Edited version of private advice

Authorisation Number: 1052255482923

Date of advice: 27 May 2024

Ruling

Subject: CGT - property development

Question

Will the sale of your property be subject to the capital gains tax ('CGT') pursuant to section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997) and assessable as statutory income under section 102-5 of the ITAA 1997?

Answer

Yes.

Question

Will the sale of the property be a taxable supply of new residential premises under section 9-5 of the A New Tax Systems (Goods and Services Tax) Act 1999?

Answer

No.

This ruling applies for the following periods:

Year ended XX XXXX 20YY

Year ended XX XXXX 20YY

The scheme commenced on:

XX XXXX 20YY

Relevant facts and circumstances

On XXXX 20XX, you entered a contract to purchase the original property for $XX.

Goods and services tax ('GST') was not applicable to this property purchase transaction.

On XX XXXX 20YY, immediately after settlement the property was used as a rental property and remained as such until XX XXXX 20YY.

You entered a plan to demolish the original property, subdivide the land and construct three townhouses on each split of the title. You enlisted professionals including a town planner, architects, and a builder to advise you and effectuate the plan.

On XX XXXX 20YY, you received a planning permit from the relevant City Council for the construction of three townhouses on the property.

On XX XXXX 20YY, you signed a loan contract with a Financial Institution which detailed that the investment loan purpose is to construct dwellings for rental purposes as opposed to a redevelopment.

On XX XXXX 20YY, you received a demolition certificate from relevant City Council providing consent to demolish the dwelling on the property. The original dwelling was demolished by XX XXXX 20YY.

On XX XXXX 20YY, a building permit was received detailing the total costs of the building work to be $XX. The total floor area of the new building work was XXm2. The building permit details the construction of three attached double storey dwellings.

On XX XXXX 20YY, the construction of the three townhouses was completed and an occupancy permit was provided to you.

You have not claimed GST credits on any construction costs or other associated expenditure in relation to the property or constructed townhouses.

You immediately commenced a process of securing tenants for all three townhouses. All properties had secured tenants by XXXX 20YY.

Your stated intention was to treat the three townhouses as long-term investment properties.

In XXXX 20YY, you became aware that the tenant of the one of the townhouses was not maintaining the property appropriately. You issued a notice to vacate to this tenant, however, you have not been able to find a suitable replacement tenant since.

Your personal finances have been impacted by the interest rate increase on the loan in addition to the lack of replacement tenant, which has impacted your ability to continue maintaining the investment loan.

You have decided to sell the property to maintain your personal finances and the remaining two rental properties. The property is currently advertised for a sale price ranging between $XX and $XX.

You have not accepted or received any offers as at the time of this ruling.

You intend to continue earning rental income on the two townhouses and have no intention to sell them.

You have not undertaken a development transaction such as this in the past.

You are not property developers and have no experience or history of conducting similar transactions personally or via any other associated entity.

You have no personal or partnership Australian Business Number.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

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 112-25

Income Tax Assessment Act 1997 section 995-1

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 23-5

A New Tax System (Goods and Services Tax) Act 1999 section 40-35

A New Tax System (Goods and Services Tax) Act 1999 section 40-75

A New Tax System (Goods and Services Tax) Act 1999 section 72-5

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 188-25

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

Reasons for decision

Question 1

Will the sale of your property be subject to the capital gains tax pursuant to section 104-10 of the ITAA 1997 and assessable as statutory income under section 102-5 of the ITAA 1997?

Summary

Yes. In considering your circumstances, you are not considered to be undertaking a business operation or commercial transaction upon the sale of the property. The sale will be a mere realisation of a capital asset. Your gain from the sale will be subject to CGT pursuant to section 104-10 of the ITAA 1997.

Detailed reasoning

Generally, an amount received in relation to subdividing land would be assessable either as:

•         ordinary income under section 6-5 of the ITAA 1997 as business income,

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

•         statutory income under the capital gains tax (CGT) provisions contained in Part 3-1 of the ITAA 1997 as a mere realisation of a capital asset.

Ordinary income

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.

