Edited version of private ruling

Authorisation Number: 1011828000610

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Ruling

Subject: Sale of a portion of pre-CGT land

Question 1:

Would the sale of the property trigger a capital gains tax (CGT) event?

Answer:

Yes.

Question 2:

Would the above capital gain or capital loss be disregarded under subsection 104-10(5) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

Yes.

Question 3:

If the property is later re-acquired, would it become a post-CGT asset?

Answer:

Yes.

Question 4:

Would the remainder of the property lose its pre-CGT status on the sale of the property?

Answer:

No.

Question 5:

Is any income tax payable on the sale of the property?

Answer:

No.

Question 6:

Is any income tax or CGT payable on the sale of the property in years to come after the property is transferred back to you?

Answer:

Decline to rule.

This ruling applies for the following periods:

1 July 2010 to 30 June 2011.

1 July 2011 to 30 June 2012.

The scheme commences on:

1 July 2010.

Relevant facts and circumstances

Before 19 September 1985 you bought land. It is a freehold title on which you run a business.

For some time, a third party have established a title over part of the land (the property).

You are currently paid rent under a lease with an option to extend.

You have been approached and requested that you enter into a permanent agreement so as to provide the third party with certainty of occupation until the land is no longer needed by them. They do not wish to retain the land once it is no longer needed, and are willing to sell it back to you at a nominal value.

You are considering selling the property with the agreement to show a sale for a price and a sale back to you once the land is no longer needed.

You have never subdivided land previously and have no plans to subdivide land in the future.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 108-5(1)

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Paragraph 108-5(2)(a)

Income Tax Assessment Act 1997 Subsection 104-10(5)

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 15-15

Income Tax Assessment Act 1997 Subsection 109-5(2)

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Section 115-5

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

Capital Gains Tax

A capital gain or capital loss may be made if a CGT event happens to a CGT asset. Subsection 108-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) describes a CGT asset as any kind of property or a legal or equitable right that is not property.

Land is considered to be a CGT asset and its disposal will constitute CGT event A1. Section 104-10 of the ITAA 1997 states that CGT event A1 occurs if you dispose of a CGT asset. A taxpayer disposes of a CGT asset if a change of ownership occurs from the taxpayer to another entity whether because of some act or event or by operation of law.

CGT event A1 happens if only part of a CGT asset is disposed of. While this may not be clearly obvious from the wording of section 104-10 of the ITAA 1997, the definition of a CGT asset includes a part of, or an interest in, a whole CGT asset (paragraph 108-5(2)(a) of the ITAA 1997).

Subsection 104-10(5) of the ITAA 1997 states that a capital gain or capital loss that is made is disregarded if the CGT asset is acquired prior to 20 September 1985.

Subdivision does not constitute the disposal of land under section 104-10 of the ITAA 1997. Taxation Determination TD 97/3 states that the effect of registering new titles under the subdivision is, for the purposes of the CGT provisions, to divide the original land parcel into two or more assets. Additionally, subdivided propertys are taken to have been acquired by the owner of the original land parcel when the original land parcel was acquired.

The time of the CGT event is when the contract is entered into for the disposal or if there is no contract - when the change of ownership occurs (section 104-10 if the ITAA 1997).

Assessable Income

As a general principle, if the sale of the land constitutes a business, or part of a business, then the proceeds will be assessable as ordinary income, under section 6-5 of the ITAA 1997. On the other hand, if the sale is a mere realisation of the land, the proceeds will be a capital amount.

The Full High Court made this observation in Federal Commissioner of Taxation v. The Myer Emporium (1987) 163 CLR 199 about the nature of profits from isolated transactions:

It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of the acquisition of acquiring for the purpose of profit making by sale. Then, if the asset is not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realisation. But it is quite another thing if the decision to sell is taken by way of implementation of an intention or purpose, existing at the time of the acquisition, of profit-making by sale, at least in the context of carrying on a business or carrying out a business operation or commercial transaction.

The Courts and the AAT have also said that the profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. Gibbs CJ in Federal Commissioner of Taxation v. Whitfords Beach Pty. Ltd. (1982) 150 CLR 355;(1982) 12 ATR 692 ;82 ATC 4031 made the following observation about the disposal of surplus:

If the taxpayer does no more than realise an asset, the profits are not taxable. It does not matter that the taxpayer goes about the realisation in an enterprising way, so as to secure the best price. As I have said in FCT v Williams (1972) 127 CLR 226 at 249: '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 caries 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'

It would appear from the cases involving the subdivision of land and from Taxation Ruling TR 92/3 that the following are the most important factors to consider:

· the intention of the parties at the time of the acquisition of the land (although this appears to be of a lesser importance where the subdivision is on a large scale as would occur with a staged subdivision)

· the intention of the parties at the time of the undertaking to strata/subdivide the land; for example, where attempts have failed to sell the land as one lot, it is less likely the entering into the venture was a business undertaking

· the nature and scale of the activities undertaken; for example, where minimal work is required in the way of road works, earthworks, sewerage, water, etc it is more likely a subdivision and sale would be a mere realisation

· where there is a repetition of transactions and a systematic course of conduct it is more likely the profit will be assessable; for example, the profit on a staged subdivision of land with timed releases to the market will be more likely to be assessable

· the manner in which the subdivision was progressed. Where the owner is heavily involved with the project, it is more likely to be considered a business undertaking and the profit assessable, and

· the nature of the other activities undertaken by the taxpayer.

