Edited version of your written advice

Authorisation Number: 1012725943473

Ruling

Subject: Subdivision of land and sale of residential lots

Question 1

Are the proceeds of sale from the subdivided lots derived by the taxpayer income according to ordinary concepts and assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

No

Question 2

Are the profits derived by the taxpayer from the sale of the subdivided lots profits arising from the carrying on or carrying out of a profit-making undertaking or plan and assessable under section 15-15 of the ITAA 1997?

Answer:

No

This ruling applies for the following period(s)

From the start of the first income year in which subdivided lots were sold until the end of the income year in which the sale of the last subdivided lot in the development is completed.

The scheme commences on

When the taxpayer first formed the intention to subdivide and sell the land.

Relevant facts and circumstances

The taxpayer owned a large parcel of land in Australia (the Property).

The Property was purchased prior to 20 September 1985 for the purposes of building a home for the taxpayer's family and carrying out a farming activity.

The taxpayer has another occupation unrelated to farming and land development which was the main source of financial support for their family.

As the taxpayer got older and their children left home they found it increasingly difficult to manage the property and conduct the farming activity, due to medical conditions.

In addition, residential subdivisions had sprung up nearby the Property as suburbia expanded in its direction.

The farming activity was winding down and the taxpayer considered the possibility of subdividing the Property and selling it as it no longer met the needs of the taxpayer' family. To this end, the taxpayer sought professional advice e.g. land surveyors as to whether the Property was subdivisible.

At or around this time, the relevant council had also proposed a change in zoning from rural to partly 'investigate for residential zoning' and 'reserve some areas for conservation'.

The taxpayer decided to take advantage of the proposed change in zoning and of the property boom at the time to advantageously realise its asset.

The taxpayer entered into a development agreement with an unrelated property developer to develop the property by seeking re-zoning of the land to residential, approval to subdivide the land into residential lots, and subdivision of the Property and sale of residential lots (the Project). The terms of the agreement provided that:

• Nothing in the agreement should be considered or interpreted as constituting a relationship of partners or constituting a party as agent or representative of the other.

• The taxpayer will contribute the Property to the Project. This will be the sole extent of the taxpayer's contribution and its role in the Project will be entirely passive. The taxpayer is not required to provide any additional capital, any expertise or otherwise be active in the Project except as otherwise provided in the agreement.

• The taxpayer would continue to be the full legal owner of the Property until such time as the contracts for sale of the residential lots are entered into and completed.

• The developer has the sole responsibility for the design, implementation and progression of the Project, and except as otherwise provided, will make all decisions in relation to the Project including:

• all aspects of dealing with the rezoning and obtaining development approval

• all aspects of the subdivision, including engaging and instructing all necessary experts and consultants and dealing with relevant authorities

• devising a plan for the sale and marketing of the residential lots (however, both parties needed to agree to the identity and commission rates for the real estate agent)

• generally manage and co-ordinate the Project

• expend any money in its opinion is reasonably required for the Project subject to the agreement

• insure the Property

• physical property matters which may arise during the course of the Project

• preparation of Project cost schedules and Project timeline and feasibility, and development and control of Project budgets, and

• reporting to the taxpayer on progress of the Project.

• The developer will fund all Project Expenses (e.g. rezoning and development costs, Government and Council contributions, approval expenses, subdivision costs, indigenous group costs, expert and consultants work and reports).

• The taxpayer retained the right to veto decisions to be made in respect of key decisions regarding the adoption of a budget, the borrowing of any money by reference to the Property, the grant of security over the Property, the entry into a material contract except in the ordinary course of business, an abnormal or unusual contract or commitment, the commencement or settling of any legal or arbitration proceedings.

• The developer is responsible for establishing a bank account for the Project in its name and ensuring that at all time sufficient funds are in the account for payment of Project Expenses.

• The Project revenue is to be distributed to the parties in accordance with a profit sharing agreement where firstly all Project expenses are reimbursed to the developer and the developer is provided a management fee based on a percentage of expenditure.

