Edited version of private advice

Authorisation Number: 1051776305313

Date of advice: 18 August 2021

Ruling

Subject: CGT small business concessions

Question 1

Did the Unit Trust A carry on a business land development, subdivision and sale during the period the X Family Trust held its ownership interest?

Answer

No

Question 2

Was the interest held by the X Family Trust in the Unit Trust A an active asset, satisfying subsection 152-40(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following period 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

Timeline of key events

Establishment of the relevant holding entities

1.     X Family Trust with investor X as individual Trustee was established.

2.     Company A was registered, with Investor X and Investor Y as equal shareholders.

3.     Unit Trust A was established with Company A as Trustee. The initial unit holding was held equally as follows:

a)               Investor X as trustee for the X Family Trust, 50% of the number of units

b)               Investor Y as trustee for the Y Family Trust, 50% of the number of units.

4.     Both investors had extensive experience in a wide range of business planning and management, including within building, construction and property development businesses.

Acquisition of the land

5.     The Land was purchased by Company A in its capacity as Trustee for the Unit Trust A.

6.     The Land consisted of several titles.

7.     At the time of the Unit Trust A's acquisition, the only use of the Land was renting a shed to an unrelated 3rd party.

8.     A development application was submitted for an industrial subdivision on the Land previously in late 20XX. The application had been made by a previous entity of Investor Y.

9.     Development Consent for the development of the Land had been provided by the local council at the time and contained many conditions to be met by the developer prior and during construction.

10.  Investor X was initially engaged by Investor Y as a consultant in the project

11.  The original attempt to development the Land had failed to materialise, and investor Y was forced to sell.

12.  As a result of Investor X and Y's previous association with the Land, and their position as directors of its corporate trustee, the Unit Trust A also inherited the knowledge and contacts associated with the prior attempt to develop the Land. This included:

a)               An existing development plan and consent granted by the Council.

b)               A website (although not fully developed).

c)               Promotional material.

d)               Contacts with potential investors, parties interested in acquiring land and parties seeking possible tenancy under the proposed land subdivision and sale.

e)               Construction budgets.

f)                Contacts and other information acquired during the course of the previous attempt to pursue the development of the Land that might prove useful should the Unit Trust A undertake the development.

13.  Prior to the Land purchase there was a perception that the Development Consent had lapsed due to inactivity. Investor X carried out extensive research on legal cases relating to the lapsing of Development Consent.

14.  On the basis of this research, Investor X provided a submission to Council that the Development Consent had remained active due to offsite works related to the consent conditions.

15.  Council subsequentially agreed that as relevant works were completed prior to the lapsing date of the consent, the Development Consent remained active.

Intent for acquiring the Land

16.  The Unit Trust A acquired the land with the intent of developing the site, selling only enough individual sites as were required to fund the proposed land development and sale and retain the balance of the property to hold and rent to third parties on a long-term basis. This was in accordance with the Development Consent granted by Council in 20XX (reference - the proposed land subdivision and sale). However, as a last resort, if the Unit Trust A could not finance the proposed land subdivision and sale, get an investor, joint venture partner or sell part of the land, the Unit Trust A had considered the possibility of simply reselling the Land as a whole should that be necessary. At the time of the disposal of the X Family Trust's final units in the Unit Trust A, the Unit Trust A had not obtained the necessary finance to pursue the proposed land subdivision and sale and all options remained available to the trust.

Bars to the development of the land

17.  At the time of acquisition of the Land by the Unit Trust A, and until the time the X Family Trust sold its remaining units in the Unit Trust A, the Unit Trust A had not commenced construction works on the proposed land subdivision and sale. The Unit Trust A was unable to do this as it was hampered by certain constraints:

a)               It had limited financial reserves; and

b)               there were a number of conditions that had to be met prior to a construction certificate being issued that would allow it to commence physical development works. One condition of these being the upgrade of a public bridge owned by the Government. Until the Government decided to fund and complete this upgrade, the Unit Trust A could not legally proceed with construction of the proposed land subdivision and sale.

