Edited version of private ruling

Authorisation Number: 1011492783962

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Ruling

Subject: Subdivision of property - construction of dwellings - sale of properties

Question 1:

Is the property considered to be trading stock for tax purposes?

Answer: No.

Question 2:

Is the gain from the sale of the subdivided land and dwellings considered assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: Yes.

This ruling applies for the following period:

1 July 2009 to 30 June 2010.

The scheme commences on:

1 July 2009.

Relevant facts and circumstances

You and your spouse own a number of residential properties which were purchased for long term investment. All are held in joint names as joint tenants with no trusts or companies involved.

The properties were purchased as long term investments however the assets represent predominantly land value with nominal rental return from the dwellings.

You have come to the conclusion that the property assets are not being used in the most effective way in terms of return and taxation and you have decided to develop all of the properties so as to maximise their value going forward. You plan to demolish the existing homes, subdivide the land and build two or three new dwellings on each. Your intention is to continue with your wealth creation plan and retain the new properties for rental return and long term investment.

Given the recent increases in market interest rates, you have recently taken the decision to sell one of the completed developments to assist with debt reduction.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5.

Income Tax Assessment Act 1997 section 10-5.

Income Tax Assessment Act 1997 section 102-5.

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Taxation treatment of land subdivisions

There are three ways profits from a land subdivision can be treated for taxation purposes:

As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock.

As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of an isolated business transaction entered into by a non-business taxpayer or outside the ordinary course of business of a taxpayer carrying on a business, which is the commercial exploitation of an asset acquired for a profit making purpose.

As statutory income under the capital gains tax (CGT) legislation, (sections 10-5 and 102-5 of the ITAA 1997), on the basis that a mere realisation of a capital asset has occurred.

Ordinary income as a result of carrying on a business of property development

The Commissioners view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11, which uses the following indicators to determine whether a taxpayer is carrying on a business:

- whether the activity has a significant commercial purpose or character;

- whether there is repetition and regularity of the activity;

- whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business;

- whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit;

- the size, scale and permanency of the activity; and

- whether the activity is better described as a hobby, a form of recreation or a sporting activity.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

In your situation, the Commissioner is satisfied you are not carrying on a business of property development. You are both in salaried employment. You purchased the property for investment purposes to use as a rental property. You have not subdivided or developed property previously for profit. Also, the repetition, scale and volume of your activity is not of the same nature as is ordinarily carried on by a property developer that is carrying on a business.

Trading stock means anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business.

Taxation Determination TD 92/124 provides that land is treated as trading stock for income tax purposes if:

- it is acquired for the purpose of resale, and

- a business activity which involves dealing in land has commenced.

Both the required purpose and the business activity must be present before land is treated as trading stock. The business activity is taken to have commenced when a taxpayer embarks on a definite and continuous cycle of operation designed to lead to the sale of the land. There must be present the continuity of activity which characterises a business (see remarks of Jacobs and Aickin JJ. in Federal Commissioner of Taxation v. St. Huberts Island Pty Ltd (1978) 138 CLR 210).

In your case the land will not be trading stock.

However, whilst you are not carrying on a business of property development, the proceeds from the sale of your subdivision and development may still be assessable as ordinary income, if those proceeds are considered to be from an isolated business transaction.

Ordinary income as a result of an isolated transaction

In some instances the proceeds from the sale of a residential property are considered capital gains. However, depending on the facts of the case the proceeds may give rise to income according to ordinary concepts under section 6-5 of the ITAA 1997 where the proceeds (or net profit) are derived from carrying out a business operation or isolated commercial transaction for the purpose of profit making (Taxation Ruling TR 92/3 and Miscellaneous Taxation Ruling MT 2006/1).

Paragraphs 13 and 49 of TR 92/3 provide a list of factors that may be relevant when considering whether an isolated transaction amounts to a business operation or commercial transaction. These are:

(a) the nature of the entity undertaking the operation or transaction;

(b) the nature and scale of other activities undertaken by the taxpayer;

(c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

(d) the nature, scale and complexity of the operation or transaction;

(e) the manner in which the operation or transaction was entered into or carried out;

(f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

(g) if the transaction involves the acquisition and disposal of property, the nature of that property; and

(h) the timing of the transaction or the various steps in the transaction.

For the purposes of determining whether the activities undertaken equate to a profit-making undertaking or scheme, MT 2006/1 aligns itself with TR 92/3 and provides a list of factors which, if present may be an indication that a profit-making undertaking or scheme is being is being carried on. These are:

- there is a change of purpose for which the land is held;

- additional land is acquired to be added to the original parcel of land;

- the parcel of land is brought into account as a business asset;

- there is a coherent plan for the subdivision of the land;

- there is a business organisation - for example a manager, office and letterhead;

- borrowed funds financed the acquisition or subdivision;

- interest on money borrowed to defray subdivisional costs was claimed as a business expense;

- there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and

- buildings have been erected on the land.

At paragraph 266 MT 2006/1 emphasises that 'No single factor will be determinative rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.'

In paragraphs 271 - 276, MT 2006/1 provides examples (28 & 29) of subdivision of land (and development in 29) that amount to an enterprise by way of constituting an isolated profit-making scheme or transaction. These examples read as follows:

Example 28

271. Stefan and Krysia discover that the local council has recently changed its by-laws to allow for smaller lots in the area. They decide to take advantage of the by-law change. They purchase a block of land with the intention to subdivide it into two lots and to sell the lots at a profit. They carry out their plan and sell both lots of land at a profit.

272. Stefan and Krysia are entitled to an ABN in respect of the subdivision on the basis that their activities are an enterprise being an adventure or concern in the nature of trade. Their activities are planned and carried out in a businesslike manner.

Example 29

273. Tobias finds an ocean front block of land for sale in a popular beachside town. He devises a plan to enable him to afford to live there. He decides to purchase the land and to build a duplex. He plans to sell one of the units and retain and live in the other. The object of his plan is to enable him to obtain private residential premises in an area that would otherwise be unaffordable for him.

274. Tobias carries out his plan. He purchases the land, and lodges the necessary development application with the local council. The development application is approved by the council, Tobias engages a builder and has the duplex built. He sells one unit, and lives in the other.

275. Tobias is entitled to an ABN. His intentions and activities have the appearance of a business deal. They are an enterprise.

276. Further, there is a reasonable expectation of profit or gain (see paragraphs 378 to 405 of this Ruling) as his plan has enabled him to be able to keep and live in one of the units.

Your situation

You have subdivided the land on which you had been generating residential rental income. You plan to construct some dwellings and sell the properties at a profit. Therefore there has been a change of purpose for which the land is held.

You have had to carry out a number of activities such as approval for the subdivision, planning and building for the dwellings, borrowing of money to complete the construction of the dwellings and then the sale of the properties.

In accordance with the direction provided in TR 92/3 and MT 2006/1 we consider that the construction of the dwellings is similar to the examples cited above. The activities proposed will amount to more than the mere realisation of an asset to its best advantage. There is a coherent plan in place to carry out a sequence of actions that will result in a profit, there is a level of development of the land beyond that necessary to secure council approval and new buildings will be erected on the land.

On a weighing of the facts of your case we find that the subdivision and construction of dwellings will constitute an isolated profit-making scheme. Accordingly, the proceeds will be considered ordinary assessable income under section 6-5 of the ITAA 1997.

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