Private ruling: Property - disposal - income v capital
Date of advice: 19 July 2016
Published: August 2016
Ruling period: Income year ending 30 June 2016 | Income year ending 30 June 2017 | Income year ending 30 June 2018 | Income year ending 30 June 2019; and | Income year ending 30 June 2020.
Date scheme commenced: 1 July 2015.

Ruling: Q1: Will the gain made from the sale of the property be assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No | Q2: Will the gain made from the sale of the property be assessable under Section 25A of the Income Tax Assessment Act 1936 (ITAA 1936)? | A2: No | Q3: Will the gain made from the sale of the property be assessable income under section 15-15 of the ITAA 1997? | A3: No | Q4: Will the property be subject to the trading stock provisions under Division 70 of the ITAA 1997? | A4: No | Q5: Will the gain made on the sale of the property be assessable under Part 3-1 of the ITAA 1997? | A5: Yes. | Q6: Will you be able to fully disregard the gain made from the sale of the property under subsection 104-10(5) of the ITAA 1997? | A6: Yes.

Relevant facts and circumstances: The Trust is a discretionary trust that was established before 20 September 1985 for the purpose of holding investments on behalf of the family group, generating investment returns and capital growth. You, are the Trustee of the Trust. The Trust currently has various holdings which are assets that have been held for long terms, generating ongoing investment income. A significant portion of the Trust's assets are held in an investment property, the Property. The contract for the purchase of the Property was entered into, with settlement occurring before 20 September 1985. The land area of the Property is less than 5,000 square meters, separated into a number of lots each with the same land area. The Property has been used as an investment property which has been rented out for commercial purposes to unrelated parties. No major improvements or developments have been made to the Property since it was acquired until the present time. A number of the Property's lots are currently tenanted to Company A, who has leased the lots since the Property was acquired. The current lease is due to expire in the future, with an option to renew for an additional period. The remaining lot/s is tenanted by Business A, who has leased the lot on a month by month basis since their lease expired a number of years previously. Targets set by the State Government's draft of City's Metropolitan Strategy outlined the requirement for an increase in the number of dwellings and jobs in the area the Property is located. Around 30 years after you had purchased the Property, you received a conditional offer from a developer to purchase the Property. The amount offered was subsequently increased. After receiving the conditional offer, you engaged the services of a valuer (the Valuer) to determine the market value of the Property. You also engaged the services of an accounting firm (the Firm) and the Valuer to formally assess the yields of the development of the Property. During the following month, the Valuer provided a valuation report (the Valuation Report) which provided the density yield of the Property, identifying that the Property could have numerous residential units, on multi levels, with ground floor retail shops. The Valuation Report also outlined that the market value of the Property was $XX,000,000. The Firm prepared a report summary with the Valuation Report which outlined that the rental income received for the Property was 1% based on the market value of the Property and that the current development potential of the Property was considered to be the highest and best use of the land compared with the present rental return. Based on the Valuation Report, you did not accept the conditional offer. In 2015, the State Government issued a Draft Plan which outlined the strategic planning framework required to support the growth of the area in which the Property is located. The analysis set out a vision which supports the increase in housing opportunities within walking distance of the Station in that area, and along key routes into the precinct. The Draft Plan identified the location of the Property as appropriate for main street shop top housing. The property located next to the Property (the Adjoining Property) was recently put on the market. The Adjoining Property has a land area of XXX square metres with a residential house and a business located on it. Both buildings are used for rental purposes, with the business premises currently leased until a future year and the residential house rented out on a week by week basis. In late 2015, a related party of yours entered into a contract to purchase the Adjoining Property with settlement to occur in the present income year. Subsequent to receiving the valuation report, the Valuer brought to your attention that there may be additional benefit in considering the development of the Adjoining Property in conjunction with the Property as combining the properties would allow a greater number of units to be developed on both the Property and the Adjoining Property than if they were to be developed separately. You are evaluating the merits and financial outcomes in selling the Property with the intention of reinvesting the sale proceeds from the sale of the Property into property investments for long term rental income. In 2016, you engaged the services of a professional (Party A) to conduct a yield study. The results of the study indicated that the Property could be developed into numerous residential units, with retail shops on the ground floor. The proposed change to the Property would align the usage with the ongoing community strategic plans of the local council. In early 2016, Party A lodged an application for pre-lodgement DA advice with the council (the Council). You