Edited version of private advice

Authorisation Number: 1052069782323

Date of advice: 12 December 2022

Ruling

Subject: Property development

Issue 1: Income tax

Question 1

Is the disposal of Unit 1 a mere realisation?

Answer

No, the disposal of Unit 1 is not a mere realisation and the net profit is treated as ordinary income and assessable under subsection 6-5(1).

Question 2

If the disposal of Unit 1 is not a mere realisation, can you use the market value of the property in calculating the net profit from the sale of Unit 1 for the purposes of subsection 6-5(1)?

Answer

Yes, for the purposes of determining the net profit that is assessable under section 6-5(1), you can use the market value applicable to the subdivided allotment for Unit 1 at the time when it is ventured into the property development.

Question 3

If the disposal of Unit 1 is not a mere realisation, are you entitled to the main residence exemption for the for the capital gain from the purchase price to the valuation price?

Answer

No, the main residence exemption does not apply to Unit 1. Any capital gain made from the sale of Unit 1 (i.e. CGT event A1) is reduced to the extent that the amount is included in assessable income under another provision.

Question 4

You moved into Unit 2 after construction was completed, can you treat Unit 2 as your main residence for the purposes of the CGT provisions?

Answer

Yes, you can treat Unit 2 as your main residence if it continues to be your main residence until you dispose of it.

Issue 2: Goods and Services Tax (GST)

Question 5

Is the sale of Unit 1 a taxable supply?

Answer

Yes.

Question 6

If the sale of Unit 1 is a taxable supply can the margin scheme be applied to the sale price?

Answer

Yes, the margin scheme can be used to reduce the amount of GST on the sale.

This ruling applies for the following periods:

Income years ending 20XX to 20XX

The scheme commences on:

20XX

Relevant facts and circumstances

During 20XX you purchased a residential property that had a dwelling (the property).

You lived in the dwelling and treated it as your main residence.

During 20XX you decided to demolish the dwelling on the property, subdivide the land into two allotments and build two units. Unit 1 was to be sold and Unit 2 was to be used as your main residence.

You decided to subdivide because the property was too big for you and the original dwelling was old. You wanted to sell Unit 1 to help finance the construction cost of Unit 2. You decided to build two units rather than just sell a vacant allotment because you didn't want to be to be disturbed by any future construction.

You have not conducted property development activities previously and do not have any experience regarding property development. You engaged a builder and architect to carry out the necessary activities to subdivide the property, get council approvals and build the two units.

You signed a contract with an architect, started planning and moved to another property (owned by your spouse).

During 20XX you got council approval and during 20XX you signed a contract with a builder.

At or about the time when the property was ventured into the property development, you obtained a valuation by a certified practicing valuer.

The property was subdivided into allotments with similar land size (i.e. 50% each) and a unit was constructed on each of the two allotments.

The units were completed in late 20XX.

In early 20XX you signed a contract to sell unit 1 and you settled in mid 20XX.

You began to reside in Unit 2 soon after construction was completed and are currently residing in this dwelling.

You registered for an ABN and for GST because it was your understanding that you were subject to the GST withholding requirements for new residential property (i.e. 'GST on settlement').

You decided to use the margin scheme to calculate the GST for Unit 1.

The sale contract included clauses about GST withholding applying to new residential premises.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 112-25

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 118-110

Income Tax Assessment Act 1997 Section 118-150

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 40-65

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

A New Tax System (Goods and Services Tax) Act 1999 Division 75

Taxation Administration Act 1953, Schedule 1, Section 14-250

Reasons for decision

Detailed reasoning - income tax

For questions 1 to 4, all legislative provisions references are to the Income Tax Assessment Act 1997 unless otherwise specified.

Question 1

There are three ways profits from a land subdivision can be treated for taxation purposes:

•    As ordinary income under section 6-5, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock.

•    As ordinary income under section 6-5, on revenue account, as a result of an isolated business transaction entered into in carrying out a business operation or commercial transaction.

•    As statutory income under the capital gains tax (CGT) legislation (section 102-5), on the basis that a mere realisation of a capital asset has occurred.

Ordinary income - carrying on a business

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

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? (TR 97/11), provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole.

Ordinary income - isolated transaction

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 (Myer Emporium)).

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income(TR 92/3), 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 as ordinary income.

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 taxpayer's 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.

Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. Paragraph 13 of TR 92/3 lists the following factors:

•    the nature of the entity undertaking the operation or transaction

•    the nature and scale of other activities undertaken by the taxpayer

•    the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained

•    the nature, scale and complexity of the operation or transaction

•    the manner in which the operation or transaction was entered into or carried out

•    the nature of any connection between the relevant taxpayer and any other party to the operation or transaction

•    if the transaction involves the acquisition and disposal of property, the nature of that property

•    the timing of the transaction or the various steps in the transaction.

