Edited version of private advice

Authorisation Number: 1052170143569

Date of advice: 20 September 2023

Ruling

Subject: Capital v revenue receipt on sale of a property

Question 1

Does the sale of the Property by the Trustee constitute the mere realisation of the Property and buildings such that the calculation of any tax payable on the sale proceeds is solely determined under the capital gains tax provisions contained in Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No. The profit from the sale of the Property is income according to ordinary concepts and is assessable under section 6-5 of the ITAA 1997.

Question 2

If the answer to question 1 is "yes", are each of the land and buildings constructed on the land separate assets for capital gains tax (CGT) purposes?

Answer

Not applicable

Question 3

If the answer to question 1 is "yes", is the apportionment of sale proceeds between the land and buildings calculated as follows:

(Value of buildings at date of sale ÷ Total sale price for land and buildings) × Total sale price less cost base of the buildings

Answer

Not applicable

Question 4

If the answer to Question 1 is "yes", is the Property (absent the buildings situated thereon) a pre-CGT asset such that any capital gain made on sale of it is disregarded under section 104-10 of the ITAA 1997?

Answer

Not applicable

Question 5

If the answer to question 1 is "yes", does the CGT discount apply in relation to the CGT events arising from the sale of the Property and buildings?

Answer

Not applicable

Question 6

If the answer to question 1 is "no", and the Commissioner considers the sale of the Property to be taxable on revenue account, is the profit on sale of the Property calculated by deducting from the sale proceeds (exclusive of GST) the direct costs of the project and the market value of the land at the time of the scheme's commencement?

Answer

Yes.

This ruling applies for the following period

Income year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Person A acquired a large block of land in 1970 (Property).

The Property had a house and a shed together with some basic structures.

Person A had planned to use the Property to generate rental income.

They lived in part of the house and rented the rest to tenants. They also leased a portion of the Property to businesses.

About 30 years after the acquisition of the Property Person A entered into a Joint Venture Agreement (JVA) with Company X to develop the Property into a shopping centre (Project).

Company X specialised in commercial construction projects.

Person A provided the Property for the Project as they had no skills or knowledge in property construction.

The JVA stated that the Project was the 'development of the Land and sale of the developed Land' stage by stage.

The JVA set out the milestones for the Project, such as:

•                     preparation of a master plan and obtaining council approval,

•                     staging of construction,

•                     funding for the Project,

•                     rental arrangements, and

•                     disposal strategies for each stage.

The JVA provided the following:

•         the Project was to construct a retail centre,

•         Person A offered the land as security for finance to fund the Project,

•         Company X was to receive a project management fee,

•         Person A and Company X would have an equal say in and must approve all major decisions relating to the Project,

•         development profit was to be shared 50/50 between Company X and Person A, after payment of the land value to Person A and project costs,

•         'development profit' was determined as 'project receipts' minus 'project costs',

•         'project receipts' was defined as sale proceeds and net rental income,

•         'project costs' was the responsibility of both parties and was defined as construction costs, land holding costs, interest on borrowings and costs associated with the sale of the Property,

•         the sale procedures were to be followed upon sale of a stage or stages,

•         Person A had an option to buy out Company X's share of the development profit by instalment payments.

When the first stage was completed the shopping centre opened and rental income started to be generated.

The Project proceeded to the next stages.

Person A did not exercise the option to buy out Company X's share of the development profit as they could not secure finance.

The Property was not subdivided as Person A did not agree to it. The Property continued to remain on single title in their sole name until they passed away.

Prior to Person A's passing the Project had been completed up to a point where it became difficult to progress to the last stage due to the low-lying location of the remainder land. The completed stages were leased to tenants and rent was being collected.

During their lifetime Person A had indicated that they wanted the Project to be completed before sale or if possible, to hold it as a source of income stream for their family.

The Property was transferred to the trustee of Person A's estate (Trustee) upon Person A's passing and was sold by the Trustee.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 118-20

Does IVA apply to this private ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement.

If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated.

Question 1

General principles

Broadly, profits from land development and sale of land can be treated for taxation purposes in the following three ways:

•                     as ordinary income under section 6-5 resulting from the carrying on a business of land development and sale as trading stock;

•                     as ordinary income under section 6-5 resulting from isolated business or commercial transaction entered into by a non-business taxpayer, or outside the ordinary course of business of a taxpayer carrying on a business;

•                     as statutory income under the CGT legislation.

Pursuant to section 118-20, where a CGT event brings about a receipt of assessable or exempt income, any resulting capital gain is reduced by that income amount.

The sale of land will be a 'mere realisation' of that asset, where that sale takes place outside of a business or commercial context. Gains, if any, from such a sale will brought to account solely as capital gains.

