Edited version of your private ruling

Authorisation Number: 1012087956707

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Ruling

Subject: Subdivision

Question 1

Will the profits made on the disposal of the subdivided lots be assessable income pursuant to section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Upon disposal, will the land satisfy the basic conditions for the small business capital gains tax (CGT) concessions under section 152-10 of the ITAA 1997?

Answer

No.

This ruling applies for the following period

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

The scheme commenced on

1 July 2011

Relevant facts

You jointly acquired land after September 1985 for $X.

After purchasing the land, you were approached by a local town planning firm to project manage the subdivision of the land into lots. This was approximately two years after purchasing the land. One planning permit for the entire property was submitted which enabled the property to be developed in stages.

Over the years several lots of the abovementioned land have been sold. The primary purpose of these previous sales was to raise funds to live off and to reduce debt.

There now remains Y acres of the original land which you intend to develop in the next two to three years as part of your transition to retirement.

You have at all times carried out your business on the land.

The property is located in a rapidly growing corridor. You have been approached in relation to the potential to subdivide the property.

You did not pursue this outcome via any meetings or submissions to Government. This zoning has been imposed by the State Government as part of a Metropolitan Strategy to accommodate future population growth.

Initial indications from draft plans currently being undertaken by State and Local Government indicate that the property will be required for residential development in the short term ie; within the next two or so years. Given this imposition you have the following logical choices:

o sell the land to allow development to proceed

o develop the land themselves

o engage a developer to project manage the development of the land.

You have no experience in urban development at the scale required by the State Government ie; target densities of 15 dwellings per hectare, open space, community facilities etc, the viable options are to sell the land or engage a project manager to develop the land.

It is also your intention to continue to operate the business for as long as possible during any subdivision process.

The current market value has been estimated at $Z million.

There are a number of planning processes that need to be completed before subdivisions.

The project will be wholly managed by a project management company specialising in project managing town planning matters and land subdivision. The applicants will have no personal involvement in the project.

The planning phase of the project (next two years) will require funding in the order $A million dollars which will be derived via a debt facility against the value of the property. Once the planning phase is complete and the project is ready to commence construction, a construction fund will be established with a requirement of approximately $B million to commence stage 1 works.

There are expected to be 8 stages to the subdivision with each stage estimated to be approximately $B million ie; total construction cost of $XX million.

Gross total proceeds are estimated to be $YY million based on a subdivision of substantial number of lots.

You have no intention to subdivide in the future.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

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

The legislative references referred to herein are from the ITAA 1997 unless otherwise stated.

Summary

The facts in your case support the view that the development of your land, subdivision and subsequent sale constitute an isolated transaction with a profit making purpose.

Detailed reasoning

Proceeds from the sale of property for tax purposes are treated as either:

1. income according to ordinary concepts under section 6-5 derived:

2. in the course of carrying on a business, or

3. from an isolated transaction for the purpose of profit making, or

4. subject to capital gains tax.

Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case.

The principle has been established that profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium). 

Taxation Ruling TR 92/3 discusses the application of the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are ordinary income and therefore assessable under section 6-5.

The subdivision and sale of land is outside the ordinary course of the activities from which you derive your income. The transaction will not occur within the ordinary course of business being carried on by you. Therefore, the activity would be best described as an isolated transaction.

According to Paragraph 1 of TR 92/3, the term isolated transactions refers to:

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

o those transactions entered into by non business taxpayers. 

Paragraph 8 of the ruling explains that 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.

Paragraph 15 of TR 92/3 provides that if a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayers business but

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

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

Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case.  Casimaty v FC of T 97 ATC 5135; (1997) 37 ATR 358 (Casimaty's case) and McCorkell v FC of T 98 ATC 2199; (1998) 39 ATR 1112 (McCorkell's case) demonstrate that in circumstances where there is an absence of profit making intention when farming land is acquired, the likelihood of any profit made on the eventual sale of land being income according to ordinary concepts is greatly diminished.

However, profits on the sale of subdivided land can still be income according to ordinary concepts within section 6-5, or as a profit making undertaking or plan within section 15-15 if the taxpayer's subdivisional activities have become a separate business operation or commercial transaction. The Commissioner's guidelines in this regard are set out in paragraph 13 of Taxation Ruling TR 92/3.

Paragraph 13 of TR 92/3 lists the following factors:

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.

