Edited version of private advice

Authorisation Number: 1051980664749

Date of advice: 19 May 2022

Ruling

Subject: Sale of trading stock

Question 1

Will the partitioning of Apartment A and Apartment B under the Second Transfer be recognised by the Company as the sale of trading stock?

Answer

No.

Question 2

If the answer to question 1 is no, can the Company disregard the capital gain arising from the partitioning of Apartment A and Apartment B under the Second Transfer by applying section 118-42 of the Income Tax Assessment Act 1997 (ITAA 1997) and apply the CGT roll-over under section 124-190 of the ITAA 1997?

Answer

Yes.

Question 3

If the Second Transfer results in an amount being included in the Company's assessable income (as trading stock or a net capital gain), does the cost of the Sale Apartments include the market value of the interests in Apartment A and Apartment B that are transferred under the Second Transfer?

Answer

Not applicable.

Question 4

Will the partitioning of Apartment A and Apartment B and the Sale Apartments under the Second Transfer be recognised by the Individual Owners as the sale of trading stock?

Answer

No.

Question 5

Can the Individual Owners disregard any capital gain arising from the partitioning under section 118-42 of the ITAA 1997 and apply the CGT roll-over under section 124-190 of the ITAA 1997?

Answer

Yes.

Question 6

Will the partitioning of the apartments be a taxable supply for the Individual Owners?

Answer

No. The partitioning of apartments will not constitute a taxable supply by the Individual Owners provided the apartments are to become their home.

Question 7

Will the partitioning of the apartments result in a payment of greater than nil under section 109C of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

The transfer by the Company of its interest in the relevant Apartment to the relevant Individual Owners may result in a payment of greater than nil under section 109C of the ITAA 1936 if the value of Individual Owners interest in the Sale Apartments is less than the value of the interest of the Company in their Apartment.

Question 8

If the answer to question 7 is yes, can the payment be converted to a loan under section 109D(4A) of the ITAA 1936?

Answer

Yes, provided that there is an obligation on the part of the relevant Individual Owners to pay to the Company the amount of the difference between the market value of the interest in the Apartment that the Company has transferred to the Individual Owners and the interest in the Sale Apartments that the Individual Owners have transferred to the Company. We would expect the loan to be documented and recorded in the financial accounts of the Company as a loan. Further, for 109D(4A) to apply the conversion must happen before the end of the private company's lodgment day for the relevant year of income.

Question 9

When the Company sells the Sale Apartments to third parties, will a proportion of sale be treated as an input taxed supply of residential premises (that are not new residential premises)?

Answer

Yes

This private ruling applies for the following periods:

For the income tax issues:

1 July 20XX to 30 June 20XX

For the GST issues:

From the date that this Ruling is issued and until the end of four years from the issue date.

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1.    The Company is an Australian resident private company. The Company is registered for GST.

2.    The Company is a wholly owned subsidiary of another company, Holding Company. Shares in Holding Company are owned 50% each by Individual A and Individual B.

3.    The Company is the owner of a block of land. The Property was acquired a 2-3 years ago.

4.    The Property was originally comprised of two adjoining lots of land that have since been amalgamated into a single title.

5.    The original purchase consisted of two existing residential dwellings from a supplier that was not registered for GST. Therefore, no GST was paid on the purchase.

6.    The Property was purchased by the Company with the intention of constructing an apartment complex on the site. The development is to involve:

•         demolishing the existing dwellings on the Property;

•         constructing a building on the property, comprising X apartments;

•         dividing the building into X strata titled apartments; and

•         selling the completed apartments on the market.

7.    Individual A and Individual B have decided that they would like to retain one of the completed apartments to occupy as their home after the development is completed (and occupy it into retirement). Their child and the child's partner, Individual C and Individual D, would also like to occupy one of the completed apartments as their home after the development is completed.

