Edited version of your private ruling

Authorisation Number: 1012069260033

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Ruling

Subject: CGT - land development

Question 1

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

Answer

No

Question 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?

Answer

Yes

Question 3

Will you be entitled to apply the 50% discount under Subdivision 115-A of the ITAA 1997 to the capital gain arising from the disposal of the subdivided lots?

Answer

Yes

Question 4

Will you be entitled to apply any of the four small business concessions under Division 152 of the ITAA 1997 to the capital gain arising from the disposal of the subdivided lots?

Answer

The Commissioner declines to rule on the ground that assumptions would be required to be made in relation to the basic conditions for the concessions. General guidance has been provided for your consideration.

This ruling applies for the following periods:

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The taxpayer is the trustee for the trust. The trust is the current registered owner of the land and is operating a business on it.

Mr and Mrs A (both deceased) had a number of children. Each is a director and shareholder of the taxpayer. However, all but one, Mr B, have little physical involvement in the management of the business of the trust.

Mr B lives on the land, he is highly qualified in his field and has been responsible for running the business for several decades. Due to his age and health he is looking to retire. He has a number of adult children who have no desire to operate the business on the land.

A number of generations of the same family owned the land in their personal names, and carried on a business on the land.

Some time ago, Mr and Mrs A ceased carrying on the business in their personal names, and commenced carrying on the business via the trust.

After Mrs A passed away, pursuant to her will, the land passed to Mr A.

The trust ceased carrying on part of the business on the land a few years ago as:

· Mr B was becoming older and he decided that the returns he was making from the no longer justified the effort involved

· The Trust was under pressure from the state government to cease the activity due to concerns relating to the condition of the adjoining land and agriculture activities, and

· At the time, the other part of the business was performing well.

A few years ago, Mr A passed away. Pursuant to his will, the land passed to the trust.

The trust has been the registered owner of the land since Mr A's death.

Mr B continues to manage the business of the trust on the land.

During the last decade, the trust has had an exclusive purchaser of the product it produces.

The trust's contract with the purchaser expires on 30 June 2012. The purchaser has informed the trust that for commercial reasons the purchaser will not be renewing its contract to purchase product from the trust.

The demand for additional product (not already under contract) in the market is poor. The price for the product has fallen significantly compared to what the trust was able to achieve several years ago.

The taxpayer wishes to retain as much of the land as possible and to subdivide and sell those parts of the land which was used primarily for the other part of the business which is now ceased.

The proposed subdivision will relate to less than half of the land and will comprise a small number of large lots.

The taxpayer intends to present the lots for sale as basic rural blocks of land. In that respect, the taxpayer intends to arrange for the lots to be:

(a) tidied with removal of debris following recent significant storm damage; and
(b) revegetated and rehabilitated to their original pastoral status to protect against future storm damage and erosion.

However, in all other respects, the taxpayer intends that only the bare minimum amount of works required to obtain council subdivision approval will in fact be undertaken on the land.

The taxpayer will not borrow any funds to undertake the subdivision. The taxpayer has engaged independent parties to undertake all work and sales associated with the subdivision.

The taxpayer does not have any timeframe within which to sell the lots. Given the current market, the taxpayer anticipates that it may take several years to sell all of the lots at a suitable price.

The taxpayer has provided estimates of the total project costs to complete the subdivision.

The anticipated construction costs relate to the cost of constructing a road, and the installation of essential amenities required for subdivision approval (such as water, power and drainage).

The taxpayer has provided the existing cost base for the land area.

The taxpayer has not borrowed any money to fund the subdivision, and is under no compulsion to sell. The taxpayer has the intention to wait for what it considers is an appropriate return for the sale of the lots.

The taxpayer has provided information in relation to the sale proceeds expected.

The remaining undivided part of the land will comprise Mr B's family residence, most of the product growing area and the dam used for the business.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 109-55

Income Tax Assessment Act 1997 section 112-25

Income Tax Assessment Act 1997 subsection 112-25(3)

Income Tax Assessment Act 1997 subsection115-30(1)

Income Tax Assessment Act 1997 subsection 115-100(a)

Income Tax Assessment Act 1997 subsection 128-15(2)

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-35

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

Question 1 and 2

Under section 6-5 of the ITAA 1997, your assessable income includes the ordinary income you derived directly or indirectly from all sources, during the income year. Although the legislation does not define income according to ordinary concepts, a substantial body of case law has evolved to identify various factors that indicate the nature of ordinary income.

Profits from the sale of property can be assessable under section 6-5 of the ITAA 1997 in the following ways:

(a) As ordinary income under section 6-5 of the ITAA 1997 as a result of carrying on a business of property development and involving the sale of property as trading stock.

