Edited version of your written advice

Authorisation Number: 1051498634855

Date of advice: 26 March 2019

Ruling

Subject: Income Tax Implications of the Potential Sale of Property

Question 1

Will the gross proceeds or net profit from the possible sale of the Property by the Trustee constitute ordinary income under section 6-5 of the ITAA 1997?

Answer

No.

Question 2

Will the gain on the possible sale of the Property by the Trustee be assessable as statutory income as a realisation of a capital gains tax (CGT) asset?

Answer

Yes.

Period to which your private ruling applies

1 July 2015 to 30 June 2021

Date upon which scheme commences

1 July 2015

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.

1. The Trustee, as trustee for the Trust, purchased a property (the Property) pursuant to the Acquisition Contract.

2. The Acquisition Contract was at arm’s length and the vendor was not an associated person of the Trustee. The supply of the Property under the Acquisition Contract was a Goods and Services Tax (GST) free supply of a going concern comprising of a leasing enterprise.

3. The Trustee acquired, and continues to hold, the Property as trustee for the Trust, which is a discretionary trust.

4. The Property is currently zoned ‘IN2 (Light Industrial)’.

5. Since acquiring the Property, the Trustee has continuously conducted a leasing enterprise. The Property contains a number of industrial units which have all been regularly leased to tenants. All units are currently leased (or actively marketed for lease).

6. There is no central office or site manager and the Trustee does not provide security in relation to the Property. However, the Trustee is responsible for cleaning the common area toilets and grounds.

7. Leasing of the commercial units is undertaken by an external professional agent. The collection of rent, management of leasing agreements and management of tenants is outsourced to a related company which charges the Trustee an annual management fee.

8. The Trust was established to acquire this Property only, and neither the Trustee nor the Trust has been involved in the development of other properties. The Trust was established, and the Property purchased, with the aim of providing a stable income stream for the beneficiaries of the Trust.

9. The Trust has no other activity or enterprise other than leasing of the commercial units at the Property, and the Trust does not own any other property.

10. When the Trustee acquired the Property, it had the intention of conducting a leasing enterprise in relation to the Property.

a. Pre-acquisition investigations were conducted prior to the Trustee purchasing the Property; the Trustee purchased the Property as a long-term investment to derive rental income.

b. When the Property was purchased by the Trustee, the marketing and promotional materials made reference to the Property capacity for rental income. It was not marketed for sale as a potential development site.

c. Pre-acquisition investigations were not conducted into the Property’s potential for re-development.

d. The acquisition of the Property was largely funded by way of a bank loan. The bank who provided the loan (the Bank) approved the loan application based on the Property’s rental income at that time.

11. The Trustee submitted, or permitted tenants to submit, various applications and plans to the relevant city’s Council (Council) for the gaining of approval to use the Property for various purposes and to make changes to the building with a view to improving rental returns. These applications typically involved proposals for changes of use of existing industrial units.

12. A development approval (DA) was approved by the Land and Environment Court in an earlier year for “subdivision creating new lot one and two and alternations to existing building on lot two to create XX units, carparking and strata subdivision”. The DA lapsed a few years later without the proposed development being undertaken. However, if the Trustee had undertaken the proposed development in accordance with the DA, it would have involved an upgrade of the existing industrial units into smaller boutique-style industrial units. Only minimal demolition works were contemplated under those proposed plans for the DA. The works primarily involved fit-out adjustments. The DA did not contemplate any new buildings or residential use. The purpose of the works under the DA would have been to increase the number of industrial units at the Property and thereby increase the Trustee’s rental returns from the existing industrial building.

13. A few years after purchasing the Property, the Trustee carried out capital works at the Property. From time to time, the Trustee has also provided advice or financial assistance to tenants at the Property to help them obtain development approvals for their required uses.

14. Since acquiring the land, the Trustee has continued to grant new leases to tenants at the Property.

15. The Bank obtained a valuation report prior to approving the bank loan. Several years later when the finance arrangements were reviewed, the Bank obtained a further valuation report. Both valuations adopt a capitalisation method of valuation based on net yield from rental income as an industrial building. Neither valuation report anticipates the possibility of residential development.

16. Approximately four years after the Trustee acquired the Property, the State Government announced a new transport project affecting areas near to/surrounding the location of the Property. The State Government approved the transport project, as well as an urban renewal project, a few years later.

