Edited version of private advice

Authorisation Number: 1052245869916

Date of advice: 9 May 2024

Ruling

Subject: GST and income tax - carrying on an enterprise and mere realisation of a capital asset

Question 1

Are you carrying on an enterprise in relation to the subdivision of the property and, as a result, required to be registered for GST pursuant to section 23-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

No. You are not carrying on an enterprise in relation to the subdivision of the property.

Question 2

Are the proceeds from the sale of the property, assessable as statutory income, on capital account, as a mere realisation of a capital asset and subject to the capital gains tax (CGT) provisions in Part 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes. The proceeds from the sale of the property are a mere realisation of a capital asset.

This ruling applies for the following period:

Year ended 30 June 2023

The scheme commenced on:

1 July 2014

Relevant facts and circumstances

Person A had an interest in a property in a residential zone (the property).

The property was transferred to a trust of which person A and person B were the directors of the trustee company.

The intention of purchasing the property was the possibility of capital improvement (depending on the taxpayer's financial situation) and long-term financial support for lifestyle and retirement.

The property was leased and tenanted until it was vacated by the tenants before demolishing.

A solicitor was engaged to make enquiries, however, in error, a transfer of the property occurred to person A and person B in their individual names. An objection was lodged to the State Revenue Office on the grounds that the trustee company decided the transfer was not to proceed and to be withdrawn. The objection was disallowed, and the matter referred to VCAT and later settled.

The settlement offer was that the stamp duty for the transfer was to be paid over 12 monthly instalments without accrual of interest. The transfer was held to be executed on DDMMYY.

Person A and person B wanted to improve the land but were having difficulties borrowing funds in the trust. Hence, two loans were obtained for construction and investment - one loan in the trust's name and the other in taxpayers' personal names.

The trust was used to obtain permits and other requirements for development. A planning permit was issued; and a building permit was issued for demolition works. Later, another permit was issued for the construction of units.

The intention of the units was to rent them out long-term to fund person A and person B's retirement.

A couple of years later, an occupancy permit was issued for the completed units.

Both loans were refinanced into one loan in person A and person B's personal names.

The property was then legally transferred from the trust to person A and person B in their personal names.

Due to quickly increasing interest rates putting financial stress on the taxpayers, a decision was made to sell one of the units and reduce the loan.

The subdivision of the property occurred and the properties were given a new address.

One of the units were sold to a third party and proceeds of the sale were used to decrease the loan amount.

The remaining units are being retained and rented out long-term.

The trust was incorrectly registered for GST which was subsequently cancelled.

Person B does not have an ABN and is not registered for GST.

Person A is a tradesperson with an ABN but is not registered for GST.

Person A and person B were not actively involved in the subdivision and construction of the units. Professionals were used to complete the building works and drawings.

The trust has not been involved in any prior developments. Person A and Person B were involved in one subdivision approximately several years ago. This was treated as capital as the properties are used as their principal place of residence and a rental.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 Section 9-5

A New Tax System (Goods and Services Tax) Act 1999 Section 9-20

A New Tax System (Goods and Services Tax) Act 1999 Section 9-40

A New Tax System (Goods and Services Tax) Act 1999 Section 23-15

A New Tax System (Goods and Services Tax) Act 1999 Section 188-10

A New Tax System (Goods and Services Tax) Act 1999 Section 188-15

A New Tax System (Goods and Services Tax) Act 1999 Section 188-20

A New Tax System (Goods and Services Tax) Act 1999 Section 195-1

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Question 1

Are you carrying on an enterprise in relation to the subdivision of the property and, as a result, required to be registered for GST pursuant to section 23-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Summary

You are not carrying on a business or enterprise in relation to the subdivision of the property.

Detailed reasoning

Section 9-40 provides that you are liable for GST on any taxable supplies that you make.

Section 9-5 provides you make a taxable supply if:

(a)  you make the supply for consideration; and

(b)  the supply is made in the course or furtherance of an enterprise that you carry on; and

(c)   the supply is connected with the indirect tax zone; and

(d)  you are registered, or required to be registered for GST.

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed.

The question in this case is whether you are making the supply of the unit in the course or furtherance of an enterprise that you carry on. If so, as you are not registered for GST, a further question will be whether you are required to be registered for GST.

Section 9-20 provides that the term 'enterprise' includes, among other things, an activity or series of activities done:

•         in the form of a business;

•         in the form of an adventure or concern in the nature of trade;

•         on a regular or continuous basis, in the form of a lease, licence or other grant of an interest in property.

Section 195-1 states that the phrase 'carrying on' in the context of an enterprise includes 'doing anything in the course of the commencement or termination of the enterprise'.

In this case, you own a number of residential properties that you rent out. As such we consider that you carry on an enterprise of leasing, being activities done on a regular or continuous basis, in the form of a lease, licence or other grant of an interest in property.

