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The taxation of a ‘profit-making scheme’ (1) - Three-step tax regimes

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If it is determined that a property was disposed of as part of a profit-making, the next issue for consideration is determining the tax payable on the disposal. In this regard, note that profit arising from the carrying on of a profit-making scheme is taxed in a rather unique way, being that the taxpayer is required to calculate the tax implications under multiple tax regimes, broadly as follows:

Step 1: The net profit is assessable in respect of the transaction under S.6-5 (or a net loss is deductible under S.8-1) in the year in which the contract for sale is settled (refer Gasparin v FCT [1994] FCA 1057 (‘Gasparin’s case’)). Broadly, the ‘net profit’ is the difference between the gross proceeds of sale less the development expenses incurred, including the cost or market value of the land. Refer to TR 92/3 and TR 92/4.

The reference to ‘net profit’ is significant as this approach is quite different to the normal tax treatment of transactions where amounts are assessable (or otherwise) in their own right, whilst deductions or expenses are deductible (or otherwise) in their own right. One important consequence of this approach is that development expenses (e.g., land costs and interest expenses) are not deductible under S.8-1 when they are incurred but, instead, are carried forward and bought to account as part of the net profit calculation in the year the net income or net loss is derived (i.e., on settlement).

Step 2: The transaction is also potentially subject to tax under the CGT regime (i.e., as having the ‘net profit’ assessed under S.6-5 does not preclude the CGT regime from applying). The capital gain (or loss) must be calculated and will essentially represent the growth in the property value from the time the property was acquired (and not the time it was ventured into the profit-making scheme). The timing of the CGT event is the contract date (not settlement date).

Step 3: Section 118-20 applies to reduce any resultant capital gain determined at Step 2 by the assessable (S.6-5) net profit determined at Step 1. This is often referred to as the ‘anti-overlap’ rule. Importantly, a capital gain will not necessarily be reduced to nil under the anti-overlap provision because of the different methodology used to calculate the net profit for S.6-5 purposes, compared to the calculation of a capital gain for CGT purposes.

Note that, whilst a taxpayer may incur a net loss and/or capital loss in respect of the disposal of property, these notes will primarily deal with the tax treatment of a net profit and/or capital gain.

 

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Written by Panbo Ye

I help people discover POWERFUL unknowns in Tax Ideas | Wealth Strategies | Retirement Planning | Finance Solutions!

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