Tax Settlement of Investment Property

Question

Dec 13 – My client & his brother in law purchased an investment property in Victoria. Did few repairs to put it on to rent.
Jun 14 – Tenanted for 1 year up to Jun15
Oct 14 – Transferred 50% of their respective share to their wives owning 25% each after the transfer out of love and affection
Dec 14 – DA applied
Apr 15 – DA Approved
Jun 15 – Decided to develop the property and my client wanted to move in and his brother in law already had PPOR so wanted to rent it or sell it(kept options open)
Jun 15 – Setup a family trust with all 4 members of family acting as both trustees and beneficiaries.
Jul 15 – Entered into a contract to build 2 dwellings
Feb 16 – Demolished House
Aug 16 – Construction Started
Dec 16 – Subdivision Titles received
Mar 17 – Due to health issues from Melbourne weather, decided to move to a warmer climate to Brisbane and started applying for jobs in Brisbane. Changed his intention to and decided to sell his property after construction. Secondly, the building took longer than expected and costs blow out and went out of affordability to live in the property.
May 17 – My client moved out to Brisbane
Aug 17 – Finished Construction & up for Sale
Oct 17 – Contract to sell the first house – Settled on Nov 17
Feb 18 – Contracted to sell the second house – settled on Jul 18

FY 2017-18 – The accountant at that time decided to show that as trust making 100% profit, paid the cost of the land to owners, distributed profits to family members in a tax-effective way. The GST was registered for Trust either at the time of settlement or after the settlement backdating from 1/7/17

My client thinks that the property should have been accounted on the capital account and apply CGT Discount.

Need some advice on this.


Answer

Here is a video on a very similar case, McCurry’s 1998, before GST. Nevertheless, it gives you an idea how hard it is if you build and then sell https://www.youtube.com/watch?v=usW1zL6QwdA&feature=emb_logo

The only way you can argue that CGT applies is for it to be the sale of a capital asset. The fact that it was held as a rental before goes out the window once you build new houses on the property. Merely realising an asset cannot apply, the building is business like, profit making motive not capital. The only possible argument is the change of plans. Intended to rent out but had to sell for …. Reason. There have been cases where the property was held for years after built and still considered a profit making venture, not capital. My approach when anyone wants to argue, change of circumstances is that they need to apply for a ruling with the ATO. Because the onus of proof is on them. The few that do, have no success.

Further, what did it say on the contract to sell? Margin scheme? It was still the individuals that sold and it doesn’t sound like they are registered for GST which could get them in a whole lot of trouble if the ATO look at it.

Profit to the trust should only be market rates. It really worries me how the GST was treated here. Even if I assume trust claimed input credits and charged the owners GST for the build and the property sale went through with no GST charged and no GST claimed, by the owners, for what the trust charged, they have still done the wrong thing. No getting away from the fact the individuals were the owners of the property and the ones who sold it and if they are not merely realising an asset then they are up from GST on that sale.

I would have considered the sale to be on revenue account too, with at very best a little bit of CGT discount, on any gain up until the time construction started.

I bet they also continued to claim the full loan for the property after they transferred it to their wives as a gift.

If I was your client I would not be arguing but laying very low impatiently waiting for those 4 years to pass.

Advice to client would be the ATO would consider that at the time the construction began there was a change of purpose, a profit making motive, no longer investment.

Here is an extract from our How not to be a developer booklet https://www.bantacs.com.au/booklets/How-Not-to-Bea-a-Developer-Booklet.pdf

“Whether you purchased the property for resale at a profit is a question of your state of mind at the time. The trouble is proving that was your state of mind. In Case R25 84 ATC 224 a group of taxpayers bought land to resell at a profit, which they did 13 years later. One of the taxpayers argued that his intention was to build a factory on the land not re sell it. The court did not accept this. Be careful to have evidence of a well researched viable use for the land other than development. You will also need to have a reason for selling that doesn’t contradict your original intention.

It is very difficult if you are a builder to claim that you purchased a property with an intention other than developing it and reselling, especially if you build a spec home. In case R51 84 ATC 392 a builder who built a block of flats and leased them to tenants for 6 years was still assessed as revenue on the profit on the sale. TD 92/135 states that even if a builder builds a home as a spec but then decides to live in it he or she is not entitled to the main residence exemption or the 50% CGT discount because it was built with a profit making motive so is taxed as normal business income.”

The Building of the houses makes it very difficult to argue there was no profit motive but worse still the profit was accounted for in the trust which I assume was on the basis that the profit was made by the builder or project manager not the property owner. On that basis the trust has no argument that it is on capital account and your client is now completely sunk (thought I think they always were) because even if CGT applies they have already recorded there is no capital gain on the sale of the property. Just a profit in the construction trust. They can’t really change their mind now and argue different.

MT 2006/1 is really for GST purposes but claims to define profit making motive in accordance with case law regarding income tax. https://www.ato.gov.au/law/view/document?DocID=MXR/MT20061/NAT/ATO/00001&PiT=20161101000000

265. From the Statham and Casimaty cases a list of factors can be ascertained that provide assistance in determining whether activities are a business or an adventure or concern in the nature of trade (a profit-making undertaking or scheme being the Australian equivalent, see paragraphs 233 to 242 of this Ruling).

If several of these factors are present it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows:[107]

· there is a change of purpose for which the land is held;

· additional land is acquired to be added to the original parcel of land;

· the parcel of land is brought into account as a business asset;

· there is a coherent plan for the subdivision of the land;

· there is a business organisation – for example a manager, office and letterhead;

· borrowed funds financed the acquisition or subdivision;

· interest on money borrowed to defray subdivisional costs was claimed as a business expense;

· there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and

· buildings have been erected on the land.

Example 29

273. Tobias finds an ocean front block of land for sale in a popular beachside town. He devises a plan to enable him to afford to live there. He decides to purchase the land and to build a duplex. He plans to sell one of the units and retain and live in the other. The object of his plan is to enable him to obtain private residential premises in an area that would otherwise be unaffordable for him.

274. Tobias carries out his plan. He purchases the land, and lodges the necessary development application with the local council. The development application is approved by the council, Tobias engages a builder and has the duplex built. He sells one unit, and lives in the other.

275. Tobias is entitled to an ABN. His intentions and activities have the appearance of a business deal. They are an enterprise.

276. Further, there is a reasonable expectation of profit or gain (see paragraphs 378 to 405 of this Ruling) as his plan has enabled him to be able to keep and live in one of the units.

Now to the point of any main residence exemption TD 92/135 https://www.ato.gov.au/law/view/document?docid=TXD/TD92135/NAT/ATO/00001 states that if they are living there while facilitating a profit-making purpose no main residence exemption. Further, when they sell, the original dwelling that has the main residence exemption is no longer what they are selling. They would have had to move into the houses they sold for that to even get a look in.

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