Edited version of private advice

Authorisation Number: 1052044504074

Date of advice: 14 October 2022

Ruling

Subject: GST - sale of new residential premises

Question 1

Will GST be payable on the sale of Units <number> and <number>, <property address> under section 9-40 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

Yes.

Question 2

Will the proceeds from the sale of Units <number> and <number>, <property address> be assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 3

Will the profit from the sale of the properties be assessable under the capital gains tax provisions as a mere realisation of a capital gains tax asset?

Answer

No.

This ruling applies for the following period:

1 July <year> to 30 June <year>

The scheme commences on:

<date>

Relevant facts and circumstances

You, <individual name>, purchased a residential property located at <property address> (Property 1) on <date> for $<amount>.

The Property is formally known as Lot <number> on Plan of Subdivision <number> being the whole of the land in Certificate of Title Volume <number> Folio <number>.

When purchased, <Property 1> consisted of approximately <number>m2 in land size, was zoned GRZ1 - General Residential Zone - Schedule 1, and contained three-bedroom, one-bathroom house with a kitchen, dining and lounge area and two car spaces.

You used this <Property 1> as your principal place of residence uninterrupted until <date>, when you moved into <property address> (Property 2), which is your current principal place of residence. You subsequently leased <Property 1> until <date>.

During <year> you received numerous complaints from your tenants in relation to the state <Property 1> that required you to spend thousands of dollars every few months in maintenance/repairs. In <date> for example you received a maintenance/repair quote from your property manager which totalled $<amount>.

It became apparent to you that it was not viable and too expensive to continue to maintain or to complete the major repairs, including underpinning, the 60-year-old house required, and you began exploring your options.

Subdivision and development of the <Property 1> and sale of the subdivided Units

In <month> <year> you were advised by the architectural company <entity name> that a two-unit development with total building size of almost <number>sqm was a viable option for <Property 1> and that council would approve your application for the unit development. The quote you obtained from <entity name> shows that you were responsible for the <task> and <task> for the purpose of submitting the building permit. Whilst you performed this function in your capacity as <professional field> consultant, all planning and building permits were solely organised by <entity name> who were the primary applicants with the requisite experience, resources and skills for the completion of this application process.

In <month> <year>, the first set of preliminary plans were submitted to <name> City Council for approval.

On <date> you obtained an opinion of market worth of <Property 1> which considered the size condition and location of the property and comparable sales data at the time from <entity name> which estimated the value of your property to be $<amount>. You obtained a market appraisal of <Property 1> before demolishing the dwelling as you thought the figure would be used as your cost base in case something went wrong in the following five years, and you were forced to sell one or both Units.

On <date> Planning Permit <number> was issued by <name> City Council allowing the development of two double storey townhouse dwellings (the Townhouses) in accordance with the endorsed plan on <Property 1>.

In <month> <year> you proceeded with developing the <Property 1> in accordance with Planning Permit P<number>. Given the low lending bank interest rates at the time your intention was to retain the two Townhouses as long-term investments and for rental income, with plans for the rental income stream to partly fund your future retirement.

In considering your options you did not seek advice on potential rental income for the Townhouses as you had been leasing the original <Property 1> for the preceding four years for $<amount> per week and you were familiar with the <Suburb> rental market. At the time you estimated a potential rental income for both Units would be approx. $<amount> per week ($<amount> for the two-bedroom townhouse and $<amount> for the three-bedroom townhouse).

You also contemplated living in one of the newly constructed Townhouses and leasing your <Property 2> for approximately $<amount> per week. You abandoned the idea of living in one of the Townhouses as you had a child approaching secondary school age and considered that schools in the <suburb> catchment area were not as good as in <suburb> where you ended up purchasing another property. You decided to buy, demolish & build in <suburb> and live there, keeping the other properties as investments instead. Refer below for details of your other properties.

On <date> you entered into a building and construction contract with builder <entity name> to construct two double storey townhouses on <Property 1> for $<amount>.

You applied for a <bank> owner-occupied home loan totalling $<amount> to fund the construction of the Townhouses. You applied for an owner-occupied loan as, at the time, you had the intention to live in one of the Townhouses for the reasons described above. In relation to your borrowings, you advised that approx. $<amount> was drawn from the existing home loan on <Property 1> and an additional $<amount> was financed to fund the basic construction. You also utilised approx. $<amount> from personal savings to fund the <Property 1> development.

You provided your household financial position as submitted in your loan application dated <date>.

You were notified your loan application was approved on <date>. The term of the loan is for 30 years with two years interest only repayments followed by interest and principal repayments following the interest only period. You advised you opted to take up the 24-month interest only repayment option, which you claim is provided by <bank> as a standard practice for owner occupied construction loans, as this reduced the monthly repayments during the construction phase where no rent could be collected from the Townhouses.

In <month> <year> the original dwelling on <Property 1> was demolished.

Construction of the Townhouses commenced in <month> <year> and was completed on <date>.

