Edited version of private advice

Authorisation Number: 1052383856239

Date of advice: 15 April 2025

Ruling

Subject: Isolated transaction

Question

Is the gain on sale of the Land assessable solely as a capital gain pursuant to sections 102-5, 104-10 and Division 115 of the Income Tax Assessment Act 1997?

Answer

Yes.

This ruling applies for the following period:

Income year ending 30 June 20YY

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

1.  The Trust forms part of a Group of entities which engages in real estate investments held for long term rental.

2.  The Trust acquired the Land for the purpose of redevelopment into an asset to be held for deriving long term rental income.

3.  The Trust took steps to develop the Land for that purpose.

4.  The Trust found the process slow and cumbersome and it was decided that any development of the entirety of the Land would be too burdensome.

5.  The rental income being derived was insufficient to cover the holding costs of the Land and the decision was taken that it should be sold.

6.  The proceeds from sale were applied to the purchase of other real estate investments to be held for long term rental.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 Division 104

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 Division 115

Reasons for decision

Generally, the proceeds from the sale of real property would be assessable either as:

•                     ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) where the land is held as trading stock and sold as part of carrying on a business of property development and sale,

•                     ordinary income under section 6-5 of the ITAA 1997 from 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 from a mere realisation of a capital asset.

Carrying on a business of property development and sale

The proceeds from the sale of trading stock of a business are ordinary income under section 6-5 of the ITAA 1997

Subsection 70-10(1) of the ITAA 1997 states that 'trading stock includes anything produced, manufactured or acquired that is held for the for purposes of manufacture, sale or exchange in the ordinary course of a business...'.

The High Court has accepted that land can be trading stock (see Federal Commissioner of Taxation v St Hubert's Island Pty Ltd 78 ATC 4104;[1978] HCA 10 (St Hubert's Island )).

In R & D Holdings v Deputy Commissioner of Taxation 2006 ATC 4472; [2006] FCA 981, Finn J made the following comments about the decision in St Hubert's Island:

46. The significance of this case for present purposes is that it is authority for the propositions that (i) land acquired for the purpose of development, subdivision (or strata division) and sale by allotments (or lots) can constitute trading stock of a business having that purpose irrespective of whether the land has been so developed and subdivided; and (ii) that business will be carried on for so long as the taxpayer engaged in the effectuation of the purpose of development, etc of the land. The emphasis in St Hubert's Island on the need to have the relevant intention of sale at the time of acquisition of the property in question is, though, without significance for s 70-10 purposes which as I have earlier noted links the intention or purpose of sale with the purpose (or purposes) for which the property is held. (emphasis in the original) (at 4480)

The Commissioners view on when land is trading stock is provided in Taxation Determination TD 92/124 Income Tax: property development: in what circumstances is land treated as 'trading stock'? which states:

1. Land is treated as trading stock for income tax purposes if:

•                    it is held for the purposes of resale; and

•                    A business activity which involves dealing in land has commenced.

2. Both the required purpose and the business activity must be present before land is treated as trading stock. The business activity is taken to have commenced when a taxpayer embarks on a definite and continuous cycle of operations designed to lead to the sale of the land.

3. It is not necessary that the acquisition of land be repetitive. A single acquisition of land for the purpose of development, subdivision and sale by a business commenced for that purpose would lead to the land being treated as trading stock.

If a taxpayer initially acquires land as a capital asset but later ventures it into a property development business, then, if the land becomes trading stock, the change is treated as a disposal and reacquisition of the land at cost or market value. Conversely, if a land development and subdivision project is abandoned, and the land stops being held as trading stock, the change is accounted for at cost.

In the current circumstances, the Trust is a part of a wider group of entities which invests in real estate. The Trust was established to acquire and develop the Land and retain it to derive rent as income and to grow the capital. The Trust took steps to develop the Land.

Based on the above, the Land was held by the Trust to derive long term rent as income and long term capital growth. The Trust took steps to develop the Land for that purpose, but found the process slow and cumbersome and it was decided that any development of the entirety of the Land would be too burdensome and the Land should be sold.

It is considered that the Land was not held for the purpose of sale, but rather was held to be retained long term to derive rent as income and for capital growth. As the Land was not held for the purpose of sale, the Land was not trading stock of the Trust.

The Trust did not sell the Land as trading stock as part of carrying on a business of property development and sale.

