Private ruling: Business - assessable income and deductions
Published: March 2013
Ruling period: Year ended 30 June 2011 | Year ended 30 June 2012
Date scheme commenced: 1 July 2010

Ruling: Q1: Do the CGT provisions of the Income Tax Assessment Act 1997 apply to your business of building/buying and selling houses? | A1: No | Q2: Are profits received from the sale of property assessable income? | A2: Yes | Q3: Are expenses deductible in the year they are incurred? | A3: Yes

Relevant facts and circumstances: You are in the business of building/buying and selling houses. You have received conflicting advice regarding the deductibility of expenses in relation to your business. The fall back position of your business is to rent houses prior to achieving a commercial sale.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 118-20 | Income Tax Assessment Act 1997 Section 6-5

Reasons for decision: Summary: Proceeds from the sale of property for tax purposes are treated as either: · income according to ordinary concepts under section 6-5 derived: 1. in the course of carrying on a business, or 2. from an isolated transaction for the purpose of profit making, or · subject to capital gains tax. Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case. You have stated that you are in the business of building/buying and selling houses. Therefore, it is accepted that any proceeds received from the sale of property would be derived in the course of carrying on that business. Section 118-20 of the Income Tax Assessment Act 1997 (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 will happen when you sell your properties, 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. You have self-assessed yourself as carrying on the business of investing in property therefore the CGT provisions of the ITAA 1997 do not apply to you. Subsection 6-5(2) 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 the income year. Receipts derived by a business in its ordinary course of trading are assessable as ordinary income under section 6-5 of the ITAA 1997. In your situation, you are carrying on the business of building/buying and selling houses, so your income earned from selling your properties is assessable as ordinary income. Under section 8-1 of the ITAA 1997 you can claim deductions for expenses 'to the extent' they are incurred in gaining or producing your assessable income, or they are necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. You cannot claim deductions under section 8-1 of the ITAA 1997 for expenses 'to the extent' to which they are of a capital, private or domestic nature or they are incurred in gaining or producing exempt income. The phrase 'necessarily incurred' does not mean that the expense was unavoidable or logically necessary. The expense must be clearly and appropriately adapted for the ends of the business. It is not necessary that the expenditure in question should produce assessable income in the same year in which the expenditure is incurred. In Steele v. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139, the High Court considered the deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production. Taxation Ruling TR 2004/4 - Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities (TR 2004/4), in considering the above decision, concludes that interest incurred in a period prior to the derivation of relevant assessable income will be incurred in gaining or producing the assessable income in the following circumstances: · it is not incurred too soon, is not preliminary to the income earning activities, and is not a prelude to those activities · it is not private or domestic · the period of outgoings prior to the derivation of relevant assessable income is not so long, taking into account the kind of income earning activities involved, that the necessary connection between outgoings and assessable income is lost · it is incurred with one end in view, the gaining or producing of assessable income, and · continuing efforts are undertaken in pursuit of that end. While this does not require constant on-site development activity, the requirement is not satisfied if the venture becomes truly dormant and the holding of the asset is passive, even if there is an intention to revive the venture at some time in the future. Whilst TR 2004/4 refers specifically to interest payments, the same principles can be applied to other outgoings, such as rental expenses and administration costs incurred prior to a business commencing. Generally, business expenses are deductible in the year they are incurred.