Circumstances leading to the disposal of The Newman Family Trusts interest

18.  After the Y Family Trust acquired its interest in the Unit Trust A, Investor Y had borrowed funds from a relative and on lent these funds to the Unit Trust A so the property purchase could settle as contracted. The loan agreement provided for the loan to be converted to an equity share in the property should Investor Y default on the repayment that was due shortly after settlement. The loan repayment was not made by the required date.

19.  After discussion with legal counsel, contracts were prepared to put into effect the default agreement between Investor Y and their relative. The relative (Investor Z) was subsequently afforded a 25% shareholding in the corporate trustee Company A and (via their Company) a 25% holding in the Unit Trust A.

20.  Investor X and Y recognised the benefit of admitting Investor Z as a unit holder because of Investor Z's many years of experience in the business of property development and their access to funding. Investor Z had knowledge of financing construction development and had contacts to the finance industry that were seen as invaluable in fulfilling the construction, planning, and financing of the proposed land subdivision and sale.

21.  Investors Z's company had the people experience and machinery capable of carrying out the construction and development stages of the proposed land subdivision and sale.

22.  Investor Z maintained involvement in aspects of the proposed land subdivision and sale through regular meetings with Investor Y.

23.  In the following year, Investor Z requested a review of the project to be undertaken by an industrial consulting business. This review concluded a property value for the Land considerably higher than it was acquired for two years earlier.

24.  Subsequently Investor Z offered to purchase the X Family Trust Units in the Unit Trust A.

25.  Investor X as trustee for the X Family Trust agreed to sell the X Family Trust's remaining units in the Unit Trust A to Investor Z's company and sale was completed a short time later.

26.  The Land represented more than 98% of the total assets of the Unit Trust A by book value in the financial year in which the sale of the X Family Trust's remaining units occurred. Accordingly, it is assumed that the market value of the Land at the time was more than 80% of the market value of all the Unit Trust A's assets.

The Unit Trust A activities during the X Family Trust ownership period

Investor X actively participated in the activities of the Unit Trust A on behalf of the X Family Trust during the time it was a unit holder in the period between 20XX-20XX. At the time, these activities consumed the vast majority of Investor X's working life. During the whole period that the X Family Trust was a unit holder in the Unit Trust A, Investor X did / assisted the Unit Trust A to carry out the following activities:

A.     Appointment of legal firm.

B.     Appointment of an accounting and advisory firm.

C.    Establishment of Unit Trust A, including receipt of stamped Unit Trust A Deed.

D.    Establishment of Company A, creation of company Constitution, registration of company and receipt of ASIC Certificate of Company Incorporation.

E.     Obtained an Australian Business Number.

F.     Established financial accounts.

G.    Registered for GST.

H.    Rented part of the land to two unrelated tenants the following buildings located on the Land:

                 i.                    A shed on the Land rented to a manufacturer / distributor. The tenant had occupied the shed prior to the relevant ownership period.

                ii.                    A house on the Land rented after engagement of a local real estate agent.

I.       Confirmed that the Development Consent obtained by the prior owner remained active prior to settlement on as previously discussed.

J.      Undertook development planning activities including a review of the existing Development Consent and aspects of the proposed land subdivision and sale. Prior to settlement of the Land, the Unit Trust A sought town planning advice from a local firm who had previously been engaged with the project. They were not formally engaged but advised that the Unit Trust A should re-visit every aspect of the planning process to ensure that current council and legal requirements were being met in light of changes since Development Consent approval was originally granted. This process included:

                 i.                    Reviewing the original consent letter and its schedule of individual conditions.

                ii.                    Reviewed the development application and its appendices which were legally part of the Development Consent.

              iii.                    Reviewed the implementation meeting minutes that had previously been held with council.

              iv.                    Reviewed the development assessment panel's report.

               v.                    Reviewed most of the relevant legislative instruments to identify any changes that had occurred post the granting of the Development Consent that may impact the proposed land subdivision and sale.

