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Ruling

Subject: Profit derived from subdivision and sale of land -capital asset or income according to ordinary concept

Issue 1

Question 1

Will the profit derived by X Pty Ltd as trustee for the Y Unit Trust from the subdivision and sale of the land be considered as mere realisation of capital asset and hence assessable under Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will any profit derived by X Pty Ltd as trustee for the Y Unit Trust from the subdivision and sale of the land be assessable as ordinary income under section 6-5 of the ITAA 1997?

Answer

No.

Question 3

If the profit from the subdivision and sale of the land is assessable under section 6-5 of the ITAA 1997, will the date of the change of the land from capital to revenue be the date when the Development Approval was granted?

Answer

Not applicable

This ruling applies for the following period

1 July 2012 to 30 June 2014

The scheme commenced on

1 July 2012

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

X Pty Ltd as trustee for Y Unit Trust (YUT) acquired the land in the 19XX financial year.

The land was a farmland. The zoning of the land was non urban.

Since the acquisition, the YUT continued farming on the land.

YUT considered sale of the land and the business due to unprofitability of the business and the age of the unit holders. However, it considered that the disposal of the farm land would not result in a reasonable return on the investment.

In order to realise the farm at its highest and best use, the YUT has undertaken to subdivide the land, develop it and sell it as separate lots.

Z, as director of X Pty Ltd and a unit holder in the YUT, engaged a project co-ordinator to assist with the following

§ the application for the DA;

§ the obtaining of work permits;

§ town planning services;

§ surveying;

§ environmental servicing; and

§ co-ordination of other consultants.

The company that the project co-ordinator represents is paid as consultant for the services it provides to YUT.

The DA was obtained in the 20XX financial year. The DA required certain infrastructure constructed.

In the 2010 - 11 financial year, YUT was in a position to start the building works required for the subdivision.

The project co-ordinator oversaw all relevant works in relation to the development and updated Z on a regular basis. Pursuant to certain Council requirement YUT conducted some of the work itself due to its own expertise in that field.

An auction of the farm equipment is scheduled in the 2011 - 12 financial year and from that time, the farming business will likely cease.

It is intended that the subdivided lots will be sold as vacant blocks. No houses, fences or other improvements will be constructed on these blocks.

A marketing consultant has been engaged to market and sell the individual lots on completion of the subdivision with Z as an additional contact due to his familiarity of the area for over two decades.

Z will be continued to be paid salary from YUT for this period. While his salary may be increased to reflect the additional co-ordination efforts involved, he will not be paid any commission for the sale of the land.

The subdivision will be financed by contributions from YUT unit holders and external finance.

It is essential for the DA that certain works commence prior to the external finance being completed.

The YUT has not previously engaged in property development.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 section 6-5

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.

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Reasons for decision

Issue 1

Question 1

Summary

The profit derived from the subdivision and sale of the land is a mere realisation of capital asset and hence assessable under Part 3-1 of the ITAA 1997?

Detailed reasoning

The question as to whether profit derived from subdivision and sale of land is considered in a number of cases.

In McClelland v FC of T 70 ATC 4115, the Privy Council held that the question to be answered was whether the facts revealed a mere realisation of capital, albeit in an enterprising way, or whether they justify a finding that the taxpayer went beyond this and engaged in a trade of dealing in the asset, albeit on one occasion only.

Lord Justice Clark, in distinguishing between proceeds that is mere realisation of capital and ordinary income, stated in California Copper Syndicate v Harris (1904) 5 TC 159 at pp 165-166 that:

…What is the line which separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be determined being - is the sum of the gain that has been made a mere enhancement of values by realising a security, or is it a gain made in an operation of business in carrying out a scheme of profit-making?

In Whiteford Beach Pty Ltd v FC of T 82 ATC 4031, Gibbs CJ said (at p.4034) that:

When the owner of an investment chooses to realize it, and obtains a greater price for it than he paid to acquire it, the enhanced price will not be income within ordinary usages and concepts, unless, to use the words of the Lord Justice Clerk in California Copper …'what is done in not merely a realisation or charge of investment, but an act done in what is truly the carrying on, or carrying out, of a business'.

