Edited version of private advice

Authorisation Number: 1052070703554

Date of advice: 5 January 2023

Ruling

Subject: CGT - property

Question

Will the sale of the adjacent residential properties be assessable under the capital gains tax provisions?

Answer

No. It will be assessable on revenue account as it was an isolated profit-making transaction.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The trustee was set up for property investment purposes. Your main business activity is land development and subdivision.

You purchased a residential property. Since acquiring Property 1, it has been leased and used exclusively to generate rental income.

You together with the owner of the adjacent property (Property 2), applied to the Council for the subdivision of the Properties 1 and 2 to create more residential lots including demolition and were granted consent subject to several conditions. It cost around $X to obtain the approval for the subdivision.

You purchased the adjacent property. Since acquiring Property 2 it has been used exclusively for family/private use of the beneficiaries.

You advise both Property 1 and 2 (the Properties) were purchased to hold for long term investment purposes.

Both Properties have retained their original physical characteristics. You have not made any alterations, renovations or any construction work since they were purchased.

You advise that the subdivision/development application was made purely to increase the intrinsic value of the Properties. You did not plan to and never have carried out any physical subdivision/partitioning activities on the Properties. Other than submitting the development application you have not taken any physical actions to affect the development/subdivision of the Properties.

You self-funded any costs you incurred in submitting the development application.

You decided to place the properties on the market. The properties were sold under a single contract. The profit is estimated to be $X.

The trustee has not carried out any subdivision activities before and doesn't have any plan to carry out similar activities in the foreseeable future.

Both Properties have retained their original physical characteristics. You have not made any alterations, renovations or any construction work since they were purchased.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 6-5(2)

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 118-20

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Ordinary income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Carrying on a business of property development

Subsection 995-1(1) of the ITAA 1997 states the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? provides some factors that indicate whether or not a business is being carried on. The question of whether a business is being carried on is a question of fact and degree.

Based on the information provided, we do not consider that any proceeds you would receive from the sale of the properties would be derived in the course of carrying on a business.

Profits from an isolated transaction

Profits arising from an isolated commercial transaction will be ordinary income if the 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 a taxpayer's business (FC of T v Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693).

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income provides guidance in determining whether profits from isolated transactions are ordinary income and assessable under section 6-5 of the ITAA 1997.

The term isolated transaction refers to:

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

•         those transactions entered into by non-business taxpayers.

If a taxpayer not carrying on a business makes a profit from an isolated transaction or operation, that profit is assessable income if both of the following elements are present:

•         the intention or purposes of the taxpayer in entering into the 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.

Profit-making does not need to be the sole or dominant purpose for entering into the transaction. A profit-making purpose must exist at the time the transaction or operation was entered into. Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case.

In this situation, Property 1 was purchased and used exclusively to generate rental income. The trustee of the Trust and the owner of the adjacent property obtained Council consent to demolish the homes and subdivide them into more residential lots. When the adjacent property became available, the trustee purchased it and now both of the properties have been sold.

Although you are not in the business of property development, to decide if any profit you make is ordinary income, we need to consider if the transaction was entered into, and the profit was made in carrying out a commercial transaction.

Paragraph 13 of TR 92/3 lists the following factors which are relevant in determining whether an isolated transaction amounts to a business operation or commercial transaction:

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 and the various steps in the transaction.

In contrast, paragraph 36 of TR 92/3 notes that the courts have often said that a profit on the mere realisation of an investment is not ordinary income, even if the taxpayer goes about the realisation in an enterprising way. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment.

Paragraphs 41 and 42 of TR 92/3 outline that where a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset 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 operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income even though the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

In addition to the above factors, for the purposes of determining whether the activities undertaken in relation to real property and development equate to a profit-making undertaking or scheme, Miscellaneous Taxation Ruling MT 2006/1 aligns itself with TR 92/3 and provides a list of factors which, if present may be an indication that a business or profit-making undertaking or scheme is being carried on.

The factors listed in paragraph 265 of MT 2006/1 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 the 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.

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.

Numerous cases have considered the assessability of profits or proceeds from the sale of property. As displayed in Federal Commissioner of Taxation v Whitford's Beach Pty Ltd 82 ATC 4031 (Whitford's Beach), and a taxpayer can embark on a profit-making scheme after property was acquired for a different purpose.

In determining whether activities relating to isolated transactions are a profit-making undertaking, 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.

Application to your circumstances

In this case, the trustee of a non-business taxpayer purchased one property for an investment. Approval for subdivision of that property and the neighbouring property into more residential lots was obtained. The Trust later purchased the neighbouring property and it was used as the main residence of the beneficiaries of the trust for a short period of time prior to both properties being sold.

In the context of considering the above authorities and factors when determining whether the sale of both properties would be viewed as a profit-making undertaking, the following general observations have been made:

•         it is the trustee of the Trust that was carrying out this transaction and the trustee had not been involved in similar activities in the past

•         the neighbouring property was purchased that was also part of the subdivision plan

•         Property 2 was owned for a short period of time

•         there is a coherent plan for the subdivision of the 2 properties into more lots which is more complex than what would have been involved in the disposal of the two properties as is. The simplest way to dispose of the property holding in the area would have been to sell Property 1 without purchasing Property 2

•         there has been a change in the nature of the property with the proposed subdivision transforming the property from the 2 residences into more lots for new residential housing purposes

•         the 2 properties together sold for almost $X million

•         the overall profit was estimated to be $X million

•         there was a demonstrated intention to profit from the subdivision of the properties when the neighbouring property was purchased.

A balanced view of these observations, with no one feature being determinative in isolation, reasonably leads to a conclusion that the intention for holding the properties has changed to a profit-making undertaking.

Although Property 2 was the main residence of one of the beneficiaries since purchase, the property had been included in the plan for subdivision with Property 1 prior to purchase. The decision to purchase Property 2 shows the choice to engage in maximising the potential profit to be made from the properties. The costs for the subdivision were self-funded.

It is viewed that your activities starting from obtaining Council approval for the subdivision for both properties, subsequent acquiring the neighbouring property (which is part of the subdivision plan) and then sold both properties together are of a sufficient scale to characterise the whole process as a commercial or profit-making undertaking. The activities go beyond a sale of 2 neighbouring properties.

We have determined that based on the facts of this situation that the sale of both properties is a profit-making commercial undertaking and the profits from the sale of these properties are considered to be ordinary assessable income under section 6-5 of the ITAA 1997.

Capital gains tax

Under section 6-10 of the ITAA 1997, assessable income also includes statutory income. Capital gains are included as assessable income under section 102-5 of the ITAA 1997.

Section 102-20 of the ITAA 1997 states that a capital gain or capital loss is made only if a CGT event happens to a CGT asset. The properties are CGT assets (section 108-5 of the ITAA 1997).

CGT event A1 happens if you dispose of a CGT asset.

Section 118-20 of the ITAA 1997 contains anti-overlap provisions which operate to reduce any capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 as a result of the sales.

Application to your situation

Making an overall assessment on the factors set out in TR 92/3, it is the Commissioner's view that the sale of the 2 properties is more than a mere realisation of capital assets.

As highlighted above, the disposal of the 2 properties are an isolated profit-making transaction and any profit made on their sale is included in your assessable income under section 6-5 of the ITAA 1997.

CGT event A1 will occur on the disposal of your ownership in each of the properties. The capital gain for each event is worked out by comparing the cost base of the asset with the capital proceeds for its disposal.

Any capital gain made on the disposal of the properties will be reduced to the extent that the profit from the sale of the lots is included in your assessable income under section 6-5 of the ITAA 1997.