In applying these principles to your case, the following facts have been considered:  

o you are operating a business using the land.

o you have been involved in property development activity in the past. Two years after purchasing the land you subdivided the land into lots and sold them off over several years period to raise funds to live off and to reduce debt.

o the approximate cost of the subdivision is expected to be $XX million and the expected total proceeds from the subdivided lots are approximately $YY million. The current market value of the land has been estimated at $Z million. The amount of the costs of the project is more than the current pre subdivision value of the land. As such the costs associated with the subdivision are considered significant.

The subdivision will generate an extra profit of approximately $ZZ million.

This is a large scale development. The planning phase of the project will take 2 years. Once the planning phase is complete and the project is ready to commence it is expected to be completed in 8 stages. There are a number of planning processes that need to be completed before subdivision commences as stated previously.

The project will be wholly managed by a project management company specialising in project managing town planning matters and land subdivision. You will have no personal involvement in the project.

The decision in FCT v Whitfords Beach Pty Ltd (1982) 150 CLR 355; 12 ATR 692; 82 ATC 4031 (Whitfords Beach case) indicates that profits from a large subdivision are likely to be income.

This test alone may not be conclusive however a more satisfactory test is the ratio of development expenditure to the value of the undeveloped land.

In this case, the value of the pre subdivided land is estimated at $Z million and the approximate cost of the subdivision is expected to be $XX million. The expected proceeds from the subdivided lots are approximately $YY million.

You state that the disposal of your land by subdivision and sale constitute the realisation of a capital asset that was acquired, not for profit making purposes.

· Whilst it is acknowledged that this may be the case, Taxation Ruling TR 92/3 at paragraphs 41 & 42 addresses this issue as follows; for example, if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either; or

· as the capital of the business; or

· into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction,

· the activity of the taxpayer constitutes the carrying on of a business or business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income although the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

Miscellaneous Taxation Ruling MT 2006/1 discusses about isolated transactions and sales of real property. From the Statham and Casimaty cases a list of factors can be ascertained that provide assistance in determining whether activities are a business or an adventure or concern in the nature of trade. These factors are as follows:

· 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.

Example 30 in MT 2006/1 found the subdivision activities were an enterprise based on the following factors:-

· there is a change of purpose for which the whole property is held;

· there is a comprehensive plan for the development of the property;

· the subdivision is developed in a businesslike manner for example there is a project manager, significant development costs, a comprehensive marketing campaign including an estate name for the land; and

· a substantial loan has been taken out to finance the development.

By undertaking a land subdivision of this scale you have taken on a financial risk akin to a normal business undertaking.

· you will not be acting as the developer, but will commission a project manager to manage the project from the preliminary planning through to the sale of the subdivided lots as a commercial undertaking.

· the property in this case is many acres of land that will be subdivided into quiet a substantial number of lots.

· you have provided a history of the land from the time the land was acquired. Two years after purchase, one planning permit for the entire property was submitted which enabled the property to be developed in stages.

On balance, it would seem that the project is an undertaking on a sufficient scale to take it well beyond the realms of a mere realisation of an asset and characterize it as a commercial undertaking.

In particular the amount of the proposed expenditure being more than the current value of the land. As a consequence, the proceeds from the sale of the land will be considered to be ordinary income and therefore assessable under section 6-5.

Small business (CGT) concessions

The basic conditions for the CGT small business concessions are found in Subdivision 152-A.

The basic conditions in section 152-10 to be satisfied for the gain are:

(a) CGT event happens in relation to a CGT asset of yours in an income year. This condition does not apply in the case of CGT event D1

(b) the event would (apart from Division 152) have resulted in the gain

(c) at least one of the following applies:

(i) you are a small business entity for the income year

(ii) you satisfy the maximum net asset value test (section 152-15)

(iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership;

(iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year;

the CGT asset satisfies the active asset test in section 152-35.

In your case a CGT event will occur on the sale of the subdivided lots.

Section 118-20 discusses the anti-overlap provisions, in particular subsection 118-20(1) states a capital gain you make from a CGT event is reduced if, because of the event, a provision of this Act (outside of this Part) includes an amount (for any income year) in your assessable income.

As the profit made on the sale of the subdivided lots will be assessable income under section 6-5 any capital gain you make from the CGT event is reduced to nil under section 118-20.

As such, although a CGT event happened, it will not result in a gain therefore condition B above is not satisfied.

As condition B is not satisfied, the small business concessions are not available.

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