The rezoning of the land occurred and the development application was approved. The development consent provided for the development of the land into X residential lots and a portion of the land was reserved for environmental reasons.

Under the Development agreement, the Property will only be subdivided into the residential lots and sold as vacant land. No buildings will be constructed on any lots prior to sale as part of the development.

The taxpayer's family home was to be subdivided into residential lots in the final stages of the development. The taxpayer and their family moved out of their home to a new family home at this stage.

The costs associated with the Project were expected to be approximately $X. The project is expected to be completed in the 20XX calendar year.

The taxpayer has not been involved in any other development activities of this nature.

Relevant legislative provisions

Section 6-5 of the ITAA 1997

Section 15-15 of the ITAA 1997

Reasons for decision

Under section 6-5 of the ITAA 1997, assessable income includes income according to ordinary concepts.

A profit arising from the carrying on or carrying out of a profit-making undertaking or plan that is not assessable as ordinary income and does not arise in respect of the sale of property acquired on or after 20 September 1985 is assessable under section 15-15 of the ITAA 1997.

Taxation Ruling TR 92/3 Income Tax: whether profits on isolated transactions are income provides guidance on whether profits on 'isolated transactions' are income according to ordinary concepts. In that Ruling 'isolated transactions' refers to transactions outside the ordinary course of business of a taxpayer or transactions entered into by non-business taxpayers. The Ruling sets out the Commissioner's view on the application of the decision of the High Court of Australia in FCT v The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693 (Myer Emporium).

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

(a) the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; and

(b) 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.

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. The expression mere realisation is used in contradistinction to a business operation or commercial transaction carrying out a profit making scheme: paragraph 36 of TR 92/3.

Case Law

In FC of T v. Williams (1972) 127 CLR 226; 72 ATC 4188; 3 ATR 283 (Williams), the taxpayer was given a one third share of a property in Perth by her husband in 1962. The land was acquired by her husband and co-owners for resale. The taxpayer was prepared to be guided by her husband in terms of when to sell the property and the method to be used. In 1969, the co-owners of the property subdivided the land and sold 27 of the 35 lots and the taxpayer received her share of the proceeds. The remaining lots were retained by one of the other co-owners. A majority of the High Court held that the proceeds were not assessable under section 25 (ordinary income) or 26(a) (profit making undertaking or scheme) of the Income Tax Assessment Act 1936 (ITAA 1936). Gibbs J stated at 4194-4195:

An owner of land who holds it until the price of land has risen and then sub-divides and sells it is not thereby engaging in an adventure in the nature of trade, or carrying out a profit-making scheme. The situation is not altered by the fact that the landowner seeks and acts upon the advice of an expert as to the best method of sub-division and sale or by the fact that he carries out work such as grading, levelling, road-building and the provision of reticulation for water and power to enable the land to be sold to its best advantage. The proceeds resulting from the mere realisation of a capital asset are not income either in accordance with ordinary concepts or within the second limb of sec. 26(a), even though the realisation is carried out in an enterprising way so as to secure the best price: McClelland v. F.C. of T., supra, at pp. 4119, 4120, and cases there cited …

Barwick CJ said at page 4190:

.. neither the resolution to realise the land by sub-division and sale, nor the sub-division and sale could, in my opinion, constitute a profit-making scheme so far as the respondent was concerned.

In FC of T v Whitfords Beach Pty Ltd (1982) 150 CLR 355; 82 ATC 4031; 12 ATR 692 (Whitfords Beach), the taxpayer company acquired the subject land to secure for the original shareholders access to a shack on the beachfront and not for any profit making purpose. On 20 December 1967, all the shares in the company were bought by three companies to obtain control of the land, with the intention of developing the land by subdivision and for sale at a profit. The land comprised 1,584 acres, of which 630 acres was subdivided into 2,000 residential blocks with the possibility of further subdivision in the future. In addition part of the land was to be used as sites for commercial purposes. On the date of acquisition of the shares, the company adopted a new set of articles and the purchasers of the shares entered a loan agreement defining their rights and obligations. Two of the purchaser companies were engaged to carry out the subdivision. The other company was the financier. The High Court upheld the Commissioner's appeal. The members of the High Court each gave different judgements and used different reasoning but decided that what was involved was more than the mere realisation of an existing asset and was either a business venture or profit undertaking or scheme. Wilson J, after referring to Williams and the decision of the House of Lords in Californian Copper Syndicate v Harris (1904) 5 Tax Cas. 159 states at page 4054:

The decision in each case must depend on its own facts, and very often will be a matter of degree.

