Revenue versus capital distinction with property transactions

There is no definition of “income” in the Tax Act and case law over the years has sought to define it. In the property context, the determination of whether something is on revenue or capital account generally depends on the particular facts relating to:

• the intention of the taxpayer when purchasing the property
  
  
• what the taxpayer subsequently does with the property and
  
  
• the nature and scale of the transaction to realise the property.
  

Profits or gains from property developments will generally be taxed in one of the following ways:

• profits assessable as ordinary income from “carrying on a business” (revenue in nature)
  
  
• profits assessable as ordinary income from an “isolated transaction” (revenue in nature)
  
  
• capital gain assessable as statutory income from an “investment” (capital in nature)
  
  
• capital gain assessable as statutory income from the mere realisation of a capital asset (capital in nature)
  
  
• capital gain not assessable as pre CGT (capital in nature)
  
  
• capital gain exempt as the developer’s main residence (capital in nature).

When considering an appropriate structure to undertake a property development transaction, one needs to consider the objectives of the transaction. These may include such things as tax and non-tax objectives, for example:

• asset protection
  
  
• cash flow requirements i.e. financing the transaction
  
  
• managing the effective tax rate
  
  
• managing the land tax holding costs
  
  
• managing the tax costs on exit
  
  
• flexibility of entry and exit of new participants.

It is imperative that the above are considered at the inception of the investment based on the facts. You cannot choose a structure retrospectively. The Courts will place particular importance on the initial intention of the developer

However, it also is important to recognise that the intention may, over time, change which may alter the income tax consequences. Accordingly, this alone means that the most flexible structure is generally preferred, ie, a structure that allows a profit to be taxed effectively whether on capital or revenue account.

Property development transactions will typically fall within one of the following scenarios:

Buy, develop and sell
This transaction is normally on revenue account depending on the factors, particularly the initial intention when acquiring the land and the manner in which it is realised. However, this may not always be the case. For example, if land is owned as a personal or investment asset and you are looking to venture it into a development to realise the land.

Buy, develop and hold
This transaction will generally be on capital account. However, circumstances may change, and again it will be necessary to clearly document the facts from the tart to establish the intention. The taxpayer’s business activities may still lead to the conclusion the profit is on revenue account ie, Bowden Investments Pty Ltd and Ors V Federal Commissioner of Taxation 87 ATC 4630.

Buy, develop and sell some and hold some
It is quite often the case that an acquisition of a single parcel of land will be for more than one purpose, ie:

• a large scale development for a long term hold but sells down some of the property to reduce debt, or
  
  
• speculative piece of land on a ‘wait and see’ basis which may either be developed and rented or sold.

In the former case, it is easy to structure the transaction to identify and separate the different components. But with the latter it will be more difficult to characterise the future realisation of the property.

When structuring property transactions, you should always get an advisor involved early and consider the best commercial and tax outcome that suits the prospective transaction.

The revenue and capital distinction, whilst settled in law, still establishes problems when the facts in the case are not clear and open to interpretation. Moore Stephens has a wealth of knowledge in the property industry. They can assist you with advice so that the appropriate structure is used with the prospective transaction.


Contact

Peppe Fusco
T +61 8 8205 6243
pfusco@moorestephens.com.au

www.moorestephens.com.au