engaged the services of numerous professionals in relation to the pre-DA application and have incurred expenses in relation to this activity. In early 2016, you received an indicative offer from Party B for the purchase of the Property and the Adjoining Property, with no DA provided. Around the time that the indicative offer was received, the appointment of another council as the new authority for the area in which the Property is located was pending, and still is. You adopted a "wait and see" approach in respect of the change in the local government authority given that change might result in changes to the planning environment, such that higher density development would be possible on the Property, which would increase its value. During the following month, the Council issued the pre-lodgement DA advice which detailed the areas of the plans that required amending to meet the building codes. It also specified additional requirements that needed to be made to the DA application and activities that must be undertaken at your cost, such as storm water management plan, waste management plan, reconstruction of kerbing and gutters, paving of footpaths. Due to the perceived potential future value uplift of the as a result the handover to the new council, and the obtaining of the pre-DA or full DA, you decided to reject the offer received from Party B and will consider offers for the combined properties which are more than $XX,000,000 based on feedback received. The estimated market value of the Property based on the advice of the Valuer, taking the sales of properties in the area the Property is located, is $XX,000,000 to $XX,000,000, with a value for the Property once the pre-DA is obtained being at the higher amount. An updated pre-DA application is currently being drafted by Party A which it is estimated will be lodged in shortly. You are seeking to realise this investment property to its maximum value, with the intention to continue to hold a financially viable long term investment property subsequent to the disposal of the Property. It is your intention to sell the Property in its entirety to a developer for its maximum value. You will sell the Property with an approved DA to increase the selling price of the Property You intend selling the Property in conjunction with the Adjacent Property with an approved DA. It is estimated that the DA will be lodged with the Council for approval in the future. You have not engaged the services of any other parties at this time other than those already engaged. You are not contemplating engaging the services of any other parties at this point. You will engage the services of real estate agent/s to sell the Property. You have not operated, nor carried on a business of property development. Neither you, nor any related parties, have undertaken any similar activities in the past and do not intend to undertake any similar activities in the future. For the purpose of this private ruling, the following will occur: • You will engage the services of others to undertake all activities in relation to the preparation and lodgement of the pre-DA and DA • Approval for the DA in relation to the Property and the Adjoining Property will be obtained • You will engage the services of a real estate agent/s to sell the Property and the Adjoining Property; and • The Property and the Adjoining Property will be sold with an approved DA.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 25A | Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 15-15 | Income Tax Assessment Act 1997 Section 102-20 | Income Tax Assessment Act 1997 Section 104-10 | 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: Detailed Reasoning - QUESTION 1:: Will the gain made from the sale of the property be assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? Summary Your activities in relation to the sale of the Property are not indicative of a business of buying and selling properties. They will not be the same, nor carried on in a manner similar to those engaging in the trade of buying and selling property or a profit-making undertaking. Accordingly, the gain made from the sale of the Property will not be assessable under section 6-5 of the ITAA 1997. Detailed reasoning | Detailed Reasoning - Taxation treatment of property sales: Section 6-5 of the ITAA 1997 provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during an income year. Ordinary income is income according to ordinary concepts, and includes income from carrying on a business. The proceeds from realising an asset will fall into one of the following situations: • It gives rise to income according to ordinary concepts under section 6-5 of the Income Tax Assessment 1997 (ITAA 1997); or • It gives rise to profit from the carrying on or carrying out of a profit-making undertaking or plan under section 25A of the ITAA 1936 if the asset was acquired before 20 September 1985; or • It gives rise to profit from the carrying on or carrying out of a profit-making undertaking or plan under section 15-15 of the ITAA 1997 if the asset was acquired before 20 September 1985; or • It gives rise to a gain under capital gains tax (CGT) provisions in Part 3-1 of the ITAA 1997. Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case. We will consider whether the profit from the sale of the Property will be assessable as ordinary income under section 6-5 of the ITAA as follows: | Detailed Reasoning - Carrying on a business of property development: Section 995 of the ITAA 1997 states the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee. To determine whether an activity, or series of activities, amounts to a business, the activity needs to be considered against the indicators of a business established by case law. In the High Court of Australia case of Hope v. Bathurst City Council (1980) 144 CLR 1; (1980) 29 ALR 577; (1980) 80 ATC 4386; [1980] HCA 16, a business was described in the following ways: It is the words "carrying on'' which imply the repetition of acts and activities which possess something of a permanent character. …activities engaged in for the purpose of profit on a continuous and repetitive basis. Transactions were entered into on a continuous and repetitive basis for the purpose of making a profit…manifested the essential characteristics required of a business. 