8.    The four individuals are referred to as the Individual Owners. The Individual Owners are not registered for GST.

9.    To facilitate the ownership of the relevant apartments to the Individual Owners, the parties are proposing to enter into the following transactions:

•         The building plans will be progressed to a point such that the final form of the development is known, and the individual apartments can be identified;

•         Individual A and B will identify the specific apartment which they wish to become the exclusive owners of when the development is completed (Apartment A);

•         Individual C and D will identify the specific apartment which they wish to become the exclusive owners of when the development is completed (Apartment B);

•         The market values of Apartment A and Apartment B and the market value of the entire apartment building complex (when completed) will be estimated based on market information;

•         Using the estimated market values of Apartment A and B and the entire building complex, the parties will determine the proportionate value of the entire complex that is intended to be represented by each of Apartment A and Apartments B when completed. This is referred to as 'the Relevant Proportion';

•         The Company will transfer the Relevant Proportion of the Property to Individuals A and B (as joint tenants) and to Individuals C and D (as joint tenants). The transfer price will be determined with reference to the market value of the Property at that time (as identified in a valuation report that will be obtained from a registered valuer). This is referred to as 'the First Transfer';

•         The transfers of the Relevant Proportion of the Property will be:

­   Recognised on revenue account by the Company for income tax purposes (sale of trading stock);

­   Recognised as a taxable supply by the Company for GST purposes. The transfer documents will agree to apply the margin scheme to the transfer; and

­   Submitted with NSW Revenue for the payment of any applicable stamp duty.

•         Any part of the transfer price that is not paid to the Company will be recorded as a loan from the Company to the relevant Individual Owners in the financial records of the Company and treated in accordance with the requirements of Division 7A of Part III of the ITAA 1936.

•         After the Relevant Proportions have been transferred, the Property will be owned as tenants in common between:

­   Individual A and B as joint tenants as to their Relevant Proportion:

­   Individual C and D as joint tenants as to their Relevant Proportion;

­   the Company being the sole owner of the remaining proportion of the Property.

•         A partitioning agreement will be entered into between the Company and the Individual Owners which will:

­   set out the ownership of the Property;

­   set out the intentions of the parties (i.e. to construct the apartment complex);

­   confirm the agreement to partition the Property in the prescribed manner;

­   cover issues such as valuation, completion, costs, adjustments, disputes, resolutions etc;

­   have schedules setting out the ownership, partitioning and agreed allocation of the completed apartments (including the allocation of Apartment A and Apartment B to the respective Individual Owners).

•         After the development application is approved by the Council, the landowners (the Company and the Individual Owners) will enter into a construction agreement with the selected builder. Under the construction agreement, all owners will be obliged to pay their proportion of the construction costs.

•         For administrative simplicity, the Company may pay the full amount of each instalment to the builder. The proportion of any construction payment that is made on behalf of the other landowners will be recorded as a loan in the relevant financial records of the Company and treated in accordance with Division 7A of Part III of the ITAA 1936.

•         After construction is completed and occupancy certificates are granted, the individual apartments will be divided into stratum units (within the meaning of 124-190(3) of the ITAA 1997).

•         After the strata title has been implemented, all X stratum units will be jointly owned (as tenants in common) by all owners (the Individual Owners and the Company) in their relevant proportions.

•         The apartments will be 'partitioned' in accordance with the terms of the partitioning agreement as follows (referred to as 'the Second Transfers'):

­   the Company and Individual C and D will transfer their interest in Apartment A to Individuals A and B who will be the sole owners of Apartment A;

­   the Company and Individuals A and B will transfer their interest in Apartment B to Individuals C and D who will be the sole owners of Apartment B;

­   The Individual Owners will transfer their interest in the remaining X apartments to the Company who will become the sole owner of these apartments (the Sale Apartments);

•         A registered valuer will be engaged to prepare a valuation report at the time of partitioning as to the market value of each of the apartments.

10.  Individuals A and B will retain Apartment A to occupy as their home.

11.  Individuals C and D will retain Apartment B to occupy as their home.

12.  The Company will sell the remaining X apartments (the Sale Apartments) on market.

Relevant legislative provisions for GST

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

Section 9-10 of the A New Tax System (Goods and Services Tax) Act 1999

Section 9-20 of the A New Tax System (Goods and Services Tax) Act 1999

Section 40-65 of the A New Tax System (Goods and Services Tax) Act 1999

Section 40-75 of the A New Tax System (Goods and Services Tax) Act 1999

Further issues for you to consider

We have limited our private ruling to the questions raised in your application. There may be related issues that you should consider, including:

•         The GST treatment of the portion of the apartments transferred from the Company to the Individual Owners under the partitioning agreement. Although the partitioning does not constitute a taxable supply for the Individual Owners, it most likely will for the Company.

•         As outlined in the facts, the Individual Owners are entering the agreement in order to obtain a home, this means that they cannot be carrying on an enterprise as their activities are private or recreational. If the Individual Owners choose to sell, they may be carrying on an enterprise which will have an effect on the GST treatment of the apartments.

