Edited version of private advice

Authorisation Number: 1052013867162

Date of advice: 24 November 2022

Ruling

Subject: CGT - property development

Question 1

Is the potential sale of the units ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Is the potential sale of the units statutory income as a capital gain (section 10-5 and 102-5 of the ITAA 1997) to the extent that it is not assessed as ordinary income under section 6-5 of the ITAA 1997?

Answer

Yes.

Question 3

Is the potential sale of the units, in the course or furtherance of an enterprise under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You own a property (the property).

The property was purchased in 20XX

Since the purchase, the property has been rented as residential property (input taxed for GST) and earning rental income.

Your intention at the time of the purchase was to add a granny flat in the future. You intended to retire in the property in around 10 years time.

You are registered for GST as the lessor of other commerical properties. You have not claimed any input tax credits in respect of the property, nor have you claimed any input tax credits for any acquisitions made in connection with the property.

You have been approached by a real estate agent with an offer to demolish the current dwelling on the property and build units on the land.

The offer suggested a Development Agrement (DA) in order to reduce the transaction costs and improve cashflow.

The DA will terminate if development approval is not obtained at no extra costs to either party.

There are no title transfers from you to the developer.

The titles will be transferred directly from you to the unit purchasers (when developed).

The outline of the proposed build is a dwelling of a number of units.

Upon negotiation, you negotiated receiving a number of units as consideration which has been accepted. There is a fixed upper limit to the value of the units you can choose.

The sale proceeds of the units will be paid directly into an account held by you in your name and the remaining amounts after all disbursements, will be paid to the developer as development fee.

You have no ultimate entitlement to any amounts from the sale proceeds of the units.

You have not undertaken any development or similar contract in the past or expecting to in the future.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 102-5

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

A New Tax System (Goods and Services Tax) Act 1999 section 9-20

A New Tax System (Goods and Services Tax) Act 1999 section 9-40

A New Tax System (Goods and Services Tax) Act 1999 section 23-5

A New Tax System (Goods and Services Tax) Act 1999 section 40-65

A New Tax System (Goods and Services Tax) Act 1999 section 195-1

Reasons for decision

Question 1

Generally, the profits from a land subdivision and sale can be treated for taxation purposes as ordinary income under section 6-5 of the ITAA 1997, if:

•         as a result of carrying on a business of property development, involving the sale of land as trading stock;

•         it is a gain from a result of an isolated commercial transaction entered into by taxpayer, (inside or outside the ordinary course of business of a taxpayer carrying on a business, where the property was acquired or subsequently held for the purpose of profit making (see TR 92/3).

Alternatively it can be treated as statutory income as CGT legislation (section 10-5 and 102-5 of the ITAA 1997) to the extent that it is not assessed as ordinary income under section 6-5 of the ITAA 1997, a mere realisation of a capital asset has occurred.

The ATO view of whether property development activities constitute the carrying of a business or an isolated transaction that is of a revenue nature or is a mere realisation of a capital asset is based on principles, factors and indicators that have been established by the Courts.

Carrying on a business

'Business' is defined by subsection 995-1(1) of the ITAA 1997. This defines business to include 'any profession, trade, employment, vocation or calling', but excludes 'occupation as an employee'.

Taxation Ruling TR 2019/1 (TR 2019/1) considers what amount s to a business and references Federal Commissioner of Taxation v Murry[7] where Gaudron, McHugh, Gummow and Hayne JJ observed '...A business is not a thing or things. It is a course of conduct carried on for the purpose of profit and involves notions of continuity and repetition of actions'.

Taxation Ruling TR 97/11 (TR 97/11) identifies the indicators of carrying on a business. Paragraph 13 of TR 97/11 identifies what Courts have indicated as the characteristics of a business:

•         whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators (see paragraphs 28 to 38);

•         whether the taxpayer has more than just an intention to engage in business (see paragraphs 39 to 46);

•         whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity (see paragraphs 47 to 54);

•         whether there is repetition and regularity of the activity (see paragraphs 55 to 62);

•         whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business (see paragraphs 63 to 67);

•         whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit (see paragraphs 68 to 76);

•         the size, scale and permanency of the activity (see paragraphs 77 to 85);

•         whether the activity is better described as a hobby, a form of recreation or a sporting activity (see paragraphs 86 to 93).