On <date> you engaged the services of a real estate agent - <entity name>, to market and sell Unit <number>, <property address> (Unit <number>).

You decided to no longer lease and to instead sell, at least one of the Townhouses in <month> <year> when you engaged a real estate agent to sell Unit <number>. This occurred within two months of the commencement of the construction of the Townhouses, within four months of the original dwelling on < Property 1> being demolished, and around the time you purchased the property in <Suburb> on which you have since decided to build your new family home (this is discussed further below). The Townhouses will not be leased for any period prior to their sale.

Your change in intention regarding the future use of the Townhouses was motived by the financial impact of the Covid-19 pandemic, the rise in inflation, increased construction and holding costs contributed to your financial incapacity to hold onto the Townhouses.

On <date> Planning Permit P<number> was issued by <name> City Council allowing the two-lot subdivision in accordance with PS<number>.

You provided a breakdown of the overall costs to develop <Property 1>.

On <date> you entered into a contract for the sale of Unit <number>, <property address> (Unit <number>) formally with purchaser <individual name> for $<amount>. This Unit is formally described in the contract of sale as Lot <number> on Plan of Subdivision <number> being the part of the land in Certificate of Title Volume <number> Folio <number>.

Even though you were not registered for GST at the time the contact was signed, the contract of sale specifies that the sale is subject to GST and that the margin scheme is to apply to the sale of the Townhouse. You explained that this was your first time selling the property and since you are not a property developer you just ticked the box offered to you on the standard contract of sale for newly built Units. You confirmed that you made that election without seeking advice from your accountant.

According to the contract of sale settlement is expected to take place on <date>.

In <month> <year> you again engaged the services of <entity name> to market and sell Unit <number>, < property address> (Unit <number>).

On <date> you entered into a contract for the sale of Unit <number>, <property address> (Unit <number>) formally with purchaser <individual name> for $<amount>. This Unit is formally described in the contact of sale as Lot <number> on Plan of Subdivision <number>being the part of the land in Certificate of Title Volume <number> Folio <number>.

All proceeds from the sales of the Townhouses will be used to finance construction of your new home in <suburb>. See below for further details regarding this property.

Other properties/investments

Your current principal place of residence is <Property 2>. You and your spouse purchased this property in <month> <year> for $<amount>.

In <month> <year> you and your spouse purchased a further investment property located at <property address> (Property 3) for $<amount> with the intention of initially leasing the property and eventually building your future main residence there. You purchased this property after you had already entered into the building and construction contract for the Townhouses in <suburb>. You obtained a loan from <bank> to purchase this property also - (mortgage <number>).

After not collecting any rental income from the <Property 3> you demolished the house in <month> <year>.

On <date> you entered into a building and construction contract with builder <entity name> for the construction of a new dwelling at <property address> for $<amount>.

On <date> you received an email from your mortgage broker from <bank> outlining some of your options for securing additional finance and/or to fund the construction of the <Property 3>. It was recommended to you in the email to sell one or both of the Townhouses.

Once construction of the house at <Property 3> is complete you plan to move into that property as your principal place of residence.

You intend to keep < Property 2> as an investment and for rental income but depending on your financial circumstances you may need to sell that property too to fund the completion of your new house in <suburb>.

Other

You are an <position> and <position> of <entity name>. Your main salary and wage occupation description is <profession>. Your spouse is <profession>.

You are not currently registered for GST.

Neither you nor your spouse have undertaken any property developments in the past.

Relevant legislative provisions

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

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

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

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

A New Tax System (Goods and Services Tax) Act 1999 section 188-10

A New Tax System (Goods and Services Tax) Act 1999 section 188-15

A New Tax System (Goods and Services Tax) Act 1999 section 188-20

A New Tax System (Goods and Services Tax) Act 1999 section 188-25

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

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Issue 1

For Issue 1,

• unless otherwise stated, all legislative references are to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)
• all legislative terms of the GST Act marked with an asterisk are defined in section 195-1 of the GST Act.
• all reference materials, published by the Australian Taxation Office (ATO), that are referred to are available on the ATO website ato.gov.au

Question 1

Will GST be payable on the sale of Units <number> and <number>, <property address> under section 9-40 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Detailed reasoning

Section 9-40 provides that you are liable for GST on any taxable supplies that you make.

You make a taxable supply where you satisfy the requirements of section 9-5 of the GST Act, which provides:

You make a taxable supply if:

a)    the entity makes the supply for consideration

b)    the supply is made in the course or furtherance of an enterprise that the entity carries on

c)    the supply is connected with Australia, and

d)    the entity is 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, the sale of Unit <number> is for consideration of $<amount> and Unit <number> is for $<amount>. You expect to receive this consideration upon settlement of each sale. These sales are connected with Australia as both of the properties are located in Australia.

It remains to be determined whether the sales of the Townhouses are in the course or furtherance of an enterprise you carry on, and whether you are required to be registered for GST.

