Private ruling: Treatment of land sale as capital gain or income
Published: May 2014
Ruling period: Year ended 30 June 2009 | Year ended 30 June 2010
Date scheme commenced: 1 July 2008

Ruling: A4: Yes

Relevant facts and circumstances: The applicant is the trustee of a trust. Retail Business The applicant has at all relevant times carried on a retail business. The applicant sold and continues to sell retail items to the private market. The applicant conducts its primary business from its retail premises. Investment Strategy of the applicant The trust, since its creation, been used as a vehicle to hold long term property assets. The applicant has always held a diverse portfolio of property assets. During the 2009 and 2010 income years, the applicant held the following property: • Several properties used to market products of the retail business, and the products of other businesses which were run or partially run by entities related to the applicant. • Vacant land purchased with the intention to construct a residence on. Upon completion of construction, the applicant intended to derive rental income from the residence for a lengthy period of time; the construction of the residence was completed; and the residence was rented to a tenant for a period of time before the property was sold. • Vacant land purchased with the intention to construct a residence on; upon completion of construction, the applicant intended to derive rental income from the residence for a lengthy period of time; the construction of the residence was either not commenced or not completed; consequently, the applicant did not lease any premises on the land to a tenant as the premises were not completed. • Property consisting of land and pre-existing dwelling • Commercial property acquired for rental income • Vacant land with purchased with the intention to construct a commercial premises on. The applicant intended to derive rental income from the commercial premises; the construction of the commercial premises was completed; and the applicant rented the commercial premises for a period of time and did not sell the property during the 2009 and 2010 income years. The applicant acquired each of the properties for the purpose of holding them long term. At the time the applicant acquired each properly, the applicant intended to: • Benefit from the long term growth in the value of the properties; and • Derive rental income from each of the properties. The properties were acquired by the applicant (and not a different entity): (a) For asset protection purposes; and (b) As part of the applicant's strategy to benefit from the capital growth of the properties and increase the assets available to the family beneficiaries of the applicant in the long term. The applicant could not obtain finance from any bank to complete construction on some properties and was under significant pressure from the bank to sell properties to reduce the level of debt it owed to the bank. Economic Boom The location experienced an economic 'boom'. The average annual capital growth rate in the value of residential properties in the location during this time was almost 20% per annum. During this period, the applicant sold two residential properties. The approximate level of debt of the applicant in the 2008 and 2009 income years was $x million (including the debts of the retail business). As a result of the GFC, and the credit crunch in the American market which flowed onto the Australian banks, many banks in Australia reviewed their loan arrangements with customers. Many banks in Australia were of the view that property in the subject location was over-valued. Consequently, many banks: (a) Obtained valuations property assets; (b) Re-assessed the loan to 'value ratios on properties; and (c) Required borrowers to repay a portion of the loan if the loan to value ratio did not meet the requirements of the bank. As a result of the GFC, the applicant was under significant financial pressure from their bank (the banker for the applicant). The bank began discussions with the applicant in relation to reducing the level of debt owed to the bank in respect of the The applicant began selling some of its properties to reduce the level of debt owed to the bank. The applicant began reducing its level of debt by selling its 'blue chip' investment properties (that is, the properties which the applicant had leased for a long period of time, were in well-established areas, had increased in value since acquisition and were easy to sell in the market at that time). The bank formally reduced the loan to value ratios required for the bank to continue to loan money against the property assets and also increased the interest cover it required. The applicant was forced to sell a number of properties in the 2009 and 2010 income years to meet the loan to value ratio requirements of the bank. At the time the properties were sold, the growth in the Australian property market had significantly declined and some areas of the market experienced negative growth. This meant that the applicant realised a gain on the sale of the properties which was much smaller than anticipated and intended. The GFC has continued to impact some areas of the economy as at today's date. As stated earlier, there was vacant land which was initially purchased to construct a residence on the land to rent. However, due to the GFC and the credit crunch, the applicant was forced to sell some of the properties before any building commenced to meet the requirements of the bank. All of the properties sold in 2009 (except for one) were held by the applicant for more than 2 years. The applicant sold properties in the 2010 income year and were each held for more than two years. Other Properties By way of background, the applicant also held (and did not sell) the other properties in the period in question but sold them at a later time. As at 30 June 2013, the applicant no longer held a portfolio of property assets due to the financial difficulties it faced during and subsequent to the GFC.

