Edited version of private advice

Authorisation Number: 1051921701338

Date of advice: 25 November 2021

Ruling

Subject: Property development

Question 1

Will the profit on the sale of the properties be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will the profit on the sale of the properties be assessable under Parts 3-1 and 3-3 of the ITAA 1997?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 March 20XX

Relevant facts and circumstances

You have had a long history of being a residential property investor having had rental properties in the past which have all been long holds, and eventually sold unchanged.

You have not been involved in any previous subdivision or developments.

Property/development details

You purchased the property with your colleague as an investment rental property.

About a year later, you and your colleague decided to sell the property with endorsed plans and permits for multiple dwellings.

In the following year, you and your colleague auctioned the property, but it was not sold in the auction.

The property was later sold to a developer.

The builder cancelled the purchase, prior to settlement date by using a special clause in the contract.

You and your colleague listed the property again for sale over the next 18 months with different agencies but received no offers.

Your colleague who had a x% share wanted to sell due to a change in family / financial circumstances.

You agreed to buy out their share and reimburse their investment capital.

You refinanced and took out a loan with a commercial lender.

The property had been rented out for some time when several events outside your control occurred:

•                 The property had a leak in the roof caused by storms, your insurance company rejected the insurance claim mentioning that the old roof covering was in bad condition and the estimated repair cost was very high.

•                 Your property management agent advised you that the tenant would be vacating the property as they would not be renewing the lease.

•                 The building permit expiries if development does not commence by a certain date.

You made the decision that you had no options but to demolish and build due the following reasons:

•                 Tenant terminated the lease.

•                 COVID and lockdown at the time had a huge impact on market prices and rental.

•                 Town Planning Permit would expire, and the property would have no added value with expired permits.

Timeline of the development

Contract with the Builder was signed in late 20xx.

Surveyor was appointed in the same year.

Demolition commenced in the following year and the work is progressing.

You hope that the property development can be completed within 18 months of the construction contract being signed.

Finance for the development

Commercial lender advised you that they would not provide you with a loan for the property development.

Your partner sold their property and provided you with a loan.

You use the loan and your own savings to fund the property development.

Your partner has lodged a caveat on the property for either ownership and or principal loan plus interest.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 15-15

Income Tax Assessment Act 1997 section 70-10

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Summary

The profit from the sale of the properties is from an isolated profit-making transaction and is assessable as ordinary income on revenue account, rather than under the capital gains tax provisions.

Taxation treatment of property sales

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

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

•                 As ordinary income 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 profit making; or

•                 As statutory income under the capital gains tax legislation as a result of the sale of a capital asset.

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

Ordinary income

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Profits from an isolated transaction

Federal Commissioner of Taxation v. Myer Emporium Ltd (1987)163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693) (Myer Emporium)is one of the leading cases which shows that the intention at the time of purchasing the asset is an important consideration in determining whether the proceeds received on disposal are on a capital or revenue account. According to the Myer Emporium case, the Full High Court expressed the view that profits made by a taxpayer who enters into an isolated transaction with a profit making purpose can be assessable income.

Taxation RulingTR 92/3 Income tax: whether profits on isolated transactions are incomeconsiders the assessability of profits on isolated transactions in light of the principles outlined in Myer Emporium. According to Paragraph 1 of TR 92/3, the term isolated transactions refers to:

•                 those transactions outside the ordinary course of business of a taxpayer carrying on a business, and

•                 those transactions entered into by non-business taxpayers.

Paragraph 35 ofTR 92/3 states that when a taxpayer makes a profit from an isolated transaction other than in the course of carrying on a business, the amount will be income where:

a)               The intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain.

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

Some of the factors to consider when looking at whether an isolated transaction amounts to a business operation or commercial transaction are listed at paragraph 13 of TR 92/3. They are:

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.

Statutory income - Capital gains tax

Under section 6-10 of the ITAA 1997, assessable income also includes statutory income. Capital gains are included as assessable income under section 102-5 of the ITAA 1997.

Section 102-20 of the ITAA 1997 states that a capital gain or capital loss is made only if a CGT event happens to a CGT asset. Real estate property is considered a CGT asset (section 108-5 of the ITAA 1997).

CGT event A1 happens if you dispose of a CGT asset (section 104-10 of the ITAA 1997).

When a CGT asset (the original asset) is split into 2 or more assets, such as when land is subdivided, the subdivision of the land into subdivided lots is not a CGT event (subsection 112-25(2) of the ITAA 1997).

Application to your circumstances

In your case, whilst we acknowledge you have a history of passive long term property investment; the complexion of this property undertaking is different.

You purchased the property (with your colleague), you decided to sell the property with endorsed plans and permits for multiple dwellings, however the sale did not go through. You purchased the % share from your colleague due to their change in family and financial circumstances. The property had been rented out for some time when several events outside your control occurred. You made the decision that you had no options but to demolish and re-build.

Furthermore, the following general observations have been made in this case:

•                 You had intention and a profit-making purpose in the activities undertaken.

•                 The transaction has been undertaken in a planned, organised and carried on in a business-like timely manner.

•                 The decision to pursue the subdivision shows a choice by you to engage in the exposure to the financial risks of the development, including the profits, losses and its general success for the purpose of maximising the potential profit made on the sale of the new dwellings.

•                 This is also demonstrated as additional finance was obtained to fund the development activities.

•                 There was no intention by you to retain the new dwellings for long term capital appreciation or to derive rental income.

•                 The facts indicate a sophisticated undertaking with a view to a profit by a non-business taxpayer.

The demolition, subdivision and sale of the new dwellings is more than a mere realisation of a capital asset or investment. The disposal is an isolated profit making transaction on revenue account as ordinary income, rather than on capital account. Any profit made on the transaction is assessable income under section 6-5 of the ITAA 1997.