In Crow v FC of T 88 ATC 4620 at 4625-4626; (1988) 19 ATR 1565 at 1573 where Lockhart J held that:

It is well established that profits obtained from the realisation of property are to be treated on revenue account and as assessable to tax 'where what is done is not merely a realisation or change of investment but an act done in what is truly the carrying on or carrying out of a business': Californian Copper Syndicate v Harris (1904) 5 TC 159 at p 166; FC of T v Whitfords Beach Pty Limited 82 ATC 4031; (1982) 150 CLR 355.

In FC of T v The Myer Emporium Ltd 87 ATC 4363, it was held (at p 4369) that:

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 acquisition of acquiring for the purpose of profit-making by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realization. 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 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. (Emphasis added).

In Case 32/96, 96 ATC 361, the taxpayer purchased 148 acres of mostly arable farming land in 1950s. Over time, the taxpayer realised part of the land for various purposes including allowing a brickworks operator to extract clay, for the expansion of a school and for the building of a hospital. Following a rezoning of the land, the taxpayer subdivided 38 lots and sold all but one. For one sale, the taxpayer was required to construct an access road which was financed by the subdivision and sale of a further 14 lots. The taxpayer claimed that the sale of the land represents the realisation of a capital asset which had been held over a long period of time and which was originally purchased for farming purposes. The Commissioner, on the other hand, clamed that having regard to the financial commitment undertaken as part of the subdivision and the fact that the taxpayer himself undertook the subdivision, the subdivision amounted to the carrying on of a business. The AAT held that:

The applicant simply "took the necessary steps to realise the land to the best advantage, especially land which had been acquired and used for a different purpose which it was no longer businesslike to carry out" (see the Scottish Australian Mining case at ATC p 140; CLR p. 195).

In Scottish Mining Co. Ltd v FC of T (1949) 9 ATD 135; (1950) 81 CLR 188, the company engaged in coal mining on land it owned since 1863, ceased to operate as a mine sometimes in 1942. Thereafter it sold off, from time to time, parcels of land formerly used for mining, for residential and other purposes, after having systematically subdivided the land, constructed roads, made sites available for schools and set aside areas for parks, etc. The subdivision was so systematic and scientific that Commissioner argued that the company had ceased to be a coal miner, and instead was carrying out the profit-making undertaking of selling land. This argument was rejected by the Court, where William J stated (at ATD p 140; CLR p 195):

…The facts would, in my opinion, have to be very strong indeed before a Court could be induced to hold that a company which had not purchased or otherwise acquired land for the purpose of profit making by sale was engaged in the business of selling land and not merely realising it when all that the company had done was to take the necessary steps to realise the land to the best advantage, especially land which had been acquired and used for a different purpose which it was no longer businesslike to carry out.

His Honour further stated (at ATD p 141; CLR p 197):

I am not prepared to hold that the appellant [company] commenced business as a land dealer in 1942 simply because it commenced to realise the Lambton lands. It was not a company which was formed for the purpose of dealing in land and there is to my mind no evidence that it engaged in such a business either before or after 1924. (Emphasis added)

In Statham & Anor v FC of T 89 ATC 4070; (1988) 20 ATR 228, the Court held that the sale by subdivision of farming land constituted a mere realisation of the asset and not proceeds of a business. The Court said (at ATC pp 4076-4077; ATR pp 235-236) that:

The questions which the Tribunal had to determine were whether the subdivision of the land in question amounted, on the one hand, merely to the advantageous and enterprising realisation of a capital asset or, on the other hand, to a business of land development carried on by the owners (sec 25(1)) or to an undertaking or scheme in which an essential element was the purpose of profit-making (sec 26(a)).

The Court considered the following factors in making the decision:

(a) the owners were at first content to sell the land as one parcel, but were unable to do so;

(b) no moneys were borrowed by them, although a guarantee was provided to Kingaroy Shire Council by way of bank guarantee;

(c) only very limited clearing and earthworks were involved;

(d) the owners relied upon the Kingaroy Shire Council to itself to carry out road works, kerbing, electricity and sewerage works which were required to be done;

(e) the owners did not erect buildings on the land; not even, for example, a site office;

(f) they had no business organisation, no manager, no office, no secretary, and no letterhead;

(g) Dr Bickerton maintained his medical practice;

(h) the owners did not advertise the land for sale;

(i) apart from the Kingaroy Shire Council's activities, the owners did not engage any contractors, although they did obtain some professional advice;

(j) the books kept in relation to the sales of land were kept by Mrs Bickerton; and

(k) the land was sold simply by listing it with the local real estate agents.

