Private ruling: Timing of deductions
Date of advice: 6 March 2024
Published: 22 April 2024
Ruling period: Year ended 30 June 20YY | Year ended 30 June 20YY
Date scheme commenced: 1 July 20YY

Ruling: Q1: Is the Trust entitled to claim a deduction for the costs of further conversion and maintenance works under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: Background The Trust acquired the land in 20YY and has been undertaking land subdivision activities on the land since the acquisition. As part of the land development approval, the Trust was required to construct and undertake further conversion and maintenance works. The subdivision completed and the subdivided lots had been sold during the income years ended 30 June 20YY and 20YY. The Trust was established for the sole purpose of acquiring and developing the Land. The directors of the Trustee have previous land development experience. The Trust acquired the land with the intention to subdivide the land the sell the individual lots for profit. The Trust did not have a written business plan, a profit and loss forecast was prepared for the land subdivision project on the land. It was projected that the development project would result in a number of lots. The acquisition of the land was financed by an interest-bearing loan. The subdivision and construction costs, including the civil works, were also financed by interest-bearing loans. A timeline showing the timing of the key events in relation to the land development on the land was set out. The planning, project management and constructions works were performed by independent contractors. The Trust did not hire any employees to work on the land subdivision project. The Trust did not build or leaded a site office, or sales office, to manage the land subdivision project. A sole agent was appointed for the marketing and sale of all lots in the development. The lots were advertised for sale through comprehensive marketing campaigns.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 Division 70 | Income Tax Assessment Act 1997 section 995-1

Reasons for decision: Detailed Reasoning - Issue: Timing of deduction - property development costs: All legislative references throughout the reasons for decision section are to the ITAA 1997 unless otherwise specified. | Summary: The Trust is entitled to claim a deduction for the costs of further conversion and maintenance works. | Detailed Reasoning - Carrying on a business: 1. The term 'business' is defined under subsection 995-1(1) as including: any profession, trade, employment, vocation or calling, but does not include occupation as an employee. 2. 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. 3. 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. TR 97/11 deals with carrying on a primary production business, however, the principles discussed in the TR 97/11 apply to any set of operations. 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. 4. TR 97/11 emphasises that no one indicator is decisive and there is often a significant overlap of these indicators. The weighting to be given to each indicator may also vary from case to case. Whether a 'business' is carried on depends on the large or general impression gained. 5. The general indicators of a business are also covered in Taxation Ruling TR 2003/4: Income tax: boat hire arrangements (see paragraphs 15-23 and further at paragraphs 62-92). While no single indicator is determinative and the determination is based on the 'large or general impression gained' ( Martin v. FC of T (1953 ) 90 CLR 470 at 474; 5 AITR 548 at 551), the prospect of profit is highly significant when assessing if an activity has the character of a business ( Stone v. FC of T [2002] FCA 1492 at [68]). 6. Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'? at paragraph 3 states that: 3. It is not necessary that the acquisition of land be repetitive. A single acquisition of land for the purpose of development, subdivision and sale by a business commenced for that purpose would lead to the land being treated as trading stock. | Detailed Reasoning - Application to the circumstances: 7. Taking the relevant facts and circumstances into consideration, and on weighing the various factors, the general impression gained is that the Trust was carrying on a business of land development, subdivision and sale. 8. The Trust was established by four individuals as a special purpose vehicle specifically for the development of the land and the sale of the subdivided lots. Activities of an entity formed by multiple parties with the common interests to make profits are generally observed to be characterised as being commercial in nature. 9. Directors of the Trustee have had extensive business and commercial experience in land development, subdivision and sale prior to this and some of which are fairly large developments. There is no evidence indicating that the activities the Trust engaged in materially differ from those of the other land development activities undertaken by the directors with land development experience. 