Edited version of private advice

Authorisation Number: 1051501577723

Date of advice: 20 May 2019

Ruling

Subject: Sale of property

Question

Will the profit from the sale of the property be treated as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You purchased a residential property (the property) in early 20XX, which was held in both of your names.

The land on which the property is situated is less than two hectares in size.

There is no formal partnership agreement in place, and you applied for a partnership ABN solely for the purpose of purchasing the property.

The initial purpose for buying the property was for one of you (Partner A) to live in. However, after you signed the contract of sale for the purchase of the property, you discovered that you were unable to borrow the required amount of funds from the bank to complete the purchase. You also advise that you were unable to cancel the contract at that point, and that there was no finance clause in the contract.

As you did not have sufficient funds to hold the property at that point in time, and in order to complete the purchase, you drew down the remaining funds required from a redraw facility on an another loan you held.

Also, at that point your intention then changed, whereby you then decided to demolish the property, build a new property and sell this once completed as soon as possible, and this is why you registered for a partnership ABN.

You each held a 50% ownership in the property.

The partnership entity registered for GST, however you intend on cancelling the GST registration, and amendments to all BAS lodged have been lodged.

The partnership entity has claimed GST credits on purchases and non-capital purchases relating to the property.

The partnership entity does not have any employees.

The partnership entity does not own any other properties to renovate or sell at a profit, nor has it previously sold any properties with the aim of making profit.

You did not obtain professional advice from an accountant or solicitor throughout the operation, nor did anyone act on your behalf to assist in locating the property. You sourced the property yourselves via a real estate website.

You did not do any research before buying the property, as you were living in the surrounding suburb of the property, and as such you were already familiar with the suburb in which the property is located.

You are close friends with each other but are not related.

Following the purchase of the property, you subsequently demolished the property, and rebuilt another house on the land. This was funded via other loan facilities you held at that time.

The property was not your main residence before it was demolished, as the condition of the house was very poor, and as such you were unable to reside in it at that point.

You did not subdivide the property.

You obtained the occupation permit for the new property in late 20XX.

After the construction was finished in late 20XX, you listed the property for sale early in the following year.

Partner A moved into the house from early in 20XX until the property was sold.

After Partner A moved in the property, you received an offer to buy the property, however this would not have covered the costs associated with the purchase and rebuild.

Following this, another sale contract was obtained a few months later, with settlement occurring a few months subsequent to that.

You made a profit on the sale of the property.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Summary

The proceeds from the sale of the property will be assessable income under section 6-5 of the ITAA 1997 as a result of you undertaking an isolated commercial transaction with a view to making a profit.

Detailed reasoning

Taxation treatment of property sales

Broadly, there are three ways profits from a land development and sale can be treated for taxation purposes:

·         as ordinary income on revenue account, as a result of carrying on a business of property development, involving the sale of land and buildings as trading stock;

·         as ordinary income 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, where the land was acquired or subsequently held for the purpose of profit making; or

·         as statutory income under the capital gains tax legislation on the basis that a realisation of a capital asset has occurred.

Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case.

We will consider each of these in relation to your situation as follows:

Carrying on a business of property development

Section 995 of the ITAA 1997 states the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 (TR 97/11) which uses the following indicators to determine whether a taxpayer is carrying on a business:

·         whether the activity has a significant commercial purpose or character;

·         whether there is repetition and regularity of the activity;

·         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;

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

·         the size, scale and permanency of the activity; and

·         whether the activity is better described as a hobby, a form of recreation or a sporting 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 of a commercial nature.

Application to your situation

After reviewing the information and documentation provided, it is the Commissioner's view that your activities in relation to the sale of the property are not those of an entity carrying on a business of developing and selling property.

The activities undertaken do not display the salient indicator of a business, which are transactions entered into on a continuous and repetitive basis.

Also, due to the activities you have undertaken, we consider your project to be small in scale, and not being carried out in a manner similar to other property development businesses.

As such, we do not consider that any proceeds you would receive from the sale of the property would be derived in the course of carrying on a business.

Therefore any gain made on the disposal of the property will not be assessable income under section 6-5 of the ITAA 1997 as ordinary income from the carrying on of a business.

Profits from an isolated transaction

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

In TR 92/3, 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.

As we have determined that you are not carrying on a property development business, paragraph 16 of TR 92/3 is relevant in your case, which provides that if a taxpayer not carrying on a business makes profit, that profit is income if:

(a)  the intention or purpose of the taxpayer in entering 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.

You have advised that the original purpose for buying the property was for Partner A to live in, however after you discovered that you were not able to borrow the amount of funds you wanted from the bank, you sourced the remaining funds required to complete the purchase from a redraw facility on another loan you held, and your intention then changed from that point, whereby you then decided to demolish the property and build a new residential dwelling in its place, to sell and profit from.

Due to this, your main intention for entering into the transaction was to make profit or gain. As such, we now need to determine whether the operation you entered into was carried out as a business operation or commercial transaction.

