For many taxpayers the difference between a capital gain and revenue income will amount to lots of tax dollars, whether they are dealing in shares or disposing of other assets.

For property developers, the dividing line between revenue and capital can be hazy at the best of times, and the Tax Commissioner may take differing views depending on whether or not the project results in a loss or a profit.

Taxpayer Alert

Profits from property developments that have been treated as capital gains are high on the ATO target list right now, and the Commissioner has now issued a Taxpayer Alert (TA 2014/1)  as a warning of his intention to audit developers to see if they are accounting for their transactions in accordance with the Commissioner’s party line, with penalties of up to 75% in deliberate cases.

The Alert also invites developers to make a voluntary disclosure before the Commissioner comes knocking,  in order to get some certainty and reduce exposure to penalties.

What is the problem?

The Commissioner is basically saying that he thinks that in some factual circumstances the correct tax treatment is to return profits as revenue and not as capital.

While the Commissioner talks about wrongful and inappropriate claims and exploitation of the system, litigation about the distinction between capital and revenue has been happening ever since there were different tax outcomes depending on how profits were categorised.  

Developers Intention - That's the Trap!!!

The recent decision in August v Commissioner of Taxation [2013] FCAFC 85, focusses on the owners "intentions" (i.e. to hold or to develop) which highlights the difficulties that taxpayers face in disputes with the Commissioner. The best legal arguments about an intention to hold property for long term rental income can fall apart very quickly if the Commissioner obtains evidence from a Bank or other sources which show a clear intention to build, tenant and sell. 

In this case what let the taxpayers down was, amongst other things, that the evidence showed they wanted to copy the successful strategy of a property developer family friend!!

Onus of Proof

To make life even harder, taxpayers have the onus of proof in tax disputes. It's not enough to show that the Commissioner has made some mistakes in arriving at his position.

In a perfect world, property developers get appropriate tax advice at the time developments are being undertaken, and documents and actions are evidence of the capital or revenue intention at the appropriate time.

In the real world, there are often conflicts between stated intentions, activities undertaken and documents and plans provided to financiers and others, so that when push comes to shove it's not the clever argument that lets you down, it's the thing that lawyers always get excited about, the evidence.

What to do

If you have treated development profits as capital gains, the Commissioner’s Alert is a warning that your tax treatment is likely to come under the microscope.