Edited version of your written advice

Authorisation Number: 1051428219580

Date of advice: 11 September 2018

Ruling

Subject: Property development, partnership arrangements and trading stock

Issue 1

Partnership status

Question 1

Are the X owners in a partnership as defined in section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for income tax and goods and services tax (GST) purposes?

Answer

Yes, the X owners are in a partnership as defined in section 995-1 of the ITAA 1997.

Question 2

If the Commissioner considers the X owners are partners in a partnership, does he consider based on the facts that the partnership is a tax law partnership or a general law partnership?

Answer

The partnership of the X owners is a general law partnership.

Question 3

Are the Y owners in a partnership as defined in section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for income tax and GST purposes?

Answer

Yes, the Y owners are in a partnership as defined in section 995-1 of the ITAA 1997.

Question 4

If the Commissioner considers the Y owners are partners in a partnership, does he consider based on the facts that the partnership is a tax law partnership or a general law partnership?

Answer

The partnership of the Y owners is a general law partnership.

Issue 2

Trading stock and income tax

Question 1

Do the X owners hold the X property and related improvements as trading stock for income tax purposes?

Answer

Yes, the X owners hold the X property and related improvements as trading stock.

Question 2

Do the Y owners hold the Y property and related improvements as trading stock for income tax purposes?

Answer

Yes, the Y owners hold the Y property and related improvements as trading stock.

Question 3

If either of the X owners or Y owners sought to consolidate the current co-ownership of either property title into one of the existing owner’s names, would section 70-100 of the ITAA 1997 apply such that the transfer could occur at the tax cost value?

Answer

Yes, provided that an election that meets the requirements in section 70-100 of the ITAA 1997 is made.

This ruling applies for the following period(s)

30 June 2016 to 30 June 2019

The scheme commences on:

In the 2015–16 income tax year

Relevant facts and circumstances

Development approval was granted for a high density, mixed use residential and commercial development.

The project

The development is being developed in stages. The stages are:

● X project: Residential space and commercial space, including a hotel and a retail precinct. The X project will be commenced ahead of the Y project.

● Y project: Residential space and commercial space, including retail and office space. The Y project will not be commenced until after the X project is sufficiently developed and sold.

● Z project: No development is required as this is parkland to be returned to the council.

At this time, demolition and construction work has not yet commenced on any of the projects.

The development was purchased in the following manner:

The ownership of the X and Y properties is reflective of the portion that relates to the residential and commercial portions to be developed and sold. Each site was purchased through three separate option and purchase agreements that acted independently of each other – if one purchase did not proceed, the others could still proceed independently.

The acquiring entities chose joint ownership as tenants-in-common as a means to provide flexibility for the owners to transfer their respective residential and commercial properties between each other via transfers or partition agreements. Any consolidation of titles into each set of the current owners’ names between the X owners or the Y owners would be undertaken through a full contract of sale outlining the rights of the parties, including the transfer of any business enterprise and associated rights. This would have the effect that ownership of each X project and Y project is recognised only in one of the existing partner’s ownership. It is anticipated that this may simplify lending security arrangements, given that two entities, instead of four, would hold title to the properties.

Additionally, the acquirers presented the following reasons for the different sets of co-owners for the X and Y properties:

● The X project and Y project are separate and distinct projects in terms of their funding, sales and delivery.

● The X site and Y site will remain separate and distinct titles at all times.

● The sale of one project is possible, while the other remains to be developed.

● Each project was acquired in two separate sets of special purpose vehicles for asset protection and funding separation.

● Risk mitigation purposes, as one project is protected from the risks of the other.

After entering into the options for acquisition, the acquiring entities experienced financial challenges in settling and taking ownership of the properties, and focused on the pre-sale of as much commercial and residential property as possible.

The X property owners have launched the residential sales on the X project site. Since then, some pre-sales have occurred. The residential sales are marketed. There is a developer represented as the developer of the project on these marketing materials. It is intended that the Y project will be marketed once the X project is developed. A term sheet was signed with a real estate and funds management group seeking to purchase the hotel from the X owners. It is intended that any commercial property that cannot be sold will be held by the X Trust and the Y Trust in their respective proportions and leased. An en-globo sales process for the entire development has also begun.