10. The Commissioner's position as to how the main indicators of carrying on a business that are outlined in the table at paragraph 18 of TR 97/11 apply to the Trust's circumstances is detailed as follows. Table 1:Circumstances to the Trust | Detailed Reasoning - Application to the Trust's circumstances: Significant commercial activity Not a significant commercial activity The Trust is carrying on significant land development activities for commercial purposes. All directors of the Trustee are highly qualified and skilled businesspersons. They already have extensive experience in land development, subdivision and sale. The Trust engaged skilled entities in relation to the land development and paid for professional services. These entities include surveyor, town planner, project manager, infrastructure construction company and real estate agent. The Trust obtained significant finance to fund the acquisition and development of the land including interest-bearing loans from external financier associated with a director. The land development project is significant in dollar terms. The commercial nature of the land development activity is similar to many other property developers in the same industry. Purpose and intention of the taxpayer in engaging in the activity No purpose or intention of the taxpayer to carry on a business activity Clear profit-making purpose and intention are present in engaging in the land development at the time of the acquisition of the land. The land was acquired and developed for the sole purpose of making profits. As evidenced by the profit and loss forecast, it was projected that this land development project would deliver a significant profit margin over costs. An intention to make a profit from the activity No intention to make a profit from the activity There was a clear intention to make a profit from the land development activity. The Trust's goal was to make profits through the subdivision of the land sale of all individual lots. In order to ensure that an approval for the development plan would be granted. The activity is or will be profitable The activity is inherently unprofitable The land development project was profitable. Repetition and regularity of activity Little repetition or regularity of activity Although the development of the land appears to be a one-off project undertaken by the Trust, it is observed that the controlling minds had been engaging in other land development and sale business or commercial activities previously. As such, the repetition and regularity of the land development activity is present from the perspective of the Trust's controlling minds. Activity carried on similar to ordinary trade Activity carried on in an ad hoc manner The activity was carried on in a manner that is consistent with or similar to ordinary land subdivision and sale businesses. The Trust actively selected the development site, sought finance, assumed the market and business risks, and engaged professionals and skilled entities to obtain the requisite planning approval and undertake the development works, with the clear purpose and intention to make profits via the sale of the subdivided lots. Activity organised and businesslike, systematic and records are kept Activity not organised in manner as normal business activity - records are not kept The Trust's development activities including land acquisition, financing, development planning and engagement of skilled entities to undertake development works are well-planned, highly organised and businesslike, directed for the purpose of generating considerable profits from these activities. The Trust applied for an ABN and is registered for GST. Records are kept, that demonstrate the activity was organised, businesslike and systematic. Activity size and scale Small size and scale The planned land acquisition, subdivision, planning and construction works took place on a substantial size and scale. The project took a number of years to complete, over multiple stages. The size and scale point towards a business being carried on. Not a hobby, recreation or sporting activity A hobby, recreation or sporting activity The Trust's activities are not considered a hobby, or a form of recreation or sporting activity, but are highly organised and systematic business operations, directed for the purpose of making a profit. A business plan exists No business plan It was stated that the Trust did not have a written business plan. However, the profit and loss forecast set out the key business proposal including financing, marketing, costing, tax considerations and sales appraisals. Commercial sales of product Sale of products to relatives and friends The Trust had tailored marketing plans in place to sell the development. The comprehensive marketing campaign was launched before the Trust applied for the planning approval and before any development works commenced. The sale of the property was undertaken in a commercial way. Has knowledge or skill Lacks knowledge or skill Directors of the Trustee and their private groups had demonstrated knowledge and extensive experience in carrying out land development businesses. 11. In conclusion, based on the facts and weighing up all main indicators, the Trust's activities constitute carrying on a business of land development, subdivision and sale. 12. Subsection 8-1(1) states: You can deduct from your assessable income any loss or outgoing to the extent that: a) it is incurred in gaining or producing your assessable income; or b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. 13. A deduction is not allowed under this provision if the loss or outgoing is capital or an outgoing of a capital nature. 