WWXY and Commissioner of Taxation
[2015] AATA 130
•6 March 2015
[2015] AATA 130
Division Taxation Appeals Division File Number
2014/3293
Re
WWXY
APPLICANT
And
Commissioner of Taxation
RESPONDENT
DECISION
Tribunal Senior Member Bernard J McCabe
Date 6 March 2015 Place Brisbane The objection decision under review is affirmed.
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Senior Member Bernard J McCabe
CATCHWORDS
INCOME TAX ASSESSMENT AND PENALTY DECISIONS – Private ruling – Characterisation of proceeds of sale – Assessable income or capital gain – Objective of scheme – Finding that taxpayer was engaged in a business of property development – Profit-making purpose from time of acquisition – Profitable sale of property within taxpayer’s contemplation – Profits of sale assessable income – Decision under review affirmed.
LEGISLATION
Income Tax Assessment Act 1997 (Cth)
Taxation Administration Act 1953 (Cth)
CASES
Federal Commissioner of Taxation v McMahon (1997) 149 ALR 159
Federal Commissioner of Taxation v The Myer Emporium Ltd (1987) 163 CLR 199
Federal Commissioner of Taxation v Williams (1972) 127 CLR 226
Kratzmann v Federal Commissioner of Taxation (1970) 1 ATR 827
McClelland v. Federal Commissioner of Taxation (1970) 120 CLR 487
Westfield Ltd v Federal Commissioner of Taxation (1990) 21 ATR 784
Westfield Limited v Federal Commissioner of Taxation (1991) 99 ALR 510
REASONS FOR DECISION
Senior Member Bernard J McCabe
6 March 2015
The taxpayer is a corporate entity. It acquired two adjoining properties in suburban Brisbane: the first in March 2006 and the second in August 2007. The taxpayer proposed developing the two parcels as part of a joint venture with another company, but the original joint venture proposal came to nothing. The taxpayer decided to rent out the two properties in their unimproved state until they were sold during the year of income ending 30 June 2014. The sale occurred shortly after the taxpayer had obtained a development application (DA) with respect to the conjoined parcels.
The taxpayer asked for a private ruling in relation to the profit made on the sale of the properties. It says the sale of the properties was properly regarded as the realisation of a capital asset, so it should be assessed for capital gain pursuant to s 6-5 of the Income Tax Assessment Act 1997 (Cth) (ITAA97). The Commissioner’s ruling of 28 January 2014 (which was mistakenly dated 28 January 2013) concluded the sale yielded assessable income, and said it should be treated accordingly. On the Commissioner’s view, the sale was not simply the realisation of a capital asset: it was the end result (even if not the planned end result) of a commercial property development that commenced when the properties were acquired. The taxpayer objected to the ruling; the objection was disallowed on 21 May 2014. The matter has now come before the Tribunal.
ESTABLISHING THE FACTS
Private rulings are made pursuant to Division 359 in Schedule 1 to the
Taxation Administration Act 1953 (Cth). The private rulings system provides taxpayers with an opportunity to “obtain a quote” from the Commissioner as to how he believes the law will apply to a given set of facts. It follows it is important to get the facts clear in the ruling.There was some dispute over whether the description of the facts in the private ruling was sufficiently extensive. The taxpayer said the ruling should have acknowledged the taxpayer had not acquired any other land or buildings, and that the properties referred to in the ruling were the only real property owned by the taxpayer during the relevant years of income. The taxpayer argued this information was provided to the Commissioner in documents lodged in support of the ruling, but it was either ignored or misunderstood (see Submissions of the Applicant at [14]-[17]). In making that argument, the taxpayer runs up against the rule described in Federal Commissioner of Taxation v McMahon (1997) 149 ALR 159. In that case, the Full Federal Court explained (at 164)
the Commissioner must identify a set of facts in the ruling and offer an opinion as to how the law applies to those identified facts. Upon review of an objection to that ruling, the Tribunal is not empowered to consider different facts that would effectively redefine the arrangement in question. As Lockhart J explained (at 164-165), the Tribunal must do no more than “go over again” the arguments as to how the law should apply to the facts identified by the Commissioner in the ruling. The taxpayer says I can nonetheless have regard to the additional facts because (a) they merely added background but did not redefine the scheme; and (b) the ruling says the description of the scheme was based on the application for private ruling and the accompanying documents and noted: “[t]hese documents form part of and are to be read with this description [in the ruling]”
(T-Documents at p 131).The additional facts – if that is how they are properly characterised – do not have the effect of redefining the scheme. At best, they provide clarification. I assume the taxpayer wants to bring those matters to my attention because it might help dispel an impression that the taxpayer (as opposed to its directors) was engaged in a wider or long-standing business of property development. But I do not think the Commissioner is making a suggestion to that effect in any event. I am not satisfied the additional facts referred to by the taxpayer are decisive.