The en-globo sales process for the whole development, and the residential pre-sales, have continued concurrently and will continue until either the development is sold or development funding is sourced.

It is estimated that the combined market value of the properties is currently at least equal to their respective costs.

Funding

Funding for the purchase of the properties was eventually provided by a funding group. This lending was secured by a first-ranking mortgage over the sites. The X owners agreed to sell the vendors a commercial part of the X property as part satisfaction of the purchase price. However, if the commercial building has not been completed by a certain date, a further cash payment to the vendors will be required. Ultimately, the properties were acquired under two separate lending agreements:

● a loan agreement entered into with the lender with the Y owners as borrowers. This funded the settlement of the Y property.

● a separate loan agreement entered into with the lenders with the X owners as borrowers. This funded the settlement of the X property and the Z property.

If a financier to fund the development and construction of the buildings cannot be found, the sites will be sold undeveloped as ‘en-globo’ sites.

The entities

X, the X Trust, Y and the Y Trust, and other entities within the wider group, are controlled by an individual. This individual owns a number of entities via a family trust. Entities associated with this individual have a long history of the acquisition, development and sale of residential and mixed use development sites. The wider group also has experience in acquiring large-scale sites, obtaining development approval, and then selling the sites ‘en-globo’ for profit.

It is common for the wider group to acquire and develop properties through both unit trusts and companies in a similar manner.

The X or Y entities have not entered into a written partnership agreement or joint venture agreement. The X or Y entities stated that there is not a requirement for such agreements to be entered into given they have the same controlling mind. However, as the project progresses, it is intended that agreements be entered into to confirm the rights of each owner.

Should a financier be found to fund the construction of the projects, the X owners and Y owners will separately enter into legal agreements that confirm the manner in which the project will be developed.

Further, the parties plan to use a special purpose development company sitting as a standalone entity, not grouped with any other entities, which will be responsible for the development of the sites and to separate the risk of the project from the owners of the property.

Separate accounting records are maintained by the X owners for the X project, and separate accounting records are maintained by the Y owners for the Y project and Z project. Each entity has its own bank account and no joint business accounts are in existence, although joint bank accounts will be created for working capital purposes and for the banking of sales proceeds either from an en-globo sale or from the development and sale of the properties.

Assumption

It is assumed that an election that meets the legislative requirements will be made under subsection 70-100(4) of the ITAA 1997 to treat the properties as disposed of at closing value.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Subsection 70-10(1)

Income Tax Assessment Act 1997 Section 70-100

Reasons for decision

Issue 1

Question 1

Summary

The X owners are carrying on a business as partners for income tax purposes.

Detailed reasoning

Section 995-1 of the ITAA 1997 provides that a partnership is:

(a) an association of persons (other than a company or a limited partnership) carrying on business as partners or in receipt of ordinary income or statutory income jointly

(b) a limited partnership.

A person is defined in section 995-1 as including a company.

The first limb of paragraph (a) refers to ‘an association of persons…carrying on business as partners.’ This reflects the common law definition of partnership, which is the relationship between parties carrying on a business in common with a view to profit. The second limb of paragraph (a) refers to the persons being ‘in receipt of ordinary income or statutory income jointly.’ This second limb is often referred to as a tax law partnership, as it expands the common law definition of partnership to persons who are not necessarily carrying on a business in association.

Taxation Ruling TR 94/8 Income tax: whether business is carried on in partnership (including ‘husband and wife’ partnerships) (TR 94/8) provides guidance on the factors taken into account when deciding whether persons are carrying on a business as partners for income tax purposes. Those factors are:

● the mutual assent and intention of the parties

● joint ownership of business assets

● registration of a business name

● a joint business account and power to operate it

● the extent to which the parties are involved in the conduct of the business

● the extent of capital contributions

● entitlement to a share of the net profits

● business records

● trading in joint names and public recognition of the partnership.

