Private ruling: Income vs capital
Date of advice: 6 April 2017
Published: May 2017
Ruling period: The year ending 30 June 2017. | The year ending 30 June 2018. | The year ending 30 June 2019.
Date scheme commenced: 23 June 2014.

Ruling: Q1: Will the proceeds from the sale of the property be assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Will the proceeds from the sale of the property be subject to the capital gains tax (CGT) provisions in Parts 3-1 and 3-3 of the ITAA 1997? | A2: Yes, however any capital gain from the capital gain tax (CGT) event will be reduced to the extent any profit is also assessable under section 6-5 of the ITAA 1997. Issue 2 | Q3: Will the property be considered to be an active asset and therefore eligible for the small business concessions? | A3: No.

Relevant facts and circumstances: In 2014 a Trust acquired land (the property). The size of property is several hectares. When the Trust acquired the property, the land was zoned ‘RUI Primary Production’. In late 2014, council rezoned the property to ‘residential’. No applications such as development applications were lodged with council. No steps were taken in relation to the subdivision or development of the property. The Trust acquired the property for market value from a unit holder of the Trust. The market value was based on a valuation report conducted by licenced valuer. The intention of the Trust was to enter into a joint venture with another party to develop the land and sell as residential house blocks. Since acquiring the property, no steps were taken in relation to the subdivision or development of the property. The property has been used to graze cattle by another Trust. The other Trust and related entities are primary producers and have never been involved in any property development activities. The trustees of the Trust are now investigating the opportunity to dispose of the property as a whole to a property developer or another interested party. The housing yield of the block will equate to some hectares due to the inclusion of green space on the block. You expect to receive a large amount on the sale of the property.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Part 3-1 | Income Tax Assessment Act 1997 Part 3-3 | Income Tax Assessment Act 1997 Subdivision 152-A

Reasons for decision: Summary: 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. Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case. We will consider each of the ways you can make a profit as outlined above in relation to the gain made on the sale of the land as follows: | Detailed Reasoning - Carrying on a business of property development: Section 995-1 of the ITAA 1997 defines ‘business’ as ‘including any profession, trade, employment, vocation or calling, but not occupation as an employee’. The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the particular facts. Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? provides the Commissioner’s view of the factors used to determine if you are in business for tax purposes. In the Commissioner’s view, the factors that are considered important in determining the question of business activity are: ● 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 regularity and repetition of the activity ● whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business ● whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit ● the size, scale and permanency of the activity, and ● whether the activity is better described as a hobby, a form of recreation or sporting activity. No one factor is decisive. The indicator must be considered in combination and as a whole. Whether a ‘business’ is carried on depends on the large or general impression. Application to your situation Applying the above factors to your circumstances, the overall view is that you are not carrying on a business as a property developer. There is a lack of regularity and repetition of the activity as there is no trading pattern of buying, developing and selling land. Any gain made on the disposal of the property will not be assessable income under section 6-5 of the ITAA 1997 as ordinary income from the carrying on of a business. | Detailed Reasoning - Isolated business transactions: Profits from isolated transactions will be assessable as ordinary income where the intention or purpose in entering into the transaction was to make a profit or gain and the transaction was entered into and the profit was made in the course of carrying out a business operation or commercial transaction 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. Paragraphs 41 and 42 of the ruling outline that where a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction, the activity of the taxpayer constitutes the carrying on of a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. Furthermore, at paragraphs 56 and 57, Taxation Ruling TR 92/3 explains that a profit is income where it is made in any of the following situations: ● a taxpayer acquires property with a purpose of making a profit by whichever means prove most suitable and a profit is later obtained by any means which implements the initial profit-making purpose; or ● a taxpayer acquires property contemplating a number of different methods of making a profit and uses one of those methods in making a profit; or ● a taxpayer enters into a transaction or operation with a purpose of making a profit by one particular means but actually obtains the profit by a different means. Whether a particular transaction has a business or commercial character depends very much on the circumstances of the case. Paragraph 13 of the ruling outlines the following factors which may be relevant when considering whether an isolated transaction amounts to a business operation or commercial transaction: ● the nature of the entity undertaking the operation or transaction ● the nature and scale of other activities undertaken by the taxpayer ● the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained ● the nature, scale and complexity of the operation or transaction ● the manner in which the operation or transaction was entered into or carried out ● the nature of any connection between the relevant taxpayer and any other party to the operation or transaction ● if the transaction involves the acquisition and disposal of property, the nature of the property, and ● the timing of the transaction or the various steps in the transaction. The direction provided within Taxation Ruling TR 92/3 and the relevant cases indicates that profits in this context are more likely to be considered ordinary income if they are made in the ordinary course of carrying on a business. Further, ordinary income may be derived from an isolated transaction which becomes commercial in nature, or as a result of profits on a transaction in which the initial intention was to make a profit on sale. Application to your situation You have provided that it was the intention of the Trust to enter into a joint venture with another party to develop the land and sell as residential house blocks. Upon consideration of the factors in Taxation Ruling TR 92/3, you entered into an isolated business transaction outside the ordinary course of business of the Trust or that the Trust is a non-business taxpayer. The nature and scale of the operation appears to be commercial in nature, in addition to the creation of the Trust which appears to be for the purpose of the scheme. The amount of money involved and potential profit sought is significant. Furthermore, the property was purchased on an urban fringe with the intention of developing suburban lots. This scheme was however abandoned, and the Trust is now considering disposing of the property as a whole to a developer or another entity. | Detailed Reasoning - Taxation Determination TD 92/126: Taxation Determination TD 92/126 Income tax: property development: if in an isolated commercial transaction land is acquired for the purpose of development, subdivision and sale but the development and subdivision do not proceed, how is a profit on a sale of the land treated for income tax purposes? provides that the net profit made on the sale of the land will be treated as assessable income. An example provided in Taxation Determination TD 92/126 states: A taxpayer purchases broadacres of land with the intention of development and subdivision into residential blocks for sale. After purchase, the property market suffers a downturn and the taxpayer's expected source of finance fails to materialise. The land lies idle until it is eventually sold some years later. The net profit on the sale of land is assessable income under subsection 25(1). Note: subsection 25(1) of the Income Tax Assessment Act 1936 is now currently section 6-5 of the ITAA 1997. Application to your situation In this case, the Trust’s initial plans to subdivide and develop the land were abandoned and as per Taxation Determination TD 92/126, the net profit made on the sale of the land will be assessable under section 6-5 of ITAA 1997 although the land was used by a connected entity in an unrelated business activity. | Detailed Reasoning - Capital gains tax: The basic CGT provisions are contained in Part 3-1 of the ITAA 1997. Broadly, these provisions include in your assessable income any assessable gain made when a CGT event happens to a CGT asset that you own (to the extent they are not reduced by capital losses). A CGT asset is any kind of property or a legal or equitable right that is not property. 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 Accordingly, while CGT event A1 under section 104-10 of the ITAA 1997 will occur on the disposal of the property, the disposal will be viewed as an isolated business transaction. Any capital gain arising from this CGT event will be reduced to the extent any profit is also assessable under section 6-5 of the ITAA 1997. In this case, any capital gain will be reduced to nil. | Detailed Reasoning - Small business concessions: As there will be no resulting assessable capital gain from the sale of the property, the active asset test and small business concessions do not apply. In this case, you will not be able to claim the small business concessions in relation to the sale of the property as the net profit made on the sale of the land will be assessable under section 6-5 of ITAA 1997, and will not be assessable as statutory income under the CGT legislation.