Edited version of private advice

Authorisation Number: 1052217550793

Date of advice: 2 February 2024

Ruling

Subject: Mere realisation of assets

Question 1

Are the proceeds or the net profit from the sale of Lots A and B ordinary income of the Trust under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) or any other provision of the Tax Acts?

Answer

No.

Question 2

Does the sale of Lots A and B constitute the mere realisation of a capital asset?

Answer

Yes.

Question 3

Would the net capital gain made on the sale of Lots A and B be included in the Trust's assessable income under section 102-5 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20YY

Relevant facts and circumstances

The Trust is part of a private group of Australian resident entities that owns significant real estate assets held:

(a)   for use as part of the farming and agricultural related activities of the group;

(b)   to derive rental income; or

(c)   for the purposes of deriving a profit from future sale and/or redevelopment.

The Trust, established by way of Trust Deed in YYYY, holds various investments, including farming and residential properties and listed shares.

Specifically, real estate assets currently held by the Trustee, in addition to Lots A and B, are:

•         properties that are rural land, zoned for residential development and acquired for development purposes; and

•         properties either deriving rental income or vacant.

The Property

Person A first became aware in or around MM 20YY, that Lots A, B and C (the Property) was up for sale.

At the date of acquisition the land was zoned general rural by the local government authority. Person A's purpose and intent in acquiring the Property was for the land to be used for grain storage. The intention was to construct grain silo storage facilities on the Property.

The purpose of the storage facilities was to enable substantial grain to be stored such that the grain could be sold at the farmer's discretion, thereby taking advantage of price fluctuations, and selling in a more optimal pricing market. There was no intent by the Trust to amend the zoning of the Property or to commence a development on the property with intent to resell.

In or around MM 20YY, the Trust engaged an engineering firm to prepare a plan for constructing grain storage facilities on the Property and to assess its feasibility.

The Property was acquired by the Trust as vacant land for $X (GST inclusive) via contract in MM 20YY. Settlement took place soon after.

In the interim period following acquisition whilst plans were being sought, the Property was fenced and used for farming. The farming activities included grazing and the storage of substantial farming materials including fencing, pipes and water irrigation materials. In addition, a sea container was brought into Lot C to house grain feed supplement.

At various intervals the Trust reviewed its strategy to determine the economic viability of using the Property as a grain storage facility. Around the 20YY year, an assessment was completed to determine whether the storage facilities could be located at the Property or at other farmland owned by the Group. The results of this assessment determined:

(a)   There are restrictions on heavy use for trucks servicing a road on the Property.

(b)   Dust suppression should be a major consideration for the Property. Dust suppression was not a consideration on the other farming property as, due to its location, it was not likely to have negative environmental impact.

As a result of this assessment, additional grain storage facilities were ultimately constructed on the other farming property.

Disposal of Lot C

In or around MM 20YY Person A was approached by an opportunistic purchaser seeking to acquire Lot C. The Property was not advertised for sale at this time.

In MM 20YY, the Trust and the buyer entered into a call option deed for the purchase of Lot C, and a sale contract for the disposal of Lot C for $X was entered into in the 20YY income year.

Disposal of Lots A and B

In 20YY the Trustee lodged an Application for Development Approval (the Application) with the local government to develop a depot comprising grain silos. Lots A and B were reconsidered as a viable grain storage option as the blocks had access to a road suitable for heavy vehicles.

Following the lodgment of the Application, the local government referred the Application to other relevant agencies for comment. One particular agency failed to provide a response in a timely manner, and the local government refused the Application on the basis that insufficient information had been provided by the Trustee. The Trustee decided not to respond to the local government's queries until such time that issues with the other relevant agency had been resolved.

In 20YY the Trust was approached with an offer to lease Lots A and B, subject to a XXX station facility being built by the Trust at its own cost. It was proposed that the XXXXXX be built above ground and then demolished in the future upon the sale of the Lots. The Trustee decided not to proceed with this offer as the return was too low compared to the value of the land of the Lots.

In MM 20YY, a third party working on an infrastructure project approached the Trustee with an offer to lease the land for a minimum of 12 months to store excess fill on Lots A and B until they were able to dispose of the fill at the end of the project. The Trustee did not proceed with the lease due to uncertainty on what was in the fill, or how and when it would be disposed of at the end of the lease.