Application to your circumstances

On balance it does not appear you are carrying on a business of property development. There is no evidence of intention to carry on a business. You do not have a business plan and engaging with a property developer is not alone indicative of carrying on a business.

Profit from an isolated transaction

Taxation Ruling TR 92/3 (TR 92/3) identifies whether profits from isolated transactions are ordinary income. TR 92/3 considers the principles outlined in the Federal Commissioner of Taxation v. The Myer Emporium Ltd (1987) 163 CLR 199 case and provides guidance in determining whether profits from isolated transactions are income and therefore assessable under subsection 25(1) of the ITAA 1936.

Where you are not carrying on a business, a profit from an isolated transaction is generally income when both of the following elements are present (paragraph 6 of TR 92/3):

•         the intention or purpose of the 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 or in carrying out a business operation or commercial transaction.

It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose (paragraph 8 of TR 92/3).

For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character (paragraph 12 of TR 92/3).

Paragraph 13 of TR 92/3 provides some matters which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction, which are the following:

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

Paragraphs 41 and 42 of TR 92/3 considers the purpose of profit-making for the sale of property:

41. The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property. However, as the High Court decisions in White v. FC of T (1968) 120 CLR 191; 15 ATD 173 and Whitfords Beach demonstrate, that is not always the case. (See also Menzies J in FC of T v. N.F. Williams (1972) 127 CLR 226 at 245; 72 ATC 4188 at 4192-4193; 3 ATR 283 at 289 and Whitfords Beach Pty Ltd v. FC of T (F.C.) 79 ATC 4648 at 4659; 10 ATR 549 at 567).

42. For example, if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either:

a)    as the capital of a business; or

b)    into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction,

the activity of the taxpayer constitutes the carrying on of a business or a business operation or commercial transaction carrying out a profit making scheme, as the case may be. The profit from the activity is income although the taxpayer did not have the purpose of profit making at the time of acquiring the asset.

Application to your circumstances

On balance, we consider your intention or purpose for entering into the transaction was to make a profit or gain. You negotiated to receive a gain over the market value of the property and the transaction entered into is not considered a mere realisation of a capital asset. You may have disposed of the property to the property developer. Instead, you engaged the property developer to undertake activities, such as demolition, subdivision approval and construction of units to the property, that go beyond simply improving a capital asset.

The transaction is commercial in nature, that is property development for profit or gain. We consider that your purpose for the property has changed from a passive rental income to a profit or gain from a property development transaction.

You should include in your assessable income a profit from an isolated transaction in accordance with the principles contained in TR 92/3, which is assessable as ordinary income under section 6-5 of the ITAA 1997.

Question 2

Section 21 of the Income Tax Assessment Act 1936 states that for a transaction where any consideration is not paid or given in cash, the money value of that consideration shall be deemed to have been paid or given.

You have received consideration not paid in cash, in the form of the construction services attributable to the units from the developer. This consideration will be included in the cost base of the units for CGT purposes when you dispose of the three units.

The sales of the units will also be a CGT event A1 (section 104-10 of the ITAA 1997) as you will dispose of your ownership interest in a CGT asset to another entity.

The subdivision of property (paragraph 112-25(1)(a) of the ITAA 1997) nor the change in purpose of the property (paragraph 112-25(1)(b) of the ITAA 1997) results in a CGT event. As such, you will not make a capital gain or capital loss at the time of the subdivision or when you changed the purpose of the property to make a profit from the development of the property.

A CGT event does arise though at the time you enter into contracts for the disposal of the units as per section 104-10 of the ITAA 1997.

The capital gain is worked out by taking the proceeds of each sale reduced by the cost base.

Once the capital gain is worked out, section 118-20 of the ITAA 1997 reduces the capital gain assessable by the profit already reported as assessable income under section 6-5 of the ITAA 1997 for the profit from an isolated transaction.

Question 3

Section 9-40 of GST Act provides that you must pay the GST payable on any taxable supply that you make.