A gain or profit from a sale that results from, or that is a part of, a commercial or business context will generally be assessable as either income from the carrying on of a business or income from a profit-making undertaking.

It is well settled law that a profit or gain made by a taxpayer outside the ordinary course of carrying on a business, but which arises from a transaction entered into by that taxpayer with the intention or purpose of making a profit or gain, will constitute assessable income, even where the transaction is an isolated one "if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit..." (FC of T v. Myer Emporium Ltd (1987) 163 CLR 199 (Myer) at 209-210).

Myer is one of the leading cases which shows that the intention at the time of acquiring the asset is an important consideration in determining whether the proceeds received on disposal of the asset are on a capital or revenue item.

While the taxpayer's motive is a relevant consideration in the determination of whether there is an isolated profit-making scheme, the purposes of the taxpayer in entering the scheme are determined objectively based on all the relevant facts. The test to be applied will be objective rather than subjective (Hayes v. F.C. of T. (1956) 96 CLR 47at p. 55).

The relevant intention or purpose of the taxpayer is the intention or purpose as discerned from an objective consideration of the facts and circumstances of the case. This is implicit from what the Court said in Myer:

'...it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income...'.

A scheme may also be a profit-making scheme notwithstanding that neither the sole nor the dominant purpose of entering into it was the making of the profit.

In Moana Sand Pty. Ltd. v. F.C. of T. 88 ATC 4897 (Moana Sands), the profit made by a taxpayer on the sale of land acquired with the twofold purpose of working and/or selling surplus sand on it and thereafter holding the land until some time in the future when it became appropriate to sell it at a profit, was held to be income according to ordinary concepts. This was in spite of a finding that the dominant purpose of the company in acquiring the land was not resale of the land at a profit. The Full Federal Court (per Sheppard, Wilcox and Lee JJ.) applied Myer in so holding.

The Full High Court case of FC of T v. Whitfords Beach Pty Ltd (1982) 150 CLR 355; 82 ATC 4031 (Whitfords Beach) observes that while 'mere realisation' may still be possible where blocks are merely subdivided to several blocks with minimal activity, where the size and scale of the activity reaches such a level that amounts to a development and improvement of the land to such a degree that it is no longer possible to say it is a mere realisation of an asset.

Mason J concluded, at ATC 4047-4048; CLR 385:

... In this respect I do not agree with the proposition which appears to be founded on remarks in some of the judgments that sale of land which has been subdivided is necessarily no more than the realization of an asset merely because it is an enterprising way of realizing the asset to the best advantage. That may be so in the case where an area of land is merely divided into several allotments. But it is not so in a case such as the present where the planned subdivision takes place on a massive scale, involving the laying-out and construction of roads, the provision of parklands, services and other improvements. All this amounts to development and improvement of the land to such a marked degree that it is impossible to say that it is mere realization of an asset. ....

Application to the facts of this case

At the time of purchase of the property, was there a profit-making purpose?

The Trustee has contended that the sale of the Property represents a mere realisation of a capital asset. When Person A acquired the Property they intended to use it to provide them with an income stream from rental income. They had a close connection to the Property and did not want to leave it.

It is accepted that Person A's original intention was to hold the Property for this purpose and they had used it to generate rental income for many years before the JV commenced.

It is also accepted that Person A's wishes during the course of the JV was that the development project be completed andsold in accordance with the terms of the JV Agreement, or if appropriate, held as an investment to generate income for the benefit of the beneficiaries of their estate.

Was the property ventured into a profit-making scheme?

A property that was not acquired in the course of a business or as part of a commercial activity can be ventured into a commercial venture some point after it was acquired. Where this has taken place, a profit that results from that venture will be treated as assessable income.

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) provides guidance in characterising profits on isolated transactions and states at paragraphs 7, 8 and 9 that:

7. 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.

8. 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.

9. 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 circumstances where there has been a change of intention in respect of a property from holding the asset as a long term capital asset, to one of selling the asset for a profit the question which arises is whether the sale was a 'mere realisation' of capital asset.

Paragraphs 41 and 42 of TR 92/3 further state that:

41. 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. 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.

While holding an asset for a long period of time may seem to indicate that it is a long-term capital investment asset, if a transaction or operation involves the sale of property, the issue of whether the original intention changed at a later time needs to be considered.,

In this case, under the terms of the JVA, Person A committed the land as the capital for a large-scale development project. It was made available for the Project and was used as security to obtain finance for the development. Person A was responsible for the costs of the Project and shared in the profits or loss of the Project.

The Property, therefore, was ventured into a profit-making scheme when the JVA was entered into.

Did the profit-making venture include sale of the property as a potential outcome?

