Property developers warned on contrived structures that muddy income/capital divide – October 2014

The Tax Office has warned property developers against using trusts to return the proceeds from projects as capital gains instead of income, warning that it has found many instances that had subsequently been shown to be contrived arrangements to allow developers to inappropriately claim CGT concessions.

In a statement, the Tax Office said it had “already raised millions in adjustments from people who exploit the system and our current compliance activity shows we are likely to make many more adjustments in the coming months.”

Profits from property developments that have been treated as capital gains are high on the Tax Office’s target list right now, with it concurrently issuing a “taxpayer alert” as a warning about arrangements that 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.
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 the proceeds used to repay the loan.
• advertising may indicate that it is available to be purchased well in advance of the project’s completion, including sales off the plan.

4. 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).

Simply stated, if a property developer has treated development profits as capital gains, the Tax Office is likely to put this under scrutiny. Penalties can reach up to 75% of the tax avoided in deliberate cases.

 

Capital vs revenue: It’s nothing new

However while the Tax Office has warned about exploitation of the system and inappropriate claims, the fact is that the distinction between capital and revenue has been the source of disputes and litigation ever since it became clear that distinct tax outcomes were dependent on how profits could be categorised.

“Intention” seems to have been the pivotal factor in many instances. A recent court decision focused on the intentions (that is, to hold or develop) of the property owners. In this case, the best legal argument about wanting to hold a property for long-term rental income was trounced by other evidence from a financier that showed an intention to build, rent, and sell.

It is important to remember that the onus of proof rests with taxpayers. With this in mind, property developers may be better advised to get appropriate tax advice at the time developments are being planned and document evidence of their intentions at that time. The (capital or revenue) profit intention of a taxpayer is based upon their individual facts and circumstances.

By obtaining the right advice from a suitably qualified professional the risk of any future conflicts over stated intentions and the consequent activities undertaken is mitigated. The taxpayer should also be mindful of the documents they provided to financiers and so on when providing documents to the Tax Office and any court or tribunal as this may either better align with their stated characterisation or alternatively disprove it.  

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