Carrying on a business of property development

Section 995-1 of the ITAA 1997 states the term business includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? (TR 97/11) outlines some factors that indicate whether or not a business of primary production is being carried on. These factors equally apply to other types of businesses. The question of whether a business is being carried on is a question of fact and degree. In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators should be considered in conjunction with the other factors.

In the Commissioner's view, the factors that are considered important in determining the question of business activity are:

•         whether the activity has a significant commercial purpose or character

•         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 regularity and repetition of the activity

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

•         whether the activity is planned, organised and carried on in a businesslike manner such that it is described as 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 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.

Isolated business transactions

In FC of T v The Myer Emporium (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693 (Myer Emporium), the Full High Court expressed the view that profits made by a taxpayer who enters into an isolated transaction with a profit-making purpose can be assessable income.

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income considers the assessability of profits on isolated transactions in light of the principles outlined in Myer Emporium. According to Paragraph 1 of TR 92/3, the term isolated transactions refer to:

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.

Taxation Ruling TR 92/3 provides guidance in determining whether profits from isolated transactions are income and therefore assessable.

A profit from an isolated transaction will generally be income when:

a) the intention or purpose of a 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 on a business operation or commercial transaction.

Profit-making does not need to be the sole or dominant purpose for entering into the transaction. A profit-making purpose must exist at the time the transaction or operation was entered into. Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case.

TR 92/3 lists the following factors which are relevant in determining whether an isolated transaction amounts to a business operation or commercial transaction:

•         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 and the various steps in the transaction.

In contrast, paragraph 36 of Taxation Ruling TR 92/3 notes that the courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment.

Paragraphs 41 and 42 of TR 92/3 outline that where a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset 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 operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income even though the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

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.

Numerous cases have considered the assessability of profits or proceeds from the sale of land including the following case:

Whitfords Beach Pty Ltd v Federal Commissioner of Taxation (1983) 14 ATR 247 where the taxpayer acquired 1.584 acres of land for non- commercial purposes. Thirteen years later, the original shareholders sold out and the company and the new ownership adopted an entirely new set of articles. It then embarked on a long and complex course of activity which involved the land being rezoned and developed as a residential subdivision. Vacant lots were sold over a period of many years for a substantial profit. The High Court held that the adoption of a new set of articles resulted in a change in the intended usage of the land. This resulted in the taxpayer's activities going beyond the realisation of a capital asset, with the activities constituting the carrying on of an actual business of subdividing and selling land.

In determining whether activities relating to isolated transactions are a profit-making undertaking, it is necessary to examine the facts and circumstances of each particular case. This may require a consideration of the factors outlined above; however, there may also be other relevant factors that need to be weighed up as part of the process of reaching an overall conclusion.

Mere realisation of an asset

Under section 6-10 of the ITAA 1997, assessable income also includes statutory income. Capital gains are included as assessable income under section 102-5 of the ITAA 1997.

Section 102-20 of the ITAA 1997 states that a capital gain or capital loss is made only if a CGT event happens to a CGT asset. Real estate property is considered a CGT asset (section 108-5 of the ITAA 1997).

CGT event A1 happens if you dispose of a CGT asset (section 104-10 of the ITAA 1997).

When a CGT asset (the original asset) is split into 2 or more assets, such as when land is subdivided, the subdivision of the land into subdivided lots is not a CGT event (subsection 112-25(2) of the ITAA 1997).

In Taxation Determination 97/3 Income tax: capital gains: if a parcel of land acquired after 19 September 1985 is subdivided into lots ('blocks'), do Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 treat a disposal of a block of the subdivided land as the disposal of part of an asset (the original land parcel) or the disposal of an asset in its own right (the subdivided block)? ('TD 97/3'), the Commissioner considers that the effect of registering separate new titles under the subdivision is, for the purposes of Parts 3-1 and 3-3 (ITAA 1997), to divide the original land parcel into two or more assets (viz., the subdivided blocks). The subdivided blocks are then treated as separate assets under the capital gains provisions. They are taken to have been acquired by the owner of the original land parcel when that original parcel was acquired.