The Court found the sale had a very few hallmarks of a business enterprise and held that what occurred was:

the mere realisation, by the most advantageous means, of the asset which the owners had on their hands when they abandoned the intention of farming the subject property.

The Court said (at p 4075):

It is well established … that the mere realisation of an asset at a profit does not necessarily render the profit taxable. The profit must arise from carrying of a business or a profit-making undertaking or scheme. The mere magnitude of the realisation does not convert it into such a business, undertaking or scheme; but the scale of the realisation activities is a relevant matter to be taken into account in determining the nature of the realisation, ie in determining whether the facts established a mere realisation of a capital asset or a business or profit-making undertaking or scheme.

In Casimaty v FC of T 97 ATC 5135, the taxpayer Casimaty acquired the property known as "Acton View" comprising of 988 acres of land from his father by way of gift in 1955. He conducted dairy and fencing business from that property until faced with financial hardship and deteriorating health, he decide to sell two third of the property by eight subdivisions between 1975 and 1995. The proceeds from the sale of the property were considered as derived in the course of carrying on of business of selling land. Ryan J found in the favour of the taxpayer. After considering many reported decisions including Stevenson V FC of T 91 ATC 4476; (1991) 29 FCR 282 upon which the ATO relied heavily to come to its decision, Ryan J stated (at ATC p 5149; ATR p 373):

An examination of the reasoning in Stevenson's Case confirms that whether the subdivisional activity is sufficiently extensive and systematic to amount to the conduct of a business is, as Lockhart J observed in Crow's Case a question of fact. Jenkinson J was not required to resolve that question of fact for himself. He was concerned only to ensure that the Tribunal had not committed any error of law arriving at the conclusion which it did. His Honour did not distil from the authorities a principle of law that a subdivision involving a hundred or more lots, the construction of roads and the reticulation of water to each lot could never amount to a mere realization of a capital asset. Any such principle would run counter to the views expressed by all but one member of the High Court in FC of T v Williams 72 ATC 4188; (1972) 127 CLR 226 where Gibbs J observed (at ATC 4194-4195; CLR 249):

'An owner of land who holds it until the price of land has risen and then sub-divides 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 sub-division 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 realisation of a capital asset are not income either in accordance with ordinary concepts or within the second limb of sec 26(a), even though the realisation is carried out in an enterprising way to as to secure the best price.'

Similar decision was arrived at by Senior Member BH Pascoe in McCorkell v FC of T 98 ATC 2199 where he took the view that McCorkell adopted a relatively passive role in the mere realisation by the most advantageous means of an asset which he had when the decided to abandon the intention of continuing to use it as an orchard.

From the above case analysis, it can be said that although there is no general indicia as to whether the proceeds for the sale of a land is a mere realisation of capital asset or derived in the course of carrying on a business, and each case depends on the fact of the case, the following factors seem to be common among the judges in deciding that the profit is a mere realisation of a capital asset, namely:

1. the taxpayer needs to show the intention or the purpose to make profit from the sale of the land when such land was originally acquired.

2. the scale of the activity in the sale of the land, while important, is not the sole determining factor.

3. subdividing and selling the land in the most advantageous and enterprising way does not make the sell from mere realisation of capital asset to carrying on a business.

In the present case, the following factors are important to make the decision as to whether the sale of the land by YUT is mere realisation of capital asset or done in the course of carrying on a business:

1. YUT acquired the land to conduct farming. The zoning of the land was non urban.

2. YUT continued farming until it was no longer profitable.

3. selling the land as a farm would not have given YUT a good return whereby decision was made to sell the business separately from the land.

4. farming business was continued even though the subdivision process commenced and until the equipment was sold.

5. Z, the director of X Pty Ltd engaged a project co-ordinator to do all preliminary works regarding the subdivision of the land including submitting application for DA, getting approval from the Land Court, obtaining work permits, town planning and environmental services, surveying etc.

6. once DA was obtained, the project co-ordinator was again engaged to source the bids for the development works and manage the contracts once successful offers were chosen. The project-coordinator also engaged the engineers that needed to be engaged for these works to be undertaken who on their parts carried on all necessary works in each individual areas of expertise.

7. YUT paid the company from which the project co-ordinator was engaged.

8. the project-coordinator liaised with Z to update on the progress of the works.

9. since YUT has expertise in certain fields it undertook to do certain works to reduce cost.

