Private ruling: Isolated transaction -revenue or capital account
Published: September 2011
Ruling period: Year ended 30 June 2011 | Year ended 30 June 2012
Date scheme commenced: 1 July 2003

Ruling: Q1: Are the proceeds from the sale of the property considered assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No.

Relevant facts and circumstances: The arrangement that is the subject of the Ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are: a. Your application for private ruling; and b. Additional information. You are an Australian resident trust. You purchased a property consisting of three lots as a single property transaction. You state that you purchased the property as an investment property for capital gain for the members of the extended family. As the family is large and spread out you considered that creating a discretionary trust was the best option for managing the investments. One lot was purchased as a tenanted residential property and consists of a single storey multi-unit dwelling (3 units including one that is uninhabitable and used for storage). The second lot is an adjoining vacant block of land used as an easement to gain two street access to the property. You believe that the purchasing of only one of the lots as a separate property would have made no sense from an investment perspective, as the development potential would have been lost. You consider that the property retains and increases its value due to its total size, street frontages and waterfront views. When you purchased the property, it had existing plans for a multi-storey dwelling, covering the three property lots. It is your understanding that the previous owners, had also bought and sold the property with the same three lots. One of your conditions in the purchase contract was that the contract was subject to satisfactory council searches to confirm the ability to construct an eight storey residential dwelling on the property. Over the period of ownership, you have undertaken feasibility studies and subsequently a new development application (DA) was made to preserve the value of the property under the planning rules existing at the time. Following that initial investigation, an architectural firm was approached to provide preliminary designs and advice for proceeding with the DA. The new DA was put in place to maximise the value of the development while the planning rules still allowed, as the planning rules in the Draft Plan proposed would have limited the scope of the development to a height restriction of three storeys. With the new DA, the value of the property is maintained as it still allows construction of eight storeys (or nine storeys with relaxation). The multi unit dwelling situated on the property is still currently tenanted (that is, two of the three units, as one is used for storage). However the tenants are on a month to month agreements and it is proposed to sell the property as vacant possession. You have entered into a contract to sell the property. You have incurred expenses for council rates, depreciation, water fees, insurance, land tax, management fees, legal expenses, development approval, repairs and maintenance and miscellaneous during the period you have held the property. Since the trust was established, it has owned one other residential property. The property was purchased, tenanted and then sold seven years later. Prior to the lodgment of the revised development application, you had not previously undertaken any other property subdivisions or developments. You are not registered for GST.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 10-5 | Income Tax Assessment Act 1997 section 102-5 | Income Tax Assessment Act 1997 section 995-1 | Income Tax Assessment Act 1997 Part 3-1

Reasons for decision: Summary: There are three ways profit from property sales can be treated for taxation purposes: 1) As ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), as a result of carrying on a business of property development. 2) As ordinary income under section 6-5 of the ITAA 1997, as a result of an isolated business transaction entered into by a non-business taxpayer or outside the ordinary course of business of a taxpayer carrying on a business. 3) As statutory income under the capital gains tax (CGT) legislation, (sections 10-5 and 102-5 of the ITAA 1997), on the basis that a mere realisation of a capital asset has occurred. | Detailed Reasoning - Carrying on a business of property development: Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'. The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the facts. Taxation Ruling TR 97/11 provides the Commissioner's view of the factors used to determine if you are in a business for tax purposes. 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. 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 impression gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour. There is nothing to indicate that you had an intention to carry on a business. The intention was to purchase a property as an investment and sell it at some later date. There is no repetition or regularity as would be expected in a property developer business. There is no regular buying and selling of land or actual activity in subdividing or developing the land. It is not carried on in a similar manner to that of the ordinary trade and it is not planned, organised and carried on in a business-like manner as there is no active involvement in any business activity. There is no size, scale and permanency of the activity. There is a substantial investment, but scale as a business is represented by ongoing activities of a substantial nature, not one-off events. In applying these factors to your circumstances, you do not have any history of being involved in property development. You merely have a history of a residential property rental. It is considered that you are not carrying on a business of property development. | Detailed Reasoning - Isolated transactions: Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year. In certain circumstances a profit made through an isolated transaction will be ordinary income. Taxation Ruling TR 92/3 deals with isolated transactions and at paragraph 16 states that: If a taxpayer not carrying on a business makes a profit, that profit is income if: · The taxpayer had a profit-making intention when entering the transaction or operation, and · The transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction. Paragraph 40 of TR 92/3 states that it is not necessary that the intention or purpose of profit making be the sole or dominant intention for entering into the transaction, although it must be a significant purpose. Paragraph 41 of that ruling also states that if the transaction or operation involves the sale of property, it is usually necessary that the taxpayer has the profit making intention or purpose at the time of acquiring the property. A transaction may be characterised as a business operation or commercial transaction if the transaction is business or commercial in character. In determining whether an isolated transaction amounts to a business operation or commercial transaction, paragraph 13 of TR 92/3 outlines a number of factors which must be considered, as follows: (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. | Detailed Reasoning - Application to your circumstances: You state that you purchased the property as an investment property for capital gain for members of your extended family. You acquired the property several years ago and you have not carried out any business activity on the property during that time. The units that existed on one of the lots have continued to be rented out on a month by month basis after you purchased the property as you intended to sell the property as vacant possession. During the period of ownership you have made a development application in respect of the property, and you have undertaken some minor repairs on the property. The new DA was put in place to maximise the value of the property while the planning rules still allowed, as the planning rules in the draft town plan would have limited the scope for any development to a height restriction of three storeys. You have not carried out any development work on the property. Your involvement in the DA process was limited to engaging experts to act on your behalf to plan and design the project, prepare development plans and engage real estate agents to organise the subsequent sale of the property. In the circumstances here, whilst the property may have been purchased with the clear intention of obtaining a DA for eight storeys, and to sell the property with the DA for a gain and you carried out your plan, this is not on its own determinative of it being in the nature of a business operation or commercial transaction. These factors can equally apply to investments where the gain is treated on capital account. Further, if a taxpayer conducts a feasibility study to ensure that he increases the value of the property by more than the cost of the project then this may be evidence of an intention to make a profit. However, this factor is not determinative as a feasibility study can also be conducted for investments. The relevant factors that relate to your case can be summarised as follows: · there is not a complex structure involved · you had not previously undertaken any other property subdivisions or developments, having only had one other property which was used for residential rental · the land was purchased for investment purposes · the property has been held for a significant period of time (7 years) prior to securing a sale contract and was rented in the interim · development approval has been obtained for multi-storey units on the land · no development activities have been carried out other than to obtain the development approval · you had little involvement in the steps of the process, engaging professionals from the beginning of the process, throughout the DA process to the sale of the property · the property will be sold as vacant possession/vacant lots in the same condition that it was purchased · you do not intend to undertake the development of this site or any other land developments in the future On balance, we consider that the proceeds from the sale of your property are not ordinary income and are not assessable under section 6-5 of the ITAA 1997. They represent a mere realisation of capital assets in the most enterprising way available so as to maximise the proceeds of the sale.

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