It follows I will focus, as required, on the scheme as identified in the ruling. That was explained as follows:
This ruling is based on the facts stated in the description of the scheme that is set out below…The arrangement that is the subject of the private ruling is described below.
This description is based on the application for private ruling dated 12 December 2013 and the accompanying documents.
These documents form part of and are to be read with this description.
You are a discretionary trust settled by a deed dated 20 August 2004 with
[the taxpayer] as your Trustee.The directors and shareholders of your Trustee are [name omitted] and
[name omitted]. Mr [name omitted] and Mr [name omitted] are named as your primary beneficiaries in the Trust deed.Mr [name omitted] and Mr [name omitted] have a history of property development through other entities. Their experience involved the physical construction of premises on land for the purposes of sale. Both have skills and expertise in the project management of construction activities.
The Property is comprised of two adjacent lots:
(a)[omitted] (‘Lot 1’), and
(b)[omitted] (‘Lot 2’).
Lot 1 was purchased and registered on 28 March 2006 with one derelict vacant house situated on the lot. It was leased to [name of tenant omitted] for a period of 18 months from July 2007 to December 2008 for use as a works depot.
Since 1 November 2012 the property has been let to [name of tenant omitted] for use as a works depot.Lot 2 was purchased and registered on 23 August 2007 with a tenanted house on the lot. The house has been continuously tenanted since the purchase of the property to you.
You acquired the Property with the intention of developing and selling it as part of a joint venture with [name omitted], a large property developer. An email, dated 6 February 2009, summarises discussions between [name omitted],
Mr [director of the taxpayer] and Mr [director of the taxpayer] regarding the joint venture.During the 2009-10 financial year the negotiations with [name omitted] fell through. You were unable to secure funding and decided to abandon your intention to carry on a development business and develop the Property.
You state that at this point you ceased to hold the Property as trading stock and began to treat it as a capital asset. The financial statement for the year ended
30 June 2012 shows an asset Land and Buildings with a book value of $3,068,367. You have not provided any details of whether you have acquired other land or buildings.You engaged an associated development management company, [name omitted] to obtain development approval (DA) for the Property to improve its anticipated price on sale. Mr [director of the taxpayer] is the sole shareholder and director of [company obtaining development approval].
The DA was obtained by [company obtaining development approval] on
20 September 2013 for development of the Property as a ten story residential development. You played no part in obtaining the DA.You engaged real estate agents to sell the Property on your behalf.
You entered into a contract on 9 December 2013 to sell the Property. The date for the settlement of the contract is 27 February 2014.
The DA is the sole improvement to the property and there has been no physical improvement to the property.
The respondent points out the text of the ruling referred to (and therefore incorporated by reference) information about the scheme contained in an email dated 6 February 2009 from officers of the taxpayer. Relevantly, that email provides:
Please find below a summary of our discussions (as best we can remember them) re a joint- venture for the site at [address of property].
1. [Name of prospective joint venturer] and [directors of taxpayer] to become joint owners on the property (structure to be discussed and agreed, tax provisions to be taken into account).
2. From this week forward [prospective joint venturer] and [directors of taxpayer] to share costs on an equal basis.
3. [Names of joint venturer and associated individuals] to be full guarantors of the existing loans of approximately $2.2 million. [Directors of taxpayer] (and their respective companies) to be released from all guarantor obligations.
