Edited version of your written advice

Authorisation Number: 1012773966080

Ruling

Subject: Land Subdivision

Question 1

Will the proceeds from the sale of the subdivided blocks of land be from carrying on a business and assessable as ordinary income with the blocks of land being considered as trading stock under section 70-30 of the ITAA 1997?

Answer

No.

Question 2

Will the proceeds from the disposal of the subdivided blocks be assessable income according to ordinary concepts under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 3

Will the proceeds from the disposal of the subdivided blocks be subject to the capital gains tax (CGT) provisions under Parts 3-1 and 3-3 of the ITAA 1997?

Answer

Yes.

Question 4

Can you apply the discount method under Division 115 of the ITAA 1997 to calculate your capital gain in relation to the disposal of your interests in the subdivided blocks?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2015

Year ended 30 June 2016

The scheme commences on:

1 July 2014

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

• The Taxpayer acquired the property after 1985 and more than 12 months ago.

• At that stage, the Property consisted of several acres of land on a single tittle. At the time of purchase, the land comprised 3 separate areas I uses, being:

• A residential house and its adjoining yard;

• An area that was leased to another entity for their use;

• A small lease to a company that used part of the land.

• At the time of acquisition the residential house was not occupied, and required some initial repairs before it was in a condition to be leased.

• The Taxpayer acquired the property at public auction.

• Shortly after purchase you began renovating the house.

• The renovations to the house were completed shortly after. The Taxpayer began advertising the house for rent.

• The residential house has been continually available for rent for residential purposes since that time.

• The entire property was rented to the tenants. Due to the size of the property, and its set up, it was used mainly by tenants who used the land for their personal use.

• At no time has the Taxpayer, their spouse or any associate used the property themselves.

• Some years later, the Taxpayer received a letter from the local council regarding a proposed land resumption

Council Rezoning of the property

• Some years after purchase, the council released a Concept Plan of Development which showed that approximately 60 percent of the Taxpayer's property would be set aside for another purpose.

Offers to sell the property

• Almost immediately after purchase, the Taxpayer received unsolicited letters from developers advising about a planned development.

• The letters highlighted that the developers wanted to buy the Property for development and that they wanted the Taxpayer to call them.

• The Taxpayer called one company which they gave the Taxpayer a verbal offer to buy the Property for $X.

• While the offer represented a potential gain of $Y in a short period of ownership, the Taxpayers however declined the offer and intended to hold it as a long term investment property.

• Later, the Taxpayer received another unsolicited letter from a different developer offering to purchase the Property for $Z.

• Following the finalisation of the Plan by the council, there had been substantial redevelopment and sub-division works undertaken on other properties in the area.

• As a consequence of the development, the Taxpayer determined that after having owned the property for a period of time, he/she would investigate selling half the property as a single lot:

• Accordingly, the Taxpayer contacted a developer to determine if they would be interested in acquiring the Taxpayer's property.

• At that time, the ability to sell the development land was restricted by the requirement that the access road for the subdivision would have to go through the neighbouring land owned by the developer, and not through the remainder of the Taxpayer's property.

• Accordingly, the ability to sell the land to anyone other than the developer was limited due to this access condition.

• The Developer made a verbal offer to the Taxpayer of $A subject to DA approval. The Taxpayer refused this offer as it was below market value.

Development Application

• The Taxpayer had a meeting with a Town Planner to discuss them obtaining DA approval for the site themselves:

• The view point of the Taxpayer being that once the DA was granted, it would provide certainty to a potential purchaser as to what they could do with the land and therefore maximise the return on the eventual sale.

• In this respect, the Taxpayer was aware that the DA approval they sought would essentially lock in a purchaser to a set arrangement which may not be to their preference.

• However, it was seen that having a DA approval in place was much better than relying on the council to adhere to an Agreement which they had already tried to void once before.

Development Arrangement

• In early 20XX, the Taxpayer approached another property developer to discuss what they should do with the Property:

• This developer is known to the Taxpayer. As such, the Taxpayer had a level of confidence that they would be able to give them advice on what they should do.

• The developer proposed to develop the properties for the Taxpayer initially on the basis that their company would undertake the development works and that the Taxpayer would have no involvement in any part of the project:

• As the land is all on one title, the developable land could not be sold to X's company outright. That is, the DA works had to be done in order to subdivide the block first, to create another title.

• As the Taxpayer always intended to retain the residential land, it was regarded as impractical to attempt to subdivide the land into two blocks initially. Not only would this have incurred unnecessary costs, but the terms of the special agreement with the Council required (such as revegetation, pet proof fencing, and changing road access) would have required changes to the entire property, which would not have been practical if subdivided into two blocks first.