(b) As ordinary income under section 6-5 of the ITAA 1997 as a result of an isolated business transaction which, although outside the ordinary course of business of a taxpayer, is entered into for the commercial exploitation of an asset acquired for a profit making purpose, that is, the profit is derived in the course of carrying out a business operation or commercial transaction.

Taxation Ruling TR 92/3 sets out the Commissioner's 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 ordinary concepts depends very much on the circumstances of the case. However, if a taxpayer carrying on a business makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayer's business, but

(a) the intention or purpose of the taxpayer in entering into the 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;

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

· 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

Applying the factors from paragraph 13 of TR 92/3 to your circumstances leads to the following conclusions:

· You acquired the property from a deceased estate, you will undertake the subdivision. It is noted that prior to this acquisition the land was used by you to carry on the business since Mr and Mrs A stopped carrying on the business in their own names.

· The land area on the property that has been approved for subdivision was previously used to carry out one component of the business, which has now ceased.

· There will not be significant value adding, however you do expect to make significant gains from the subdivision.

· The land area on the property with approval for subdivision will be developed into a small number of rural lots, the subdivision is of a small scale. The development will be limited to that required to secure council approval.

· The subdivision is being carried out in your name and not as a separate business.

· There are no other parties to the operation.

· The land in question has been used for some time to carry on primary production businesses. You have held the subject property for a short period of time, acquiring it through the estate of Mr A. The land has been used during this time to carry on the business.

· You took steps to proceed with the subdivision reasonably soon after acquiring the property however the property was acquired through the deceased estate as a result of generational handover.

A consideration of the above factors leads to the overall impression that the intention to subdivide your property is more weighted toward the mere realisation of the asset, carried out in an enterprising manner.

The sale of the subdivided lots will not be treated as a profit from an isolated transaction under the guidelines of TR 92/3. The proceeds would be assessable as capital gains under Part 3-1 and Part 3-3 of the ITAA 1997.

Note: this ruling does not consider the outcome of any further land development activity that may occur on your land.

Question 3

Land or an interest in land is a CGT asset (section 108-5 of the ITAA 1997).

A CGT event does not happen where land is subdivided into separate blocks of land (section 112-25 of the ITAA 1997). A subdivision of land results in the creation of separate CGT assets, being the new blocks of land. The cost base of the original land must be reasonably apportioned across the new blocks of land (subsection 112-25(3) of the ITAA 1997). Further, a taxpayer is treated as having acquired subdivided blocks of land at the same time as it acquired the original block of land.

A capital gain made by a trust is reduced by 50% if it relates to the disposal of a CGT asset held by the trust for a period of at least 12 months prior to the relevant CGT event (subsection 115-100(a) of the ITAA 1997).

For the purposes of calculating whether the 12 month rule has been met, a taxpayer is treated as having acquired the CGT asset at the time the deceased individual acquired the asset (subsection 115-30(1) of the ITAA 1997).

You hold the land as trustee for the trust. You acquired the land pursuant to the terms of Mr A's estate. Mr A acquired the land pursuant to the terms of Mrs A's estate.

As a result, you would be treated as having acquired the lots at the time of Mrs A's death, being a period greater than 12 months. Therefore you can apply the 50% discount to any future capital gain arising from the disposal of the lots.

Question 4

Summary

Under paragraph 357-110(1)(a) of Schedule 1 to the Taxation Administration Act 1953 the Commissioner can decline to rule on a private ruling where it is considered that correctly making a private ruling would depend on making an assumption about future events.

In this case, the Commissioner declines to rule on this issue on the ground that assumptions would be required to be made in relation to the active asset test.

Where a CGT asset passes to a taxpayer as a beneficiary of a deceased estate, the taxpayer is taken to have acquired the asset at the time the relevant individual died (subsection 128-15(2) of the ITAA 1997). In this case, the trust acquired the asset from the deceased estate and has used it during this time in the carrying on of a business. It follows that the asset would pass the active asset test if the subdivided land was disposed of within double the period of time it has been owned.

However, there are a number of uncertain facts surrounding the proposed development activity. It is unknown when the subdivision will be completed and when the subsequent sales will be executed. A part of the business has ceased and it is uncertain for how long the other part of the business will continue to operate.

The active asset test is a basic condition which must be satisfied to access any of the small business CGT concessions. There is significant uncertainty around key aspects of the trust's ability to meet the requirements of the test. As a result, the Commissioner declines to rule and has provided general guidance on the concessions as an alternative.