Supply in the course or furtherance of enterprise

Section 9-20 relevantly defines enterprise to include an activity, or series of activities, done:

a)    In the form of a business

b)    In the form of an adventure or concern in the nature of trade or

c)    On a regular or continuous basis, in the form of a lease, license or other grant of an interest in property

The meaning of 'enterprise' is considered in Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number (MT 2006/1) and in Goods and Services Tax Determination GSTD 2006/6 Goods and services tax: does MT 2006/1 have equal application to the meaning of 'entity' and 'enterprise' for the purposes of the A New Tax System (Goods and Services Tax) Act 1999? (GSTD 2006/6) which provides that the discussion on 'enterprise' in MT 2006/1 applies to the GST Act.

Paragraph 159 of MT 2006/1 discusses how to determine the extent to which an activity or a series of activities amounts to an enterprise:

159. Whether or not an activity, or series of activities, amounts to an enterprise is a question of fact and degree having regard to all of the circumstances of the case.

Furthermore, paragraph 160 of MT 2006/1 discusses the need to identify all the relevant activities in order to determine the existence of an enterprise:

160. It is important that the relevant activity or series of activities are identified in order to determine whether an enterprise is being carried on. This is because one activity may not amount to an enterprise but that activity taken into account with other activities may form an enterprise. All activities need to be taken into account including activities from the commencement to the termination of the enterprise. For further information on commencement and termination activities, see paragraphs 120 to 148 of this Ruling.

Consequently, the relevant activities are the activities associated with the development of <Property 1> and includes the demolition of <Property 1>, preparing and subdividing the land, construction of the Townhouses, marketing and the sale of the newly constructed Townhouses.

It is noted at the outset that while your spouse was involved in securing the home loan with respect to the Townhouses, the facts show that:

• she was not a joint or part owner of the <Property 1>
• she was not involved in obtaining the services of real estate agents and building contractors and other consultants in developing the Townhouses
• she was not listed as a vendor on the contract of sale for both Units.

Consequently, we consider your spouse's role in the development of <Property 1> to not be sufficient enough to amount to an enterprise, either done in her own right or jointly with you, and so the remaining analysis will focus on your involvement in the activities associated with the development of <Property 1> and the subsequent subdivision and sale of the Townhouses.

These activities will now be examined in light of the relevant types of enterprises under section 9-20 described above.

Firstly, it is necessary to consider whether your activities are in the form of a business.

In the form of a business

Section 195-1 provides that a 'business' includes any profession, trade, employment, vocation or

calling, but does not include occupation as an employee.

Paragraphs 170 to 232 of MT 2006/1 discuss factors to consider when determining whether an

activity or series of activities are done in the form of a business.

As noted in paragraph 176 of MT 2006/1, the meaning of 'business' is considered in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? (TR 97/11). Although TR 97/11 deals with carrying on a primary production business, the principles discussed in TR 97/11 apply to any business.

Paragraphs 177 to 179 of MT 2006/1 discuss the main indicators of carrying on a business, with reference to the principles in TR 97/11:

Indicators of a business

177. To determine whether an activity, or series of activities, amounts to a business, the activity needs to be considered against the indicators of a business established by case law.

178. TR 97/11 discusses the main indicators of carrying on a business. Based on that discussion some indicators are:

•         a significant commercial activity;

•         a purpose and intention of the taxpayer to engage in commercial activity;

•         the activity is or will be profitable;

•         the recurrent or regular nature of the activity;

•         the activity is carried on in a similar manner to that of other businesses in the same or similar trade;

•         activity is systematic, organised and carried on in a businesslike manner and records are kept;

•         the activities are of a reasonable size and scale;

•         a business plan exists;

•         commercial sales of product; and

•         the entity has relevant knowledge or skill.

179. There is no single test to determine whether a business is being carried on. Paragraph 12 of TR 97/11 states that 'whilst each case might turn on its own particular facts, the determination of the question is generally the result of a process of weighing all the relevant indicators'. TR 97/11 can be referred to for a fuller discussion on whether a particular activity constitutes the carrying on of a business.

We consider that the following facts in your case are indicators of you are carrying on a business:

• You had a coherent plan for the development, subdivision, construction and sale of the Townhouses. Your activities were conducted in a systematic way and business-like way similar to those conducting a property development business/enterprise. In assessing viable options to address the deteriorating condition of <Property 1> you:

• sought expert advice about your options for subdivision of the Property
• used your existing knowledge of rental market in the <suburb> area
• obtained market appraisal of the property in its original condition

•         Despite your lack of experience in property development, you utilised your professional expertise to perform functions such as preparing <task> and <taks> as a consultant to <entity name> for the purposes of obtaining the building permit. You sought advice and/or the services of experts to complete other functions that you did not have personal expertise in. Examples of experts you sought services from include:

• Architectural company - <entity name>
• Land surveyors - <entity name>
• Builder - <entity name>
• Real estate agent - <entity name>

• You intended and expected to make a profit, initially from the leasing of the Townhouses and subsequently through the sale of the Townhouses. Your communications with your mortgage broker show that you are relying on the profits from the sale of the Townhouses to partly fund the construction of your new family home in <suburb>.
• You engaged the services of a real estate agent to market the properties for sale to the general public. You engaged a real estate agent to market Unit <number> for sale just two months after the commencement of its construction.
• You invested capital and obtained a substantial loan from <bank> to build the two Townhouses.
• Your activities were organised, and you maintained records of your expenditure.