In addition to the above, 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), provides a list of factors relevant to isolated transactions and sales of real property (paragraph 265). If several of the 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 listed 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 the land

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

•    borrowed funds financed the acquisition

•    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

•    buildings have been erected on the land.

No single factor is determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

Capital gains tax (CGT)

CGT is the tax that you pay on certain gains you make. You may make a capital gain as a result of a CGT event happening to an asset in which you have an ownership interest. The most common CGT event, CGT event A1 (section 104-10 of the ITAA 1997), occurs when you dispose of your ownership interest in a CGT asset to another entity.

Application to your situation

In your case, you are not considered to be carrying on a business of buying, selling or developing land. However, we do consider that you have made a profit from an isolated business or commercial transaction.

We consider that you undertook the property subdivision with the intention of making a profit by selling Unit 1. Making an overall assessment of the factors set out in TR 92/3, we consider that your activities are a separate business operation or commercial transaction.

You subdivided the property because you considered it too large for your purposes. You did not sell the excess vacant allotment but instead, you built two units with the intention to sell one to finance the other.

It was the sort of transaction that a person in business would undertake. You engaged an architect and builder, applied to the council to subdivide the property and borrowed funds to undertake the development of the property.

The money contributed to the subdivision was significant; each unit costing approximately $xx to build and the value of the land at the time it was ventured into the subdivision was $xx.

You expected to profit from developing the property and you used the sale proceeds from Unit 1 to finance Unit 2, the property you live in.

Whilst you originally purchased the property to live in, your intention changed. You wanted a smaller property with a new dwelling, and this was made possible by selling Unit 1.

You intention in undertaking the property subdivision was to make a profit and this was carried out by way of a business operation or commercial transaction, in a similar manner to a property developer carrying on a business.

We consider that the net profit from the sale of Unit 1 is ordinary income and assessable pursuant to section 6-5.

Question 2

For the purposes of determining the net profit that is assessable under section 6-5(1), you use the market value applicable to the subdivided allotment for Unit 1 at the time when it was ventured into the property development. Taxation Determination TD 97/1 provides that it is the market value of the land when it is ventured into a business of development, subdivision and sale that should be taken into account when calculating net profit.

A certified practicing valuer provided a value for the property on or about the time you ventured the property into the subdivision. The valuation included comparable property sales to determine the value of your property on a 'vacant possession basis'. We accept that you can use this valuation to calculate the net profit you made from the sale of Unit 1.

Question 3

Section 102-20 of the ITAA 1997 provides that you make a capital gain or loss as a result of a CGT event happening to a CGT asset. CGT assets include real estate acquired on or after 20 September 1985.

When you subdivide a block of land, each block that results is registered with a separate title. For CGT purposes, the original land parcel is divided into two or more separate assets. Subdividing land does not result in a CGT event if you retain ownership of the subdivided blocks (section 112-25). You do not make a capital gain or a capital loss at the time of subdividing the property.

The cost base of each new asset (i.e. subdivided block) is worked out under subsection 112-25(3). The date you acquired the subdivided blocks is the date you acquired the original land. The cost base of the original land is divided between the subdivided blocks on a reasonable basis (refer to TD 97/3). In your situation, apportioning 50% of the property's cost base to each subdivided block is considered a reasonable basis.

The main residence exemption applies where you make a capital gain or capital loss from a CGT event that happens in relation to a dwelling that is your main residence (section 118-110). The main residence exemption does not apply to the sale of Unit 1 because it is a new asset for the purposes of section 112-25 and it was not your main residence.

Under section 118-20, any capital gain you make in relation to the sale of Unit 1 (i.e. CGT event A1), is reduced to the extent that the amount is assessable income under another provision; in your situation under section 6-5.

Question 4

The main residence exemption can apply to land you own for an additional period of up to four years if you build a dwelling on the land (section 118-150). In such a case, the exemption applies from the time the land is acquired.

The exemption will apply for a maximum period of four years before you occupy the new dwelling. However, where the land is acquired with a dwelling already on it, the four year period begins from the time the dwelling is vacated (subsection 118-150(5)).

For the exemption to apply, the dwelling on the land that is constructed must become your main residence as soon as practicable after the work is finished and continue to be so for at least three months.