17. The transport project has greatly enhanced the value of the Property and its potential for a redevelopment. These measures were not known, and could not have been predicted, by the Trustee at the time it purchased the Property.

18. Eight to ten years after the Trustee acquired the Property, the Trustee participated in several pre-planning proposal meetings with the Council to seek guidance from Council officers regarding the information required to support a rezoning request in relation to the Property.

19. During that time, the Trustee engaged consultants to conduct planning assessment reports and the Trustee subsequently submitted materials (the Planning Proposal Request) to Council.

20. The key component of the Planning Proposal Request included a change in zoning of the Property from Industrial (IN2) to Medium Density Residential (R3). The Council later resolved not to support the Planning Proposal Request. The Trustee subsequently referred the matter for review, where it was recommended that the application be submitted for a Gateway determination.

21. To date, the Trustee has incurred expenses in relation to the Planning Proposal Request. The costs include legal fees, fees paid to external planning consultants and Council fees and charges.

22. The Trustee is now considering selling the Property. The proposed sale would be subject to and conditional upon:

a. a Gateway determination approving a change in zoning to Medium Density Residential; and

b. a development application being approved substantially in accordance with the Planning Proposal Request.

The Trustee’s key arguments in support of its private ruling application

1. The only enterprise the Trustee has carried on in relation to the Property is the activity of conducting a passive leasing enterprise.

2. The proposed sale of the Property in the circumstances described in the facts would not involve trading stock. It would be a once-off disposal of an asset that was purchased by the Trustee over a decade ago, where the Trustee’s intention in acquiring the Property was to hold it as a long-term investment to derive a stable (rental) income stream for the beneficiaries of the Trust. This is also the basis upon which the Bank loaned funds to the Trustee to finance the acquisition.

3. As the Trustee proposes to sell the Property in its current condition (but subject to a favourable Gateway determination approving a change in zoning), any substantial development activities in relation to the Property would be undertaken by the third party purchaser, and not by the Trustee.

4. The Trustee is not carrying on a property development business in relation to the Property.

5. A taxpayer who holds land does not commence carrying on a business of land development and improvement simply by taking steps to secure the rezoning of a parcel of land.

6. The Trustee did not have a profit-making purpose when it acquired the Property. Therefore, the possible sale would not be made in carrying out a profit-making scheme, and any profit on that sale should not constitute ordinary income.

7. No steps were taken to rezone the Property prior to the announcements regarding the urban renewal plan and the transport project.

8. There has been no change to the Trust Deed of the Trust, and the director and shareholder of the Trustee has not changed throughout the Trustee’s ownership of the Property.

9. When the Trustee purchased the Property, a sale for profit was no more than a mere possibility.

10. It was only after the announcements for the transport project and the urban renewal plan that the Trustee began to pursue its application for rezoning under the Planning Proposal Request. It was those unplanned State Government initiatives that made the Property desirable for possible redevelopment.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 70-10

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Parts 3-1 and 3-3

Reasons for decision

Question 1

Will the gross proceeds or net profit from the possible sale of the Property by the Trustee constitute ordinary income under section 6-5 of the ITAA 1997?

Summary

The gross proceeds or net profit from the possible sale of the Property by the Trustee will not constitute ordinary income under section 6-5 of the ITAA 1997.

Detailed reasoning

There are three means by which proceeds from the possible sale of the Property owned by the Trust can be treated for taxation purposes:

1. As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as income (gross proceeds) generated in the ordinary course of carrying on a business of property development, involving the purchase and sale of land and buildings as trading stock.

2. As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of an isolated transaction, where net profits are included in assessable income.

3. As statutory income under the capital gains tax (CGT) legislation – section 102-5 of the ITAA 1997 – on the basis that a realisation of a capital asset has occurred.

The scope of the response to Question 1 will address the first two means only, with the third being discussed in the response to Question 2.

Section 6-5 of the ITAA 1997 provides that the assessable income of an Australia resident includes the ordinary income derived directly or indirectly from all sources, whether in or out of Australia.

‘Ordinary income’ is defined in section 6-5 of the ITAA 1997 to mean ‘income according to ordinary concepts’. The legislation does not provide any specific guidance on what is meant by ‘income according to ordinary concepts’. However, a substantial body of case law has evolved over time that identifies various factors that are taken into account in determining when an amount is ‘income according to ordinary concepts’.

