1 Is any part of the proceeds from the sale of Townhouse B assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Yes. Question 2 Will a capital gains tax (CGT) event occur on the sale of Townhouse B? Answer Yes. This ruling applies for the following period : Year ending 30 June 20XX Year ending 30 June 20XX The scheme commenced on: 1 July 20XX
On Date one, you commenced working at School A. You were employed as XXXX of Campus. At the time of your employment, you were renting an apartment type property nearby to minimise travel time due to the need to regularly return to school campus out of hours. You spend a lot of time training for sporting events, so residing close to work and suitable training locations is an important factor in your decision making. Being able to minimise travel time with a view to maximising your sports training and work inputs is important to you. You purchased a property (the Property) on Date two. The property consisted of a three bedroom house on a block approximately XXX square metres in size. You purchased the property as it was positioned around equal distance from both campuses of your employer thereby giving you manageable travel time should your role change. You originally purchased the property to live in with the potential to build something new to live in at a later date. Settlement occurred on Date 3. You have never lived at the property. You submitted a planning permit application on Date 4.
On Date 5, you commenced renting the property out. You commenced renting out the property as you had to live on site at your employment and accommodation was provided. On Date 6, you were appointed XXX at the Campus A of your employer. The planning permit was approved on Date 7. The planning permit was issued by the relevant council on Date 8 allowing the construction of two dwellings on the lot in accordance with the endorsed plans and subject to the conditions listed on the permit documentation. The following activities were undertaken in preparation for the subdivision; • land title survey • preparation of the relevant documentation in accordance with the Subdivision Act 1988 for lodging the plan of subdivision with council. Neither you nor any related entities have been involved in any subdivision activities or land development You have funded the subdivision activities using your savings and employment income. On Date 11, you received approval from the bank to refinance the property. On Date 11, you received approval from the bank for a construction loan. You ceased renting out the house on the property on Date 12.
The house on the property was demolished on Date 13. You began to consider subdividing and possibly selling one of the townhouses after demolition of the original dwelling occurred. Prior to that, depending on how your employment changed or stayed the same, you were considering moving back in or selling with an approved planning permit. By selling one of the townhouses, you are hoping to achieve a high enough price so that you can almost or completely pay off your mortgage. On Date 14, permission to subdivide was granted by the relevant council. You engaged Company A to design the dwelling. You engaged Company B to do the building. You engaged Company C to do the subdivision. The townhouses are expected to be completed within the next few months. The townhouses have several bedrooms each. You will move into one of the townhouses (Townhouse A) during the ruling period. You will sell one of the townhouses (Townhouse B) within the ruling period. You are not registered for GST.
Income Tax Assessment Act 1997 section 6-5 Income Tax Assessment Act 1997 subsection 70-10(1) Income Tax Assessment Act 1997 section 104-10 Income Tax Assessment Act 1997 section 108-5 Income Tax Assessment Act 1997 section 118-120 Income Tax Assessment Act 1997 section 995-1 Income Tax Assessment Act 1997 Part 3-1
Question 1 Summary Part of the proceeds from the sale of Townhouse B will be assessable under section 6-5 of the ITAA 1997 . Detailed reasoning The proceeds from the sale of Townhouse B can be treated in the following ways: a) ordinary income under section 6-5 of the ITAA 1997 as a result of carrying on a business of property development, involving the sale of property as trading stock b) ordinary income under section 6-5 as a result of an isolated commercial transaction c) statutory income under the capital gains tax legislation. Ordinary income - held as trading stock and sold as part of carrying on a business Section 995-1 of the ITAA 1997 states that the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee. Trading stock is defined in subsection 70-10(1) of the ITAA 1997 as anything produced, manufactured or acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course of business, and includes livestock. Whether a business is being carried on is a question of fact and degree. Taxation Ruling TR 97/11
Income tax: am I carrying on a business of primary production? outlines the factors to be considered in determining whether a taxpayer is carrying on a business. Some of the factors that may indicate a business is being carried on are outlined in TR 97/11: (a) whether the activity has a significant commercial purpose or character; (b) whether the taxpayer has more than just an intention to engage in business; (c) whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity; (d) whether there is repetition and regularity of the activity; (e) 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; (f) whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit; (g) the size, scale and permanency of the activity; and (h) 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. Ordinary income from an isolated profit-making transaction The High Court's decision in FC of T v The Myer Emporium Ltd 87 ATC 4363 established that a profit arising from an isolated transaction will be income where the taxpayer's purpose in entering into the transaction was to make a profit. Taxation Ruling TR 92/3 Income tax: Whether profits on isolated transactions are income provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income. Paragraph 35 of TR 92/3 provides that a profit from an isolated transaction will generally be income when both of the following elements are present: a) The intention or purpose of the taxpayer in entering into the profit-making transaction was to make a profit or gain. b) The transaction was entered into, and the profit was made, in the course of carrying out a business or carrying out a business operation or commercial operation.
The relevant intention or purpose of the 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. 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 ( Federal Commissioner of Taxation v Cooling) [1990] FCA 297; (1990) 22 FCR at 57. Paragraphs 7 and 8 of TR 92/3 confirm that It is sufficient that profit-making is a significant purpose for entering into the transaction. If a transaction or operation is outside the ordinary course of a taxpayer's business, the intention or purpose of profit-making must exist in relation to the transaction or operation in question (paragraph 10 of TR 92/3). For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character (paragraph 12 of TR 92/3).