Pursuant to section 118-150, you can treat Unit 2 as your main residence because:

•    The time between vacating the property and moving into Unit 2 was within four years (subsection 118-150(4))

•    You moved into Unit 2 as soon as practicable after construction

•    Unit 2 has been your main residence for at least 3 months.

You can treat Unit 2 as your main residence if it continues to be your main residence until you dispose of it. The extent of the main residence exemption for Unit 2 will need to be considered at the time a CGT event happens in relation to Unit 2 in the future.

Detailed reasoning - GST

For question 5 and 6, all legislative provisions are references to the A New Tax System (Goods and Services Tax) Act 1999 unless otherwise specified.

Question 5

Section 9-40 requires you to pay GST on any taxable supply you make.

Section 9-5 provides that you make a taxable supply if:

a) you make the supply for consideration

b) the supply is made in the course or furtherance of an enterprise that you carry on

c) the supply is connected with the indirect tax zone (Australia), and

d) 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.

Based on the facts provided, the supply of Unit 1 is not GST-free or input taxed. The supply of the original property was input taxed residential premises.

For the sale of Unit 1 to be a taxable supply, all the conditions of a taxable supply under section 9-5 must be met.

You subdivided and sold Unit 1 and received consideration. You satisfy the requirements of paragraphs 9-5(a) and 9-5(c).

You voluntarily registered for GST, but you stated that you did so in error. There are two issues to consider:

•    whether the sale of Unit 1 was made in the course or furtherance of an enterprise that you carry on

and if so,

•    whether you would have been required to register had you not done so voluntarily.

Enterprise

The term 'enterprise' is defined in subsection 9-20(1) to include, among other things, an activity or series of activities done:

•    in the form of a business, or

•    in the form of an adventure or concern in the nature of trade.

An assessment must be made to determine if the act of subdividing the property amounts to an enterprise of dealing with the property either as a series of activities in the form of a business or in the form of an adventure in the nature of trade.

MT 2006/1 provides guidance on the meaning of 'enterprise' for GST purposes. According to MT 2006/1, a business generally includes a trade that is engaged in on a regular or continuous basis, while 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. Isolated or one-off transactions will fall into this category.

TR 97/11 provides the main indicators of carrying on a business and TR 92/3 provides guidance in relation to isolated or one-off business ventures or profit-making schemes.

You purchased the property with the intention of using it as a residence. This indicates that in 2013 you did not have the intention to acquire and sell at a profit. Holding an asset for private use is not normally within the ambit of an enterprise.

In 2017 you decided that the property was too big and this is when you decided to subdivide the original property and create two allotments. This change is not indicative of a profit motive per se. We consider that in terms of assessing the scale of your subdivision and sale activity, it is not enough that there be land changing hands without anything more. In your case, you constructed units on both subdivided allotments, intending to live in Unit 2 and to sell Unit 1. On this basis, there is no repetition and it is a small scale. However, being a small scale as a factor viewed alone does not prevent the activity or series of activities from being an enterprise.

You changed your intention to reside in the original property and subdivided part of it to build Unit 1. From 2017 you had the intention to sell Unit 1 at a profit.

You retained expertise to assist you to pursue the steps of the subdivision and you have contended that, as a result, you do not have the expertise to conduct a land development enterprise or act in the form of a business. The retention of experts is often present in commercial arrangements. You have retained consultants including a builder and an architect, to ensure that the units were built properly and that they met the local government requirements. Ultimately, Unit 1 was put on the market to achieve the best price. The fact you did not do the work yourself is not necessarily indicative that you were not acting in a business-like manner. As local council requirements are becoming more complex and potentially more costly, the decision to employ consultants is the hallmark of business deals in more recent times (Ian Mark Collins & Mieneke Mianno Collins ATF The Collins Retirement Fund and Commissioner of Taxation (Taxation) [2022] AATA 628 (Collins) at paragraph 63).

A factor adding weight to the business-like manner of the arrangement is the fact that you did not sell the allotment as vacant land but instead had a building constructed for sale. In FCT v Whitfords Beach Pty Ltd (1968) 120 CLR 191 and Collins, the taxpayers only subdivided the land and did not sell the allotments with a structure on it as in your case. In Collins it was argued that they could have sold the allotments with a residence on them but instead "left further profits on the table".

As the transaction may be described as one-off, we need to consider the extended definition of enterprise and whether these activities fall in the form of an adventure or concern in the nature of trade; being transactions that have a commercial nature and entered into for a profit-making purpose.

Considering the factors in paragraph TR 92/3, you are an individual and the activities are not on a major scale. However, the arrangement is more complex than a mere subdivision and it was carried out in a manner expected of any business-like endeavour of land development.