In general, a receipt will constitute income according to ordinary concepts if it is a receipt arising out of a taxpayer’s employment or in the normal scope of a taxpayer’s business. In limited circumstances, gains not within the ordinary scope of a taxpayer’s business may form part of ordinary income.

Section 995-1 of the ITAA 1997 defines ‘business as ‘including any profession, trade, employment, vocation or calling, but does not include any occupation as an employee’.

Does the Property constitute trading stock?

Under section 70-10 of the ITAA 1997, ‘trading stock’ is defined as including ‘anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business’.

In order to determine if the Property constitutes ‘trading stock’, it is necessary to firstly consider whether the Trust is carrying on a business of buying and selling real property.

Whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the particular facts.

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? discusses the Commissioner's view on whether a taxpayer is carrying on a business. Ultimately, the question of whether the activities of a taxpayer amount to a business is decided on the facts of each case. The Commissioner considers that the following matters (listed at paragraph 13 of TR 97/11) are relevant in determining whether a taxpayer is conducting a business of acquiring property for the purpose of making a profit on its subsequent sale:

1. whether the activity has a significant commercial purpose or character

2. whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

3. whether there is repetition and regularity of the activity

4. 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

5. the volume of the operations and the amount of capital employed

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

7. the size, scale and permanency of the 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 profile.

The scale of development activities in particular has been considered by the courts in determining whether a property development business is being carried on as opposed to the mere realisation of a capital asset. In Scottish Australian Mining Co Ltd v FCT (1950) 81 CLR 188 (Scottish Australian Mining), land was purchased by a company for the purposes of carrying on its coal mining operations. The mining operations ceased approximately 60 years later. The company subdivided the land and sold it in parcels at a profit. The development of the land required the company to construct roads and a railway station and to make sites available for schools, churches and recreation areas. Despite the extent of the development, the court held that the sale of the land was no more than the mere realisation of a capital asset. Williams J said:

The facts would, in my opinion, have to be very strong indeed before a Court could be induced to hold that a company which had not purchased or otherwise acquired land for the purpose of profit making by sale was engaged in the business of selling land and not merely realising it when all that the company had done was to take the necessary steps to realise the land to the best advantage, especially land which had been acquired and used for a different purpose which it was no longer businesslike to carry out.

However, in FCT v Whitfords Beach Pty Ltd (1982) 150 CLR 355 (Whitfords Beach), Mason J and Wilson J seemed to doubt the correctness of the court’s earlier decision in Scottish Australian Mining due to the scale of the development activities undertaken by the company in that case.

The Federal Court has since endeavoured to reconcile those decisions. For example, in Stevenson v FCT 91 ATC 4476 (Stevenson), the taxpayer owned and worked on a farm of approximately 446 acres that had been in his family since 1904. The taxpayer sold 26 acres to a statutory body in 1965, and later sold a further 360 acres to a company for farming. Of the remaining 90 acres, the taxpayer decided to keep a few acres for himself and his family and the rest would be subdivided, which was conditional on the provision of water and sewerage reticulation. After attempts to sell the whole area marked for subdivision (as an en globo development site) failed, the taxpayer decided to subdivide the land into more than 180 blocks. Jenkinson J upheld the Tribunal’s finding that the taxpayer’s activities went beyond what could be accepted as the mere realisation of a capital asset. The Tribunal had particular regard to the degree of the taxpayer’s personal involvement in the planning, in the negotiations with the shire council, in obtaining finance, in employing contractors, in the marketing of the blocks and in their actual sale. Jenkinson J accepted the Tribunal’s observations and said:

It is, I think, difficult to discriminate between mere realisation and the conduct of a business by reference directly to the magnitude of the physical activity or the physical effect of the activity, although Mason J does seem to regard the degree of development and improvement of the land as critical. The magnitude of a substantial subdivisional enterprise does, however, commonly entail such a degree of systematic organisation, planning, management and repetition of purposeful profit-making activity that the carrying on of a business may be more clearly discerned than in a case ‘where an area of land is merely divided into several allotments.’

It was the magnitude of the enterprise that led Jenkinson J to find that the taxpayer had commenced carrying on a business. Jenkinson J distinguished the situation in that case from one where ‘land is merely divided into several allotments’.

