Edited version of your private ruling

Authorisation Number: 1012458421999

Ruling

Subject: Subdivision of land - sale

Question 1

Will the profit made on the sale of the subdivided blocks of land be assessable ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

If the answer to question 1 is no, will any profit attributable to the sale of the subdivided blocks be an assessable capital gain under parts 3-1 and 3-3 of the ITAA 1997?

Answer

Yes, to the extent of the capital improvements only

This ruling applies for the following periods:

1 July 2013 to 30 June 2016

Relevant facts and circumstances

1. You acquired as joint tenants all that land ('the Land") before 20 September 1985.

2. The entirety of the Land was purchased by you for use X.

3. You had intended to construct your principal place of residence on that lot and as part of your retirement to use the land for Y purpose.

4. However you did not build your principal place of residence on that lot. You have only grazed livestock on that lot for you, at your age, have had health problems and can no longer work full-time.

5. Accordingly you have now decided to sell the lot.

6. You propose that the lot be further subdivided into a number of additional lots.

7. To sell those additional lots you will need to incur legal costs in causing the present lot to be subdivided, and in connecting electricity to the proposed additional lots. You may need to incur some fencing and landscaping costs. Total costs expected to be incurred by you are over the threshold which will be more than 5% of the total sale proceeds.

8. You will engage a real estate agent to sell the proposed additional lots.

Relevant legislative provisions

Income Tax Assessment Act 1977 section 6-5,

Income Tax Assessment Act 1977 section 6-10,

Income Tax Assessment Act 1977 paragraph 104-10(5)(a),

Income Tax Assessment Act 1977 section 108-5,

Income Tax Assessment Act 1977 subsection 108-70(3),

Income Tax Assessment Act 1977 section 108-80,

Income Tax Assessment Act 1977 section 108-85,

Income Tax Assessment Act 1977 section 112-25 and

Income Tax Assessment Act 1977 section 116-40.

Reasons for decision

Question 1

Summary

Any profit made on the disposal of the subdivided blocks of land will not be assessable as ordinary income under 6-5 of the ITAA 1997.

Detailed reasoning

Section 6-5 of the ITAA 1997 states your ordinary income according to ordinary concepts is assessable income. Taxation legislation provides no specific guidance on what is meant by ordinary income. However, case law on the topic has identified the following relevant criteria:

· the characteristics of periodicity, recurrence or regularity;

· associated with business activities or services rendered, as distinct from the mere sale of property; and

· solicited, as distinct from a windfall.

Section 6-10 of the ITAA 1997 provides that your assessable income also includes some amounts which are not ordinary income called statutory income.

Where land is subdivided and sold it is necessary to determine whether the income received by the vendor on the sale of the blocks is considered to be assessable income, either

i. ordinary income from a business activity or as part of a profit making undertaking or scheme, or

ii. statutory income and assessable via the capital gains provision, contained in Parts 3-1 and 3-3 of the ITAA 1997.

In your situation, your proposed subdivision and sales of land does not have the characteristics of periodicity, recurrence or regularity. Therefore, income from your subdivision will not be assessable as ordinary income under section 6-5 of the ITAA 1997. However, if your subdivision has the characteristics of a business or commercial transaction, it may be deemed to be assessable under section 6-5 of the ITAA 1997.

The Commissioner's view regarding whether profits from isolated transactions are assessable as ordinary income is detailed in Taxation Ruling TR 92/3. For a transaction to be considered to be of a business or commercial nature, it is usually necessary that a taxpayer has the purpose of profit-making at the time of acquiring the property. Paragraph 13 of TR 92/3 includes other matters to be considered:

· 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 your situation, the facts, as outlined above, indicate that your subdivision will not have the characteristics of a business transaction. Accordingly, income from your subdivision will not be assessable under section 6-5 of the ITAA 1997.

Question 2

Summary

The profit attributable to the sale of the subdivided blocks will not be an assessable capital gain, as the land was acquired before 20 September 1985 but any capital gain or capital loss made in respect of the related capital improvements which constitutes a separate CGT asset will not be disregarded under paragraph 104-10(5)(a) of the ITAA 1997.

Detailed reasoning

For the CGT provisions of the ITAA 1997 to be applicable, there needs to be a CGT event that happens to a CGT asset.

CGT asset is defined in section 108-5 of the ITAA 1997. Note 1 of section 108-5 of the ITAA 1997 makes it clear that land is a CGT asset.