Overview of the small business CGT concessions

The four small business CGT concessions are contained in Division 152 of the ITAA 1997. To qualify for the small business CGT concessions, you must satisfy several conditions that are common to all the concessions. These are called the 'basic conditions'.

Each concession also has further requirements that you must satisfy for the concession to apply (except for the small business 50% active asset reduction which applies if the basic conditions are satisfied).

The basic conditions are contained in section 152-10 of the ITAA 1997 and are set out below:

(a) a CGT event happens in relation to a CGT asset in an income year;

(b) the CGT event would otherwise have resulted in a capital gain;

(c) one or more of the following applies:

(i) the taxpayer satisfies the maximum net asset value test;

(ii) the taxpayer is a small business entity for the income year;

(iii) the asset is an interest in an asset of a partnership which is a small business entity for the income year, and the taxpayer is a
partner in that partnership;

(iv) the conditions mentioned in section 152-10(IA) or (1B) are satisfied are satisfied in relation to the CGT asset in the
income year; and

(d) the CGT asset satisfies the active asset test.

Active Asset Test

A CGT asset satisfies the active asset test if the asset was an active asset of the taxpayer during at least half the period beginning when the taxpayer acquired the asset and ending at the earlier of:

(a) the CGT event; or

(b) the cessation of the business if the relevant business ceased to be carried on in the 12 months before that time (section 152-35 of the ITAA 1997).

If a CGT asset passes to a taxpayer as a beneficiary of a deceased estate, the taxpayer is taken to have acquired the asset at the time the relevant individual died (subsection 128-15(2) of the ITAA 1997).

A CGT asset will be an active asset if the taxpayer owns the asset, and it is used, or held ready for use, in the course of carrying on a business that is carried on by the taxpayer, their affiliate or another entity that is connected with the taxpayer.

In calculating the active asset period consideration must be given to the point in time the taxpayer ceases to use, or hold ready for use, the asset in the business.

Small Business 50% Reduction

To apply the small business 50% active asset reduction, you only need to satisfy the basic conditions. There are no further requirements.

Small Business 15 Year Exemption
You can disregard a capital gain from a CGT event happening to a CGT asset you have owned for at least 15 years if you:

· satisfy the basic conditions for the small business CGT concessions (the active asset test requires the asset to have been an active asset for at least 7.5 years of the whole period of ownership)

· continuously owned the CGT asset for the 15-year period ending just before the CGT event happened.

Further conditions apply for companies or trusts.

Retirement exemption

If you are a trust you can also choose to disregard all or part of a capital gain if:

· you satisfy the basic conditions

· you satisfy the significant individual test

· you keep a written record of the amount you choose to disregard (the exempt amount) and, if there are more than one CGT concession stakeholders, each stakeholder's percentage of the exempt amount (one may be nil but together they must add up to 100%)

· you make a payment to at least one of your CGT concession stakeholders

· worked out by reference to each individual's percentage of the exempt amount

the payment must be equal to the exempt amount or the amount of capital proceeds

An individual's lifetime CGT retirement exemption limit is $500,000, reduced by any previous CGT exempt amounts the individual has disregarded under the retirement exemption. This includes amounts disregarded under former (repealed) retirement exemption provisions. For a company or trust with eight CGT concession stakeholders (four significant individuals and their four spouses where the spouse has a business participation percentage greater than zero), the limit is effectively $4 million ($500,000 for each stakeholder).

Small business roll-over

To qualify for the small business roll-over you need to satisfy the basic conditions that apply to all the CGT small business concessions. There are roll-over conditions that must also be satisfied by the end of the replacement asset period. This period starts one year before and ends two years after the last CGT event that occurs in the income year for which you choose the roll-over.

If the roll-over conditions are not met within the replacement asset period the gain will become assessable.

You satisfy the roll-over conditions if:

· you acquire one or more CGT assets as replacement assets or make a capital improvement to one or more existing assets, or both, within the replacement asset period 

· the replacement asset, or the asset to which the capital improvement was made is an active asset at the end of the replacement asset period. A depreciating asset such as plant can be a replacement asset

If you choose the roll-over, all or part of the capital gain will not be included in your assessable income until a change in circumstances happens, for example you don't meet the roll-over conditions within the specified time period.

If your use of the replacement or improved asset changes (for example, you no longer use it in the business or you sell it) this is a change in circumstances.

When a change in circumstances happens the deferred capital gain will crystallise - that is, all or part of the capital gain previously deferred will become assessable.

Further information on the concessions can be found in our publication 'Advanced guide to capital gains tax concessions for small business 2008-09' which is available on our website www.ato.gov.au.

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