You may apply for another private ruling on these or any other matters.

Reasons for Decision

Question 1

Will the partitioning of Apartment A and Apartment B under the Second Transfer be recognised by the Company as the sale of trading stock?

Summary

The partitioning of Apartment A and Apartment B under the Second Transfer will not be a disposal of trading stock.

Detailed reasoning

1.    Subsection 70-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states:

Trading stock includes:

(a) anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and

(b) live stock.

Land as trading stock

2.    In considering whether land is trading stock, Taxation Determination TD 92/124 Income Tax: property development: in what circumstances is land treated as 'trading stock'? (TD 92/124) states:

1. Land is 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.

2. Both the required purpose and the business activity must be present before land is treated as trading stock. The 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.

3. It is not necessary that the acquisition of land be repetitive. A single acquisition of land for the purpose of development, subdivision and sale by a business commenced for that purpose would lead to the land being treated as trading stock.

3.    Land can be trading stock before it has been turned into the condition in which it is intended to be ultimately sold - that is, land intended to be sold after subdivision is trading stock before it is subdivided (FCT v St Hubert's Island Pty Ltd (In Liq) [1978] HCA 10; (1978) 138 CLR 210 (St Hubert's Island); R & D Holdings Pty Ltd v DCT [2006] FCA 981 (R & D Holdings).

4.    It is only when the land is subdivided, so that different parts of the land become an identifiable and segregated parcel of land subject to separate title or titles separate from the other parts of the land, that each separate plot of land becomes an individual article of trading stock (Barina Corporation Ltd v FC of T 85 ATC 4847).

5.    Where land is to be subdivided as part of a property development, all of the parts of the land when subdivided may not ultimately be held as trading stock. In Commissioner of Taxation v Kurts Development Ltd (1998) 86 FCR 337; (1998) 39 ATR 493; 98 ATC 4877 (Kurts Development), the taxpayer was in the busines of developing and subdividing undeveloped land (broadacres). The dispute concerned whether certain infrastructure costs associated with developing certain parts of the land, called 'Infrastructure Land', should be included in the cost of the taxpayer's trading stock. The development approval required that the taxpayer undertake certain works on the Infrastructure Land for the purpose of roads, parks, sewerage, etc. The land would be dedicated to the Crown or a public authority upon and by registration of the subdivision. The Full Federal Court held that the infrastructure costs were part of the cost of the resultant individual subdivided lots, and therefore, should be included in the taxpayer's cost of trading stock.

6.    The Full Federal Court in Kurts Development (per Emmet J with whom the other members of the Court agreed) found:

•         as a practical matter, the Taxpayer was not permitted to complete the sale of, and cannot give title in respect of, individual subdivided lots until after the issue of separate titles in respect of the individual subdivided lots upon registration of a plan of subdivision;

•         it was only when the plan of subdivision was registered that the Infrastructure Land became an identifiable and segregated parcel of land subject to separate title, separate from the other parts of the original broadacre land;

•         the broadacres, as originally acquired by the Taxpayer, was an article of trading stock

•         the partially developed broadacres, before individual subdivided lots are created by registration of a plan of subdivision, can be characterised as work in progress - work in progress can also be regarded as trading stock;

•         the effect of the registration of the plan of subdivision is to convert the trading stock comprising the broadacres originally acquired by the Taxpayer into trading stock of a different category, namely, individual subdivided lots;

•         the infrastructure land was never intended for sale and it was never separately acquired - it was never at any stage a separate article of the taxpayer's trading stock;

•         the Taxpayer's business involves converting one form of trading stock into a different form of trading stock. One cost of so doing is the Infrastructure Costs. Another cost is the cost of the Infrastructure Land;

•         the Infrastructure Costs were properly to be characterised as part of the cost price of the resultant individual subdivided lots.

7.    In Starco Pty Ltd v FC of T [2002] AATA 6;2002 ATC 2013, an entity purchased land to subdivide and develop into a multi-unit development for the purposes of sale of units and also for certain units to be transferred to family members of the owners of the entity as private residences. The business entity paid the construction costs for the entire development and was reimbursed by family members for the costs related to their private residence. The business entity sold 31 units to the public off the plan and 4 of the units were to be transferred to family members. Senior member DW Muller was satisfied that the family members that were involved were in a joint venture to construct the four units to be their private residences at cost. The four units were never intended to be part of the trading stock of the business entity, nor were they ever treated as trading stock by the business entity. The senior member held that the transfer of the units to the family members was not a disposal of trading stock by the entity outside the ordinary course of business.

