Private ruling: Property development – Revenue versus capital
Date of advice: 21 February 2018
Published: June 2018
Ruling period: 1 July 2017 to 30 June 2018 | 1 July 2018 to 30 June 2019 | 1 July 2019 to 30 June 2020 | 1 July 2020 to 30 June 2021
Date scheme commenced: 1 July 2015

Ruling: Q1: Was the Property acquired by the taxpayers as part of a profit making undertaking or scheme? | A1: Yes. | Q2: Will any net profit made on the sale of the Property be ordinary income and assessable to the taxpayers under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: Yes. | Q3: Will any net loss on the sale of the Property be deductible to the taxpayers under section 8-1 of the ITAA 1997? | A3: Yes.

Relevant facts and circumstances: You began looking for property in a location that would be suitable as a small-scale development project. Over a number of years, you corresponded with a bank in relation to your proposals to purchase, develop and sell a number of separate properties in various locations. You formed the belief that property prices in those areas were rising rapidly. You discussed your beliefs and intentions with the bank over this time. You made offers to purchase these properties, but were not successful. During the process you realised you would need to sell your own house to afford the cost of a development. You sold your house and leased it back again so that you could continue to live in it. You purchased a vacant block of land (the Property) for $X.X million. Based on your research and previous experience in the property market, at the time of purchase you believed the Property was under-priced. Your intention was to sell a property for a profit by obtaining a development approval (DA) for the property and selling the property with the DA. You borrowed an amount from the bank on a XX year loan to purchase the Property. The remainder of the money came from your own funds – largely from the sale of your house. You engaged an architect to prepare concept plans to apply for DA for the Property. The concept plans were finalised during the following year. You engaged town planners to apply for DA to build a house on the Property which was submitted to the council during the following month, with council granting the DA after a short period. You consulted a real estate agent who advised you the Property would sell for an amount between $X.X and $X.X million with the DA. You appointed a real estate agent during the following month to market and list the Property for auction. As part of the marketing campaign you hired a viewing platform to allow prospective purchasers to see the view from what would be the second story of a virtual new house. The Property went to auction, however it was passed in as there was no bid above what you had paid. Since that date the Property has remained on the market. You have not received an offer greater than the amount you paid for the Property at this point. You decided to build a house on the Property for the purpose of selling it at a profit (the Project). You are proposing to spend around $X million on building the house. You approached the bank to obtain finance to build the house. You engaged a designer to prepare drawings of the house to obtain building approval. You have researched sourcing materials and prices for the interior of the house. As of a number of months ago you had spent $XXX,XXX on purchasing, marketing and developing costs in relation to the Property. You expect to sell the Property and newly constructed house for an amount over $X.X million. You base this on recent sales around the Property. You expect to be involved in property development again at a point in the future. However you have no active plans at this point, and you will wait to evaluate the success of the Project before you start planning for a new undertaking.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 15-15 | Income Tax Assessment Act 1997 Section 118-20 | 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: Summary: At this point, your activities in relation to the Property do not display the salient indicator of a business, which are transactions entered into on a continuous and repetitive basis and it is viewed that you are not carrying on a business. However, the Property was purchased with the intention of making a profit through resale. While the method of sale has changed, the intention to make a profit was not abandoned. Therefore, it is viewed that your activities will be a profit making undertaking and any profit or loss made from the sale of the Property will be accounted for on revenue account. Accordingly, any profits you make on the sale of the Property will be assessable under section 6-5 of the ITAA 1997 and any losses will be deductible under section 8-1 of the ITAA 1997. This will be the case whether you sell the Property with a completed house or the Property with a DA. | Detailed Reasoning - Property development: As a general principle, profits from property sales will either be assessable as ordinary income under section 6-5 of the ITAA 1997 or statutory income under the capital gains tax provisions. Where the profit has been made as a result of a taxpayer carrying on a business of property development or as a result of a taxpayer entering into an isolated business transaction, the profit will be assessable as ordinary income. However, where the profit is a mere realisation of a capital asset, the profit will be assessable under the capital gains tax provisions. If you are an Australian resident, all ordinary income which you derive during an income year is included in your assessable income under section 6-5 of the ITAA 1997. Ordinary income is defined as income according to ordinary concepts. | Detailed Reasoning - Carrying on a business: Ordinary income generally includes income that arises in the ordinary course of a taxpayer’s business. However, in certain circumstances proceeds not within the ordinary course of the taxpayer’s business may form part of their ordinary income. 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. There have been several cases in which the courts have addressed the question of whether the proceeds received for the sale of an asset are revenue or capital in nature. The decision in each case depended on its own facts, and very often will be a matter of degree. The extent of the personal involvement of the taxpayer in much of the planning, organisation and management of the activities has been held to be significant factors in the determination of whether or not a business was being carried out. For example: ● In Stevenson v FC of T (1991) 91 ATC 4476; (1991) 22 ATR 56; (1991) 29 FCR 282 (Stevenson) the degree of the taxpayer’s involvement was seen as an indicator of a business being conducted; and ● The lack of personal taxpayer involvement was seen as a relevant to the finding that a business was not being conducted in the cases of Stratham V FCT 89 ATC 4070, McCorkell v FCT 98 ATC 2199 (McCorkell) and Casimaty v FCT 97 ATC 5 (Casimaty). | Detailed Reasoning - Profit making undertaking: The principle has been established that profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business ( FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium