Tax and GST issues with small property developments

1 Tax and GST issues with small property developments 22 May 2015 Greg Cahill Partner T 61 7 3231 2425 E Level 21, 400 George Street Brisbane 4000 Australia GPO Box 834, Brisbane 4001 Tax and GST issues with small property developments i CONTENTS 1. INTRODUCTION .. 1 2. ALTERNATIVE MODELS .. 1 3. MERE REALISATION .. 2 4. SOME 4 5. SOME RISK FACTORS .. 5 6. WHAT ARE THE CONSEQUENCES IF THE DEVELOPMENT IS NOT A MERE REALISATION? .. 8 7. CONSEQUENCES IF DEVELOPMENT IS A BUSINESS .. 8 8. WHAT IF THE DEVELOPMENT AMOUNTS TO A PROFIT MAKING UNDERTAKING BUT IS NOT A BUSINESS? .. 10 9. GST issues FOR small developments .. 11 10. CONCLUSION .. 13 Tax and GST issues with small property developments 1 of 13 1. INTRODUCTION There are many instances where landowners have an opportunity to subdivide and sell land they have owned for a long period of time.

2 This commonly occurs where primary producers own land on the outskirts of urban centres and residential expansion means that the best use of the land is for residential purposes rather than farming. In some cases, these property developments can be quite substantial with the prospect of large profits from the project. This raises the question of how the profit should be characterised. Generally there will be three alternatives. (a) The subdivision and sale of the land may qualify as a mere realisation of a capital asset. (b) The scale of the development may be such that it constitutes carrying on a business of property development. (c) The development may move beyond mere realisation of the land but fall short of the requirements for carrying on a business, in which case it will be characterised as a profit making undertaking or scheme.

3 Correctly classifying the activities will be very important, particularly where the land is a pre-CGT asset or the clients may be able to apply the small business concessions if they make a capital gain on disposal of the land (as opposed to ordinary profit form a development venture). There are also different GST outcomes if the project qualifies as a mere realisation rather than a profit making undertaking or business. In this paper I propose to consider the circumstances in which a small to medium subdivision may qualify as a mere realisation and when the project may become a profit making undertaking or business. The paper only deals with issues arising from raw land subdivisions and does no consider additional issues that arise where the development also involves the construction of improvements on the land ( strata title developments ).

4 I will also limit the discussion to the issues that are relevant if the property was not originally acquired with the intention of reselling at a profit or development as, in those situations, the profit will be ordinary income irrespective of how long the property is owned or whether the profit is generated from the precise means that were contemplated at the time of 2. ALTERNATIVE MODELS In situations where a party owns lands that is suitable for development and they want to ensure that profits from the development are treated as being on capital account, there are several common approaches that seem to be used in practice with the intention of preserving the capital status of the asset. The landowner can elect to sell the entire property in a single sale - generally to a developer. A sale of a single asset which has not been acquired for purposes of resale at a profit or development will qualify as a capital receipt.

5 However, the practical disadvantage of this is that clients will usually receive a lesser sum if they are selling to a developer who takes on the development risk. The landowner may undertake the development themselves. 1 Westfield Limited v Commissioner of Taxation [1991] FCA 86 and TR 92/3 Tax and GST issues with small property developments 2 of 13 In other cases, clients will enter into a joint venture arrangement with a developer where the landowner contributes the land and the developer entity provides expertise/finance with the profits from the project being shared. The agreement commonly provides that the landowner will get a fixed price for their land but this will be payable in instalments out of sale proceeds as the sale of lots to end buyers are settled.

6 I understand that the features and implications of this type of structure are being considered by another speaker at this seminar but it is worth noting that these arrangements will not qualify as a joint venture at law or under the GST Act. The objective with the joint development approach is generally to achieve an outcome where the landowner receives a greater sum than if they merely sold the land to the developer and to save stamp duty by leaving the land in the name of the landowner until developed lots are sold to end buyers. Also, if the landowner takes a passive role with the developer project managing (and often financing) the development, the landowner enhances the argument that the exercise is nothing more than a mere realisation of the capital asset. Where clients do not want to involve third parties but are concerned the ATO will argue the magnitude of the project is such that it will be classified as a land development business or profit making undertaking, a common approach is to adopt the joint venture model but with a related entity (usually a company).