Paragraph five of TR 94/8 provides that the weight given to these factors varies with the individual circumstances of a case. The factors are not exhaustive, are considered objectively, and no single factor is decisive, although the entitlement to a share of the net profits is essential.

Each of the factors will now be considered in detail below, for both the X owners and the Y owners.

Mutual asset and intention of the parties

Paragraph 10 of TR 94/8 provides that the essential element when considering whether a partnership exists is the genuine intention of all the parties to act as partners. This intention must be demonstrated by the conduct of the parties.

Paragraph 12 of TR 94/8 provides that a written or an oral agreement is accepted as prima facie evidence of an intention to act as partners. However, a written and signed agreement is not necessary to demonstrate an intention, as this agreement can be inferred from a course of conduct agreed to by all parties.

In this case, the X owners and Y owners have not entered into partnership agreements between each other. The conduct of each party must therefore be considered in determining whether their conduct infers a mutual intention to operate as a partnership.

Joint ownership of business assets

Paragraph 16 of TR 94/8 provides that the joint ownership of business assets, together with a joint liability to business debt, is indicative of a business partnership. All partners must be liable for the business’s debts, not only to the extent of the partnership property but also to the full extent of their personal resources.

In this case, the X owners and Y owners own the properties as tenants-in-common in the following proportions:

Additionally, both the X owners and Y owners entered into funding agreements with the ABC Group and they are each liable for the debt regarding those funding agreements.

Registration of a business name

Paragraph 17 of TR 94/8 provides that the use of a business name, or the names of the partners trading in joint names, can be an external sign of the existence of a partnership to third parties.

In this case, the X owners and Y owners have not registered business names. The X project is being marketed under a specific name with a developer, the name of the wider corporate group. It is intended that the Y owners will market their property once the X project has been developed. Based on publicly available marketing materials, it is not clear to the general public that the partnership between the X owners and the partnership between the Y owners exist.

Joint business account and power to operate the account

Paragraph 18 of TR 94/8 provides that the existence of a joint bank account, specifically named and used as a business account, is another positive factor in establishing that business is being carried on in partnership. This factor is given greater weight where the bank at which the account is held is aware the parties are acting in partnership and all parties have the power to operate the account.

In this case, no joint bank account exists between the X owners, nor with the Y owners. Each party has its own bank account, although joint bank accounts will be created for working capital purposes and for the banking of sales proceeds either from an en-globo sale or from the development and sales of the properties.

The extent to which the parties are involved in the conduct of the business

Paragraph 20 of TR 94/8 provides that while it is not essential that all partners actively participate in the partnership, such participation supports the existence of the partnership.

In this case, the X owners and Y owners entered into contractual agreements to purchase their respective properties together and to seek funding for the purchases. Additionally, the X owners together entered into a term sheet for the development of the hotel portion of their property. This indicates that both X owners and both Y owners are actively engaged in the conduct of the business.

The extent of capital contributions

Paragraph 24 of TR 94/8 provides that the parties’ sharing of contributions to assets and capital weighs in favour of the existence of a partnership. Contributions may be made at the start of, or during, a partnership.

In this case, both parties to each partnership have contributed to capital largely by way of land parcels in their respective proportions. Further funding will be provided by each party during the development phase of each project.

Entitlement to a share of the net profits

Paragraph 25 of TR 94/8 provides that partners share between them the profits and losses of the partnership activity. A situation in which profits are shared in line with clearly stated rights and entitlements in a partnership agreement is prima facie evidence of the existence of a partnership.

In this case, both X owners and Y owners have entered into property purchases that outline the legal ownership of property in their respective proportions. Each owner has their own respective share of the income resulting from that proportion of property ownership.

Although neither the X owners nor the Y owners have entered into partnership agreements, prior to the commencement of the development works, formal legal agreements will be entered into between the X owners and between the Y owners to re-affirm the rights of the respective owners and confirm the share in the net profits of the project.

