Edited version of your written advice

Authorisation Number: 4120044633295

Date of advice: 21 March 2018

Ruling

Subject: Construction and sale of a dwelling

Question 1

Will the profit from the sale of the dwelling be assessable income under section 6-5 of the Income Tax Assessment Act 1997?

Answer 1

Yes

Question 2

Will the profit from the sale of the dwelling be assessable under the capital gains tax provisions in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997?

Answer 2

Yes, however section 118-20 of the Income Tax Assessment Act 1997 will apply to reduce the capital gain to the extent that the profit from the sale of the dwelling is otherwise included as assessable income under section 6-5 of the Income Assessment Act 1997 (ITAA 1997).

This ruling applies for the following periods:

Year ending 30 June 2018

The scheme commences on:

1 July 2016

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You, being S and T decided to become property investors.

T is employed full time and S works part time.

You sought advice from a mortgage professional. You initially wanted to acquire a number of properties for the purposes of investment, utilising existing equity in your own home. After attending housing sales and not being able to find a suitable property to invest in, you decided to build an investment property for the purposes of renting.

The mortgage professional suggested a line of credit (LOC) loan which would allow you to pay 20% of the deposit price, stamp duty and other up-front costs associated with purchasing between 2 or 3 future investment properties.

The mortgage professional established a LOC loan for the amount of $XXX,XXX.

In 20XX you paid a deposit to a builder (the builder) to purchase a property (the property). The property consisted of vacant land (land) and you entered into a contract with the builder to build a dwelling on the land (the dwelling) as part of a house and land package. You entered into a purchase contract with the builder in 20XX. The contract with the builder was for a dwelling to be constructed for $XXX,XXX on the land. The purchase price of the land was $XXX,XXX.

Building work in relation to the dwelling commenced in 20XX.

At the time of commencing building work you expected a rental return of $XXX.XX per week.

You took out loans to cover XX% of the land and building costs of the dwelling.

Repayments of up to XX% of loans were made via your offset LOC account.

Over the next 12 months you became increasingly concerned about the risk associated with purchasing the dwelling. You felt that you were subjected to financial stress due to the following:

● Interest rates were increasing in relation to the loans the LOC and your existing private home loan.

● Further development of the surrounding area resulted in many rental and properties for sale becoming available in the market, which according to you were or had the potential to drive down rental and sale prices.

● Additional construction and completion costs resulted in you exhausting your line of credit and borrowing money from your family.

● You had no other savings and renovations carried out on your principal place of residence (private dwelling) depleted your financial resources.

After visiting the accountant in 20XX, you formed a partnership and obtained an ABN for this partnership. The partnership entitled S and T to a percentage of the future income from the rent or sale of future investment properties. You also registered the partnership for GST. You claim the formation of the partnership agreement and registration for GST was for future investment houses you contemplated building.

Building work on the dwelling was completed in 20XX.

In 20XX you spoke to the real estate agent about either selling or renting out the dwelling. The real estate agent indicated at this time that there were buyers interested in purchasing your dwelling.

The dwelling was marketed by the real estate agent in 20XX for rent or for sale. The rental amount being sought at this time was $XXX.XX per week.

In 20XX, you cancelled your ABN and GST registration, as you believed GST would not be payable on the sale of the dwelling as it would be used for rental purposes and only applied to future investment properties you may purchase.

You entered into a contract to sell the dwelling to the purchaser a short time following construction. The sale price did not include GST.

The new purchasers moved into dwelling immediately and rented it from you prior to the completion of the sale. You received rental income of $XXX.XX per week.

The dwelling was sold for $XXX,XXX, with the date of settlement of sale being 20XX.

You have used the proceeds from the sale of the dwelling to pay any remaining debt relating to the loans and LOC loan.

You have previously not engaged in property subdivision activities and do not intend to engage in such activities in the future.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Question 1 and 2

Summary

You are not carrying on a business of property development because your activities do not display the salient indicator of a business, which are transactions entered into on a continuous and repetitive basis. However, any profit or loss from the sale of the dwelling will still be accounted for on revenue account as an isolated transaction because you entered into the transaction for the primary purpose of making a profit on its sale.

Capital gains tax event A1 will still occur on the sale of the dwelling and any capital gain arising from this capital gains tax event will be reduced by the amount included as assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

Taxation treatment of property sales

There are three ways profits from property sales can be treated for taxation purposes:

1. As ordinary income under section 6-5, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock; or

2. As ordinary income under section 6-5, on revenue account, as a result of an isolated commercial transaction entered into by a non-business taxpayer, or outside the ordinary course of business of a taxpayer carrying on a business, which is the commercial exploitation of an asset acquired for a profit making purpose; or

3. As statutory income under the capital gains tax legislation on the basis that a realisation of a capital asset has occurred.

Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case.

We will consider each of these in relation to your situation as follows:

Carrying on a business of property development

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

To determine whether an activity, or series of activities, amounts to a business, the activity needs to be considered against the indicators of a business established by case law.

In the High Court of Australia case of Hope v. Bathurst City Council (1980) 144 CLR 1; (1980) 29 ALR 577; (1980) 80 ATC 4386; [1980] HCA 16, a business was described in the following ways:

It is the words “carrying on'' which imply the repetition of acts and activities which possess something of a permanent character.

…activities engaged in for the purpose of profit on a continuous and repetitive basis.