In the ordinary course of a business

8.    The phrase 'in the ordinary course of a business' is not defined and as such must be interpreted according to its ordinary meaning and legislative context. Whether an article is held in the manner prescribed in subsection 70-10(1) of the ITAA 1997 is a question of fact.

9.    The Explanatory Memorandum to the Tax Law Improvement Bill 1997 Tax Law Improvement Act 1997 which amended the definition of "trading stock" in the context of other amendments states:

1.9 The expression 'in the ordinary course of a business' will be added to the definition to make clear that merely holding an asset for manufacture, sale or exchange will not make it trading stock. The Joint Committee of Public Accounts in An Advisory Report on the Tax Law Improvement Bill 1996 (Report 348) recommended the addition of those words after the word 'held'. They have actually been added after 'manufacture, sale or exchange' because they are intended to qualify those activities rather than the holding. These examples illustrate the significance of the words:

If a manufacturer, no longer requiring a factory, simply puts it up for sale, it might hold the factory for the purpose of sale but that sale would not be in the ordinary course of its business. In such a case, the factory would not be trading stock.

On the other hand, a potter might turn a hobby into a business. The pots, part-finished and completed, plus the clay and other raw materials, would become trading stock because they would be held for manufacture or sale in the ordinary course of a business.

10.  In Downs Distributing Co Pty Ltd v Associated Blue Star Stores Pty Ltd (In Liq) [1948] HCA 14, Rich J noted that the phrase 'in the ordinary course of business":

...means that the transaction must fall into place as part of the undistinguished common flow of business done, that it should form part of the ordinary business as carried on, calling for no remark and arising out of no special or particular situation.

11.  In Re EJ Taylor & Son Pty Ltd [1964] HCA 11, Dixon CJ noted that:

The time-honoured phrase "in the ordinary course of business" is meant to refer to transactions regularly taking place in a sustained course of activity or some usual process naturally passing without examination.

Application to your circumstances

12.  In this case, the Property acquired by the Company was trading stock of the Company since the original acquisition of the two lots of land. The entire Property has, since acquisition, been held by the Company for the purposes of development, subdivision and sale.

13.  You have indicated that the Company will treat the transfer of the Relevant Proportion of the Property to the Individual Owners for market value as a sale of trading stock.

14.  The interest that the Company holds in the Property following the First Transfer will continue to be held for the purposes of development, subdivision and sale of the Property (subject to the partitioning agreement). At this stage, the interest is in the Property in its entirety (as there are no separate titles) and it will continue to be trading stock of the Company.

15.  After the subdivision has been completed, and the separate stratum units have come into existence, the Company will hold its interest in Apartment A and Apartment B in accordance with the partitioning agreement. Under the partitioning agreement, the Company has agreed to transfer its interest in Apartment A and Apartment B to the Individual Owners in exchange for the Individual Owners transferring their interest in the Sale Apartments to the Company. The Second Transfers are not part of the ordinary or common flow of the business that is carried on by the Company. The Second Transfers result from the arrangements entered into between the joint owners of the Property under the partitioning agreement.

16.  In our view, from the time that they come into existence Apartment A and Apartment B will not be held for the purposes of sale or exchange in the ordinary course of business of the Company. That is, these stratum units will not be held at any time as trading stock of the Company.

17.  The Second Transfers of the interest in Apartment A and Apartment B by the Company will be the disposal of a CGT asset and will be dealt with under the CGT provisions.

Question 2

If the answer to question 1 is no, can the Company disregard the capital gain arising from the partitioning of Apartment A and Apartment B under the Second Transfer by applying section 118-42 of the ITAA 1997 and apply the CGT roll-over under section 124-190 of the ITAA 1997?

Summary

The Company can disregard the capital gain arising from the partitioning of Apartment A and Apartment B under the Second Transfers by applying section 118-42 of the ITAA 1997 and can apply the CGT roll-over under section 124-190 of the ITAA 1997.

Detailed reasoning

18.  The disposal of a partial interest in the new stratum units by way of transfer on partition will give rise to CGT event A1 under section 104-10 of the ITAA 1997.