In Casimaty v FCT 97 ATC 5135 (Casimaty), the Federal Court consider facts that were quite similar to those in Stevenson’s case, but Ryan J reached a different conclusion. That case involved land previously used by the taxpayer in a dairy farming business that was no longer financially viable. The Taxpayer had originally acquired the land from his father and, at that time, he had only contemplated farming the land. It became necessary for the taxpayer to sell portions of the land to alleviate financial hardship. As there was no ready market for large farming lots, the taxpayer sold off approximately two-thirds of the property as subdivided lots. Ryan J referred to the earlier judgment of the court in Stevenson and said that Jenkinson J did not distil from the authorities a principle of law that a subdivision involving a hundred or more lots, the construction of roads and the reticulation of water to each lot could never amount to a mere realisation of a capital asset. Ryan J observed that any such principle would run counter to the views expressed by all but one of the members of the High Court in FCT v Williams (1972) 127 CLR 226, where Gibbs J had observed:

An owner of land who holds it until the price of land has risen and then sub-divides and sells it is not thereby engaging in an adventure in the nature of trade, or carrying out a profit-making scheme. The situation is not altered by the fact that the landowner seeks and acts upon the advice of an expert as to the best method of sub-division and sale or by the fact that he carries out work such as grading, levelling, road-building and the provision of reticulation for water and power to enable the land to be sold to its best advantage. The proceeds resulting from the mere realisation of a capital asset are not income either in accordance with ordinary concepts or within the second limb of sec. 26(a), even though the realisation is carried out in an enterprising way so as to secure the best price.

Ryan J later said:

Nor did the taxpayer undertake any works on, or development of, the land beyond what was necessary to secure the approval by the municipal authorities of the successive plans of subdivision and enhance the presentation of individual allotments for sale as vacant blocks. Had he constructed dwelling houses, internal fencing or other improvements, it would have been easier to impute to him an intention to carry on a business of land development and improvement. Similarly, had he set up his own sales organisation or advertised or conducted sales himself instead of entrusting those activities entirely to his traditional agents, Roberts Ltd, the inference would have been more strongly available that he had gone into the business of selling farmlets or rural residential allotments. That inference was drawn by the Tribunal in Stevenson’s case where the taxpayer, at least from stage 2 of his development, personally dealt with prospective purchasers as well as ‘multi-listing’ the blocks with a variety of agents.

Having regard to the factors highlighted in paragraph 13 of TR 97/11 and the above case law, the Commissioner is of the view that the Trust is not carrying on a business of acquiring property for the purpose of profit-making by sale. This position is primarily supported by the following facts:

1. The Trustee’s intention in acquiring the Property was to hold it as a long-term investment to derive a stable (rental) income stream, and the Property has since been held for that purpose for over a decade. The only enterprise the Trustee would have carried on in relation to the Property is the activity of conducting a passive leasing enterprise.

2. There is no central office or site manager. Leasing of the commercial units on the Property is undertaken by an external professional agent. The collection of rent, management of leasing agreements and management of tenants is outsourced to a related company which charges the Trustee an annual management fee.

3. The Trust was established to acquire this property only, and has no other activity or enterprise other than leasing of the commercial units at the Property.

4. The Trust does not own any other property, and the Trustee and the Trust have not been involved in the development of other properties.

5. The purpose of the capital works at the Property eight to ten years after acquiring the Property was merely to enhance rental returns, and not for the purpose of selling the Property.

6. When the Trustee purchased the Property, it could not have known (or predicted) that a transport project and urban renewal plan would occur.

7. It was only after the announcements (approximately eight to ten years after acquiring the Property) that the Trustee began to pursue its application for rezoning the Property under the Planning Proposal Request. It was those unplanned State Government initiatives that made the Property desirable for possible redevelopment.

8. As the Trustee proposes to sell the Property in its current condition, but subject to a favourable Gateway determination approving a change in zoning, any substantial development activities would be undertaken by the third party purchaser and not by the Trustee.

9. The above case authorities demonstrate that a taxpayer who holds land does not commence carrying on a business of land development and improvement merely by taking steps to secure the rezoning of a parcel of land. If the Trustee sells the Property in the circumstances described in the facts provided, the Trustee – in participating in several pre-planning proposal meetings with the Council, and in engaging consultants to conduct planning assessment reports – will have done no more than to take steps to secure the rezoning of its capital asset. In particular:

- The magnitude of the costs involved in pursuing the Planning Proposal Request is relatively insubstantial when compared to the costs involved in undertaking a redevelopment of the Property.

