Derivation of income: pre-completion sales contracts

If a property developer enters into a sales contract prior to completion of construction (known as a pre-completion contract or an off the plan sales contract), are the amounts receivable pursuant to the contract included in assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) at the time of entering into that contract?

No. The amounts will only be included in assessable income of the property developer under subsection 6-5 of the ITAA 1997 once all contingencies under the contract cease to exist.

The taxpayer carries on the business of property development and purchased land for the purpose of developing a mixed residential and commercial complex. The taxpayer retained ownership of the property throughout the course of development.

The taxpayer entered into a contract with a builder to construct the entire project. Prior to construction commencing, the taxpayer entered into a number of pre-completion sales contracts for both the residential apartments and commercial complex. Purchasers paid a deposit upon entering into the contract with the balance due at settlement which followed completion of the project.

The project was deemed complete when an occupancy certificate had issued in respect of building completion and a strata plan had been registered.

The land and buildings were trading stock of the property developer.

Subsection 70-80(1) of the ITAA 1997 provides that the proceeds from the disposal of trading stock are to be included in assessable income as ordinary income. Under subsection 6-5(2) of the ITAA 1997 a taxpayer is required to include in assessable income the ordinary income it derives during the income year.

In Commissioner of Taxes (S.A.) v. Executor Trustee and Agency Co. of South Australia Ltd (1938) 63 CLR 108 (Carden's Case) it was established that the method of accounting for assessable income should be such that it provides a 'substantially correct reflex of the taxpayer's true income'. Barratt and Others v. Commissioner of Taxation (1992) 36 FCR 222; 92 ATC 4275; (1992) 23 ATR 339 is authority for the proposition that income is derived when there is a present right to receive a quantifiable amount that is not subject to any contingency or defeasibility. In J Rowe and Son Pty Ltd v. Federal Commissioner of Taxation (1971) 124 CLR 421; 71 ATC 4157; (1971)2 ATR 497 the court indicated that income from the sale of stock is derived when the stock is sold and a debt is created.

In Gasparin v. Commissioner of Taxation (1994) 50 FCR 73; 94 ATC 4280; (1994) 28 ATR 130 ( Gasparin ), the Full Federal Court held that income from the sale of allotments of land, which formed the taxpayer's trading stock, was not derived when the contracts for sale became unconditional. Rather, the income was derived once settlement occurred.

In its judgment, the court referred to the statement of Mason CJ in Sunbird Plaza Proprietary Limited v. Maloney and Anor (1987-1988) 166 CLR 245. In that case, a contract for the sale of a home unit provided for a 10% deposit on exchange of contracts and the balance within 14 days notice of the registration of a building unit plan. Settlement had not taken place and there had been no conveyance when the matter came before the court. His Honour said: Here the balance of the purchase price was payable 'upon settlement'. Settlement has not taken place and there has been no conveyance of the property being sold. Once this is accepted, the appellant is faced with a daunting task in making good the submission that the respondent guarantors are liable under their joint and several guarantee to pay the balance of the purchase price and interest thereon, notwithstanding the absence of an accrued liability on the part of the purchaser to make the payment.

In Gasparin , the court determined the following: • the trading stock was real property and the allotments remained registered in the name of the vendors until settlement • until settlement the vendors had not lost dispositive power and had not ceased to have proprietary interest in the land • the allotments remained trading stock on hand until each transaction proceeded to the point where a debt accrued due from the purchaser, and • it was only when all contingencies and uncertainties are satisfied that a debt, being a sum certain, accrued due to the taxpayer and it was at that point that income was derived for the purpose of levying taxation (that is, at settlement).

In this instance, the units making up the mixed residential and commercial complex remain trading stock of the taxpayer until each transaction proceeds to the point where a debt accrues from the purchaser. They remain registered in the name of the taxpayer and it is not until settlement that the taxpayer loses dispositive power and ceases to have any proprietary interest in the property. It is only at settlement, when all contingencies and uncertainties cease to exist, that a debt accrues due to the taxpayer and income is derived for the purposes of levying taxation.

Therefore, the amounts receivable are to be brought to account as assessable income under subsection 6-5(2) of the ITAA 1997 at the time of settlement