Edited version of private advice

Authorisation Number: 1051937061969

Date of advice: 18 January 2022

Ruling

Subject: Property development

Question 1

Will the proceeds from the sale of the subdivided residential lots constitute ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will the proceeds from the sale of the subdivided residential lots be subject to capital gains tax (CGT) under Parts 3-1 and 3-3 of the ITAA 1997?

Answer

Yes. However, subsection 118-25(1) of the ITAA 1997 will apply to disregard the capital gain.

Question 3

Is the sale of the new residential premises a taxable supply under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (the GST Act)?

Answer

Yes.

This ruling applies for the following period

1 July 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You jointly acquired a residential property in 20AA with the intention of holding it for long term investment to generate rental income.

You and the other owner jointly borrowed $WWW to acquire the property.

Approximately one year after acquiring the property you decided to inquire about subdividing some lots off, while retaining the existing house.

You were not aware of whether the subdivision of the land was possible prior to its purchase.

Your intention for the subdivision was to continue renting out the house and construct a residential dwelling on each of the new lots with the intention of renting all lots long term upon the completion of construction.

From 20BB to 20CC, you engaged architects, civil engineers, and town planning consultants to assist with acquiring the information required to submit the Development Approval application with the local council.

You encountered several difficulties in obtaining approval for the subdivision application, but it was finally approved in 20GG.

In 20GG, you and the co-owner applied for a joint loan to fund the development of the lots. This application states the intention of the loan was to "Build investment properties to increase net wealth".

You engaged a third party builder to construct the new residential dwellings in or around June 20HH and construction was mostly finished by June 20II with approximately $AAA drawn down on the loan.

Further council issues and associated expenses were encountered, and final council approval wasn't granted until 20KK.

The existing house continued to provide rental income throughout this period.

You are the director of a company that undertakes commercial building construction, and you hold a builders supervisor's licence.

You have a history of having numerous residential rental properties that you acquired, renovated, and then rented for extended periods of time (all in excess of 5 years) prior to eventually selling them for a capital gain.

This was your first time you have undertaken this type of investment which involved a new build.

You and the other owner did not register for GST for the purpose of the ownership and sale of the properties and therefore did not claimed any input tax credits for costs incurred.

You have an existing and separate GST registration for a business you previously operated of leasing commercial premises.

You intend to do further property development however currently the market is too high and not favourable for investment and you will look again in the future.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 70-10

Income Tax Assessment Act 1997 Section 118-25

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Parts 3-1 and 3-3

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

A New Tax System (Goods and Services Tax) Act 1999 Section 23-10

Reasons for decision

There are three ways profits from property sales can be treated for taxation purposes:

1. As ordinary income under section 6-5 of the ITAA, 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, 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 capital gains tax legislation.

Under section 6-5 of the ITAA 1997, your assessable income includes the ordinary income you derived directly or indirectly from all sources, during the income year.

Carrying on a business

Subsection 995-1(1) of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the particular facts.

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. In the Commissioner's view, the factors that are considered important in determining the question of business activity are:

•         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 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 sporting activity.

No one factor is decisive. The indicators must be considered in combination and as a whole.

As to when such a business is taken to have commenced, Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'?,also states that a business activity is taken to have commenced when a taxpayer embarks on a "definite and continuous cycle of operations designed to lead to the sale of the land." That is, the land will become trading stock when you are demonstrably fully committed to the business of land development. When that occurs is determined by a consideration of the facts of the case.

Trading Stock

When the business starts, the subdivided land becomes trading stock. Section 70-10 of the ITAA 1997 provides that trading stock includes anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business.

Taxation Determination TD 92/124 states that land will be treated as trading stock for income tax purposes if it is held for the purpose of resale and a business activity which involves dealing in land has commenced. Where such a business exists, the proceeds from the sale will be assessable under section 6-5 of the ITAA.

Isolated transactions

Alternatively, Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income discusses profits on isolated transactions and the application of the principles outlined in the decision of the Full High Court of Australia in FCT v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693. This ruling states that profits on isolated transactions may be income.

Profit from an isolated transaction will be ordinary income where:

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

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

Profits on the sale of subdivided land can therefore be income according to ordinary concepts within section 6-5 of the ITAA 1997, if the taxpayer's subdivisional activities have become a separate business operation or commercial transaction, or an isolated profit-making venture.

Taxation Ruling TR 92/3 outlines that the relevant intention or purpose of the taxpayer, of making a profit or gain, is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

In very general terms, a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations.

CGT provisions

CGT event A1 in section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you dispose of each subdivided block. You will make a capital gain if the capital proceeds from the disposal of the block are more than the cost base of the block. You will make a capital loss of those capital proceeds are less than the reduced cost base of the block.

Where the land is treated as trading stock, section 118-25 of the ITAA 1997 provides that a capital gain or capital loss you make at the time of CGT event is disregarded.

Application to your situation

Carrying on a business

We acknowledge the property may have been acquired initially with the intention to hold for investment, at least in the short to medium term before resale. However, the intent for which land is held can change the asset from being a capital asset.

You have prior history of property development and intend to be involved in further developments in the future.

We'll consider the factors from TR 97/11 outlined above:

Whether the activity has a significant commercial purpose or character

Paragraph 29 of TR 97/11 in part states:

A way of establishing that there is a significant commercial purpose or character is to compare the activities with those of a taxpayer who is carrying on a similar activity that is a business. Any knowledge, previous experience or skill of the taxpayer in the activity, and any advice taken by the taxpayer in the conduct of the business should also be considered but are not necessarily determinative.