- The Planning Proposal Request is a single step (albeit that the Council’s decision was referred for review, after which it was recommended that it be submitted for a Gateway determination) that does not involve systematic organisation, planning, management and repetition.

- During the period of time in which the Trustee pursued the Planning Proposal Request, the Trustee did not contemplate the Property’s redevelopment for the purpose of resale. The Trustee’s decision to sell the Property occurred after submitting the relevant materials to the Council for the Planning Proposal Request.

As the Trust is not carrying on a business of acquiring property for the purpose of profit-making by sale, the Property would not constitute ‘trading stock’ under section 70-10 of the ITAA 1997.

Would the possible sale of the Property constitute an isolated commercial transaction?

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income provides the Commissioner’s view on whether profits from isolated transactions are assessable as ordinary income under the former subsection 25(1) of the Income Tax Assessment Act 1936 (now section 6-5 of the ITAA 1997).

Paragraph 1 of TR 92/3 provides that the term 'isolated transaction' refers to those transactions:

1. outside the ordinary course of business, and

2. entered into by non-business taxpayers.

In particular, TR 92/3 sets out the Commissioner’s views in relation to the application of the decision of the Full Court of the High Court of Australia in FC of T v The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693 (Myer Emporium). In the Myer Emporium case, the High Court said:

Although it is well settled that a profit or gain made in the ordinary course of carrying on a business constitutes income, it does not follow that a profit or gain made in a transaction entered into otherwise than in the ordinary course of carrying on the taxpayer's business is not income. Because a business is carried on with a view to profit, a gain made in the ordinary course of carrying on the business is invested with the profit-making purpose, thereby stamping the profit with the character of income. But a gain made otherwise than in the ordinary course of carrying on the business which nevertheless arises from a transaction entered into by the taxpayer with the intention or purpose of making a profit or gain may well constitute income. Whether it does depends very much on the circumstances of the case. Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a ‘one-off’ transaction preclude it from being properly characterised as income…The authorities establish that a profit or gain so made will constitute income if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit.

As held in Myer Emporium, whether a profit from an isolated transaction is income according to ordinary concepts depends on the circumstances of a case.

In circumstances where a taxpayer carrying on a business makes a profit from a transaction or operation, paragraph 15 of TR 92/3 states such a profit is income if the transaction or operation:

(a) is in the ordinary course of the taxpayer’s business…provided that any gross receipt from the transaction or operation is not income; or

(b) is in the course of the taxpayer’s business, although not within the ordinary course of that business, and the taxpayer entered the transaction or operation with the intention or purpose of making a profit; or

(c) is not in the course of the taxpayer’s business, but

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

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

However, paragraph 15 of TR 92/3 is applicable only if the Trust is carrying on a business.

As per the discussion under the previous sub-heading above in relation to whether the Property constitutes ‘trading stock’, the Commissioner concluded that the Trust is not carrying on a business of property development involving the purchase and subsequent sale of real property (and that the Trust is undertaking a leasing enterprise only). For the same reasons, the Commissioner also considers that the leasing enterprise undertaken by the Trust does not constitute the carrying on of a business. The basis for this view is that the Trust uses the Property merely for passive rental income purposes, where leasing of the commercial units on the Property is undertaken by an external professional agent, and the collection of rent, management of leasing agreements and management of tenants is outsourced to a related company for an annual management fee. There is no central office or site manager. Further, the Trust was established to acquire this property only, and has no other activity or enterprise other than leasing of the commercial units at the Property, and the Trust does not own any other property.

Therefore, as the leasing enterprise carried on by the Trust is merely of a passive nature and does not constitute the carrying on of a business, paragraph 16 of TR 92/3 would be relevant in the event the Trust makes a net profit from the proposed sale of the Property. Paragraph 16 of TR 92/3 states the following:

If a taxpayer not carrying on a business makes a profit, 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.

Each of the two elements or conditions in paragraph 16 of TR 92/3 is discussed below in considering whether or not a profit made by the Trust from the proposed sale of the Property would be income.