10. a marketing agency has been engaged to market and sell the subdivided lots in the most profitable way with Z as a contact.

11. all the blocks will be sold as vacant lots. No house, fence or other improvements will be built on the blocks.

12. Z is paid a salary from YUT which might increase to reflect his additional responsibilities involving the subdivision and sale of the land.

13. YUT has never engaged in property development previously.

From the above facts, it is considered that the subdivision and sale of the land is a mere realisation of capital asset. There was no intention or purpose on the part of YUT to carry on a business of subdivision and sale of the land. The farming business was continued until it was no longer profitable. The systematic and extensive activities involved in the subdivision and sale of the land show nothing but the most enterprising way that the trustee could realise the best outcome from the land which could no longer sustain the farming business.

Question 2

Summary

The profit derived from the subdivision and sale of the land is not assessable as ordinary income under section 6-5 of the ITAA 1997.

Detailed reasoning

Section 6-5(1) of the ITAA 1997 states that:

Your assessable income includes income according to ordinary concept, which is called ordinary income.

There is no definition of ordinary income in the tax legislation and it therefore takes its ordinary meaning. The Oxford English Dictionary defines income as:

Periodical (usually total annual) receipts from one's business, land, work, investments, and so on.

The Macquarie Dictionary defines income as:

The returns that come in periodically, especially annually, from one's work, property business, etc; revenue; receipts or something that comes in.

While the Courts have not applied a strict definition of income for each receipt, they have traditionally identified a number of characteristics that provide the basis in determining whether a receipt is income. The main characteristics that have been identified may include the receipt being:

§ received periodically and regularly

§ relied upon or expected

§ earned, and

§ for the replacement of income.

In the present case, the land was acquired in the 19XX financial year for the purpose of carrying on farming business. The plan to subdivide and sell the land arose only when the farming business became unprofitable and the unit holders aged. Although plan to subdivide and sell the land started in the 20XX financial year, and the DA was obtained in the 20XX financial year, the farming business continued until the 2010 - 11 financial year. The farming business will cease when the farm equipment is put on auction in the 2011 - 12 financial year. A project co-ordinator was engaged to conduct all works related to subdivision and development of the land. The subdivision and sale of the land, though done in a systematic way, does not contain any of the qualities of being income according to ordinary concept. There is no periodicity, regularity, or recurrence in sale of the land. It is just one piece land that the trustee is subdividing and selling. It is not to replace the income earned from the farming business.

However, periodicity, recurrence or regularity is not always essential for an amount to be income. In the case of FC of T v The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693, where the High Court clearly established that the profit arising from an isolated transaction will be an income nature if the taxpayer's purpose in entering into the transaction was to make a profit.

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR) sets out the Commissioner's view regarding the profits from isolated transactions and when an isolated transaction amounts to a business operation. Paragraph 35 of the TR states:

35. A profit from an isolated transaction is …generally assessable income when both 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.

Paragraph 9 of the TR further states:

9. The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If 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 property.

In this case, when the land was acquired by YUT, there was no intention or purpose to make profit from the sale of the land.

Paragraph 13 of the TR states:

13. Some matters which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are the following:

(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.

The nature of YUT cannot be said to be a property developer. It has no previous experience in property development. The fact that it engaged a project-coordinator to carry out all related activities in subdividing and developing the land and the fact that it engaged a marketing company to sell the land substantiate the claim that YUT has no experience in property development.

The scale of the activity, although quite extensive and systematic, YUT's involvement in the entire process was minimal and limited to certain works, an area in which it has previous experience. Again putting Z as an additional marketing contact is because of his familiarity of the area. He does not have marketing experience nor is he employee of the marketing company engaged to carry out the marketing of the land.

YUT intends to sell the subdivided land to unrelated parties. The project co-ordinator, town planner, engineers, contractors, marketing and other consultants that have been engaged are unrelated to YUT.

The land was acquired in the 19XX financial year for the purpose of farming business which continued over two decades. The farming business continued even after the process for subdivision of the land commenced and will cease when the farming equipment is sold in the 2011 - 12 financial year. It was not acquired for the purpose of resale.

Considering all these factors, the sub-division and the sale of the land cannot be considered as a business operation or commercial transaction and hence the profit from the sale is not income derived from ordinary course of business. Therefore the profit is not assessable as income under section 6-5 of the ITAA 1997.

Question 3

Summary

Since the answer to question 2 is 'no', there is no need to address this question.

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