Edited version of private ruling

Authorisation Number: 1011503249544

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Ruling

Subject: CGT - property

1. Will the proceeds from the sale of the development be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes.

2. Will the proceeds from the sale of your subdivided land be assessable under the capital gains tax (CGT) provisions under Part 3-1 of the ITAA 1997?

Yes.

This ruling applies for the following periods:

1 July 2010 - 30 June 2011.

1 July 2011 - 30 June 2012.

1 July 2012 - 30 June 2013.

The scheme commences on:

1 July 2004.

Relevant facts and circumstances

The taxpayer inherited land. The land was not purchased to subdivide. Crops were grown and cattle agisted on the land for lengthy periods after purchase.

Action was initiated by the owner of a nearby block of land to investigate subdivision possibilities. The local shire council at that time indicated that they would strongly prefer only one major road exit onto the main road. Consequently, a meeting of the owners of the adjoining blocks of land were convened to see if there was any interest in presenting a single plan to the council which would embrace all the blocks of land.

The land owners chose a person to act as convener and negotiator with the council. A subdivisional plan for the whole land has been approved by the council involving road works, sewerage, water reticulation, electricity and telephone connections.

The shire council submitted a tender price to draw up all engineering plans and to carry out the actual works to completion. The land owners accepted council's tender and construction of all stages has now been completed.

In order to ensure the development works were completed in the event of death or bankruptcy of any of the participating parties, a 'joint venture' agreement was drawn up by a solicitor and signed by all parties. Such an agreement was required by individual financiers of the parties and the shire council.

The taxpayer and their spouse have recently retired from their professional work. However, they have other investment interests including rental properties and have not in the past nor will be in the future directly involved in the work associated with the subdivision. Each individual owner has made his/her own arrangements in relation to finance, legal and accounting matters and selling arrangements. The taxpayer has not formed any special legal entity such as a company to undertake this subdivision; they have retained ownership in their own name.

The development works for all stages are now complete. A small number of the taxpayer's blocks remain unsold. It is anticipated these will be sold in the next few years.

The land subdivision transaction has been the subject of prior private rulings. The outcome of the prior rulings was that the transaction amounted to a realisation of a capital asset.

There is current demand in the area for high density housing. The taxpayer is planning to use a number of adjacent blocks to have s constructed for resale. The planning and construction will be undertaken by contractors.

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 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 of the ITAA 1936 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 of the ITAA 1936 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.

Reasons for decision

Question 1

Taxation Ruling TR 92/3 sets out the Commissioners view on whether profits made from isolated transactions are ordinary income.

'Isolated transactions' refers to:

· those transactions outside the ordinary course of business of a taxpayer carrying on a business, and

· those transactions entered into by non-business taxpayers.

Whether a profit from an isolated transaction is income according to the ordinary concepts and usages of mankind depends very much on the circumstances of the case. However, where a taxpayer who does not carry on a business makes a profit from an isolated transaction, that profit is income if:

(a) the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain; and

(b) the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

Intention

The relevant intention or purpose of the taxpayer (of making a profit or gain) is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. Where a transaction or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the land or property.

Carrying out a commercial transaction

Paragraph 13 of TR 92/3 lists factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction. Relevant factors include:

· the nature of the entity undertaking the operation or transaction

· the nature and scale of other activities undertaken by the taxpayer

· the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained

· the nature, scale and complexity of the operation or transaction

· the manner in which the operation or transaction was entered into or carried out

· if the transaction involves the acquisition and disposal of property, the nature of that property, and

· the timing of the transaction or the various steps in the transaction.

In addition to the above factors, for the purposes of determining whether the activities undertaken in relation to real property and development equate to a profit-making undertaking or scheme, Miscellaneous Taxation Ruling MT 2006/1 aligns itself with TR 92/3 and provides a list of factors which, if present may be an indication that a business or profit-making undertaking or scheme is being carried on. Relevant factors include:

· there is a change of purpose for which the land is held

· there is a coherent plan for the subdivision of the land

· 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.

No single factor is determinative rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

Application to your situation

The proposed activity in relation to the development will amount to more than the mere realisation of the original asset to its best advantage. There is a change of purpose for which the land is held, new buildings will be erected on the land for the purpose of selling and there is a coherent plan under development to carry out a sequence of actions that will result in a profit. From an objective examination of the facts the intention of the taxpayer in entering into the transaction is to produce a profit.

