A recent Administrative Appeals Tribunal (AAT) decision re-emphasizes that taxpayers who purchase, subdivide, and sell land within a short timeframe may have entered into an isolated profit-making transaction, with any gains assessed on revenue account.    

Revenue or capital?

Income tax typically applies to the sale of land in one of three ways:

1. On revenue account when the taxpayer is carrying on a business and holds the land as trading stock.

2. On revenue account when the taxpayer has ventured into an isolated profit-making transaction.

3. On capital account when the transaction is a mere realization of a capital asset. 

Taxpayers, particularly Mum and Dad investors, typically self-assess land sales on capital account.

Summary

In the case of McCarthy and Commissioner of Taxation [2021] AATA 1511, the taxpayers (a husband and wife with no history of property development) were unsuccessful in discharging their statutory burden of proof that the purchase, subdivision, and sale of land (Property) was not an isolated profit-making transaction.

The taxpayers maintained that, when they acquired the Property, it was with a view to renting it out long-term with an option to subdivide in the future. The reason for subdividing the Property and selling the lots was to maximise the potential of the asset as the plan to hold the Property long-term had proven to be financially unsustainable.

However, the surrounding facts and circumstances were contrary to the taxpayers’ position. This was particularly because the taxpayers:

• had purchased, subdivided, and sold the Property within a 12-month period (a plan of subdivision was lodged 11 days after purchase!)

• were unable to lead evidence regarding any calculation, enquiry or action which would support their contentions that the Property was planned to be rented out long term.

Accordingly, and objectively viewed, the purchase, subdivision and sale of the Property was a transaction that a person in business would undertake. At the time of the purchase of the Property, subdivision and sale of the Property for a profit was a “not insignificant purpose” in the transaction.  Therefore, any gain is assessed on revenue account.

Principles

The Tribunal’s views were formed having regard to the following principles arising from the case law in relation to isolated profit-making transactions:

1. A profit or gain will constitute income if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit‑making by the means giving rise to the profit.  (Myer Emporium)

2. If the circumstances are such as to give rise to the inference that the taxpayer’s intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer’s business.” (Myer Emporium)

3. If the transaction exhibits features which give it the character of a “business deal” or the taxpayer’s activities in acquiring the intended profit-making property are the kinds of things that a business person would do in seeking to make an intended profit, then the property will have been acquired in a “business operation or commercial transaction”. (Grieg)

4. In determining whether a transaction is a “business operation or commercial transaction” a court should have regard to not only the evidence of the taxpayer as to what was in their mind, but also to the surrounding facts and to the events that actually occurred. (McCurry)

5. The profit-making purpose should be present at the time of acquisition, though there may be circumstances where the profit-making purpose arises after acquisition through some transformation or change in the ownership or control of the taxpayer. (Whitfords Beach)

6. The relevant purpose must include the purpose of profit-making by the very means by which the profit was in fact made. Such a purpose can be found where the means is but one alternative contemplated by the taxpayer. (Westfield)

7. It is not necessary that the intention or purpose of the profit-making by sale be the sole or dominant purpose of the taxpayer, however, it should be a “not insignificant” aspect of the taxpayer’s purpose. (Cooling)

8. It is not necessary for a taxpayer to have planned every step of the profit-making purpose – the mode of achieving the profit can lack specificity of detail and it will be sufficient if it is found that a taxpayer had only a general plan or expectation or intention formed. (Westfield)

9. It is the taxpayer’s intention or purpose determined objectively, not the subjective intention which is relevant. (Cooling)

Conclusion

The significance that the case law places on assessing a taxpayer’s purpose objectively was crucial to the AAT’s conclusions. That is, the objective purpose overrid the taxpayer’s subjective purpose. So too was the wide-scope as to what constitutes a “business deal” for the purposes of isolated profit-making transactions (as outlined in Grieg - reported here).

Taxpayers who purchased property last year in the height of the Covid-19 pandemic might be contemplating enhancing the value of that property and selling it following a recent spike in property prices. Cases like McCarthy are a warning to such taxpayers to proceed with caution.

For more information please contact:

Edward Hennebry
Senior Associate
T +61 3 9611 0113
E: ehennebry@sladen.com.au

Neil Brydges
Principal Lawyer | Accredited Specialist in Tax Law
M +61 407 821 157 | T +61 3 9611 0176
E: nbrydges@sladen.com.au

Daniel Smedley
Principal | Accredited Specialist in Tax Law
M +61 411 319 327|  T +61 3 9611 0105
E: dsmedley@sladen.com.au