Private ruling: Proposed sale of the Centre
Date of advice: 3 July 2017
Published: November 2017
Ruling period: 01 July 2016 to 30 June 2019
Date scheme commenced: 1 July 2016

Ruling: Q1: Will the gain expected to be made by the Trust on the sale of real property lots held by the Trust, be assessed as ordinary income pursuant to section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No | Q2: Will the gain expected to be made by the Trust on the sale of real property lots held by the Trust, be subject to the capital gains and losses provisions contained within Part 3-1 of the ITAA 1997? | A2: Yes

Relevant facts and circumstances: The Trust 1. The Trust (the Trust) is established by deed (the Deed) in 2001. The Trust is a discretionary trust. The primary beneficiaries of the Trust are Individual A and Individual B. Company One was also the first trustee of the Trust. 2. Company One was removed as trustee in 2010 and Company Two was appointed as trustee of the Trust. 3. Company Two’s sole director is Individual A. 4. Company Two’s share are held by Individual A (one-third share), Individual B (one-third share) and Individual A and Individual C (one-third share jointly). 5. Individual B is related to Individual C. 6. Individual A and Individual C are both project managers of property developments 7. The 'primary beneficiaries’ of trust are Individual A and Individual C. Broadly, other related individuals and entities associated with the 'primary beneficiaries’ may also benefit under the trust. 8. The Trust is registered for GST and has always described its enterprise as a property investor. The Property 9. The Property is a building in an urban centre. 10. In 2001 the Trust acquired the Property as tenants in common in equal shares with Company Three. At the time of purchase the Property was seven years old. 11. To purchase its share of the Property the Trust borrowed almost all the required funds. 12. Company Three is a proprietary company limited by shares. 13. The Trust accounted for the acquisition of the Property on capital account. 14. The Trust did not claim GST input tax credits on the purchase of the Property because due to pre-existing leases it was an acquisition of a going concern. 15. Shortly after purchase the Trust and Company Three partitioned the Property and as a consequence the Property was divided into four separate real property lots as follows: ● Lot 1 is a basement and is owned jointly as tenants in common in equal shares by the Trust and Company Three. ● Lot 2 is wholly owned by Company Three. ● Lot 3 and Lot 4 are wholly owned by the Trust. Leasing arrangement for the Property Lot 1 16. At the time of acquisition of the Property by the Trust and Company Three Lot 1 was leased to until 2007 and the lease was rolled over until 2009. 17. In 2009 the Trust and Company Three leased Lot 1 until the end of 2014. This lease was subsequently renewed until the end of 2019. Lot 3 18. At the time of acquisition of the Property Lot 3 was subject to a lease to until December 2015. The lease was renewed to December 2025. Lot 4 19. At the time of acquisition of the Property, Lot 4, was leased until June 2009 which was extended until June 2018. 20. The Lessee of Lot 4 went into liquidation. The Trust had to restructure Lot 4 to allow it to derive an acceptable return from leasing. 21. In September 2010 Lot 4 was subdivided into Lot 4.1 and Lot 4.2 22. Lot 4.1 is leased until 30 November 2018 with options for two further five year periods. 23. Lot 4.2 is until 29 February 2020. Income and Activities of the Trust 24. The Trust has stated that it purchased the interest in the Property because of the long term income flows offered by tenants who then occupied the Lots, the availability of immediate positive cash flow, the potential capital gains, and access to tax depreciation and building allowances. 25. The activities of the Trust only involve the investment in the Property. 26. The only income received by the Trust is the rental income from the Property. 27. The Trust has made and funded $X in capital improvements to its lots since the time of acquisition. 28. The Trust has spent $X in repairs to its lots since the time of acquisition. 29. At the end of the 2000’s the Trust unsuccessfully tried to sell Lot 3. 30. Early in the 2010’s the Trust and Company Three unsuccessfully sought to sell the entirety of the Property. Joint Planning Proposal by the Trust and Company Three 31. In the mid 2010’s the Trust and Company Three submitted a planning proposal to the Council. This Planning Proposal was prepared by Company Four on behalf of the Trust and Company Three (Planning Proposal). 32. The Planning Proposal outlines the redevelopment of the Property. 33. The Planning Proposal was accompanied by a range of plans and reports prepared by specialist consultants. 34. In a meeting in 2015 the Council rejected the planning proposal for the Property. 35. In 2016 the Trust and Company Three lodged amended concept plans to the Council and the amended Planning Proposal was refused 36. The Trust and Company Three have now been referred to a state government department for review. 37. $X had been expended by the Trust in respect of the Planning Proposal: 38. The Trust advised that they did not lend any of the money to fund the Planning Proposal. 39. Other than pursuing the Planning Proposal the Trust has not engaged in any other activities regarding the property development of the Centre. 40. The Trust advised that it is not in a position to undertake the scale of development outlined in the Planning Proposal and intends to sell their interest in the Centre to an unrelated third party or parties. Property development activities since 2000 41. Individual A and Individual B have undertaken a number of property development projects jointly and individually since 2000. Intentions of the Trust regarding the proposed sale