Paragraph 13 of TR 92/3 provides some factors to consider when determining whether an isolated transaction amounts to a business operation or commercial transaction. These factors include the following: (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 very general terms, a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations (paragraph 49 of TR 92/3). Generally, the taxpayer must have the requisite purpose of profit-making at the time of entering into the purchase of the property. However, if the taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either: (a) as the capital of a business; or (b) into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction. the activity of the taxpayer constitutes the carrying on of a business or a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income although the taxpayer did not have the purpose of profit making at the time of acquiring the asset. The case of McCurry & Anor v FC of T
[1998] FCA 512;98 ATC 4487 (McCurry) is a relevant authority which confirms that a transaction can be an isolated profit-making undertaking, even where the intention was not present at the time of acquiring the asset. In McCurry, two siblings purchased land in 19YY in NSW for $XX,000. They subsequently borrowed $XX,000 from a bank to enable them to construct three townhouses after demolishing an old house on the land. After being unsuccessful in their bid to sell the units prior to their completion, they lived in two of the units with various family members before successfully selling the units a year and a half later. Relevant factors in the conclusion that the activities went beyond the mere realisation of a capital asset were that the taxpayers put the properties on the market shortly prior to their completion, took no steps to acquire tenants, and it was likely that they would need to sell the properties at some stage to repay the substantial bank loan. In the words of the Court: Profit-making by the sale of the units always remained an option for the brothers, notwithstanding that, for some period, when it was convenient to do so, the units were used for another purpose.
Mere realisation Where the sale of a property is a 'mere realisation', the sale is on capital account and CGT rules will generally apply. These proceeds are not ordinary income. As outlined in paragraph 36 of TR 92/3, the courts have often said that the profit on the mere realisation of an investment will not be income, even where the taxpayer goes about the realisation in an enterprising way. However, where the original asset is transformed, this goes beyond a mere realisation of an investment. The extent of the transformation will be relevant when determining whether the undertaking is profit making in nature. In Whitfords Beach Pty Ltd v Federal Commissioner of Taxation (79 ATC 4648) Justice Deane stated:
Thus a goldsmith who sells in his shop his patrimony of a single gold bar does not necessarily receive the proceeds of sale as income merely because he takes advantage of his shop to sell his capital asset more advantageously. On the other hand, the master goldsmith who labours to turn such a gold bar into finely wrought brooches which he displays and sells with his other gold wares, could not be said to receive the whole of those particular brooches as capital merely because the gold from which they had been fashioned had not been acquired by him for the purposes of his business but had been received as a gift from his father. Where the original asset has been transformed so that it no longer retains its original character, the disposal of that asset will go beyond a mere realisation. Application to your circumstances
You are not in the business of property development. However, as outlined in paragraph 49 of TR 92/3, your transaction may constitute a profit-making undertaking, if but for missing the element of repetition, it has the character of a business operation or commercial transaction. Therefore, it is necessary to consider whether the sale of Townhouse B will be an isolated profit making transaction. At the time of purchasing the original property, you did so with the intention to initially live in the property and potentially build something new at a later date. However, once you demolished the original dwelling and subdivided it, your intention changed. Your intention to make a profit commenced on or about the time you made the decision to demolish the original dwelling.
Even though the transaction was a one-off, one of the dominant purposes for you entering into the transaction was to gain a profit on the sale. By demolishing the initial dwelling and constructing two new townhouses, you have transformed the nature of the asset. You are not selling the asset that you originally acquired but are selling an asset that has undergone significant transformation, such that you are hoping to be able to pay off your mortgage with the profits obtained. By selling Townhouse B, you are hoping to achieve a high enough sale price to be able to partially or completely pay off your mortgage. Therefore, you are hoping to make a profit. The sale of Townhouse B will constitute a profit-making undertaking as there is a transformation of the original asset as part of the sale process. The part of the proceeds that represents the net profit from the sale of Townhouse B will be assessable under section 6-5 of the ITAA 1997 as ordinary income. Question 2 Summary A CGT event will occur on the sale of Townhouse B. Detailed reasoning Section 108-5 of the ITAA 1997 provides that a CGT asset is any kind of property, or a legal or equitable interest that is not property.
Section 104-10 of the ITAA 1997 provides that CGT event A1 happens if you dispose of a CGT asset. Section 118-20 of the ITAA 1997 contains anti-overlap provisions which operate to reduce capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 of the ITAA 1997, for example, as ordinary income under section 6-5 of the ITAA 1997. Refer to QC 71028 Tax consequences on sales of small-scale land subdivisions on our website for worked examples of the income tax and GST consequences. Application to your circumstances As outlined in Question 1, the net profit from the sale of Townhouse B will be assessable under section 6-5 of the ITAA 1997. Townhouse B is a CGT asset. Therefore, the proceeds from the sale of Townhouse B will also be subject to the capital gains tax provisions in Part 3-1 of the ITAA 1997. On the sale of Townhouse B, CGT event A1 will occur. Any capital gain made on the sale of Townhouse B is included in your assessable income. You can reduce any capital gain from the sale of Townhouse B by the net profit amount from the sale you include in your assessable income.
As you have owned the property for at least 12 months, you meet the conditions for the 50% CGT discount on the sale of Townhouse B.