Edited version of private advice

Authorisation Number: 1052118471611

Date of advice: 25 May 2023

Ruling

Subject: GST and sale of rental properties

Question 1

Is the sale of the townhouses by an entity a mere realisation of a capital asset for CGT purposes and not ordinary income under 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes, the sale of the townhouses by the entity is a mere realisation of a capital asset for CGT purposes and not ordinary income under 6-5 of the ITAA 1997.

Question 2

Is the entity required to be registered for GST under the A New Tax System (Goods and Services) Act 1999 (GST Act)?

Answer

No, the entity is not required to be registered for GST under the GST Act.

Relevant facts and circumstances

An entity purchased a block of land and built townhouses to receive rental income as a long-term investment.

The entity was not registered for GST and did not claim any input tax credits related to the relevant acquisitions.

The townhouses were rented out progressively upon completion with an entity hired to manage marketing, leasing, property maintenance and maintenance of the rental roll for the townhouses.

Due to some external unforeseen factors, the entity decided to sell the townhouses.

The entity does not have a history of buying and selling properties prior to the sale of the townhouses. Its only income source is from the rental of the townhouses.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

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

A New Tax System (Goods and Services Tax) Act 1999 Division 188

Reasons for decision

Question 1

Detailed reasoning

All legislative references in Question 1 of this ruling are of the ITAA 1997 unless otherwise stated.

In general, proceeds from the sale of land will be taxed for income tax purposes in one of the following ways:

•                as ordinary income, where the land is held as trading stock and sold as part of carrying on a business of property development,

•                as ordinary income, where land is not trading stock and is sold as part of an isolated commercial transaction entered into with a profit-making intention,

•                as statutory income under the CGT provisions, where the land is neither trading stock nor the subject of an isolated profit-making scheme or undertaking and the proceeds of sale are the mere realisation of a capital asset.

Where the land is sold as part of carrying on a business of property development or as part of an isolated profit-making scheme, the proceeds will be included in your assessable income in accordance with subsection 6-5(1) of the ITAA 1997.

Isolated commercial transaction

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income discusses profits on isolated transactions and the application of the principles outlined in the decision of theFull High Court of Australia in Commissioner of Taxation v Myer Emporium Ltd [1987] HCA 18 (Myer Emporium). This ruling states that profits on isolated transactions may be income.

Profit from an isolated transaction will be ordinary income where:

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

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

TR 92/3 outlines that 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.

Profits on the sale of subdivided land can therefore be income according to ordinary concepts within section 6-5 of the ITAA 1997 if the taxpayer's subdivisional activities amount to a business operation or commercial transaction.

Paragraph 42 of TR 92/3 provides that 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.

At paragraphs 56 and 57, TR 92/3 explains that a profit is income where it is made in any of the following situations:

•                a taxpayer acquires property with a purpose of making a profit by whichever means prove most suitable and a profit is later obtained by any means which implements the initial profit-making purpose; or

•                a taxpayer acquires property contemplating a number of different methods of making a profit and uses one of those methods in making a profit; or

•                a taxpayer enters into a transaction or operation with a purpose of making a profit by one particular means but actually obtains the profit by a different means.

Furthermore, 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) deals in part the taxation consequences of isolated transactions relating to the sale of land and states in paragraph 263:

The issue to be decided is whether the activities 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.

MT 2006/1refers to the cases of Statham & Anor v. Federal Commissioner of Taxation [1988] FCA 761 (Statham) and Casimaty, George v. Federal Commissioner of Taxation [1997] FCA 1388(Casimaty) as cases that provide guidance on when activities to subdivide land may amount to a profit-making undertaking or scheme. In both cases, farm land was subdivided and sold and based on the facts of those cases, the courts held that the sales of the subdivided lots were a mere realisation of a capital asset.

MT 2006/1 notes that from the Statham and Casimaty cases a list of factors can be ascertained that provide assistance in determining whether an activity is a profit-making undertaking or scheme. Those factors are:

•                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.

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.

Profit-making intention

If the transaction 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 decision in Commissioner of Taxation v. Whitfords Beach Pty Ltd [1982] HCA 8 (Whitfords Beach) demonstrates, that is not always the case. For example, if a taxpayer acquires an asset with an intention of using it for personal enjoyment but later decides to venture or commit the asset either as the capital of a business or into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction, the profit is income even though the taxpayer did not have the purpose of profit-making at the time of acquisition.

Business operation or commercial transaction

Factors listed in paragraph 13 of TR 92/3, which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction, include:

•                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, and

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

In determining whether activities relating to isolated transactions are a profit-making undertaking or are the realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. 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.

