Edited version of your written advice

Authorisation Number: 1051438177677

Date of advice: 24 October 2018

Ruling

Subject: Land - disposal of trading stock

Question 1

Are the proceeds from sale of the final stage assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Did section 70-110 of the ITAA 1997 apply to the final stage in early 2015?

Answer

No

Question 3

Did the sale of the final stage constitute the disposal of trading stock by the entity, in the ordinary course of its business for the purposes of Division 70?

Answer

Yes

Question 4

Did the sale of the final stage constitute the disposal of trading stock by the entity outside the ordinary course of its business, for the purposes of section 70-90 of the ITAA 1997?

Answer

No

Question 5

Did the gain made on the sale of the final stage constitute a capital gain under the capital gains tax provisions in Parts 3-1 to 3-3 of the ITAA 1997?

Answer

No

This ruling applies for the following periods:

Year of income ended 30 June 2017

Year of income ended 30 June 2018

The scheme commences on:

1 July 2016

Relevant facts and circumstances

The entity was specifically established as the vehicle for the acquisition of a block of land (the Combined Block).

At the time of purchase by the entity, a Development Approval (DA) had been granted for a staged development (of a mixture of both residential and commercial areas within each stage) of the Combined Block and another unrelated entity had already completed Stage 1 of the development.

At the time of purchase, the intention of the entity was initially to undertake the next stage of the development (after obtaining a new DA) and then after this stage was completed, obtain a new DA for the final stage and undertake development of that stage.

At the time of purchasing the Combined Block, the entity held no other land for potential development or resale.

The entity did not have a written business plan and there are no minutes of meetings regarding the purchase of the Combined Block.

The first stage of the development was undertaken and completed by the entity, with the proceeds of sale returned as ordinary income for tax purposes. Some finished units (predominantly commercial) have been retained by the entity for investment purposes.

Before the finalisation of sales from this stage, the entity commenced off-the-plan sales of the final stage units.

The entity also commenced negotiations with a Retailer to lease an area of the final stage for the Retailer to establish an outlet.

The entity also lodged a new development application with the Council in relation to the final stage. This application was not accepted by the Council, and was withdrawn.

The entity continued discussions with Council over an extended period with a view to obtaining approval for the proposed final stage development.

During this period, an unsolicited offer was received to purchase the final stage land. This offer was rejected by the entity as it still had the intention of proceeding with the development.

During this period negotiations continued with the Retailer, with a Letter of Offer from the Retailer being accepted by the entity. This confirmed the intention of both parties to enter into an Agreement for Lease for the to-be-built retail premises to be included in the proposed development.

Although the initial offer to purchase the land was rejected, discussions continued over an extended period with the same entity which eventuated in a Put and Call Options Deed being entered into between both parties, with the purchaser the grantee of the call option and the entity as grantor.

A call option fee was payable on signing of the Deed, and the Option Deed provided for the eventual sale, subject to several conditions in respect of the future lease to the Retailer.

The Option Deed was amended on several occasions to extend the exercise date. The purchaser exercised the call option on the exercise date and the sale of the land concluded.

Relevant legislative provisions

Income tax assessment Act 1997 section 6-5

Income tax assessment Act 1997 Subdivision 70-D

Income tax assessment Act 1997 section 70-80

Income tax assessment Act 1997 section 70-90

Income tax assessment Act 1997 section 70-110

Reasons for decision

All references are to the Income Tax Assessment Act 1997, unless otherwise stated.

Subdivision 70-D deals with disposal of trading stock.

Under section 70-80, if you dispose of trading stock in the ordinary course of business, the amount received for that trading stock is assessable income under section 6-5.

Alternatively, if the disposal of trading stock occurs outside the ordinary course of business, the market value of the item of trading stock, at the time of disposal, is included in assessable income (section 70-90).

In circumstances where an item ceases to be held as trading stock, but is still owned by the same entity, section 70-110 will treat the item of trading stock as if it had been sold and re-acquired by the entity at its cost price.