Business records

Paragraph 26 of TR 94/8 provides that the existence of a partnership is supported when business activities are entered in records that are separate and distinct from those kept for other business and private activities. Business records include:

● books of account

● minutes of partnership meetings

● memoranda of decisions reached, especially regarding shares of income and losses.

Paragraph 27 of TR 94/8 provides that the maintenance of business records in the name of the parties or in the name of the partnership, rather than in the name of one party only, is indicative of the existence of a partnership.

In this case, two sets of accounts have been maintained throughout the period of property ownership. Separate accounting records, including a balance sheet and profit and loss statements, are maintained by the X owners for the X project, and separate accounting records are maintained by the Y owners for the Y project and Z project.

The accounts are prepared for the purposes of splitting the share of respective income and costs and the share of assets and liabilities.

Trading in joint names and public recognition of the partnership

Paragraph 28 of TR 94/8 provides that the conclusion that a partnership exists is supported if the parties, by trading in joint names, make it clear to persons dealing with them that they are in a partnership. Banks, suppliers and customers dealing with a partnership should be aware that they are trading with a partnership, as opposed to dealing with an individual. It is important that creditors of a partnership know that they are dealing with a partnership, as partners are obliged, jointly and severally, to meet the partnership debts to the full extent of their own resources.

The following are relevant in this regard:

● contracts with the partnership

● advertising in the partnership name.

In this case, the X owners and the Y owners respectively entered into funding agreements with the lenders to fund the purchase of the properties. Additionally, the X owners entered into a term sheet for the development of the hotel and a contract with the vendors to sell a portion of the commercial property to them. And while the development is marketed to the public under the developer’s name, purchasers of the apartments enter into a contract with the X owners.

Conclusion

Having regard to all of the above factors, it is considered that the X owners are carrying on a business as partners for income tax and GST purposes. As such, the X owners form a general law partnership and a partnership for tax law purposes in accordance with the definition in section 995-1.

Question 2

As explained in the detailed reasoning for Issue 1, Question 1, the X owners are in a general law partnership.

Question 3

Having regard to all of the factors in the detailed reasoning for Issue 1, Question 1, it is considered that the Y owners are carrying on a business as partners for income tax and GST purposes. As such, the Y owners form a general law partnership and a partnership for tax law purposes in accordance with the definition in section 995-1.

Question 4

As explained in the detailed reasoning for Issue 1, Question 1, the Y owners are in a general law partnership.

Issue 2

Question 1

Summary

It is considered that the X owners hold the properties and related improvements as trading stock, as they hold their property for the purpose of resale and have commenced a business activity that involves dealing in land.

Detailed reasoning

Subsection 70-10(1) states:

Trading stock includes:

(a) anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and

(b) live stock.

In considering whether property is trading stock, Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as ‘trading stock’? (TD 92/124) is relevant.

TD 92/124 provides that land is treated as trading stock for income tax purposes if:

● it is held for the purpose of resale

● a business activity that involves dealing in land has commenced.

Both the required purpose and the business activity must be present before land is treated as trading stock. The business activity is taken to have commenced when a taxpayer embarks on a definite and continuous cycle of operations designed to lead to the sale of the land.

Paragraph 3 of TD 92/124 also provides that a single acquisition of land for the purpose of development, subdivision and sale by a business commenced for that purpose would lead to the land being treated as trading stock.

It must now be determined whether the X owners and Y owners have held their respective properties for the purpose of resale. This is particularly relevant as the properties may be sold en-globo, may be sold post-development, or the commercial portions that are unsold may be leased.

In R & D Holdings Ptv Ltd v DCT [2006] FCA 981, the taxpayer said his intention was to hold the property as an investment for the ultimate benefit of his children. The property was shown as an investment in the 1996 and 1997 accounts, but it appeared as trading stock at the end of the 1998 year. The trust that owned the property had a mixed purpose - some of its properties were held as capital investments and not sold, and some were refurbished and sold or sold following subdivision. The taxpayer had a long history of property development for resale using both corporate and trust structures, including CBD office premises as in the present case.