              vi.                    Investigated the use of Asset Protection Zones (APZs) for roadways to reduce the internal road footprint, considering any implications for the design of services. A previous agreement had been reached for the purchase of adjacent land to be dedicated to the road corridor. However, a review of the implementation meeting had identified additional requirements and therefore cost. An alternative the owners were pursuing, involved the use of the Asset Protection Zone (APZ) to provide access to lots without the requirement for the land purchase.

             vii.                    Obtained electricity line maps and consulted with solar investment company in relation to the potential for onsite solar power generation. Considered the feasibility could potentially involve a ring main interconnected internal electrical grid with rooftop solar of retained premises supply power at cost to leased or sold premises.

           viii.                    Considered changes to the stormwater catchment plan, in order to reduce the footprint, potentially increasing the area of saleable land. In addition, investigated the potential for retaining water for re-use.

              ix.                    Identified an error in stormwater corridor, reduction of the corridor width had previously been agreed but had not been officially documented.

               x.                    Researched contractors for civil construction, ecological consultants, and a principal certifying officer.

              xi.                    Liaised with the state rail corporation to investigate requirements for connection and operation of the rail system.

             xii.                    Consideration of the purchase of other properties in the area to allow further development in the precinct.

           xiii.                    Consideration of the council requirements identified a significant increase in contributions required. This was a consequence of the required offsite road upgrade works having been completed by an external agency.

           xiv.                    Liaised with a representative from local community in relation to the local reserve rehabilitation.

            xv.                    Began consideration of what would be required for the vegetation management plan. This was informed by a review of reports that had been previously completed by external consultants.

           xvi.                    Approached council about reviewing the conditions of consent relating to a staged implementation of the proposed land subdivision and sale, but nothing came of this.

K.     Physical work on the project site could not start until the Development Consent Construction Certificate conditions were completed. The Unit Trust A's progress on these conditions are summarised as follows:

                 i.                    Lobbied Government to upgrade the road over rail bridge. Although the upgrade of the bridge by the Government was not completed until shortly after the X Family Trust disposed of its interest in the Unit Trust A, the bulk of the work to get the bridge upgrade gazetted and approved, with Government funding provided, was completed before the sale of the interest. Until it was completed a construction certificate could not be issued.

                ii.                    Lobbied Government for completion of offsite roadworks required in relation to construction certificate conditions.

              iii.                    Considered alternative solutions involving the use of the APZ's to satisfy one of the conditions that required land to be purchased to allow access for certain lots.

              iv.                    Other construction certificate conditions requiring significant investment involving consultants and engineers. These were not progressed during the ownership period due to a lack of funding.

L.     Determined land value:

                 i.                    Approached a range of professional commercial valuers and real estate professionals. This provided estimates on the value of the proposed land subdivision and sale in addition to seeking interest to formally value.

                ii.                    Reviewed the state's Valuer-General Report for the local area as well as recent sales to provide an estimate of the increase in price of similar industrial land.

              iii.                    Conducted a review of land, economic and transport studies relevant to the region to be considered in the context of the land subdivision and sale proposal.

              iv.                    Engaged an industrial property consulting business to provide an updated appraisal for internal purposes.

               v.                    Provided a submission to the council for updating information in relation to the Land in the previously released Urban Growth Management Strategy to correct errors. Amendments were accepted by council and included in their subsequent Urban Growth Management Strategy.

