Edited version of private advice

Authorisation Number: 1051625217388

Date of advice: 9 April 2020

Ruling

Subject: Capital gains and specific entitlement

Question 1

Was the sale of the property on capital account?

Answer

Yes

Question 2

Will the Trustee be assessed on the capital gain made on the sale of the property if the remainder beneficiaries are specifically entitled under section 115-228 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 3

Did you make a taxable supply of land when you sold the property, pursuant to section 9-5 of A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

No

Question 4

Are you required to be registered for GST under section 23-5 of the GST Act?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 20xx

Year ended 30 June 20xx

Year ended 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

Person A (the deceased) owned a pre-CGT property with a dwelling built in the early 19XXs (the Property). It was the long term matrimonial home of the deceased and their spouse (Person B).

Person A passed away with a Will. The beneficiaries of the will are Person B and their children. The deceased's will provides Person B with a life interest in Person A's estate. The deceased's children are the residual beneficiaries in equal shares and proportions.

The will also provides certain powers to the trustees, including the power to sell property and the power to permit Person B to use and occupy the property rent-free.

Person B remained in the matrimonial home before they were admitted to an aged care facility. They passed away not long after moving into care.

The executor and trustee for the deceased's estate (the Trustee) engaged a real estate agent to sell the property shortly after the Court granted probate on Person B's estate.

The real estate agent advertised the property for sale. It was recommended that the dwelling be demolished. The trustee acted on the said advice.

The dwelling was subsequently demolished and the costs were funded by Person B's estate.

The Trustee did not apply for any rezoning or subdivision. He is retired and has no experience in land development.

The following year, the Trustee engaged the services of another real estate agent to sell the cleared block of land. Some expressions of interest were received, but none of these came to fruition.

The Trustee sought a retrospective property valuation report for the vacant land. The land was valued at par with the property inclusive of the dwelling.

The Trustee sold the land to a property developer who planned to construct an apartment building on it.

The parties entered into a contract for sale which included a special conditions clause in relation to the development of the property. The special conditions clause included the following terms:

·         The Vendor agrees to provide consent in relation to the Purchaser lodging for development applications and planning permits.

·         The Purchaser is solely responsible for development costs.

The sale of the property was settled.

The trust had no outstanding liabilities, other than intra-family liabilities relating to demolition of the dwelling. All other assets and liabilities of the estate have been dealt with except for the sales proceeds from the property and a receivable owing from a related family trust.

The Trustee has not made the choice under section 115-230 of the ITAA 1997 to be specifically entitled to the capital gain made on the sale of the property.

The remainder beneficiaries are all Australian residents and none of them are under a legal disability.

The Trustee has not distributed any amount to the remainder beneficiaries from the sales proceeds at the time of this ruling application.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 subsection 104-10(2)

Income Tax Assessment Act 1997 subsection 104-10(3)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 118-20

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part3-3

Income Tax Assessment Act 1997 Subdivision 115-C

Income Tax Assessment Act 1997 section 115-225

Income Tax Assessment Act 1997 section 115-227

Income Tax Assessment Act 1997 section 115-228

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 9-40

Reasons for decision

Question 1

Was the sale of the Property on capital account?

Summary

The sale of the Property is a 'mere realisation' of a capital asset.

Detailed reasoning

Taxation treatment of property sales

There are three ways profits from a land sub-division can be treated for taxation purposes:

1.      As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock.

2.    As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of an isolated commercial transaction entered into by a non-business taxpayer or outside the ordinary course of business of a taxpayer carrying on a business, which is the commercial exploitation of an asset acquired for a profit making purpose.

3.    As statutory income under the capital gains tax (CGT) regime (sections 10-5 and 102-5 of the ITAA 1997) on the basis that a mere realisation of a capital asset has occurred.

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

Carrying on a business of property development

Section 995-1 of the ITA 1997 states that 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 Income tax: am I carrying on a business of primary production? Although TR 97/11 deals with the issues of determining whether a taxpayer is carrying on a business of primary production, the same principles can be applied to the question of whether a taxpayer is in the business of property development.

Paragraph 13 of TR 97/11 includes 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 a commercial flavour.