Whilst the above facts indicate the existence of a significant commercial activity carried on in a business-like manner with the intention and real prospect of making a profit, all of which are strong indicators of carrying on of a business, the facts overall suggest that the indicators set out in paragraph 178 of MT 2006/1 are not present to a sufficient degree to warrant the conclusion that you are carrying on a business. We consider that the activities you have undertaken do not display the salient indicator of a business which are transactions entered into a continuous and repetitive basis. You confirmed that you have never been involved in property development before and that your activities represent a one-off transaction involving <Property 1>. The Townhouses you constructed to replace the deteriorating existing dwelling were initially intended to be used as long-term investment properties but due to change in circumstances you had to sell them instead. While your activities represent a significant commercial activity that is profitable, we think they are not of such a size that would overcome the lack of recurring or regular activities and justify the finding of a business of property development being carried on.

Given the activities of developing and selling the Townhouses does not amount to carrying on a business, it needs to be determined whether they can be considered an enterprise in the form of an adventure or concern in the nature of trade.

In the form of an adventure or concern in the nature of trade

'An adventure or concern in the nature of trade' is not defined in the GST Act.

Paragraph 234 of MT 2006/1 distinguishes between activities done in the form of a 'business' and those done in the form of 'an adventure or concern in the nature of trade':

234. Ordinarily, the term 'business' would encompass trade engaged in, on a regular or continuous basis. However, an adventure or concern in the nature of trade may be an isolated or one-off transaction that does not amount to a business but which has the characteristics of a business deal.

The commercial nature of a transaction or scheme is significant in determining whether the activities are done in the form of an adventure or concern in the nature of trade. This is further explained in MT 2006/1:

237. The term 'profit making undertaking or scheme' like the term 'an adventure or concern in the nature of trade' concerns transactions of a commercial nature which are entered into for profit-making but are not part of the activities of an on-going business. Both terms require the features of a business deal, see McClelland v. Federal Commissioner of Taxation, in which Lord Donovan, delivering the opinion of the majority, said:

It seems to their Lordships that an 'undertaking or scheme' to produce this result must - at any rate where the transaction is one of acquisition and resale - exhibit features which give it the character of a business deal. It is true that the word 'business' does not appear in the section; but given the premise that the profit produced has to be income in its character their Lordships think the notion of business is implicit in the words 'undertaking or scheme'.

Paragraph 244 of MT 2006/1 further explains that an adventure or concern in the nature of trade includes a commercial activity that does not amount to a business, but which has the characteristics of a business deal are of a revenue nature. However, the sale of the family home, car and other private assets are not, in the absence of other factors, adventures or concerns in the nature of trade.

Paragraph 245 of MT 2006/1 refers to 'the badges of trade' which provides a 'common sense guidance' in reaching a conclusion on whether a transaction has the characteristics of a business deal and whether an asset is held as a trading/revenue asset or a capital/investment asset held for either investment or personal enjoyment. While an activity such as the selling of an asset may not of itself amount to an enterprise, account should be taken of the other activities leading up to the sale to determine if an enterprise is carried on.

The Commissioner has made the following comments about the badges of trade in MT 2006/1:

The subject matter of realisation

247. This badge of trade considers the form and the quantity of property acquired. If the property provides either an income or personal enjoyment to the owner it is more likely to be an investment than a trading asset.

The length of period of ownership

249. A trading asset is generally dealt with or traded within a short time after acquisition. ...

The frequency or number of similar transactions

251. The greater the frequency of similar transactions the greater the likelihood of trade.

Supplementary work on or in connection with the property realised

252. Improving property beyond preparing an asset for sale, to bring it into a more marketable condition and gain a better price suggests an element of trade.

The circumstances that were responsible for the realisation

253. Trade involves operations of a commercial character. As assets can be sold for reasons other than trade, the circumstances behind the sale need to be considered. For example, a quick resale may have occurred as a result of sudden financial difficulties.

Motive

254. If the activities on an objective assessment have the characteristics of trade, the person's motive is not relevant. It is relevant in those cases where the evidence is not conclusive. An intention to resell at the time of acquisition may be an indicator of the resale being an adventure or concern in the nature of trade.

255. Motive is also important in cases if there is a change in character of the asset. For example, a trading asset becoming an investment asset when the person decides to keep the asset, either for income producing purposes or personal enjoyment.

