Edited version of private advice

Authorisation Number: 1052106629272

Date of advice: 11 April 2023

Ruling

Subject: Assessable income

Question 1

Will the proceeds from the sale of the Property by the Taxpayer be assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will a gain on the sale of the Property by Taxpayer be subject to the capital gains tax rules under Part 3-1 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods

Year ending 30 June 20XX to 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

X and Y - background

The taxpayer, X, is married to Y.

X and Y have 3 school-aged children.

The Taxpayer is not currently employed and was previously employed as a marketing consultant.

Y has been a registered builder for XX years. Y is the sole director of Y Pty Ltd. Y Pty Ltd operates a business of construction of commercial buildings. Y Pty Ltd is a builder only and is not a property developer. Its business is concerned with the construction of commercial buildings on land owned by arm's-length customers, rather than on land owned by Y Pty Ltd or any of its related parties.

X has assisted with maintaining Y Pty Ltd's books since 20XX.

Purchase of the Land

The Taxpayer entered into a contract for sale to purchase vacant land (the Land) and upon settlement of the purchase the Taxpayer became the sole registered proprietor of the Land.

X and Y obtained finance for the purchase of the Land from a bank. The borrowers were X and Y.

The Land, combined with the subsequent residential dwelling constructed on the Land, as specified below (the Dwelling), are referred to herein as "the Property".

X has submitted their intention in purchasing the Land was to build a holiday home and ultimately make it their family's main residence.

Construction of the Dwelling

Following the purchase of the Land, and obtaining the necessary plans and permits, construction of the Dwelling commenced.

Construction of the Dwelling was undertaken by Y Pty Ltd.

Construction of the Dwelling was completed, and the certificate of occupancy was issued, in December 20XX.

Construction of the Dwelling took significantly longer than would otherwise be the case due to changes in design and ensuring the Dwelling would be finished to a perfect standard.

The design and construction of the Dwelling was implemented in accordance with X and Y's personal requirements and standards; and that it was completed in accordance with the Dwelling's intended future use as their main residence (and consequently at a greater cost than would otherwise have been the case); and without being driven by considerations as to the resale value.

In particular, the Dwelling was constructed with several specific features in accordance with X and Y's needs.

In relation to the circumstances around the construction of the dwelling:

•         No business plan was prepared.

•         No commercial or business arrangements were planned, organised or carried on.

•         No predetermined budget was set for the construction of the Dwelling.

•         Construction costs were as much as were required to achieve the desired finished product and were not measured against any anticipated resale value.

Use of the Property

The Taxpayer made a decision to offer the Property for rent, rather than using the Property as a holiday home with short-term rentals at other times and entered into a 12-month lease commencing in 20XX. The decision to offer the property for rent on a longer-term basis was due to the following a downturn in Y Pty Ltd's business and uncertainty in the short-term holiday rental market due to COVID factors.

Following the expiry of the initial term, the tenancy continued on a month-by-month basis.

Sale of the Property

The Taxpayer decided to sell the Property due to the Property not fulfilling X and Y's expectations. Further X and Y saw a potential sale of the Property solidifying their financial position and decided to put the Property on the market before the market further declines.

Other land-related activities

X and Y's only other activities and involvements in respect of real property which they have owned or controlled are as follows:

•         X and Y previously purchased land on which Y Pty Ltd constructed a dwelling. From 20XX (following completion of construction) until 20XX this property was used by X and Y as their main residence. This property was sold in 20XX.

•         In 20XX the Taxpayer purchased another property. It is currently the X and Y's main residence.

•         In view of the sale of the Property, during 20XX X and Y purchased further property. X and Y intend to renovate the existing dwelling on this land, and it will serve as the family's main residence in the longer term (effectively replacing the Property as their intended future main residence in retirement).

Relevant legislative provisions

Section 6-5 of the ITAA 1997

Section 104-10 of the ITAA 1997

Part 3-1 of the ITAA 1997

Reasons for decision

Question 1

Section 6-5(1)

Subsection 6-5(1) of ITAA 1997 defines 'assessable income' as follows:

"Your assessable income includes income according to ordinary concepts, which is called ordinary income."

The legislation does not provide any specific guidance on what is meant by "income according to ordinary concepts". The Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 4) of 1996 (Cth) states that it has been left to the courts to develop principles for determining what is "ordinary income".

Case law has identified various factors which may be relevant in determining whether an amount is income according to ordinary concepts. These include:

         whether the amount has the characteristics of periodicity, recurrence or regularity;

         whether it is convertible into money or money's worth;

         whether it is associated with business activities or services rendered, as distinct from the mere sale of property; and

         whether it is solicited, as distinct from a windfall.

