Private ruling: Capital v Revenue on the proposed sale of property
Date of advice: 20 December 2017
Published: May 2018
Ruling period: Year ending 30 June 20CC | Year ending 30 June 20DD
Date scheme commenced: 1 July 20BB

Ruling: Q1: Will a gain from the proposed sale of the Property constitute assessable income under section 6-5 of the Income Tax Assessment Act 1997? | A1: No | Q2: Will a gain on the proposed sale for the Property be assessable as statutory income under section 6-10 of the Income Tax Assessment Act 1997? | A2: Yes

Relevant facts and circumstances: General Background The Trust is a unit trust which is owned 100% by a family Discretionary Trust. The beneficiaries of the family Discretionary Trust are the members of one particular family. The family owns interests in other entities that perform similar activities to the Trust, including through a tax consolidated Group. The Trust has never been a part of the tax consolidated group. The Property The trust currently owns two freehold properties in State A (the Property). The Trust was established approximately 20 years ago for the sole purpose of acquiring the Property. The Property was acquired from an unrelated party during that same year. The Property was purchased with the intention to lease out to third parties, and derive long term rent from those tenants. Since acquisition, the only major refurbishment was undertaken in 19AA, to update the design and construction of the building to increase the rental return on the Property. The Property was leased to unrelated third parties for most of the period of ownership. The trustee of the Trust does not, and has not previously, engaged in any business other than the leasing of the Property. The Trust is considering marketing the Property for sale to an unrelated third party. Any disposal will result in a change in the legal and beneficial ownership of the Property. No final decision has yet been made to sell the property. If a sale occurs, the Property will be disposed of in its current condition, with no development activities being undertaken prior to disposal. It is anticipated that if the Property were to be sold, the Trustee will make a gain on the proposed sale of the Property.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 6-10 | Income Tax Assessment Act 1997 section 10-5 | Income Tax Assessment Act 1997 section 102-5 | Income Tax Assessment Act 1997 section 102-20 | Income Tax Assessment Act 1997 section 104-10 | Income Tax Assessment Act 1997 section 108-5