case). Taxation Ruling TR 92/3 (TR 92/3) considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income. From the cases and from TR 92/3, it would appear that the following are the most important factors to consider when determining whether profits made as a result of an isolated business transaction are assessable income: (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. TR 92/3 explains that it is not necessary that the intention or purpose of profit-making be the sole or even the dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose. Paragraph 14 of TR 92/3 says it doesn’t matter if the way you ultimately obtain a profit. Where your intention is to purchase and resell the property for the purpose of making a profit it will remain on revenue account. In determining whether an isolated transaction amounts to a business operation or commercial transaction the following factors are relevant: 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. The courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment. TR 92/3 and Taxation Ruling TR 92/4 (TR 92/4) discuss the tax treatment of ‘profits’ and ‘losses’ from isolated transactions. Here, the terms ‘profits’ and losses’ infer the tax treatment of an isolated transaction only occurs on completion of the transaction. This treatment follows Taxation Determination TD 92/126 , which states “net profit” made on the sale of the land from an isolated transaction is assessable income and “in calculating the profit on the sale of the land the cost of the land is deducted from the proceeds of sale.” This treatment is confirmed in Taxation Ruling TR 2000/8 where it is stated at Paragraph 87 that: …if an investor's activities amount to an isolated business transaction that is not the carrying on of a business, outgoings are only deductible on completion of the transaction. It is then that the final profit, or loss, is calculated for income tax purposes (see Commercial and General Acceptance Ltd v. FC of T 77 ATC 4375; (1977) 7 ATR 716). TR 92/4 states that a loss from a project is generally deductible under section 8-1 of the ITAA 1997 where, when the taxpayer began the project they intended to make a profit and the loss was made in the course of carrying out the project. | Detailed Reasoning - Capital gains tax: 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. CGT event A1 under section 104-10 happens if you dispose a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property. The inclusion of the profit or gain on the sale of a CGT asset as ordinary income does not mean that a CGT event does not happen in relation to the asset. However, section 118-20 of the ITAA 1997 operates to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. Therefore, while a CGT event will occur when an asset is sold (CGT event A1), any capital gain will be reduced by the amount included as ordinary assessable income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Application to your situation: Prior to embarking on the Project, you spent considerable time looking at other opportunities that would have involved development and sale of property. The Property as purchased was a vacant block of land. As is, it has no income generating capability. To undertake the Project, which consists of building a house on the Property that you have received the DA for and have borrowed funds for, will require additional expenditure equal to the land value. Shortly after purchasing the Property you took steps to add to its value and prepare it for resale. You obtained architects plans and DA, and engaged a real estate agent to market the Property. You incurred expenses as part of the sale process. The Property was offered at auction a relatively short period after purchase, without success. You now propose to build a house on the Property and then sell it. The Property remains on the market, and you would sell it as a vacant block with a DA if you received a high enough price. You have not undertaken any relevant property developments in the past. You do intend to be involved in future property developments, but you at this point do not have any concrete plans. You have entered into the Project with the intent of selling at a profit. The Project is on a small scale with no repetition or regularity, being a small block suitable for only a single dwelling. You have not previously been involved in a relevant property development, and have no current plans to engage in future developments. The development and sale of the Property is outside the ordinary course of the activities from which you derive your income. While all businesses begin with a single transaction, there is currently not enough evidence to show that this is the start of a business of property development. However, if you do engage in further property development, it is very likely that you be considered to be in business from that point. Based on the information provided, we do not consider that you are carrying on a business on buying and selling property, or that this is the commencement of you carrying on a business of buying and selling land. Therefore, any gain made on the disposal of the Property will not be considered as ordinary income from the carrying on of a business. The Project would be best described as an isolated transaction. To be considered a profit making scheme, the intention of the taxpayer to make a profit does not need to be the sole intention or even the dominant intention on entering into the transaction, merely a significant intention. In this case, the Commissioner is satisfied that your intention in purchasing the Property was the resale of the Property at a profit. Even though your intentions have now changed and you propose to develop the Property by building a house on it, you still intend to sell it at a profit. As outlined in paragraph 14 of TR 92/3, it will not matter whether you sell the Property with DA or after a newly constructed house has been built on the Property. Where your intention was and remains to purchase and resell the Property for the purpose of making a profit it will remain on revenue account. The Project is a profit making scheme. Deductions for on-going expenses incurred in relation to the Project will not be available to you, but will be accounted for at the completion of the transaction when calculating the net profit or net loss made on the sale of the Property. If the income from the Project exceeds the expenditure, the net income will be taxable income for you. If the expenses of the Project exceed the income, the net losses will be deductible against your other income. You will be able to offset any losses against other income in the year you sell, or carry them forward to offset against income in future years. CGT event A1 will still occur when the Property is sold. However, as the disposal of the Property is viewed as a profit making undertaking, any capital gain arising from this CGT event will be reduced to the extent that the profit will be assessable under section 6-5 of the ITAA 1997. Note: If you engage in further property development activities in future years it is likely that these activities would be considered to be the carrying on of a business of property development.