By pursuing development approval from council, arranging for the development to be completed under contract and planning the sale you have adopted a plan to securing from the ultimate sale of the s a much greater return than otherwise could have been expected. These activities are planned, organised and coherent. The proposed development is a transaction that is commercial in nature.

The proceeds will be considered ordinary assessable income under section 6-5 of the ITAA 1997.

Question 2

Taxation Ruling TR 92/3 deals with whether profits on isolated transactions are income. It states at Para. 35:

A profit from an isolated transaction is therefore generally assessable income when both of the following elements are present:

(a) The intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain.

(b) The transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

In the Full Federal Court case Westfield Ltd v. Commissioner of Taxation (1991) 28 FCR 333; 91 ATC 4234; (1991) 21 ATR 1398, Hill J (with whom Lockhart and Gummow JJ agreed) said:

... it is difficult to conceive of a case where a taxpayer would be said to have made a profit from the carrying on, or carrying out, of a profit making scheme, where, in the case of a scheme involving the acquisition and resale of land, there was, at the time of acquisition, no purpose of resale of land, but only the possibility (present, one may observe, in the case of every acquisition of land) that the land may be resold. The same may be said to be the case where subsection 25(1) is involved.

The mere realisation of a capital asset, carried out in an enterprising manner so as to secure the best price, would not constitute income under ordinary concepts. As Gibbs J, member of the High Court in Federal Commissioner of Taxation v. Williams (1972) 127 CLR 226; 72 ATC 4188; (1972) 3 ATR 283, observed:-

An owner of land who holds it until the price of land has risen and then subdivides and sells it is not thereby engaging in an adventure in the nature of trade, or carrying out a profit-making scheme. The situation is not altered by the fact that the landowner seeks and acts upon the advice of an expert as to the best method of subdivision and sale or by the fact that he carries out work such as grading, levelling, road building and the provision of reticulation for water and power to enable the land to be sold to its best advantage. The proceeds resulting from the mere realization of a capital asset are not income either in accordance with ordinary concepts or within the second limb of s26(a), even though the realization is carried out in an enterprising way so as to secure the best price.

Based on the information provided, the subdivision and the sale of land would be considered the mere realisation of a capital asset, carried out in an enterprising manner. The proceeds would be assessable as capital gains under Part 3-1 of the ITAA 1997.

In reaching this conclusion we also considered whether your activity amounted to the carrying on of a business of land development and concluded that the activity did not amount to a business.

Capital Improvements and Capital Gains Tax (CGT)

According to section 108-5 of the ITAA 1997 land or an interest in land is a CGT asset. The sale of a CGT asset which represents a mere realisation of the capital assets will be subject to the CGT provisions and the disposal will give rise to CGT event A1 under section 104-10 of the ITAA 1997.

The subdivision or splitting of the land alone will not result in a CGT event (subsection 112-25(1) of the ITAA 1997). However, the development and realisation of the subdivided land will, upon its disposal, result in a capital gain if the capital proceeds are more than the asset's cost base and conversely, will result in a capital loss if the capital proceeds are less than the asset's cost base (subsection 104-10(4) of the ITAA 1997.

The cost base of a CGT asset is calculated under section 110-25 of the ITAA 1997 and includes five elements. The first element is the total of the market value of the money you paid or other property you gave to acquire the asset (subsection 110-25(2) of the ITAA 1997). In this case, the taxpayer inherited the land from her mother at the time of her death and hence she would have acquired it for its market value at the date of death of the taxpayer's mother (item 4 in subsection 128-15(4) of the ITAA 1997). The cost base also includes certain other costs associated with acquiring, holding and disposing of the asset and which would include such things as the construction of roads, electrical connections, surveyor's fees and land preparation costs.

Taxation Determination TD 97/3 discusses certain CGT issues relating to the subdivision of land. Example 2 in TD 97/3 explains the Commissioner's view on the apportionment of costs incurred in subdividing land. It suggests that it is reasonable to apportion costs over the new blocks created by the subdivision.

TD 97/3 also indicates that the disposal of a subdivided block is treated as the disposal of an asset in its own right, and not as a disposal of part of an asset (original parcel of land).

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