When Person A and Company X entered into the JVA the intention of the parties was to develop and sell the developed land as stated in the JVA.

The JVA contemplates the sale of the Property as part of setting the milestones, the procedures for sale and the calculation of development profits.

The sale of the Property was a necessary consequence of implementing the terms of the JVA. The intention to possibly sell the Property existed at the time the JVA was entered into.

Other evidence provided indicate Person A's preference for the development to be completed and sold in accordance with the terms of the JVA, or if appropriate, held as an investment to generate an income stream.

It is not necessary that the profit-making by sale be the sole or dominant purpose for entering into a transaction. It is sufficient if profit-making by sale is a significant purpose. This is clear from Moana Sands and the view expressed in TR 92/3.

The profit-making by sale is a significant purpose in this case. Person A entered into the JVA to develop a shopping centre on undeveloped land and to sell. Given the magnitude and sophistication of the development it is concluded that Person A undertook the Project for the purpose of profit.

To summarise this point, although Mr. A desired that the Project remain intact as an income producing asset for their off-spring, the JVA they entered into had a significant purpose and possible outcome of profit by sale. Accordingly, there was a change of purpose from holding the Property as a capital asset. Person A entered into the JVA with the purpose of making a profit. Profit from sale of the Property as a whole or in portions was an outcome contemplated by that Agreement. The profit-making purpose existed in relation to the Project by which profit was in fact made.

Was there a profit-making undertaking with the characteristics of a business operation or commercial transaction?

Paragraph 35 of TR 92/3 states that profit from an isolated transaction is generally assessable income when the intention of the taxpayer in entering into the transaction was to make a profit or gain and profit was made in carrying out a business operation or commercial transaction.

Some matters which may be relevant in considering whether an isolated transaction amounts to a commercial transaction are noted in paragraph 14 of TR 92/3 to include:

•                     the nature of the entity undertaking the transaction;

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

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

•                     the nature, scale and complexity of the transaction;

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

•                     the nature of any connection between the parties;

•                     the nature of the property if the transaction involves the acquisition and disposal of a property;

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

These indicators must be considered in combination and as a whole. No one indicator is decisive. A conclusion that a transaction is commercial is gained from looking at all the indicators and whether these indicators give the transaction a commercial flavour.

The fact that Person A acquired the Property with the intention to hold it to generate an income stream and they had no prior skills or business in property development will not prevent their activities during the joint venture constituting a business of which the profit arising on sale is income according to ordinary concepts.

It can be clearly discerned from the scope of the operation that Person A had entered into a business enterprise with a profit-making purpose.

The construction of the shopping centre with a large number of retail premises was carried out on undeveloped land and required significant and sophisticated planning, organisation and management. It was a large-scale project which involved a multi-stage construction of buildings as well as provision of necessary infrastructure such as access roads, other services and improvements together with regulatory and environmental compliance.

The Project was carried out in a business-like manner. There was a coherent plan executed with repetition and continuity of business activities to enable the Project to start and progress to completion.

Did Person A participate in the business of the project?

Person A did not merely provide the land for the development and leave the decision-making and management of the Project to Company A. They provided the land as security for the borrowings for the purpose of the joint venture.

The JVA also stated Person A and Company X would have an equal say in and must approve all major decisions relating to the Project.

'Project Costs' is defined to be the responsibility of both parties.

Therefore, Person A was not a passive participant. They were a decision-maker and were exposed to the financial risks of undertaking the Project.

Given the complexity and sophistication of the Project, its size and scale and the manner of Person A's participation the Commissioner considers that the activities undertaken by Person A go beyond merely realising the Property in an enterprising way. Person A entered into a commercial transaction to make a profit when they entered into the JVA. The profit is considered profit from an isolated transaction and is assessable as ordinary income under section 6-5.

Question 6

The profit from the sale of the Property is the gain in the value of the Property from the date of the JVA. It is calculated by deducting from the sale proceeds:

•                     the market value of the Property as at this date, and

•                     development expenses determined in accordance with appropriate accounting principles.

In calculating the profit no deduction is allowable until the year of income in which the profit is derived.

TD 97/1 Income tax: property development: if land, originally acquired as a capital asset, is later ventured into a business of development, subdivision and sale, how is the market value of the land calculated at the time it is ventured into the business? provides that the market value of the land is determined having regard to the 'highest and best use' that can be made of the land. Due weight is given to the land's potential utility and to the probability of consent being given for such potential use.

The value of the Property is the market value of the land on the date Person A entered into the JVA together with any improvements as at this date, taken into consideration the development potential.

The profit from the sale of the Property is assessable under section 6-5 in the income year in which settlement took place.