19.  Section 118-42 of the ITAA 1997 states that if:

(a)    you own land on which there is a building; and

(b)  you subdivide the building into stratum units (within the meaning of subsection 124-190(3) of the ITAA 1997); and

(c)   you transfer each unit to the entity who had the right to occupy it just before the subdivision;

a capital gain or capital loss you make from transferring the unit is disregarded.

20.  Under section 124-190 of the ITAA 1997, you can choose to obtain a roll-over if:

(a)    you own property (the 'original asset') that gives you a right to occupy a unit in a building;

(b)  the building's owner subdivides it into stratum units (within the meaning of subsection 124-190(3) of the ITAA 1997); and

(c)   the owner transfers to you the stratum unit (the 'new asset') that corresponds to the unit you had the right to occupy just before the subdivision.

21.  The cost base of the new stratum unit is worked out according to subsections 124-10(3) and 124-190(2) of the ITAA 1997.

22.  The choice to obtain roll-over relief under subsection 124-190(1) of the ITAA 1997 must be made by the time the taxpayer lodges their income tax return for the income year in which the transfer occurs, or within any further period allowed by the Commissioner (subsection 103-25(1) of the ITAA 1997).

23.  The consequences of choosing to obtain the roll-over are set out in section 124-10, and include:

(a)    any capital gain or capital loss the taxpayer makes from the disposal of their tenancy in common interest (the 'original asset') is disregarded (subsection 124-10(2)), and

(b)  the first element of that original asset's cost base and reduced cost base are carried over and included in the first element of the cost base and reduced cost base of the new asset's (new stratum unit's) cost base (subsection 124-10(3)).

24.  Essentially the operation of sections 118-42, 124-190 and 124-10 of the ITAA 1997 results in the CGT attributes of the 'original asset' (the property from which the right to occupy was derived) being rolled over to the 'new asset' (the stratum unit) for CGT purposes.

25.  That is, the first element of the cost base of the new stratum unit includes the cost base of the original asset.

26.  Taxation Ruling TR 97/4 Income tax: capital gains: roll-over relief for buildings subdivided under strata title law into stratum units and common property sets out the Commissioner's view on tenants in common subdividing a building and transferring their interests so that each tenant in common becomes a registered proprietor of a stratum unit. TR 97/4 dealt with section 160ZZPG of the Income Tax Assessment Act 1936 (ITAA 1936) which contained roll-over relief that applied where land on which a building or buildings were erected was subdivided into strata units or strata units and common property and immediately before and after the subdivision a taxpayer had a particular asset in relation to the land. Section 160ZZPG of the ITAA 1936 was repealed and replaced by sections 118-42 and 124-190 of the ITAA 1997.

27.  Roll-over relief is only available if, before the conversion process, the tenants in common entered into an agreement or understanding granting each tenant in common exclusive occupation (including an exclusive right of possession) of a particular unit: paragraph 12 and 44 of TR 97/4.

28.  Roll-over relief is sufficiently wide in its terms to extend to newly constructed buildings and joint venture developments: paragraph 15 and 63 (Example 4) in TR 97/4.

Application to your circumstances

29.  Any capital gain or capital loss made by the Company under the Second Transfers will be disregarded in accordance with section 118-42 of the ITAA 1997 as:

(a)    the Company owned the Property (as a tenant in common with the Individual Owners) on which there will be a building (when developed);

(b)  the Company will subdivide the building into stratum units, as defined in subsection 124-190(3), and

(c)   it will transfer the interest it holds in Apartment A to Individuals A and B and in Apartment B to Individuals C and D who had an exclusive right to occupy those Apartments under the partitioning agreement (and therefore 'just before the subdivision').

30.  Subsection 124-190(1) may provide roll-over relief, at the option of the Company, in relation to the transfer to it of the partial interests in the Sale Apartments from the Individual Owners, as:

(a)    the Company owned the Property (that is, the holding of a tenancy in common interest in the Property and the building constructed under the development) that will give it a right to occupy units (the Sale Apartments) in that building;

(b)    the Company and the Individual Owners (who own the building as tenants in common of the Property) will subdivide it into stratum units, as defined in subsection 124-190(3); and

(c)    following the subdivision, the Individual Owners will transfer to the Company the stratum units (the Sale Apartments) that corresponds to the Apartments they had the right to occupy just before the subdivision under the partitioning agreement.

31.  Therefore, the Company will satisfy the conditions in section 124-190 of the ITAA 1997 for roll-over relief.

32.  It is noted that the Sale Apartments will be held as trading stock and any capital gain made on the sale of these apartments will be disregarded: section 118-25 of the ITAA 1997.

