Private ruling: Common facility in retirement village - whether trading stock or capital asset
Published: March 2012
Ruling period: 1 July 2010 to 30 June 2012
Date scheme commenced: 1 July 2010

Ruling: Q1: Will X Pty Ltd, a company that acts as nominees for Y Pty Ltd and Z Pty Ltd (the Parties), be entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), as modified by section 70-25 of the ITAA 1997 for the cost of developing and constructing the communal facilities of a retirement Village as an outgoing incurred in connection with acquiring its trading stock, being Independent Living Units (ILUs) to be sold to eligible purchasers? | A1: No. | Q2: Will X Pty Ltd be entitled to a deduction under section 8-1 of the ITAA 1997, as modified by section 70-25 of the ITAA 1997, for the cost of the land comprised of the communal facilities as an outgoing incurred in connection with acquiring its trading stock, being the ILUs to be sold to eligible purchasers? | A2: No.

Relevant facts and circumstances: This ruling is based on the facts in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. X Pty Ltd (the Nominee) acts as nominee for Y Pty Ltd and Z Pty Ltd (the Parties). The Nominee is the registered owner of a piece of land (the Development Land), and holds the Development Land as nominee/bare trustee for the Parties as tenants in common in equal shares. The purpose of the arrangement is to develop the Development Land into a retirement village and sell freehold interests in the completed Independent Living Units (ILUs) to prospective eligible residents. The Nominee is in the business of developing and selling retirement villages. W Pty Ltd (Management Company) also acts as nominee of the same Parties in regards to the provisions of management services to the residents of the retirement village. A plan of subdivision for the Development Land was certified by the relevant Council and registered with the relevant government authority few years back. In accordance with the plan of subdivision, the retirement village is to comprise of ILUs, common property and communal facilities designed for and to be utilised as the residence of persons of 60 years of age or over. The Nominee incurred expenses to construct the communal facilities which were completed a few years back (Development Costs). The Nominees also incurred expenses to acquire the subdivided lot on which the Communal facilities are constructed (Land Cost). Any contract of sale entered into between the Nominee as vendor and an eligible resident as purchaser will be subject to and conditional upon the purchaser entering into a Management Agreement with the Nominee and the Management Company. The Nominee and the Management Company have agreed in principle that the Communal Facilities will ultimately be sold to the Management Company. The Nominee advised that prior to that sale being completed, the Nominee as the registered owner of the Communal Facilities will lease those Facilities to the Management Company. When the Nominee registered the Plan of Subdivision in respect of the Development Land, a Body Corporate was constituted. As per the Agency Agreement entered into among the Nominee, the Management Company and the Body Corporate, the Nominee is the sole proprietor of the whole of the land comprised in the Plan and the sole member of the Body Corporate and the Body Corporate Committee. The Agency Agreement agrees to transfer to the Management Company the Communal Facility for the purpose of its management. The Agency Agreement states that the Body Corporate wishes to appoint the Management Company and the Management Company has agreed to act as agent of the Body Corporate in connection with the management and administration of the property at the retirement village and exercise and perform the powers and duties of the Body Corporate. The Management Committee has agreed to provide management services and Owners Corporation Services in exchange of related service fees.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 section 70-10 | Income Tax Assessment Act 1997 section 70-25 | Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision: Summary: The Nominee is not entitled to a deduction under section 8-1 of the ITAA 1997, as modified by section 70-25 of the ITAA 1997 for the cost of developing and constructing the communal facilities of HGRV as an outgoing incurred in connection with acquiring its trading stock. | Detailed Reasoning - Detailed reasoning: Subsection 8-1(1) of the ITAA 1997 states that: You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income A deduction is not allowed under section 8-1 of the ITAA 1997 if the loss or outgoing is a capital or of a capital nature: paragraph 8-1(2)(a). This exception, however, is modified by section 70-25 of the ITAA 1997 which states that: An outgoing you incur in connection with acquiring an item of trading stock is not an outgoing of capital or of a capital nature. In the present case, the Nominee acquired the Development Land to develop it into a retirement village. An essential feature of the retirement village is the Communal Facilities. Although, the cost of constructing the Communal Facilities is of a capital in nature, we need to determine, whether it is an item of trading stock in order to establish whether or not the modification to section 8-1 would apply. In other words, whether 70-25 of the ITAA 1997 would apply to disregard the exception in paragraph 8-1(2)(a) of the ITAA 1997. A trading stock is defined in section 70-10 of the ITAA 1997 as follows: 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) live stock The term "business" is defined under subsection 995-1(1) of the ITAA 1997 as any profession, trade, employment, vocation or calling, but does not include occupation as an employee. Development and selling the retirement village is done in the ordinary course of the Nominee's business. In the present case, the Nominee acquired Development Land, in