Developing as a Business. Income Tax, CGT & GST

[pierso]

I guess I’m what some people would call a serial business owner/operator with my fair share of successes and failures.

Previous business have usually been high risk, capital intensive, involved staff levels of 30-60 and fairly stressful. Getting old now (40!) and looking to transition to a quieter existence (particularly less staff, o’heads etc.).

I’m interested in learning some property investment / development skills that I can use through my 40s, 50s 60s and onwards. I see myself being able to work from home and share the journey with my wife and spend some more time with the kids.

Anyway enough waffle, on to the meat of the post...

Currently I am a sole director and 90% shareholder in a Pty Ltd business in a totally unrelated industry that has large accumulated losses and a large loan outstanding to me. The business is in decline and I will probably run it down for the cash it produces over the next couple of years before closing the doors (of the activity not the structure).

I’m particularly interested in performing a/some project(s) based around buying subdivisible property /reno’ing old house to improve yield / renting / subdividing /selling both properties.
My questions are ...
i) If I perform these activities as a business within the above Pty Ltd structure would properties acquired be treated as trading stock, so upon successful sale any profits would be treated as exactly that – trading profits, not capital gains and therefore subject to company income tax ( and therefore can be offset against prior years losses)rather than CGT? And that no CGT would be incurred?

ii) What are the GST implications of the purchase of the property and subsequent sale of the two properties?

Looking for general advice at this stage to see if the above activities suit my situation. Will of course seek more detailed personalised advice should things progress further.

Sorry for long post - hope you're not all asleep by this point. Many thanks in advance for any pointers.

pierso

 

[Propertunity]

My questions are ...
i) If I perform these activities as a business within the above Pty Ltd structure would properties acquired be treated as trading stock, so upon successful sale any profits would be treated as exactly that – trading profits, not capital gains and therefore subject to company income tax ( and therefore can be offset against prior years losses)rather than CGT?

Yes

And that no CGT would be incurred?

Yes

ii) What are the GST implications of the purchase of the property and subsequent sale of the two properties?

The sale of new property needs to have GST collected on it.

Julia Hartman from Bantacs is good on this stuff. www.bantacs.com.au

 

[pierso]

Thanks Prop. You may remember I had a couple of different questions regarding the same type of activities about a month which you kindly answered for me. I continue to lurk, read and learn. No doubt I will be contacting you directly when I am closer to going ahead.
pierso

 

[Terryw]

You may or may not be treated as a developer and the properties trading stock.

see definition of trading stock in the tax act:
section 70-10, Income Tax Assessment Act 1997, and

see TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'?
http://law.ato.gov.au/atolaw/view.htm?locid='TXD/TD92124/NAT/ATO'

 

[pierso]

Thanks Terry

 

[Propertunity]

see TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'?
http://law.ato.gov.au/atolaw/view.htm?locid='TXD/TD92124/NAT/ATO'

Terry, I would have thought this

3. It is not necessary that the acquisition of land be repetitive. A single acquisition of land for the purpose of development, subdivision and sale by a business commenced for that purpose would lead to the land being treated as trading stock.

makes it reasonably clear? yes/no?

 

[Terryw]

Terry, I would have thought this
makes it reasonably clear? yes/no?

Yes, even doing once could mean you are a developer. However, it could also be argued that you are an investor too. Depends on the circumstances I think.

 

[Ms Jade]

Terry, I would have thought this
makes it reasonably clear? yes/no?

I don't find the determination clear at all; 'though I guess it's clear that a sole development may be be treated as trading stock. I guess we'd have to look at cases to determine what has been interpreted as a 'business activity' to satisfy the second part of the test.
This explanation:

when a taxpayer embarks on a definite and continuous cycle of operations designed to lead to the sale of the land

raises more questions to me than answers, especially the bold bit. Perhaps you should go on a holiday for a few weeks mid-way through the development?

 

[Belu]

my understanding is you get one go at it. if you intend to develop and hold, its ok. if you develop and sell - its a business and GST and business tax (either sole trader or company tax) applies.

 

[Ms Jade]

Actually, it's not that simple either. No one is questioning the 'renovate and hold.' If you sell, it's not necessarily subject to income tax as it depends on what your purpose was in buying the land. If it's been held for a while as an IP your purpose may have been to use it for income producing purposes. You may renovate or even develop the land before selling it and can claim it was simply realising the sale of an asset.

 

[Propertunity]

The OP said he wanted to make a business out of it:

I’m particularly interested in performing a/some project(s) based around buying subdivisible property /reno’ing old house to improve yield / renting / subdividing /selling both properties.

......so if his intentions are clear at the outset, then I think he has a good chance of the land being classified as 'trading stock', which was his original Q.

 

[Belu]

Actually, it's not that simple either. No one is questioning the 'renovate and hold.' If you sell, it's not necessarily subject to income tax as it depends on what your purpose was in buying the land. If it's been held for a while as an IP your purpose may have been to use it for income producing purposes. You may renovate or even develop the land before selling it and can claim it was simply realising the sale of an asset.

what period of time would you consider holding to exempt you from the additional tax please?

 

[Perp]

what period of time would you consider holding to exempt you from the additional tax please?

As indicated, it's not so much to do with a time period but your intention when you purchased - it's not black and white. The ATO would look at all the clues.

If your purpose had been to rent, you likely hired a PM, placed ads to rent the property, stated the anticipated rental income in your loan application, etc.

If your purpose was to develop, you may have made the purchase subject to DA, or lodged a DA immediately after settlement, you may have purchased within a company structure rather than a trust or personal name, and you may have applied for development finance.

Be very careful about getting an entity classified as being in the business of developing by the ATO, because my understanding is that all property purchased by that entity is treated as trading stock, ie loses the 50% CGT exemption.

So if you have a Trust that owns a bunch of IPs which have experienced significant capital growth, then decide to do a development within that Trust, the ATO may deem that the Trust is in the business of developing, and all the IPs already owned may lose CGT exemption, even though they are intended for buy and hold. Ouch!

It's not clear cut, either, ie not automatic, but you need to be aware that it can complicate your tax affairs to do a development within a structure which also has "buy and holds". To protect your position regarding existing assets, I believe that you should get a PBR stating that the entity has had a change of purpose at a particular point in time, and that the existing assets remain eligible for 50% CGT discount, or - preferably - have an entirely different entity own development properties (which is wise from a risk management as well as a tax position). I'm not 100% sure that this second strategy (different structure) would work to prevent previous investments being contaminated, if all directors/beneficiaries/shareholders etc of the new entity were the same as for the investing entity.

The point is that you need to be aware of potential tax implications of doing a development and get expert advice prior to signing a contract!

 

[coastymike]

Depends on the facts of the case. Have applied for a number of private rulings on this matter and the particular facts are critical to making a determination.

Relevant things to consider

Section 25A(1) ITAA 1936 http://www.austlii.edu.au/au/legis/cth/consol_act/itaa1936240/s25a.html

Section 15-15 ITAA 1997
http://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s15.15.html

FC of T V Myer Emporium Ltd

Westfield Limited v FC of T

Stevenson v FC of T

Casimaty vs FC of T

McCorkell v FC of T

Taxation Ruling 92/3

These should be a good starting point

 

[Ms Jade]

Agree with Perp; especially this, from my limited understanding:

preferably - have an entirely different entity own development properties (which is wise from a risk management as well as a tax position).

I think that separate entities - especially if a company - will work OK, despite the fact that the same directors also own buy-&-hold properties in other structures. Remember that a company is a legal person distinct from its directors.

 

[Ms Jade]

^^Mike, thanks for the cases; will have to check them out.