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Authorisation Number: 1012166316612

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Ruling

Subject: CGT and the assessability of the proceeds from a land subdivision

Questions:

1. Did CGT event A1 in section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997) happen when the original property was amalgamated under the 'not in common ownership' (NICO) plan of consolidation?

Answer: No.

2. Will the gains made on the disposal of the subdivided lots be assessable pursuant to section 6-5 of the ITAA 1997?

Answer: Yes.

3. Will the gains made on the disposal of the subdivided lots be assessable under section 15-15 of the ITAA 1997?

Answer: No.

4. Will the disposal of the subdivided lots trigger CGT event A1 under section 104-10 of the ITAA 1997?

Answer: Yes.

5. Will any remaining capital gains made on the disposal of the subdivided lots be eligible for the CGT 50% discount under subdivision 115A of the ITAA 1997?

Answer: Yes.

This ruling applies for the following period

Year ended 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

The scheme commenced on

1 July 2011

Relevant facts

You and your spouse are directors of entities carrying on your family businesses. The principle family business was in the hospitality industry until the business was sold. Currently, your business involves managing a portfolio of investments on behalf of the companies.

You and your spouse acquired a property (original property) as joint tenants after 1985.

Your intention was to use the property for primary production activities.

You constructed a house on the property soon after purchase and you have used this as your main residence ever since.

More than 15 years ago, you were approached by a neighbour who wanted to purchase part of an adjacent property. They were unable to purchase the entire property and you and your spouse agreed to purchase a portion of the adjacent property as it enhanced your primary production business.

You (and the vendor) lodged a 'not in common ownership' (NICO) plan of consolidation in respect of the original property and the second property and the NICO title for the consolidated property (the property) issued soon after purchase.

The property has now been zoned as industrial. No rezoning request was made by you or on your behalf.

The property has large expansive paddocks with limited vegetation, which, until recent years, was used predominately used for grazing purposes.

The property is currently valued at approximately $X.

Land adjacent to the property is currently being developed as an industrial park. As a result of the industrial park development, the property is no longer suitable for rural domestic use or as a residence for you and your spouse, and you intend to dispose of the property.

You have been advised that, in order to realise the maximum capital value of the property, you should undertake a land development project on the property. Broadly, this would involve subdividing the land into a number of lots and selling the lots to the public.

The estimated cost of the subdivision, which includes the construction of access roads and the connection of basic utilities, is approximately $W. The project will be funded through a loan secured against the property. The total proceeds from the sale of the lots are expected to be between $Y and $Z million.

You and your spouse are not, nor have you ever been, in the business of property development and have no expertise relevant to property subdivision activities.

You will commission a project manager to manage the day to day running of the development, from the preliminary planning to the sale of the subdivided lots.

Market conditions and conditions of funding may require the development to be split into stages for presales and construction. No decisions have yet been made about the stages or the time frame over which the stages will be completed.

You plan to commence the development later in 2012.

Relevant legislative provisions

Income Tax Assessment Act 1997 - section 6-5

Income Tax Assessment Act 1997 - section 15-15

Income Tax Assessment Act 1997 - section 104-10

Income Tax Assessment Act 1997 - section 112-25

Income Tax Assessment Act 1997 - Division 115

Income Tax Assessment Act 1997 - section 118-20

Reasons for decision

Question 1.

CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1) of the ITAA 1997).

You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law.

Generally, CGT event A1 will happen when the title to two properties owned by different entities is merged. This is because each co-owner acquires, as a result of the merger, an interest in the land previously owned by the other.

However, a NICO title does not involve co-ownership of land in the generally understood sense (that is, a tenancy in common or joint tenancy). The NICO title recognises that each proprietor continues to own the land described in their previous title deed (though the NICO title requires both owners to agree to any subsequent transfer of any part of the land).

In your case, it is considered that there has been no change of ownership of the land. Therefore, CGT event A1 in section 104-10 of the ITAA 1997 has not happened and the land owned by you and your spouse before the issuing of the NICO title continues to be owned by you and your spouse after the issuing of the NICO title.