Goods and Services Tax Ruling GSTR 2002/5 Goods and services tax: when is a 'supply of a going concern' GST-free? (GSTR 2002/5) discusses when a 'supply of a going concern' is GST-free in respect to leasing enterprises. Paragraph 151 of GSTR 2002/5 states in part that where a building has not previously been leased to a tenant, but is being actively marketed, an 'enterprise of leasing' is not operating until the activity of leasing actually commences. The activity of leasing commences when at least one tenant enters into an agreement to lease or occupies the building. As such, we do not consider the sale of one unit to be in the course or furtherance of your leasing enterprise given that the unit had never been leased or rented.

Given the above, the next issue to consider is whether your activities undertaken in regard to the construction of the units and subsequent sale of the one unit is considered to be the course of another enterprise that you carry on. As discussed above, the term 'enterprise' includes an activity or series of activities done in the form of a business or in the form of an adventure or concern in the nature of trade.

Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on and enterprise for the purposes of entitlement to an Australian Business Number (MT 2006/1) provides the Tax Office view on the meaning of 'enterprise' for the purposes of entitlement to an Australian Business Number (ABN). Goods and Services Tax Determination GSTD 2006/6 Goods and Services Tax: does MT 2006/1 have equal application to the meaning of 'entity' and 'enterprise' for the purposes of the A New Tax System (Goods and Services Tax) Act 1999 (GSTD 2006/6) provides that the discussion in MT 2006/1 equally applies to the term 'enterprise' as used in the GST Act and can be relied on for GST purposes.

In the form of a business

Paragraphs 170 to 232 of MT 2006/1 discuss factors to consider when determining whether an activity or series of activities are done in the form of a business. Paragraph 178 of MT 2006/1 lists, with reference to Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production?, indicators of carrying on a business:

•         a significant commercial activity;

•         a purpose and intention of the taxpayer to engage in commercial activity;

•         an intention to make a profit from the activity;

•         the activity is or will be profitable;

•         the recurrent or regular nature of the activity;

•         the activity is carried on in a similar manner to that of other businesses in the same or similar trade;

•         activity is systematic, organised and carried on in a businesslike manner and records are kept;

•         the activities are of a reasonable size and scale;

•         a business plan exists;

•         commercial sales of product; and

•         the entity has relevant knowledge or skill.

Paragraph 179 of MT 2006/1 states that there is no single test to determine whether a business is being carried on. Whilst each case might turn on its own particular facts, the determination of the question is generally the result of a process of weighing all the relevant indicators.

Application to your circumstances

The trust acquired the property and it was rented out. Your intention as trustees of the trust was for possible capital improvement (depending on your financial situation) and long-term financial support for your lifestyle and retirement.

As the trust was unable to obtain funding for the development, the trust transferred the property to you.

You demolished the existing dwelling and constructed new units with the intention to also lease/rent the premises. The development of the units was not entered into with the intention of making a profit by sale. It was your sole intention that you would generate an income stream as a result of renting the three new dwellings.

Person A is a tradesperson operating as a sole trader and Person B works in hospitality (neither of you work in the building or property development industry). You have previously been involved with subdividing and construction of residential premises several years ago. One of the new premises became your primary place of residence and the other you have held onto which has been rented out.

We consider that the activities you have undertaken do not display the salient indicator of a business, which are transactions entered into on a continuous and repetitive basis. This is a one-off project that is not considered to being carried out in a manner similar to other property development businesses.

Given the above, we do not consider your activities in regard to the construction of the townhouses and subsequent sale of 1 unit to have been done in the form of a business.

In the form of an adventure or concern in the nature of trade

Paragraph 234 of MT 2006/1 provides that ordinarily, the term 'business' would encompass trade engaged in, on a regular or continuous basis. However, an adventure or concern in the nature of trade may be an isolated or one-off transaction that does not amount to a business but which has the characteristics of a business deal.

Paragraphs 243 to 257 of MT 2006/1 discuss the characteristics of trade, including the badges of trade as referred to in a number of judicial decisions:

•         the subject matter of the realisation;

•         length of period of ownership;

•         frequency or number of similar transactions;

•         supplementary work on or in connection with the property realised;

•         circumstances that were responsible for the realisation;

•         motive.

Application to your situation

Paragraph 247 of MT 2006/1 discusses that where property provides either an income or personal enjoyment to the owner it is more likely to be an investment than a trading asset. Typically, a trading asset is dealt with or traded within a short time after its acquisition. In this case it was always your intention that all units were to provide a future income stream. You entered into residential lease agreements for the other units shortly after completion; however, the increase in interest rates put financial stress on you and the decision was made to sell one unit to reduce the loan.

Paragraph 253 of MT 2006/1 acknowledges that assets can be sold for reasons other than trade and that the circumstances behind the sale need to be considered.

Paragraph 254 of MT 2006/1 discusses that in some cases, the motive behind the sale of an asset is a relevant consideration. In this case, your original intention was to generate a future income stream from leasing the premises and not to engage in trade by selling the newly constructed properties. The purpose of constructing the units was to hold as investment assets.

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 property was not for the purpose of trade. As such we do not consider your activities of constructing three residential Units and subsequently selling one of the units as being done in the form of an adventure or concern in the nature of trade.

Conclusion

The activities you have undertaken in regard to the construction of the three Units and subsequent sale of one unit is not considered to be the course of an enterprise that you carry on.