• The nature of the proposed arrangement is as follows:

• The town planner has completed the DA application, which once approved by Council will provide for the subdivision of the current property from one title into the following:

♥ A single title of about X acres, which comprises the existing residential premises, and adjoining land. This is the land subject to the special restrictions which, under the special agreement, is not able to be developed or cleared and must always remain as a single title.

• A subdivision of about X lots on the remaining land for residential purposes.

• The development company will enter into a contract with the Taxpayer to develop half the property which is able to be built on:

• The terms of development agreement are as follows:

• The Taxpayer will have no involvement in any contracts, negotiations, or other works or matters arising in relation to undertaking the subdivision of the land.

• The developer will engage all the contractors and incur all the costs to undertake the development of the property into the subdivided lots. The Taxpayer has no say in what costs are incurred, how the work is to be performed, or who is to do the work.

• The developer will also arrange for the marketing and sales of the lots to the eventual purchasers. The developer will engage real estate agents and solicitors to draft up the contracts for the sales.

• The work undertaken will be to the bare minimum required to meet the Council's conditions to get the subdivision plan approved.

• The developer expects to fund the development costs out of its own resources and will not be using the Taxpayer's property as security for the development.

• There is no intention to construct and sell properties on the sites, though the Taxpayer may decide to retain one lot for building a residential premise on for him/ herself to keep.

• The Taxpayer will receive the entirety of the sale proceeds from the lots to be sold, less the development fee paid to the developer

• The development fee paid to developer will be based on an agreed formula.

• The development cost will be determined based on the total cost to subdivide the land including (i) the DA application cost and (ii) any net GST payable.

• Essentially the Taxpayer has agreed to pay the developer the development fee to maximise his/her return on the sale of the lots by incentivising the developer to (i) minimise costs and maximise selling price.

• This was seen as necessary because the Taxpayer has no involvement or ability to override the developer in terms of the costs incurred or the sale prices negotiated for the lots.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 6-5

Income Tax Assessment Act 1997 - Section 70-10

Income Tax Assessment Act 1997 - Section 115-25

Income Tax Assessment Act 1997 - Section 115-100

Reasons for decision

Section 70-10 of the ITAA 1997 states trading stock includes anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business.

Taxation Determination TD 92/124, which is about circumstances when land is treated as trading stock, states land is treated as trading stock for income tax purposes if it is held for the purpose of resale; and business activity which involves dealing in land has commenced. It further states:

Both the required purpose and the business activity must be present before land is treated as trading stock. The business activity is taken to have commenced when a taxpayer embarks on a definite and continuous cycle of operations designed to lead to the sale of the land. It is not necessary that the acquisition of land be repetitive. A single acquisition of land for the purpose of development, subdivision and sale by a business commenced for that purpose would lead to the land being treated as trading stock.

The nature of business activity is explained in detail in Taxation Ruling (TR) 97/11. This ruling at Paragraph 13 highlights the various indicators that have been identified by the courts that need to be considered in determining whether a business is being carried on. They are reproduced below:

• whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators;

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

• whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity;

• whether there is repetition and regularity of the activity;

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

• whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at 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 a sporting activity.

Application to your circumstances

In your case, the following observations are relevant:

• your activity lacks a significant commercial purpose in that you are only disposing of a single parcel of land and are not purchasing neighbouring land to increase the magnitude of the undertaking;

• you have no intention to engage in business;

• although your activity may have a prospect of profit, this is not considered to be the main purpose;

• any repetition and regularity is limited to this single landholding;

• your activity is carried on in a much smaller scale to an entity that is in the business of land development for commercial gain;

• any planning or organisation is not undertaken by you, but rather the developer who you have engaged;

• the size and scale are relatively small and the activity is not permanent.

It is therefore concluded that your activities do not amount to a business. As such, the land cannot be held to be trading stock. As such any proceeds of sale will not be assessable on the basis of being the disposal of trading stock.

Isolated commercial transactions

Taxation Ruling TR 92/3 is about whether profits on isolated transactions are income. Here, specifically in relation to the disposal of property, paragraphs 49(g) and 9 state:

In very general terms, a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations.

Some factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are…if the transaction involves the acquisition and disposal of property, the nature of that property (Edwards v. Bairstow ; Hobart Bridge 82 CLR at 383). For example, if the property has no use other than as the subject of trade, the conclusion that the property was acquired for the purpose of trade and, therefore, that the transaction was commercial in nature, would be readily drawn…

The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property.