Intention or purpose of the Trust in entering a possible profit-making transaction or operation

According to paragraphs 7 and 8 of TR 92/3, the relevant intention or purpose of the taxpayer (of making a profit or gain) is not the subjective intention or purpose of the taxpayer, but rather the taxpayer’s intention or purpose that can be discerned from an objective consideration of the facts and circumstances of the case.

It is also not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. Paragraph 40 of TR 92/3 provides that it is sufficient if profit-making is a significant purpose. However, the profit-making purpose must be more than a mere possibility. In Westfield v FCT 91 ATC 4234, Hill J said:

While a profit-making scheme may lack specificity of detail, the mode of achieving that profit must be one contemplated by the taxpayer as at least one of the alternatives by which the profit could be realised … But, even if that goes too far, it is difficult to conceive of a case where a taxpayer would be said to have made a profit from the carrying on, or carrying out, of a profit-making scheme, where, in the case of the scheme involving the acquisition and resale of land, there was, at the time of acquisition, no purpose of resale of land, but only the possibility (present, one may observe, in the case of every acquisition of land) that the land may be resold.

Paragraph 41 of TR 92/3 states that if a transaction or operation involves the sale of property, it is usually necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property. However, this is not always the case, as there may be special circumstances where the requisite profit-making purpose arises some time after acquisition of a property.

An example is provided in paragraph 42 of TR 92/3 where a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either as the capital of a business or into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction. In such circumstances, the activity of the taxpayer would constitute the carrying on of a business or a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity would be income despite the taxpayer not having the purpose of profit-making at the time of acquiring the asset.

Further, in Whitfords Beach, the High Court found a ‘profit-making scheme’ even though land was originally acquired by a company for the passive recreational use of the shareholders. However, in that case, the company came under the ownership and control of new shareholders whose purpose was to use the company’s asset for a profit-making undertaking or scheme.

In Casimaty, it was held that significant changes in organisational structure or control of a landholding entity may alter the timing for the requisite profit-making purpose. Where there is no such change, it is apparent from the decision of the Full Court in Westfield that the profit-making purpose must be present when the asset is first acquired. It was held in that case that:

Once it is clear that the activity of buying and selling, which generated the profit, was not an activity in the ordinary course of business, or, for that matter, an ordinary incident of some other business activity, the profit in question will only form part of the assessable income of the appellant, by virtue of it being income in accordance with the ordinary concepts of mankind, if the appellant had a purpose of profit-making at the time of acquisition.

Based on an objective consideration of the facts provided, the Commissioner is of the view that – while the possible sale of the Property would constitute a profit-making undertaking – the Trustee did not have the requisite profit-making purpose when the Property was acquired:

1. When the Trustee purchased the Property, the Trustee’s intention was to acquire and hold the Property as a long-term investment to derive rental income (which was also the basis on which the Trustee obtained the finance required to fund the acquisition). The Trustee has continuously held the Property for this purpose since its acquisition (a period of over ten years), where leasing of the commercial units was undertaken by an external professional agent, and the collection of rent, management of leasing agreements and management of tenants was outsourced to a related company which charged the Trustee an annual management fee.

2. The Trustee did not conduct any pre-acquisition investigations into the Property’s potential for redevelopment at the time of acquiring the Property.

3. The Trust has no other activity or enterprise other than leasing of the commercial units at the Property, and the Trust does not own any other property.

4. When the Trustee purchased the Property, a sale for profit was no more than a mere possibility.

5. When the Trustee purchased the Property, it could not have known (or predicted) that a transport project and urban renewal plan would occur.

6. It was only after announcements regarding the urban renewal plan and the transport project (approximately eight to ten years after acquiring the Property) that the Trustee began to pursue its application for rezoning the Property under the Planning Proposal Request. It was those unplanned State Government initiatives that made the Property desirable for possible redevelopment.

Further, the Commissioner considers that the requisite profit-making purpose also did not arise at any time after the Trust’s acquisition of the Property. This is supported by the Commissioner’s earlier conclusion above that the Trust has not carried on a property development business (involving the purchase and sale of real property) since the Property was acquired. Further, there has been no change to the Trust Deed of the Trust since the Property’s acquisition, and the director and shareholder of the Trustee has not changed throughout the Trustee’s ownership of the Property. The nature of the Property as an investment for rental income purposes has not been changed to that of a trading asset as a result of the Trustee pursuing the Planning Proposal Request. At the time of pursuing the Planning Proposal Request (that is, prior to the recent decision of the Trustee to sell the Property), the (potentially redeveloped) Property would still be used for its original purpose as an investment property to generate (enhanced) rental income.

