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Ruling

Subject: The assessability of proceeds from a land subdivision

Questions:

1. Are the proceeds from the sale of the subdivided lots on capital account a mere realisation of a capital asset?

Answer:

Yes.

2. Will any capital gain or capital loss you make on the disposal of each subdivided block be disregarded for CGT purposes?

Answer:

Yes. 

3. Will the infrastructure/improvements carried out on the land be considered a separate CGT asset under section 108-70 of the ITAA 1997?

Answer:

No. 

This ruling applies for the following period

Year ended 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

The scheme commenced on

1 July 2011

Relevant facts

You and your spouse own adjoining parcels of land (the land) as joint tenants. Both parcels (parcel A and parcel B) were purchased prior to 1985.

The land has been used to conduct primary production activities for over 30 years.

There is a residence on parcel A but this has never been used as your primary residence.

You have never been involved in a land subdivision or development before.

You first considered selling the land a number of years ago and some soil testing was undertaken at that time. The land was put on the market at this time without any division or infrastructure in place.

There was some interest but terms could not be agreed upon. Issues arose about the suitability of the land for residential development for various reasons and you took the land off the market after six months.

In 200X, you considered subdividing the land, as the best way to realise the land. However, complications arose again for various reasons.

In 20YY, you again reconsidered subdividing the land and engaged surveyors and engineers and development approval was sought to develop the land. Approval is being sought in stages with part of parcel B to be subdivided first.

A plan of division was registered and new titles issued for Z lots. A number of these lots have been made available for sale with a number have already sold. Two lots have vested in the local council, being a reserve and a road. The final lot is the remainder of the land.

The subdivided lots are listed for sale with a real estate agent.

As part of the development approval, you were required to undertake infrastructure work, such as block fill, sewerage, stormwater, water supply, electricity supply, gas supply, telephone lines, road, footpaths and kerbs. This was the minimum required under the development approval terms.

The infrastructure works were carried out at arm's length by an unrelated third party.

You have invested over $Y (including government and utility charges) to develop the land between a certain period of years. You are not registered for GST purposes and no input tax credits have been claimed.

Funding for the development has been provided by family members on an informal basis.

It is not yet known if any further subdivision will occur. There is a proposal for a further Z lots on parcel B but this has not yet been approved.

Full subdivision of parcel B could result in a specific amount of lots.

There are no plans at present to develop parcel A.

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 - Subsection 104-10(5).

Income Tax Assessment Act 1997 - Subsection 108-70.

Income Tax Assessment Act 1997 - Subsection 112-25.

Reasons for decision

Income tax provisions 

Under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), your assessable income includes the ordinary income you derived directly or indirectly from all sources, during the income year. Additionally, section 15-15 of the ITAA 1997 includes profit arising from the carrying on or carrying out of a profit-making undertaking or plan. However, this provision does not apply to a profit that is assessable as ordinary income under section 6-5 of the ITAA 1997, or which arises in respect of the sale of property acquired on or after 20 September 1985.

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. 

In FC of T v The Myer Emporium (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693 (Myer Emporium), the Full High Court expressed the view that profits made by a taxpayer who enters into an isolated transaction with a profit making purpose can be assessable income.

Taxation Ruling TR 92/3 considers the assessability of profits on isolated transactions in light of the principles outlined in Myer Emporium. According to Paragraph 1 of TR 92/3, the term 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.

Paragraph 6 of TR 92/3 provides that a profit from an isolated transaction will generally be income when both the following elements are present:

· your intention or purpose in entering into the transaction was to make a profit or gain, and

· 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.

Additionally, if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to commit the asset, either:

· as the capital of a business or  

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

this activity constitutes the carrying on of a business, or a business operation or commercial transaction. The profit from such activity is income even though the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

Some of the factors to consider when looking at whether an isolated transaction amounts to a business operation or commercial transaction are listed at paragraph 13 of TR 92/3. They are: 

(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.

Profits on the sale of subdivided land can therefore be income according to ordinary concepts within section 6-5 of the ITAA 1997, or as a profit making undertaking or plan within section 15-15 of the ITAA 1997, if the taxpayer's subdivisional activities have become a separate business operation or commercial transaction, or an isolated profit making venture.  

In contrast, paragraph 36 of TR 92/3 notes that the courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment.

In your case, the property was originally purchased for the sole purpose of carrying out primary production business activities which were conducted on the land for an extensive period prior to the subdivision. You have never been in the business of land development and you will have only undertaken minimum required under the development approval terms in the subdivision of the land. Therefore, the proceeds from the sale of the subdivided land are not ordinary income and not assessable under sections 6-5 or 15-15 of the ITAA 1997. The proceeds represent a mere realisation of a capital asset which will fall for consideration under the CGT provisions in Part 3-1 of the ITAA 1997.

CGT provisions 

CGT event A1 in section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you dispose of each subdivided block. You will make a capital gain if the capital proceeds from the disposal of the block are more than the cost base of the block. You will make a capital loss of those capital proceeds are less than the reduced cost base of the block. 

Subsection 104-10(5) of the ITAA 1997, however, contains an exception, where any capital gain or capital loss made is disregarded if the asset was acquired before 20 September 1985.

When a CGT asset (the original asset) is split into 2 or more assets (the new assets), such as when land is subdivided, the subdivision of the land into subdivided blocks is not a CGT event, according to subsection 112-25(2) of the ITAA 1997. Where the original land was acquired before 20 September 1985, each new block retains its pre-CGT status (Taxation Determination TD 7).

Under subsection 108-70(3) of the ITAA 1997, capital improvements to a pre-CGT asset that are related to each other may be treated as a separate CGT asset if the total of their cost bases when a CGT event (for example a disposal) happens in relation to the asset, is:

· more than the improvement threshold for the relevant income year, and

· more than 5% of the capital proceeds from the event.

In your case, you acquired the original parcel of land prior to 1985; therefore, the subdivided blocks will also have been acquired prior to 1985.

The total subdivision and land development costs are considered related to each other in accordance with section 108-80 of the ITAA 1997. The total cost of these capital improvements is to be allocated over all of the subdivided blocks. Accordingly, if the capital improvement expenditure applicable to each subdivided block is less than the improvement threshold for the relevant year and 5% of the capital proceeds then, for the purposes of any subsequent disposal, the capital improvement is not taken to be a separate CGT asset.

In your case, your total expenditure was more than $Y and your subdivision resulted in a number of subdivided lots, X of which have been put up for sale. The capital improvement threshold for the 2011-12 financial year was $130,418. The capital improvement expenditure applicable to each subdivided block is less than the improvement threshold. Therefore, the capital improvement is not taken to be a separate CGT asset and each new block will retain its pre-CGT status.

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