M.    Marketed the proposed land subdivision and sale opportunity to financiers and potential tenants / purchasers:

                 i.                    Updated marketing information as required when project proposal milestones were achieved.

                ii.                    Developed a sales material (brochure) for the proposed land subdivision and sale.

              iii.                    Provided tailored information to potential purchasers, tenants and investors.

              iv.                    Provided updates to interested parties about the proposed land subdivision and sale progress.

               v.                    Revised relationships and promoted the land subdivision and sale proposal.

              vi.                    Purchased domain name and created an enquiries email address.

             vii.                    Worked with designer and developer to create website to the Beta test phase. This was not fully launched as funds were used for brochure and material used in a targeted marketing approach.

           viii.                    Contracted graphic design, photographic work, PowerPoint presentations and aerial photos for the use in the brochure and materials used to promote the proposed land subdivision and sale.

              ix.                    Participated in membership of local chamber of commerce to promote the proposed land subdivision and sale.

               x.                    Identified real estate agencies to promote the property.

              xi.                    Maintained relationships with relevant industry bodies to promote the proposed land subdivision and sale.

             xii.                    Sort to have the proposed land subdivision and sale listed with Austrade.

           xiii.                    Made presentations to councillors to provide information about the project proposal.

           xiv.                    Arranged aerial photographs of the site and surrounding area.

            xv.                    Targeted marketing approaches and engagement to several potential anchor tenants, purchasers and investors.

N.    Revised the inherited construction budget to current prices. The revision considered inflation in addition to changes resulting from the planning review, development optimisation and other changes that had occurred since it was originally prepared.

O.    Conducted preparatory, pre-contract discussions with potential civil contractors for the proposed land subdivision and sale.

P.     Pursued potential finance and equity partners.

Q.    Received interest in the proposed land subdivision and sale from an overseas buyer for the Land, however prior to discussions with the Foreign Investment Review Board (FIRB) concluded the parties were not legitimate purchasers, so it went no further.

The X Family Trust provided an estimate of the value of work of Investor X contributed to the activities of the trust.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Summary

It is the Commissioner's view that the activities undertaken by the Unit Trust A during the X Family Trust Ownership period were preliminary and preparatory in nature and did not amount to carrying on a business of property development, sale and rental.

Detailed reasoning

Section 995-1 of the ITAA 1997 states that the term 'business', includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

The question of whether a business is being carried on is a question of fact and degree and depends on the impression of a taxpayer's activities considered as a whole. Over the years the courts have developed a series of indicators to determine if a business is being carried on. The Commissioner's view on relevant factors used to determine if an entity is carrying on a business are set out in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production?:

•                 Whether the activity has a significant commercial purpose or character.

•                 Whether the taxpayer has more than just an intention to engage in business.

•                 Whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity.

•                 Whether there is regularity and repetition of the activity.

•                 Whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business.

•                 Whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit.

•                 The size, scale and permanency of the activity.

•                 Whether the activity is better described as a hobby, a form of recreation or sporting activity.

In the present case it is asserted that Unit Trust A had commenced a business of property development, sale, and rental.

However, here the critical question is whether the activities undertaken by the Unit Trust A were merely preliminary or preparatory to the carrying on of such a business or whether the business had actually commenced.

Preparatory activities - When does a business activity commence?

The actual date of commencement of a business activity is a question of fact and the nature of the activity said to amount to the business is critical to determining whether that business has actually commenced (Goodman Fielder Wattie Ltd v. FC of T 91 ATC 4438 at 4447; (1991) 22 ATR 26) (Goodman Fielder Wattie).

For a particular business activity to have commenced a person must have1:

•                 Committed to the activity - that is they had purpose, intention and made the decision to commence the business activity (Goodman Fielder Wattie at [4447], Softwood Pulp and Paper Ltd v FC of T 76 ATC 4439 (1976) 7 ATR 101 at [4451] (Softwood), John Fairfax & Sons Pty Ltd v. Federal Commissioner of Taxation (1959) 101 CLR 30

•                 acquired the minimum level of business assets to allow that business activity to be carried on; and

•                 actually commenced the relevant business operations.

A mere intention or desire to carry on a business is insufficient (Southern Estates Pty. Ltd. v. Federal Commissioner of Taxation [1967] HCA 16; (1967) 117 CLR 481 per Brennan; McTiernan J and Barwick CJ at 488 on appeal - endorsed by Brennan J in Inglis v. FC of T 80 ATC 4001 at [4004-4005]; (1979) 10 ATR 493 (Inglis) at 496-497; Calkin v. CIR [1984] 1 NZLR 440; J & R. O'Kane & Co. v. Inland Revenue Commissioners (1920) 12 TC 303 at [347]).