In MM 20YY, the Trustee received an Industrial Development Assessment report from Company Z that sets out an assessment for the potential use of Lots A and B, and to better understand the demand for the development of Lots A and B.

Also in MM 20YY, architects provided the Trustee with a fee proposal for the provision of architectural services and anticipated consultant costs should the Trustee proceed with the development.

In MM 20YY an expression of interest was released by Company Y to gauge any interest in the market for a purpose-built facility to be constructed on Lots A and B for a successful tenant (EOI Campaign).

In response to the EOI Campaign, the Trustee received:

•         an approach from a company wanting to lease Lots A and B if a warehouse and distribution facility could be built on the land, and

•         a formal offer from Company A, offering to purchase Lots A and B for $X subject to Company A obtaining a lease for the property within 12 months of purchase.

The Trustee initially did not accept Company A's offer. However, in MM 20YY Company A was granted an Option for Purchase of Lots A and B for $X, plus GST. An Option Deed was executed in MM 20YY.

In MM 20YY a Notice of Assignment was executed under which Company A assigned its rights and interests under the Option Deed to Company B as trustee for Trust B.

The Option for Purchase was exercised in MM 20YY, a sale contract for the disposal of Lots A and B was executed on the same date and settlement of Lots A and B happened later that month.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 70-80(1)

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-5

Reasons for decision

All subsequent legislative references are to the ITAA 1997.

Summary

The proceeds from the sale of the Lots A and B will not be assessable as ordinary income under section 6-5. The sale of Lots A and B constitute the mere realisation of a capital asset and the net capital gain made on the sale should be included in the Trust's assessable income under section 102-5.

Detailed reasoning

The proceeds from the disposal of land held as an item of trading stock in the ordinary course of business is included in assessable income (under section 6-5) as ordinary income (subsection 70-80(1)).

The profits on sale of the property will also give rise to ordinary income under section 6-5 if:

•         the intention or purpose (objective) of the taxpayer in entering into the transaction or operation 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 or in carrying out a business operation or commercial transaction.

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

The Trust's intention when acquiring the Property was to use it as a grain storage facility for its farming activities. In the period following acquisition, the Property was used for storage and sheep grazing purposes. There was never any intention or plan to rezone, subdivide or develop the land, and no subdivision or development activities were performed prior to the sale for the purpose of maximising the sale proceeds.

Although the Trust is involved in property development and resale activities in respect of other properties in its portfolio, the clear purpose of acquiring the Property was for use in farming activities.

The present circumstances can be clearly distinguished from the decision in FCT v. Whitfords Beach Pty Ltd (1982) 150 CLR 355, which established that a profit making intent does not always need to exist at the date of acquisition of a property in order for an isolated transaction to be ordinary income. In that case although no profit making intent existed initially, following the sale of the taxpayer to a larger group, extensive business-like activities were later carried out in respect of the development.

No such activities were carried out to complete the sale in this case. The Trust did not actively market Lots A and B for sale (nor Lot C prior to its sale), and merely sold Lots A and B (like Lot C) 'as is' after the Trust was approached by an interested buyer.

We have therefore concluded that the Trust did not hold Lots A and B as an item of trading stock (for sale in the ordinary course of business), and the Trust did not acquire Lots A and B for the purpose of profit making by sale (nor did that purpose change over time).

Gains from the sale of real property (other than a main residence) can be assessable on capital account as statutory income under the capital gains tax (CGT) regime (section 102-5) on the basis that a mere realisation of a capital asset has occurred. The expression 'mere realisation' is used to contradistinguish a business operation or a commercial transaction carrying out a profit-making scheme (FC of T v. The Myer Emporium Ltd (1987) at 163 CLR 213; 87 ATC 4368-4369; 18 ATR 699-700).

Section 102-5 includes in assessable income an amount that is a net capital gain. Under section 102-20, a person makes a capital gain if a CGT event happens.

CGT event A1 under section 104-10 happens when you dispose of a CGT asset to someone else and there is a change in ownership from you to another entity (section 104-10). The gain or loss is made when you enter into the contract for disposal (where there is a contract for the disposal).

Section 108-5 provides that a CGT asset is any kind of property, or a legal or equitable right that is not property. Lots A and B are a CGT asset and their sale by the Trust constituted a mere realisation.

CGT event A1 happened to the Trust upon the sale of Lots A and B and the capital gain made on that sale is included in the Trust's assessable income.