14. This exception is modified by section 70-25 for the costs of acquiring items of trading stock, which states: An outgoing you incur in connection with acquiring an item of trading stock is not an outgoing of capital or of a capital nature. 15. Further, subsection 70-5(2) provides that your outgoings and earnings (for trading stock purposes) are on revenue account, not capital account. As a result: (a) the gross outgoings are usually deductible as general deductions under section 8-1 (when the trading stock becomes trading stock on hand); and (b) the gross earnings are usually assessable as ordinary income under section 6-5 (when the trading stock stops being trading stock on hand). 16. Trading stock is defined in subsection 70-10(1) as including: a) anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and b) livestock. 17. In Kurts Development Limited v FC of T (1998) 39 ATR 493 ( Kurts ), the case involved a property developer who acquired underdeveloped land and converted it into subdivided lots for the purpose of resale. As part of the process of subdivision and sale, a portion of the land acquired was required to be converted into public infrastructure, namely roads, parks, sewerage, drainage, etc. Ownership of these infrastructures eventually reverted to the Crown or relevant public authority. In addition, certain external costs were incurred on neighbouring public land and infrastructure not owned by the taxpayer, but which would assist in the provision of services to the taxpayer's subdivided lots, and otherwise for works done by local authority in relation to the subdivision. 18. The issue in Kurts was whether the costs incurred in developing the public infrastructure, including the cost of land used for that purpose, and the external costs, formed part of the cost of the subdivided lots for trading stock purposes, and therefore part of the value of the taxpayer's trading stock on hand at year end, even after the infrastructure land became separately identifiable. 19. The Court decided in favour of Kurts Development Ltd stating that the infrastructure land was never a separate article of trading stock in its own right. One form of trading stock, the raw land acquired, is merely converted to a different form of trading stock, the subdivided lots. Therefore, all costs incurred in creating those individual lots were held to be part of the cost price. 20. In relation to land being treated as trading stock, in Taxation Determination TD 92/124 - Income tax: property development: in what circumstances is land treated as 'trading stock'? , paragraphs 1 and 2 state that: 1. Land is treated as trading stock for income tax purposes if: • it is held for the purpose of resale; and • A business activity which involves dealing in land has commenced. 2. Both the required purpose and the business activity must be present before land is treated as trading stock. The business activity is taken to have commenced when a taxpayer embarks on a definite and continuous cycle of operations designed to lead to the sale of the land. | Detailed Reasoning - Application to the circumstances: 21. According to the legal principles established in Kurts , and the Commissioner's view in TD 92/124, it can be concluded that: c) the land the Trust developed is trading stock for income tax purposes because it was held for the purpose of development and resale, and the Trust conducted a business involving dealing in the land; d) the costs relating to the conversion and maintenance form part of the infrastructure costs, which were incurred in creating the individual lots as trading stock and hence are deductible to the Trust as a general deduction under section 8-1, pursuant to subsection 70-5(2); e) the costs therefore form part of the cost price of the subdivided lots for trading stock purposes; and f) the Trust is required to account for the value of trading stock for tax purposes in accordance with Division 70. 22. Section 70-15 relevantly provides the rules on which income year an outgoing for trading stock is deducted. Section 70-15 states that: 70-15(1): This section tells you in which income year to deduct under section 8-1 (about general deductions) an outgoing incurred in connection with acquiring an item of trading stock. (The outgoing must be deductible under that section.) 70-15(2): If the item becomes part of your trading stock on hand before or during the income year in which you incur the outgoing, deduct it in that income year. 70-15(3): Otherwise, deduct the outgoing in the first income year: (a) during which the item becomes part of your trading stock on hand; or (b) for which an amount is included in your assessable income in connection with the disposal of that item. | Detailed Reasoning - Conclusion: 23. Based on the relevant facts and circumstances and the analysis above, it is concluded that: a) The Trust was carrying on a business of land development, subdivision and sale in respect of the project on the land; b) The costs relating to the further conversion and maintenance works formed part of the value of trading stock. The Trust is entitled to deduct these costs under section 8-1 and subsection 70-5(2) in the income years ended 30 June 20YY and 20YY. c) The Trust is required to apportion the deductions for these costs across the income years ended 30 June 20YY and 20YY on a reasonable basis.