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. 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 impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour. | Detailed Reasoning - Isolated business transactions: Profits from isolated transactions will be assessable as ordinary income where the intention or purpose in entering into the transaction was to make a profit or gain and the transaction was entered into and the profit was made in the course of carrying out a business operation or commercial transaction Taxation Ruling TR 92/3 (TR 92/3) sets out the Commissioner's view of the general principles and factors that have been considered in determining whether an isolated transaction is of a revenue nature. Paragraph 1 of TR 92/3 outlines that isolated transactions are: a) those transactions outside the ordinary course of business of a taxpayer carrying on a business; and b) those transactions entered into by non-business taxpayers. The ruling outlines at paragraph 6 that whether a profit from an isolated transaction will be ordinary income will depend on the circumstances of the case, however a profit from an isolated transaction will be ordinary income when: a) the intention or purpose of a 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 operation or commercial transaction. TR 92/3 outlines that 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. If a transaction or operation is outside the ordinary course of a taxpayer's business, the intention or purpose of profit-making must exist in relation to the transaction or operation in question. The transaction may take place in the course of carrying on a business even if the transaction is outside the ordinary course of the taxpayer's business. Paragraphs 41 and 42 of the ruling outline that where a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction, the activity of the taxpayer constitutes the carrying on of a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. Whether a particular transaction has a business or commercial character depends very much on the circumstances of the case. Paragraph 13 of the ruling outlines the following factors which may be relevant when considering whether an isolated transaction amounts to a business operation or commercial transaction: • the nature of the entity undertaking the operation or transaction • the nature and scale of other activities undertaken by the taxpayer • the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained • the nature, scale and complexity of the operation or transaction • the manner in which the operation or transaction was entered into or carried out • the nature of any connection between the relevant taxpayer and any other party to the operation or transaction • if the transaction involves the acquisition and disposal of property, the nature of the property, and • the timing of the transaction or the various steps in the transaction. The direction provided within TR 92/3 and the above cases indicates that profits in this context are more likely to be considered ordinary income if they are made in the ordinary course of carrying on a business. Further, ordinary income may be derived from an isolated transaction which becomes commercial in nature, or as a result of profits on a transaction in which the initial intention was to make a profit on sale. Application to your situation In this case, the Property was purchased by you before 20 September 1985. You have used the Property as an investment property, commercially renting it to unrelated parties since it was purchased until the present time. You received a conditional offer for the Property that you had refused after you obtained the Valuation Report which identified that that market value of the Property was higher than the offered amount. The Valuation Report identified that numerous residential units, over multi levels including ground floor retail shops, could be constructed on the Property. Around the same time that the conditional offer was received, the appointment of a new council as the new authority for the area in which the Property is located was pending. You decided to wait until you were able to determine whether there would be any changes to the planning environment which may increase the value of the Property. The Adjacent Property was put on the market, and a related party of yours acquired the property. The valuer who provided the Valuation Report advised you that there could be an additional benefit to you if the Property was developed with the Adjacent Property. You engaged the services of Party A to prepare an application for the pre-lodgement DA, which was lodged in early 2016. The Council issued pre-lodgement advice after a short period of time. You have determined that you will sell the Property in conjunction with the Adjacent Property, with an approved DA. You will engage the services of professional/s in relation to the obtaining of an approved DA, and the subsequent selling of the Property and Adjacent Property with the approved DA. You have not operated, nor carried on a business of property development. Neither you, nor any related parties have undertaken anything of a similar nature to the purchase and sale of the Property and do not intend to undertake any similar activities in the future. Based on the information and documentation provided, there is nothing to suggest that the sale of the Property will be the beginning of a continuing business