Edited version of your written advice

Authorisation Number: 1012708575391

Ruling

Subject: Subdivision of farmland

Question 1

Will any profits from the sale of the developed lots be assessable as income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will any profits from the sale of the developed lots be assessable as income under section 15-15 of the ITAA 1997?

Answer

No

Question 3

If the answer to question 1 or 2 is yes whether the fee paid to the developers will be allowed as a deduction in calculating the taxable income of the taxpayer?

Answer

Not applicable

Question 4

Whether the part of the properties disposed by the taxpayer pursuant to this arrangement qualify as active assets as defined in section 152-35 of the ITAA 1997?

Answer

Yes

Question 5

If the answer to Question 4 is yes do you satisfy paragraph 152-10(1)(c) of the ITAA 1997 to the extent that you are a small business entity in the relevant year of each respective sale?

Answer

Yes, provided you continue to carry on a business and your aggregated turnover remains under $2,000,000

Question 6

Will the fee to the developer be included in the cost base of the relevant assets sold?

Answer

Yes

This ruling applies for the following period(s)

Income year ended 30 June 2014

Income year ended 30 June 2015

Income year ended 30 June 2016

Income year ended 30 June 2017

Income year ended 30 June 2018

Income year ended 30 June 2019

The scheme commences on

1 July 2013

Relevant facts and circumstances

You own several rural adjoining properties which you use in a primary production business.

The properties have been in your family for XX years.

You reside on one of the lots.

You received title of x lots on 19xx.

You received title on x lots on your spouse's death in 20xx.

The turnover of you and your connected entities does not currently exceed $2million. The turnover of your farming business is below the GST threshold but you are voluntarily registered for GST.

A developer has approached you to develop the land.

You have signed a provisional agreement with the developer subject to final negotiations.

The terms of the agreement are as follows:

• the developer will develop a portion of your land

• you will provide the developer a licence to enter the land and carry out development work

• you will be paid an amount upon entering the contract

• the developer will have the final decision on all matters concerning the property

• you will be represented on a management committee as an observer only

• the developer will fund all the development costs

• the sale of the lots will be made by the developer on your behalf

• from the sales proceeds you will reimburse the developer for costs incurred in the development and a development fee

• the development fee will be X% of the net proceeds

• you will retain X% of the net proceeds

You have provided the following details about the extent of the development

• no structures will be built on the land, except potentially a sales office for the developer

• no additional land has been purchased

• the development will only be to the extent necessary to meet council requirements.

You will retain part of the land and continue to carry on a farming operation on a reduced scale.

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 152-10

Income Tax Assessment Act 1997 section 152-25

Income Tax Assessment Act 1997 section 152-30

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 328-110

Reasons for decision

Generally the proceeds from transactions involving the sale of real property will be assessable as ordinary income under section 6-5 of the ITAA 1997 where they are income from a business activity or profits from an isolated commercial transaction. In those instances where the profits of the sale would have been ordinary income any losses will generally be deductible. Alternatively, where the sale of real property is not part of a business or an isolated commercial transaction any profit or loss will be subject to the capital gain tax provisions.

Carrying on a business

The question of whether a business is being carried on is a question of fact and degree to be determined on a case by case basis. The courts have developed a series of indicators to determine the matter, which are summarised in Taxation Ruling TR 97/11. Although TR 97/11 specifically refers to primary production, the same principles apply to all businesses. Some indicators of carrying on a business which the courts have considered to be relevant include:

• whether the activity has a significant commercial purposes or character

• whether the taxpayer has more than just an intention to engage in business

• whether there is regularity and repetition of the activity

• whether the activity is of the same kind, and carried on in a similar manner, to that of ordinary trade in that line of business

• whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

• the size, scale and permanency of the activity, and

• whether the activity is better described as a hobby, a form of recreation or sporting activity.

Applying the above indicators to your circumstances, it is clear that you are not in the business of developing or selling property. Consequently the proceeds will not be assessable as business income under section 6-5 of the ITAA 1997.

Isolated commercial transactions

However the proceeds of any sale of property may still be assessable as ordinary income from an isolated commercial transaction. The Commissioner's view on whether profits on isolated transactions are assessable income under ordinary concepts is contained in Taxation Ruling TR 92/3. Profit from an isolated transaction is ordinary income where both:

• the intention and purpose for the taxpayer 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.

As was held in FC of T v The Myer Emporium Ltd (1987) 163 CLR 1999 the relevant intention is your intention taking into account objective consideration of all the fact and circumstances of the case.

It is a general principle that where a person purchases land not for the purpose of resale, and then sells the land either in its entirety or in separate lots that the party is merely realising their assets (see Californian Copper Syndicate v Harris (1904) 5 Tax Cas 159 and does not have a profit making purpose or intention. However this may not always be the case where there is an intervening act and a clear change in purpose for the use of the land (see White v FCT (1968) 120 CLR 191, Whitfords Beach v FCT 150 CLR 366).