MT 2006/1 also discusses isolated transactions and sales of real property and, at paragraph 265, it presents a list of factors which, if present, may be an indication that a business or an adventure or concern in the nature of trade is being carried on.

The facts indicate that you have changed your use of the property as you held the property for personal reasons but subsequently altered the configuration to sell a portion of it with a new building constructed upon it.

You do not operate as a property developer in such a way that you have an office or letterhead. However, given that subdivisions are becoming increasingly complex there is less weight given to the fact you do not have traditional badges of trade.

To date, you have not treated expenditure as business expenses but you have kept details of the costs incurred in relation to the sale of Unit 1. Furthermore, you built on the subdivided land and did not merely sell the excess vacant allotment.

We consider that you are carrying on an enterprise of subdividing the land and selling new residential premises. We consider that you have met 9-5(b) as you made a supply in the course of your enterprise.

We note that you are registered already and the sales have already taken place. You have completed your obligation to provide notice to any prospective purchaser under section 14-250 of Schedule 1 of the Taxation Administration Act 1953 that the recipient will be in receipt of a taxable supply of potential residential land and GST was withheld accordingly. You have met paragraph 9-5(d) as you are registered or required to be registered for GST.

Conclusion

As the sale meets the taxable supply conditions in section 9-5, you are entitled to input tax credits for any creditable acquisitions you made in relation Unit 1.

New residential premises

Paragraph 40-65(2)(a) sets out that a sale of real property is input taxed but the sale is not input taxed to the extent that it is new residential premises. Section 40-75 sets out the meaning of 'new residential premises'. Paragraph 40-75(1)(c) clarifies that premises are new residential premises 'if they have been built, or contain a building that has been built, to replace demolished premises on the same land'.

Premises stay as new residential premises if they are used for input taxed residential activity for a period of five years under paragraph 40-75(2)(c). Potentially, if you cease residing in Unit 1 and it is sold within five years of receiving notification that it is habitable, it may be a taxable supply.

Question 6

The sale contract for Unit 1 indicates that the sale was to be made subject to the margin scheme. Accordingly, one of the requirements for the application of the margin scheme was met as you and the purchaser agreed in writing on or before the sale that the margin scheme applied to that sale. This requirement is in subsection 75-5(1A).

You acquired the property in 2013 for the consideration stated in the contract. As you acquired the property in 2013, the relevant public ruling to apply to your circumstances is Goods and Services Tax ruling, GSTR 2006/8 Goods and services tax: the margin scheme for supplies of real property acquired on or after 1 July 2000 (GSTR 2006/8). Under paragraph 75-5(1)(a), the threshold requirements for application of the margin scheme are that you must have made a taxable supply of real property by selling a freehold interest in land. As stated above, you made a taxable supply when you sold Unit 1.

Subsection 75-5(2) sets out that the margin scheme cannot be used where the supply is ineligible for the margin scheme. Paragraphs 75-5(3)(a) to (g) lists the conditions that invalidate the use of the margin scheme. We accept that none of these factors make the sale of Unit 1 ineligible for the margin scheme.

Subsection 75-10(1) provides that if a taxable supply of real property is made under the margin scheme, the GST on the supply is 1/11^th of the margin for the supply. Subsection 75-10(2) defines the margin as the amount by which the consideration for the supply exceeds your acquisition of the interest in the property. That is, the margin is the difference between the price for which you purchased the property and the price for which you subsequently sold it. As a result, you pay a concessional amount of GST calculated on that margin rather than the total sale amount of the final sale.

Section 75-14 ensures that the costs of any improvements in relation to the real property are not included in the margin calculation. This includes the costs for the works required in meeting subdivision requirements and the fees you were charged by your builder. While these costs are not part of the margin calculation, they may be creditable acquisitions and you can claim the associated input tax credits. Refer to GSTR 2006/8 at paragraphs 56 and 57.

Section 75-15 provides rules to work out the margin in situations where you make a taxable supply of real property that relates only to part of the land or premises. This section applies to you because you made a taxable supply of part of the property you acquired in 2013.

You will be required to work out the margin with reference to a proportion of the amount you paid to acquire the property. Calculating the proportion is dealt with in GSTR 2006/8 at paragraphs 58 to 61. Where the value of the land is uniform per square metre, it may be suitable in your case to apply the land area method.

Conclusion

The margin scheme is available to you as you meet the threshold requirements in Division 75 because you:

•    made a taxable supply in relation to Unit 1

•    made the agreement in writing on or before the settlement of Unit 1

•    acquired the property without GST in the price.

In calculating the margin you need to apportion your personal use of the property from the usage in your enterprise.