Private ruling: Sale of property - loss - deductions - carrying on a business - isolated transaction - mere realisation
Date of advice: 30 March 2016
Published: May 2016
Ruling period: 30 June 2015.
Date scheme commenced: 1 July 2014.

Ruling: Q1: Will you be eligible to claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for your share of the loss made on the sale of the property? | A1: No. | Q2: Will the loss from the sale of the property be subject to the capital gains tax (CGT) provisions under Part 3-1 of the ITAA 1997? | A2: Yes.

Relevant facts and circumstances: In 20XX, you and your spouse made the decision to enter into the property market. You had a strict budget and due to your strict situation, your options were limited to a capital city or an area of a specific state. You and your spouse opted for state option. Prior to the purchase of the property you and your spouse conducted research of properties in the relevant state from a number of sources, such as magazines and websites. Your research indicated that from around January 20VV to about December 20XX, the median house price in the area you were looking to purchase a property had increased over $60,000 for a three bedroom house. Statistics from the area you were interested in showed strong growth around March 20XX, up by over 70% which had been encouraging due to the area in which you were interested in being close to two cities. New building approvals were also up during the 20WW-20XX income year in one of the nearby cities, showing consumer confidence in the area. Relying on this information you and your spouse were confident of property growth in the relevant region based on the upwards trend. Your spouse's parent, Person A, lives in the area you were interested in buying a property and purchasing a property in that area ensured that you and your spouse had accommodation options and extra labour support for the proposed project. Around June 20XX, you and your spouse signed a contract to purchase the property for over $200,000. The land area of the property is 2 acres. Around September 20XX, settlement on the purchase of the property occurred. Once you had sourced the property for the project, the title of Person A's property was used to secure finance for the project. The total budget for this project was between $60,000 and $80,000. You noted that the pricing trends might allow for a profit of about $80,000 if the property was to be sold once the renovations were completed. Once the settlement on the purchase of the property had occurred, you commenced the renovation work on the property with the majority of the planning having already taken place due to the time taken to secure the finance and the settlement period. The following work was undertaken on the property from just prior to settlement on the purchase of the property occurring until around 22 months after settlement occurred: • Photograph and take internal and external measurements of the property • Kitchen supplier measure and quote • Preparation of kitchen area for installation, wallpaper removal, mould remediation, replacement of kitchen window and flooring • Internal wall and doorway removal and repositioning, conversion of pantry into bathroom • Installation of kitchen, installation of plumbing in the bathroom, tiling bathroom and kitchen • Colour bond roof and veranda repairs/replacement • Bathroom accessory fit out • Timber floor sand and seal • Exterior roof painting • Internal painting including the painting of internal pressed tin ceilings in each room • Internal painting and electrical installations of light fittings and hot water service • Laundry construction including plumbing, electrical, tiling and cupboard and bench installation • Weatherboard replacement and preparation for painting • Complete painting exterior weatherboards and installation of cast iron fireplace inserts • Painting internal/exterior timber door frames and windows; and • Demolition and re-construction of veranda You spent the following on the project: Expense Amount Retail Over $25,000 Trades Over $45,000 Fares Over $ 5,000 Financial Institute Over $70,000 Real Estate Over $10,000 Utilities Over $ 5,000 You and your spouse maintained your employment roles and would undertake work on the property at every opportunity, and planned the renovation work around your annual leave and public holidays to maximise the time available. Those periods were for differing numbers of days, ranging from around 5 days to less than 20 days on each occasion. Mid-way through the renovations, the state's biggest industry provider (Company A) went into liquidation and the property market froze with a lack of buying confidence in the market. The renovation project was completed over a two year period, comprising of over 10 visits and around 12 weeks of work. A reasonable sale price was determined in close consultation with the local real estate agents. The property was put on the market over two years after settlement on the purchase of the property occurred. The property was on the market for over two years. During this time, the real estate agent handling the sale of the property recommended that you and your spouse consider using the property as a rental property. However, you continued with your plan of selling the property and releasing the title to Parent A's property. The property was not rented out during your ownership period. A contract for the sale of the property was signed around 46 months after settlement on the purchase of the property had occurred with settlement occurring around four years after the settlement on the purchase of the property had occurred. You and your spouse have made a loss on the sale of the property.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 102-20 | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Section 995-1