Subdivision of Farmland

Numerous court cases have considered the application of the above principles in relation to the subdivision of land originally purchased and used for primary production. In Statham v FCT 89 ATC 4070 it was held that a significant staged, subdivision of property previously used as a cattle beef farm was a mere realisation. In reaching this conclusion the Federal Court had regard to the following:

• the owners were content to sell the land as once parcel but were unable to do so

• no money was borrowed by them, although a bank guarantee was provided

• only very limited clearing and earthworks were involved

• the owners relied upon the council to carry out roadwork's, kerbing, electricity and sewerage works

• the owner did not erect building on the land

• there was no business organisation or structure

• the taxpayer maintained their occupation

• the owners did not advertise the land

• the owners did not engage contractors

Another case similarly favourable to the taxpayer was the case of McCorkell v FCT 98 ATC 2199. In that case the AAT held that the subdivision and sale of a commercial orchid was a mere realisation of a capital asset. In reaching this conclusion the Deputy President had regard to the following factors:

• the taxpayer was not directly involved in the planning and contracting of work

• the taxpayer had no involvement in marketing the land

• taxpayer relied on consultants

• taxpayer did no more than necessary than to secure the necessary approvals and enhance the presentation of the properties ready for sale

• urban developments were beginning to encroach on the land and consequently it was concluded that it was reasonable that the taxpayer consider his options available to him to realise the property to his best advantage.

These cases can be contrasted against the decision in Stevenson v FCT 91 ATC 4476 which was unfavourable to the taxpayer. In that case the taxpayer decided to develop and sell the majority of his farm. The case was an appeal from an AAT decision which had determined the sale to not be a mere realisation based on the following:

• the taxpayer was the sole decision maker in relation to the development

• the taxpayer personally sought and obtained finance for the development

• the taxpayer personally dealt with the council and prospective purchasers

• the taxpayer controlled the marketing of the subdivided properties

• the taxpayer personally undertook work on the development to save in labour costs.

In upholding the decision of the AAT the Federal Court agreed with the Tribunal that the fact that the owner of the asset undertook much of the planning and managing of the activities, they had crossed the line between merely realising the asset into carrying on a business.

Application to your circumstances

In applying the above case law to your factual circumstance we consider that your circumstances are on point with Statham and McCorkell. The development and subdivision of your land will be a mere realisation and not an isolated commercial transaction. In reaching this conclusion we have had regard to the following:

• The properties have been in your family for an extended period of time. During the entire period the property has been used in a primary production business.

• You would be content to sell the property in its entirety undeveloped but due to the encroaching developments the developer is the only willing purchaser and they were not open to the option of purchasing the land.

• While on a relatively large scale being that there will be approximately x residential lots, the development is limited in that you will not be purchasing additional land, building structures or developing the land beyond the minimum amount to meet council requirements.

• You have a limited involvement in the development, in that the final decision in all matters will be made by the developer. Further while the final property sales will be between yourself and third parties, the developer will be acting as your agent and will solely be responsible for the marketing and sale of the properties.

Consequently as the sale of the subdivided properties will be a mere realisation any profits made on those sales will not be assessable as ordinary income but will instead be dealt with under the capital gains regime.

Active Asset Test

It is a general condition of small business relief that the asset must pass the active asset test in section 152-35 of the ITAA 1997. This test is satisfied if:

(a)  you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the period detailed below or

(b)  you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7 ½ years during the period detailed below:

The period:

(a)      begins when you acquired the asset and

(b)      ends at the earlier of:

(i)        the CGT event and

(ii)      if the relevant business ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows) when the business ceased.

Section 152-40 of the ITAA 1997 provides the meaning of active asset. A CGT asset is an active asset if it is used or held ready for use in the course of carrying on a business. It is clear that rural land used in a primary production business will be an active asset.

Even if the primary production activity ceases on the property due to the property development you will still satisfy the active asset test in section 152-35 of the ITAA 1997, as the their will be a period either greater than half the period of ownership or for properties held longer than 15 years greater than 7 ½ years where the asset has been actively used in your business.

Subdividing land does not result in a CGT event where you retain ownership of the subdivided blocks. Each subdivided lot is deemed to have been acquired at the same time you acquired the original parcel of land and the cost base is divided amongst the different lots. Consequently each individual parcel of subdivided land will all be active assets under section 152-40 of the ITAA 1997.

Small Business Entities

Section 328-110(1) of the ITAA 1997 provides you are a small business entity if you meet the following for the current year:

(a)      you carry on a business in the current year; and

(b)     one or both of the following applies:

(i)      you carried on a business in the income year (the previous year) before the current year and your aggregated turnover for the previous year was less than $2 million;

(ii)     your aggregated turnover for the current year is likely to be less than $2 million

Section 328-110(5) applies to treat you as if you carried on a business in an income year where:

(a) in that year you were winding up a business you previously carried on; and

(b) you were a small business entity for the income year in which you stoped carrying on that business.

Applying the above to your factual circumstance you have carried on the business of operating a farm since you acquired the property. You have stated that the aggregate turnover of you and your connected entities will be below $2,000,000. Therefore you will be a small business entity for the purpose of section 328 of the ITAA 1997.

Even if you cease your primary production business on the property as the development progresses further the effect of section 328-110(5) of ITAA 1997 will be to treat you as still being a small business entity when you sell the subdivided lots, as you are disposing of the asset in the course of winding up your primary production business. Your actions in developing, subdividing and selling the individual lots are still in essence you disposing of the assets of your business, merely in an enterprising way so as to secure the best price (see FCT v Williams (1972) 127 CLR 226).

Development Fee and the Cost Base

Section 110-25 of the ITAA 1997 deals with the cost base of a CGT asset. Subsection 110-25(5) provides that the fourth element of a CGT asset's cost base is capital expenditure incurred:

a) The purpose or the expected effect of which is to increase or preserve the asset's value; or

b) That relates to installing or moving the asset.

It is considered that entering into the agreement will create a legal obligation for you to pay a percentage of the net proceeds to the developer. It is clear that the benefit you receive from paying this fee is the development and subdivision of the land which clearly has the effect of increasing the value of your land. Consequently the development fee will be an expense incurred in increasing the value of a capital asset being your land and can consequently be included in the fourth element of the cost base.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).