Therefore, the first element/condition (profit-making purpose) of paragraph 16 of TR 92/3 is not satisfied.

Carrying out of a business operation or commercial transaction

For a transaction to be characterised as a business operation or a commercial transaction, paragraph 47 of TR 9/3 states that it is sufficient if the transaction is business or commercial in character. However, whether a particular transaction has a business or commercial character depends very much on the circumstances of the case.

Paragraph 49 of TR 92/3 provides that 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. That paragraph highlights the following factors which 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 (Ruhamah Property Co. Ltd. v F C of T (1928) 41 CLR 148 at 154; Hobart Bridge Co. Ltd. v FC of T (1951) 82 CLR 372 at 383; FC of T v Radnor Pty Ltd 91 ATC 4689; 22 ATR 344). For example, if the taxpayer is a corporation with substantial assets rather than an individual, that may be an indication that the operation or transaction was commercial in nature. However, if the taxpayer acts in the capacity of trustee of a family trust, the inference that the transaction was commercial or business in nature may not be drawn so readily;

(b) the nature and scale of other activities undertaken by the taxpayer (Western Gold Mines N.L. v C. of T. (W.A.) (1938) 59 CLR 729 at 740);

(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. This factor would include whether professional agents and advisers were used and whether the operation or transaction took place in a public market;

(f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction. For example, the relationship between the parties may suggest that the operation or transaction was essentially a family dealing and not business or commercial in nature;

(g) if the transaction involves the acquisition and disposal of property, the nature of that property (Edwards v. Bairstow; Hobart Bridge 82 CLR at 383). For example, if the property has no use other than as the subject of trade, the conclusion that the property was acquired for the purpose of trade and, therefore, that the transaction was commercial in nature, would be readily drawn; and

(h) the timing of the transaction or the various steps in the transaction (Ruhamah Property 41 CLR at 154). For example, if the relevant transaction consists of the acquisition and disposal of property, the holding of the property for many years may indicate that the transaction was not business or commercial in nature.

Of the two elements/conditions of paragraph 16 of TR 92/3, both must be satisfied in order for a profit from an isolated transaction (where a business is not being carried on) to be classified as income. As concluded earlier, the first element/condition (profit-making purpose) of paragraph 16 of TR 92/3 is not satisfied. Therefore, it is not necessary to discuss further the second element/ condition (business operation or commercial transaction) of paragraph 16 of TR 92/3.

As both of the elements/conditions of paragraph 16 of TR 92/3 would not be satisfied in respect of the proposed scheme, any net profit the Trustee receives from the possible sale of the Property would not constitute income under section 6-5 of the ITAA 1997.

Conclusion

The Trust is not carrying on a business of property development involving the purchase and sale of land and buildings as trading stock. As such, (gross) proceeds from the possible sale of the Property owned by the Trust would not be treated as ordinary income under section 6-5 of the ITAA 1997 on the basis of the Trustee carrying on a business of property development.

The leasing enterprise undertaken by the Trust also does not constitute the carrying on of a business.

A net profit from an isolated transaction, being the possible sale of the Property, also would not constitute ordinary income under section 6-5 of the ITAA 1997, as both of the elements/conditions of paragraph 16 of TR 92/3 would not be satisfied in respect of the proposed sale transaction. In particular, the Trustee did not have the requisite profit-making purpose when the Property was acquired, nor did a profit-making purpose arise at any time after the Trust’s acquisition of the Property.

Therefore, the gross proceeds or net profit from the possible sale of the Property by the Trustee will not constitute ordinary income under section 6-5 of the ITAA 1997.

Question 2

Will the gain on the possible sale of the Property by the Trustee be assessable as statutory income as a realisation of a CGT asset?

Summary

The gain on the possible sale of the Property by the Trustee would be assessable as statutory income as a realisation of a CGT asset.

Detailed reasoning

Under section 6-10 of the ITAA 1997, assessable income also includes amounts that are not ordinary income but are included as assessable income by provisions of the tax law. These amounts are called ‘statutory income’. Capital gains are an example of statutory income.