Property development can vary in size and scale from a small number of lots where subdivision activity is minimal to large scale developments with many lots requiring substantial infrastructure, and still be considered business activities depending on the other factors below. In your case the acquisition of properties and subsequent renovation or building of dwellings, while not a traditional property development, is quite common. The 'flipping' of houses is common and you carry out your activity similarly to other house flippers with the only difference being that you usually intend to rent the properties for a few years before reselling. We do not consider the holding of the properties for rent in short/medium term is an important factor. The intention is always to resale the property for profit at some point after renovating/building. It could be argued that the properties are held for some other commercial purpose as part of a broader business plan, such as to provide cashflow over those years. Likewise, the fact the properties are not held in a company or trust, for example, is not considered decisive either way as there may be other reasons for not doing so, such as ability to obtain finance.

In addition, given your background and connections in the building and construction industry and your history of similar developments previously, the acquisition of the property, subsequent subdivision, construction of some dwellings and sale of those dwellings at a profit has a significant commercial purpose and character.

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

Your actions in previously acquiring properties which you renovated, rented for approximately 5 years and then sold, along with your actions with the properties in question as well as your intention to do similar developments in the future indicate more than an intention to engage in business.

You contend the reason for the sale of the properties was financial hardship suffered by the co-owner at the time, however there is insufficient evidence to support this.

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

You would not undertake such developments if you did not have profit making as a purpose. Your previous property developments and this development have been profitable. However, properties acquired and held for long term investment and then sold are usually also profitable, so this factor is not decisive either way on its own.

Whether there is regularity and repetition of the activity

There is regularity and repetition to your activity despite previous properties being held for a number of years before resale and despite this being your first new build. You have previously developed properties which you held for short to medium term rental before sale, you developed and sold this property and have intentions to do similar developments in the future. This displays regularity and repetition, despite there often being a number of years between acquisition and resale.

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

This has been addressed under the first factor above on significant commercial purpose.

Whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit

As discussed above it is considered your property development activity is carried on in a businesslike manner including that your intention was always to resell at a profit, usually after renting for a few years. With the properties in question, although they were held for many years, you took steps to subdivide after approximately 1 year of acquiring the original property, once the subdivision was approved you contracted a building company and once construction was certified as complete in 20GG you sold one within a few months and the other within a year. Delays getting the subdivision approved and getting the new buildings certified were outside your control.

The size, scale and permanency of the activity, and

Although the size and scale of the activity may be considered small in terms of number of lots, there was a considerable outlay involved in acquiring the property, subdividing and building and the sale prices of the two new dwellings is also relatively significant. Over $Bm was spent acquiring, subdividing and developing the property, including original house you've retained, and sale proceeds from selling the new dwellings totals $Cm. So while the size or scale may be considered small, the intention to make a profit was always there and a considerable profit was made.

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

Not applicable for such an activity.

The overall impression when considering all of the above factors is that you are carrying on a business of property development. You have previously developed properties which you held for short to medium term rental before sale, you developed and sold this property and have intentions to do similar developments in the future which indicates repetition and regularity. You undertook steps to subdivide and develop this property after about 12 months of acquisition and all delays after that time before the new dwellings were able to be sold was outside your control and in borrowing significant funds undertook the risk involved with the activity which displays a significant commercial purpose or character and that the activity is planned, organised and carried on in a businesslike manner.

Even though this is not the first time you have engaged in a property development, even a single development can be a business. As well, every business begins with a single transaction - repetition and regularity is established over time. You have indicated you are likely to perform further such property developments in the future which you will sell, again for a profit, possibly after retaining for rental income for a few years.

Isolated transactions

Given you have conducted previous property development activities and intend to do so again and that it is considered these activities amount to the carrying on of a business, we will not consider whether the development in question was an isolated transaction.

Therefore, proceeds from the sale of the two new dwellings will constitute income carrying on a business and should be included as ordinary income under section 6-5 of the ITAA 1997.

As you are carrying on a business of property development, the new dwellings will be treated as trading stock under section 70-10 of the ITAA 1997 and any capital gain or loss made at the time of sale of the two new dwellings will be disregarded under paragraph 118-25(1)(a) of the ITAA 1997.

Conclusion

In this case, you are considered to be carrying on a business of property development and any profit from the sale of the two new dwellings will be assessable as ordinary income under section 6-5 of the ITAA 1997. The properties will be considered trading stock, and any capital gain or loss made at the time of sale of the subdivided lots will be disregarded under subsection 118-25(1) of the ITAA 1997.

Question 3

Is the sale of the new residential premises a taxable supply under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (the GST Act)?

Answer

Yes.

Detailed reasoning

Section 9-5 provides that you make a taxable supply where you meet the following requirements:

•         you make the supply for consideration;

•         the supply is made in the course or furtherance of an enterprise that you carry on,

•         the supply is connected with the indirect tax zone (Australia); and

•         you are registered or required to be registered for GST.

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

In this case in accordance with the view in GSTR 2004/6 we consider that the relevant entity making the supply of the properties for the purposes of the above provision is the tax law partnership. Therefore, where the partnership satisfies the requirements of section 9-5 of the GST Act it will make a taxable supply.

The supply of the properties by the partnership is made for consideration and in the course or furtherance of an enterprise that the partnership carries on. In addition, the supply is connected with Australia. The partnership is not registered for GST, therefore what remains to be determined is whether the partnership is required to be registered for GST.

Section 23-5 of the GST Act provides that you are required to be registered if you carry on an enterprise and your GST turnover meets the registration turnover threshold, which is currently set at an amount of $75,000.

The partnerships GST turnover will meet the particular turnover threshold if:

•         its current GST turnover is at or above the threshold and its projected GST turnover is at or above the threshold, or

•         its projected GST turnover is at or above the threshold.

In this case the partnerships GST turnover is more than $75,000 and is therefore required to be registered. As the supply of the lots is neither GST-free nor input taxed the partnership will be making a taxable supply pursuant to section 9-5 of the GST Act.