Transactions were entered into on a continuous and repetitive basis for the purpose of making a profit…manifested the essential characteristics required of a business.

For a one-off land subdivision to be considered to be of a business or commercial nature, it is usually necessary that a taxpayer has the purpose of profit-making at the time of acquiring the property.

The Commissioner’s view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 (TR 97/11) which uses the following indicators to determine 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.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

Isolated transactions

Profits arising from an isolated transaction as a result of entering into a profit-making undertaking or scheme will be ordinary income under section 6-5 of the ITAA 1997, on revenue account, (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693 (Myer Emporium)). This is distinguished from a ‘mere realisation’ which is not ordinary income.

Taxation Ruling TR 92/3: Income Tax: whether profits on isolated transactions are income (TR 92/3) sets out the ATO view as to the application of the decision in Myer Emporium and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income.

Paragraph 16 of TR 92/3 states:

If a taxpayer not carrying on a business makes a profit, that profit is income if:

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

(b) the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

TR 92/3 outlines that 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.

A taxpayer’s intention may change from the time of acquiring and holding the asset. Profit from the activity is income when the taxpayer’s intention changes, even though the taxpayer’s intention at the time of acquiring the asset was not to use it for purpose of profit making. Paragraph 42 of TR 92/3 states:

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.

Paragraph 13 of TR 92/3 outlines the following factors which may be relevant when considering whether an isolated commercial 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 the property, and

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

Miscellaneous Taxation Ruling MT 2006/1 (MT 2006/1) aligns itself with TR 92/3 and provides a list of the following factors which, if present may be an indication that a business or profit-making undertaking or scheme is being carried on.

● there is a change of purpose for which the land is held;

● there is a coherent plan for the subdivision of the land;

● there is a level of development of the land beyond that necessary to secure council approval for the subdivision;

● additional land is acquired to be added to the original parcel of land;

● the parcel of land is brought into account as a business asset;

● there is a business organisation, for example a manager, office and letterhead;

● borrowed funds financed the acquisition and subdivision;

● interest on money borrowed to defray subdivisional costs was claimed as a business expense; and

● buildings have been erected on the land.

In determining whether activities relating to isolated transactions are an enterprise or are the mere realisation of a capital asset, 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. 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.

Capital gains tax provisions

The capital gains tax (CGT) provisions are contained in Parts 3-1 and 3-3 of the ITAA 1997. Broadly, the provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own.

When a CGT asset (the original asset) is split into 2 or more assets (the new assets), such as when land is subdivided, the subdivision of the land into subdivided blocks is not a CGT event.

CGT event A1 happens if you dispose a CGT asset.

Section 118-20 of the ITAA 1997 contains anti-overlap provisions which operate to reduce any capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 of the ITAA 1997 as a result of the sale, for example, as ordinary income under section 6-5 of the ITAA 1997.

Application to your situation

After reviewing the information and documentation provided, it is the Commissioner’s view that the activities involved with the construction of the dwelling on vacant land and its subsequent sale are not those of an entity carrying on a business of developing property.

Your activities do not display the salient indicator of a property development business, which are transactions entered into on a continuous and repetitive basis. The building of the dwelling was undertaken by another party you engaged and the activity is a relatively small one off project. You have not undertaken any similar activities in the past in relation to property development, nor will you undertake any similar activities in the future.

Your activity has not been brought to account as a business asset and there is no business organisation involved. There is no formal manager engaged and no business plan. You have not engaged a project manager given the small scale of the development and you have not entered into any financial arrangement with a developer.

An objective assessment of the information provided establishes that your intention in entering into the transaction to build a dwelling was for the purpose of making a profit or gain from an isolated transaction.

You purchased the land as part of a land and house package with a view of originally retaining the house for rental purposes.

Your intention in relation to the dwelling changed and your activities show an intention to generate a profit through building a dwelling and immediately selling the dwelling to pay the debts arising in relation to your activities and to realise a high sale price before other properties were released onto the market. As outlined in paragraph 42 of TR 92/3, when a taxpayer’s intention in relation to an asset changes and the taxpayer decides to venture into a profit-making scheme with the characteristics of an isolated transaction, the activity of the taxpayer will constitute the carrying out of a profit-making scheme.

The nature of the property was transformed when the dwelling was completed, from vacant land to a dwelling being placed on it. The building of the dwelling on the land will increase its value to reflect the market value of the dwelling and land, which is significantly higher than the value of undeveloped land.

You held a dual intention at the time when construction of the dwelling was completed to either rent or sell it, evidenced by your actions in placing the dwelling on the market for either rent or sale in 2017. Your expectation of obtaining a rental return when you commenced building the dwelling was realised as the dwelling was marketed for rent at $XXX.XX per week when completed. When your real estate agent expressed to you there were potential purchasers that held an interest in your dwelling, this coupled with the financial stress you were under, resulted in your making a decision to sell the dwelling. You did not abandon that dual intention of either selling or renting the dwelling up to the time of its sale. You immediately entered into a sale contract with a purchaser within approximately X months following construction of the dwelling. You realised a profit from the sale of the dwelling.

Based on the information provided, it is viewed that the building and sale of the dwelling is a profit making undertaking. Therefore, the profits from the sale of the dwelling will be assessable as ordinary income under section 6-5 of the ITAA 1997. Whilst CGT event A1 will occur on the sale of the dwelling, any capital gain arising from this CGT event will be reduced by the amount included as assessable income under section 6-5 of the ITAA 1997.