GST registration

As you are not currently registered for GST, the next issue to consider is whether you are required to be registered for GST.

Section 23-5 provides that you are required to be registered for GST if you are carrying on an enterprise and your GST turnover meets the registration turnover threshold (currently $75,000).

As discussed above, it is considered that the rental of your residential properties constitutes an 'enterprise' for GST purposes.

The meaning of GST turnover is contained in Division 188. Section 188-10 provides that your GST turnover will meet the registration turnover threshold if:

a)    your current GST turnover is at or above the threshold ($75,000) and the Commissioner is not satisfied that your projected GST turnover is below $75,000, or

b)    your projected GST turnover is at or above $75,000.

Your 'current GST turnover' is the sum of your turnover for the current month and the previous 11 months.

Your 'projected GST turnover' is the sum of your turnover for the current month and the next 11 months.

Paragraphs 188-15(1)(a) and 188-20(1)(a) provide that input taxed supplies are disregarded when calculating your current and projected turnovers respectively. As such, your input taxed supplies of leasing residential premises are disregarded when determining whether you meet the GST registration turnover threshold.

Furthermore, paragraphs 188-15(1)(c) and 188-20(1)(c) provide that supplies that are not made in connection with an enterprise that you carry on are also disregarded. Therefore, the proceeds from the sale of one unit will also be disregarded in calculations for the purposes of determining whether you are required to register for GST.

Given the above, your GST turnover does not meet the registration turnover threshold and you are not required to register for GST.

Conclusion

The sale of one unit is not a taxable supply as defined in section 9-5 as paragraphs 9-5(b) and 9-5(d) are not satisfied.

Question 2

Are the proceeds from the sale of the property, assessable as statutory income, on capital account, as a mere realisation of a capital asset and subject to the capital gains tax (CGT) provisions in Part 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

Yes. The proceeds from the sale of the property are a mere realisation of a capital asset.

Detailed reasoning

Subsection 6-5(2) of the 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.

Section 6-10 of the ITAA 1997 states your assessable income also includes some amounts that are not ordinary income, which is assessable as statutory income.

There are 3 ways the proceeds from a property development can be treated for taxation purposes:

•         Assessable ordinary income under section 6-5 of the ITAA 1997 as income from carrying on a business of property development;

•         Assessable ordinary income under section 6-5 of the ITAA 1997 as income from an isolated commercial transaction with a view to profit; or

•         A mere realisation of a capital asset, assessable under Parts 3-1 and 3-3 as statutory income.

Taxation Ruling 97/11 Income tax: am I carrying on a business of primary production? (TR 97/11) provides the Commissioners view on whether a taxpayer is carrying on a business. Although TR 97/11 deals with the issues in determining whether a taxpayer is carrying on a business of primary production, the same principles can be applied to the question of whether a taxpayer is carrying on any type of business including property subdivision and development.

Paragraph 13 of TR 97/11 states that the following indicators are relevant in determining whether a taxpayer is carrying on a business:

•         whether the activity has a significant commercial purpose or character;

•         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.

Whether a business is being carried on depends on the impression gained from looking at all the indicators against the case facts and whether these indicators provide the operations with a commercial flavour.

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

Paragraph 6 of TR 92/3 states profit from an isolated transaction is generally income when both of the following elements are present:

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

b)    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.

Paragraph 7 of TR 92/3 goes on to state 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.

Paragraph 13 of TR 92/3 states some of the matters which may be relevant in considering 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 or the various steps in the transaction.

If a transaction satisfies the elements set out above, it is generally not a mere realisation of an investment.

Application to your situation

The trust acquired the property and it was rented out. Your intention as trustees of the trust was for possible capital improvement (depending on your financial situation) and long-term financial support for your lifestyle and retirement.

As the trust was unable to obtain funding for the development, the trust transferred the property to you.

You demolished the existing dwelling and constructed new units with the intention to also lease/rent the premises. The development of the three units was not entered into with the intention of making a profit by sale. It was your sole intention that you would generate an income stream as a result of renting the three new dwellings.

Person A is tradesperson and operates as a sole trader and Person B works in hospitality (neither of you work in the building or property development industry). You have previously been involved with subdividing and construction of two new residential premises several years ago. One of the new premises became your primary place of residence and the other you have held onto which has been rented out.

This is a one-off project that is not considered to being carried out in a manner similar to other property development businesses. It does not have a commercial purpose or character. There is no repetition or regularity to the activity. The activity is on a small scale in comparison to that of the ordinary trade. The activity is not planned and organised in a businesslike manner and the activity size is small and a one-off activity. The activity is not considered to be a hobby. Hence, we consider that the activities you have undertaken do not have the indicators of carrying on a business or isolated commercial transaction.

Therefore, on an objective consideration of the facts and circumstances of the case, it is considered that the gain made on the disposal of unit 1 was not from a commercial or business transaction of person A and person B. It is objectively viewed as a mere realisation of a capital asset and will be assessable under Part 3-1 and Part 3-3 the ITAA 1997.

Conclusion

The proceeds from the sale of the unit are regarded as a mere realisation of a capital asset, recorded on capital account, and subject to the capital gains tax provisions.