In Statham & Anor v. FC of T (1988) 16 ALD 723; 20 ATR 228; 89 ATC 4070 (Statham), the taxpayers were the trustees of a deceased estate. The deceased had acquired the subject land from his father in 1970. The land was acquired by the deceased so that he might raise his family in a rural environment and conduct some farming activity. In 1976 he sold off a 36 hectare portion of the property and some urban blocks. Also he sold a further half share of 30 hectares being most of the balance of the farming property to his sister's company. Part of the property was retained by the deceased so that he might subdivide and sell it. In 1976 the deceased and his sister's company entered into a partnership to raise beef cattle on the property. However, this was not achieved for a variety of reasons including that the deceased's health deteriorated. A decision was made during 1979 to subdivide and sell the whole or part of the land. There were four stages of subdivision involving in total 105 lots that were sold. The subdivision involved a relatively simple approval process. After the approval was obtained the local council undertook all necessary work including road, earthworks, sewerage and electrical work. The lots were sold through listing it with local agents. The Full Federal Court noted that the mere magnitude of the realisation does not convert the activity into a business undertaking or scheme, although it is a relevant matter to take into account. The Court considered that the proceeds of sale were not income according to ordinary concepts nor did a profit arise from the carrying on or carrying out of a profit making undertaking or scheme. The Court determined that what occurred was (at page 4077):

the mere realisation, by the most advantageous means, of the asset which the owners had on their hands when they abandoned the intention of farming the subject property.

The Court considered the following factors were significant (page 4076):

(a) the owners were at first content to sell the land as one parcel, but were unable to do so;

(b) no moneys were borrowed by them, although a guarantee was provided to Kingaroy Shire Council by way of bank guarantee;

(c) only very limited clearing and earthworks were involved;

(d) the owners relied upon the Kingaroy Shire Council to itself to carry out road works, kerbing, electricity and sewerage works which were required to be done;

(e) the owners did not erect buildings on the land; not even, for example, a site office;

(f) they had no business organisation, no manager, no office, no secretary, and no letterhead;

(g) Dr Bickerton maintained his medical practice;

(h) the owners did not advertise the land for sale;

(i) apart from the Kingaroy Shire Council's activities, the owners did not engage any contractors, although they did obtain some professional advice;

(j) the books kept in relation to the sales of land were kept by Mrs Bickerton; and

(k) the land was sold simply by listing it with the local real estate agents.

In Stevenson v FC of T 91 ATC 4476 (Stevenson), the taxpayer owned and worked a farm of 476 acres that had been in his family since 1904. He bought it in 1953. In the early 1970s, about 386 acres were sold. By 1976, the Applicant desired to sell most of his farm and retain only a few acres for his own use. He was granted permission to sell residential blocks of the land subject to conditions requiring substantial expenditure on the provision of water and sewerage reticulation before any blocks could be sold. However, he could not find a developer who would pay his asking price and late in 1976 he decided to fulfil the conditions himself and to sell the land in subdivided blocks. The subdivision was carried out in stages from 1977 and more than 180 out of 220 subdivided blocks were sold between 1980 and 1986.