the ordinary course of its business, for the purpose of developing it into ILUs to be sold to eligible residents of the retirement village. Therefore, the ILUs are trading stock for the Nominee. However, the land referrable to the Communal Facilities and the Communal Facilities are not held for the purpose of sale but are leased to the Management Company. We need to look at what the ATO's view is in relation to such situation. Taxation Ruling TR 2002/14 - Income tax: taxation of retirement village operators (TR 2002/14) explains the ATO view as to how taxation law would apply in relation to operators, developers and managers of retirement villages. According to paragraph 8 of the TR 2002/14, 8. Where a taxpayer acquires land and develops a retirement village for the purpose of selling the entire village, the land and buildings are trading stock of the property developer and the trading stock provisions will apply. (Emphasis added) Paragraph 9 of the TR 2002/14 further elaborates on the strata tilted units as follows: 9. Where a taxpayer develops or acquires the strata title to residential units in a retirement village for the purposes of sale, the trading stock provisions apply. However paragraph 10 states: 10. Where title to common areas is to pass to strata title residents, or to a body corporate owned by the residents, the cost of those common areas should be treated as part of the cost of developing or acquiring trading stock. In the present case, the entire village is not sold but ILUs are sold to eligible residents. The Communal Facilities continued to be owned by the Nominee. Although there is a provision in the Agency Agreement that the Management Company is entitled to be registered as the proprietor, at present it is eased to the Management Company to provide the management and owners corporation services in exchange of services fees. Even though the title to the Communal Facilities transfers to the Management Company as envisaged in the Management Agreement, paragraph 10 of TR 2002/14 will still not apply as the Management Company is neither strata titled resident nor a body corporate owned by the resident. Under the Agency Agreement, the Nominee is the sole member of the Body Corporate and the Body Corporate Committee and the Body Corporate appoints the Management Company as an agent of the Body Corporate. In other words, the Communal Facilities continue to be owned by the Nominee or the agent of the Nominee. Paragraph 11 of the TR 2002/14 states that: 11. Where common facilities will continue to be owned by the village operator after the strata units are sold, the operator will have stopped holding the common facilities as trading stock immediately after separate title to them has been created on subdivision. Section 70-110 will operate to treat the village operator as having sold the common facilities, in the ordinary course of business, at their cost. This amount is assessable income, and the common facilities will not be included in closing stock at the end of the financial year. The operator will be taken to have immediately bought the common facilities for the same amount, and that amount will be treated as an outgoing of a capital nature. Accordingly, since the Communal Facilities continue to be owned by the Nominee or its agent after the ILUs are sold, it will stop being the trading stock for the Nominee from the time when separate title to the land in relation to the Communal Facilities was created on subdivision. The outgoing in relation to developing the Communal Facilities will be considered as loss or outgoing of a capital nature. Therefore, deduction will not be allowed under section 8-1 of the ITAA 1997. The Nominee has submitted the argument that the principle in Federal Commissioner of Taxation v Kurts Development Ltd (1998) 98 ATC 4877 ( Kurts Case ) would apply to the present case. We consider the argument here. Kurt Development Ltd was a property developer which acquired undeveloped land and converted it into subdivided lots for the purpose of sale. As part of the process of subdivision and sale, a portion of the land acquired was required to be converted into public infrastructure, namely roads, parks, sewerage, drainage etc. Ownership of these infrastructures eventually reverted to the Crown or relevant public authority. In addition, certain external costs were incurred on neighbouring public land and infrastructure not owned by the taxpayer, but which would assist in the provision of services to the taxpayer's subdivided lots, and otherwise for works done by local authority in relation to the subdivision. The issue in Kurts Case was whether the costs incurred in developing the public infrastructure, including the cost of land used for that purpose, and the external costs, formed part of the cost of the subdivided lots for trading stock purposes, and therefore part of the value of the taxpayer's trading stock on hand at year end, even after the infrastructure land became separately identifiable. The Court decided in favour of Kurts Development Ltd stating that the infrastructure land was never a separate article of trading stock in its own right. One form of trading stock, the raw land acquired, is merely converted into a different form of trading stock, the subdivided lots. Therefore all costs incurred in creating those individual lost were held to be part of the cost price. The Nominee argues in the present case that the principle enunciated in Kurts Case should be applicable. That principle being that costs that did not relate directly to an item of trading stock but which were necessarily incurred in bringing that trading stock to the state and condition in which it was to be sold should be included in calculating the costs of each item of trading stock. We distinguish Kurts Case and the present case. In Kurts Case , the subdivided lands would not come into existence if the infrastructure costs on building the roads, water works or sewerage