Dear Mr. Patrick In the previous meeting we discussed the case of investing in developing a real estate project. After thoroughly researching your instructions, I have compiled this Letter of Advice to clarify the impact of stock trading on your real estate. My advice is given based on the applicable law directly relevant to your case, the Income Tax Assessment Act 1997 (Cth) (ITAA 1997). Besides, in this advisory letter, I also provide calculations for the period from 2019 to 2021 for your reference.
Dear Mr Patrick In the previous meeting we discussed the case of investing in developing a real estate project After thoroughly researching your instructions, I have compiled this Letter of Advice to clarify the impact of stock trading on your real estate My advice is given based on the applicable law directly relevant to your case, the Income Tax Assessment Act 1997 (Cth) ("ITAA 1997") Besides, in this advisory letter, I also provide calculations for the period from 2019 to 2021 for your reference SUMMARY OF ADVICE Based on your actual case, in this letter, we mention some facts and assumptions as presented in the summary as follows: First, applying the rules of stock trading does not provide optimal tax results in your business situation The rationale is that the purchase and development deductions are deferred until the property is sold Second, the capital gain is an asset's value increase that gives it more value than its original purchase price Therefore, in your case, when the property's market value is more significant than its original value (also known as the cost base), and the stock valuation does not apply the cost-based valuation method, costs will result in capital gain When cost pricing is replaced by market pricing, you will have a higher net profit This statement is because the value of the real estate at the end of the financial year increases according to the market price TAX IMPLICATIONS OF TRADING STOCK Under the concept of trading shares specified in Sections 70-10 1of the Income Tax Assessment Act 1997 (Cth) and TD 92/1242, the land owned by the subrogation is Tax Assessment Act 1997 (Cth) s 70 - 10 TD 92/124 considered a trading stock when the taxpayer holds it to make a profit through its resale in the course of the land business When an asset in your case is land retained as a business stock is sold, tax matters are subject to Division 70 Accordingly, Division 70 provides provisions relating to the capital rate (CTG) system (see s 118-25 for details)3 and for-profit planning regimes (also known as surplus ) In case a taxpayer holds the real estate as trading stock to sell this property, the tax implications that emerge include: I Gross Income from Sales is assessed on the revenue account The gross revenue from the sale of the taxpayer's land generates taxable income as defined in s 6-54 Patrick earned two profits of $15 million in 2019 and $14.5 million in 2021 Under the provisions of s 6-5, these two profits are considered payable income tax As far as profit-making plans, these earnings are gross income, not net sales The critical issue here is that by the time of settlement, the revenue from the sale of real estate retained by the taxpayer as trading stock will not have formed Therefore it will not be counted in Patrick's taxable income II Deductions for the cost of trading stock on hand are deferred Usually, the cost of trading stock will include all related costs, such as the cost of buying and developing real estate retained as trading stock However, according to the provisions stated in s 8-15, the expenses of trading stocks are allowed to be deducted In other words, Division 70 will delay deducting the costs of trading stocks until the taxpayer no longer holds the trading stock (for example, the taxpayer sells, donates, Tax Assessment Act 1997 (Cth) s 118-25 Tax Assessment Act 1997 (Cth) s 6-5 Ibid s - etc.) Based on this provision, determining the deduction date for the acquisition of trading stock by calculating the taxable income generated from this transaction is effectively done The method of implementation is specified in s 70-35: Firstly, in the case that at the end of the year, the value of trading stocks is greater than the value of trading stocks at the beginning of the year, the surplus will be allocated to taxable income Second, if, at the end of the year, the value of the trading stocks is lower than the value of the trading stocks at the beginning of the year, the excess will be deducted Applying to Patrick's specific case, in all three years, the value of the trading stock at the beginning of the year is greater than the value of the trading stock, so that the excess will be deducted The analysis data can be found in detail in the appendix attached to this letter III Immediate deductions for certain costs According to s - 17, there are some items of expenses that are not included in the cost of trading stocks Instead of being deferred as prescribed in IT 2350 7, IT 24028, and TD 92/1329 on trading stocks, they will be deducted immediately as regular business expenses This cost category and the moderate cost are not directly tied to the development of the property In this case, Patrick bought the land as trading stock, so like Kurts, interest, Ibid s 70 - 35 IT2350 IT 2402 TD 92/132 council rates, and land taxes incurred during and after the land purchase will not be included in the cost of the property10 VALUATION METHODS In a market economy, businesses are free to compete and develop Therefore, ensuring that each of their businesses survives and develops sustainably requires managers to make a series of optimal decisions Of all the decisions, the decision on product pricing is one of the most challenging decisions for managers of all types of businesses If this decision is inappropriate, it will affect the profit, the volume of products consumed, and the reputation and brand of the enterprise in the long-term development strategy Therefore, when making decisions on product selling prices, it is necessary to base on economic theories of the selling price process I Cost price After careful study of the relevant documents, we advise that according to s 70-45(1) 11 of ITAA 1997, Patrick Pty Ltd can value every hectare of the company's land as trading stock at the end of the year by "cost" Under the provisions of ss 31(1) 12 of this Act, the cost of land acquisition and development expenses directly related to the conversion of land in order to ensure that the real estate is eligible for sale constitutes the cost of the trading stock (see details at Philip Morris Ltd v FC)13 10 FC of T v Kurts Development Limited 98 ATC 4877; (1998) 39 ATR 493 11 Tax Assessment Act 1997 (Cth) s 70-45(1) 12 Ibid ss 31(1) 13 Phillip Morris Ltd v F.C of T., 79 ATC 4350: 10 ATR 44 In addition, the content in TD 92/132 14 indicates that if a business purchases real estate to keep as trading stock, then interest, council price, and land tax are incurred during and after the real estate acquisition Such property is not amortized to cost The reason for the above regulation is that in the future, whether the property develops or not, these costs will still be incurred II Pricing at market price How the market value of land is determined is described in TD 97/1 15, precisely that the market value of land is calculated based on the highest and best use to which the property can contribute In determining the market value of a property, careful consideration should be given to the future utility of the land and the intended use of the land that may be approved For example, when a piece of land is within a specified range that can be subdivided for sale, the value is often higher than that of the ineligible plots The same can be applied to the real estate of Patrick Pty Ltd I believe that when the company uses the product's market price, it helps Patrick Pty Ltd There are more opportunities to increase sales and net profit than cost-based pricing The reason for making the above statement is that the market price of land tends to increase at the close of the financial year Reference calculations are detailed in the appendix attached to this letter The last thing I would like to mention concerns the tax implications in the case of Patrick Pty Ltd.'s use of the real estate, like trading stock Calculation details can be found in the appendix attached to this letter CONCLUSION Calculation results show that Patrick Pty Ltd Applying the trading stock rule to the company's land is not tax optimal because deductions for acquisition and development expenses are deferred until the trading stock (in this case, the land) is sold 14 TD 92/132 15 TD 97/1 In addition, the sale of this trading stock by Patrick Pty Ltd as real estate may result in a capital gain if the asset's original price is less than its market value and the company does not use the cost price method to value trading stocks Finally, we recommend your company with the expectation that your company will achieve more significant revenue and net profit using the market valuation method APPENDIX Income calculation table with consideration of expenses Workings for determining opening and closing land value at cost: Calculation of income considering market value concept