Trading stock: residential properties instalment sales contracts

Are residential properties 'trading stock' within the meaning of section 70-10 of the Income Tax Assessment Act 1997 (ITAA 1997), when they are held by a taxpayer engaged in a business of selling them under instalment sales contracts with vendor finance?

Yes. The residential properties held by the taxpayer are 'trading stock' for the purposes of section 70-10 of the ITAA 1997, provided they are held for sale in the ordinary course of the business of selling properties under instalment contracts.

Facts

The taxpayer carries on a business of buying and selling residential properties. The properties are sold under instalment sales contracts with vendor finance.

The instalment sales contract has the following features: • the sale price represents a profit over the investor's purchase price • the purchaser will pay the investor a deposit • vendor finance is provided to the purchaser with interest charged at a premium above the rate of interest paid by the investor on their mortgage on the property • payment of the balance of the price, plus interest, is by instalments over a substantial period such as 25 years • the deposit and instalments are not refundable • the purchaser is licensed to occupy and entitled to possession of the property during the term of the instalment contract • the contract states that this occupation or possession is not by way of lease • the purchaser is required to reimburse the investor for the rates and taxes on the property • the purchaser is required to keep the property in good condition and repair • the investor retains title to the property until the final instalment is paid and the contract is completed • if the purchaser defaults on the contract the deposit and instalments paid are forfeited to the investor.

The taxpayer did not use the properties for any other purpose prior to sale. The properties were sold for an amount that was in excess of the amount paid by the taxpayer to acquire the property. Each property was sold within six months of it being acquired by the taxpayer.

The term 'trading stock' is defined in section 70-10 of the ITAA 1997 as including anything produced, manufactured or acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course of carrying on a business.

Since the decision of the High Court in St Hubert's Island Pty Ltd v. Federal Commissioner of Taxation (1978) 138 CLR 210; 78 ATC 4104; (1978) 8 ATR 452 it has been clear that land may be 'trading stock'.

Paragraph 1.9 of the Supplementary Explanatory Memorandum - Senate, which accompanied the Tax Law Improvement Act 1997 stated that 'The expression "in the ordinary course of a business" was added to the definition to make clear that merely holding an asset for manufacture, sale or exchange will not make it trading stock.'

In John v. Federal Commissioner of Taxation (1989) 166 CLR 417 at 429; (1989) 20 ATR 1 at 8; 89 ATC 4101 at 4107 (the John Case) the majority of the High Court held that an item will be trading stock if 'the person is a trader in the goods which are claimed to be trading stock.' In addition, in the John Case the High Court stated that the relevant purpose did not need to be a dominant purpose.

The taxpayer is engaged in a business activity that consists of selling residential properties under instalment contracts. In selling the properties under an instalment contract, the taxpayer also derived interest income over the period of the sale contracts. Whilst the taxpayer may have held the property in order to derive this interest income, the property was also held for the purpose of sale.

In addition, the properties were held for the purpose of sale in the ordinary course of the taxpayer's business of selling residential properties under instalment contracts.

Accordingly, the residential properties held by the taxpayer and sold under instalment sales contracts are 'trading stock' for the purposes of section 70-10 of the ITAA 1997