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 70-10 | Income Tax Assessment Act 1997 Part 3-1

Reasons for decision: Summary: The proceeds from the sale of the Trust’s interest in the Building, on an arm’s length basis to an unrelated third party, will not be taxed as ordinary income under section 6-5 of the ITAA 1997. The proposed sale of the lots to an unrelated third party is not made in the course of a business operated by the Trust and therefore cannot be trading stock sold as part of a business. Further, at the time of acquisition of the Building, there was no intention to make a profit from resale of the property and therefore the proceeds cannot be taxed as part of an isolated profit making scheme | Detailed Reasoning - Question 2: Will the gain expected to be made by the Trust on the sale of real property lots held by the Trust, be subject to the capital gains and losses provisions contained within Part 3-1 of the ITAA 1997? | Detailed Reasoning - Answer: Yes | Detailed Reasoning - Detailed reasoning: Generally, the proceeds of the sale of land will be taxed in as ordinary income where: (1) The land is held as trading stock and sold as part of a business; or (2) The land is not trading stock and is sold as part of an isolated profit making scheme or undertaking. | Detailed Reasoning - Land held as trading stock and sold as part of a business: Subsection 70-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that trading stock includes: (a) anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and (b) livestock The High Court has accepted that land can be trading stock (see Federal Commissioner of Taxation v St Hubert’s Island Pty Ltd (1978) 138 CLR 210 which considered the meaning of “trading stock” in the Income Tax Assessment Act 1936 ). Further land can also be trading stock even before it has been subdivided or before improvements have been made for sale. This is supported by the judgement of Mason J in St Hubert’s Island where he stated, at 228-229, that: If trading stock according to its ordinary meaning denotes land as well as goods and commodities, it must follow that land may form part of the trading stock of a business before it has been converted into the condition in which it is intended to be sold. Just as raw materials and partly manufactured goods form part of the trading stock of a manufacturer, so also virgin land which has been acquired by a land developer for the purpose of improvement, subdivision and sale in the form of allotments will form part of his trading stock. In R & D Holdings Pty Ltd v Deputy Federal Commissioner of Taxation 2006 ATC 4472 Finn J, after identifying the St Hubert’s Island case as the seminal case on whether land can be trading stock, made the following comments about the decision in St Hubert’s Island (at 4480): 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) Finn J went on to discuss the High Court decision in John v Federal Commissioner of Taxation (1989) 166 CLR 417, which also considered the meaning of “trading stock” in the 1936 Act, and made the following comments about purpose (at 4481): 50. …, there is one aspect of John which is of present assistance. It was indicated in the joint judgement (at 430) that the s 6(1) definition of “trading stock was predicated on the prescribed purpose (i.e. of manufacture, sale or exchange) attending the acquisition of the item in question”. However, it was indicated that the definition did not require that the relevant purpose be the sole or dominant purpose”. I can see no reason why a like view should not be taken to the like purpose requirement for which the relevant property is held in the s 70-10 definition of the 1997 Act. The significance of this for present purposes is that I have found below that R & D Holdings held the Bulletin Place property at the relevant time for the dual purposes of sale or lease of subdivided lots. These two purposes clearly are not “contrary or inconsistent”… Therefore for land to be trading stock it must be held for the purpose of development and sale but the purpose of sale need not be the main purpose for holding the land. It can be held for the dual purpose of resale and lease. For the purposes of section 6-5 of the ITAA 1997 ordinary income includes profits and gains made in the ordinary course of a business and any profits that arise as an ordinary incident of a business. Therefore land will be held for the purpose of sale where the sale of land is a normal operation in