Paragraph 258 to 261 of MT 2006/1 further considers the character of an asset and distinguishes between trade/revenue assets and capital/investment assets as follows:

Trade v. investment assets

258. United Kingdom cases categorise assets as either trading assets or investment assets. Assets purchased with the intention of holding them for a reasonable period of time, to be held as income producing assets or to be held for the pleasure or enjoyment of the person, are more likely not to be purchased for trading purposes.

259. Examples of investment assets are rental properties, business plant and machinery, the family home, family cars and other private assets. The mere disposal of investment assets does not amount to trade.

260. Assets can change their character but cannot have a dual character at the same time.

261. Investment assets such as business plant and machinery are used by entities in carrying on a business. The purchase and disposal of those types of assets is ordinarily considered not to be an adventure or concern in the nature of trade for UK income tax purposes.

Isolated Property Transactions

Paragraphs 262 to 267 apply the 'badges of trade' concept discussed above to isolated property transactions, in order to determine whether an isolated property transaction can be considered to be an enterprise in the form of an adventure or concern in the nature of trade.

Paragraph 262 of MT 2006/1 acknowledges that the question of whether an entity is carrying on an enterprise often arises where there are 'one-offs' or isolated real property transactions.

Paragraph 263 continues, stating that the issue to be decided is whether the activities being conducted are an enterprise in that they are of a revenue nature as they are considered to be activities of carrying on a business or an adventure or concern in the nature of trade (profit making undertaking or scheme) as opposed to the mere realisation of a capital asset.

Paragraph 264 of MT 2006/1 discusses two seminal cases in this area: Statham & Anor v Federal Commissioner of Taxation 89 ATC 4070 (Statham) and Casimaty v FC of T 97 ATC 5135 (Casimaty).

Paragraph 265 of MT 2006/1 extracts the key elements of both cases and provides a list of factors that can be used to assist in determining whether isolated property transactions are an adventure or concern in the nature of trade or a mere realisation of a capital asset:

265. From the Statham and Casimaty cases a list of factors can be ascertained that provide assistance in determining whether activities are a business or an adventure or concern in the nature of trade (a profit-making undertaking or scheme being the Australian equivalent, see paragraphs 233 to 242 of this Ruling). If several of these factors are present it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows:

•         there is a change of purpose for which the land is held;

•         additional land is acquired to be added to the original parcel of land;

•         the parcel of land is brought into account as a business asset;

•         there is a coherent plan for the subdivision of land;

•         there is a business organisation - for example, a manager, office and letterhead;

•         borrowed funds financed the acquisition or subdivision;

•         interest on money borrowed to defray subdivisional costs was claimed as a business expense;

•         there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and

•         buildings have been erected on the land.

In addition to the above, paragraphs 266 and 267 of MT 2006/1 provides that there may be other relevant factors outside this list that a present on the facts of a given case, and that no individual factor is determinative to the question of whether an enterprise is present:

266. In determining whether activities relating to isolated transactions are an enterprise or are the mere realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. This may require a consideration of the factors outlined above, however there may also be other relevant factors that need to be weighed up as part of the process of reaching an overall conclusion. No single factor will be determinative rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

267. No two cases are likely to be exactly the same. For instance, while the conclusions reached in the Statham and Casimaty cases were similar, different facts and factors were considered to reach the respective conclusions.

Application to this case

You purchased <Property 1> in <month> <year> and used it as you principal place of residence for approximately <number> years and subsequently leased and generated rental income until <year>. During this prolonged period of time, ownership of <Property 1> was characterised as a capital asset which provided you with either personal enjoyment or income.

We consider that during the period where you derived rental income from this property you were carrying on a leasing enterprise within the meaning of paragraph 9-20(c) of the GST Act.

The purpose of subdividing and building the Townhouses was initially to lease and hold for investment purposes and not for trading purposes. While you did have a brief intention to use one of the Townhouses as your principal place of residence, for the reasons discussed in the facts your intention for the use of this Townhouse quickly changed to leasing as well. We consider your leasing enterprise identified above was still continuing, and the Townhouses would be considered capital assets from which future rental income would be derived.

However, you then placed both Townhouses on the market for sale. You indicated this was motivated by the financial impact of the Covid-19 pandemic, the rise in inflation, increased construction and holding costs contributed to your financial incapacity to hold onto the two Townhouses. Notwithstanding all of these factors, we note that in <month> <year> when you applied to <bank> for the loan of $<amount> to fund the construction of the Townhouses your surplus household income to service that loan was in the vicinity of $<amount> per month and that you also had access to cash savings of $<amount> of which you utilised $<amount> towards funding the development. We consider that your intention with regards to the Townhouses changed from building to rent to building to sell in <month> <year> with the majority of the activities and expenditure incurred in the property development after you made this decision.