Paragraph 47 of TR 92/3 provides that for a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character.

Paragraph 48 (iii) of TR 92/3 is of particular relevance to your circumstances, and outlines the following as an instance of a business operation or commercial transaction:

A partnership purchased a complete spinning plant with a view to resale at a profit, having no intention of using the plant to derive income from spinning, and later sold the plant at a profit (Edwards v. Bairstow (1956) AC 14).

Your circumstances align with this, as in your case you purchased the property with a view to resale at a profit, and you have not advised that the property was used to derive income. As such this could be considered as a business transaction or a commercial operation.

Paragraph 49 of TR 92/3 also provides that in very general terms, 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.

Whether a particular transaction has a business or commercial character depends very much on the circumstances of the case. Paragraph 49 of the ruling outlines the following factors which may be relevant when considering whether an isolated transaction amounts to a business operation or commercial transaction:

·         the nature of the entity undertaking the operation or transaction;

·         the nature and scale of other activities undertaken by the taxpayer;

·         the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

·         the nature, scale and complexity of the operation or transaction;

·         the manner in which the operation or transaction was entered into or carried out;

·         the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

·         if the transaction involves the acquisition and disposal of property, the nature of the property, and

·         the timing of the transaction or the various steps in the transaction.

In determining whether activities relating to isolated transactions are a profit making undertaking or are the realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. This may require a consideration of the factors outlined above; however there may also be other relevant factors that need to be weighed up as part of the process of reaching an overall conclusion. No single factor will be determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

The direction provided within TR 92/3 indicates that ordinary income may be derived from an isolated transaction which becomes commercial in nature, or as a result of profits on a transaction in which the initial intention was to make a profit on sale.

Application to your situation

In your case, the following key points indicate that the isolated transaction amounts to that of a business operation or commercial transaction:

·         The partnership applied for an Australian Business Number (ABN) solely for the purpose of purchasing the property.

·         The partnership also registered for Goods and Services Tax (GST), and claimed GST credits on purchases and non-capital purchases relating to the property.

·         The purchase of the property was a significant financial outlay for you.

·         The building costs were also another significant financial outlay.

·         The property was only held for a fairly short period of time, and a significant percentage of this time covered the demolition and rebuild of the property.

·         Partner A only lived in the property for a short period of time leading up to when the property was sold.

·         Neither partner did any research before buying the property, however this was largely due to their familiarity of the surrounding suburbs of the property.

However, we also considered the following points which could indicate that the transaction did not amount to that of a business operation or commercial transaction:

·         The partnership entity does not own any other properties to renovate and sell, nor has the partnership previously sold any other properties with the aim of making profit.

·         The partnership entity does not have any employees.

·         Neither partner obtained any professional advice from an accountant or solicitor throughout the operation.

Whilst we acknowledge that there were some facts above that could support the view that the isolated transaction did not amount to that of a business operation or commercial transaction, we consider that the overall manner in which the project was entered into and carried out by you had the nature of a business operation or commercial transaction.

The development of the property was not a simple and uninvolved development and your actions demonstrate that the development of the property and subsequent sale were undertaken on the basis that it would be profitable, and that a gain would be made on the disposal of the property.

Despite Partner A moving into the property from early in 20XX until the property was sold, this does not alter the fact that your initial and overall intention for the vast majority of the time you owned the property was to make a profit from the activity. This, along with the fact that Partner A was living in the property for only a very short period of time before it was sold does not alter the fact that you had in fact entered into and carried out a profit making operation.

Based on the information provided, it is viewed that the project has the characteristics of a commercial transaction and that your activities were the carrying out of a profit making undertaking. Therefore, any profit made on the sale of the property will be assessable as ordinary income under section 6-5 of the ITAA 1997.

Capital gains tax

The capital gains tax (CGT) provisions are contained in Parts 3-1 and 3-3 of the ITAA 1997. Broadly, the provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own.

Section 102-20 if the Income Tax Assessment Act 1997 (ITAA 1997) provides that a capital gain or loss happens only as a result of a CGT event. The most common event is CGT event A1 which happens when a person disposes of a CGT asset to someone else under section 104-10 of the ITAA 1997. CGT assets include real estate acquired on or after 20 September 1985.

The inclusion of the profit or gain on the sale of a CGT asset as ordinary income does not mean that a CGT event does not happen in relation to the asset. However, section 118-20 of the ITAA 1997 operates to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains.

Therefore, while CGT event A1 will occur when an asset is sold, any capital gain will be reduced by the amount included as ordinary assessable income under section 6-5 of the ITAA 1997.

Application to your situation

Making an overall assessment on the factors set out in TR 92/3, it is the Commissioner's view that the sale of the property will not be a mere realisation of a capital asset. Therefore, any profit made on its sale will be included in your assessable income under section 6-5 of the ITAA 1997.

While CGT event A1 occurred on the sale of the property, any capital gain made on its disposal will be reduced to the extent that the profit from its sale will be included in your assessable income under section 6-5 of the ITAA 1997.