course of carrying on a business. It was established by the Full Federal Court in Grollo Nominees Pty Ltd v FCT [1997] FCA 659; 97 ATC 4585 that, where an entity is part of a wider group of entities, it is not correct to treat the activities of a single member of the group in isolation to the activities of the wider group. They said at 4633-4635: The solution to the problem lies in the correct characterisation of the moneys which came to Grollo Australia's credit to enable it to carry out the building work. … The starting point for a consideration of the problem here is the fact that Grollo Australia was one of the Grollo Group of companies. The Group carried on business as substantial builders of commercial and industrial buildings. Over the years it had also engaged in construction work for public authorities. It had been in business for over ten years, that is, at the time these transactions were entered into. Grollo Australia was a new member of the Group. It was the vehicle which was used for this project. It was the joint venturer for the Grollo interests and it entered into the arrangements with the other joint ventures, St Martins. Originally, it was not intended to be the builder; the builder was to be Grofam. It was only when problems were encountered as a consequence of that being the case that the structure of the arrangement was changed so that Grollo Australia became, at least nominally, the builder employing Grofam as a sub-builder to carry out the building work involved in the project. … Grollo Australia, at least up to the stage of this project, had not been engaged in the building industry in the sense of having carried out other building projects as had Grofam. But it would not be correct to treat its activities in isolation of those of the remainder of the Group. It was part of a group which was regularly carrying out building projects, whether for the Grollos themselves or for other persons. It is true that the project in question was very large and was probably the largest project which the Group had on hand during the years of construction which began in 1981. But it was, nevertheless, but one more project. The 'primary beneficiaries’ of the Trust are Individual A and Individual C, and the director of the corporate trustee of the Trust is Individual A. Individual A and Individual B undertake property development activities through a range of entities in their individual capacity, jointly together, jointly with third parties and individually with third parties. However the only activities of the Trust relate to the leasing of the lots in the Property and, since 2013, pursuing the Planning Proposal with Council. No other entity related to either Individual A or Individual B was involved in the purchase of the Trust’s interest in the Property. In respect of the pursuing the Planning Proposal with Council the Trust has engaged, jointly with Company Three, an unrelated third party consultant (Company Four). Based on the facts provided, it is difficult to identify a group of entities associated with the Trust. The Trust is not considered to be part of wider group of entities. In R & D Holdings and St Hubert’s Island it was found that the development of one specific property can constitute a property development business, with the property being trading stock and the sale of the property within the ordinary course of business. The determination of whether property is trading stock of a property development business is a question of fact. The development of one specific property can constitute a property development business. Finn J stated in R & D Holdings, at paragraph 34: I reject R & D Holdings’ contention that, for the Bulletin Place land to be trading stock, it must first be shown that the Hallam Trust carried on a business of trading in land in the sense of buying and selling land with some regularity or system. That contention is not supported by the language of s70-10 and is inconsistent with the decision in St Hubert’s Island . Jacob J, in St Hubert’s Island at 238, stated: The company was carrying on a business of trading so long as it was pursuing its activities with an intention to sell off the land in subdivided lots and the land was its trading stock so long as the intention continued. Section 995-1 of the ITAA 1997 provides that “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? sets out the Commissioners view on when an entity is carrying on a business. The ruling specifically considers whether an entity is carrying on a business of primary production, but the indicators of business identified also apply to other areas: 26. From the judgments it is clear that the relevant indicators of whether a business of primary production is being carried on by a taxpayer are: ● does the activity have a significant commercial purpose or character? ● does the taxpayer have more than a mere intention to engage in business? ● is there an intention to make a profit or a genuine belief that a profit will be made? Will the activity be profitable? ● is there repetition and regularity in the activity? i.e., how often is the activity engaged in? How much time does the taxpayer spend on the activity? ● is