Section 15-15 of the ITAA 1997 includes in assessable income all profit from the carrying on or carrying out of a profit-making undertaking or plan.

Case law has concluded that the mere realisation of a capital asset which was not acquired for the purpose of profit making by sale does not constitute a profit-making undertaking or scheme within meaning of section 15-15 of the ITAA 1997, even though the realisation is effected in the most advantageous manner: Scottish Australian Mining Co Ltd v. Federal Commissioner of Taxation (1950) 81 CLR 188; [1951] ALR 407; (1950) 4 AITR 443; (1950) 9 ATD 135, White v. Federal Commissioner of Taxation (1968) 120 CLR 191; [1969] ALR 217; (1968) 10 AITR 709; (1968) 15 ATD 173, Federal Commissioner of Taxation v. Whitfords Beach Pty Ltd (1982) 150 CLR 355;(1982) 12 ATR 692 ;82 ATC 4031.

In Statham v. FCT (1988) 20 ATR 228; 89 ATC 4070, the Full Federal Court confirmed this approach. The court held that the subdivision in question was only a mere realisation and not a profit-making undertaking or scheme. Some of the factors considered were:

· the subdivision and development occurred over a long period of time

· the work proceeded methodically over this extended period, and

· the size of the subdivision,

· were not sufficient to indicate a business venture or profit-making scheme.

Application to your circumstances

Question 1:

There will be a CGT event if a change of ownership occurs. The CGT event will be CGT event A1. As you will sell the property, there will be a change of ownership. The time of the CGT event is when the contract for sale is entered into or, if there is no contract, when the change of ownership takes place.

Question 2:

The capital gain or capital loss on the disposal of the land that you acquired prior to the 20 September 1985 is disregarded under subsection 104-10(5) of the ITAA 1997. CGT will not be payable on the proceeds from the sale of the property.

Question 3:

Once the property is sold it is not an asset of yours. If you acquire the property at some time in the future it will be a post-CGT asset. In accordance with subsection 109-5(2) of the ITAA 1997, acquisition in respect of CGT event A1 happens when an entity disposes of a CGT asset to you.

Question 4:

You acquired a large property of land prior to 19 September 1985. You have since established a title to a small area of the land that is leased to a third party. You now plan to sell that area of land to the third party.

The sale of one part of the pre-CGT land does not change the pre-CGT status of the remaining land. The land that is not disposed of will maintain its original acquisition date.

Question 5:

It is considered that the proposed sale of the property will constitute a mere realisation of a capital asset because of the following:

· there was a long period of leasing and it is only because the third party is wanting a more secure arrangement that the sale is being considered

· there is only one property that will be sold; the activity is small, and

· the activities do not appear as though they have been carried out in a businesslike manner.

Therefore, the profit on the sale of the subdivided land is not considered to be ordinary income under section 6-5 of the ITAA 1997.

Additionally, the action to sell the land lacks the features of a profit-making plan or carrying on a business. The acquisition of the land was not with the intention of reselling at a profit. The land was purchased a number of years ago and has been used in the business since that time. There are no plans to subdivide future land and you wish to re-purchase the property to maintain the original holding.

Therefore, the profit on the sale of the land is not assessable under section 15-15 of the ITAA 1997.

Question 6:

A private ruling is provided by the Commissioner on a certain set of facts. You are now considering selling the property. It may be some time in the future that the property will be acquired by you. We consider that this transaction will be too far in the future and cannot provide you with a ruling. However, we can provide some general advice on the current circumstances.

You make a capital gain if your capital proceeds are greater than your cost base, for example, if you receive more for an asset than you paid for it. You make a capital loss if your capital proceeds are less than your reduced cost base.

If the property is re-purchased, and then sold with the original parcel of land, the overall capital proceeds will need to be allocated to the separate assets, being the pre-CGT land and the post-CGT land. In the absence of an agreed allocation, you will need to make a reasonable apportionment of the capital proceeds to the separate assets. It would be expected that you would have regard to and be able to justify your reasonable apportionment based on the relevant market values of the separate assets at the time of making the contract.

Section 110-25 of the ITAA 1997 provides a list of what can be included in the cost base of an asset. This section lists five categories of payments (called elements in the legislation). These are:

· acquisition costs

· incidental costs

· costs of owning the CGT asset incurred after 20 August 1991

· capital expenditure incurred to increase or preserve the asset's value or installing or moving the asset (not including goodwill)

· amounts incurred for establishing, preserving of defending your title to the asset.

Under section 115-5 of the ITAA 1997, you make a discount capital gain if the following requirements are satisfied:

· you are an individual, a trust or a complying superannuation entity

· a CGT event happens to an asset you own

· the CGT event happened after 11.45am (by legal time in the ACT) on 21 September 1999

· you acquired the asset at least 12 months before the CGT event, and

· you did not choose to use the indexation method.

Under the discount method you reduce your capital gain by the discount percentage. For individuals, the discount percentage is 50%. However, you can reduce the capital gain only after you have applied all the capital losses for the year and any unapplied net capital losses from earlier years.

Note:

If in the Agreement there is a payment to you for the surrender or cancellation of the lease, CGT event C2 will happen and there are CGT consequences.

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