The taxpayer appealed to the Federal Court from an unfavourable decision of the Administrative Appeals Tribunal on his objection. Jenkinson J held, in dismissing the taxpayer's appeal, that in distinguishing between a mere realisation and the carrying on of a business, it is relevant that the owner of the asset undertook the planning and management of the development activities.  In summary, the Tribunal considered the following factors caused it to decide that what occurred was more than a mere realisation of a capital asset (Jenkinson J found no error of law was made in reaching this conclusion):

• The extent of the taxpayer's personal involvement in the planning and implementation of the subdivision - he negotiated with the local council and the State Rivers and Water Suppy Commission, he engaged and paid the surveyors/engineer/planners, State Electricity Commission and other contractors.

• The extent of the taxpayer's involvement with the marketing and sale of the blocks - the taxpayer gave a general instruction to a number of agents to sell the blocks and he also placed an advertisement in a newspaper and a sign on the property. Purchasers were invited to ring his home number. When he reached agreement with the purchaser he instructed his solicitors to prepare the contracts.

• The subdivision and development was substantial.

• The taxpayer obtained finance and he risked it - he borrowed money in progressive advances for the subdivision to be undertaken.

In Casimaty v. FC of T 97 ATC 5135; (1997) 37 ATR 358 (Casimaty), the taxpayer was a farmer who in the early 1950's purchased farming land from his father and adjoining land on which he erected a homestead. The taxpayer conducted a dairy business on part of the land and ran some sheep and beef cattle on the rest. The taxpayer also carried out a fencing business with his son. In 1965 compulsory pasteurisation was bought in which made the dairying uneconomical. In the following years the taxpayer borrowed through a mortgage on the property while he continued raising beef and sheep. From 1967 to 1969 the farm suffered badly from drought and the taxpayer suffered financial hardship. The taxpayer attempted to sell the property in or around 1972/1973 but this failed. Due to increasing financial difficulties and failing health the taxpayer started to sell portions of the property. The taxpayer then over the next 20 years engaged in a series of subdivisions. After analysing a number of cases, and specifically referring to Stevenson, Ryan J stated at page 5149:

An examination of the reasoning in Stevenson's Case confirms that whether the subdivisional activity is sufficiently extensive and systematic to amount to the conduct of a business is, as Lockhart J observed in Crow's Case a question of fact. Jenkinson J was not required to resolve that question of fact for himself. He was concerned only to ensure that the Tribunal had not committed any error of law in arriving at the conclusion which it did. His Honour did not distil from the authorities a principle of law that a subdivision involving a hundred or more lots, the construction of roads and the reticulation of water to each lot could never amount to a mere realization of a capital asset. Any such principle would run counter to the views expressed by all but one member of the High Court in FC of T v NF Williams … where Gibbs J observed at ATC 4194-4195; CLR 249 [see passage quoted earlier in these reasons]:

Ryan J held that the taxpayer did not carry on a business as a land developer nor did the sales occur in the course of a profit undertaking or scheme. In reaching this conclusion, Ryan J considered the following matters:

• The indisputable fact that the taxpayer acquired and continued to hold the property for use as a residence and conduct of a business of primary production, there being nothing to suggest a change in the purpose or object with which the property was held (distinguishing Whitfords Beach);

• The taxpayer did not acquire other land to be added to the original land;

• The taxpayer had previously carried on farming and fencing business activities with his wife and son respectively but did not attempt to bring the property to account as a partnership asset;

• The subdivision was undertaken in response to the exigencies of increasing debt and deteriorating health. No coherent plan was conceived at the outset for the development;

• The Taxpayer did not undertake any development or works beyond that necessary to secure the council approval for the subdivisions and enhance the presentation of the various lots;

• He did not set up a sales organisation or advertise or conduct sales himself.

In McCorkell v FC of T 98 ATC 2199, the taxpayer had inherited from his father a 15 hectare property on which he conducted an orchard business. The property was worked as a commercial orchard for many years. In the early 1980s the land was rezoned as future residential. The taxpayer contemplated retirement and, as he had no family to continue the orchard business, selling the land. In August 1984, a permit was issued for subdivision of part of the property into 40 housing lots. In September 1990 a further permit was issued for a further 17 housing lots. On completion of the subdivision, 37 lots were sold over the 1990 to 1994 income years. All development and subdivision work was contracted out, and estate agents handled the sales.