of property sales. Your activities do not display the salient indicator of a business, being transactions entered into on a continuous and repetitive basis. Therefore, it is the Commissioner's view that your activities in relation to the sale of the Property are not those of an entity carrying on a business of buying and selling property. Making an overall assessment on the factors set out in TR 93/2, it is the Commissioner's view that the sale of the Property will not be considered commercial in nature, given that the Property is a long-held privately owned property that has been used as an investment property to produce rental income. In conclusion, the activities involved in the sale of the Property will not amount to carrying on a business. The activity will not have the character of a business operation or a commercial transaction. There is no indication that your activity will become a separate business operation or commercial transaction, or that you will be carrying on, or are carrying out a profit-making undertaking or plan. Therefore, as it is not viewed that you are carrying on a business or that the activities will be an isolated transaction, any gain arising from the sale of the Property. Accordingly, any gain made on the sale of the Property will not be assessable as ordinary income under section 6-5 of the ITAA 1997. | Detailed Reasoning - QUESTION 2:: Will the gain made from the sale of the property be assessable under Section 25A of the Income Tax Assessment Act 1936 (ITAA 1936)? Summary Any gain made from the sale of the Property will not be assessable income under section 25A of the ITAA 1936 as the sale will occur after the 1997-98 income year. Detailed reasoning Section 25A of the ITAA 1936 applies to the sale of property acquired prior to 21 September 1985. However, it will not apply to a profit arising in the 1997-98 income year or later income years from the carrying on or carrying out of a profit-making undertaking or scheme, even if the undertaking or scheme was entered into, or began to be carried on or carried out, before the 1997-98 income year. Application to your situation While you purchased the Property before 21 September 1985, as outlined above, to be considered to have carried on or carried out a profit-making undertaking or plan under section 25A of the ITAA 1936 the profit making needs to have been conducted prior to 1997-98 year. As the sale of the Property will occur after the 1997-98 income year any gain realised from the sale of the Property will not be assessable income pursuant to section 25A of the ITAA 1936. Therefore, this section is not applicable to your situation. | Detailed Reasoning - QUESTION 3:: Will the gain made from the sale of the property be assessable income under section 15-15 of the ITAA 1997? Summary The gain made from the sale of the Property will not be assessable income under section 15-15 of the ITAA 1997. Detailed reasoning Section 15-15 of the ITAA 1997 includes in assessable income any profit from the carrying on or carrying out of a profit-making undertaking or plan and is applicable when an asset was acquired before 20 September 1985 and the profit arises after 1997-98 year. Application to your situation It has been determined that the sale of the Property will not amount to the carrying on of a business. Based on the information provided, you did not have a profit-making purpose at the time you acquired the Property and that the sale of the Property will amount to the realisation of a private capital asset, and therefore does not constitute a business or profit-making undertaking or scheme. Therefore, the gain made on the sale of the Property will not be assessable under section 15-15 of the ITAA 1997. | Detailed Reasoning - QUESTION 4:: Will the property be subject to the trading stock provisions under Division 70 of the ITAA 1997? Summary As you are not carrying on a business, the Property is not considered to be trading stock. Detailed reasoning Trading stock is defined widely to include anything produced, manufactured or acquired that is held for the purpose of manufacture, sale or exchange in the ordinary course of business (section 70-10 ITAA 1997). The proceeds from the sale of an item of trading stock disposed of in the ordinary course of business will be ordinary income and included as assessable income under section 6-5 ITAA 1997 (section 70-80 ITAA 1997). An asset will only be trading stock if both the required purpose and the business activity are present. When assessing whether an item is held for the purposes of resale, the previous activities of the taxpayer, the taxpayer's controlling mind and the activities of related entities are relevant factors ( R&D Holdings Pty Ltd v. Deputy Commissioner of Taxation [2006] FCA 981, (2006) 2006 ATC 4472; (2006) 64 ATR 71). Property cannot be trading stock unless it is an asset of a business trading in property of that kind ( Federal Commissioner of Taxation v. St Hubert's Island Pty Ltd (in liq) (1978) 138 CLR 210; 78 ATC 4104; (1978) 8 ATR 452). ATO guidance provides that land will be treated as trading stock for income tax purposes if it is held for the purpose of resale and a business activity which involves dealing in land has commenced (Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as "trading stock"? ). Application to your situation Based on the information provided it has been determined that you are not carrying on a business, that the Property had been acquired to be used, and was used, as an investment property. While you are seeking to sell the whole Property in a manner to obtain the best return, this will not preclude the sale of the Property from being the realisation of a capital asset. Therefore, the Property will not be viewed as trading stock in accordance with section 70-10 of the ITAA 1997 and this section will not be applicable in your