Private ruling: Carrying on a property development business - trading stock - partnership
Date of advice: 15 December 2020
Published: March 2021
Ruling period: 1 July 20XX to 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Is the Company carrying on a business of property development? | A1: Yes | Q2: If the answer to question 1 is no, are the developments the Company undertakes on capital account and any gains or losses made on the projects treated as capital gains or losses? | A2: The property developments undertaken by the Company in carrying on its business are not on capital account. | Q3: If the Company is carrying on a business, do the projects undertaken constitute trading stock? | A3: Land held by the Company for development and resale in its development projects will be trading stock. | Q4: Will the proposed arrangement with builders constitute a partnership? | A4: No | Q5: If land acquired is trading stock, must all trading stock be valued using the same basis of valuation or can each item of trading stock be valued on a different basis? | A5: Each item of land that is trading stock can be valued using a different method of valuation.

Relevant facts and circumstances: The Company is a property development company and is owned 100% (indirectly)by an individual who is the sole director and who manages the Company The individual also owns a part share in a building company. The building company is owned XX% (indirectly) by the individual and XX% by another person who is a registered builder and is the sole director. The Company has purchased land with the intention of building multiple buildings on the property and selling them to the public either off-the-plan or completed. All profits on the sale of the project will flow to the Company which will then be reinvested into the next property development project. The goal of the Company is to develop multiple properties per annum. The Company will engage a builder to build the buildings on the property. The builder will liaise with consultants, organise tradespeople, undertake project management and any other builder's duties required to construct the project. The builder engaged may be the building company in which the individual owns a XX% share or the builder may be a third party builder, depending on pricing to build the buildings. The Company will enter a standard building contract with the builder it engages for its projects. A blank copy of the document, Housing Industry Association (HIA) Medium Works Commercial Contract Conditions (Plain Language Version for use without an architect or superintendent) has been provided and forms part of the application for private ruling. The contract provides that the agreement is made between the client and the builder and it specifies the rights and responsibilities of the parties. The contract obligates the builder to carry out and complete the works specified in the contract and that the client pay the builder the contracted price. The contracted price that the Company will pay the builder will be the project costs to construct the project plus a negotiated reasonable rate on the builder's margin, negotiated with the builder at the start of the project. The builder will never share in the losses from the development project and will not make capital contributions of money or assets to the development projects. The Company and the builder will not: enter a written or oral partnership agreement with each other register, or trade in, a partnership business name operate a joint bank account in a partnership name purchase and/or own land jointly, jointly own other business assets or have joint liability for business debt advertise, enter contracts and issue invoices, receipts, tenders, etc in a partnership name, or keep business records (books of account, minutes of partnership meetings, memoranda of decisions) in a partnership name, separate and distinct from their own business records. The Company may also be engaged from time-to-time as a consultant to research, plan and manage property developments by other businesses. In these situations, the individual, acting on behalf of the Company, will consult based on their knowledge of the industry and engage other third party consultants or contractors in areas outside of their knowledge base. The Company will be paid a consulting fee for works completed. Relevant legislative provisions Income Tax Assessment Act 1936 subsection 6(1) Income Tax Assessment Act 1997 section 6-5 Income Tax Assessment Act 1997 section 8-1 Income Tax Assessment Act 1997 subsection 70-10(1) Income Tax Assessment Act 1997 section 70-40 Income Tax Assessment Act 1997 section 70-45 Income Tax Assessment Act 1997 subsection 70-45(1) Income Tax Assessment Act 1997 Part 3-1 Income Tax Assessment Act 1997 Part 3-3 Income Tax Assessment Act 1997 section 104-10 Income Tax Assessment Act 1997 section 118-20 Income Tax Assessment Act 1997 subsection 995-1(1)


Reasons for decision: Summary: The Company is carrying on a business of property development. | Detailed Reasoning - Detailed reasoning: Subsection 995-1(1) of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'. The courts have identified a number of indicators that are relevant to determining whether activities constitute the carrying on of a business. If it is concluded that an entity carries on a business in a general sense, it is then necessary to determine the scope and nature of that business. That is, whether a company 'carries on a particular business'. The scope of the business carried on is relevant to whether an amount the business receives, or whether expenditure incurred, is capital in nature or is on revenue account. Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? (TR 97/11) considers the indicators that are relevant to whether or not an entity is carrying on a business of primary production. Although TR 97/11 is targeted to primary production activities, it is accepted that these indicators are no different from the indicators to be considered to determine whether activities in any other area constitute the carrying on of a business. These indicators are set out at paragraph 13 of TR 97/11 and are as follows: Whether the activity has a significant commercial purpose or character; Whether the taxpayer has more than just an intention to engage in business; Whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity; 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; Whether the activity is better described as a hobby, a form of recreation or a sporting activity. TR 97/11 emphasises that no one indicator is decisive and there is often a significant overlap of these indicators. The weighting to be given to each indicator may also vary from case to case. The indicators must be considered in combination and as a whole and whether a business is being carried on depends on the 'large or general impression gained'. While the indicia set out in case law, as discussed in TR 97/11, are relevant to companies, companies are typically formed for the purpose of carrying on a business (American Leaf Blending Co Sdn Bhd v Director-General of Inland Revenue [1979] AC 676 (American Leaf) and Inland Revenue Commissioners v Westleigh Estates Co Ltd [1924] 1 KB 390 (Westleigh). In Westleigh and American Leaf , it was observed that where a company aims to make, and has a prospect of profit, it is presumed that the company intends to, and does in fact, carry on a business . In American Leaf , Diplock LJ observed that this means any gainful use to which a company puts its assets will, on its face, amount to the carrying on of a business. Unlike individuals, a company's profitable activities are unlikely to be in the nature of a hobby or be undertaken to meet a domestic need. Thus, any profit-making activities a company conducts are unlikely to have a domestic or personal character and are likely to be characterised as being commercial in nature. | Detailed Reasoning - Application to the Company: Taking into account the Company's circumstances, and on weighing the various business indicators, it is considered that the Company is carrying on a business of property development. As observed in Westleigh and American Leaf, companies are typically formed for the purpose of carrying on a business and where a company aims to make, and has a prospect of profit, it is presumed that the company intends to, and does in fact, carry on a business. Despite this presumption, it is also relevant to consider the business indicators discussed in TR 97/11 in relation to the Company's circumstances. The Company purchased land with the intention of building multiple buildings on the land and selling them to the public either off-the-plan or completed. The development of the land will result in the nature of the land being changed significantly. The development is not simple and uninvolved and indicates that the Company has sufficient knowledge and skill to carry on a business of property development. The nature of the current development project also evidences that the size and scale of the activity undertaken by the Company has a significant commercial character. In addition to undertaking its own development projects, the Company may also be engaged from time-to-time as a consultant to research, plan and manage property developments by other businesses. The fact that the Company will be engaged to consult by other developers indicates its industry knowledge and skill in property development. The Company has a clear intention to profit from the property development activities because the goal of the Company is to develop multiple properties per annum and the profit from the sale of the current project will be reinvested into the next property development project. There will clearly be repetition and regularity of property development activity. There is no evidence to suggest that the property development activities to be undertaken, including the contracting out of building activities by the Company to another entity under the terms of a written contract, are not of the same kind as, or carried on in a manner that is not characteristic of, other businesses in the property development industry. A sufficient degree of system and organisation in the conduct of the activity is expected to be employed based on the commercial character of the activity and the evident experience of those involved in the activity. As stated in TR 97/11, the indicators of a business being carried on must be considered in combination and as a whole, and whether a business is being carried on depends on the 'large or general impression gained'. The large and general impression gained after examining the Company's circumstances is that the Company is carrying on a business of property development. | Summary: Gains or losses made on development projects undertaken by the Company are not treated as capital gains/losses and are not on capital account. | Detailed Reasoning - Detailed reasoning: The proceeds from the sale of land can be treated as: assessable ordinary income under section 6-5 of the ITAA 1997 from carrying on a business of property development, subdivision and sale, or resale; or from an isolated business or commercial transaction; or a mere realisation of a capital asset, assessable under Parts 3-1 and 3-3 of the ITAA 1997. Section 6-5 of ITAA 1997 provides that the assessable income of an Australian resident for taxation purposes includes ordinary income derived directly or indirectly from all sources. Ordinary income has been held to include income from carrying on a business. Therefore, where an entity is carrying on a business of property development the income derived from carrying on that business will be included in its assessable income pursuant to section 6-5. A deduction is allowed under section 8-1 of the ITAA 1997 for losses or outgoings necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, a deduction is not allowed under section 8-1 of the ITAA 1997 to the extent that the loss or outgoing is of a capital nature. Other relevant provisions of the Income Tax Assessment Act 1936 (ITAA 1936) or the ITAA 1997 may allow deductions for expenditure incurred in the course of carrying on a business that are not deductible under section 8-1. The basic distinction between the sale of property as part of a business, or alternatively, as an isolated 'profit making' undertaking or scheme is that the latter will generally be a one-off event and not carried out in an overly organised or systematic manner. Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) provides guidance to determine whether profits from isolated transactions are ordinary income. In Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199 the High Court stated at 211: ...a receipt may constitute income, if it arises from an isolated operation or commercial transaction entered into otherwise than in the ordinary course of the carrying on of the taxpayer's business, so long as the taxpayer entered into the transaction with the intention or purpose of making a relevant profit or gain from the transaction. In contrast to the sale of land being an isolated business or commercial transaction, or from carrying on a business, the sale may be the mere realisation of a capital asset. The Commissioner accepts that where the activities undertaken by an entity are no more than the mere realisation of a capital asset, any realised gain on the transaction will be a capital gain under the capital gains tax (CGT) provisions in the ITAA 1997. The expression 'mere realisation' is used to distinguish a mere realisation from a business operation or a commercial transaction carrying out a profit-making scheme. Profits made on the realisation of capital assets can still be ordinary income if the activities go beyond a mere realisation and instead become a separate business operation or commercial transaction. The 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 of the ITAA 1997 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 in assessable income of the profit or gain on the sale of a CGT asset 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 the Company: The Company is carrying on a business of property development therefore the proceeds received by the Company from carrying on its business of property development will be ordinary income and will be included in its assessable income in accordance with section 6-5 of the ITAA 1997. Expenditure incurred by the Company in the course of carrying on its business is deductible under section 8-1 of the ITAA 1997 or other relevant provisions of the ITAA 1936 or ITAA 1997. | Summary: Land held by the Company for the purpose of development and resale in its property development business will be trading stock. | Detailed Reasoning - Detailed reasoning: Subsection 70-10(1) states: 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. In considering whether property is trading stock, Taxation Determination TD 92/124 Income Tax: property development: in what circumstances is land treated as 'trading stock'? (TD 92/124) states: 1. Land is 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. 2. Both the required purpose and the business activity must be present before land is treated as trading stock. The business activity is taken to have commenced when a taxpayer embarks on a definite and continuous cycle of operations designed to lead to the sale of the land. 3. It is not necessary that the acquisition of land be repetitive. A single acquisition of land for the purpose of development, subdivision and sale by a business commenced for that purpose would lead to the land being treated as trading stock. As stated in paragraph 3 of TD 92/124, it is not necessary that the acquisition of land be repetitive. That is, the development of one specific property can constitute a property development business, in which case the sale of the property is within the ordinary course of that business and the property is trading stock ( R & D Holdings Pty Ltd v DCT [2006] FCA 981 ( R & D Holdings ) and FCT v St Hubert's Island Pty Ltd (In Liq) [19781 HCA 10; (1978) 138 CLR 210 ( St Hubert's Island) ) . Land that is not initially acquired for subdivision, development and sale, but is later 'held' for that purpose will also be trading stock. Land can be trading stock before it has been turned into the condition in which it is intended to be ultimately sold - that is, land intended to be sold after subdivision is still trading stock before it is subdivided ( R & D Holdings ; St Hubert's Island). It is only when the land is subdivided, so that different parts of the land become an identifiable and segregated parcel of land subject to separate title or titles, separate from the other parts of the land that each plot of land becomes an individual article of trading stock ( Barina Corporation Ltd v FC of T 85 ATC 4186). The Commissioner's view that broadacre land (that is not yet subdivided) ventured into a business of subdivision, development and sale can be trading stock is stated in ATO Interpretative Decision ATO ID 2004/532 Income Tax: business of subdivision - time when land becomes trading stock (ATO ID 2004/532). Where broadacres are to be subdivided as part of a property development the entire broadacres may not be trading stock. In Federal Commissioner of Taxation v. Kurts Development Ltd (1998) 86 FCR 337; (1998) 39 ATR 493; 98 ATC 4877 certain parts of the broadacres were 'Infrastructure Land' to be dedicated to the Crown or a public authority for the purpose of roads, parks, sewerage, etc. That dedication was effected upon the registration of a plan of subdivision. It was only at that moment that the Infrastructure Land became an identifiable and segregated parcel of land subject to separate title, separate from the other part of the original broadacres. The Tribunal considered that whilst the broadacres as originally acquired were an article of trading stock, the Infrastructure Land could never be part of the taxpayer's trading stock. The Infrastructure Land was never intended for sale and the dedication of the land