Reasons for decision: Detailed Reasoning - Deductibility of losses: Section 8-1 of ITAA 1997 allows as a deduction losses and outgoings incurred in the gaining or producing of assessable income unless they are capital, private or domestic outgoings. To determine whether the proceeds from the sale of a property should be treated as revenue or capital, we need to consider whether a business is being carried on, an isolated transaction has occurred, or if it is a sale of a capital asset. Application to your situation We have considered the nature of your situation to determine whether you are entitled to claim deduction losses arising in relation to the purchasing, renovation and sale of the property as follows: | Detailed Reasoning - Carrying on a business: Section 995-1 of the ITAA 1997 states the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee. To determine whether an activity, or series of activities, amounts to a business, the activity needs to be considered against the indicators of a business established by case law. In the High Court of Australia case of Hope v. Bathurst City Council (1980) 144 CLR 1; (1980) 29 ALR 577; (1980) 80 ATC 4386; [1980] HCA 16, a business was described in the following ways: It is the words "carrying on'' which imply the repetition of acts and activities which possess something of a permanent character. …activities engaged in for the purpose of profit on a continuous and repetitive basis. Transactions were entered into on a continuous and repetitive basis for the purpose of making a profit…manifested the essential characteristics required of a business. The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 (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 • whether the activity is better described as a hobby, a form of recreation or a sporting activity. In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour. Application to your situation After reviewing the information and documentation provided, it is the Commissioner's view that your activities are not those of an entity carrying on a business of renovating and selling properties. The activities undertaken do not display the salient indicator of a business, which are transactions entered into on a continuous and repetitive basis. The renovation and sale of the property is a small project that was not carried on in a manner similar to other business involved with the buying, renovating and selling of properties. Therefore, any expenses incurred in relation to the renovation and sale of the property will not be deductible under section 8-1 of the ITAA 1997 from the carrying on of a business. | Detailed Reasoning - Isolated transaction: Taxation Ruling TR 92/4 (TR 92/4) provides guidance in determining whether losses on isolated transactions are deductible. The ruling considers the application of the High Court decision in FCT of T v Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693. Paragraph 16 of that ruling says that a loss from an isolated transaction is generally deductible if: (a) in entering into the transaction the taxpayer intended or expected to derive a profit which would have been assessable income; and (b) the transaction was entered into, and the loss was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction. Paragraph 15 of TR 92/4 refers to considerations outlined in Taxation Ruling TR 92/3 (TR 92/3), which deals with profits made on isolated transactions, as being relevant to the deductibility of losses on isolated transactions. TR 92/3 provides guidance in determining whether profits from isolated transactions are taxable. A profit from an isolated transaction is generally income when both of 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 relevant intention or purpose of a 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. Paragraphs 46 onwards of TR 92/3 provide advice on what constitutes a business or commercial transaction. Paragraph 49 of TR 92/3 lists the following factors which may be relevant in determining whether an isolated transaction amounts to a business operation or commercial transaction: • the nature of the entity undertaking the operation or transaction (e.g. a company with substantial assets, rather than an individual, may be an indication that the operation or transaction was commercial in nature); • the nature or scale of the other activities undertaken by the taxpayer; • the amount of money involved in the operation or transaction; • the nature, scale and complexity of the operation or transaction; • the manner in which the operation or transaction was entered into or carried out (e.g. were professional agents or advisers used and was the transaction in the public market); • the nature of any connection between the relevant taxpayer and any other party to the operation or transaction (e.g. whether it was within a family unit); • if the transaction involves the acquisition or disposal of property, the nature of that property (e.g. was there any other use of the property other than for trade); and • the timing of the transaction or the various steps in the transaction (e.g. if the relevant transaction involved the acquisition and disposal of property, the holding of property for many years may indicate there is no business or commercial transaction). Application to your situation When determining whether your activities are those of an isolated transaction, we have taken the following into consideration: • you argue that your intention was for you and your spouse to renovate a property with the intention of selling it at the completion of the renovation works to make a profit, with the profit then being used to source another property and do the same thing. • you claimed that due to the size and complex nature of the project, and knowing the importance of completing the works in a timely manner, you and your spouse had carried out work on the property at every opportunity • you advised that you and your spouse undertook the renovations to the property when you could and planned the renovation work around your annual leave, and public holidays, spending less than 20 days on the renovations on each occasion. It took around two years for the renovations to be completed. • the property was put on the market over two years after it was purchased and the sale contract was not entered into until over four years after the property had been purchased; and • Company