Reasons for decision: Summary: The gain from the proposed sale of the Property will not constitute assessable income under section 6-5 of the ITAA 1997 | Detailed Reasoning - Detailed reasoning: There are two ways profits from property sales can be treated under section 6-5 of the ITAA 1997 for taxation purposes: (1) As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of carrying on a business of property development, involving the sale of property as trading stock. (2) As ordinary income under section 6-5 of the ITAA 1997, on revenue account, 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, which is the commercial exploitation of an asset acquired for a profit making purpose. A gain from the disposal of property will be stamped with the character of income where: 1. it is made in the ordinary course of carrying on a business; that is, where "what ... is done is not merely a realisation or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business": California Copper Syndicate v Harris (1904) 5 TC 159 at pp.165-166; and London Australia Investment Company Limited v Commissioner of Taxation (1976-1977) 138 CLR 106; 2. it is made outside of the ordinary course of a taxpayer's business from an isolated (or "extraordinary") transaction entered into with the intention or purpose of making a profit. (This is the so-called first limb or strand of the decision in Commissioner of Taxation v The Myer Emporium Ltd (1987) 163 CLR 199 at pp.209-210); or 3. it is made from an isolated or one-off business venture or profit-making scheme: Commissioner of Taxation v Whitfords Beach Pty Ltd (1982) 150 CLR 355. In respect of isolated or one-off business ventures or profit making schemes, Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) at paragraphs 33 – 36 states: 33. The views expressed in Whitfords Beach and Myer that profits from isolated transactions can be assessable income must be looked at in the context of the facts involved in those cases. In Myer , the taxpayer was carrying on a large business at the time it entered into the transactions and, in Whitfords Beach, the taxpayer company embarked on a substantial business venture. 34. Nevertheless, there is a strong line of reasoning through the judgments in Whitfords Beach and Myer that suggests that profits made by a taxpayer who enters into an isolated transaction with a profit-making purpose can be assessable income. In Myer , at 163 CLR 213; 87 ATC 4369; 18 ATR 699-700, the Full High Court had this to say about the nature of profits from isolated transactions: 'It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose 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 realisation. 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 a business or carrying out a business operation or commercial transaction.' 35. A profit from an isolated transaction is therefore generally assessable 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. (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. 36. 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. The expression 'mere realisation' is used to contradistinguish a business operation or a commercial transaction carrying out a profit-making scheme ( Myer at 163 CLR 213; 87 ATC 4368-4369; 18 ATR 699-700). If a transaction satisfies the elements set out in paragraph 35 it is generally not a mere realisation of an investment. From the above it can be concluded that where there was an intention from the outset to sell a property development at a profit and where the property development is made in the course of carrying on a business or as a commercial transaction, these activities are of a revenue nature and therefore assessable under section 6-5 of the ITAA 1997. | Detailed Reasoning - Will the sale form part of the Taxpayer’s ordinary business activities?: In your case, the business activities of the related group include activities similar to the Trust. However, the trust has never been a part of the tax consolidated group and the trust’s investment can be clearly distinguished from the business activities undertaken by the associated entities. In FLZY and Commissioner of Taxation (Taxation) [2016] AATA 348, the need to consider the discrete nature of business activities conducted on each property was highlighted. The Trust has not engaged in any business other than the leasing of the Property. In relation to the Property of this ruling, the Trust’s activities have been confined to purchasing and renting of the property with no development activities conducted. Therefore, it can be concluded that the sale of the Property will not form part of the taxpayer’s ordinary business activities. | Detailed Reasoning - At the time of purchase was there a profit making purpose?: Where a profit making activity is a one off or isolated transaction and not part of the Taxpayer’s ordinary business activities, the activities may still be revenue in nature and assessable under section 6-5 of the ITAA 1997 where at the time of purchase there was a profit making purpose. When considering the intentions of a Taxpayer at the time of acquiring the land or a property development, paragraph 38 of TR 92/3 states: 38. The intention or purpose of the taxpayer (of making a profit or gain) referred to in Myer 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. This is implicit from what the Court said, in the passage quoted in paragraph 30 above: '..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..'. From the provided facts and an objective analysis of what the taxpayer did upon acquiring the Property, it is evident that the taxpayer’s primary intention was to lease the Property to earn rental income. The facts demonstrate that the trust was established with the purpose of acquiring the specific property and the Property has been leased out for the majority of the time since the acquisition. No further development and no interaction with associated entities in relation to the Property solidifies that the sale of the Property was not the primary intention of the taxpayer. The Commissioner considers that the circumstances surrounding the proposed sale of the Property indicate that the taxpayer’s decision to sell the property constitutes a mere realisation of a capital asset and is not connected with any intention to sell the property from the outset as a profit making activity. Therefore, any gains realised on the proposed sale of the Property will not constitute assessable income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Question 2: To the extent that the answer to Question 1 is “no”, will the gain on the proposed sale of the Property be assessable as statutory income under section 6-10 of the ITAA 1997? | Summary: The gain on the proposed sale of the Property will be assessable as statutory income under section 6-10 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Another way that profits from property sales can be treated for taxation purposes will be as statutory income under section 6-10 of the ITAA 1997. The list of statutory income to be included as your assessable income is set out in section 10-5 of the ITAA 1997. Section 102-5 of the ITAA 1997 provides that your assessable income includes an amount that is a net capital gain. Under section 102-20 of the ITAA 1997, you can only make a capital gain or loss when a CGT event happens. The gain or loss is made at the time of the CGT event and can only be made in respect of a CGT asset. Note 1 of section 108-5 of the ITAA 1997 lists land and buildings as an example of a CGT asset. From the reasoning from question 1, the Commissioner considered the decision to sell the Property as a mere realisation of a CGT asset. When the proposed sale of the property occurs, CGT Event A1 would occur as per section 104-10 of the ITAA 1997. Therefore, any gains realised from the proposed sale of the Property will be a capital gain under section 102-5 of the ITAA 1997 and as a result, assessable income under section 6-10 of the ITAA 1997.

Will a gain from the proposed sale of the Property constitute assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?