Section 102-5 of the ITAA 1997 provides that a taxpayer’s assessable income includes their net capital gain (if any) for the income year. As a general rule, a taxpayer is required to include in their assessable income any capital gain they make from a CGT event that happens to a CGT asset the taxpayer acquired on or after 20 September 1985. Pursuant to section 108-5 of the ITAA 1997, a CGT asset is any kind of property, or a legal or equitable right that is not property. Accordingly, land and buildings are CGT assets.

Proceeds from the sale of property more often represent the mere realisation of capital assets, which will fall for consideration under the CGT provisions in Part 3-1 and Part 3-3 of the ITAA 1997.

In the course of its decision in Myer Emporium, the Full High Court said that profits made on a realisation or change of investments may constitute income if the investments were initially acquired as part of a business with the intention or purpose that they be realised subsequently in order to capture the profit arising from the expected increase in value. In a joint judgment, their Honours stated:

It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of acquisition of acquiring for the purpose of profit-making by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realization. But it is quite another thing if the decision to sell is taken by way of implementation of an intention or purpose, existing at the time of acquisition, of profit-making by sale, at least in the context of carrying on a business or carrying out a business operation or commercial transaction.

A ‘mere realisation’ of assets was found to have been effected in Statham & Anor v FC of T 89 ATC 4070 (Statham), with the consequence that no income was assessable. The taxpayers were the trustees of a deceased estate. The deceased had acquired 270 acres in 1970 on which to raise his family. In 1976, the deceased sold a half interest in part of the property to a company controlled by his sister and her husband. The deceased and the company entered into a partnership to raise cattle on the property but, for a number of reasons, the business failed and, in 1979, it was decided to subdivide and sell the property. The subdivision work was carried out by the local council and local real estate agents handled the advertising and sale of the lots. The deceased died in 1980 and the subdivided lots were sold between 1980 and 1986. The Full Federal Court held that what occurred was:

the mere realisation, by the most advantageous means, of the asset which the owners had on their hands when they abandoned the intention of farming the subject property.

The court was satisfied that the owners did not enter into the business of selling land, and said there was nothing surprising in the fact that the owners applied themselves in an enterprising way to the realisation of a capital asset, in a manner calculated to maximise their receipts. But the fact that this occurred does not necessarily make the proceeds either profits from an undertaking or scheme, or income from a business. The court said:

It is well established... that the mere realisation of an asset at a profit does not necessarily render the profit taxable. The profit must arise from the carrying on of a business or a profit-making undertaking or scheme. The mere magnitude of the realisation does not convert it into such a business, undertaking or scheme; but the scale of the realisation activities is a relevant matter to be taken into account in determining the nature of the realisation, ie in determining whether the facts establish a mere realisation of a capital asset or a business or profit-making undertaking or scheme.

Paragraph 36 of TR 92/3 states:

The courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. The expression ‘mere realisation’ is used to contradistinguish a business operation or a commercial transaction carrying out a profit-making scheme. If a transaction satisfies the elements set out in paragraph 35¹, it is generally not a mere realisation of an investment.

As per the Commissioner’s response to Question 1, the Trustee did not have a profit-making intent at the time of purchasing the Property, as the Trustee’s intention was to hold the Property as an investment that would generate passive rental income/capital returns on a long-term basis. The Trustee was not carrying on a business of purchasing and selling real property, as particularly demonstrated by the Trustee holding onto the Property (the only property in its portfolio) for over ten years. The requisite profit-making purpose also did not arise at any time after the Trust’s acquisition of the Property, as determined in the response to Question 1.

Without a profit-making intent, the activities of the Trust would not ordinarily be regarded as revenue-based income.

Despite the potentially sizeable profit from the possible sale of the Property, the mere magnitude of the realisation does not convert the activities of the Trustee into a business (as held in Statham).

Therefore, in applying the principle held in Myer Emporium as stated above, as the Property is deemed to be a capital asset and not a revenue asset, and in the absence of a profit-making intent by the Trustee, it is the Commissioner's view that the possible sale of the Property would more accurately represent the mere realisation of a capital asset.

As a mere realisation of a capital asset, the proceeds from the possible sale of the Property would not be assessable as ordinary income under section 6-5 of the ITAA 1997. The proceeds from the possible sale of the Property would be subject to the CGT provisions provided in Part 3-1 and Part 3-3 of the ITAA 1997.