Private ruling: Capital gains tax
Published: February 2014
Ruling period: Year ended 30 June 2013 | Year ending 30 June 2014
Date scheme commenced: 1 July 2012

Ruling: Q1: Are you entitled to apply the 50% capital gains tax (CGT) discount to the sale of the property? | A1: No.

Relevant facts and circumstances: You purchased a property which was less than 2 hectares in size and had a very old dilapidated house on it. This house was on multiple titles but was sold as one property. The dilapidated old house was not in suitable condition to rent to a third party. You lived in this property while you built your main residence on the remaining land. Once you moved into the main residence, the old dilapidated house stayed vacant as it was not in acceptable condition to rent to other parties. During this time, you treated the entire property as your main residence. There was no internal fencing separating the properties. The ownership costs of holding a bigger block were becoming financially onerous. You were looking towards retirement, and wanted to downsize your residence. You were advised that the best way to realise the value of the main residence was to build units in place of the dilapidated house You therefore decided to sell your main residence and subdivide the remainder of the property into two lots. You demolished the dilapidated building and built units. You live in one as your main residence and the other unit was sold. You have no history in real estate development or sales. No funds were borrowed to build the units. You engaged a builder to construct the units. You did not have a business plan.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 10-5 | Income Tax Assessment Act 1997 section 102-5 | Income Tax Assessment Act 1997 section 118-20

Reasons for decision: Summary: You have subdivided a block of land, built units on these blocks and sold a unit. Before we can consider whether or not you are entitled to apply the 50% general discount, we will need to determine whether the proceeds received from the sale of the unit: · is assessable ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as you were carrying on a business of property development · is assessable ordinary income under section 6-5 of the ITAA 1997 as you conducted an isolated commercial transaction with a view to a profit, or · is a realisation of a capital asset and assessable under the capital gains tax provisions of the ITAA 1997. Carrying on a business of property development It has been stated that you have no history in real estate development or sales. Therefore, it is accepted that any proceeds received from the sale of the subdivided land would not be derived in the course of carrying on a business. Profits from an isolated transaction Profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business ( FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium). Taxation Ruling TR 92/3 considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income. If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayers business but: · the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain, and · the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction. Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of subdivided land can be assessed as ordinary income within section 6-5 of the ITAA 1997. TR 92/3 lists the following factors to be considered: a) the nature of the entity undertaking the operation or transaction b) the nature and scale of other activities undertaken by the taxpayer c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained d) the nature, scale and complexity of the operation or transaction e) the manner in which the operation or transaction was entered into or carried out f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction g) if the transaction involves the acquisition and disposal of property, the nature of that property, and h) the timing of the transaction or the various steps in the transaction. 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. Miscellaneous Taxation Ruling MT 2006/1 provides a list of specific factors relevant to isolated transactions and sales of real property. If several of the factors are present, it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows: § 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. No single factor is determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities. | Detailed Reasoning - Application to your circumstances: In this case, you originally purchased the property as your main residence. However, we consider there was a change of purpose for which the property was held when you decided to subdivide, demolish the dilapidated building and develop the land. You subdivided the block and built units. You live in one as your main residence, and the other was sold. It would appear that the subdivision project has the characteristics of a commercial transaction. Therefore, as the activity was entered into, and any profits made, in the course of carrying out an isolated transaction with a view to a profit, the proceeds will be considered ordinary assessable income under section 6-5 of the ITAA 1997. Assessable under the capital gains tax provisions Section 118-20 of the ITAA 1997 primarily exists to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. In the absence of such a provision, it is conceivable that a receipt properly characterised as ordinary income and which has also been derived as a result of a CGT event could result in the receipt being taxed twice. Therefore, whilst CGT event A1 occurred when you sold the unit, any capital gain will be disregarded to the extent of any amount already included as ordinary assessable income under section 6-5 of the ITAA 1997. Therefore, as no amount is assessable as a capital gain, you are not entitled to apply the 50% general discount.