It was held that the taxpayer adopted a relatively passive role in the mere realisation, by the most advantageous means, of an asset which he owned at the time when he decided to abandon the intention to use it as an orchard. The Tribunal was of the view that the facts were very similar to those in Statham as follows:

(a) Mr McCorkell had initially contemplated selling the land as one parcel but had not been able to attract a satisfactory offer.

(b) A small amount of money was borrowed for a short period but he was not prepared to risk funds for the complete subdivision at the outset. A guarantee was provided by Mr McCorkell's bank to the Shepparton Water Board in connection with the provision of water and sewerage reticulation in the normal form required by that authority.

(c) The works carried out in developing the subdivisions were no more than what was necessary to secure the approval of the authorities and enhance the presentation of the individual allotments for sale. In the words of Mr Muir ``It was no different to any other residential subdivision, and a fairly straightforward one at that.''

(d) Mr McCorkell relied upon the surveyors and engineers represented by Mr Muir to carry out the work required. That firm engaged the contractors and approved their accounts for payment by Mr McCorkell. He had no direct contractual relationship with any contractor.

(e) Mr McCorkell had no site office or building on the land and no direct contact with contractors or potential purchasers.

(f) Mr McCorkell had no business organisation, office or letterhead.

(g) He continued as an orchardist until 1991 when he retired and leased the balance of the property as an orchard.

(h) He had no involvement in advertising or promoting the sale of the land. The only evidence of any connection with advertising was the building by him of a board on which advertising prepared by the agents was placed and a contribution to the costs of advertising designed and arranged by the agents.

(i) Mr McCorkell obtained professional advice from surveyors, his solicitor, a consultant and estate agents but in all cases relied on their advice and appointed them to carry out the required functions.

(j) A separate bank account was maintained to which proceeds of sale were deposited directly by the estate agents or the solicitor. No evidence of any more formal records or accounts was provided.

(k) The land was sold simply by placing it in the hands of two local real estate agents who recommended and had accepted prices. All negotiations for sale were conducted by the agents. Mr McCorkell had no direct contact with potential buyers other than three relations who were sent by him to the estate agents to discuss possible purchase.

Taxpayer's intention or purpose

As stated in paragraph 6(a) of TR 92//3, the taxpayer's intention or purpose must be examined.

Paragraph 41 of TR 92/3 notes that if a transaction or operation involves the sale of property it is usually necessary that the taxpayer has the purpose of profit making at the time of acquiring the property. However, as demonstrated in Whitfords Beach this is not always the case where the asset is committed to a business venture or commercial transaction.

Application to your circumstances

In this case, the taxpayer acquired the property over 30 years ago. The property was used to build a family home and to carry on a farming activity. The land was not acquired for a profit-making purpose.

Whether the nature of the transaction amounts to a business operation or commercial transaction

Paragraph 13 of TR 92/3 lists some of the factors to consider when looking at whether an isolated transaction amounts to a business operation or commercial transaction: 

(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.

At paragraph 49(h) of TR 92/3, regarding the relevance of the timing of the transactions or steps in the transaction, it states:

… For example, if the relevant transaction consists of the acquisition and disposal of property, the holding of the property for many years may indicate that the transaction was not business or commercial in nature. [emphasis added]

Application to your circumstances

(a) The nature of the entity undertaking the operation or transaction

The owner of the Property and the entity undertaking the transaction is an individual that has owned the Property and lived on the property with their family for many years. The Property was otherwise used by the taxpayer for farming activities.

(b) the nature and scale of other activities undertaken by the taxpayer

The taxpayer carries out a farming activity on the Property prior to the commencement of the land subdivision. The taxpayer has not been involved in any other development activities of this nature. The taxpayer has another occupation unrelated to farming and land development which has been the main source of financial support for their family.

(c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained

The estimated cost for the development and sale of the Property and the anticipated profits are significant. Furthermore, the operation is considered to be on a significant scale. However, it is noted that cost, profit and scale of a land division into residential vacant lots will to a large extent be dependent on the size of the property to be divided. This factor would not, on its own, be inconsistent with a finding that the undertaking of the taxpayer was realisation of a capital asset by the most advantageous means.

