By Cameron Tilley and Parminder Nijjhar
The distinction between income and capital for property investment trusts is vitally important in determining the ultimate taxation effect on the sale of landholdings.
To establish whether landholdings are to be on revenue or capital account, it is important to consider principles that have been established though common law in addition to the statute law as presented in the Income Tax Assessment Act under section 6 and 8. The history of case law that has arisen on this topic has allowed us to provide the following summary of the principles:
- Realisation of land is not considered to be profit even if it is in the most beneficial way
- More than realisation, may be assessable, if it can be established that there is a profit making intention
- Even if there is only an isolated transaction, such a sale and the profit may be considered revenue if it can be established that such a sale was done so in the ordinary course or business or if it is said that the sale is commercial or it was done so as a business operation.
In addition to common law, the ATO has provided guidance on how to distinguish between income and capital in respect of isolated transactions as outlined in TR 92/3. This tax ruling outlined the following factors that needs to be considered in drawing the distinction:
- The nature and magnitude of the operation as well as any other operations that are carried out by the taxpayer (if any)
- The reason the land was firstly acquired and secondly sold
- The property’s nature
- The level of involvement of the taxpayer in the development/improvement of land
- The timing of the sale
In practice what does this mean for property investment trusts? Essentially, land that is considered to be revenue in nature and whereby a profit has been made, this profit will be taxed in the hands to the beneficiaries at their marginal tax rate. On the other hand, where land is on revenue account but a loss is made, the loss will be deductible.
In terms of land that is capital in nature, if a gain is made from a sale the trust may be able to apply the 50% capital gains tax discount. Furthermore if capital losses exist, the gain on such a transaction can be offset against those losses present.
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