Question 2.

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

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

· in the course of carrying on a business, or

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

· subject to capital gains tax.

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

Carrying on a business

You have stated that you and your spouse are not, nor have you ever been, in the business of property development and have no expertise relevant to property subdivision activities. Therefore, it is accepted that any proceeds received from the sale of the subdivided land would not be derived in the course of carrying on a business.

Isolated profit making transaction

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 considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income.

TR 92/3 defines the term 'isolated transactions' as:

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

· transactions entered into by non business taxpayers. 

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.

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:

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

· 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.  Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of subdivided land can be assessed as ordinary income within section 6-5 of the ITAA 1997. TR 92/3 lists the following factors to be considered:

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 your case, you and your spouse are directors of entities carrying on your family businesses. The principle family business was in the hospitality industry until the business was sold. Currently, your business involves managing a portfolio of investments on behalf of the companies. You have not been involved in any property development activities in the past and this is will be your first subdivision project.

The approximate cost of the subdivision is expected to be $W and the expected total proceeds from the subdivided lots are between $Y and $Z. The value of the un-subdivided land is approximately $X. Therefore, the cost of the project is more than half of the maximum value of the un-subdivided land. As such, the costs associated with the subdivision are considered significant. The subdivision will generate an extra profit of approximately $U. The scale of the development will result in a number of lots. The subdivision will require infrastructure comprising the construction of access roads and the connection of basic utilities.

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 your case, the value of the un-subdivided land is approximately $Xn and the approximate cost of the subdivision is expected to be $W. The expected proceeds from the subdivided lots are between $Y and $Z.

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

Whilst it is acknowledged that this may be the case, 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:

· 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 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 talks about isolated transactions and sales of real property and provides a list of factors to be considered 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.

In your case, the financial risk you propose to undertake in a land subdivision of this scale is akin to a normal business activity.

· 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 will be subdivided into a number of lots.

· you have provided a history of the land since acquisition. You built a house and have lived at the property for a number of years. The land has been rezoned and other properties in your area are being developed.

On balance, it would seem that the project you propose is an undertaking of 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 half of the maximum current value of the land. Therefore, the proceeds from the sale of the subdivided land will be assessable under section 6-5 of the ITAA 1997 as ordinary income.

Question 3.

Subsection 15-15(1) of the ITAA 1997 states that your assessable income includes profit arising from the carrying on or carrying out of a profit-making undertaking or plan. Subsection 15-15(2) of the ITAA 1997 goes on to say this section does not apply to a profit that is assessable as ordinary income under section 6-5 of the ITAA 1997; or if it arises in respect of the sale of property acquired on or after 20 September 1985.

As discussed above, any profits received from the sale of the subdivided land will be assessable under section 6-5 of the ITAA 1997, and the land was purchased after 20 September 1985. Therefore, any profits will not be assessable under section 15-15 of the ITAA 1997.

Question 4.

As discussed above, CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1) of the ITAA 1997).

While the subdividing of the land is not a CGT event (subsection 112-25(2) of the ITAA 1997), the subdivided land is a CGT asset. You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. When you sell the subdivided lots, you will be disposing of a CGT asset and CGT event A1 will happen.

Question 5.

Section 118-20 of the ITAA 1997 primarily exists to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. In the absence of such a provision, it is conceivable that a receipt properly characterised as ordinary income and which has also been derived as a result of a CGT event could result in the receipt being taxed twice. Therefore, whilst CGT event A1 will happen when you sell the subdivided lots, any capital gain will be disregarded to the extent of any amount already included as ordinary assessable income under section 6-5 of the ITAA 1997.

Under Division 115 of the ITAA 1997, you qualify for the 50% general CGT discount if you:

· are an individual,

· a CGT event happens to an asset you own,

· the CGT event happened after 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. 

Where there are discount capital gains, capital losses must first be offset against the capital gains eligible for discount. 

From the facts provided you would be eligible to claim the 50% discount on any remaining capital gain arising from the sale of the property.

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