Paragraph 32 of TR 92/3 provides that profits or gains made in the ordinary course of carrying on a business will include:

a profit or gain arising from a transaction which is an ordinary incident of the business activity of the taxpayer, although not a transaction entered into directly in its main business activity

It was held in Myer Emporium that:

A profit or gain made as a result of an isolated venture or a "one-off" transaction will constitute income if the property generating a profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means of giving rise to profit;

This was discussed in Westfield Ltd v Commissioner of Taxation [1991] FCA 97:

It does not, however, follow from the judgment in Myer, or, for that matter, from the judgments in any later cases, that every profit made by a taxpayer in the course of his business activity will be of an income nature. To so express the proposition is to express it too widely, and to eliminate the distinction between an income and a capital profit. A taxpayer carrying on a business might sell its headquarters in order to move to larger premises and make a profit over historical cost. The transaction of sale may be one which arises in the ordinary course of the taxpayer's business, but that profit will not ordinarily be income, particularly where,' at the time of acquisition of the site, there was no intention or purpose of profit-making by sale when the premises became too small.

And further discussed in Rosgoe Pty Ltd v Commissioner of Taxation [2015] FCA 1231 at [25]:

When, later, the property was sold, "the profit here arose not from the purchase but from the sale and because the sale was not part of the profit-making scheme the profit did not arise 'from the carrying on or carrying out' of that scheme.

The timing of the requisite intention or purpose is adopted by the Commissioner in TR 92/3 at paragraph 9:

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.

Mere realisation of a capital asset

The distinction between a 'mere realisation or change in investment' and 'an act done in what is truly the carrying on, or carrying out, of a business', is provided by Lord Justice Clerk in Californian Copper Syndicate v. Harris (Inspector of Taxes) (1904) 5 TC 159 at page 166:

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 gain that has been made a mere enhancement of value by realising a security, or is it a gain made in an operation of business in carrying out a scheme for profit-making?

Lord Justice Clerk's approach was adopted with approval by the High Court of Australia in Whitfords Beach, with Gibbs CJ stating at paragraph 3 on page 389:

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..."what is done is not merely a realisation or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business".

These principles were applied in Statham, where it was held that the sale of a rural property that had been subject to four stages of subdivision was a mere realisation of the property. In their joint judgment, Woodward, Lockhart and Hartigan JJ provided at page 4076 that:

There is nothing surprising in the fact that they went about this realisation in a manner calculated to maximise their receipts. The fact that this occurred does not necessarily make the proceeds either profits from an undertaking or scheme, or income from a business.

Application of the law

Based on the facts of this case, the sale of the townhouses by the entity is a mere realisation of its capital assets. Accordingly, the proceeds from the sale of the townhouses will not be included in the entity's assessable income in accordance with subsection 6-5(1) of the ITAA 1997.

Question 2

Detailed reasoning

All legislative references in Question 2 of this ruling are of the GST Act unless otherwise stated.

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

In this case, it is clear that the entity is carrying on an enterprise of providing residential rent, thereby making input taxed supplies under section 40-35. In this regard, we have to consider if its GST turnover meets the GST registration turnover threshold, in particular, to consider if the sale of the townhouses on the Property will have any effect on its GST turnover.

Subsection 188-10(1) provides that an entity has a GST turnover that meets the registration turnover threshold if the entity's:

•                current GST turnover is at or above the turnover and the Commissioner is not satisfied that the entity's projected GST turnover is below the turnover threshold, or

•                projected GST turnover is at or above the turnover threshold. (emphasis added)

These terms are defined in sections 188-15 and 188-20 respectively, subject to certain exclusions, as follows:

•                current GST turnover at a time during a particular month is the sum of the values of all the supplies that you made, or are likely to make, during the current month and the preceding 11 months

•                projected GST turnover at a time during a particular month is the sum of the values of all the supplies that you made, or are likely to make, during that month and the next 11 months. (emphasis added)

Both sections 188-15 and 188-20 also provide that input taxed supplies are not included in working out the current GST turnover and projected GST turnover respectively.

Section 188-25 provides that the following are excluded from '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:

•           ceasing to carry on an enterprise; or

•           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 sets out the Commissioner's views on the meaning of GST turnover.

Paragraph 31 of GSTR 2001/7 provides that 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.

Paragraphs 33 and 34 of GSTR 2001/7 further provides that 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).

'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'.

Application of the law

Based on the facts of this case, the entity does not have a GST turnover that meets the registration turnover threshold. Therefore, the entity is not required to be registered for GST under the GST Act.