Relevant legislative provisions: 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 6-5 | Income Tax Assessment Act 1997 s ection 108-5

Reasons for decision: Summary: It is the Commissioner's view that the sale of the properties is outside the ordinary course of business, and more accurately represents the mere realisation of capital assets held by the trust. That is, properties were not purchased with a profit-making purpose, but to hold as an investment, to generate long-term capital appreciation and rental income. As a mere realisation of a capital asset, the proceeds from sale are not assessable as ordinary income under section 6-5 of the ITAA 1997. The proceeds from sale of the applicant's properties are subject to the CGT provisions provided in Part 3-1 and Part 3-3 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: There are three ways in which profits from your sale of your properties sale can be treated for taxation purposes: • as ordinary income under section 6-5 of the ITAA 1997, on revenue account, as income generated in the ordinary course of carrying on a business of buying/selling property, • as ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of an isolated commercial transaction, where net profits are included in assessable income, or • as statutory income under the capital gains tax (CGT) regime in Part 3-1 and Part 3-3 of the ITAA 1997, on the basis that a mere realisation of a capital asset has occurred. | Detailed Reasoning - Carrying on a business: The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11, which uses the following indicators to determine whether a taxpayer is carrying on a business: • whether the activity has a significant commercial purpose or character; • 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; and • the volume of the operations and the amount of capital employed. | Detailed Reasoning - Significant commercial purpose or character: TR 97/11, paragraph 29 states" The phrase 'significant commercial purpose' is referred to by Walsh J in Thomas v. FC of T 72 ATC 4094; (1972) 3 ATR 165, (refer to paragraph 81) and discussed further by Gibbs CJ and Stephen J in Hope . The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity (refer to paragraphs 77 to 85), the repetition and regularity of activity (refer to paragraphs 55 to 62) and the profit indicators (refer to paragraphs 47 to 54). A way of establishing that there is a significant commercial purpose or character is to compare the activities with those of a taxpayer who is carrying on a similar activity that is a business. Any knowledge, previous experience or skill of the taxpayer in the activity, and any advice taken by the taxpayer in the conduct of the business should also be considered but are not necessarily determinative: see Thomas . In that case, Walsh J found that the taxpayer's activities in growing macadamia nut trees and avocado pear trees amounted to the carrying on of a business. The court was influenced by the scale of the activity, and the taxpayer's expectation of an ongoing financial return. Consideration should also be given to whether the taxpayer is a pioneer in the activity or has developed a new method of undertaking the activity, whether successful or not. A taxpayer who is carrying on a business in property development will meet the elements above, including a business plan, feasibility studies, profit indicators, and a history of development and sales. Although you have an investment strategy, you do not have a structured business plan. Based on the facts provided in the private ruling request, there appears to be no significant commercial purpose or character in your property portfolio. | Detailed Reasoning - The intention of the taxpayer: Similar to the point above on significant commercial purpose or character, your intention must be factored into the decision. TR 97/11 states: 39. The intention of the taxpayer in engaging in the activity is a relevant indicator: see Thomas . However, a mere intention to carry on a business is not enough. There must be activity. Brennan J in Inglis v. FC of T 80 ATC 4001 at 4004-4005; (1979) 10 ATR 493 at 496-497 said that: 'The carrying on of a business is not a matter merely of intention. It is a matter of activity. ... At the end of the day, the extent of activity determines whether the business is being carried on. That is a question of fact and degree.' See also J&R O'Kane & Co v. IR Commissioners (1920) 12 ATC 303 at 347 and Case K9 78 ATC 98 at 103; 22 CTBR (NS) Case 29 at 302. 40. This indicator is particularly related to: • whether the activity is preparatory or preliminary to the ultimate activity; • whether there is an intention to make a profit; and • whether the activity is better described as a hobby or the pursuit of a recreational or sporting activity. You state your intention was not to be carrying on a business, but to invest in long term property investments. Your activity (as described in the facts) is consistent with your intention. | Detailed Reasoning - Prospect of profit: TR 97/11 factors in the prospect of profit as an indicator an activity is considered to be carrying on a business. In your situation, whether you were carrying on a business or not, there was an expectation of profit, but the difference is in your circumstance is your intention (long term) was to realise a capital gain, and your 'profit' is not to be recognised as income in the ordinary sense, but a capital gain. | Detailed Reasoning - Repetition and regularity: It is often a feature of a business that similar sorts of activities are repeated on a regular basis. A decision is dependent upon 'the large or general impression gained' and whether these indicators provide the activities with a commercial flavour after considering the indicators in combination and as a whole (paragraph 16 of TR 97/11). The receipt of income from leasing an asset for use by others does not, of itself, amount to the carrying on