You engaged a real estate agent to sell Unit <number> in <month> <year>, just two months after the construction of the Townhouses commenced (<month> <year>) and four months from when you demolished <Property 1>. You entered into a contract for the sale of this Unit in <month> <year> for $<amount>. You gave authority for the same real estate agent to sell Unit <number> in <month> <year>. Neither of the Townhouses will be leased at any point prior to their sale.

You had a profit-making intention with respect to the use of the land encompassing, first, <Property 1>, and second, the Townhouses, since you moved from <Property 1> into <Property 2>. That profit-making intention never ceased, however the nature of the profit intended to be derived from <Property 1> and Townhouses changed from passive rental income to actively selling what amounted to your property development 'trading stock' - namely, the constructed Townhouses.

The change in purpose in which the property was held occurred at the same period of time you purchased <Property 3> for $<amount> on which you are now building your new family home. As per the building and construction contract the cost to build your new house is $<amount>.

We consider that this change was done to maximise the profit-making potential of your property development activities, and therefore maximise the reduction that could be made to the outstanding debts you (and your spouse) were liable for. Your profit-making intention in selling the Townhouses is evidenced by the email you received from your mortgage broker (although dated several months after you initially placed the Townhouse on the market for sale). In the email your broker advises that your borrowing capacity increases from $<amount> to $<amount> and that you would also have surplus funds of between $<amount> to $<amount> to fund the construction of your new home in <suburb> if you were to sell both Townhouses.

By selling instead of renting the Townhouses, you reduced the outstanding debts you (and your spouse) were liable for, you also maximised your borrowing capacity, created surplus funds and income to service the loan you obtained to purchase <Property 3>, as well as the loan you are hoping to obtain to fund the demolition and construction of your new family home. Consequently, not only did you intend and expect to make a profit from the sale of the Townhouses you are relying on that profit to partly fund the construction of your new family home.

We consider that the intention to maximise the profit on the use of the Townhouses by selling them instead of renting them just two months into the construction phase, supports the view that the nature of those Townhouses changed from a capital asset to a revenue asset.

Whilst you did not acquire additional land to be added to the original parcel of land in which to subdivide and construct the Townhouses, by erecting two townhouses on the land, you developed the land beyond that necessary to secure council approval for the subdivision.

We note you have not previously acquired and sold other properties in a manner similar to this sale. Despite your lack of experience in property development, you utilised your <profession> expertise to perform functions such as preparing <task> and <task> for the purposes of obtaining the building permit, albeit as a consultant to <entity name>. You sought advice and/or the services of experts to compete those functions you were unable to perform. Examples of experts you sought services from include:

• Architectural company - <entity name>
• Land surveyors - <entity name>
• Builder - <entity name>
• Real estate agent - <entity name>

You had a coherent plan for the development, subdivision, construction and sale of the Townhouses. Your activities were conducted in a systematic and business-like way similar to those conducting a property development enterprise. In assessing viable options to address the deteriorating condition of <Property 1> you;

• sought expert advice about your options for subdivision of the property
• used your existing knowledge of rental market in the <suburb> area
• obtained market appraisal of the property in its original condition

You invested capital and obtained a substantial loan from <bank> to build the Townhouses. We note the term of the loan is for 30 years which supports your initial intention to continue to hold the property for a prolonged period of time. Additionally, you used approx. $<amount> of the $<amount> you listed in your loan application, of your own savings to partly fund some of the subdivision and construction costs.

You also maintained records of your expenditure, but the property was not brought into account as a business asset.

Conclusion

On balance having considered the facts of the case against the badges of trade and other factors listed above, we consider the activities you have undertaken in the development, subdivision, construction and sale of the Townhouses have been carried out in a business-like manner, with the ultimate goal being the production of profit and were done in the form of an adventure or concern in the nature of trade and as such fall within the definition of enterprise under subsection 9-20(1).

Supply by an entity that is registered or required to be required to be registered

As you are not registered for GST, it needs to be established whether or not you are required to be registered for GST in relation to the sale of the Townhouses that you have constructed.

Section 23-5 of the GST Act provides that an entity is required to be registered for GST if it is carrying on an enterprise and its GST turnover meets the registration turnover threshold (currently $75,000 or $150,000 for non-profit bodies).

As you are not a non-profit body, the registration turnover threshold that applies to you is $75,000.

GST turnover

Subsection 188-10(1), when read together with paragraph 188-10(3)(b), provides that you have a GST turnover that meets the registration turnover threshold if:

a)    your current GST turnover is at or above the registration turnover threshold and the Commissioner is not satisfied that your projected GST turnover is below the registration turnover threshold; or

b)    your projected GST turnover is at or above the registration turnover threshold.

As mentioned above, the registration turnover threshold that applies to you is $75,000.

'Current GST turnover' is defined in subsection 188-15(1) as the sum of the values of all of your supplies made in a particular month and the preceding 11 months other than:

a)    supplies that are input taxed

b)    supplies that are not for consideration

c)    supplies that are not made in connection with an enterprise that you carry on.

