Private ruling: CGT - isolated profit making transaction or mere realisation of a capital asset
Published: November 2014
Ruling period: Year ending 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: 1. Will the net profits from the sale of the duplex construction be considered assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as an isolated transaction? | A2: No.

Relevant facts and circumstances: You carry on a business as a sole trader. The turnover of your business is above the minimum threshold (currently $75,000) and as such you are registered for GST. You purchased a property. The property is a residential property. It has been rented during that time except for relatively short periods where it was empty for reasons beyond your control, but was available for rent through a real estate agent at those times. The property was not purchased for the purpose of redevelopment but as an investment. You are not a developer and have never undertaken a development project either personally or through any entity (partnership, trust, etc.) You wish to demolish the existing building and replace it with a duplex being new residential premises. You intend to sell the duplex.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 and | Income Tax Assessment Act 1997 Section 118-20.

Reasons for decision: Summary: There are three ways profits from a land subdivision 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. 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. 3. As statutory income under the capital gains tax (CGT) legislation, (sections 10-5 and 102-5 of the ITAA 1997), on the basis that a mere realisation of a capital asset has occurred. | Detailed Reasoning - Carrying on a business of property development: It has been stated that you are not, nor have you ever been, in the business of property development and have no expertise relevant to property subdivision activities. Therefore, it is accepted that any proceeds received from the sale of the subdivided land would not be derived in the course of carrying on a business. However, whilst you are not carrying on a business of property development, the proceeds from the sale of your redevelopment may still be assessable as ordinary income, if those proceeds are considered to be from an isolated business transaction. | Detailed Reasoning - Isolated commercial transaction with a view to profit: Profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business ( FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium). Taxation Ruling TR 92/3 considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income. TR 92/3 defines the term 'isolated transactions' as: • transactions outside the ordinary course of business of a taxpayer carrying on a business, and • transactions entered into by non-business taxpayers. 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. If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayers business but: • 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. Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of subdivided land can be assessed as ordinary income within section 6-5 of the ITAA 1997. TR 92/3 lists the following factors to be considered: 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. In addition to the above general factors, Miscellaneous Taxation Ruling MT 2006/1 provides a list of specific factors relevant to isolated transactions and sales of real property. If several of the 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: n there is a change of purpose for which the land is held; n additional land is acquired to be added to the original parcel of land; n the parcel of land is brought into account as a business asset; n there is a coherent plan for the subdivision of the land; n there is a business organisation - for example a manager, office and letterhead; n borrowed funds financed the acquisition or subdivision; n interest on money borrowed to defray subdivisional costs was claimed as a business expense; n there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and n 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. | Detailed Reasoning - Application to your circumstances: You are considering redeveloping the land on which you had been generating residential rental income. You plan to construct a duplex structure and sell the properties at a profit. Therefore there has been a change of purpose for which the land is held. You will have to carry out a number of activities such as approval for the subdivision, planning and building of the dwellings, borrowing of money to complete the construction of the dwellings and then the sale of the properties. The activities proposed will amount to more than the mere realisation of an asset to its best advantage. There is a coherent plan in place to carry out a sequence of actions that will result in a profit, there is a level of development of the land beyond that necessary to secure council approval and new buildings will be erected on the land. On a weighing of the facts of your case we find that the proposed development of land and sale of the duplex will constitute an isolated profit-making scheme. Accordingly, the proceeds will be considered ordinary assessable income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Assessable under the capital gains tax provisions: Section 118-20 of the ITAA 1997 primarily exists to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. In the absence of such a provision, it is conceivable that a receipt properly characterised as ordinary income and which has also been derived as a result of a CGT event could result in the receipt being taxed twice. Therefore, whilst CGT event A1 will happen upon sale of the duplex, any capital gain will be disregarded to the extent of any amount already included as ordinary assessable income under section 6-5 of the ITAA 1997.

2. Will the net gain from the sale of the duplex construction be taxed under the capital gains tax provisions of the ITAA 1997 as a mere realisation of a capital asset?