"The Taxpayer" and Commissioner of Taxation

[2006] AATA 508

Administrative

Appeals

Tribunal

 

DECISION AND REASONS FOR DECISION [2006] AATA 508

ADMINISTRATIVE APPEALS TRIBUNAL      )

)          No WT2004/380

TAXATION APPEALS DIVISION		)
Re		“THE TAXPAYER”

Applicant

And COMMISSIONER OF TAXATION

Respondent

DECISION

Tribunal Mr A Sweidan Senior Member

Date12 June 2006

PlacePerth

Decision The Tribunal affirms the decision under review.

.............[Sgd. Mr A Sweidan] ....................

Senior Member

CATCHWORDS: Income Tax – whether units held as trading stock – capital gains tax provisions not applicable.

REASONS FOR DECISION

12 June 2006 Senior Member A Sweidan           

1.      In this matter the applicant seeks a review by the Tribunal of a decision by the respondent disallowing an objection lodged by the respondent to an assessment issued by the respondent for the year ended 30 June 2003.

2. The applicant was assessed by the respondent to taxation on an amount of $91, 633 under section 92 of the Income Tax Assessment Act 1936 (Cth) as income from the share which the applicant had in a partnership, being the applicant’s share of the partnership’s net income.

3.      The applicant contended that the applicant was entitled to the small business 50 percent reduction under sections 152-205 of the Income Tax Assessment Act 1997 (Cth) (“ITAA 1997”) on the grounds that the amount in question represents capital gains derived from a sale of assets of the partnership under section 108-5 of the ITAA 1997.

4.      The respondent determined that the share of the net profit from the “Gordon Project” (see further below) was not a capital gain but constituted ordinary income derived from the sale of trading stock and accordingly any capital gain made on the disposal of those units is disregarded under paragraph 118-25(1)(b) of the ITAA 1997.

5.      The applicant was represented at the hearing by Mr P Nettleton, solicitor, and the respondent was represented by Mr J D Allanson of counsel. The Tribunal had before it the “T Documents” as well as a number of other exhibits.

6.      The parties also filed a statement of agreed facts. That statement reads relevantly as follows:

FACTS

Overview

1.   The Applicant is a private Australian resident company.

2.   In 2000, the Applicant entered a partnership with Tifad Developments Pty Ltd (Tifad). There was no written agreement but a verbal agreement under which the Applicant and Tifad were to contribute equally to the costs and share equally in the profits of the partnership.

The Gordon Project

3.    On 8 November 2000 the partnership purchased two properties at Gordon in the State of New South Wales, for the purpose of developing the properties and building units on them (the Gordon Project).

4.    The properties were purchased for a total of $2.6m. The total cost of construction in the development was $6,369,750.

5.    The costs of the project were financed by the partnership obtaining loans from financial institutions. The partnership established bank accounts for the Gordon project. All expenses of the project were paid by the partnership.

6.    Proceeds of the sale of the units were paid into the partnership accounts.

The Turrumurra Land

7.    On or about 4 July 2002, the Applicant on its own behalf contracted to purchase property at Rohini Street, Turramurra in the State of New South Wales for a purchase price of $900,000.

The Applicant’s Returns

8.    The Applicant filed income tax returns for the years ended 30 June 2001, 2002 and 2003. In those returns the Applicant declared an amount as income from its individual interest in the net income of the partnership as follows:

8.1in the year ended 30 June 2001, gross distribution from partnership (loss) of $7147;

8.2in the year ended 30 June 2002, gross distribution from partnership of $374,487;

8.3in the year ended 30 June 2003, gross distribution from partnership of $91,633.

9.    On 16 January 2004, the Respondent issued a notice of assessment of income tax for the Applicant for the year ended 30 June 2003 including the amount of $91,633 in the Applicant’s assessable income.

The Objection

10.  By notice of objection dated 24 February 2004, the Applicant objected to the assessment on the grounds that the amount of $91,633 was not ordinary income but was a capital gain. The Applicant claimed:

10.1during the year of income, it carried on business primarily as a landlord and not as a property developer;

10.2the purchase of the land at Gordon was incidental to that primary business, and the intention of the Applicant was to rent out the units and derive rental income from them;

10.3the Applicant sold the units in the Gordon project to raise capital for the investment in the purchase of the Turramurra property on which it intended to build shops and offices.

11.  On 15 July 2004 the Respondent disallowed the objection.

7.      The applicant’s director Mr John Franze gave evidence at the hearing of the matter before the Tribunal. Prior to the hearing the applicant filed a witness statement from Mr Franze. Paragraphs 2 to 19 of that statement read as follows:

2.    I am a director and shareholder of …, the Applicant herein (“Company”).

3.    In or about 1994, the Company entered into a lease agreement as tenant of a shop at 101 Pittwater Road Kilara for the purpose of opening a retail charcoal chicken business.

4.    The business was successful and the Company sold it in or about April 1995 for $200,000.00.

5.    The Company then entered into a contract for the purchase of a property at 14A Hannam Street Beecroft (“Beecroft”) for $435,000.00. Beecroft consisted of a shop and a residential unit.

6.    The Company refurbished Beecroft and leased the shop to a retail charcoal chicken business and the unit to a residential tenant.

7.    On 12 September 1997, the Company entered into a contract to purchase another property at 60 Bronti Road Bondi Junction (“Bondi Junction”). That property consisted of a commercial shop and a residential unit upstairs.

8.    The Company refurbished Bondi Junction also and leased the shop to a charcoal chicken business and the unit to LJ Hookers Real Estate agents.