Section 9-5 of the GST Act provides that you make a taxable supply if:

•         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 (essentially 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.

The supply of the property will clearly be for consideration. Such consideration will consist of the sale price specified in the sale contract for each unit. Hence, the first requirement of a taxable supply will be met. As the property is on real property (land) that is in Australia and you are registered for GST, the third and the fourth requirements of a taxable supply are also met.

None of the provisions in the GST Act that could make a supply GST-free or input taxed will be applicable in relation to the supply (sale) of the property. Specifically, it is noted that the property (once the sales settle), will consist of the supply of new residential premises. Section 40-65(2)(b) of the GST Act provides that the sale of residential premises, to the extent that they are new residential premises, will not be an input taxed supply of residential premises.

You have sought clarification from us if the sale of the units is in the course or furtherance of an enterprise that you carry on which is the second requirement of a taxable supply.

In the current circumstances, we consider that you are registered for GST (the fourth requirement of a taxable supply) and that the supply (sale) will be made in the course or furtherance of your enterprise (the second requirement of a taxable supply), for the reasons provided below.

Carrying on an enterprise/supply made in the course or furtherance of an enterprise

For the sale of the property to be made in the course or furtherance of your enterprise, the sale of the property must have a connection to your enterprise.

Goods and Services Tax Ruling GSTR 2004/8 Goods and services tax: when does an entity have a decreasing adjustment under Division 132' considers the meaning of 'in the course or furtherance of an enterprise'. At paragraph 28 it states:

28.  For the sale of a thing to be made in the course or furtherance of your enterprise, the sale of the thing must have a connection with your enterprise. Whether a connection between the sale of the thing and your enterprise exists will depend on the facts and circumstances. The Explanatory Memorandum to the A New Tax System (Goods and Services Tax) Bill 1998 states:

'In the course or furtherance' is not defined but is broad enough to cover any supplies made in connection with your enterprise. An act done for the purpose or object of furthering an enterprise, or achieving its goals, is a furtherance of an enterprise although it may not always be in the course of that enterprise. 'In the course or furtherance' does not extend to the supply of private commodities, such as when a car dealer sells his or her own private car. See Case N43 (1991) 13 NZTC 3361.

Paragraph 29 of GSTR 2004/8 further states:

29.  Given the broad meaning of 'in the course or furtherance', a sale of a thing is capable of being made in the course or furtherance of an enterprise regardless of the extent to which it has a connection with the enterprise, so long as it has some connection. The GST Act does not require that the thing must be applied primarily or principally in carrying on the enterprise for the supply of the thing to be in the course or furtherance of an enterprise. Accordingly, a connection between the sale of the thing and your enterprise exists even if, at the time of its sale, the thing is applied in carrying on the enterprise to a minor or secondary extent.

The sale of the property will be in the course or furtherance of your enterprise where it has some connection with the enterprise. Paragraph 30 of GSTR 2004/8 considers characteristics which indicate the following characteristics of a thing which indicates strongly that the sale of a thing has a connection with your enterprise:

•         at the time of sale it formed part of the assets of your enterprise (for example, it is trading stock or a depreciable asset for income tax purposes);

•         at the time of sale it was applied in carrying on your enterprise to at least some extent; and

•         it is sold as a transaction of your enterprise.

Each of these points will indicate a connection and not all of the points need to be satisfied. The word 'Asset' is not defined in the GST Act. The Macquarie Dictionary online, www.macquariedictionary.com.au, accessed 5 July 2022, defines the term as 2. an item of property, as a building, a piece of equipment, etc...,3. an economic resource.... In this respect the property is an asset which you are seeking to realise. As you are registered for GST, the sale of that asset will be a taxable supply where the requirements of section 9-5 are met.

Note: trading stock and depreciable assets for income tax purposes are merely two types of assets and do not represent an exhaustive list of assets an enterprise can have.

Application to your circumstances

The facts and circumstances of the sale of the property establish a sufficient connection with your enterprise such that paragraph 9-5(b) of the GST Act will be satisfied. Given that the other elements of section 9-5 of the GST Act will also be met, the sale of the property will be a taxable supply.