Division 104 of the ITAA 1997 sets out the CGT events that can happen to a CGT asset. In this case, the appropriate CGT event that will happen when the land (the 4 subdivided blocks) are sold is CGT event A1, section 104-10 of the ITAA 1997.

Under CGT event A1,

(1) you make a capital gain if the capital proceeds from the disposal (sale) are more than the assets cost base (as described in subdivision 110-A of the ITAA 1997;

(2) you make a capital loss if the capital proceeds are less than the assets reduced cost base (as described in subdivision 110-B of the ITAA 1997).

However, subsection 104-10(5) states that any capital gain or capital loss you make as a result of CGT event A1 happening is disregarded if you acquired the asset before 20 September 1985.

Note: Subsection 112-25(2) of the ITAA 1997 states that when a CGT asset is split into two or more assets, such as when the land is subdivided, the subdividing of the land is not a CGT event. Therefore, a CGT event will not happen to the land until it is sold.

In your case, you acquired the land that will be subdivided into a number of blocks before 20 September 1985. Therefore, the profit attributable to the sale of the blocks will be disregarded.

However, Division 108-D of the ITAA 1997 sets out the circumstances when a capital improvement to a CGT asset is taken to be a separate asset.

Subsection 108-70(2) of the ITAA 1997 states that a capital improvement to a CGT asset acquired before 20 September 1985 is a separate asset if the cost base (assuming it is a separate asset) is

a) more than the improvement threshold for the income year in which the CGT event happened and

b) more than 5% of the capital proceeds on disposal from the event.

In accordance with Taxation Determination TD 2012/14 the improvement threshold for the relevant year is $134,200.

In determining whether the subdivision costs are a separate asset, it needs to be determined if the capital improvements are related or unrelated.

In determining whether capital improvements are related to each other, section 108-80 of the ITAA 1997 provides that the factors to be considered include:

a) the nature of the CGT asset to which the improvements are made

b) the nature, location, size, value, quality, composition and utility of each improvement

c) whether an improvement depends in a physical, economic, commercial or practical sense on another improvement

d) whether the improvements are part of an overall project

e) whether the improvements are of the same kind, and

f) whether the improvements are made within a reasonable period of time of each other.

To sell those additional lots you will need to incur legal costs in causing the lot to be subdivided, connecting electricity to the proposed additional lots and some relatively fencing and landscaping costs.

Having considered the relevant factors above and the circumstances of your case, including:

· the assets to which the improvements will be made consist of individual block of land in their state;

· the improvements will be undertaken as part of an overall project;

· the improvements may not have been of the same kind, but they will be for the completion of the project;

· the improvements will be made within a reasonable time period of each other in order to complete the project;

it is considered that the improvements to the blocks of land in your circumstances are related to each other in accordance with section 108-80 of the ITAA 1997.

This accords with ATO Interpretative Decision ATO ID 2002/386 that capital improvements made to pre-CGT land in connection with its post-CGT development and subdivision were related to each other. Note: although this ATOID has been withdrawn, it was only withdrawn because it is a restatement of the law, not because it incorrectly applied the law.

It follows that as the capital improvements are related, the costs of the improvements, in total, are used to determine if the costs constitute one separate asset.

You have advised that the costs of the work you will incur in relation to the land and the estimated total sale proceeds.

As stated the capital improvements are considered to be related, based on your estimation on the costs of capital improvements; the total sale proceeds and the improvement threshold in the relevant year, the capital improvements will be a separate asset under subsection 108-70(2) of the ITAA 1997, and any capital gain made on the sale of this asset assessable.

Further, the relevant year for determining the appropriate improvement threshold and the costs of capital improvements are in the year that the asset is sold. The improvement threshold is adjusted each year to take account of inflation.

Where the related capital improvements constitute, a separate CGT asset, any capital gain or capital loss made in respect of the separate CGT asset will not be disregarded under paragraph 104-10(5)(a) of the ITAA 1997. That is, the separate asset is taken to have been acquired on or after 20 September 1985.

As the improvement is a separate asset, the capital proceeds from the event must be apportioned between the original asset and the improvement in accordance with section 116-40 of the ITAA 1997.

When a CGT event occurs to the original asset, the capital proceeds need to be reasonably attributed to the capital improvements. Any capital gain on the capital improvements is calculated as follows:

Capital gain on capital improvement = Attributable proceeds - cost base of improvements.

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