Question 3

Not applicable

Question 4

Will the partitioning of Apartment A and Apartment B and the Sale Apartments under the Second Transfer be recognised by the Individual Owners as the sale of trading stock?

Summary

The partitioning of Apartment A and Apartment B and the Sale Apartments under the Second Transfer will not be recognised by the Individual Owners as the sale of trading stock.

Detailed reasoning

33.  The relevant law is discussed under question 1.

Application to your circumstances

34.  In this instance, the interest in the Property acquired by the Individual Owners was not trading stock of the Individuals as they did not acquire or hold their interest in the Property for the purposes of any sale or exchange in the ordinary course of business.

35.  The Individuals acquired their interest in the Property so that after the subdivision has been completed, and the separate stratum units have come into existence, they will acquire their respective Apartment under the partitioning agreement, to occupy as their home.

36.  Therefore. it is accepted that the interest held in the subdivided stratum units when they come into existence by the Individual Owners is not held as trading stock. Their interest in the subdivided units will be held on capital account.

Question 5

Can the Individual Owners disregard any capital gain arising from the partitioning under section 118-42 of the ITAA 1997 and apply the CGT roll-over under section 124-190 of the ITAA 1997?

Summary

The Individual Owners can disregard any capital gain arising from the partitioning under section 118-42 of the ITAA 1997 and chose to apply the CGT roll-over under section 124-190 of the ITAA 1997.

Detailed reasoning

The relevant law is discussed in Question 2

Application to your circumstances

37.  Any capital gain or capital loss made by the Individual Owners under the Second Transfers will be disregarded in accordance with section 118-42 as:

(a)    The Individual Owners owned the Property (as a tenants in common with the Company) on which there will be a building (when developed);

(b)  The Individual Owners together with the Company will subdivide the building into stratum units, as defined in subsection 124-190(3), and

(c)   They will transfer the interest they hold in the other Individual Owners' Apartment and the Sale Apartments to those Individual Owners and the Company respectively who had an exclusive right to occupy those Apartments under the partitioning agreement (and therefore 'just before the subdivision').

38.  Subsection 124-190(1) may provide roll-over relief, at the Individual Owners option, as:

(a)    they owned the Property (that is, the holding of a tenancy in common interest in the Property and the building constructed under the development) that will give them a right to occupy units (the relevant Apartment) in that building;

(b)    the Company and the Individual Owners (who own the building as tenants in common of the Property) will subdivide it into stratum units, as defined in subsection 124-190(3); and

(c)    following the subdivision, the Individual Owners and the Company will transfer their partial interest in the stratum units to the relevant party that had the right to occupy those units just before the subdivision under the partitioning agreement.

39.  Therefore, the Individual Owners will satisfy the conditions in section 124-190 of the ITAA 1997 for roll-over relief. The consequence of choosing to obtain the roll-over are set out in section 124-10 of the ITAA 1997 and include:

(a)    any capital gain or capital loss that the Individual Owners make from the disposal of their tenancy in common interest is disregarded (subsection 124-10(2)); and

(b)    The first element of that original asset's cost base and reduced cost base are carried over and included in the first element of the cost base and reduced cost base of the relevant Apartment transferred to the relevant Individual Owners.

Question 6

Will the partitioning of the apartments be a taxable supply for the Individual Owners?

Summary

A supply is broadly defined as any form of supply whatsoever, this means that each co-owner is making a supply of land under a partitioning agreement.

For a supply to be taxable it must satisfy a number of requirements, most relevantly it must be made in connection with the supplier's enterprise. As the individual owners are entering into the agreement in order to obtain residential property for their personal use, the supply will not be made in connection with any enterprise they carry on.

Detailed reasoning

40.  The transfer by each co-owner of their respective interest in the land to be taken by the other co-owners severally meets the definition of a supply as defined by subsection 9-10(1) of the A New Tax System (Goods and Services Tax) Act 1999 (GST act).

41.  Under section 9-5 of the GST act, 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

42.  Based on the facts provided, the individual owners are making a supply of land, that is connected with the indirect tax zone, for consideration. Given the value of the supply, it's likely that the individual owners would be required to be registered if carrying on an enterprise. This means that it must be determined whether the Individual Owners are carrying on an enterprise in order to ascertain whether they are making a taxable supply.