'Projected GST turnover' is defined in subsection 188-20(1) as the sum of the values of all of your supplies made in a particular month and the following 11 months other than:

a)    supplies that are input taxed

b)    supplies that are not for consideration

c)    supplies that are not made in connection with an enterprise that you carry on.

Section 188-25 requires you to disregard the following when calculating your projected GST turnover:

a)    any supply made, or likely to be made, by you by way of transfer of ownership of a capital asset of yours; and

b)    any supply made, or likely to be made, by you solely as a consequence of:

                            (i)        ceasing to carry on an enterprise; or

                           (ii)        substantially and permanently reducing the size or scale of an enterprise.

Goods and Services Tax Ruling GSTR 2001/7 Goods and services tax: meaning of GST turnover, including the effect of section 188-25 on projected GST turnover (GSTR 2001/7) explains the meaning of 'capital asset' in the context of section 188-25 in paragraphs 31 to 36:

Meaning of 'capital assets'

31. The GST Act does not define the term 'capital assets'. Generally, the term 'capital assets' refers to those assets that make up 'the profit yielding subject' of an enterprise. They are often referred to as 'structural assets' and may be described as 'the business entity, structure or organisation set up or established for the earning of profits'.

32. 'Capital assets' can include tangible assets such as your factory, shop or office, your land on which they stand, fixtures and fittings, plant, furniture, machinery and motor vehicles that are retained by you to produce income. 'Capital assets' can also include intangible assets, such as your goodwill.

33. Capital assets are 'radically different from assets which are turned over and bought and sold in the course of trading operations'. An asset which is acquired and used for resale in the course of carrying on an enterprise (for example, trading stock) is not a 'capital asset' for the purposes of paragraph 188-25(a).

34. 'Capital assets' are to be distinguished from 'revenue assets'. A 'revenue asset' is 'an asset whose realisation is inherent in, or incidental to, the carrying on of a business'.

35. If the means by which you derive income is through the disposal of an asset, the asset will be of a revenue nature rather than a capital asset even if such a disposal is an occasional or one-off transaction. Isolated transactions are discussed further at paragraphs 46 and 47.

36. Over the period that an asset is held by an entity, its character may change from capital to revenue or from revenue to capital. For the purposes of section 188-25 the character of an asset must be determined at the time of expected supply.

As discussed above, your activities of developing and selling the Townhouses constitute the carrying on of an enterprise. At the time of the intended sale, the nature of your asset had changed from a capital asset to a revenue (trading) asset. The sale of the Townhouses do not constitute the transfer of a capital asset and paragraph 188-25(a) does not apply. You are deriving income from the disposal of a revenue (trading) asset even if the disposal is part of a one-off transaction.

Therefore, the sale of the new property is not excluded from the calculation of your projected GST turnover. Hence, the value of the sales must be included in the calculation of your current and projected GST turnovers.

You are therefore required to be registered for GST.

As you meet all the requirements under section 9-5 of the GST act the supply of both of your Townhouses with be a taxable supply unless it is GST-free or input taxed.

There is no provision in the GST Act that makes your supply GST-free and therefore we need to consider whether the supply of the property will be input taxed.

New residential premises

Section 40-65 of theGST Act provides that the sale of real property (residential premises) is input taxed. However, the sale of residential premises is not input taxed to the extent that the residential premises are new residential premises.

Section 40-75 of theGST Act provides that residential premises are new residential premises if they have not previously been sold as residential premises and have not previously been the subject of a long-term lease, or have been created through substantial renovations, or have been built or contain a building that has been built to replace demolished premises on the same land.

However, the premises are not new residential premises if for the period of at least five years the premises have been used for making supplies that are input taxed.

The Townhouses were built to replace <Property 1>, have neither previously been sold as residential premises nor been leased for a period of at least five years therefore Units <number> and <number> are new residential premises, and their sale will not be input taxed.

Conclusion

The sale of Units <number> and <number> <property address> are taxable supplies under section 9-5. GST is payable on their sale under section 9-40 and you are required to register for GST pursuant to section 23-5.

Issue 2

Question 2

Will the proceeds from the sale of Unit <number> and Unit <number> <property address> be assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Detailed reasoning

Profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium).

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions (TR92/3) are income considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 97) as ordinary income.

TR 92/3 defines the term 'isolated transactions' as:

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

•         transactions entered into by non-business taxpayers.

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.

If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayers business but:

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

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

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.

Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the asset can be assessed as ordinary income within section 6-5 of the ITAA 97.

Numerous cases have considered the assessability of profits or proceeds from the sale of land including the following cases:

Case E20, 73 ATC 160, which involved two builders, claimed that certain properties were purchased out of the funds of the partnership as an investment to derive rents and that other properties were acquired to build houses thereon and let them. These claims were rejected and it was held that the profits from the sale of properties sold pursuant to a forced sale were assessable. The properties were acquired with the intention of committing them to whatever profit-making purpose commended itself to the taxpayers at the appropriate time so that the profit was assessable as ordinary income.