of a business. Taxation ruling IT 2423 at paragraph 5 provides: "A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations. An individual who derives income from the rent of one or two residential properties would not normally be thought of as carrying on a business. On the other hand if rent was derived from a number of properties or from a block of apartments that may indicate the existence of a business." You advise you are carrying on a retail business, and that the trust is used as a vehicle to hold properties for long term investment. The facts that: • the trust regularly acquired new properties; • the property portfolio held by the trust is large, and • the trust sold a large number of properties during the year is not sufficient to amount to 'carrying on a business', as it is acceptable that the intention was to hold property for long term capital gains, where activities considered to be carrying on a business would tend to be more planned and carried on in a business-like manner. The property sales were not planned. The sales were undertaken because the bank required the taxpayer applicant) to reduce its level of debt. | Detailed Reasoning - Isolated business transactions: Taxation Ruling TR 92/3 provides the Commissioners view on whether profits from isolated transactions are assessable as ordinary income and explains the term 'isolated transactions' refers to those transactions outside the ordinary course of business, and those transactions entered into by non-business taxpayers. TR 92/3 states profit from an isolated transaction is generally income when both the following elements are present: (a) the intention or purpose of the 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, or in carrying out a business operation or commercial transaction. The profit-making purpose (where a taxpayer acquires an asset with the intention to resell it quickly and make a profit on the deal) must exist at the time of entering into the transaction. It need not be the dominant purpose, but must be a significant purpose or intention. Paragraph 46 of TR 92/3 confirms that where a taxpayer enters into a transaction outside the ordinary course of carrying on a business or as an individual, it is necessary to consider whether it is a commercial transaction. Paragraph 13 provides some aspect that may be relevant in reaching this conclusion as follows: (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. (i) If an isolated transaction is outside the ordinary course of a business being carried on or by individuals, the intention or purpose of making profits must exist in relation to the specific transaction in question. | Detailed Reasoning - Mere realisation of a capital asset: The proceeds of sale of property more often represent the mere realisation of capital assets, which will fall for consideration under the CGT provisions in Part 3-1 and Part 3-3 of the ITAA 1997. Section 108-5 of the ITAA 1997 provides that 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 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you dispose of each property. You will make a capital gain if the capital proceeds from the disposal are more than the cost base of each block. You will make a capital loss if those capital proceeds are less than the reduced cost base of each block. Several cases distinguish characteristics of 'mere realisation' from the concept of carrying on a business. In California Copper Syndicate v Harris 5 TC 159, Clerk LJ expressed the distinction between the 'mere realisation' of an asset and the carrying on of a business as follows: 'Is the sum of gain that has been made a mere enhancement of value by realising a security, or is it a gain made in an operation of business in carrying out a scheme for profit-making?' In another case, Scottish Australian Mining Co Ltd v FCT (1950) 81 CLR 188, the taxpayer was a mining company which owned a substantial parcel of land that it had mined over the course of several years. Once the mine had been exhausted, the taxpayer sought to sell the land. To obtain the best price, the taxpayer subdivided the land, and undertook substantial development of the land including the construction of roads, the building of a railway station, granting land to public institutions and setting aside land for parks. The taxpayer obtained a substantial profit on the sale of the subdivided lots. The High Court decided that the profit realised by the taxpayer was on capital account as the activities and sale constituted a 'mere realisation' of the land. The High Court found that the activities undertaken on the site were '…necessary steps to realise the land to its best advantage..' The court stated: 'The facts would, in my opinion, have to be very strong indeed before a court could be induced to hold that a company which had not purchased or otherwise acquired land for the purpose of profit making by sale was engaged in the business of selling land and not merely realising it when all that the company had done was to take the necessary steps to realise the land to the best advantage, especially land which had been acquired and used for a different purpose which it was no longer businesslike to carry out.' In Westfield the taxpayer purchased a piece of land with the view to constructing a shopping centre. The main business activity of the taxpayer was the design, construction, letting and management of shopping centres. The taxpayer sold the land to a third party for a substantial profit. The taxpayer was subsequently engaged by thy purchaser to design and construct the shopping centre to be built. The Court held that the resale of the land was not part of the taxpayer's ordinary business activity or a necessary incident thereof, since the taxpayer's business activity was the construction of shopping centres and leasing or managemenIt on their own land, on the land of others or on a joint venture. The Court said (at 343): 'It cannot be said, in the present