The proceeds of the sale of the Property will fall within the scope of 'income according to ordinary concepts' if it is derived in the course of carrying on a business.

TR 97/11

TR 97/11 Incometax: am I carrying on a business of primary production? (TR 97/11)discusses whether a taxpayer is carrying on a business.

TR 97/11 outlines several indicators which provide general guidance as to the existence of a business. The indicators as set out in TR 97/11 are as follows:

•         Whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators;

•         Whether the taxpayer has more than just an intention to engage in business;

•         Whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity;

•         Whether there is repetition and regularity of the activity;

•         Whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business;

•         Whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit;

•         The size, scale and permanency of the activity; and

•         Whether the activity is better described as a hobby, a form of recreation or a sporting activity.

Each of these indicators is examined below in the context of the facts in this case.

The activity has a significant commercial purpose or character

TR 97/11 states the following:

"In showing that a business is being carried on, it is important that the taxpayer is able to provide evidence that shows there is a significant commercial purpose or character to the

primary production activity, i.e., that the activity is carried on for commercial reasons and in a commercially viable manner...

...The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity (refer to paragraphs 77 to 85), the repetition and regularity of activity (refer to paragraphs 55 to 62) and the profit indicators (refer to paragraphs 47 to 54). A way of establishing that there is a significant commercial purpose or character is to compare the activities with those of a taxpayer who is carrying on a similar activity that is a business. Any knowledge, previous experience or skill of the taxpayer in the activity, and any advice taken by the taxpayer in the conduct of the business should also be considered but are not necessarily determinative..."

The circumstances around the purchase, development and sale of the Property do not reflect a significant commercial purpose or character. In particular:

•         X and Y had only been involved in the purchase and development of their former main residence. There is a further intention to renovate a property, but again this is intended to be their principal place of residence in the long term.

•         No business plan was prepared in respect of the purchase, development and sale of the Property.

•         No commercial or business arrangements were planned, organised or carried on.

•         No predetermined budget was set for the construction of the Dwelling.

•         The design and construction of the Dwelling was specific to the family's own tastes and preferences.

These above factors indicate that the Property was not purchased and developed with a commercial purpose.

More than just an intention to engage in business

TR 97/11 sets out the following:

"The intention of the taxpayer in engaging in the activity is a relevant indicator: see Thomas. However, a mere intention to carry on a business is not enough. There must be activity..."

X did not have an intention to engage in business with regard to the purchase of the Land and the construction of the Dwelling. The intention of purchasing the land was to build a holiday home.

Construction of the dwelling was completed in December 20XX, during the COVID19 pandemic. Y Pty Ltd was experiencing a financial downturn around this time, which was the first instance the plans for the Property deviated from X's original intention. Meeting a real estate agent by chance at the beach at that time led to X and Y's initial consideration of selling the property.

In light of the absence of indicators reflecting a commercial purpose or character (as discussed above), it is accepted that the Taxpayer had no intention to engage in business.

Whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

TR 97/11 states the following:

"Stronger evidence of an intention to make a profit occurs when the taxpayer has conducted research into his/her proposed activity, consulted experts or received advice on the running of the activity and the profitability of it before setting up the business."

No developer, development manager or other builder was engaged, reflecting the fact that the Property was intended to be used as a holiday house, occasional short-term holiday rental, and ultimately the family's main residence upon retirement.

The facts indicate that the construction was very specific to the family's own tastes and preferences rather than done in order to make profit. For example, certain expenditure incurred in the construction of the dwelling is of a personal nature and points away from an intention to make a profit:

Whether there is repetition and regularity of the activity

TR 97/11 sets out the following:

"The repetition of activities by the same person over a period of time on a regular basis helps to determine whether there is the 'carrying on' of a business...

...The taxpayer should undertake at least the minimum activities necessary to maintain a commercial quantity and quality of product for sale."

X has not engaged in activities which could be considered repetitive and regular in relation to property development. In considering, from a broader perspective, the activities and businesses in which X's associates and family have been involved, it is noted that:

•         Y has only been involved in overseeing one residential construction, which was their former main residence.

•         Y Pty Ltd's business is that of construction (specifically of commercial facilities) and not that of property development.

Whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business

TR 97/11 states the following:

"An activity is more likely to be a business when it is carried on in a manner similar to that in which other participants in the same industry carry on their activities...