Statham & Anor v. FC of T 89 ATC 4070 20 ATR 228 where the property was subdivided and sold after a business of raising cattle had failed. The taxpayer relied on the local council to carry out the subdivision work and the local real estate agents handled the advertising and sale of the lots. The Full Federal Court held that what occurred was the realisation, by the most advantageous means, of the asset which the owners had on their hands when they abandoned the intention of farming the subject property.

Casimaty v FC of T 97 ATC 5135; (1997) 37 ATR 358 where due to the growing debt and the ill health of the taxpayer, primary production land was progressively subdivided and sold off over a period of 18 years. There was no coherent plan conceived for the subdivision of the whole property. The taxpayer had acquired and had continued to hold and use the residence and conduct the business of a primary producer on the property. Therefore, there was no change of purpose of object for which the property had been held. In his judgment, Ryan J in the Federal Court held that the profits resulted from the mere realisation of a capital asset and as such the profits were not assessable as ordinary income.

Richardson v FC of T 97 ATC 5098, in which the taxpayer was an engineer who operated a building and project management business through a company (IR Pty Ltd). The company was also the trustee of a family trust of which the taxpayer was a beneficiary. As part of the construction of a building for another company, IR Pty Ltd (as trustee of the family trust) sold a parcel of land and purchased another for the same consideration. The parcel of land was then used as a rental property until sold. The profit made on disposal was ordinary income of the trust as the family trust had a purpose or intention of profit-making when entering into the relevant transactions and the acquisition was made as part of the trust's business of deal making.

McCurry & Anor v FC of T 98 ATC 4487, in which two brothers bought a block of land in 1986 for $32,000. They subsequently borrowed $80,000 to enable them to construct three townhouses. They could not sell the townhouses and, in mid-1987, they and members of their family moved into two of the townhouses. The third townhouse was used partly as a storeroom for a news agency business purchased by the family and partly as accommodation for visitors. The townhouses were sold in December 1988, but the family remained in two of them as tenants. The court found that profit-making by sale (rather than the receiving of rental income) was the dominant factor. Accordingly, the net profit arising from sale of the property was ordinary income.

As demonstrated in the above cases, a taxpayer can embark on a profit-making scheme after property was acquired for a different purpose.

In regards to your circumstances, you purchased <Property 1> in <month> <year> and it was your principal place of residence until <month> <year>. You then leased the property until <month> <year>. You subsequently demolished the existing house and subdivided the land and built two new townhouses. You have sold both of the townhouses at the time of this ruling.

As stated above, it is not necessary that the sole or dominant intention or purpose for entering into the transaction is to make a profit, providing it is a significant purpose. A significant purpose of what you have undertaken is to sell it at a profit. Therefore, the proceeds from the sale of the dwellings will be assessable under section 6-5 of the ITAA 1997 as ordinary income from an isolated profit-making transaction.

Question 3

Will the profit from the sale of the properties be assessable under the capital gains tax provisions as a mere realisation of a capital gains tax asset?

Detailed reasoning

A sale that is more than a 'mere realisation' will be on revenue account and proceeds will generally be assessable as either income from the carrying on of a business or income from a profit-making undertaking or scheme.

The expression 'mere realisation' is used to distinguish a mere realisation from a business operation or a commercial transaction carrying out a profit-making scheme.

Profits made on the realisation of capital assets can still be ordinary income if the activities go beyond a mere realisation and instead become a separate business operation or commercial transaction even though the taxpayer did not have a purpose of profit-making at the time of acquiring the asset.

In McClelland v FC of T [1970] HCA 39, for example, the Privy Council held that the question to be answered was whether the facts revealed a mere realisation of capital, albeit in an enterprising way, or whether they justify a finding that the taxpayer went beyond this and engaged in a trade of dealing in the asset, albeit on one occasion only.

Lord Justice Clark, in distinguishing between proceeds that is mere realisation of capital and ordinary income, stated in California Copper Syndicate v Harris (1904) 5 TC 159 at pp 165-166 that:

...What is the line which separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be determined being - is the sum of the gain that has been made a mere enhancement of values by realising a security, or is it a gain made in an operation of business in carrying out a scheme of profit-making?

In FC of T v Whitfords Beach Pty Ltd 82 ATC 4031, Gibbs CJ similarly said (at p.4034) that:

When the owner of an investment chooses to realize it, and obtains a greater price for it than he paid to acquire it, the enhanced price will not be income within ordinary usages and concepts, unless, to use the words of the Lord Justice Clerk in California Copper...'what is done in not merely a realisation or charge of investment, but an act done in what is truly the carrying on, or carrying out, of a business'.

You demolished the original property and built and sold two new properties. You have gone beyond 'mere realisation' of your asset. We consider that the proceeds from the sales are more appropriately characterised as an isolated profit-making transaction rather than a 'mere realisation' of a capital gains tax asset.