the activity of the same kind and carried on in a similar way to that of the ordinary trade? ● is the activity organised in a businesslike manner? ● what is the size or scale of the activity? ● is the activity better described as a hobby, a form of recreation or a sporting activity? In purchasing its interest in the Property the Trust borrowed almost all of the funds from A Bank. Some minor borrowings were made from other entities associated with Individual A which have now been repaid. . The Trust acquired the Property as tenants in common in equal shares with Company Three and then partitioned the Property so that the Trust and Company Three owned distinct strata lots. At the time of purchase, the Property was seven years old with ongoing leases including a twenty year lease for Lot 3, which had an expiry date of in late 2015 with a further twenty year option. In 2013 the Trust, in conjunction with Company Three, engaged consultants to effect a change in the Council’s Local Environment Plan to permit extensive development of the Property. The Trust contends that the Planning Proposal was submitted to change the zoning of the Property’s site to increase the value of the lots owned by the Trust. The Trust is not intending to undertaken the development of the site outlined in the Planning Proposal but expects to sell it on an arm’s length basis to an unrelated third party. In respect of redeveloping the site the Trust has not commenced any other activity, other than pursuing the changes to the Local Environmental Plan. The evidence regarding the intention and activities of the Trust does not indicate that the Trust is engaged in business of property development. Therefore the sale of the Trust’s interest in the Property to an unrelated third party is not considered to be the sale of trading stock as part of a business. Sold as part of an isolated profit making scheme or undertaking In Federal Commissioner of Taxation v Myer Emporium Limited (1987) 163 CLR199 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 profits from a realisation of capital, and profits from a profit making scheme or undertaking (at 213): … this Court… 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. In Westfield Ltd v Federal Commissioner of Taxation 21 ATR 1398 Hill J made the following comments about the purpose of profit-making: When in Myer the High Court spoke of profits made in the ordinary course of business, their Honours were not speaking in a temporal sense. Rather, …, it is necessary that the purpose of profit-making must exist in relation to the particular operation. In a case where the transaction, which gives rise to the profit, is itself a part of the ordinary business (eg a profit on the sale of shares made by a share trader), the identification of the business activity itself will stamp the transaction as one having a profit-making purpose. Similarly, where the transaction is an ordinary incident of the business activity of the taxpayer, albeit not directly its main business activity, the same can be said. The profit making purpose can be inferred from the association of the transaction of purchase and sale with that business activity… Once it is clear that the activity of buying and selling, which generated the profit, was not an activity in the ordinary course of business, or, for that matter, an ordinary incident of some other business activity, the profit in question will only form part of the assessable income of the appellant, by virtue of its being income in accordance with the ordinary concepts of mankind, if the appellant had a purpose of profit –making at the time of acquisition. What is meant by “ profit-making ” in this context? … where a transaction falls outside the ordinary scope of the business, so as not to be a part of that business, there must exist, in my opinion, a purpose of profit-making by the very means by which the profit was in fact made. So much is implicit in the decision of the High Court in Myer . There may be a case, the present is not one, where the evidence establishes that the taxpayer has the purpose or intention of making a profit by turning an asset to account, although the means to be adopted to generate that profits have not been determined… While a profit-making scheme may lack specificity of detail, the mode of achieving that profit must be one contemplated by the taxpayer as at least one of the alternatives by which the profit could be realised … But, even if that go too far, it is difficult to conceive of a case where a taxpayer would be said to have made a profit from the carrying on, or carrying out, of a profit-making scheme, where, in the case of a scheme involving the acquisition and resale of land, there was, at the time of acquisition, no purpose of resale of land, but only the possibility (present, one may observe, in the case of every acquisition of land) that the land may be resold. (at 1407-1408) If a taxpayer is not engaged in a business of property development it is necessary to consider whether the taxpayer engaged in a profit-making undertaking in accordance with the principles outlined in Taxation Ruling TR 92/3 Income Tax: whether profits on isolated transactions are income such that the net profit is assessable under section 6-5 of the ITAA 1997. Taxation Ruling TR 92/3 Income Tax: whether profits on isolated transactions are income states: 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 the profit-making be the sole or dominant intention or purpose of the taxpayer. Rather, it is the taxpayer’s intention or purpose discerned from an objective consideration of the fact and circumstances of the case. 