Edited version of private advice

Authorisation Number: 1051557710478

Date of advice: 30 July 2019

Ruling

Subject: Sale of real property and enterprise

Question

Is your sale of new residential premises a taxable supply?

Answer

Yes. The sale is a taxable supply as it is made in the course of your enterprise.

This ruling applies for the following periods:

The scheme commences on:

Relevant facts and circumstances

You are not currently and at all relevant times were not registered for GST.

You purchased the property in 20XX as an investment property.

Soon after the purchase you listed and began renting the property as residential premises.

This use of the property continued until demolition later.

Early 20XX you were in the market to obtain a primary place of residence (PPR) and decided to use the property (due to a larger land size) to build your PPR and simultaneously construct two additional properties with the intention to hold as investment properties (with a long term view of capital growth).

Planning permits and required applications for the subsequent subdivision and construction of the houses commenced February 20XX, with the eventual completion of all three properties along with occupancy certificates being issued in 20XX.

As a result the property was subdivided into 3 lots: lot A, lot B, and lot C.

You occupied lot A in 20XX.

Obtaining tenants for the properties was more difficult than expected for you. Specifically lot C took over four months to secure a tenant.

The property located at lot C became your investment property and after a period of advertising for tenants was first rented out in late 20XX.

As a result of the difficulty in tenanting the properties you began experiencing significant financial difficulties with the ability to keep up with repayment obligations and ongoing expenses becoming an issue.

Due to your financial situation, you decided to sell lot B with advertising commencing in mid-20XX with the eventual sale taking place in late 20XX.

The settlement period was shorter than usual as settlement funds were required to relieve your financial difficulties.

Your stated intention from the outset was to hold both properties as investment properties with the goal of long-term capital growth rather than to sell shortly after construction due to financial difficulties forcing your hand.

Lot B was not rented to a tenant prior to being sold.

Additional borrowings were required to complete the three properties constructed.

Sale of the property was at arm's length to a third party.

You experienced increased cash flow pressures with the servicing of the loan relating to the three properties as additional and unexpected costs of construction and subdivision compounded these difficulties and put immense pressure on you.

Relevant legislative provisions

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

A New Tax System (Goods and Services Tax) Act 1999 section 9-20

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

A New Tax System (Goods and Services Tax) Act 1999 section 25-55

A New Tax System (Goods and Services Tax) Act 1999 section 188-10

A New Tax System (Goods and Services Tax) Act 1999 section 188-20 and

A New Tax System (Goods and Services Tax) Act 1999 section 188-25.

Reasons for decision

Section 9-5 of the GST Act states:

You make a taxable supply if:

(a) you make the supply for consideration; and

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

(c) the supply is connected with Australia; and

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

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

Under paragraph 9-5(d) of the GST Act, one of the requirements for making a taxable supply is that the supplier is:

(i) registered for GST, or

(ii) required to be registered for GST.

The land that you propose to sell has been used as a capital asset in your enterprise of leasing residential premises. Enterprise is defined in section 9-20 (1)(c).

You subdivided the land in Victoria into 3 separate lots one of which you sold for consideration. The property is located in Australia and the GST-free and input tax provisions do not apply in your circumstances as the property you sold (lot B) was new residential premises.

Your current turnover is less than the GST registration threshold and you are not registered for GST. Therefore, unless you are required to be registered for GST your supply of the lots will not be a taxable supply.

Section 23-5 of the GST Act states:

You are required to be registered under this Act if:

(a) you are carrying on an enterprise; and

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

Note: It is the entity that carries on the enterprise that is required to be registered (and not the enterprise).

On the facts provided, you satisfy paragraph 23-5(a) of the GST Act as you are carrying on an enterprise that includes the leasing of property to tenants who reside in the residential premises and as discussed below you were engaged in the enterprise of property development.

Subsection 23-15(1) of the GST Act states:

(1) Your registration turnover threshold (unless you are a non-profit body) is:

(a) $50,000; or

(b) such higher amount as the regulations specify.

The A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations) specifies that for paragraph 23-15(1)(b) of the GST Act, the amount is $75 000.

