ATO ID 2004/27: Derivation of income: residential properties instalment sales contracts - carrying on a business
Date of decision: 28 November 2003
Year of income: Year ended 30 June 2000 Year ended 30 June 2001 Year ended 30 June 2002
Business line: Private Groups and High Wealth Individuals

Issue
For a taxpayer carrying on a business, are payments received from the sale of residential properties under instalment sales contracts included in assessable income under subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) in the income year in which the contract is entered into?

Decision
No. The payments will not be included in the assessable income of the taxpayer under subsection 6-5(1) of the ITAA 1997 in the income year in which the contract is entered into, as the income has not yet been derived.

Facts
The taxpayer carries on a business of buying and selling residential properties. The properties are sold under instalment sales contracts with vendor finance. The instalment sales contract has the following features: It is common ground that the interest is included in assessable income in the year it is received. The taxpayer did not use the properties for any other purpose prior to sale. The properties were sold for an amount that was in excess of the amount paid by the taxpayer to acquire the property. Each property was sold within six months of it being acquired by the taxpayer. The properties are trading stock for the purposes of subdivision 70-C of the ITAA 1997.

Reasons for decision
Summary: Taxation Ruling TR 97/15 at paragraph 23 states that: It is an accepted principle of income tax law that the method under which a taxpayer accounts for its business or income producing activities for the purposes of income tax must 'give a substantially correct reflex of the taxpayer's true income' (see Dixon J in The Commissioner of Taxes (South Australia) v The Executor Trustee and Agency Company of South Australia Ltd (1938) 63 CLR 108 at 154; (1938) 5 ATD 98 at 131 (Carden's case)). In Commissioner of Taxes v. Executor, Trustee & Agency Co of SA Ltd (1938) 63 CLR 108 at 155; (1938) 5 ATD 98 at 132; (1938) 1 AITR 416 at 442 (the Carden Case ) Dixon J stated: Speaking generally, in the assessment of income the object is to discover what gains have during the period of account come home to the taxpayer in a realized or immediately realizable form. Paragraph 28 of TR 97/15 states that based on the decisions in J Rowe & Son Pty Ltd v. Federal Commissioner of Taxation (1971) 124 CLR 421, the Carden Case and Gasparin v. Federal Commissioner of Taxation (1994) 50 FCR 73 71 ATC 4157; (1971) 2 ATR 497 (the Gasparin Case) it is clear that the sale price of trading stock is derived as income of the seller when the sale price becomes a presently existing debt. In the Gasparin Case, von Doussa J in agreeing with the taxpayer's (the appellant) argument that income from the sale of the allotments of land was not derived until settlement, stated: If the appellant's approach is correct, the allotments remained trading stock on hand until each transaction progressed to the point where a debt accrued due from the purchaser i.e. at settlement. If before that point was reached, a contract of sale came to an end, the allotment remain as stock on hand and no accounting consequences would arise, save in respect of the deposit payment made by the purchaser which might, depending on the circumstances in which the contract of sale came to an end, be forfeited to the vendors and thereupon become an actual receipt at that time. On the other hand, if the Commissioner's approach is correct so that the income is taken to be derived from a sale as soon as a contract of sale becomes unconditional, the Act does not readily provide a means for reversing the imputed derivation of income from the contract which later failed. The difficulty arises from the fact that there is until settlement no debt which can be brought to account as a bad debt under section 63. Paragraph 89 of Taxation Ruling TR 97/9 states in relation to the Gasparin Case: The derivation of income from the sale of goods should be contrasted with the derivation of income from the sale of real property. It was held in Gasparin that income from the sale of land was not derived until settlement had taken place. We do not think that von Doussa J's decision was based on the fact that legal ownership in the land would not be transferred until settlement. The explanation for the judgement rather lies in the realisation that a vendor in a real property transaction will not have performed all that is needed to become entitled to a payment prior to settlement. At settlement, transfers are effected which put the purchaser in a position to become registered as owner. As such, the vendor does not earn the income from the sale until settlement. Under the instalment sales contracts in question, whilst the relevant contracts provide for the payment of instalments over a number of years, as in the Gasparin Case the income from the sale of the properties has not been derived until settlement of the contracts. Until settlement, the vendor has not done all that is required in order to derive the payments in respect of the sale of the properties. At settlement, the vendor will transfer the title to the property and have done all that is necessary for the income to have 'come home'. Until that point in time, the properties remain part of the trading stock of the vendor, and no income from the sales has been derived under subsection 6-5(2) of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 subdivision 70-C section 6-5
Case references: The Commissioner of Taxes (South Australia) v. The Executor Trustee and Agency Company of South Australia Ltd (1938) 63 CLR 108 (1938) 5 ATD 98 (1938) 1 AITR 416
Related public rulings and determinations: Taxation Ruling TR 97/15 | Taxation Ruling TR 97/9
Related ATO interpretative decisions: ATO ID 2004/25 | ATO ID 2004/26 | ATO ID 2004/28 | ATO ID 2004/29
Subject references: Disposal of real estate Disposal of trading stock Real estate income Sale by instalments