9.    The Company still owns Bondi Junction.

10.  In or about November 1997, the Company sold Beecroft to the owner of the charcoal chicken business for $900,000.00. The proceeds were used to partially retire debt of the Company.

11.  In or about November 2000, the Company entered into a partnership with Tifad Developments Pty Ltd (“Tifad”) to purchase two parcels of land at Gordon to build units (“projects”). This was the first and only time the Company had entered into such an arrangement.

12.  The full amount of funds for the project were borrowed from bankers.

13.  The project was completed in one stage.

14.  The principals of both partners worked at the project, taking time off from their normal occupations to do so. They personally supervised subcontractors hired to carry out parts of the project such as concreters, plumbers, electricians, and painters’ etcetera.

15.  The project was undertaken with the intention of developing and renting out the units but if an opportunity arose, it was going to be sold.

16.  The partnership kept separate books from the partners’ usual books and another accountant dealt with the BAS preparation and accounts.

17.  Once the project was completed, the partnership dissolved.

18.  The directors then came across another property at Turramurra (“Turramurra”) which they considered to be a better investment than the Gordon project. They decided to sell the units in the project to repay the loans and invest the gain in Turramurra.

19.  The units were sold by 2003 through agents who had been appointed specifically for the project.

8.      When Mr Franze gave evidence he said that the statement was incorrect in that he said “I don’t agree that I’m called a developer. I purely buy commercial properties to rent and purely rent. And the incident we are talking about in Gordon where I entered into a partnership was a purely one off incident.” However he did not dispute the statement in paragraph 15 that “if an opportunity arose, it was going to be sold”.

9.      Under cross-examination Mr Franze said that the applicant and its partner Tifad built 12 units on the Gordon property all of which were sold.

10.     Mr Franze further testified that the partnership borrowed close to $9,000,000.00 to purchase and develop the property and that this was on short term finance. The borrowings were “until we sold them”. He also said that “once we had rented all the units we could have then approached the banks again and got a fixed loan like I do for my normal business.” He acknowledged that the rental returns, if the completed units had been let, would not have covered the interest payments but said that the applicant had other money and other sources of income that would have offset it. However, under cross-examination it emerged that in the relevant year the applicant company only had other income of approximately $3,000.

11.     Further under cross-examination Mr Franze said that when the property was purchased it was a condition of the contract that if the units were sold they had to be sold through a particular agent and that there was an agent for sale from the time the property was bought. He went on to say that the agent was engaged properly six months into the project and that some sales were made “off the plan” and that in about May or June 2001 ie prior to completion, the units were already being advertised for sale. Three units were sold in December 2001 and three in January 2002 so that six of the twelve units were sold within two months of practical completion.

12.     Mr Franze confirmed that none of the units were retained by either of the partners and no unit was ever rented by them.

13.     Mr Franze said that the reason that the Gordon units were sold was because a better opportunity to purchase land at Turramurra came up and that this led to a change of intention. However, he acknowledged that the Turramurra land was not purchased until July 2002 and further that it was only close to when it was bought that the Turramurra land became attractive to purchase although he had been aware of it for some time previously.

14.     It is clear from the evidence of Mr Franze that the units at Gordon had been advertised for approximately a year prior to the time that the Turramurra land was purchased.

Contentions

15.     The applicant contended that the Gordon land was purchased not for development and sale, but for development and retention so that the units could be leased out to obtain rental income. However, the respondent contended that the applicant’s statement that it intended to hold the Gordon land as an investment following completion of the development is completely inconsistent with the way the project was initiated, the way in which the project proceeded and the way in which the units were sold. The respondent pointed to the fact that the finance for the project was short term and the interest burden was beyond the apparent capacity of the applicant to meet.

16.     The respondent contended that the applicant and its partner were clearly carrying on a business being the development and sale of the units and that the profit derived from the sale of the units was income according to ordinary concepts, being gains made in the ordinary course of carrying on a business. Furthermore, the partnership tax returns show that the land bought by the partnership and developed was treated as trading stock in their accounts, albeit that the applicant’s accountant said in a letter to the respondent that this was only done pending the outcome of a ruling application which had been lodged by the applicant.

17.     The respondent contended that the applicant’s explanation that there was a “change of mind” when a better investment, being the Turramurra land, became available to it does not fit the chronology because on the applicant’s own version of events the Gordon land had been advertised in May or June 2001 and the Turramurra land was only purchased in July 2002.

18.     The Tribunal finds that, as contended by the respondent, the applicant and its partner were, having regard to all of the facts as set out above, in fact carrying on a business in relation to the purchase, development and sale of the Gordon property. The applicant failed to discharge the onus which rested on the applicant of showing that as alleged by the applicant the property was purchased for the purpose of developing units and holding them for long term rental purposes.

DECISION

19.      In the circumstances the capital gains tax provisions which the applicant sought to have applied to the profit realised by the applicant from the sale of the units have no application as the units were, in the Tribunal’s view, quite clearly held as trading stock, and the profit derived from their sale is taxable as ordinary income.

20.     Accordingly, the Tribunal affirms the decision under review.

I certify that the 20 preceding paragraphs are a true copy of the reasons for the decision herein of Mr A Sweidan, Senior Member

Signed:         ........[Sdg. R Riberi ].....................................
  Associate

Date of Hearing  11 April 2006
Date of Decision  12 June 2006
Counsel for the Applicant          
Solicitor for the Applicant          Mr P Nettleton, Brett Davies Lawyers
Counsel for the Respondent     Mr J D Allanson
Solicitor for the Respondent     Mr G Windsor, Australian Government Solicitor