Land can come within the definition of ‘trading stock’ (Federal Commission of Taxation v. St Hubert's Island Pty Ltd (in liq) (1978) 138 CLR 210; 78 ATC 4104; (1978) 8 ATR 452) (St Hubert’s Island).

Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'? (TD 92/124) confirms that it is the Commissioner’s view that land will be trading stock for income tax purposes if:

● it is held for the purpose of resale; and

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

TD 92/124 explains 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. It is not necessary that the acquisition of land be repetitive. 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.

Therefore, if land is held for the purpose of development, subdivision and sale by a taxpayer carrying on a business of property development it will be trading stock of that business.

In R & D Holdings Pty Ltd v. Deputy Commissioner of Taxation 2006 ATC 4472; (2006) 64 ATR 71; [2006] FCA 981 (R&D Holdings), Finn J. rejected the notion that land can only be trading stock if it is part of a business of repetitive buying and selling of land. In R&D Holdings, Finn J. discussed the St Hubert’s Island case in detail before making the following observations about that case (at 46):

.... it [St Hubert’s Island] is authority for the propositions that (i) land acquired for the purpose of development, subdivision (or strata division) and sale by allotment (or lots) can constitute trading stock of a business having that purpose irrespective of whether the land has been so developed and subdivided; and (ii) that business will be carried on for so long as the taxpayer engaged in the effectuation of the purpose of development, etc of the land.

Furthermore, Finn J. commented that it is possible for land to be held for ‘multiple purposes (or “open options”) of sale and/or lease after construction because the options themselves were likely to be affected by the contingencies of interest rate, the economy and tenancy take up’.

In the current case, the facts confirm that the land in question was acquired as trading stock of a property development business. In particular:

● The entity was established for the specific purpose of undertaking the development on the land, in stages.

● The first stage of the development was successfully undertaken, and the resulting units were either sold or held for long term lease by the entity.

● At the time of purchase of the land, it was the intention of the entity to undertake the development of the final stage at some time in the future (after completing the first stage).

● The entity commenced off the plan sales of blocks, prior to the lodging of the amended DA application with Council. Those contracts that had been entered into were rescinded, just before the last day available to the entity to rescind the contracts. This was a prudent business decision on behalf of the entity, given the difficulty and delays that had occurred in relation to receiving council approval for the amended DA.

● The entity has treated the sales from the completed stage as part of a business of property development.

The applicant has argued that at some point in a specified month, the entity changed its intention in relation to what it would do with the remaining land, and at that time a decision was made that it was no longer carrying on the business of property development, and that it would hold the land as an investment. Resulting from this decision, the applicant argues that the land was no longer being held as trading stock but as a capital asset of the business. The Commissioner does not accept this contention for the following reasons:

● The land was trading stock of the business being carried on by the entity at the time that it was purchased.

● There is no documentation recording any decision made that the entity was no longer in the business of property development and that the land was transferred from being trading stock to being held on capital account.

● The financial statements prepared for the entity as at 30 June in the year that the decision was purported to have been made show that the land was still being treated as trading stock for accounting purposes at that date.

● The entity continued to actively pursue the development as it continued to pursue the amended DA through council.

At the time of entering into the Put and Call Option Deed, there is no evidence that there had been any change in the entity’s intentions. It was still actively pursuing the DA application with council. Having been approached by the purchaser with an offer to purchase the land, it was also pursuing that offer. The fact that the entity was in active negotiations with the purchaser regarding the purchase of the land does not mean that the land was no longer trading stock. All that has happened is that an item of trading stock is being sold in a different manner than had originally been envisaged by the entity at the time of purchase. The sale of the land is the sale of trading stock.

Accordingly, the proceeds from the sale of the land will be assessable income under section 6-5, because it is the sale of trading stock within the ordinary course of business being carried on by the entity.

The sale of the land was not the sale of trading stock outside the ordinary course of business. Therefore, section 70-90 will not apply.

The Commissioner does not accept that the entity ceased holding the land as trading stock at any point prior to the sale of the land, and therefore section 70-110 will have no application.

Because the land was trading stock of the entity for the entire period that it was owned, any capital gain or capital loss made on the sale of the land will be disregarded under paragraph 118-25(1)(a).