works were not undertaken. In the words of Emmett J (p. 4883-4884), They are all expenses which had to be incurred in order to create the individual lots. But for that expenditure, the individual subdivided lots would not have been created. While we acknowledge that communal facilities are an essential feature of retirement villages and the presence of such facilities enhances its value as well as adds to the quality of living standard for the village residents, they are not as essential as not allowing a retirement village to come into existence. Kurts Development Ltd would not even be allowed to the subdivision unless those infrastructure works were undertaken which is not the case with the Nominee. | Summary: The Nominee is not entitled to a deduction under section 8-1 of the ITAA 1997, as modified by section 70-25 of the ITAA 1997, for the cost of the land comprised of the communal facilities as an outgoing incurred in connection with acquiring its trading stock. | Detailed Reasoning - Detailed reasoning: Subsection 8-1(1) of the ITAA 1997 states that: You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income A deduction is not allowed under section 8-1 of the ITAA 1997 if the loss or outgoing is a capital or of a capital nature: paragraph 8-1(2)(a). This exception, however, is modified by section 70-25 of the ITAA 1997 which states that: An outgoing you incur in connection with acquiring an item of trading stock is not an outgoing of capital or of a capital nature. A trading stock is defined in section 70-10 of the ITAA 1997 as follows: 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) live stock The term "business" is defined under subsection 995-1(1) of the ITAA 1997 as … any profession, trade, employment, vocation or calling, but does not include occupation as an employee. In the present case, the Nominee, in the ordinary course of its business, acquired the Development Land for the purpose of developing it into ILUs to be sold to eligible residents of the retirement village. As the ILUs are held for the purpose of sale, they would be trading stock for the Nominee. However, the land referrable to the Communal Facilities is not held for the purpose of sale to eligible residents but is held by the Nominee and is leased to the Management Company. Taxation Ruling TR 2002/14 - Income tax: taxation of retirement village operators (TR 2002/14) explains the ATO view as to how taxation law would apply in relation to operators, developers and managers of retirement villages. According to paragraph 8 of the TR 2002/14, 8. Where a taxpayer acquires land and develops retirement village for the purpose of selling the entire village, the land and buildings are trading stock of the property developer and the trading stock provisions will apply. (Emphasis added) In the present case, the entire village is not sold. The land referable to the Communal Facilities is leased to the Management Company. Paragraph 10 of the TR 2002/14 elaborates on common areas in retirement villages as follows: 10. Where title to common areas is to pass to strata title residents, or to a body corporate owned by the residents, the cost of those common areas should be treated as part of the cost of developing or acquiring trading stock. In the present case, the land where the Common Facilities are built, is leased to the Management Company. Although there is a provision in the Agency Agreement that the Management Company is entitled to be registered as the proprietor, paragraph 10 of TR 2002/14 will still not apply as the Management Company is neither strata titled resident nor a body corporate owned by the resident. Under the Agency Agreement, the Nominee is the sole member of the Body Corporate and the Body Corporate Committee and the Body Corporate appoints the Management Company as an agent of the Body Corporate. In other words, the land referable to the Communal Facilities continues to be owned by the Nominee or the agent of the Nominee. Paragraph 11 of the TR 2002/14 states that: 11. Where common facilities will continue to be owned by the village operator after the strata units are sold, the operator will have stopped holding the common facilities as trading stock immediately after separate title to them has been created on subdivision. Section 70-110 will operate to treat the village operator as having sold the common facilities, in the ordinary course of business, at their cost. This amount is assessable income, and the common facilities will not be included in closing stock at the end of the financial year. The operator will be taken to have immediately bought the common facilities for the same amount, and that amount will be treated as an outgoing of a capital nature. Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'? deals specifically with the issue of land. According to paragraph 1: Land is treated as trading stock for income tax purposes if: o it is held for the purpose of resale; and o A business activity which involves dealing in land has commenced. In the present case, the land referable to the Communal Facilities is not held by the Nominee for the purpose of resale but is leased to the Management Company. Accordingly, since the land referable to the Communal Facilities continue to be owned by the Nominee or its agent after the ILUs are sold, it will stop being the trading stock for the Nominee from the time when separate title to the land was created on subdivision. The outgoing will be considered as a loss or outgoing of a capital nature. Therefore, deduction will not be allowed under section 8-1 of the ITAA 1997. The Nominee has submitted the argument that the principle of Kurts Case would apply in relation to the cost of acquiring the land referable to the Communal Facilities. We have addressed this in the reasoning for question one above and the same would apply in relation to the land referable to the Communal Facilities.

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