of property can either be treated as on the revenue account, and taxed as ordinary income under section 6-5 of the ITAA 1997 (as either a business of property renovation; or an isolated profit making transaction), or as on the capital account, and taxed as statutory income under the Capital Gains Tax (CGT) legislation. Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case.

Carrying on a business of property development

Taxation Ruling TR 97/11 is about carrying on a business. Whether an entity is carrying on a business has been considered extensively by the courts, using the following indicators:

1. the nature of the activities, particularly whether they have the purpose of profit making;

2. the repetition and regularity of the activities;

3. organisation in a businesslike manner, including 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;

4. the volume of the operations; and

5. the amount of capital employed.

In deciding whether a person is carrying on a business, the above indicators are weighed up. However equal weighting may not be given to each indicator. The indictors that carry the strongest weighting are repetition and regularity of activities, organisation in a businesslike manner and volume of operations.

Isolated profit making transaction

Profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium).

Taxation Ruling TR 92/3 considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income.

The Commissioner considers that the following matters (listed at paragraph 13 of TR 92/3) may be relevant in determining whether an isolated transaction amounts to a business operation or commercial transaction:

(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.

The must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually necessary that you hold the purpose of profit-making at the time of acquiring the property, or form the intent to change the way you hold the property later. The purpose will not be the subjective purpose as stated by the taxpayer, but the objective purpose, as discerned from the taxpayer's actions.

Capital gains tax

The CGT provisions are contained in Part 3-1 of the ITAA 1997. 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 of the ITAA 1997 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. Where an amount is included in your income as ordinary income, it will not also be treated as a capital gain.

Application of the law to your facts - Question 1

There are elements of business-like organisation in the way the Taxpayer has conducted the property renovation. The Taxpayer has prepared a detailed budget, produced the detailed property plans needed to bring the renovation to a successful conclusion and kept financial records. The Taxpayer has relied upon advisors and professional agents when conducting the renovations. The Taxpayer's activity, while small scale and isolated, had a profit making intent.

The Taxpayer's activity in renovating and selling property lacked scale, repetition of activity, permanency and volume of operation. While the Taxpayer has invested a reasonable amount of capital in the undertaking, the activity has been limited to a single building. The Taxpayer has stated that they have the intention of undertaking further renovations, but at this stage there is no evidence of actions to support this intention. The taxpayer has earned income as an advisor regarding property renovations, however there is not enough link between this and their own renovation to establish that they are both part of the same business.

The timing involved in carrying out the renovation would be considered drawn out for a commercial undertaking. The Taxpayer has undertaken the activity in their own name, rather than using a business entity.

On balance, the evidence does not support the position that the Taxpayer is engaged in a business of property development.

Application of the law to your facts - Question 2

Whilst the Taxpayer was not carrying on a business, the income from the sale of the renovation of the dwelling is still ordinary income. The loss they have incurred is considered to be a loss from an isolated commercial transaction.

From very early on the Taxpayer began to hold the dwelling for the purposes of resale at a profit, and all their actions with regards to the renovation were directed towards a profit-making end. The significant capital invested in the renovation, the detailed planning behind the work and the detailed budgeting are all indicative of profit making intent.

The activities the Taxpayer carried out involved substantially more than merely realising their asset. The Taxpayer significantly improved the property and increased its value. The amount the Taxpayer spent on the renovation was close to the value of the existing dwelling (not including the value of the land).

The Taxpayer's purpose in renovating the dwelling was to make a profit from its subsequent sale. The Commissioner accepts that the Taxpayer had a profit making intention when they began the renovation of the dwelling and that the intended property development is of a commercial nature having regard to the factors in TR 92/3.

The fact that the Taxpayer instead incurred a loss on the sale does not detract from the profit making intention behind entering into the scheme.

Regarding a loss from an isolated transaction, paragraph 4 of TR 92/4 states:

A loss from an isolated transaction is generally deductible under subsection 51(1) if:

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

(a) the transaction was entered into, and the loss was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

Importantly, the net profit or loss from an isolated transaction is determined at the time the transaction or development is completed. The development expenses incurred in years prior to the completion are not deductible in the year incurred as they do not sufficiently relate to the Taxpayer's assessable income. That is, the associated expenses are taken into account in the financial year that the Taxpayer disposes of the property when calculating the net profit. The expenses are not incurred in earning the Taxpayer's assessable income from advising on property renovations

The Taxpayer will be able to offset the loss against gains in the year the scheme ended, or carry forward sny unused amounts to offset against future income.

As the renovation is on the revenue account, there is no need to consider the capital gains tax provisions.