4. [Prospective joint venturer] and [directors of the taxpayer] to move the project forward to Development Approval stage to achieve the best outcome possible for the site and JV partners. Upon receipt of a DA for the property, [prospective joint venturer] to pay [directors of taxpayer] a cash amount of $1.5 million. A second amount of $1.5 million is also payable, but can be raised as debt in the project. This second $1.5M is subject to a performance criteria of GFA achieved. This GFA figure is nominally 10,000 square metres for the full $1.5M payment. Ratchet provisions to be discussed and decided.
5. Moving forward to completion of the project, [prospective joint venturer] and [directors of the taxpayer] will organise equity and/or mezzanine requirements equally. [Prospective joint venturer and associated entities] remain sole guarantors of all debt (primary and mezz) for the entire project through to completion.
5. At completion, [directors of the taxpayer] receive a further $3.0M of proceeds as priority payment as the balance of the purchase price of the property.
6. After this priority payment, profits are shared equally between [prospective joint venturer] and [directors of the taxpayer].
Further items to be discussed:
Structure of entity;
Project Management (through to DA ad then from DA to completion);
Equity requirements, timing and options.
It seems likely the author of the email confused the identities of the taxpayer company and its directors. It is unclear why directors would be receiving payments in respect of a corporate opportunity, for example. But that is not a question that arises in the current proceedings, and the email’s intent is clear enough for present purposes.
SHOULD THE PROCEEDS OF THE SALE OF THE PROPERTY BE REGARDED AS ORDINARY INCOME OR CAPITAL GAIN?
The taxpayer’s argument
The land was sold at a profit. The answer to the question of how the profit ought to be taxed starts with s 6-5 of the ITAA97. That section says one’s assessable income includes income according to ordinary concepts, or ordinary income. Section 10-5 says assessable income also includes capital gains. The amount of any capital gain is worked out in accordance with s 102-5.
The taxpayer says the profit or gain cannot be regarded as ordinary income. For a start, it says the profit was not made in the ordinary course of carrying on a business.
The taxpayer argues (at [25] of its submissions) the scheme described in the ruling does not provide a basis for a finding that the taxpayer was conducting a business.
The taxpayer argues the facts of the scheme suggest – at most – the taxpayer “previously held an intention to carry on a business in respect of the development of the Property” [emphasis added]: taxpayer’s submissions, at [27]. The taxpayer argues there were no other developments underway or in contemplation during the relevant year of income. Indeed, it says there was little activity of any kind that would support a finding that the taxpayer was engaged in a business at the relevant time.A finding that the transaction did not occur in the ordinary course of a business does not, of itself, resolve the matter in favour of the taxpayer. As the High Court explained in Federal Commissioner of Taxation v The Myer Emporium Ltd (1987) 163 CLR 199,
a transaction might indeed be outside the ordinary course of a taxpayer’s business but the profits from that transaction will still be regarded as ordinary income if the transaction was part of a specific profit-making scheme: at 215 per Mason ACJ, Wilson, Brennan, Deane and Dawson JJ. In the course of discussing the specific example of a transaction that occurred following a change or realization of investments, the Court noted (at 213):
It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of acquisition of acquiring for the purpose of profit-making by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realization. But it is quite another thing if the decision to sell is taken by way of implementation of an intention or purpose, existing at the time of acquisition, of profit-making by sale, at least in the context of carrying on a business or carrying out a business operation or commercial transaction.
As Hill J explained in Westfield Limited v Federal Commissioner of Taxation (1991) 99 ALR 510 (at 519), the decision in Myer:
…emphasises that where a transaction occurs outside the scope of ordinary business activities, it will be necessary to find, not merely that the transaction is “commercial” but also that there was, at the time it was entered into, the intention or purpose of making a relevant profit. [Emphasis added]
It follows I must consider whether the facts set out in the Ruling suggest the taxpayer had in relation to the land dealing (as distinct from other activities) “the purpose of
profit-making by the means giving rise to the profit”: see Myer at 210.
