FLZY vs Commissioner of Taxation

Capital vs Revenue

This case concerns the tax treatment of a transaction involving the sale of a commercial office building to the value of $70m dollars.

The taxpayer, founder of the 'Doma Group', is in the business of property leasing and property development. 

In 1999, a family trust to which the taxpayer was a beneficiary acquired a commercial office building in Canberra with an accompanying carpark.

There was an issue with the carpark being that it was not compliant with the 'ACT Building Code'.  Thus, it was not legally marketable to the general public.  After several options were explored, the hard-heads of the family trust decided that it would not continue the carpark business and decided instead to build a new eight story commercial property in its place.  The re-development, named the 'Glasshouse' took place in 2005 and cost roughly $30m.

The family trust sold the Glasshouse in 2007 after receiving an offer which was simply 'too good to refuse'.¹  The taxpayer contended that the family trust never intended to sell the commercial development at any time during its period of ownership, and that the apparent re-consideration arose only after an offer far above what they ever expected to receive was offered.  It was also contended by the taxpayer that they had developed growing fears of a 'property bubble' situation arising in Canberra.

The reason that contention is important, and the reason the Commissioner argued against it, is because Westfield vs CoT and the High Court in CoT vs Myer have established that:

"A profit or gain made as a result of an isolated venture or a ‘one-off’ transaction will constitute income if the property generating a profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the
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Where a transaction occurs outside the scope of ordinary business activities, it will be necessary to find, not merely that the transaction is ‘commercial’ but also that there was, at the time it was entered into, the intention or purpose of making a relevant profit." ²

Unless it can be shown that the construction of the glasshouse was:

(1)  In the 'ordinary course of the family trust's business', or;

(2)  That the property was purchased with the 'intention of making a profit' from selling the building upon completion, as opposed to holding it for the long term to derive rental income.

Then the property will be treated on the capital account, and taxed at half the rate.

The Decision

Deputy President of the Tribunal S E Frost found as follows:

"My view of the proper characterisation of the Doma Group’s business activities means that I must reject the Commissioner’s submissions that the Group was carrying on ‘a business of the acquisition, development and disposal of properties or, alternatively, a business which included investing in property assets’.
Neither of those characterisations, in my view, can be sustained on a proper wide survey and exact scrutiny of the Group’s activities, because they fail to acknowledge the discrete nature of the different activities that the Group was undertaking.

The first of those characterisations could hardly be less exact. It is so generalised as to be quite misleading. Admittedly, the Doma Group did all of those things – acquisition, development and disposal – but it did not do all of them with respect to all of its properties. To say that that was its business is to avoid the very careful examination of its activities that was mandated by the High Court in Western Gold Mines. It is plain from the evidence of both Ivan and Jure, which in this respect I accept, that there had been for many years, and including during the relevant period, an approach of carefully assessing the best use of a particular property and then putting the property to that use. The Commissioner attempted to gloss over that approach, suggesting that in reality what the Group was doing was to acquire a property, develop it, and then sell it when the market was right. That led the Commissioner to suggest that the reason a property would not be sold reasonably soon after its development was that the Group could not obtain a high enough price for it. That suggestion is contrary to the evidence, and I reject it.

The second characterisation – that the Group was carrying on a business which included investing in property assets – is unhelpful. Like the first characterisation, it ignores the discrete nature of the Group’s different activities and the specific allocation of a given property to an identified activity. If such a simplistic label were correct then the distinction between revenue gains and capital gains would be meaningless for any entity that carried on a business ‘which included investing in property assets’. I do not see how that can possibly be so." ³

For completeness, the Deputy President added:

"The fact is, in the case before me, that circumstances presented themselves which made selling the property a sensible thing to do, despite the desire and intention to retain the property as an income-generating asset, and despite Ivan’s resistance to selling it. The price was simply too good. And it is relevant to note that the three properties acquired on disposal of the Glasshouse are still owned by the Doma Group, almost nine years after the transaction." ⁴

The continuing trend in 'isolated transaction' related tax law is a strong focus on the intention of parties at the time of entering into the scheme.  The intention in this case was made clear by the taxpayer's correspondence with real estate agents from the beginning, various letters to St George Bank, the repeated turning down of offers over a long period of time and the taxpayer's behaviour as a businessman over that period in general. 

The precise reason as to why controllers of the family trust eventually caved in and sold the property is not of paramount importance.  As long as there was a clear change in circumstances strong enough to change the original intention (within reason), the original intention itself is all that is needed to determine the capital nature of an asset. 

However, if you carry on a property development business you should seek tax advice before making any 'capital purchases'.  Although this case was clear cut, each depends on its own facts and circumstances.

Notes:

http://www.austlii.edu.au/au/cases/cth/AATA/2016/348.html

1.  p62.
2.  p49
3.  p55-58
4.  p61