Court cases about property development

Numerous court cases have considered the assessability of profits or proceeds from the sale of land. As a general principle, if the sale of land constitutes a business or commercial transaction, then the proceeds will be assessable as ordinary income. On the other hand, if the sale is a mere realisation of the land, the proceeds will be a capital amount.

In the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135 (Casimaty), legal principles in relation to the subdivision of land were discussed at length, including the following court cases.

In Commissioner of Taxes v Melbourne Trust Limited [1914] AC 1001 (Melbourne Trust), a scheme was regarded as assessable income because it did not involve the liquidating or realising of old assets.

In the High Court of Australia case Ruhamah Property Co Ltd v Federal Commissioner of Taxation (1928) 41 CLR 148 (Ruhamah), it was observed, at 154:

A man has capacity to sell his property, but he may be realizing it and changing his form of investment and not engaging in a profit-making scheme. So it is with a company with power to sell: it may be realizing its property and changing the form of investment and not engaging in any profit-making scheme. Much must depend upon whether the company has taken the property into its trade and traded in it: whether it conducted a trading concern as opposed to a mere realization (cf. Alabama Co.'s Case (1926) 11 Tax Cas., at pp. 253-255). The nature of the company, the character of its assets, the nature of the business carried on by it and the particular sale or realization are all relevant to the issue.

The reference in Ruhamah is to The Alabama Coal, Iron, Land and Colonization Co Ltd v Mylam (1926) 11 TC 232, where it was said:

In order to see clearly…his Lordship suggested (ibid) that "there must be something in the nature of buying at any rate, and not merely selling, which is mere turning your property into money''.

In the High Court of Australia case of Scottish Australian Mining Co. Ltd. v. Federal Commissioner of Taxation (1950) 9 ATD 135; (1950) 81 CLR 188 (Scottish Australian Mining), the taxpayer company was formed to carry on a business of coal mining, for which it purchased land. After the coal mining operations ended, the company subdivided the land, built roads and a railway station, made sites available for schools, churches and parks and sold the subdivided parcels at a considerable profit. It was held the profits should not be included in the company's assessable income because the company was not formed for the purpose of dealing in land and that it had not in fact engaged in such a business.

In the Supreme Court (Tasmania) case Roberts v Federal Commissioner of Taxation (1981) 12 ATR 191; (1981) 81 ATC 4421, in upholding the taxpayers' appeal against their assessment to tax, the court, at 4425, took account of the following matters, each of which has a parallel in the situation of the taxpayer in Casimaty:

The appellants were market gardeners, the McGann land had in fact to the appellants' knowledge been successfully used as a market garden and they in fact did use it as such after purchase.

The appellants had never before been involved in the subdivision of land or the buying and selling of land for profit, but had been involved in the business of market gardening for many years.

In the Full High Court case of Federal Commissioner of Taxation v. Whitfords Beach Pty. Ltd. 82 ATC 4031 (Whitfords Beach), it was decided the subdivision was done in the course of what was truly a business venture. Essentially, the reason for this was three companies bought the shares in the company only to obtain control of the land, with the intention that the taxpayer would cause the land to be developed, subdivided and sold at a profit. Gibbs CJ concluded:

In the present case I gravely doubt whether the profits resulting from the development, subdivision and sale of the land would have been taxable if it had not been for the events that occurred on 20th December 1967. Had those events not occurred, the situation of the taxpayer would have been analogous to that of the company in Scottish Australian Mining Co. Ltd. v. F.C. of T. However, on 20th December 1967, the taxpayer was transformed from a company which held land for the domestic purposes of its shareholders to a company whose purpose was to engage in a commercial venture with a view to profit.

Although Mason J, in Whitfords Beach, contrary to Gibbs CJ, brought into question the application of Scottish Australian Mining (and the prior historical precedents), by asserting a profit making scheme could be constituted by selling alone due to the sheer the magnitude of a subdivision, the court in Casimaty appeared to fall back on the historical precedents (prior to the comments of Mason J in Whitfords Beach), when it said at 97 ATC 5149, about another court decision:

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 72 ATC 4188; (1972) 127 CLR 226 where Gibbs J observed, at ATC 4194-4195; CLR 249:

"As 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…even though the realisation is carried out in an enterprising way so as to secure the best price.''