...In considering this indicator the following factors might be compared with the characteristics of others engaged in the same type of business:

-       The volume of sales. If there is a small number of sales it is less likely that a business is being carried on. The volume of sales should be capable of producing a profit at some time. However, allowance is made for droughts, fires and other uncontrollable events which may effect the volume of sales. We also accept that in the early stages of an activity, sales may be low;

-       The types of customers the taxpayer sells his/her product to - wholesalers, retailers, the public at large, or friends or relatives - and the manner in which this marketing takes place;

-       The sort of expenses incurred by the taxpayer;

-       The amount invested in capital items; previous experience of the taxpayer. A taxpayer who does not have any knowledge or experience may be expected to have sought advice from experts. However, it is recognised that a taxpayer may be a pioneer in the industry. The taxpayer may have conducted research into the activity, decided that the traditional approach is wrong. He/she may be trying to conduct the activity with a view to profit in a new but businesslike way; and

-       The activity should also be compared with that of a keen amateur... A taxpayer who:

•         Has no knowledge or experience of the primary production activity that he/she intends to enter into; and

•         Does not seek advice or conduct research; and

•         Starts the activity"

As previously outlined, the absence of a commercial or business-like character in the relevant activities in this case indicates that the purchase and development of the Property has not been carried out in a similar manner to that in which property developers would carry on their activities.

Whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit

TR 97/11 states the following:

"In Newton v. Pyke the court suggested that business should be conducted systematically. A business is characteristically carried on in a systematic and organised manner rather than on an ad hoc basis."

The purchase and development of the Property were carried out over a considerable period of time (almost 5 years). It is accepted that the length of time taken to construct the Dwelling arose from the changes in its design and specifications, which were made to reflect the X and Y's own personal desires.

This is in contrast to the strict timeframes within which the construction of such dwellings are ordinarily completed, where the development is conducted in a business-like manner with the view to the maximisation of profits.

It is relevant again that no business plan was prepared in respect of the purchase, development and sale of the Property; no commercial or business arrangements were planned, organised or carried on; and no predetermined budget was set for the construction of the Dwelling.

The size, scale and permanency of the activity

TR 97/11 sets out the following:

"The larger the scale of the activity the more likely it will be that the taxpayer is carrying on a business of primary production. However, this is not always the case. The size or scale of the activity is not a determinative test..."

Although the value of the Property may be significant, the other indicators considered above point to the likelihood that the X and Y have not been carrying on a business.

Whether the activity is better described as a hobby, a form of recreation or a sporting activity

While the activity cannot be described as a hobby, form of recreation or a sporting activity, the other indicators considered above point to the likelihood that X and Y have not been carrying on a business.

In light of the above considerations, it is the Commissioner's view that purchase, development and the sale of the property are not transactions entered into by X in the ordinary course of carrying on a business, such that it would be considered for this reason to be assessable income under subsection 6-5(1) of ITAA 1997.

Taxation Ruling TR 92/3 (TR 92/3)

However, the question remains as to whether the sale of the property can be considered to be part of an isolated profit-making undertaking or scheme (outside the ordinary course of a business) with the characteristics of a business operation or commercial transaction, which carries the consequence that profits from the undertaking or scheme would be considered to be ordinary income within the scope of subsection 6-5(1).

TR 92/3 provides guidance in determining whether profits from isolated transactions are income, defining 'isolated transactions' as:

"(a) those transactions outside the ordinary course of business of a taxpayer carrying on a business; and

(b) those transactions entered into by non-business taxpayers."

As discussed earlier, X is not "carrying on a business" in respect of the purchase, development and sale of the Property.

The profits from the sale may nevertheless be income if the conditions outlined in paragraph 16 of TR 92/3 apply:

"If a taxpayer not carrying on a business makes a profit, that profit is income if:

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

(b)  the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction."

Intention

The following paragraphs of TR 92/3 discusses the concept of intention further:

"The relevant intention or purpose of the taxpayer (of making a profit or gain) is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

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.

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, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property...

In our view a profit made in either of the following situations is income:

(a)  a taxpayer acquires property with a purpose of making a profit by which ever means prove most suitable and a profit is later obtained by any means which implements the initial profit-making purpose (Steinberg; Premier Automatic Ticket Issuers Ltd v. FC of T (1933) 50 CLR 268 at 300; Myer, especially at 163 CLR 211; 87 ATC 4367; 18 ATR 698); or

(b)  a taxpayer acquires property contemplating a number of different methods of making a profit and uses one of those methods in making a profit."

As noted earlier, from an objective consideration of the facts and circumstances, X did not have an intention to make a profit when purchasing the property.

TR 92/3 however also discusses the situation in which the taxpayer's intention subsequently changes, particularly where the activities involve real property. Paragraphs 41 and 42 state:

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

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

(a)  as the capital of a business; or

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

As per paragraph 42(b), the issue in this case remains whether X had, at a point in time subsequent to the purchase of the Land, changed their intentions in relation to the Property by instead venturing the Property into an (isolated) profit-making undertaking 'with the characteristics of a business operation or commercial transaction'.