In this case, for the business to have commenced, it must be shown that the Unit Trust A had committed to the activity, embarking on a definite and continuous cycle of operations designed to lead to the development, subdivision and sale of the land (see for example Whitfords Beach Pty Ltd v. FC of T 83 ATC 4277; (1983) 14 ATR 247 (Whitfords Beach)and Puzey v. Commissioner of Taxation (2003) 53 ATR 614).

In Inglis per Davies (with whom St. John J agreed at [4007-4008]), a lack of certainty as to the use, where there are multiple options for the future use of an asset (in that case the land), was a factor that weighed against a conclusion that a business (of primary production) was carried on at a particular time. In that case, the land may have been used for private purposes, primary production, or alternatively, sale contracts could proceed to allow a family company to undertake a primary production activity.

In Softwood Pulp and Paper Ltd v. FC of T 76 ATC 4439; (1976) 7 ATR 101, activities relating to the establishment of a paper production operation were considered to be preliminary to carrying on a business. Menhennitt J found "that the taxpayer never committed itself to go on with the project, never made a final definitive decision to do so" An important fact in the reasoning provided by Menhennitt J, was that the taxpayer lacked the capital required to undertake the proposed activity (see also Goodman Fielder Wattie at [4448]).

Whitfords Beach examined the issue of the commencement of a business activity and the factors to consider when determining the commencement of a business activity. These factors were a consideration of the taxpayer's purpose and the taxpayer's activities. Bowen CJ, Morling and Fitzgerald JJ said, at ATC 4282; ATR 253:

'Of course, it does not follow that all the activities engaged in by the taxpayer were necessarily in the course of that business or that some of them were not merely preparatory to it. In order to determine when the taxpayer's relevant business commenced and when its land or the various parts of it were committed to or ventured in that business, it is necessary to have regard both to the taxpayer's purposes and to its activities.'

Whitford's Beach involved a change of intention and the undertaking of activities which showed a business had clearly commenced. This followed a transfer of share ownership, a change in the directors and a change in the articles of association occurred on 20 December 1967. On the same day, Whitford's Beach embarked on clear course of action which can be said to be the commencement of the business -including, contracting general managers to undertake the subdivision and development of the land, Wilson J at [4053] adopted the words from the Federal Court where Deane J stated:

It is plain the effect of the transactions and events of 20 December 1967 was completely to transform the sub-stratum of the taxpayer. At the commencement of that day, the taxpayer was a company whose only significant asset was land which had been acquired for the purpose of safeguarding the interests of its shareholders as owners of the Whitford's Beach shacks and which, under the Articles of Association was, when subdivision became possible, to be allocated among the shareholders with any surplus to be dealt with as the company might, in general meeting, decide. At the end of that day, the taxpayer had set out upon a projected course of activity in relation to that land which involved procuring changes of zoning, the development of the subject land as a residential subdivision and the eventual sale, over a period of many years, of the subdivided lots....

Application to your circumstances

Taking all the available facts into consideration, and on weighing the relevant facts, on balance the better view is that a business of property development, sale and rental had not commenced during the period the X Family Trust held its ownership interest. The key facts leading to this conclusion are that:

•                 The Unit Trust A did not have the finance necessary to undertake the development as per the existing development consent issued by local council.

•                 There were a number of options still being contemplated by the Unit Trust A including the sale of the Land as a whole or the possible development, subdivision and sale of some or all if the Land by the taxpayer, or entering into a joint venture or partnership with another user.

•                 The marketing activity undertaken are properly characterised as activities aimed at establishing the viability of the project (seeking to identify whether there was interest in the proposed land) and seeking the necessary finance and or investors necessary for the Unit Trust A to undertake the proposed development.