7 The rationale behind this approach is that, because the landowner receives a fixed price for the land and is not actively involved in the development (in their personal capacity), the land value they receive will be characterised as capital from the mere realisation of their asset with the development profit being derived by their corporate co-venturer. In the balance of this paper I will consider various issues that may arise with each of these models in the context of the mere realisation/profit making distinction and the consequential GST implications. 3. MERE REALISATION There are numerous authorities that confirm that a taxpayer who has land which is a capital asset and who develops the land in an enterprising way can treat the profits from the realisation as capital if the development is nothing more than the mere realisation of the capital However, before embarking on a detailed analysis of what is required to establish that the development of land is a mere realisation, it is important to appreciate that, if the land was originally acquired for resale at a profit or development, the profit from the sale or development of the land will be assessable as ordinary income irrespective of the sale of the project.

8 Therefore when advising clients in relation to these issues it is important to ascertain whether there is any evidence of a profit making intention at the time of acquisition. This was the problem that confronted the taxpayer in Reiger and Commissioner of The taxpayer in that case argued they had acquired land near Noosa for the purpose of establishing a palm nursery and in fact did plant some palm trees on the property but did not go about this in a business like way. The problem for the taxpayer was that, some time after acquiring the property they said in a letter to the Noosa Shire Council that: 2 For example, Allied Pastoral Holdings v FCT 83 ATC 4015, Statham v. FCT 89 ATC 470 and Casimaty v FCT 97 ATC 5135. 3 [2002] AATA 88 Tax and GST issues with small property developments 3 of 13 I have bought the property with the intend (sic) to subdivide the land in accordance with the strategic plan in force at the time, thus creating the opportunity of having housing lots for my own family, my parents, my brother, other family members and other nature loving families This statement of intention to subdivide the land was fatal to the taxpayer s argument that their intention had been to establish a business on the land .

9 The ATO s views as to the issues the courts have considered in determining whether a taxpayer who develops land has undertaken a mere realisation or embarked on a profit making undertaking or business have been encapsulated in a number of public The mere realisation principle is succinctly stated in the commonly cited decision of Lord Justice Clerk in Californian Cooper Syndicates v Harris:5 It is quite a well settled principle in dealing with questions of assessment of Income Tax, that where the owner of an ordinary investment chooses to realise it, and obtains a greater price for it than he originally acquired it at, the enhanced price is not profit in the sense of Schedule SD of the Income Tax Act of 1982 assessable to Income Tax. But it is equally well established that enhanced values obtained from realisation or conversion of securities may be so assessable, where what is done is not merely a realisation or change of investment but an act done in what is truly the carrying on, or carrying out of a business.

10 In Westfield Limited v Commissioner of Taxation6 Hill J held that: Once it is clear that the activity of buying and selling, which generated the profit was not an activity in the ordinary course of business, or, for that matter an ordinary incident of some other business activity, the profit in question will only form part of the assessable income of the appellant by virtue of its being income in accordance with the ordinary concepts of mankind, if the appellant has a purpose of profit making at the time of Later in the judgment His Honour said that: While a profit-making scheme may lack specificity of detail, the mode of achieving that profit must be one contemplated by the taxpayer as at least one of the alternatives by which the profit could be It is difficult to conceive of a case where a taxpayer would be said to have made a profit from the carrying on, or carrying out, of a profit-making scheme, where, in the case of the scheme involving the acquisition and resale of land , there was, at the time of acquisition, no purpose of resale of land but only the the land may be The ATO appears to disagree with the views expressed by Justice Hill on this latter point (not withstanding that its application for special leave to appeal was rejected by the High Court).