Edited version of private advice

Authorisation Number: 1051994867321

Date of advice: 15 June 2022

Ruling

Subject: CGT - small business concessions

Question 1

Do you meet the conditions in section 152-10 of the Income Tax Assessment Act 1997 to apply the capital gains tax (CGT) small business concessions to the capital gain made upon the disposal of the property?

Answer

No.

This ruling applies for the following periods:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You are a sole trader and have carry on a property development business.

The aspects of your business includes:

•         Rural subdivision;

•         House building and development; and

•         Land development.

In March 20XX you and your sibling inherited a property (the property).

You commenced investigating the development potential of the property whilst the estate was being settled.

This included land tenure and planning investigations, meeting with Council planning officers, real estate agents and neighbours. These activities are typical for your property development business and the projects previously undertaken.

Based on experience, you identified the development potential in the property and decided to acquire your sibling's interest in the property.

On 30 October 20XX you acquired your sister's interest, becoming the sole owner of the property.

You undertook the following actions as part of your business to bring the project to fruition:

•         Meetings with a real estate agent, a solicitor and adjoining property owners.

•         Obtained legal advice that confirmed there was an adverse possession issue in relation to the property.

•         Met with Council regarding your subdivision plans and you were advised that the acquisition and realignment of neighbouring land (the neighbouring block) would be required for the plan of subdivision to take place.

•         Prepared a plan of subdivision and met with Council planning officers.

•         Prepared a Native Vegetation Removal Report.

•         Wrote to the owner of the neighbouring block with an offer to purchase the neighbouring block on two occasions.

•         Your offers to acquire the neighbouring block were rejected.

•         February 20XX the adverse possession issue had not been able to be resolved and you decided to not proceed with the subdivision.

•         You listed the property for sale with a real estate agent in March 20XX.

•         The property sold XX June 20XX.

The actions taken in relation to the property are those that would be expected to be undertaken with any potential project undertaken in your property development business.

The actions taken are time consuming and costly but a necessary part of the project. The expenses incurred from the subdivision activities were accounted for as business expenses in your property development business.

The property was rented from acquisition until XX June 20XX.

You declared the rental income and expenses in your income tax returns for the relevant periods.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 subsection 152-35(1)

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 subsection 70-10(1)

Income Tax Assessment Act 1936 subsection 25(1)

Income Tax Assessment Act 1997 section 6-5

Reasons for decision

To qualify for the CGT small business concessions, you must satisfy several conditions that are common to all the concessions.

Section 152-10 of the Income tax Assessment Act 1997 (ITAA 1997) contains the basic conditions you must satisfy to be eligible for the small business CGT concessions. These conditions are:

(a)    a CGT event happens in relation to a CGT asset in an income year.

(b)    the event would have resulted in the gain

(c)     at least one of the following applies:

(i)            you are a small business entity for the income year

(ii)           you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997

(iii)          you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership or

(iv)          you do not carry on a business, but your CGT asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you.

(d)    the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

To be eligible to apply the small business CGT concessions you must satisfy all four of the basic conditions above.

Active asset test

Subsection 152-35(1) of the ITAA 1997 states that a CGT asset satisfies the active asset test if:

•         you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the period of ownership, or

•         you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7 and a half years.

Section 152-40 of the ITAA 1997 provides the meaning of 'active asset'. A CGT asset will be an active asset at a time if, at that time, you own the asset and the asset was used or held ready for use by you, an affiliate of yours, or by another entity that is 'connected with' you, in the course of carrying on a business.

Trading Stock

Subsection 70-10(1) of the ITAA 1997 provides the meaning of trading stock.

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.

The Commissioner has issued Taxpayer Alert TA 2014/1 and Taxation Determination TD 92/124 on the issue of whether land could constitute trading stock in particular circumstances.

In Taxpayer Alert TA 2014/1, the Commissioner has warned taxpayers of certain arrangements whereby a trust undertakes property development activities as part of its normal business. The underlying property under such arrangements could constitute trading stock under section 70-10 of the ITAA 1997 on the basis that the trustee would be carrying on a business of property development.

In Taxation Determination TD 92/124 provides that 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.

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.

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.

Taxation Determination TD 92/127 also provides that where land that is acquired for development, subdivision and sale and the development is abandoned and the land sold in a partly developed state, the land is treated as trading stock and the net profit made on the sale of the land is assessable income under subsection 25(1) of the Income Tax Assessment Act 1936 (now section 6-5 of the ITAA 1997).

Application to your circumstances

In your case, you undertake property development activities as part of your normal business. The property was held for the purpose of resale and business activity had commenced that directly related to the development and sale of the property. The expenses incurred undertaking the development activities were accounted for as your business expenses. As soon as it became clear that your subdivision development plans were not able to proceed (due to the offer to acquire the neighbouring property being rejected and the adverse possession issue unable to be resolved) the property was put on the market and sold. You continue to carry on your business of property development. It is considered that the property was held for the purpose of sale in the ordinary course of your business, therefore the property will be treated as trading stock under subsection 70-10(1) of the ITAA 1997.

Your case differs from the facts in Rosgoe Pty Ltd v FC of T [2015] FCA 1231 (Rosgoe) as you carry on a business of property development and have done so from 20XX and continue to carry on that business today. You undertook development activities directly relating to the development and sale of the property as part of your business activities. In Rosgoe the intention was to develop the property as part of a joint venture with a large property developer, however negotiations fell through with the large property developer and at that point the intention to carry on a development business and develop the property was abandoned.

The fact that the property was rented from acquisition until disposal does not prevent the property from being treated as trading stock.

As the property is considered trading stock, it is not an active asset and therefore the property is unable to satisfy the active asset test under section 152-35 of the ITAA 1997. As the active asset test has not been satisfied, you have not met the conditions required under subsection 152-10(1) of the ITAA 1997 to be eligible to apply the small business concessions in relation to the disposal of the property.