Business operation or commercial transaction

TR 92/3 provides as follows:

"In very general terms, a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations. Some factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are the following:

(a)  the nature of the entity undertaking the operation or transaction (Ruhamah Property Co. Ltd. v. F C of T (1928) 41 CLR 148 at 154; Hobart Bridge Co. Ltd. v. FC of T (1951) 82 CLR 372 at 383; FC of T v. Radnor Pty Ltd 91 ATC 4689; 22 ATR 344). For example, if the taxpayer is a corporation with substantial assets rather than an individual, that may be an indication that the operation or transaction was commercial in nature. However, if the taxpayer acts in the capacity of trustee of a family trust, the inference that the transaction was commercial or business in nature may not be drawn so readily;

(b)  the nature and scale of other activities undertaken by the taxpayer (Western Gold Mines N.L. v. C. of T. (W.A.) (1938) 59 CLR 729 at 740);

(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. This factor would include whether professional agents and advisers were used and whether the operation or transaction took place in a public market;

(f)    the nature of any connection between the relevant taxpayer and any other party to the operation or transaction. For example, the relationship between the parties may suggest that the operation or transaction was essentially a family dealing and not business or commercial in nature;

(g)  if the transaction involves the acquisition and disposal of property, the nature of that property (Edwards v. Bairstow; Hobart Bridge 82 CLR at 383). For example, if the property has no use other than as the subject of trade, the conclusion that the property was acquired for the purpose of trade and, therefore, that the transaction was commercial in nature, would be readily drawn; and

(h)  the timing of the transaction or the various steps in the transaction (Ruhamah Property 41 CLR at 154). For example, if the relevant transaction consists of the acquisition and disposal of property, the holding of the property for many years may indicate that the transaction was not business or commercial in nature."

In considering the abovementioned factors, many of the facts in this case which were examined earlier in our consideration of TR 97/11 are also relevant here.

Broadly speaking, the facts in this case do not suggest that X had adopted an intention to use the Property for a profit-making purpose - nor that the Property was, in fact, applied as part of a commercial undertaking - either at the time of the purchase of the Land or throughout the 4-to-5-year development period in which the construction of the dwelling took place. The circumstances support the fact that, throughout this period, X had maintained the intention to use the Property as a personal home for their family. In this regard, it is again considered relevant that:

•         The nature of the Property development indicates that it was constructed for private residential use. In particular:

o   The fact that it is an (unusually) large family home with a number of bedrooms is consistent with the Taxpayer's submission that it was built to accommodate X and Y's extended family.

o   The various specifications to the home were tailored to X and Y's tastes and to accommodate their personal assets.

•         At no point during the construction of the Dwelling was a business plan prepared; nor were any commercial or business arrangements planned, organised or carried on. No predetermined budget was set for the construction of the Dwelling.

•         The timing of the undertakings also points away from an intention to utilise the Property as part of a profit-making operation.

It is noted again that the time from purchase to the completion of the development of the Property, being approximately 5 years in this case, is generally longer than a typical lifecycle time frame for a commercial property development transaction, and is consistent with reason that it was due to changes in the design and to ensure that the Dwelling would be finished to a standard desired by X and Y, on account of the family's planned personal use of the Dwelling.

It is noted that X's decision to offer the Property for rent, rather than to use it as a holiday home, was made after the completion of the development, and was motivated by financial necessity following a downturn in the economic conditions in 20XX and 20XX.

The subsequent decision to sell the Property was made as a safety buffer, and the result of the X and Y's uncertainty that, given market conditions and the decrease in Y Pty Ltd's profits in 20XX and 20XX, they would be able to comfortably repay the loan in relation to the Property.

The sale in this regard occurred at a point in time after the development of the Property and as a result of financial necessity. It is not taken as any indication that the development itself was carried out as a business operation or commercial endeavour as part of a profit-making scheme.

Consequently, the sale of the property will not occur in the course of carrying on a business or carrying out a transaction entered into for a profit-making purpose. Proceeds from the sale of the Property by X will not be assessable income under section 6-5 of ITAA 1997.

Question 2

Subsection 104-10(1) of the ITAA 1997, which is contained in Part 3-1 of the ITAA 1997, states that CGT event A1 happens "if you dispose of a CGT asset".

Subsection 104-10(2) provides as follows:

"You dispose of a *CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner."

In this case, the relevant CGT asset, being the Property, has been disposed of following the sale of the Property, since a change of ownership occurs between X, as vendor, and the purchaser of the Property.

It follows that the disposal falls within the scope of CGT event A1 in subsection 104-10, and consequently that the gain on the sale of the Property by X is subject to Part 3-1 of the ITAA 1997.