Isolated business transactions

Profits arising from an isolated transaction as a result of entering into a profit-making undertaking or scheme will be ordinary income under section 6-5 of the ITAA 1997, on revenue account, (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693(Myer Emporium)). This is distinguished from a 'mere realisation' which is not ordinary income.

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) sets out the Commissioner's view on the application of the decision in Myer Emporium and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income.

Paragraph 1 of TR 92/3 provides that 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.

Paragraph 6 of TR 92/3 provides that a profit from an isolated transaction is generally income when both of the following elements are present:

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

(b)  the transaction was entered into, and the profit was made in the course of carrying on a business operation or commercial transaction.

Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of subdivided land can be assessed as ordinary income within section 6-5 of the ITAA 1997.

Paragraph 13 of TR 92/3 lists the following factors which are relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction include:

(a)  the nature of the entity undertaking the operation or transaction;

(b)  the nature and scale of other activities undertaken by the taxpayer;

(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;

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

(g)  if the transaction involves the acquisition and disposal of property, the nature of that property; and

(h)  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.

Mere Realisation

Where the sale is a 'mere realisation' the sale is on capital account to which the CGT rules will generally apply. These proceeds are not ordinary income.

A sale that is more than a 'mere realisation' will be on revenue account and proceeds will generally be assessable as either income from the carrying on of a business or income from a profit making undertaking or scheme.

The expression 'mere realisation' is used to distinguish a mere realisation from a business operation or a commercial transaction carrying out a profit-making scheme.

Profits made on the realisation of capital assets can still be ordinary income if the activities go beyond a mere realisation and instead become a separate business operation or commercial transaction even though the taxpayer did not have a purpose of profit-making at the time of acquiring the asset.

Application to your circumstances

The Commissioner considers that the Trustee has not undertaken a business operation or commercial transaction.

The following factors were also considered:

·         The length of time that the property has been held as the main residence.

·         The period it took for the Trustee to put the property in the market for sale from the time the life tenant passed away. The Trustee decided to sell the property soon after the life tenant's death for the benefit of the remainder beneficiaries.

·         The property was simply listed with the local real estate agents.

·         The Trustee was neither a property developer, nor was he involved in buying and profitably selling developed land or land for development.

·         The market value of the property before and after the dwelling was demolished.

·         The Trustee did not receive any purchase offers prior to prior to selling the land to a property developer.

·         The Trustee had limited involvement in the development of the property. The Trustee only granted access and license to the Purchaser during the preparatory stage of development.

·         The Purchaser applied for the development consent and funded the development.

The sale of the property is a mere realisation of an asset: it is the disposal of a CGT asset that is subject to capital gains tax. Upon execution of the sale contract CGT event A1 happened in relation to the property.

Question 2

Will the Trustee be assessed on the capital gain made on the sale of the property if the remainder beneficiaries are specifically entitled under section 115-228 of the ITAA 1997?

Summary

No. The Trustee will not be assessed on the capital gain made on the sale of the property as the beneficiaries were made specifically entitled to the trust's capital gain under section 115-228 of the ITAA 1997.

Detailed Reasoning

Specifically entitled beneficiaries

Subdivision 115-C of the ITAA 1997 sets out the rules for calculating a beneficiary's net capital gain if they are entitled to a distribution from a trust that includes a net capital gain.

Section 115-228 of the ITAA 1997 outlines when a beneficiary will be regarded as specifically entitled to a trust capital gain (either in whole or in part). A beneficiary is specifically entitled to a capital gain if the following two conditions are satisfied:

·         The first condition for a beneficiary to be specifically entitled to a capital gain is that the beneficiary receives, or is reasonably expected to receive, an amount equal to their share of the net financial benefit that is referable to the capital gain. A beneficiary's entitlement can be expressed as a dollar amount, a share of the trust gain or distribution, or using a known formula provided it refers to the capital gain.