situation. | Detailed Reasoning - QUESTION 5:: Will the gain made on the sale of the property be assessable under Part 3-1 of the ITAA 1997? Summary The sale of the Property is not viewed as being undertaken as part of a carrying on of a business, or undertaking a profit-making undertaking, but as a mere realisation of a long held capital asset. Therefore, any gain made on the disposal of the Property will be assessable under the capital gains tax provisions. Detailed reasoning | Detailed Reasoning - Mere realisation of a capital asset: The distinction between a mere realisation of a capital asset and a transaction that is done in carrying on a business is not always clear and is a question of fact. The issue was addressed in Californian Copper Syndicate v. Harris (Inspector of Taxes) (1904) 5 TC 159 at 165 where Lord Justice Clerk stated: It is quite a well settled principle in dealing with questions of assessment of Income Tax, that where the owner of an ordinary investment chooses to realise it, and obtain a greater price for it than he originally acquired it at, the enhanced price is not profit assessable to Income Tax. But it is equally well established that enhanced value obtained from realisation or conversion of securities may be so assessable, where what is done it truly carrying on, or carrying out, or a business. What is the line which separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be determined being - Is the sum of gain that has been made a mere enhancement of values be realising a security, or is it a gain made in an operation of business in carrying out a scheme of profit making? The determination of whether an amount is from a mere realisation or from a business operation is an objective test that requires a close examination of all relevant circumstances. In London Australia Investment Co Ltd v. Federal Commissioner of Taxation (1977) 138 CLR 106, Gibbs J, when considering the criterion of whether a sale was a business operation carried out in the course of the business of profit-making, stated that: To apply this criterion it is necessary 'to make both a wide survey and an exact scrutiny of the taxpayer's activities': Western Gold Mines N.L v C. of T (W.A) (1938) 59 C.L.R 729, at p 729, at p. 740. Different considerations may apply depending on whether the taxpayer is an individual or a company. In the latter case it is necessary to have regard to the nature of the company, the character of the assets realized, the nature of the business carried on by the company and the particular realization which produced the profit: Hobart Bridge Co. Ltd v F.C. of T. (1951) 82 C.L.R. 371, at p. 383, citing Ruhamah Property Co. Ltd. v F.C. of T. at p. 154. The mere realisation of a capital asset will not give rise to ordinary income even where the realisation is carried out in an enterprising way to secure the best price. ( Scottish Australian Mining Co Ltd v. Federal Commissioner of Taxation (1950) 81 CLR 188). In Statham & Anor v. Federal Commissioner of Taxation (1988) 20 ATR 228; 16 ALD 723; 89 ATC 4070 (Statham) it was found that a mere realisation of assets had been effected even though the owners had applied themselves in an enterprising way to the realisation with the consequence that proceeds from the sale of land were not assessable income. The Full Federal Court held at 4077 that what occurred was: The mere realisation, by the most advantageous means, of the asset which the owners had on their hands when they abandoned the intention of farming the subject property. In circumstances where there is an absence of profit-making intention, the likelihood of any profit made on the eventual sale of an asset being ordinary income is greatly diminished. The reasons prompting the sale may be a relevant consideration. Application to your situation You intend selling the Property with an approved DA to enable you to gain the maximum proceeds from the sale of the whole property. As outlined above, it has been determined the activities involved in the sale of the Property will not amount to carrying on a business. The activity will not have the character of a business operation or a commercial transaction. There is no indication that your activity will become a separate business operation or commercial transaction, or that you will be carrying on, or are carrying out a profit-making undertaking or plan. Therefore, as it is not viewed that you are carrying on a business, or that the activities will be an isolated transaction, any gain arising from the sale of the Property will be a mere realisation of your Property. Accordingly, any gain made on the sale of the Property will be accounted for under the capital gains tax provisions contained in Part 3-1 of the ITAA 1997. | Detailed Reasoning - QUESTION 6:: Will you be able to fully disregard the gain made from the sale of the property under subsection 104-10(5) of the ITAA 1997? Summary As you acquired your ownership interest in the Property before 20 September 1985, the Property is a pre-capital gains tax asset. Therefore, any capital gain made on the disposal of the Property will be disregarded. Detailed reasoning The capital gains tax (CGT) provisions are contained in Part 3-1 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 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. However, any capital gain or capital loss made on the disposal of a CGT asset will be disregarded if the asset was acquired before 20 September 1985 under subsection 104-10(5) of the ITAA 1997. Application to your situation In this case, the Property was acquired before 20 September 1985. Therefore, the Property is a pre-CGT asset. While CGT event A1 will occur when the sale contract of the Property is entered into, as the Property is a pre-CGT asset, any capital gain made on the disposal of the Property will be disregarded under Part 3-1 of the ITAA 1997.