Paragraph (a) of the definition of 'GST turnover' in section 195-1 states that in relation to meeting a turnover threshold - has the meaning given by subsection 188-10(1) of the GST Act, and the subsection states:

(1) You have a GST turnover that meets a particular turnover threshold if:

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

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

Under section 188-15 of the GST Act, generally:

(1) Your current GST turnover at a time during a particular month is the sum of the *values of all the supplies that you have made, or are likely to make, during the 12 months ending at the end of that month, other than:

(a) supplies that are input taxed; or

(b) supplies that are not for *consideration (and are not taxable supplies under section 72-5); or

(c) supplies that are not made in connection with an enterprise that you carry on.

Under section 188-20 of the GST Act, generally:

(1) Your projected GST turnover at a time during a particular month is the sum of the *values of all the supplies that you have made, or are likely to make, during that month and the next 11 months, other than:

(a) supplies that are *input taxed; or

(b) supplies that are not for *consideration (and are not *taxable supplies under section 72-5); or

(c) supplies that are not made in connection with an *enterprise that you *carry on.

In your case, the income you have derived in the current month and the preceding 11 months has been income derived from a lease of residential premises which is under $75,000.

Leasing of residential premises is an input taxed supply under Division 40 of the GST Act and therefore will be excluded in calculating your current and projected GST turnover. Accordingly, your current GST turnover may not meet the GST registration turnover threshold of $75,000 on this basis alone.

Additionally, in calculating projected GST turnover, section 188-25 of the GST Act provides:

In working out your *projected GST turnover, disregard:

(a) any supply made, or likely to be made, by you by way of transfer of ownership of a capital asset of yours; and

(b) any supply made, or likely to be made, by you solely as a consequence of:

(i) ceasing to carry on an *enterprise; or

(ii) substantially and permanently reducing the size or scale of an enterprise.

Of relevance for consideration in this case is paragraph 188-25(a) of the GST Act.

Goods and Services Tax Ruling GSTR 2001/7, Goods and services tax: meaning of GST turnover, including the effect of section 188-25 on projected GST turnoverincludes guidance onthe meaning capital assets. GSTR 2001/7 explains:

31. The GST Act does not define the term 'capital assets'. Generally, the term 'capital assets' refers to those assets that make up 'the profit yielding subject' of an enterprise. They are often referred to as 'structural assets' and may be described as 'the business entity, structure or organisation set up or established for the earning of profits'.

32. 'Capital assets' can include tangible assets such as your factory, shop or office, your land on which they stand, fixtures and fittings, plant, furniture, machinery and motor vehicles that are retained by you to produce income.....

33. Capital assets are 'radically different from assets which are turned over and bought and sold in the course of trading operations'. An asset which is acquired and used for resale in the course of carrying on an enterprise (for example, trading stock) is not a 'capital asset' for the purposes of paragraph 188-25(a).

34. 'Capital assets' are to be distinguished from 'revenue assets'. A 'revenue asset' is 'an asset whose realisation is inherent in, or incidental to, the carrying on of a business'.

35. If the means by which you derive income is through the disposal of an asset, the asset will be of a revenue nature rather than a capital asset even if such a disposal is an occasional or one-off transaction. Isolated transactions are discussed further at paragraphs 46 and 47.

36. Over the period that an asset is held by an entity, its character may change from capital to revenue or from revenue to capital. For the purposes of section 188-25 the character of an asset must be determined at the time of expected supply. [Footnotes excluded].

In your case, when you constructed and supplied lot B, you supplied new residential premises in the course of a property development enterprise as your intention changed when you began the subdivision and sale enterprise discussed below.

In considering the explanation in GSTR 2001/7, we consider the supply of lot B is not a capital asset. Accordingly, paragraph 188-25(a) of the GST Act, is disregarded in working out the projected GST turnover.

Enterprise

The ATO view on the meaning of the term 'enterprise' is explained in detail in Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number (MT 2006/1).

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

·         a business encompasses trade engaged on a regular basis.

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

Paragraph 244 of MT 2006/1 explains that an adventure or concern in the nature of trade includes a commercial activity that does not amount to a business but which has the characteristics of a business deal. It refers to 'the badges of trade' and outlines a number of factors that may be taken into account when determining whether assets have the characteristics of 'trade' and held for income producing purposes, or held as an investment asset or for personal enjoyment.

Paragraphs 258 and 259 of MT 2006/1 provide guidance on the distinction between trading/revenue assets and investment/capital assets. They provide the following:

·         Assets can be categorised as trading/revenue assets or capital/ investment assets. Assets purchased with the intention of holding them for a reasonable period of time, to be held as income producing assets or to be held for the pleasure or enjoyment of the person, are more likely not to be purchased for trading purposes.