The decision in Westfield, which post-dated the High Court’s decision in Myer, is of particular relevance to this enquiry. In Westfield, the developer acquired property which was intended to be developed as a shopping centre. The real objective of the acquisition was for use in negotiations over the redevelopment of an existing shopping centre that adjoined the site. The taxpayer wanted to use the land as a bargaining chip.
Those negotiations were successful: the taxpayer entered into an agreement with the owner of the neighbouring centre to redevelop and operate the centre. As part of the agreed outcome, the taxpayer sold the land it had acquired to the owner of the other centre at a profit. The Commissioner concluded the profits from the sale formed part of the taxpayer’s ordinary income. Sheppard J, the judge at first instance, accepted the taxpayer was not in the business of buying and selling land at a profit: his Honour concluded the taxpayer was in the business of buying or developing and operating shopping centres. His Honour also found the taxpayer did not have a clear idea of what would happen to the land after it was acquired, although Sheppard J acknowledged the taxpayer must have at least contemplated the possibility that the land would be sold. Notwithstanding those findings of fact, his Honour concluded the sale was part of an overall profit-making scheme. Sheppard J said it was impossible to separate out the dealing in land from the larger enterprise in which the taxpayer was engaged:
Westfield Ltd v Federal Commissioner of Taxation(1990) 21 ATR 784 at 791-792.
The Full Court took a different view. Hill J explained (at 521):
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 taxpayer], by virtue of its being income in accordance with the ordinary concepts of mankind, if [the taxpayer] had a purpose of profit-making at the time of acquisition.
The Full Court found the land sale was not part of a larger profit-making scheme.
Hill J concluded that identifying a sale of the undeveloped land as a possible outcome was not enough given the factual finding that the taxpayer did not have a purpose of reselling the land at a profit when it acquired the property: at 517-518. The taxpayer’s real intention in that case was to use the property as an asset to generate assessable income in the course of its business of developing and operating shopping centres:
at 521. The evidence did not establish the taxpayer had the further (and necessary) purpose of making a profit by somehow turning that asset to account: at 521.
(His Honour added the taxpayer was not required to have worked out all the details of how the profit-making purpose was to be achieved at the time the transaction was entered into, provided the taxpayer had that end in mind: at 521.)
The taxpayer in this case argued the facts in the ruling do not disclose a purpose of reselling the land at a profit at the time of the acquisition. The taxpayer says, in effect, it purchased the property like the taxpayer in Westfield with a view to using the asset
(after transforming it through the development process) to generate assessable income, not to make a profit on resale. The taxpayer in this case adds that, once its original plan for the property was abandoned, it did not adopt a new profit-making scheme with respect to the land. It simply held onto the property for a time during which it derived rental income. In due course, it decided to sell the asset. To maximise its profit on the sale, the taxpayer obtained development approval. It denied it had devised a new
profit-making scheme to replace the old plan. The taxpayer claimed it merely attended to the “realization [of the property] in an enterprising way so as to secure the best price": McClelland v Federal Commissioner of Taxation (1970) 120 CLR 487 at 494 per
Lord Donovan, Viscount Dilhorne and Lord Wilberforce; see also Federal Commissioner of Taxation v Williams (1972) 127 CLR 226 at 249 per Gibbs J.
The taxpayer in this case claimed it was really like the taxpayer in Kratzmann v Federal Commissioner of Taxation (1970) 1 ATR 827. In Kratzmann, the taxpayer purchased a property with a view to developing it into a block of flats that would, in due course, be sold off at a profit. The scheme was abandoned and the property was sold at a profit. Menzies J in the High Court concluded the profit was the product of a sale of the
land – a mere realisation of the asset – rather than as a result of a profit-making scheme which had been abandoned: at 829. The taxpayer in this case says the Tribunal should reach the same view as Menzies J did in Kratzmann: see applicant’s submissions at [55].
