Edited version of your written advice

Authorisation Number: 1051414148669

Date of advice: 17 August 2018

Ruling

Subject: Subdivision and development of residential lots

Question

Will the proceeds from the sale of the subdivided residential lot be subject to capital gains tax (CGT) under Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question

Will the proceeds from the sale of the subdivided residential lots be assessable as ordinary income under section 6-5 of the ITAA 1997?

Answer

Yes

Question

Will the supply of subdivided residential lots be a taxable supply under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999?

Answer

Yes

This ruling applies for the following periods:

1 July 2018 – 30 June 2019.

1 July 2019 – 30 June 2020.

The scheme commences on:

1 July 2018.

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.

You (the owners) of the property (the property) are entering into arrangements to demolish their existing main residence for number a years and build three residential units.

The property has been the owners’ main residence since its acquisition.

Subdivision will take effect to create three new lots that are jointly owned by the current owners.

One unit will be retained as their main residence and the remaining units are intended for sale.

They have evaluated the likelihood of selling the property as it is and have obtained an indicative market value for this purpose from the real estate agent.

As joint owners of the land, the entity undertaking this venture is a partnership. Development option via a family trust will only be considered as a last resort to secure the capital gain tax exemption available to this property as their main residence.

The owners will engage others to complete development works. They will not personally undertake any works themselves except for instructing and engaging architects and builders. They will use real estate agents for the sale.

It will be financed by bank funding on the security of land and proposed building works. They will need to sell the other units to pay off the debt.

Once completed the indicative selling price would be substantial amount per residential unit

They have not undertaken any such subdivision in the past and do not propose to do any more in the future.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Subsection 995-1(1)

A New Tax System (Goods and Services Tax) Act 1999 Section 9-5

A New Tax System (Goods and Services Tax) Act 1999 Section 9-40

A New Tax System (Goods and Services Tax) Act 1999 Section 23-5

A New Tax System (Goods and Services Tax) Act 1999 Division 188

Summary

On balance, it is considered that you will enter isolated transaction and the proceeds are on revenue. Profits will be assessed under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997). Costs related to the subdivision will be included under section 8-1 of the ITAA 1997.

Any capital gain you make will be reduced under 118-20 of the ITAA 1997 to the extent that the profit from the sale of the properties is otherwise included as assessable income including under section 6-5 of the ITAA 1997.

The supply of the residential units are new residential premises, not including the main residence and will be taxable supplies under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999.

Detailed reasoning

Issue 1

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

1. As ordinary income under section 6-5 of the ITAA, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock; or

2. As ordinary income under section 6-5 of the ITAA, 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; or

3. As statutory income under the capital gains tax legislation.

Under section 6-5 of the ITAA 1997, your assessable income includes the ordinary income you derived directly or indirectly from all sources, during the income year.

Taxation Ruling 92/3 (TR 92/3) Income tax: whether profits on isolated transactions are income explains the term 'isolated transactions' refers to:

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

(b) those transactions entered into by non-business taxpayers.

TR 92/3 explains a profit from an isolated transaction is generally income when both of the following elements are present:

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

(b) 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.

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.

In this case, profits on the sale of the subdivided residential lots can therefore be income according to ordinary concepts within section 6-5 of the ITAA 1997 if the taxpayer’s subdivisional activities amount to a business operation or commercial transaction.

In your case, you do not carry on a business of buying, selling or developing land. There is a demonstrated intention to profit and the transaction will been undertaken in a commercial manner using borrowed funds. You will also be completing more than what is required for the subdivision activities and buildings will be constructed on the land. You will retain financial control and assume financial risk of the development. You will incur significant expenses in relation to the development when compared to the property’s market value. Based on the figures provided, the objective intention is that the development will be undertaken for the purpose of producing a profit.

Therefore, any profit from the development and subdivision will constitute a profit from an isolated transaction and should be included as ordinary income under section 6-5 of the ITAA 1997.

In addition, any costs associated with the development and subdivision will be deductible under section 8-1 of the ITAA 1997.

Capital gains tax

CGT event A1 in section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you dispose of each subdivided block. You will make a capital gain if the capital proceeds from the disposal of the block are more than the cost base of the block. You will make a capital loss of those capital proceeds are less than the reduced cost base of the block.