did not constitute a sale. | Detailed Reasoning - Application to the Company: The Company carries on a business of property development. Land held by the Company for the purposes of development and sale in its business is trading stock as defined in section 70-30 of the ITAA 1997. However, if the Company owns broadacre land that will be subdivided as part of a property development, the broadacres in their entirety may not be trading stock. Any part of the broadacres that was never intended for sale will not be trading stock as it is not 'held for the purposes of resale' as required in TD 92/124 and ATO ID 2004/532. | Summary: The proposed arrangement between the Company and the builder will not constitute a partnership. | Detailed Reasoning - Detailed reasoning: Subsection 6(1) of the ITAA 1936 states that 'partnership' has the same meaning as in the ITAA 1997. Subsection 995-1(1) of the ITAA 1997 states: partnership means: (a) an association of persons (other than a company or a limited partnership) carrying on business as partners or in receipt of ordinary income or statutory income jointly; or (b) a limited partnership. A 'person' is defined in subsection 995-1(1) as including a company. The first limb of paragraph (a) refers to 'an association of persons...carrying on business as partners.' This reflects the common law definition of partnership, which is the relationship between parties carrying on a business in common with a view to profit. The second limb of paragraph (a) refers to the persons being 'in receipt of ordinary income or statutory income jointly.' This second limb is often referred to as a tax law partnership, as it expands the common law definition of partnership to persons who are not necessarily carrying on a business in association. Taxation Ruling TR 94/8 Income tax: whether business is carried on in partnership (including 'husband and wife' partnerships) (TR 94/8) outlines the following non-exhaustive factors that should be taken into account in deciding whether a partnership exists for income tax purposes: the mutual assent and intention of the parties; joint ownership or leasing of business assets (including business premises); registration of a business name; a joint business account (specifically named and used as a business account), able to be operated by all partners; extent to which parties are involved in the conduct of the business; extent of capital contributions; entitlements to a share of net profits; business records (eg books of account and minutes of partnership meetings); trading in joint names; and public awareness of the existence of the partnership, particularly by creditors, suppliers and customers (eg invoices, business letters and advertising in the partnership name). Whether a partnership exists is a question of fact indicated by the intent and conduct of the parties concerned. Paragraph 5 of TR 94/8 states that no single factor is decisive and the weight to be given to each factor varies with individual circumstances, although entitlement to a share of net profits is essential. Each of the factors as discussed in TR 94/8 is summarised below. | Detailed Reasoning - Mutual assent and intention: Mutual assent and intention to act as partners is the essential element in demonstrating the existence of a partnership between two or more persons. However, a stated intention of a partnership is not, of itself, sufficient to establish a partnership, as the intention must be manifested by conduct ( Re Megevand; Ex Parte Dalhasse (1878) 7 Ch. D 511). The parties must understand what the partnership relationship entails, which requires more than a general understanding between them that they are in business as partners ( I.R. Commrs v. Williamson (1928) 14 TC 335) ( Williamson) . The existence or absence of a partnership agreement, written or oral, is not conclusive evidence of an intention or lack of intention to act as partners. However, a partnership agreement will be prima facie evidence of such an intention, particularly if the evidence shows that the parties have acted in accordance with the terms of the agreement. | Detailed Reasoning - Joint ownership of business assets: The joint ownership of business assets, together with a joint liability to business debt, is indicative of a business partnership. All partners must be liable for the partnership's debts not only to the extent of the partnership property, but also to the full extent of their personal resources. | Detailed Reasoning - Registration of a business name: The registration of a business name by the parties is a positive factor in determining the existence of a partnership. The use of a business name, or the names of the parties trading in joint names, can be an external sign of the existence of a partnership to third parties. | Detailed Reasoning - Joint business account and power to operate the account: The existence of a joint bank account, specifically named and used as a business account, is another positive factor in establishing that business is being carried on in partnership. This factor is given greater weight where the bank at which the account is held is aware the parties are acting in partnership and all parties have the power to operate the account. | Detailed Reasoning - Extent to which parties are involved in the conduct of the business: While it is not essential all partners actively participate in a partnership, such participation supports the existence of a partnership. Exclusive performance of all the work or activities of a business by one party will not, of itself, negate the conclusion that a partnership exists. | Detailed Reasoning - Extent of capital contributions: The sharing by the parties of contributions to assets and capital weighs in favour of the existence of a partnership. When the Commissioner examines relationships between parties to determine whether they are in partnership, the Commissioner assesses the relative capital contributions of the parties to that relationship. | Detailed Reasoning - Entitlement to a share