The proceeds from the mere realisation of an asset are not ordinary income, even though the realisation is carried out in an enterprising way so as to secure the best price.

Paragraph 36 of TR 92/3 states the courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. The expression 'mere realisation' is used to contradistinguish a business operation or a commercial transaction carrying out a profit-making scheme.

In McClelland v FC of T 70 ATC 4115, the Privy Council held that the question to be answered was whether the facts revealed a mere realisation of capital, albeit in an enterprising way, or whether they justify a finding that the taxpayer went beyond this and engaged in a trade of dealing in the asset, albeit on one occasion only.

Application to your circumstances

In applying the factors detailed within TR 97/11 to your circumstances, we consider that you are not carrying on a business of property development.

In reviewing whether your land subdivision activities amount to a profit-making undertaking or plan, the relevant factors in your case are summarised as follows:

•         Your intention on the initial acquisition was for a long-term rental property.

•         The original property or dwelling was initially purchased and utilised to derive rental income for approximately XX years and XX months.

•         Your intention after the demolition of the original property was to develop three townhouses for long-term rental purposes, on completion of the development all townhouses were immediately rented with tenants.

•         You have not undertaken any other property development activities and enlisted various professionals to assist you with the development.

•         The transaction was of a small scale and not complex, involving one initial property acquisition and building of three townhouses.

•         The development was financed by a XX-year loan term from the Financial Institution detailing a specific purpose of developing properties for rental purposes. The loan indicates that your intent was not to sell the properties within a short-term period.

•         The property was rented immediately after completion of the development and was held for approximately XX months as at the time of this ruling.

•         You have had to withdraw increased wages from your business to maintain the loan repayments as a result of increased interest rates and additional cost of living pressures.

•         Due to the change in financial circumstances, you have decided to sell the property. This decision was reached approximately XX months after completion of the development which shows that you leased the property for a reasonable time before you have made the decision to sell.

•         You intend to retain the two remaining townhouses for long term rental purposes.

In your circumstances the Commissioner considers based on the information provided, your activities are not that of undertaking a business operation or commercial transaction. The proceeds from the sale of the property will be subject to capital tax pursuant to section 104-10 of the ITAA 1997 and assessable as statutory income under section 102-5 of the ITAA 1997.

Question 2

Will the sale of the property be a taxable supply of new residential premises under section 9-5 of the A New Tax Systems (Goods and Services Tax) Act 1999?

Summary

No. As you were not registered for GST, nor required to be registered at the time you made a supply of new residential premises, you have not satisfied all the requirements of section 9-5. The sale of the property is not considered a taxable supply under section 9-5.

Detailed reasoning

Unless otherwise stated, all legislative references within the reasoning in this section are in reference to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act).

All legislative terms of the GST Act marked with an asterisk are defined in section 195-1 of the GST Act.

An entity makes a taxable supply where all the requirements of section 9-5 are satisfied.

Section 9-5 provides that 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 Australia; and

d)    you are *registered or *required to be registered.

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

You make a supply of residential premises for consideration. Residential premises is defined in section 195-1 to mean land or a building that:

(a) is occupied as a residence or for residential accommodation; or

The term 'enterprise' is defined in section 9-20 and includes an activity, or series of activities, done on a regular or continuous basis, in the form of a lease, licence or other grant of an interest in property. Consequently, you are conducting an enterprise of leasing residential property. Section 195-1 states that carrying on an *enterprise includes doing anything in the course of the commencement or termination of the enterprise. Disposing of the townhouse, would be considered in the course of the enterprise in respect to the leasing enterprise you are engaged in.

The townhouses that you built on the property are buildings that are occupied as a residence. When you lease the townhouses, you receive a payment of rent as consideration for the supply of those residential premises. Section 40-35 states that a supply of premises that is by way of lease, hire or licence (including a renewal or extension of a lease, hire or licence) is input taxed if the supply is of *residential premises. Therefore, the supply of leasing the townhouses is input taxed.