·         Examples of capital/investment assets are rental properties, business plant and machinery, the family home, family cars and other private assets. The mere disposal of capital/investment assets does not amount to trade.

The property in part was originally held as part of your leasing enterprise. We acknowledge that the property was held as a capital asset for the purposes of that leasing enterprise.

However, the relevant issue in your circumstances is whether you changed your intention in regards to portions of your property and conducted a development enterprise.

While an activity such as the selling of an asset may not of itself amount to an enterprise, account should be taken of the other activities leading up to the sale to determine if an enterprise is carried on.

Paragraph 264 of MT 2006/1 discusses two court cases [Statham & Anor v. Federal Commissioner of Taxation (Statham) and Casimaty v. FC of T (Casimaty)] involving subdivision and development of properties that were originally held as capital/investments assets, where the court decided that the sale of the post-subdivision lots was the mere realisation of capital/investment assets.

From these cases a list of factors can be ascertained that provide assistance in determining whether activities are a business or an adventure or concern in the nature of trade as opposed to the mere realisation of a capital asset.

Paragraphs 178 of MT 2006/1 set out the indicators of a business and paragraph 265 sets out relevant factors when examining isolated transactions

Indicators of carrying on a business.

·         a significant commercial activity;

·         a purpose and intention of the taxpayer to engage in commercial activity;

·         an intention to make a profit from the activity;

·         the activity is or will be profitable;

·         the recurrent or regular nature of the activity;

·         the activity is carried on in a similar manner to that of other businesses in the same or similar trade;

·         activity is systematic, organised and carried on in a businesslike manner and records are kept;

·         the activities are of a reasonable size and scale;

·         a business plan exists;

·         commercial sales of product; and

·         the entity has relevant knowledge or skill.

Factors used to examine an isolated transaction:

·         there is a change of purpose for which the land is held;

·         additional land is acquired to be added to the original parcel of land;

·         the parcel of land is brought into account as a business asset;

·         there is a coherent plan for the subdivision of the land;

·         there is a business organisation (for example, a manager, office and letterhead);

·         borrowed funds financed the acquisition or subdivision;

·         interest on money borrowed to defray subdivisional costs was claimed as a business expense;

·         there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and

·         buildings have been erected on the land.

In addition other factors that may be relevant include:

·         the length of time the property had been held and the purpose to which it was put to in that time; and

·         the personal involvement in the development activity.

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.

In applying the above factors to this case, we acknowledge that:

·         Lot B that you sold is the remaining land from the original land you purchased as an investment property.

·         You have consistently used portions of your land as a capital asset to derive income from the lease of the land since it was acquired until the house was demolished and the new residences were constructed.

·         Your original intention in purchasing the land was to hold the land as an income earning real property as a long term investment, whereby a lessee would occupy the house. The characteristics of the land predisposed the land to this use, as the land is residential in nature.

·         You formed the intention to conduct a development enterprise.

·         The activities in developing the property were small scale.

·         There has been only one sale.

While the factors above in isolation would support the view that you are merely realising a capital asset when you sell the lots, we consider that the following factors lend support to the conclusion that your supplies are made in the course or furtherance of an enterprise of subdivision and sale:

·         You changed your intention and decided to enter a profit making undertaking or scheme.

·         You had only held the land for approximately three years before you decided to subdivide and sell.

·         The development of lot B and constructing residential premises to sell.

·         Your activity involving preparing the Property for sale was a significant commercial activity and you intended to make a profit.

·         You borrowed funds to conduct the subdivision and sale.

·         The activity was conducted in a similar manner to other entities similar in size and structure to yourself

·         Your sale proceeds were significant

·         You marketed the property for sale.

In considering all the relevant facts surrounding your circumstances, including the above factors, we consider the purpose for which that portion of the land not used for the residential leasing activity has changed over time.

On balance, we consider that over the period that the land was held by you, its character has changed from capital to revenue for lot B. The undertaking was significant compared with other activities that may have only been the mere subdivision and sale of the lot. Therefore, when you sold lot B the Commissioner considers the sale of new residential premises was not be the sale of a capital asset. Accordingly, paragraph 188-25(a) of the GST Act will not apply and the supply (likely to exceed $75,000) must be included in your projected turnover.

The Commissioner is satisfied that you were required to be registered for GST.