The respondent’s argument
The Commissioner says the taxpayer was engaged in a business of property development from the time of the acquisition of the two lots in 2006 and 2007, and that the sale of the property after the taxpayer obtained development approval occurred in the course of that business. The Commissioner acknowledges the plans for an extensive redevelopment described in the email of 6 February 2009 did not come to fruition entirely as intended. But the Commissioner insists the detailed plans (such as they were) were just means to an end – that end being, in the words of the email of 6 February, “mov[ing] the project forward to Development Approval stage to achieve the best outcome possible for the site and JV partners”: see T-documents at 72. The Commissioner says the taxpayer may have preferred to undertake a comprehensive development in company with other parties but the evidence in the email – and common sense – suggests from the outset that the taxpayer regarded the possibility of a profitable resale after obtaining relevant approvals as an acceptable outcome. On that view, the taxpayer was in the business of acquiring property for redevelopment but without a fixed view of how that redevelopment was to occur. The development approval was subsequently obtained with the assistance of a third party, rather than in the way originally envisaged, but the Commissioner says that makes no difference. The subsequent sale of the land after obtaining development approval was at the core of the business, and was in any event a profit-making scheme in its own right that was in contemplation from the time the two lots were first acquired.
Findings
The question of whether or not a taxpayer is engaged in a business is a question of fact. The cases make it clear that one must look to a range of indicia that might suggest the taxpayer was (or was not) engaged in a business, as opposed to a single transaction, or something else. I am inclined to think the taxpayer in this case was conducting a business of property development. The ruling (including the email of 6 February 2009) notes:
· the directors of the taxpayer were experienced builders, and it is clear they were bringing that experience to bear in the course of the development;
· the taxpayer organised finance and acquired the two conjoined parcels of land in separate transactions with a view to their aggregation;
· the taxpayer’s directors engaged in negotiations with a prospective joint venture partner on the details of how the development would proceed, and be financed; and
· when the negotiations with the prospective joint venturer failed, interests associated with the directors of the taxpayer set about obtaining development approval – a reasonably complex endeavour. (If I understand the taxpayer’s argument correctly, the fact the taxpayer had someone else act on its behalf tended to suggest the taxpayer was not itself engaged in a business. That does not necessarily follow: the practice of engaging and working with others to achieve an agreed end may in fact indicate the existence of a business.)
It follows I do not accept the taxpayer’s claim that it was not engaged in a business at all during the relevant period. Moreover I am satisfied the business described in the
ruling – especially having regard to the fourth dot point in the email of 6 February 2009 which refers to “mov[ing] the project forward to Development Approval stage to achieve the best outcome possible for the site and JV partners” – contemplates a business that is broader than developing the property in a particular way with the participation of a particular joint venturer. I accept the email in particular is evidence that the taxpayer contemplated the property being resold at a profit after obtaining development approval, even if that was not the preferred option. I accept the sale occurred in the ordinary course of the taxpayer’s business, which means that profits generated by the sale should be brought to account as ordinary income.
I should add I would conclude the profits were ordinary income even if I accepted the taxpayer’s argument that, as a matter of fact, there was not sufficient system, regularity and scale to justify a finding the taxpayer was engaged in a business, or if I agreed the sale was outside the scope of whatever business did exist. In that event, I would still be required to consider whether the isolated or unusual transaction that eventuated had a profit-making purpose from the outset. I am satisfied from the evidence I have already discussed – specifically, the fourth dot point in the email of 6 February 2009 – that it did. The email records the taxpayer’s objective of achieving “the best outcome possible”.
A range of successful outcomes must have been in contemplation. That range presumably included (and certainly did not exclude) the possibility of a profitable sale after obtaining a development approval. This case is different to the situation in Westfield, where a profitable resale of the land did not form any part of the taxpayer’s objective, even if the taxpayer knew that was one possible outcome of the transaction.
CONCLUSION
I am satisfied the Commissioner was correct in its conclusion that the sale of the property in the year of income was not the mere realisation of a capital asset. Given the facts set out in the private ruling, I am satisfied the profits from the sale should be brought into account as ordinary income for the purposes of s 6-5 of ITAA97. The objection decision is therefore affirmed.
I certify that the preceding 23 (twenty-three) paragraphs are a true copy of the reasons for the decision herein of Senior Member Bernard J McCabe.
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Associate
Dated 6 March 2015
Solicitors for the Applicant HWL Ebsworth Lawyers Advocate for the Respondent Australian Taxation Office
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