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Mischaracterising property development receipts as capital gain

August 11, 2014

The ATO has released a taxpayer alert on those using trusts to mischaracterise the proceeds of property development as capital gains rather than income on revenue account in order to access the 50% capital gains discount. The alert can be read at: TA 2014/1

The ATO states in its alert:

“This Taxpayer Alert applies to arrangements which display all or most of the following:

 1. An entity with experience in either developing or selling property, or in the property and construction industry, establishes a new trust for the purpose of acquiring property for development and sale.

 2. In some cases the trust deed may expressly state that the purpose of the trust is to hold the developed property as a capital asset to generate rental income. In other cases the trust deed may be silent as to its purpose.

 3. Activity is then undertaken in a manner which is at odds with the stated purpose of treating the developed property as a capital asset. For example:

  • Documents prepared in connection with obtaining finance for the development may indicate that the dwellings constructed on the land are to be sold within a certain timeframe and that the proceeds are to be used to repay the loan.
  • Communication with local government authorities overseeing building approvals may describe the activity as being the development of property for sale.
  • Real estate agents may be engaged early in the development process, and advertising to the general public may indicate that the dwellings/subdivided blocks of land are available to be purchased well in advance of the project’s completion, including sales off the plan.

4. The property is sold soon after completion of the development, where the underlying property may have been held for as little as 13 months.

5. The trustee treats the sale proceeds as being on capital account, and because the trustee acquired the underlying property more than 12 months before the sale, it claims the general 50% capital gains tax discount (in other words, it treats the gain/profit in respect of each sale as a discounted capital gain).

On the face of it, the ATO is giving notice of audit treatment to experienced property developers not to pose as investors by characterising developments for sale as construction for rental investment in order to claim the 50% capital gains discount when the development is completed and sold.

But the alert comes off the back of the recent decision in August v Commissioner of Taxation [2013] FCAFC 85.  The decision can be read here and is a warning for less dissembling investors who develop a property with the intention to hold as a long-term investment but subsequently change their mind and sell the property for a profit after development is complete. To better ensure the property is treated a capital asset rather than trading stock they need to ensure that all documentation in relation to the property (purchase, financing, development, ownership, management, leasing, selling etc) is consistent with their stated intentions and that they can provide the ATO with that documentary evidence and documentary evidence that the decision to sell was a change of mind for a bona fide reason such as an offer to good to refuse or a change in their financial circumstances. Moreover their actual words and actions must be consistent with that  documentary evidence.  Investors purchasing property with a mind to potential development and sale down the track should seek professional tax advice at the outset.

This publication is intended only to provide a summary of the subject matter covered. It does not purport to be comprehensive or to render legal advice. The publication reflects the law at the date the publication was written which may differ at the date the publication is being read. No reader should act on the basis of any matter contained in this publication without first obtaining specific professional advice.

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