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12/04/2017 | Matt Neibling structure, tax effective, event, property

Tax Events Series - Five Years On

Structuring tax-effective property transactions
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Our Tax Events seminar series is now in it’s fifth year, and still steaming ahead. We have seen more than 350 participants joining us so far for a compelling topic: “Structuring Tax-Effective Property Transactions”.

One of this seminar's presenters, Redchip’s Taxation Associate, Trung Vu, outlines below how vital the facts are in determining whether a property transaction is a mere realisation of a capital asset or a profit-making undertaking.

When we look at capital versus revenue to determine the nature of a property transaction, we consider the following:

  • The transaction is regarded as being a capital one when your activities in realising the land are passive in nature; or
  • It’s a revenue transaction if it’s acquired for a profit purpose, or the activities are commercial in nature.

Aside from the usual taxation implications of the distinction between capital and revenue transactions, there are other issues to consider – the availability of capital gains exemptions or concessions, deemed cost base rules when capital assets are assessed on revenue account and, finally, GST implications.

The starting point is always to consider the nature of the proposed transactions and determine their taxation characteristics, that is, whether the proposed transactions represent a “mere realisation” and therefore on capital account and prima facie subject to the CGT provisions, or whether the proposed transaction is on revenue account.

Mere realisation

There is a long history of cases to which we can refer in providing advice, particularly whether the disposal of the property is a mere realisation.

The case that started our thinking about the nature of these transactions occurred in 1904. If it is a mere realisation of a capital asset, it is therefore solely treated within the context of the CGT rules (Part 3-1 ITAA 1997).

One of the issues that often occurs with residential properties that are subsequently subdivided, is application of the CGT exemption for residential property provided by subdivision 118-B. Of particular note is the situation with “adjacent land”. To qualify for exemption under s118-120, the adjacent land must satisfy the following conditions:

  • Used primarily for private or domestic purposes in association with the dwelling;
  • Must not be disposed of separately from the dwelling, i.e. the same CGT Event must affect the land and the dwelling; and
  • The maximum area of the land (including the land under the dwelling) must not exceed 2 hectares.

In circumstances where property is initially acquired for a capital or private purpose, and subsequently applied by the taxpayer for use/conversion in a different manner to facilitate the disposal of the property, the taxation implications identified above have some practical impacts:

  • What are the factors that influence the taxation characteristics of the transaction? and
  • How do you calculate the assessable profit where the transaction is not a mere realisation?

Profit-making scheme 

Where a taxpayer’s activities and involvement with the development of the property go beyond a mere realisation, then section 6-5 ITAA 1997 will apply to assess the “profit”. It is to be noted that a profit-making scheme does not necessarily mean that the taxpayer is carrying on a business. For a business to be conducted, the types of factors outlined in TR 97/11 must be evident (referred to below).

Both from the case law and the ATO’s various rulings, an isolated transaction conducted outside the taxpayer’s usual business activity can still come within the ambit of section 6- 5. The taxation implications of an isolated transaction, and the directional legal precedents in relation to the subject, are fairly standard, although the defining factors are not.

What can be stated with a degree of certainty is that if a taxpayer:

  • Intends to undertake a profit-making scheme when the property was originally acquired, irrespective whether the strategy to implement that scheme is known, the resulting profit is assessable as ordinary income (note the loss would similarly be deductible).
  • Commences to apply the property for some commercially and profit-motivated purpose, it most likely the resulting profit will be assessable pursuant to section 6-5.

If a property has been applied to a profit-making scheme, the profit will be assessable when the property is sold. The elements of the profit calculation include:

  • The proceeds from the sale of the property;
  • The cost base of the profit; and
  • The development and financing costs

A full copy of the Structuring Tax-Effective Property Transactions paper is available for download, along with a webinar presented recently by Trung Vu.