Private ruling: Capital vs revenue - GST
Date of advice: 21 May 2019
Published: July 2019
Ruling period: 1 July 2018 to 30 June 2019

Ruling: Q1: Are the proceeds from the sale subject to capital gains tax (CGT) under Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997)?? | A1: No. | Q2: Are the profits from the sale assessable under section 6-5 of the ITAA 1997?? | A2: Yes. | Q3: Will the sale be subject to GST? | A3: Yes.

Relevant facts and circumstances: You acquired the property as a testamentary gift from your late relative; the property compromised a single residential dwelling on land split across two separate titles this was split during the ownership period of your relative for unknown reasons. You resided in the property after the legal title change. During the period of your occupation, you sought to demolish the existing dwelling and construct new buildings on the land. You initially planned to reside in one dwelling and use the second dwelling for investment purposes. You and your child had a verbal agreement that they would pay the costs of the build and once the property had been rented you would pay back the loan. You have never been involved in property development activities in the past and do not look to do this is the future. Council approved the development application to demolish the existing structures and construction of the duplex. You have provided details of relevant market valuations. You have provided details of the costs associated with the works. These works were paid by using the borrowed funds. You were later advised the rental return would not be as high as you desired on one of the dwellings and it was subsequently.

Relevant legislative provisions: Income Tax Assessment Act 1997 Part 3-1 | Income Tax Assessment Act 1997 Part 3-3 | Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 128-15(4) | A New Tax System (Goods and Services Tax) Act 1999 section 9-5 | A New Tax System (Goods and Services Tax) Act 1999 subsection 9-20(1) | A New Tax System (Goods and Services Tax) Act 1999 Section 9-40