of net profits: Partners share between them the profits and losses of the partnership activity ( Williamson ). The rights of the parties to a share of the net income or loss of the partnership must be examined. A situation in which profits are shared in line with clearly stated rights and entitlements in the partnership agreement is prima facie evidence of the existence of a partnership. | Detailed Reasoning - Business records: The maintenance of business records in the name of the parties or in the name of the partnership, rather than in the name of one party only, is indicative of the existence of a partnership. The existence of a partnership is also supported when business activities are entered in records that are separate and distinct from those kept for other business and private activities. Business records include: books of account (with accounts for each partner's capital contribution, drawings, and share of profit or loss), minutes of partnership meetings, and memoranda of decisions reached, especially regarding shares of income and losses. Trading in joint names and public recognition of the partnership The existence of a partnership is supported if the parties, by trading in joint names, make it clear to persons dealing with them that they are in partnership. For example, evidence in the form of invoices, receipts, tenders, business letters, written and oral contracts and advertising in the partnership name will be relevant. Banks, suppliers, and customers dealing with a partnership should be aware they are trading with a partnership. It is important that creditors of a partnership are aware that they are dealing with a partnership, as partners are obliged, jointly and severally to meet the debts to the full extent of their own resources. | Detailed Reasoning - Application to the Company: The Company proposes entering an arrangement with a builder to build the buildings on the property. The Company will enter a standard building contract with the builder. The contract specifies the rights and responsibilities as agreed between both parties, obligating the builder to carry out and complete the works specified in the contract for the contracted sum. The Company will pay the builder the project costs to construct the project plus a negotiated reasonable rate on the builder's margin. The builder will not share in any profits or losses from the development project and will not make capital contributions of money or assets to the project. The Company and the builder will not: enter a written or oral partnership agreement register, or trade in, a partnership business name operate a joint bank account in a partnership name purchase and/or own land jointly, jointly own other business assets or have joint liability for business debt advertise, enter contracts and issue invoices, receipts, tenders, etc in a partnership name, or keep business records (books of account, minutes of partnership meetings, memoranda of decisions) in a partnership name, separate and distinct from their own business records. Whether a partnership exists is a question of fact indicated by the intent and conduct of the parties concerned. The proposed arrangement between the Company and the builder does not evidence mutual assent and intention to act as partners. The Company and the builder do not intend to act as partners and will not enter a written or oral partnership agreement with each other. The proposed contract between the Company and the builder does not refer to the parties as being in a partnership. Rather, it makes clear that it is a contractual arrangement whereby the builder undertakes the works specified in the contract for the contracted sum. In addition to a lack of intention to act as partners, the proposed arrangement will not demonstrate the conduct described in TR 94/8 as being evidence of a partnership. The Company and the builder will be required to perform their respective obligations under the building agreement, however, the proposed arrangement between the Company and the builder will not constitute a partnership. | Summary: The Company may elect to value its land that is trading stock using a different basis of valuation for each year for each item of trading stock. | Detailed Reasoning - Detailed reasoning: Section 70-45 of the ITAA 1997 provides for the value of a taxpayer's trading stock at the end of a year of income. Subsection 70-45(1) states: You must elect to value each item of trading stock on hand at the end of an income year at: (a) its cost; or (b) its market selling value; or (c) its replacement value. A taxpayer can choose a different method each year for different items of stock. The closing value for an item of trading stock at the end of one income year automatically becomes its opening value at the beginning of the next income year (section 70-40 of the ITAA 1997). The choices given to a taxpayer in valuing trading stock on hand are clearly explained by Fullagar J in Australasian Jam Co Pty Ltd v FC of T 10 ATD 217; (1953) 88 CLR 23: The section in terms allows to the taxpayer considerable freedom of choice. He may adopt one method of valuation for one part of his stock, and another method for another part. And he is not bound to adhere from year to year to any method of valuation for any part of his stock: he may change the basis as to the whole or any part of his stock from year to year at will. On the other hand, the section is imperative in that it requires him to adopt for each article of his stock one or other of the three prescribed bases of valuation. He is not at liberty to adopt some other basis of his own. And...the value at which his stock is brought into account at the beginning of a year shall be the value at which it was brought into account at the close of the preceding year... | Detailed Reasoning - Application to the Company: The Company may elect to value its land that is trading stock at cost, market selling value or replacement value and can choose a different method each year for each item of trading stock .