·         The second condition for a beneficiary to have a specific entitlement to a capital gain is that the beneficiary's entitlement to the amount is recorded in its character as referable to the capital gain, in the accounts or records of the trust no later than two months after the end of the income year. This record must be contained in the accounts or records of the trust, such as the trust deed, trust accounts, resolutions and distribution statements, including schedules and notes attached to, or intended to be read with, these documents. A record for tax purposes only does not create specific entitlement.

When a beneficiary is specifically entitled to a capital gain, any resulting extra capital gain (subsection 115-215(3) of the ITAA 1997) will be taken into account in determining the beneficiary's net capital gain to be included in their assessable income. Alternatively, capital gains to which no beneficiary is specifically entitled flow proportionally to beneficiaries and/or the trustee based on their proportional share of the income of the trust estate.

A trustee of a resident trust estate is allowed to make a choice that has the effect that the trustee will be assessed on a capital gain of the trust if no trust property representing the capital gain has been paid to or applied for the benefit of a beneficiary of the trust. In this case, the Trustee has not made a choice to be specifically entitled to any of the capital gains under section 115-230 of the ITAA 1997.

In this case, the estate did not earn any income. The only part of the estate that remains available prior to it being fully administered is the actual proceeds of the trust (reduced by trust losses and expenses) from selling the property.

In accordance with the Will, the Testamentary Trust's deed, the financial benefit representing the capital gain is the asset (or the value of that asset), and the only beneficiaries entitled to receive this are the children of the deceased. The Trustee has exclusively set aside the net capital gain for the beneficiaries.

The Will which created the Testamentary Trust meets the description of a record of the trust and records the financial benefit that the beneficiaries are expected to receive in its character as referable to the capital gain.

The two conditions for the beneficiaries of the deceased's estate to be viewed as being specifically entitled have been met. The beneficiaries have been made specifically entitled to the capital gain for the purposes of section 115-228 of the ITAA 1997. Accordingly, as the remainder beneficiaries are all Australian residents and none of them are under a legal disability, the Trustee will not be assessed on the capital gain.

Questions 3 and 4 GST

In this reasoning unless otherwise stated:

·         all legislative references are to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)

·         reference material(s) referred to are available on the Australian Taxation Office (ATO) website www.ato.gov.au

Section 9-40 provides that you must pay the GST on any taxable supplies that you make.

Section 9-5 provides:

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 the indirect tax zone; 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.

As you were not registered for GST, the question in this case is whether you were making a supply of the Properties in the course or furtherance of an enterprise that you carried on. If so, we must then determine whether you were required to be registered for GST.

Section 9-20 provides that the term 'enterprise' includes, among other things, an activity or series of activities done in the form of a business or done in the form of an adventure or concern in the nature of trade. The phrase 'carry on' in the context of an enterprise includes doing anything in the course of the commencement or termination of the enterprise.

Miscellaneous Taxation Ruling MT 2006/1 (MT 2006/1) provides the Tax Office view on the meaning of 'enterprise' for the purposes of entitlement to an Australian Business Number (ABN). Goods and Services Tax Determination GSTD 2006/6 provides that the discussion in MT 2006/1 equally applies to the term 'enterprise' as used in the GST Act and can be relied on for GST purposes.

Paragraph 178 of MT 2006/1 lists a number of indicators considered when attempting to determine whether an activity or series of activities amount to 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.

Furthermore, 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'. This paragraph provides that:

·         a business encompasses 'trade engaged in, on a regular or continuous 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.

Paragraph 262 of MT 2006/1 acknowledges that the question of whether an entity is carrying on an enterprise often arises where there are 'one-offs' or isolated real property transactions. Paragraph 263 continues stating that the issue to be decided is whether the activities being conducted are an enterprise in that they are of a revenue nature as they are considered to be activities of carrying on a business or an adventure or concern in the nature of trade (profit making undertaking or scheme) as opposed to the mere realisation of a capital asset.

Given the facts of this case, we consider that the activity of selling the land is not in the course of carrying on a 'business'. We do not consider your activities constitute an adventure or concern in the nature of trade and as such are not an 'enterprise' for the purposes of GST. Therefore the sale of the land would be considered to be the mere realisation of a capital asset.

As it is considered that the sale of the land did not constitute an 'enterprise' for GST purposes, you are not required to be registered for GST.