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

Any capital gain you make will be reduced under 118-20 of the ITAA 1997 to the extent that the profit from the sale of the properties is otherwise included as assessable income including under section 6-5 of the ITAA 1997.

Issue 2

Entity

As joint owners of the land and the owners engage others to complete development works, the entity undertaking this venture is XX and XX. A partnership is an entity for GST purposes.

Enterprise

Section 9-20 of the GST Act provides that the term ‘enterprise’ includes, among other things, an activity or series of activities done in the form of a business or in the form of an adventure or concern in the nature of trade. The phrase ‘carry on’ in the context of an enterprise includes doing anything in the course of the commencement or termination of the enterprise.

Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number provides guidance on what activities will amount to an enterprise.

Paragraph 234 of MT 2006/1 distinguishes between activities done in the form of a ‘business’ and those done in the form of ‘an adventure or concern in the nature of trade’. In particular:

● A business encompasses trade engaged in on a regular or continuous basis.

● An adventure or concern in the nature of trade may be an isolated or one-off transaction that does not amount to a business, but which has the characteristics of a business deal.

Based on the information provided, the factors outlined in paragraph 265 on balance indicate an isolated transaction/one off (profit making undertaking), in particular;

● There is a change in purpose for which the land is held

● The is a coherent plan for the subdivision of the land

● There are funds borrowed to undertake this development (not insignificant in relation to the enterprise)

● There is development on the land beyond that necessary to secure council approval,

● In keeping with development of the land, buildings in the form of residential units are being constructed, for the purpose of sale

The buildings for sale are trading (revenue) assets and not investment assets. There is no intention to hold them for investment purposes or for personal use.

The enterprise is a development enterprise for the purpose of demolishing existing premises, making improvements to the land (building a number of residential units), and subdivision into separate lots for sale of some of the lots.

The activities undertaken by the entity satisfies s9-20(1)(b) of the GST Act, being activities or a series of activities undertaken in the form of an adventure or concern in the nature of trade.

Registration

Section 23-5 of the GST Act provides that you are required to be registered for GST if:

(a) you are carrying on an enterprise, and

(b) your GST turnover meets the registration turnover threshold.

The registration turnover threshold is currently $75,000.

Section 188-10 of the GST Act provides that you have a GST turnover that meets a particular turnover threshold if:

(a) your current GST turnover is at or above the turnover threshold and the Commissioner is not satisfied that your projected GST turnover is below the turnover threshold, or

(b) your projected GST turnover is at or above the turnover threshold.

Of relevance here is your projected GST turnover. Section 188-20 provides that your projected GST turnover at a time during a particular month is the sum of the values of all the supplies that you have made or are likely to make during that month and the next 11 months other than input taxed supplies.

In working out your projected GST turnover, paragraph 188-25(a) of the GST Act requires that you disregard any supply made or likely to be made, by you by way of transfer of ownership of a capital asset of yours.

Paragraph 260 of MT 2006/1 explains that assets can change their character from being capital/investment assets to being trading/revenue assets, or vice versa, but cannot have a dual character at the same time.

Paragraph 31 of GSTR 2001/7 provides commentary on what is meant by ‘capital assets’. It refers to those assets that make up the ‘profit yielding structure’, as opposed to trading assets (revenue assets) that are turned over and bought and sold in the course of trading operations.

The Partnership is carrying on a property development enterprise and the subsequent supply of the residential units will exceed the $75,000 threshold.

Taxable Supply

Section 9-5 of the GST Act provides that you make a taxable supply if:

(a) you make the supply for consideration

(b) the supply is made in the course or furtherance of an enterprise that you carry on

(c) the supply is connected with the indirect tax zone (Australia), and

(d) you are registered, or required to be registered for GST.

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed.

The supply of the residential units are new residential premises, not including the main residence will be taxable supplies as per subsection 9-5 of the GST Act.

Input Tax Credits

The entity registered for GST is entitled to input tax credits in relation to acquisitions to the extent that they are acquired in carrying on the enterprise, except for supplies that are input taxed or for a private or domestic purpose as outlined under Division 11 of the GST Act.