In its concluding remarks, the court in Casimaty discussed the concept of 'a change in the purpose or object' of the relevant land, where it distinguished the taxpayer's case from other cases, where a change in purpose had actually occurred (as follows):

In coming to that conclusion, I have been influenced primarily by the indisputable fact that he acquired and continued to hold "Acton View" for use as a residence and the conduct of the business of a primary producer. Apart from the activities necessarily undertaken to obtain approval from time to time for subdivision of parts of the property, there is nothing to suggest a change in the purpose or object with which "Acton View'' was held.

In this respect, the present is to be contrasted with those cases in which particular circumstances provided an occasion for imputing to the landholder a change of purpose. In Whitfords Beach those circumstances were the passing of control of the landholding company from the owners of the fishing shacks to the three development companies. In Official Receiver v Federal Commissioner of Taxation (Fox's Case) the critical circumstance was that control of the land passed to the Official Receiver who sought the instructions of the creditors as to whether he should dispose of the land in its undeveloped state or undertake its extensive development to increase the return to the creditors. In the Melbourne Trust Case one critical consideration was the formation of the realization company as a distinct entity with shareholders unrelated to the failed banks or their creditors.

Thus, in addressing the subject of 'a change in the purpose or object', the court in Casimaty appeared to not simply state the mere subdivision of land was inherently a change of purpose. Instead, the court in Casimaty only cited cases where a change of the use of the asset coincided with a change in controlling interests, which echoes Ruhamah, as previously cited, which emphasised a change in the form of investment (rather than a change in purpose) , as follows:

A man has capacity to sell his property, but he may be realizing it and changing his form of investment and not engaging in a profit-making scheme.

In its final conclusion, the court in Casimaty highlighted the taxpayer did not undertake development of the land beyond what was necessary to enhance the presentation of individual allotments for sale as vacant blocks (such as constructing houses, internal fencing or other improvements; setting up his own sales organization or advertised or conducted sales himself instead of entrusting those activities entirely to traditional agents; which would have been easier to impute to him an intention to carry on a business of land development and improvement).

As was done in Casimaty, we note the cases and principles cited above, which support the happening of mere realisation, are distinguished from cases, such as Stevenson v FC of T 91 ATC 4476; (1991) 29 FCR 282 (Stevenson), in which it was decided the taxpayer was carrying on a business due to his active personal involvement in the planning, financing, undertaking and selling of the subdivision.

Application to your circumstances

In your situation the following is noted:

• your intention in acquiring the land was to use to generate rental income

• the land was used for these purposes for several years;

• the level of complexity is considered to be low as you intend to only perform the bare minimum of works to satisfy council's requirements;

• only a section of your landholding is being subdivided due to the existence of special conditions;

• the size and scale of your undertaking is not considered significant in that X lots will be created;

• you will have no personal involvement as all arrangements, preparations, scheduling etc will be performed by the developer that you have engaged;

• you will construct no buildings or other structures on any of the blocks intended to be sold;

• you may retain one block for a future residence yourself;

• although you may generate greater proceeds than selling the land 'as is' any increased profits is considered merely incidental.

Therefore, the Commissioner is of the view that any profit or gain from the disposal of the subdivided lots will not constitute ordinary assessable income under section 6-5.

Rather, you are considered to be merely realising an asset in an enterprising way as to achieve the highest possible proceeds.

CGT 50% discount

Section 115-100 of the ITAA 1997 provides that a discount percentage of 50% may be applied to a capital gain made by an individual that is considered to be a discount capital gain.

In order to be a discount capital gain, section 115-25 provides that the CGT event that gave rise to the capital gain must relate to an asset that was acquired at least 12 months prior to that CGT event.

Section 112-25 considers the issue of split assets. It is specifically stated that the splitting of an asset is not a CGT event in itself and the original cost base of the asset is reasonably apportioned to each of the new assets.

Application to your circumstances

In your case, the act of subdividing the blocks into separate titles is not a CGT event. Your cost base of the entire block will be reasonably apportioned between each of the subdivided blocks.

As the subdivision itself was not a CGT event, you are not considered to have sold any CGT asset at that time. Accordingly, each of the subdivided blocks will retain the initial acquisition date of the original single block.

As such, each individual block will have been owned by you for more than 12 months and you will be entitled to apply the general 50% CGT discount under Division 115.

Summary

• The proceeds of sale of the individual blocks will not represent the disposal of trading stock;

• Any profits or gains on the disposal of individual blocks will not be considered isolated commercial transactions as envisaged by TR 92/3 and as such not assessable as ordinary income;

• Any profits or gains on the disposal of the individual blocks will be considered under the CGT provisions of the taxation legislation;

• You will be entitled to the 50% discount under Division 115 upon the realisation of any capital gains on the disposal of the individual blocks.

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