The ATO has, for some time, been looking at certain property development arrangements (“PDA”s) between related parties involving long-term construction contracts including issuing a Taxpayer Alert.

As a result, the ATO have issued, Draft PCG 2026/D2 , which contains a risk assessment framework on the potential application of the anti-avoidance legislation to certain arrangements. The guidance has retrospective effect.

Whilst the ATO acknowledges that the use of PDAs is common in Australia and these do not generally result in anti-avoidance issues, the ATO’s concerns centre around the use of PDAs between:

• entities with common ownership or control; or
• entities who are not dealing with each other at arm’s length.

The ATO is seeking to target entities that undertake a single economic activity (property development) but separate the various components (eg land ownership and development activities) to defer the recognition of income and circumvent the trading stock rules.

Similar to a number of PCG’s the guidance provides a risk assessment framework with two zones – green (low risk) and red (high risk).  The allocation of an arrangement into a category will depend on its terms and conditions.

An arrangement will be low risk if it has any of the following features:

The PDA:

• is structured so that amounts are payable progressively by the landowner to the developer and income is recognised progressively by the developer throughout the project – a tax liability arises throughout the development; or
• provides for payment on completion, but income is recognised progressively by the developer over the life of the project in accordance with TR 2018/3 (tax treatment of long-term construction contracts) – this would result in a cashflow impact to the developer as a tax liability arises even though no cash is received; or
• annual increases in the value of the land arising from development activities are recognised as assessable income in accordance with the trading stock rules (eg by the landowner) – this would appear to result in an income basis being applied to the land.

In contrast for an arrangement to be high risk, it must have all the following features:

• the landowner and developer are under common ownership or control, or are not dealing with each other at arm’s length; and
• a developer is interposed between the landowner and builder or sub-contractors; and
• the developer claims deductions for construction costs paid to the builder and other development costs as they are incurred, while recognising income from the landowner on completion; and
• the landowner does not recognise an annual increase in the value of trading stock arising from the development activities and construction works undertaken on the land as assessable income; and
• the purported project losses are used across the broader economic group or used to offset other income derived by the developer.

Clearly the guidelines do not cater for all potential scenarios, and it is expected that a large number will fall outside of the low or high-risk categories.  If so, then the current ATO guidance is that they may engage with the parties to better understand the nature of the arrangement.

The ATO are seeking to identify where taxpayers have a mismatch of deductions and income through structures where the entities are under common control.  The fact that the income deferral unwinds in a later income year is not a consideration for the ATO as part of this process.

As part of any review process the ATO would typically request financial statements, group structures, copies of the legal agreements between the parties and any other relevant contracts including bank funding documents.  Taxpayers should ensure that their documentation is up to date and reflective of the actual activities undertaken.

Should you be considering undertaking a property development in conjunction with a related party please reach out to your engagement partner.