Isolated transaction for the purpose of profit or mere realisation

In Federal Commissioner of Taxation v Myer Emporium Limited (1987) 163 CLR 199 the High Court determined that profits made otherwise than in the ordinary course of a business are income where there is an intention or purpose to make a profit from the transaction:

Although it is well settled that a profit or gain made in the ordinary course of carrying on a business constitutes income, it does not follow that a profit or gain made in a transaction entered into otherwise than in the ordinary course of carrying on the taxpayer's business is not income. Because a business is carried on with a view to profit, a gain made in the ordinary course of carrying on the business is invested with the profit-making purpose, thereby stamping the profit with the character of income. But a gain made otherwise than in the ordinary course of carrying on the business which nevertheless arises from a transaction entered into by the taxpayer with the intention or purpose of making a profit or gain may well constitute income. Whether it does depends very much on the circumstances of the case. Generally speaking, however, 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, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a "one-off" transaction preclude it from being properly characterized as income... The authorities establish that a profit or gain so made will constitute income if the property generating the profit or gain was acquired for the purpose of profit-making by the means giving rise to the profit. (at 209-210)

The Court distinguished between proceeds from a realisation of capital, and profits from a business operation or commercial transaction:

... over the years this Court, as well as the Privy Council, has accepted that profits derived in a business operation or commercial transaction carrying out a profit-making scheme are income, whereas the proceeds of a mere realization or change of investment or from an enhancement of capital are not income...

The proposition that a mere realization or change of investment is not income requires some elaboration. First, the emphasis is on the adjective "mere"... Secondly, profits made on a realization or change of investments may constitute income if the investments were initially acquired as part of a business with the intention or purpose that they be realized subsequently in order to capture the profit arising from their expected increase in value... It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose to sell at the time of acquisition of acquiring for the purpose of profit-making by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realization. But it is quite another thing if the decision to sell is taken by way of implementation of an intention or purpose, existing at the time of acquisition, of profit-making by sale, at least in the context of carrying on business or carrying out a business operation or commercial transaction. (at 213)

The Commissioner's view on whether a transaction has a profit-making purpose is set out in Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income, which states the following:

6. Whether a profit from an isolated transaction is income according to the ordinary concepts and usages of mankind depends very much on the circumstances of the case. However, a 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.

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.

10. If a transaction or operation is outside the ordinary course of a taxpayer's business, the intention or purpose of profit-making must exist in relation to the transaction or operation in question.

In the current circumstances, the Trust is part of a group of entities and was created to hold the Land. The Group acquired the Land to develop it and retain it to derive long term rent and for capital growth. The Trust took steps to develop the Land.

The Trust decided to sell the Land as they felt the development of the entirety of the Land would be too great a burden.

The above shows that the Trust acquired the Land to hold it long term. It was intended that the Trust would develop the Land and retain it to derive long term rental income and grow the capital. The Trust took steps to develop the Land for that purpose, but found the process slow and cumbersome and it was decided that any development of the entirety of the Land would be too burdensome and the Land should be sold.

On balance, it is considered that the Trust did not enter into the transaction (the acquisition of the Land) for the purpose or intention of making a profit or gain by sale.

The proceeds from sale are not ordinary income and assessable under section 6-5 of the ITAA 1997 but are a 'mere realisation' of a capital asset and assessable under the capital gains tax provisions in Part 3-1 of the ITAA 1997 (which includes sections 102-5, 104-10 and Division 115).

The gain from the sale of the Land is assessable solely as a capital gain under sections 102-5 and 104-10 of the ITAA 1997.

Subsection 102-5(1) of the ITAA 1997 states that 'your assessable income includes your net capital gain (if any) for the income year', and provides the calculation to work out a capital gain. Section 102-20 of the ITAA 1997 states that 'you make a capital gain or capital loss if and only if a CGT event happens to a CGT asset. The gain or loss is made at the time of the event'.

Subsection 108-5(1) of the ITAA 1997 states that 'a CGT asset is any kind of property, or a legal or equitable right that is not property'.

The CGT events are set out in Division 104 of the ITAA 1997. Subsection 104-10(1) of the ITAA 1997 states that, 'CGT event A1 happens if you dispose of a CGT asset'. Subsection 104-10(2) of the ITAA 1997, states that 'you dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of the law...'. Subsection104-10(3) of the ITAA 1997 states that 'the time of the event is when you enter into the contract for the disposal, or if there is no contract - when the change of ownership occurs'. Division 115 of the ITAA 1997 concerns discount capital gains and trusts' net capital gains.

When the Trust sold the Land CGT event A1 happened, and any capital gain from the sale will be included in the assessable income of the Trust under section 102-5 of the ITAA 1997.