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. … 16. 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. | Detailed Reasoning - Intention to make a profit: With every transaction involving the acquisition of land there will be a possibility that a profit will be made on the resale of land. Westfield established that the possibility that land may be resold for profit is not sufficient, there must be the intention or purpose to make a profit on resale, usually at the time the land was acquired. The purpose to profit or gain does not have to be the dominant purpose, it is sufficient if profit-making is a significant purpose. The intention to make a profit is determined by the objective consideration of the facts. The Trust has owned its interest in the Centre for nearly fifteen years. The length of time that land does not necessarily indicate whether land is being held for the purpose of resale. In Antlers Pty Ltd (in liq) v FCT [1997] FCA 114; (1997) 35 ATR 64 land owned for twenty years was found as being acquired for the purpose resale for profit. However in that case, the owner was in liquidation for ten of the twenty years which had contributed to the delay in the land being sold For the entire period of ownership each lot has been commercially leased on five to twenty year leases with options to extend. For the first seven years the net cash income from the Centre was positive, averaging $X per year for those years. Since 2009 the Centre has not been as profitable with a reduction in rental income due to leasing problems with some of the lots. Overall for the period from 2002-2015 there has been a total net cash income of $X. The Trust has made and funded $X in capital improvements and spent $X in repairs since the time of acquisition. The Trust attempted, unsuccessfully, to sell Lot 3 in the late 2000’s and to sell the Property in its entirety, jointly with the co-owner, in the early 2010’s. While Individual A (the controlling mind of the Trust) and Individual B are involved in property developments they also hold properties for investment. On the facts provided the Trust is not part of a group of property development entities associated with Individual A or Individual B. The Trust stated that it purchased the property for 'long term income flows offered by tenants who occupied the lots, the availability of immediate positive cash flows, the potential capital gains, and access to tax depreciation and building allowances’. On the balance, the facts indicate that at the time of acquisition of the Property the Trust intended to hold the property as a long term investment. The facts do not indicate that one of the purposes for purchasing the Property was for profit by resale. In conclusion, the proceeds from the sale of Trust’s interest in the Property, on an arm’s length basis to an unrelated third party, will not be taxed as ordinary income under section 6-5 of the ITAA 1997. The proposed sale of the lots to an unrelated third party is not made in the course of a business operated by the Trust and therefore cannot be trading stock sold as part of a business. Further, at the time of acquisition of the Property, there was no intention to make a profit from resale of the property and therefore the proceeds cannot be taxed as part of an isolated profit making scheme. | Detailed Reasoning - Question 2: Will the gain expected to be made by the Trust on the sale of real property lots held by the Trust be subject to the capital gains and losses provisions contained within Part 3-1 of the ITAA 1997? Yes. Section 100-20 of the ITAA 1997 provides that you can only make a capital gain or capital loss if a capital gains tax (CGT) event happens. The CGT events are provided in Division 104 of the ITAA 1997. Most CGT events involve a CGT asset (section 100-25 of the ITAA 1997). Under section 104-5 CGT event A1 covers the disposal of a CGT Asset. The meaning of CGT asset is provided in section 108-5 of the ITAA, which states that a CGT asset is any kind of property, or a legal or equitable right that is not property (subsection 108-5(1)), and includes land and buildings (Note 1 to section 108-5). The Property is a CGT asset and the sale of the Property will be CGT event A1. The gain expected to be made by the Trust on the sale of the Property will be capital proceeds. The capital gain, from the CGT event A1, will be the capital proceeds from sale of the Centre (as determined under Division 116 of the ITAA 1997) less the cost base (as determined by Subdivision 110-A of the ITAA 1997). Under section 102-5 of the ITAA 1997 the capital gain made from the sale of the Property is used to calculate your net capital gain which is included in your assessable income for that year.