Edited version of private advice

Authorisation Number: 1051639184074

Date of advice: 05 March 2020

Ruling

Subject: Assessable income - sale of property - revenue versus capital

Question

Is the profit from the sale of the property assessable as ordinary income?

Answer

Yes.

This ruling applies for the following period

Year ending 30 June 2020

The scheme commenced on

1 July 2019

Relevant facts and circumstances

You are a professional builder.

You have previously purchased a number of properties which you have renovated and rented out. These properties were financed with bank loans.

You are currently renovating another property. The purchase of this property and the cost of renovations were financed with loans from family members.

You have encountered financial pressures and are planning to sell the property following the completion of the renovations.

A statement from a family member that loaned you the money stated that the loan would be repaid on the sale of the property once the renovations are completed.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Reasons for decision

Summary

You are not considered to be carrying on a business in your individual capacity. However, the acquisition, renovation and sale of the property is considered to be in the nature of an isolated commercial transaction undertaken for the purpose of making a profit. As such, the profit you make from the sale of the property will be assessable as ordinary income under section 6-5 of the ITAA 1997.

While capital gains tax (CGT) event A1 will happen upon the sale of the property, any capital gain made on its disposal will be reduced to the extent that the profit from its sale is already included in your assessable income.

Detailed reasoning

Broadly, there are three main ways profits from a property sale 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 business 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 CGT legislation on the basis that a mere realisation of a capital asset has occurred.

Carrying on a business

Taxation Ruling TR 97/11 outlines some factors that indicate whether or not a business is being carried on.

Based on the information provided, we do not consider that any profit made from the sale of the property would be derived in the course of carrying on a business in your individual capacity.

Profits from an isolated transaction

Profits arising from an isolated business or commercial transaction will be ordinary income if the purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693)(Myer Emporium).

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income.

TR 92/3 defines the term 'isolated transactions' as:

• transactions outside the ordinary course of business of a taxpayer carrying on a business, and
• transactions entered into by non-business taxpayers.

If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayer's business but:

·         the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain, and

·         the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction

Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of land can be assessed as ordinary income within section 6-5 of the ITAA 1997. TR 92/3 lists the following factors to be considered:

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 contrast, paragraph 36 of TR 92/3 notes that 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. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment.

In addition to the above general factors contained in TR 92/3, 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 provides a list of specific factors relevant to isolated transactions and sales of real property. These factors are as follows:

·         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 determining whether activities relating to isolated transactions are an enterprise or are the mere 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.

Application to your circumstances

Although you are not considered to be carrying on a business in your individual capacity, it is not considered that the transaction (selling the property) is a mere realisation of an asset. You are not merely selling a property you had been using as a rental property or your home; you spent a substantial amount renovating the property, which will considerably increase the value of the property and will likely result in a profit (no matter how long the property is held).

While it is acknowledged that you purchased and rented out the other properties following renovations, and it was your stated intention to do the same with the property, the available evidence indicates that you purchased the property to renovate and sell it at a profit.

The declaration from the family member who lent you money to finance the acquisition of the property states that the 'money is to be repaid on the sale of this property once the renovations are completed'. This declaration suggests that the lender had an expectation that the property was to be sold soon after the renovations were completed and points towards an intention that the property was acquired to renovate and be sold at a profit. Additionally, the property can be distinguished from the other properties as it was acquired with private loans from family members whereas the other properties were financed with bank loans.

You are a professional builder and renovated the property yourself. After an objective consideration of the facts, it is the Commissioner's view that the renovation and sale of the property has the characteristics of a commercial transaction. That is, your transaction goes beyond that of a mere realisation of a capital asset.

Accordingly, the profit you make from the sale of the property is assessable as ordinary income under section 6-5 of the ITAA 1997.

Additional information - assessable under the capital gains tax provisions

The CGT provisions are contained in Part 3-1 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.

CGT event A1 happens if you dispose a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property (section 104-10 of the ITAA 1997). CGT event A1 will happen when you dispose of the property.

A capital gain you make from a CGT event is reduced if, because of the event, a provision of the ITAA 1997 (outside of Part 3.1) includes an amount (for any income year) in your assessable income or exempt income (subsection 118-20(1) of the ITAA 1997).

Subsection 118-20(1) of the ITAA 1997 applies to an amount that, under a provision of the ITAA1997 (outside of part 3.1), is included in your assessable income or exempt income in relation to a CGT asset as if it were so included because of the CGT event referred to in that subsection if the amount would also be taken into account in working out the amount of a capital gain you make (subsection 118-20(1A) of the ITAA 1997).

Section 118-20 of the ITAA 1997 primarily exists to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. In the absence of such a provision, it is conceivable that a receipt properly characterised as ordinary income and which has also been derived as a result of a CGT event could result in the receipt being taxed twice.

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