The Federal Court found that the taxpayer's intention was not to hold the property as an investment, but that the property was held for the dual profit making purposes of sale or lease of subdivided lots. On that basis, the court was satisfied that the property was held for the purposes of sale. Accordingly, development and sale does not have to be the sole or dominant purpose of holding property for it to treated as trading stock - a dual purpose of, for instance, sale or lease is sufficient.

The court also found that in assessing the taxpayer's intention, the previous activities of the taxpayer and the taxpayer's controlling mind and related entities are a key factor.

In this case, the X owners and Y owners hold the properties for the dual purpose of sale en-globo, development and sale of their projects, or the lease of unsold commercial portions of the properties. In addition, entities within the wider corporate group with the same controlling mind have a long history of the acquisition, development and sale of residential and mixed use development sites. The wider group also has experience in acquiring large-scale sites, obtaining development approval, and then selling the sites ‘en-globo’ for profit. It can be determined for the purposes of TD 92/124 that the X owners and Y owners therefore are holding their respective properties for the purposes of resale.

In determining whether a business activity that involves dealing in land has commenced, TD 92/124 provides that the business activity is taken to have commenced when a taxpayer embarks on a definite and continuous cycle of operations designed to lead to the sale of the land.

In this case, the X owners and Y owners have embarked on a definite and continuous cycle of operations design to lead to the sale of the land and this business activity commenced when the owners took dispositive power over the properties at settlement.

Accordingly, it is considered that the X owners and the Y owners hold the properties and related improvements as trading stock.

Question 2

As explained in the detailed reasoning for Issue 2, Question 1, the Y owners hold the properties and related improvements as trading stock.

Question 3

Summary

Provided that an election is made that meets the conditions specified in section 70-100, the transfer value of the trading stock would be its value as trading stock of the transferor on hand at the end of an income year ending on that day.

Detailed reasoning

It has been determined that the X owners and the Y owners hold the properties and related improvements as trading stock. If the X owners or the Y owners were to transfer each of their respective shares of their properties to the other partner in their partnership, it must now be determined whether that property, as trading stock, can be valued as being disposed of at that time at its tax value.

Subsection 70-100(1) provides that trading stock is treated as having been disposed of outside the ordinary course of business if it stops being trading stock of an entity and, immediately afterwards, an entity that owned the item immediately beforehand still has an interest in the trading stock, either alone or with others.

When trading stock is transferred from one entity to another under the circumstances specified in subsection 70-100(1), an election is available under subsection 70-100(4) to treat the trading stock as having been disposed of for what would have been its value as trading stock of the transferor on hand at the end of an income year ending on that day.

Section 70-100 provides that the election can only be made if all of the following conditions are met:

● immediately after the item stops being trading stock on hand of the transferor, it is an asset of a business carried on by the transferee

● immediately after the item stops being trading stock on hand of the transferor, the entities that owned it immediately beforehand have (between them) interests in the item whose total value is at least 25% of the item’s market value on that day

● the value elected is less than that market value

● the item is not a thing in action

● the election is made before 1 September following the end of the financial year in which the item stops being trading stock on hand of the transferor

● the election is made in writing, and signed by each of the entities that owned the item immediately before it stops being trading stock on hand of the transferor and the entities that own it immediately afterwards

● the consideration received by the transferor must not substantially exceed the market value of that item.

Subsection 70-100(5) provides that if this election is made, the item’s value is included in the transferor’s assessable income for the income year that includes that day. The transferee is treated as having bought the item for the same value on that day.

In this case, if an en-globo sale of the X property and/or the Y property does not occur and the projects are developed, the X owners and Y owners may elect to consolidate the titles such that ownership of each X property and Y property is recognised only in one of the existing partner’s ownership. Any consolidation of titles into each set of the current owners’ names between the X owners or the Y owners would be undertaken through a full contract of sale outlining the rights of the parties, including the transfer of any business enterprise and associated rights.

Provided that an election is made that meets the conditions specified in section 70-100, the transfer value of the trading stock would be its value as trading stock of the transferor on hand at the end of an income year ending on that day.