(d) the nature, scale and complexity of the operation or transaction

The Property will be subdivided into residential lots and sold as vacant land. The whole process of subdivision and sale will take place in X stages.

Given the size of the Property and the nature of such subdivisions it is accepted that there is complexity to the operation and it is not considered to be a small scale. However, no buildings will be constructed on any lots prior to sale as part of the development. The development includes the work in the preparation of the Property to the point of issue of separate titles and sales of subdivided lots only.

(e) the manner in which the operation or transaction was entered into or carried out

The development agreement the taxpayer entered into with developer provides that the role of the taxpayer is to provide the Property to the project and is otherwise is passive.

The developer is responsible for design and implementation of the Project. This includes dealings with council, State government and other relevant bodies and the engagement and instruction of experts and contractors. The developer is also responsible for marketing and sales of the residential lots. The developer is responsible for funding the costs associated with the development and in the ordinary course will be reimbursed from the proceeds of sale of the residential lots and receive a management fee for its services as well as the ability to share in the profits. The developer is responsible for establishing a bank account for the project and keeping proper accounts and records for the Project.

The taxpayer is not required to provide any additional capital or any expertise in the Project. It is required to execute documents for the subdivision and contracts for sale of lots. It also retains some input into key decisions to be made in the adoption of a budget, the granting of security over the property, abnormal or unusual contracts and commencement and settling of legal or arbitration proceeds. These matters are considered consistent with the taxpayer's ownership of the Property and ensuring that it realise the best price for its asset.

(f) if the transaction involves the acquisition and disposal of property, the nature of that property

As discussed above, the Property was obtained to provide a family home and for the conduct of a farming activity. At this time, the Property was zoned rural. It was not acquired for any profit-making land development purpose.

After holding the Property for many years, circumstances changed as the taxpayer got older, the farming activity was winding down, the expanding residential development and the proposed change in zoning the taxpayer decided to subdivide and sell the property as it was no longer suitable for the future needs of the family.

(g) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction

The taxpayer is unrelated to the developer that was engaged to carry out the subdivision. As explained above, the taxpayer had a passive role in the development providing the property and retaining some input in key decisions.

Conclusion

The original purpose for the purchase of the Property was to build a family home and to carry on a farming activity. There was no profit-making motive in the original acquisition of the Property. That is, the facts do not indicate that the taxpayer intended, when acquiring the Property, to make a profit from any future sale. Many years later there existed a desire to realise a capital asset in order to secure the best price as the taxpayer and their family had decided that the Property no longer met their future needs.

Although the size and scale of the subdivision is large and there is a substantial amount of money involved, on balance it is considered that the factors listed at paragraph 9 of TR 92/3 tend to indicate a lack of business or commercial character. That is, the following factors support a finding that the proceeds from the sale of the subdivided lots derived by the taxpayer are the proceeds from the mere realisation of a capital asset by the most advantageous means:

• the taxpayer has held the property for many years and it has been used as a family home and for the conduct of a farming activity;

• the taxpayer has another occupation unrelated to farming and land development which has been the main source of financial support for their family

• the taxpayer has not been involved in any other land development activities;

• the taxpayer has no expertise related to property development activities;

• the development costs are funded by the developer; and

• the taxpayer has a passive role in the design, planning and contracting work for the residential subdivision and in selling the lots, albeit retaining input in some key decisions that would enable it to protect and secure the best price for its asset.

In short, it is considered that there was no profit-making intention in originally acquiring the Property. In addition, the taxpayer has not commenced a separate business operation. Nor has the taxpayer derived profit from the carrying on or carrying out of a profit making undertaking or plan.

Consequently, the proceeds received from the sale of the residential lots are not ordinary income assessable under section 6-5 of the ITAA 1997 nor are the profits assessable under section 15-15 of the ITAA 1997.

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