43.  The term enterprise is defined by section 9-20 of the GST act and can be broadly summarised as an activity or series of activities done in the form of a business, adventure or concern in the nature of trade. One-off property transactions can constitute an enterprise where an individual intends to sell, resell or develop for profit. Private recreational pursuits and hobbies are specifically excluded from being considered an enterprise. Given the Individual Owners are entering into the agreement in order to obtain a home, it's reasonable to conclude that they are not carrying on an enterprise.

44.  As cited in the application, GSTR 2009/2 - Goods and services tax: partitioning of land clarifies that even if one or more of the owners is making a supply of land in connection with their enterprise, it does not mean that the owners, who are not carrying on an enterprise, are doing so.

Question 7

Will the partitioning of the apartments result in a payment of greater than nil under section 109C of the Income Tax Assessment Act 1936 (ITAA 1936)?

Summary

The transfer by the Company of its interest in the relevant Apartment to the relevant Individual Owners may result in a payment of greater than nil under section 109C of the Income Tax Assessment Act 1936 (ITAA 1936) if the value of the Individual Owners interest in the Sale Apartments is less than the value of the interest of the Company in their Apartment.

Detailed reasoning

45.  Division 7A of Part III of the ITAA 1936 is broadly directed at ensuring that disguised or informal distributions of private company profits to shareholders or their associates are included in the assessable income of the shareholder or associate.

46.  Under paragraph 109C(1)(a) of the ITAA 1936, where a private company makes a payment to an entity and that entity is a shareholder or an associate of a shareholder of that company, the private company is taken to have paid a dividend to the shareholder or associate.

47.  Under section 109ZD of the ITAA 1936, associate has the meaning given by section 318 of the ITAA 1936.

48.  For the purposes of Division 7A of Part III of the ITAA 1936, payment has the meaning given in subsection 109C(3) and section 109CA. Relevantly, subsection 109C(3) defines 'payment' as including 'a transfer of property to the entity'.

49.  Pursuant to subsection 109C(4) of the ITAA 1936, the amount of a payment consisting of a transfer of property is the amount that would have been paid for the transfer by parties dealing at arm's length less any consideration given by the transferee for the transfer. The amount of a payment is nil if the consideration given by the transferee equals or exceeds the amount that would have been paid at arm's length for the transfer. Put another way, the amount that is treated as a dividend is equal to the difference between the arm's length value of the property and any consideration that may have been given by the transferee in respect of the transfer: paragraph 9.23 of the Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 3) 1998.

50.  Subsection 109C(2) of the ITAA 1936 provides that the amount of the dividend will be the amount of the payment subject to the company's distributable surplus calculated under section 109Y of the ITAA 1936.

51.  Subdivision D of Division 7A contains rules about payments that are not treated as dividends. One of the exclusions is contained in section 109J of the ITAA 1936, which provides:

A private company is not taken under section 109C to pay a dividend because of the payment of an amount, to the extent that the payment:

(a) discharges an obligation of the private company to pay money to the entity; and

(b) is not more than would have been required to discharge the obligation had the private company and entity been dealing with each other at arm's length.

52.  Paragraph 109J(a) of the ITAA 1936 requires the obligation which is discharged to be for a payment of money: paragraph 91 of Taxation Ruling TR 2014/5 Income tax: matrimonial property proceedings and payments of money or transfers of property by a private company to a shareholder (or their associate. Where the obligation imposed on the private company is to transfer property, paragraph 109J(a) of the ITAA 1936 is not satisfied.

Application to your circumstances

53.  Pursuant to paragraph 318(2)(d) and (f) of the ITAA 1936, the Individual Owners will be associates of Holding Company, the 100% shareholder in the Company.

54.  The transfer by the Company of its interest in Apartment A and Apartment B under the partitioning agreement to the relevant Individual Owners will be a transfer of property, and therefore, a payment under subsection 109C(3) of the ITAA 1936.

55.  As the Company will make a payment to an associate of a shareholder, subsection 109C(1) of the ITAA 1936 will deem a dividend to have been paid to the Individual Owners.

56.  The amount that is treated as a dividend where property is transferred is equal to the difference between the arm's length value of the property and any consideration that may have been given by the transferee in respect of the transfer under subsection 109C(4) of the ITAA 1936.

57.  Under the partitioning agreement, the Individual owners will transfer their interest in the Sale Apartments to the Company and the Company will transfer its interest in Apartment A and Apartment B to the respective individual Owners. The consideration that is being given by the Individual Owners to the Company for the transfer is their respective interests in the Sale Apartments.

