The ATO is examining arrangements where property developers are using trusts to return the proceeds from property developments as capital gains instead of income on revenue account.
ATO Deputy Commissioner Tim Dyce said the ATO has “begun auditing property developers who are carrying out activities which conflict with their stated purpose of capital investment”. He said a “growing number of property developers are using trusts to suggest a development is a capital asset to generate rental income and claim the 50% capital gains discount”. Mr Dyce warned that penalties of up to 75% of the tax avoided can apply to those found to be deliberately using special purpose trusts to mischaracterise the proceeds of property developments.
The ATO says the arrangements it is concerned with display all or most of the following aspects:
- 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;
- 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. In other cases the trust deed may be silent as to its purpose;
- 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 that the proceeds are to be used to repay the loan;
- communication with local government authorities overseeing building approvals may describe the activity as being the development of property for sale; and
- real estate agents may be engaged early in the development process, and advertising to the general public may indicate that the dwellings/subdivided blocks of land are available to be purchased well in advance of the project’s completion, including sales off the plan;
- the property is sold soon after completion of the development, where the underlying property may have been held for as little as 13 months; and
- 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% discount for capital gains (in other words, it treats the gain/profit in respect of each sale as a discounted capital gain).
The ATO said it was concerned that arrangements of this type could give rise to various tax issues, including whether:
- the underlying property constitutes trading stock under the tax law on the basis that the trustee is carrying on a business of property development;
- the gross proceeds from sale constitute ordinary income under the tax law on the basis that the trustee is carrying on a business of property development; and
- the net profit from sale is ordinary income under the tax law on the basis that, although the trustee is not carrying on a business of property development, it is nevertheless involved in a profit-making undertaking.
The ATO said it has made adjustments to increase the net income of a number of trusts. It said penalties will be significantly reduced if taxpayers make a voluntary disclosure.