Upon the sale of the property, you make a supply of new residential premises. In section 40-75(1), residential premises are defined as new residential premises if:

(a) have not previously been sold as residential premises (other than * commercial residential premises) and have not previously been the subject of a * long-term lease; or

(b) have been create through * substantial renovations of a building; or

(c) have been built, or contain a building that has been built, to replace demolished premises on the same land.

Paragraphs (b) and (c) have effect subject to paragraph (a).

According to the facts, the property has not been previously sold as residential premises and has not been the subject of a long-term lease. A long-term lease means a supply by way of lease, hire or licence (including a renewal or extension of a lease, hire or licence) for at least 50 years if

(a) at the time of the lease, hire or licence, or the renewal or extension of the lease, hire or licence, it was reasonable to expect that it would continue for at least 50 years; and

(b) unless the supplier is an * Australian government agency - the terms of the lease, hire or licence, or the renewal or extension of the lease, hire or licence, as they apply to the * recipient are substantially the same as those under which the supplier held the premises.

Further, section 40-75(2)(c), excludes residential premises as new residential premises if the premises were last built more than 5 years ago and the premises have only been used to make input taxed supplies under section 40-35(1)(a). This exclusion will not apply in your circumstances; the property was built in 20YY, and is currently listed for sale, assuming the property is sold within 5 years from XX XXXX 20YY, you will make a supply of a new residential premises.

The final requirement under section 9-5 is that you are registered for GST or required to be registered. As you were not registered for GST at the time you made the supply of new residential premises, it must be determined whether you were required to be registered for GST under section 23-5.

You are required to be registered for GST if you are carrying on an enterprise and your GST turnover meets the registration turnover threshold.

Section 188-10 states:

(1) You have a GST turnover that meets a particular turnover threshold if:

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

(b) your projected GST turnover is at or above the turnover threshold.

Under section 188-15 of the GST Act:

(1) Your current GST turnover at a time during a particular month is the sum of the values of all the supplies that you have made, or are likely to make, during the 12 months ending at the end of that month, other than:

(a) supplies that are input taxed; or

(b) supplies that are not for *consideration (and are not taxable supplies under section 72-5); or

(c) supplies that are not made in connection with an enterprise that you carry on.

In your case, the sale of the Lot 3 is assumed to derive income over $75,000 based on the listed prices for sale.

Under section 188-20 of the GST Act:

(1) Your projected GST turnover at a time during a particular month is the sum of the values of all the supplies that you have made, or are likely to make, during that month and the next 11 months, other than:

(a) supplies that are input taxed; or

(b) supplies that are not for consideration (and are not taxable supplies under section 72-5); or

(c) supplies that are not made in connection with an enterprise that you carry on.

In working out your projected GST turnover, section 188-25 of the GST Act says to disregard:

(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:

(i) ceasing to carry on an enterprise; or

(ii) 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(GSTR 2001/7)includes guidance on the meaning capital assets. GSTR 2001/7 explains:

31. 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. They are often referred to as 'structural assets' and may be described as 'the business entity, structure or organisation set up or established for the earning of profits'.

32. 'Capital assets' can include tangible assets such as your factory, shop or office, your land on which they stand, fixtures and fittings, plant, furniture, machinery and motor vehicles that are retained by you to produce income [...]

33. 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).

34. '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'.

35. If the means by which you derive income is through the disposal of an asset, the asset will be of a revenue nature rather than a capital asset even if such a disposal is an occasional or one-off transaction. Isolated transactions are discussed further at paragraphs 46 and 47.

36. Over the period that an asset is held by an entity, its character may change from capital to revenue or from revenue to capital. For the purposes of section 188-25 the character of an asset must be determined at the time of expected supply.

Consistent with the income tax decision above, the proceeds from the property will be capital in nature. Therefore, for the purpose of GST registration, the proceeds from the sale of the property are not included when calculating your GST turnover. For completeness, the supply of leasing residential premises is input taxed under section 40-35 and are also excluded from your GST turnover under section 188-20(1)(a).

As you were not registered for GST, nor required to be registered at the time you made a supply of new residential premises, you have not satisfied all the requirements of section 9-5. The sale of the property is not a taxable supply under section 9-5.