58.  A registered valuer will be engaged to prepare a valuation report at the time of partitioning as to the market value of each of the apartments.

59.  If the value of the respective Individual Owners interests in the Sale Apartments is less than the value of the interest of the Company in their respective Apartment, the difference will be taken to be the amount of the payment from the Company to the respective Individual Owners under section 109C(4) of the ITAA 1936.

60.  If the values of the interests are equal or if the value of the interest of the Company in the respective Individual Owners apartment is less than their interests in the Sale Apartments, the payment under section 109C of the ITAA 1936 will be nil. This is because the consideration provided by the Individual Owners will be equal to or more than the market value of the property transferred to them by the Company.

61.  Section 109J of the ITAA 1936 will not apply to the payment from the Company to the Individual Owners constituted by the transfer of property because under the partitioning agreement the Company will be discharging an obligation to transfer property and not to make a payment of money.

Question 8

If the answer to question 7 is yes, can the payment be converted to a loan under section 109D(4A) of the ITAA 1936?

Summary

If the market value of the apartments are unequal and the partitioning results in a payment from the Company to the Individual Owners, that payment can be converted to a loan to which subsection 109D(4) of the ITAA 1936 may apply.

Detailed reasoning

62.  Payments converted to loans before the end of the private company's lodgment day are treated as loans from the time the company made the payment pursuant to subsection 109D(4A) of the ITAA 1936. Subsection 109C(3A) of the ITAA 1936 provides that a loan to an entity is not a payment to the entity.

63.  A loan for the purposes of Division 7A under subsection 109D(3) of the ITAA 1936 includes:

(a)    an advance of money; and

(b)    a provision of credit or any other form of financial accommodation; and

(c)    a payment of an amount for, on account of, on behalf of or at the request of, an entity, if there is an express or implied obligation to repay the amount; and

(d)    a transaction (whatever its terms or form) which in substance effects a loan of money.

64.  All of the paragraphs of the definition of loan require some obligation on the part of the recipient of the benefit to pay an amount to the provider: see Taxation Ruling TR 2010/3 and Draft Taxation Determination TD 2022/D1.

Application to your circumstances

65.  In the circumstances outlined in this case, there does not appear to presently be an intention that there be an obligation on the part of the Individual Owners to pay any difference to the Company should the market value of the apartments be unequal and the partitioning results in a payment from the Company to the Individual Owners under subsection 109C of the ITAA 1936.

66.  However, we accept that if a payment is required, that payment can be converted to a loan to which subsection 109D(4A) of the ITAA 1936. There should be an obligation on the part of the Individual Owners to pay to the Company the amount of the difference between the market value of the interest in the Apartment that it has transferred to the Individual Owners and the interest that the Individual Owners have transferred to the Company. We would expect the loan to be documented and recorded in the financial accounts of the Company as a loan. Further, for 109D(4A) to apply the conversion must happen before the end of the private company's lodgment day for the relevant year of income.

Question 9

Summary

The sale of residential premises, used for residential accommodation is input taxed. An exception to this is the sale of new residential premises, residential property that has yet to be sold, which is taxable.

Under a partitioning agreement the involved parties are making a supply of their interest in the property. This means that a partitioning agreement qualifies as the first 'sale' of new residential premises.

However, this is only to the extent that is transferred under the partitioning agreement, the portion of interest that a party retains in the property as its own will retain the characteristics of new residential premises.

This means that, when sold, a portion of the property will be input taxed while the remainder will be taxable.

Detailed reasoning

67.  Under section 40-65 of the GST act, the sale of real property is input taxed only to the extent that the property is residential premises to be used for residential accommodation. However, the sale is not input taxed if the residential premises are new.

68.  Mostly relevantly, new residential premises are defined by paragraph 40-75(1)(a) of the GST act as such if they have not previously been sold as residential premises (other than commercial residential premises) and have not previously been the subject of a long-term lease.

69.  Paragraph 172 of GSTR 2009/2 clarifies that, as the partitioning of land constitutes a supply made by each party involved, if the property exhibits the characteristics of residential property at the time the partitioning is considered to be the first sale of the property. Any subsequent sales that follow the partitioning will not be new residential property to the extent that is transferred to the Company from the Individual Owners. The portion of interest that the Company retained in the property will remain new residential property and therefore taxable.