Reasons for decision: Detailed Reasoning - Capital vs revenue: There are three ways profits from property sales can be treated 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 land as trading stock; or 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; or 3. As statutory income under the CGT provisions in the ITAA 1997. Under section 6-5 of the ITAA 1997, the assessable income of an Australian resident includes ordinary income derived both in and out of Australia during an income year. Ordinary income is defined as income according to ordinary concepts. In FC of T v The Myer Emporium (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693 ( Myer Emporium ), the Full High Court expressed the view that profits made by a taxpayer who enters into an isolated transaction with a profit making purpose can be assessable income. Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income 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 Taxation Ruling 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. Taxation Ruling 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. In contrast, paragraph 36 of TR 92/3 notes that 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. Furthermore, Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number deals in part the taxation consequences of isolated transactions relating to the sale of land and states in paragraph 263: The issue to be decided is whether the activities are an enterprise in that they are of a revenue nature as they are considered to be activities of carrying on a business or an adventure or concern in the nature of trade (profit making undertaking or scheme) as opposed to the mere realisation of a capital asset. Miscellaneous Taxation Ruling MT 2006/1 refers to the cases of Statham & Anor v. Federal Commissioner of Taxation (Statham) and Casimaty v. Federal Commissioner of Taxation (Casimaty) as cases that provide guidance on when activities to subdivide land may amount to a profit-making undertaking or scheme. In both cases, farm land was subdivided and sold and based on the facts of those cases, the courts held that the sales of the subdivided lots were a mere realisation of a capital asset. Miscellaneous Taxation Ruling MT 2006/1 notes that from the Statham and Casimaty cases a list of factors can be ascertained that provide assistance in determining whether an activity is a profit-making undertaking or scheme. Those factors are: ● there is a change of purpose for which the land is held, ● additional land is acquired to be added to the original parcel of land, ● the parcel of land is brought into account as a business asset, ● there is a coherent plan for the subdivision of the land, ● there is a business organisation - for example a manager, office and letterhead, ● borrowed funds financed the acquisition or subdivision, ● interest on money borrowed to defray subdivisional costs was claimed as a business expense, ● there is a level of development of the land beyond that necessary to secure council approval for the subdivision, and ● buildings have been erected on the land. ● In very general terms, a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations. | Detailed Reasoning - Capital gains tax provisions: CGT event A1 under section 104-10 happens if you dispose a CGT asset. You make a capital gain if your capital proceeds exceed the CGT asset’s cost base. Section 118-20 contains anti-overlap provisions which operate to reduce capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 of the ITAA 1997, for example, as ordinary income under section 6-5 of the ITAA 1997. Application to your situation In your case, you do not carry on a business of buying, selling or developing land. You decided firstly to demolish the existing dwelling and build a duplex in which you would reside in one and rent the other for investment purposes. Although you stated your initial intention may not have been for the purpose of profit making at the time you acquired the dwelling, the short period of ownership and development activities support you held the duplex for development and resale for a profit. You have ventured into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction. You do not work in related industry to property development. However, the activities undertaken in the nature of business operations or commercial transactions as you demolished the existing dwelling and built the duplex. The plans for the development were coherent and included significant improvements to the land. You further obtained financing for the purpose of construction, with the borrowing of funds indicating a certain level of commerciality to your activities. Once the dwelling was titled changed into your name development approvals and construction of the duplex was within a short period of time. Based on the figures provided, the costs incurred in the development were significant when compared to the initial unimproved value of the land which contained the original dwelling, further indicating a profit making purpose. On balance, it is accepted that you do not carry on a business of property development; however you have entered into a profit making undertaking or scheme. The proceeds from the sale of the duplex are from an isolated transaction and are on revenue. This means that you have derived ordinary income which is assessable under section 6-5 of the ITAA 1997. Whilst CGT event A1 will occur on the disposal of the duplex, this will still be viewed as an isolated transaction. Any profit from the sale will be assessable as ordinary income under section 6-5 of the ITAA 1997 as an isolated transaction. Any capital gain arising from the CGT event will be reduced to the extent any profit is assessable under section 6-5 of the ITAA 1997. | Detailed Reasoning - Goods and Services Tax (GST): Section 9-40 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that you are liable for GST on any taxable supplies that you make. Section 9-5 of the GST Act provides that you make a ‘ taxable supply’ if: (a) you make the supply for consideration (b) the supply is made in the course or furtherance of an enterprise that you carry on (c) the supply is connected with the indirect tax zone (Australia), and (d) you are registered, or required to be registered for GST. However, the supply is not a taxable supply to the extent that it is GST-free or input taxed. You developed the land and constructed dwellings. For the supply of the property to be a taxable supply, all of the requirements in section 9-5 of the GST Act must be satisfied. In this case, you sold a duplex for consideration in Australia. Therefore, paragraphs 9-5(a) and 9-5(c) of the GST Act will be satisfied. Further, the supply of the duplex in your situation will neither be GST-free or input taxed. Accordingly, we must determine whether: (a) your sale of the duplex is in the course or furtherance of an enterprise that you are carrying on, and (b) if so, whether you are required to be registered for GST. | Detailed Reasoning - Enterprise: Section 9-20 of the GST Act provides that the term ‘enterprise’ includes, among other things, an activity or series of activities done in the form of a business or in the form of an adventure or concern in the nature of trade. The phrase ‘carry on’ in the context of an enterprise includes doing anything in the course of the commencement or termination of the enterprise. Miscellaneous Taxation Ruling MT 2006/1 guidance on what activities will amount to an enterprise. Paragraph 234 of MT 2006/1 distinguishes between activities done in the form of a ‘business’ and those done in the form of ‘an adventure or concern in the nature of trade’. In particular: ● A business encompasses trade engaged in on a regular or continuous basis. ● An adventure or concern in the nature of trade may be an isolated or one-off transaction that does not amount to a business, but which has the characteristics of a business deal. The relevant factors in Miscellaneous Taxation Ruling MT 2006/1 have previously been addressed above. Application to your situation In relevance to the sale of the duplex there were a number of separate activities that amount to having the characteristics of a business deal. Significant works occurred for the duplex to be erected. There was a degree of autonomy, the borrowing of funds, engaging in professional services to carry out the development and short period of time before the sale of the duplex. After examining all the facts and circumstances, on balance, we consider your activities are a series of activities done in the form of an adventure or concern in the nature of trade. We will now need to consider if you need to register for GST. | Detailed Reasoning - Are you required to be registered for GST?: As you are not currently registered for GST, it needs to be established whether or not you are required to be registered for GST in relation to your activities. Section 23-5 of the GST Act requires you to be registered for GST if: a) you are carrying on an enterprise and b) your GST turnover meets or exceeds the registration turnover threshold. (The current registration turnover threshold is $75,000.) As set out above we consider that: you are carrying on a property development enterprise and the supplies in this enterprise will be supply of the duplex which resulted from converting the original property, a capital asset, to a revenue asset used in your enterprise. Therefore the value of the supply of the duplex will be included in your turnover threshold. As the sale value exceeds $75,000 you are required to be registered for GST.