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The taxation of a ‘profit-making scheme’ (2) - Tax regimes step 1: Calculating the net profit (1)

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Step 1: Calculating the net profit 

Net profit is calculated as the difference between the gross proceeds from the sale of the property less direct and recurrent development expenses incurred.   

Direct development costs include the cost or value of the land, the cost of subdivision approval and the environmental impact statement, site clearing costs, soil and water conservation works, landscaping, engineering fees and costs of construction works. Some common examples of recurrent expenses taken into account in calculating net profit are rates and land taxes, interest, motor vehicle expenses, accounting fees, and salary and wages paid.  

These direct development costs and recurrent expenses are included in calculating the net profit that, in turn, is included in assessable income under S.6-5 in the income year in which the contract for sale settles (i.e., not the income year in which the contract was entered into). Notably, this means these costs are not immediately deductible when incurred.

Be aware that the value of the owner’s own work over and above, or in lieu of, any salary actually paid is not taken into account to calculate net profit. Furthermore, based on comments made in Commercial and General Acceptance Limited v FCT [1977] HCA 47, costs that generally would not be deductible under the tax law cannot be subtracted from the gross proceeds of sale in order to calculate the net profit. Examples of this may include entertainment expenses and fines.

How is the cost of land included in net profit?

One of the more significant development costs taken into account in the net profit calculation is the cost of land. The cost of land is taken into account for calculating net profit if the land was committed to the profit-making scheme when the land was acquired. However, if land is ventured into a profit-making scheme sometime after it was acquired, the market value of land at the time it was committed to the profit-making scheme is taken into account to calculate net profit. FCT v Whitfords Beach Pty Ltd [1982] HCA 8 (‘Whitfords Beach case’) provides authority for this approach.  Therefore, if land was previously held as a ‘capital asset’ or was held privately, this cost will not be the original price paid by the taxpayer but will be the market value of the land when it was committed into the profit-making scheme. Refer to TD 97/1.

 

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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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