case, that resale of land was part of the ordinary business activity as all, or, for that matter, a necessary incident of that business activity. That business activity was relevantly the construction of shopping centres, their leasing or management, either on the applicant's own land, on the land of others, or on joint venture land.' The Court held that the taxpayer lacked the necessary profit-making purpose at the time of the acquisition of the property. The Court said (at 344): While a profit-making scheme may lack specificity of detail, the mode of achieving that profit must be one contemplated by the taxpayer as at least one of the alternatives by which the profit could be realised. Such was the case in Steinberg . But, even if that go too far, it is difficult to conceive of a case where a taxpayer would be said to have made a profit from the carrying on, or carrying out, of a profit-making scheme, where, in the case of the scheme involving the acquisition and resale of land, there was, at the time of acquisition, no purpose of resale of land, but only the possibility (present, one may observe, in the case of every acquisition of land) that the land may be resold.' In the recent case of August v Federal Commissioner of Taxation (2013) FCAFC 85, the trial judge noted that there were no contemporaneous documents that evidenced Mr August's purposes or intentions when acquiring the relevant land. In that case, it was found that the Melba properties were sold as part of a profit-making scheme. The Hume property was also found to be sold as part of a profit-making scheme. In the August case, the Melba properties were sold in one transaction for the sum of $2.33 million. The Hume property was also sold in one transaction to Optus Networks Pty Ltd for more than $5 million. In applying this to the facts of your case, the relevant transactions include the sale of categories of land, some of which had significant improvements and others with no improvements; all of which are considered to be held for long term purposes and not quickly sold for profit. When entering the purchase transaction of the house and land, your intention was not to resell the property quickly, but to hold it as an investment that would increase in value over the long term. Without a profit-making intent your activities would not ordinarily be regarded as revenue-based income. The following facts also support a conclusion that the property related activities and transactions were not isolated commercial transactions: • You provided the houses to tenants for them to use in exchange for rent; • When you decided to build the new premises you planned to hold on to the properties, as before, for investment purposes. • When construction was complete the new premises were leased to tenants for their use. • All rentable premises have been rented prior to sale. • You have not used the premises as your business premises. • The sale of all your properties in the 2009 and 2010 income years was due to pressure from your bank, as a result of the vast decline in the property market. It is the Commissioner's view that the sale of the rental properties is outside the ordinary course of business, and more accurately represents the mere realisation of capital assets owned as individuals, as joint tenants. The properties were not purchased with a profit-making purpose, but to hold as an investment, to generate long-term capital appreciation and returns of a capital nature. As stated earlier, the sales were undertaken because your bank required the applicant to reduce its level of debt. As a mere realisation of a capital asset, the proceeds from the sales are not assessable as ordinary income under section 6-5 of the ITAA 1997. The proceeds are assessable under the CGT provisions provided in Part 3-1 and Part 3-3 of the ITAA 1997. | Summary: As a mere realisation of a capital asset, the proceeds from sale are not assessable as ordinary income under section 6-5 of the ITAA 1997. The proceeds from sale of your properties are subject to the CGT provisions provided in Part 3-1 and Part 3-3 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: The schedule provided by you as part of this ruling indicates a gain, and therefore , with respect to the conclusion in 1(a), the applicant made a capital gain on the sale of the 2009 Properties in the 2009 income year, pursuant to Part 3-1 of the ITAA 1997. The gain may be reduced by any concession under Part 3-1 and/or Part 3-3 of the ITAA 1997 that the applicant qualifies for. | Summary: As per summary in question 1(a) | Detailed Reasoning - Detailed reasoning: As per detailed reasoning in question 1(a) | Summary: As a mere realisation of a capital asset, the proceeds from sale are not assessable as ordinary income under section 6-5 of the ITAA 1997. The proceeds from sale of your properties are subject to the CGT provisions provided in Part 3-1 and Part 3-3 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: The schedule provided by you as part of this ruling for 2010 indicates a total gain of $X and therefore, with respect to the conclusion in 1(a), the applicant made a capital gain on the sale of the 2010 Properties in the 2010 income year, pursuant to Part 3-1 of the ITAA 1997. The gain can be reduced by any concessions under Part 3-1 and/or Part 3-3 of the ITAA 1997 that the applicant qualifies for.

Is the applicant required to include the gain on the sale of the 2009 properties as income pursuant to section 6-5 of the ITAA 1997 in the 2009 income year? | Question 1(b): Did the applicant make a capital gain on the sale of the 2009 Properties in the 2009 income year, pursuant to Part 3-1 of the ITAA 1997? | Question 1(c): Is the applicant required to include the gain on the sale of the 2010 Properties as income pursuant to Part 3-1 of the ITAA 1997? | Question 1(d): Did the applicant make a capital gain on the sale of the 2010 Properties as income pursuant to Part 3-1 of the ITAA 1997?