Private ruling: income from a property development
Published: April 2012
Ruling period: Year ended 30 June 2012 | Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015
Date scheme commenced: 1 July 2011

Ruling: Q1: Are the proceeds of the sale of the remaining units assessable under the capital gains tax provisions of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No | Q2: Are the proceeds of the sale of the remaining units assessable as ordinary income under section 6-5 of the ITAA 1997? | A2: Yes

Relevant facts and circumstances: You jointly own a property which has been your principal place of residence for forty years. You have received approval from Council to develop the property. Property development has now started. The existing home is to be demolished and replaced with some new residential units. After construction of the units, you will keep one unit as your main residence and sell the remaining units. The total revenue received from the sale of the remaining units is expected to exceed the construction costs of the total development. The project is to be mainly funded by a bank loan with the balance of funds to come from your personal monies. You have no prior experience in developing property and are engaging professionals in all aspects of the development and sale of the units. You neither have an Australian business number (ABN) individually or as a partnership with the Australian Taxation Office (ATO), nor are you registered for GST. You state that the property development is a one-off event. You are not carrying on a property development business and do not intend to commence one.

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

Reasons for decision: Summary: The proceeds to be received on the sale of the remaining units of the proposed development are assessable as ordinary income. While the activity is not considered to be a business of property development, it constitutes a profit-making undertaking or scheme (or an adventure or concern in the nature of trade) and is therefore considered an isolated commercial transaction conducted with a view to a profit. The activities undertaken for the development go beyond that of a mere realisation of a capital asset as they involve significant change and value adding to the original asset. | Detailed Reasoning - Detailed reasoning: You intend to demolish your existing home and replace it with some new residential units, one of which you will keep and the remainder will be sold. We will need to determine whether the income received from the sale of the remaining units: · is assessable ordinary income under section 6-5 of the 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 mere realisation of a capital asset. In this context, where the income or net income from the transaction is assessable under these general provisions, the capital gains provisions will not apply: Section 118-20 of the ITAA 1997. Income from carrying on a business of property development 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 facts provided. Taxation Ruling TR 97/11 provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. Indicators include commercial significance or character, regularity and repetition, organisation, size, scale and permanency. No one factor is decisive. The indicators must be considered in combination and as a whole. Whether a 'business' is carried on depends on the large or general impression gained. From the facts provided, and in applying the business indicators to your circumstances, we make the following observations: · you have not previously been engaged in property development · you do not intend to commence a property development business · you will have minimal involvement in the construction and sales processes for the development (as you are engaging other parties for these purposes). · this is a one-off activity that is unlikely to be repeated. Therefore, the large and general impression gained after examining your activity against the business indictors indentified in TR 97/11, is that you are not considered to be carrying on a business of property development. Income from an isolated transaction Paragraph 234 of Miscellaneous Taxation Ruling MT2006/1 distinguishes between a business and an adventure or concern in the nature of trade (or profit-making undertaking or scheme). It provides that the term 'business', would encompass trade engaged in, or on, a regular or continuous basis. However, it goes on to say that an adventure or concern in the nature of trade may be an isolated or one-off transaction that does not amount to a business deal but has the characteristics of a business deal. The question of whether an entity is carrying on an enterprise often arises where there are one-off property transactions. The decision to be made is whether the activities are an adventure or concern in the nature of trade as opposed to the mere realisation of a capital asset. Taxation Ruling TR 92/3 sets out the Commissioners view on whether profits made from isolated transactions are ordinary income. 'Isolated transactions' refers to: · those transactions outside the ordinary course of business of a taxpayer carrying on a business; and · those transactions entered into by non-business taxpayers. Whether a profit from an isolated transaction is income according to ordinary concepts depends very much on the circumstances of the case. However, where a taxpayer who does not carry on a business makes a profit from an isolated transaction, that profit is income if: · 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. Intention or purpose 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. It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose. In your case, in undertaking the proposed plan, you would realise a significant profit from the sale of the properties, over and above what would be expected from a simple subdivision and sale of the land. In addition, the expected revenue from the sale of the remaining units will be sufficient to cover the costs of the development. Therefore, it would be reasonable to conclude that a significant purpose in undertaking the development is to make a profit or gain. Carrying out a commercial transaction For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character. Paragraph 13 of TR 92/3 lists factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction. Relevant factors include: · 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; · if the transaction involves the acquisition and disposal of property, the nature of that property; and · the timing of the transaction or the various steps in the transaction. In addition to the above general factors, MT 2006/1 provides a list of specific factors relevant to real property and development, if several of these 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. Paragraph 284 to 287 of MT 2006/1 provides an example of a subdivision of land that amounts to an enterprise by way of constituting an isolated profit-making scheme or transaction. This example reads as follows: 284. Prakash and Indira have lived in the same house on a large block of land for a number of years. They decide that they would like to move from the area and develop a plan to maximise the sale proceeds from their land. 285. They consider their best course of action is to demolish their house, subdivide their land into two blocks and to build a new house on each block. 286. Prakash and Indira lodge the necessary development application with the local council and receive approval for their plan. They arrange for : · their house to be demolished ; · the land to be subdivided ; · a builder to be engaged ; · two houses to be built ; · water meters, telephone and electricity to be supplied to the new houses ; and · a real estate agent to market and sell the houses. 287. Prakash and Indira carry out their plan and make a profit. They are entitled to an ABN in respect of the subdivision on the basis that their activities go beyond the minimal activities needed to sell the subdivided land. The activities are an enterprise as a number of activities have been undertaken which involved the demolition of their house, subdivision of the land and the building of new houses. In your case, your proposed development is similar to the example given above. Your proposed plan is to demolish your existing home and replace it with 5 new residential units, 4 of which will be sold, with one being retained as your main residence. In addition; · you have engaged professionals to handle all aspects of the development and sale of the units · the activity is similar to the type that a property developer would conduct, since you are developing the land in an organised and professional manner · a substantial amount of money has been borrowed to finance the development, indicating that the value of capital risked is significant. · the development represents significant value adding to the original asset, with the expected revenues from the sale of the remaining units being sufficient to cover the costs of the development. Based on the information provided, it is considered that the transaction is commercial in character due to the magnitude of profit, the significant value adding expected to be achieved and, the amount of capital risked in carrying out the project. The number of activities undertaken goes beyond the minimal activities needed to simply subdivide and sell the land. This indicates that the transaction is beyond that of a mere realisation of a capital asset and is in the form of an adventure or concern in the nature of trade (or profit-making undertaking or scheme). Therefore, on a weighing of the facts of your case we find that this transaction will be entered into, and any profits made, in the course of carrying out an isolated commercial transaction with a view to a profit. Accordingly, the proceeds will be considered ordinary assessable income under section 6-5 of the ITAA 1997.

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