•                 The Unit Trust A was not in a position to and did not have or enter any contracts with any third parties to undertake the development - notably a town planner and a civil contractor. All discussions with civil contractors were merely preliminary and helped establish a potential budget. The town planner approached was not contracted, rather merely advised them they needed to carefully consider the existing development consent to ensure there were no changes to requirements.

•                 The Unit Trust A was not in a position to obtain a construction certificate to enable it to commence the development as, among other things this was contingent on Government completing an upgrade to the road over rail bridge. This was out of the Unit Trust A's control.

•                 The Unit Trust A spent time considering any changes to the inherited existing plans that would be required, and how they could be implemented, including liaising with relevant stakeholders such as the council.

The activities undertaken during the relevant time period are consistent with simply disposing of the Land or undertaking the proposed activity of property development, sale and rental. While there was a clear desire to conduct a property development, sale and rental business, during the relevant period of ownership, the facts show Unit Trust A was not in a position to and had not made a definitive commitment to start business.

It could be argued that the lobbying of Government to upgrade the road over rail bridge to meet the construction certificate conditions, was part of undertaking the proposed land subdivision and sale. However, this activity is also consistent with option still contemplated by the Unit Trust A at the time, of simply disposing of the Land at a profit. Given, that the Unit Trust A was not in a position to finance the development and had not definitively committed to the proposed land subdivision and sale, it is considered that this was not the first step in a property development, sale and rental business.

On balance, considered as a whole, the activities undertaken by the Unit Trust A up to the sale of the X Family Trust's interest in it, are best characterised as preliminary activities aimed to put it in a position to undertake the proposed development, sale and rental activity or the potential sale.

For these reasons, up to and including the time the X Family Trust disposed of its interest in the Unit Trust A, the Commissioner is of the view that it had not commenced a business of property development, sale and rental.

Question 2

Summary

As the market value of the Land was more than 20% of the total assets that were held by the Unit Trust A at the time, subsection 152-40(3) of the ITAA 1997 was not satisfied. The remaining units in the Unit Trust A sold by the X Family Trust were, therefore, not an active asset.

Detailed reasoning

In order for the X Family Trust to be eligible for CGT small business relief on its disposal of the units it held in Unit Trust A, the units must be an active asset (section 152-10(1)(d) of the ITAA 1997).

Subsection 152-40(1) of the ITAA 1997 provides that a CGT asset is an active asset at a particular time if:

a)               you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a business that is carried on (whether alone or in partnership) by:

                                     i.                    you; or

                                   ii.                    your affiliate; or

                                  iii.                    another entity that is connected with you; or

b)               if the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

In accordance with subsection 152-40(3), units in a unit trust that is a resident trust for CGT purpose will be an active asset at a particular time if:

                           i.          The market values of the active assets of the trust; and

                          ii.          The market value of any financial instruments of the trust that are inherently connected with a business that the trust carries on; and

                         iii.          Any cash of the trust that is inherently connected with such a business;

is 80% or more of the market value of all of the assets of the company or trust.

The Land represented more than 20% of the market value of the Unit Trust A's assets at the time the X Family Trust sold its units in the Unit Trust A.

As the Unit Trust A was not carrying on a business, it follows that the Land was not being used or held ready for use in the course of carrying on a business of the Unit Trust A. The only use of the Land at the time the X Family Trust disposed of its remaining units in the Unit Trust A was renting it to an unrelated third parties. The Land was therefore not an active asset of the Unit Trust A at the time the X Family trust disposed of its remaining units.

Given the market value of the Land was more than 20% of the total assets that were held by the Unit Trust A at the time, it follows that subsection 152-40(3) of the ITAA 1997 was not satisfied. This is because the market value of active assets of the Unit Trust A, and financial instruments or cash connected with a business conducted by Unit Trust A are less than 80% of all of the assets of the Unit Trust A.

It follows that the remaining units in the Unit Trust A sold by the X Family Trust were therefore not an active asset.

Consequentially, the CGT small business concessions are not available to the X Family Trust to reduce the capital gain arising from their sale.

1 TR 2001/14 at paragraph 69A