A went into liquidation after you had purchased the property. You stated that as your property was large enough, being 2 acres and rural and semi-rural, it suited that industry and machinery could easily be stored on it; and • you had estimated that around 25%-45% of your buyer's market was eliminated with the Company A liquidation. As a result of the liquidation of Company A, there was increased pressure to complete the renovations and sell the property as the profit margin would be reduced. Based on the information provided, it is not viewed that the scale and complexity of your renovation project is of the nature, scale and complexity that would expected of entities undertaking renovation projects in a commercial transaction. Your renovations took around two years to complete, with you and your spouse working during the occasions you had a break from your employment, spending over 10 periods of around 5 to 15 days completing renovation work on the property. The manner in which you undertook the project is not viewed as being undertaken in a manner that an entity undertaking a commercial transaction would complete the project where the objective would be to renovate and sell the property as quickly as possible to reduce the amount of interest on any borrowed funds and to obtain the profit from the sale of the property as quickly as possible. It would be expected that an entity undertaking a commercial transaction would have an exit strategy to enable them to determine when they should sell the property to reduce the likelihood of making any losses. When Company A went into liquidation it would be reasonable to expect that you and your spouse would have assessed whether or not to proceed with the project given the market conditions, to have not undertaken the renovations to the extent that you had, or to have sold the property as soon as possible prior to, or shortly after Company A went into liquidation to reduce the likelihood of any losses. Based on the information provided, it is not viewed that your renovation activities and the sale of the property were an isolated transaction. Therefore, any expenses incurred in relation to the renovation and sale of the property will not be deductible under section 8-1 of the ITAA 1997 from the undertaking of an isolated transaction. | Detailed Reasoning - Conclusion: In many instances, it is obvious that an activity is being carried on as a business or is an isolated transaction and no further investigation is required. Where it is less obvious, regard must be had for any other potential outcome when determining whether a particular activity should be considered to constitute a business, an isolated transaction or a mere realisation and in determining the tests are to be applied in reaching such a determination. There are many decided cases that consider the issue where the potential outcome is between 'business or hobby' or 'employee or independent contractor' (with an independent contractor being considered to carry on a business). In this case, we are considering the question of 'Are you carrying on a business' with the other potential outcome being that the activity constitutes an investment that generates assessable income. There are many decided cases that consider the issue where the potential outcome is between 'business or hobby' or 'revenue or capital'. In this case, we are considering the question of whether or not your activities constitute an isolated transaction. You made reference in the private ruling application to the Federal Court decision in August v FCT [2012] FCA 682. In that case, the Federal Court held that income the taxpayers had received as beneficiaries of a number of trusts was income according to ordinary concepts and not of a capital nature. The Commissioner considers matters on a case by case basis according to the facts of that case. Therefore, we have taken the factors outlined above into consideration and applied them to the facts of your situation when making our decision as to whether or not your renovation project activities are those of someone carrying on a business of renovating and selling properties, an isolated transaction and a mere realisation. You argued that it was your intention to make a profit on the renovation and sale of the property, however no evidence has been provided to support that you had the sole intention of reselling it to make a profit. We consider that if your dominant purpose for the property was to renovate it and resell it at a profit it would be expected that you would put it on the market as a matter of priority, notwithstanding property market fluctuations, in order to minimize costs including interest obligations. Generally, taxpayers who intend conducting the renovations themselves, where the intention is to re-sell the renovated property for a profit, undertake the activity when they are able to dedicate their time fully to the project. Generally, taxpayers taking a long time to complete renovations and then sell the property are not considered to be commercial in nature given that the dominant motive should be to make a profit. You continued with the renovations after Company A's operations became stressed which resulted in a contraction in the buyer's market for this type of property. As outlined above, the Commissioner does not view your activities in relation to the buying, renovation and sale of the property were the same as the activities of someone carrying on a business, or an isolated transaction. On the basis of the above discussion, we consider that the loss that has been made on the renovation and sale of the property is capital in nature and is therefore not deductible under section 8-1 of the ITAA 1997. The loss was not incurred in gaining or producing assessable income and it did not occur as a result of an isolated transaction entered into for the purpose of profit. Therefore, proceeds from the property will be subject to the CGT provisions and any expenses incurred in relation to the buying, owning, renovating and sale of the property will be included in the cost base/reduced cost base of the property.