Edited version of your written advice

Authorisation Number: 1013043496705

Date of advice: 30 June 2016

Ruling

Subject: Property - subdivision - Am I in business? - isolated transaction - mere realisation

Question 1:

Will the profit from the sale of the subdivided vacant lots of land be treated as ordinary income under section 6 -5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of the taxpayer carrying on a business of property development?

Answer:

No.

Question 2:

Will the profit from the sale of the subdivided vacant lots of land be treated as ordinary income under section 6-5 ITAA 1997 as a result of an "isolated transaction" carried out for profit and commercial in character?

Answer:

Yes.

Question 3:

Will the profit from the sale of the subdivided vacant lots of land be treated as statutory income under the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997?

Answer:

Yes. However, section 118-20 of the ITAA 1997 will apply to reduce the capital gain to the extent that the profit from the sale of the subdivided vacant lots of land is otherwise included as assessable income under section 6-5 of the ITAA 1997.

This ruling applies for the following periods

Income year ending 30 June 2016

Income year ending 30 June 2017

Income year ending 30 June 2018

Income year ending 30 June 2019; and

Income year ending 30 June 2020.

The scheme commences on

The scheme has commenced

Relevant facts and circumstances

Information and documentation has been provided with this private ruling application, which should be read in conjunction with and forms part of the scheme.

After 20 September 1985, Person A and Person B (the Persons) purchased vacant land (the Property).

A house was constructed on the Property which has been the Persons' main residence after it was constructed until the present time.

The Persons want to downsize the Property by subdividing the property and selling the vacant land. The proceeds from the sale of the subdivided vacant lots of land will be used for their retirement.

The company (You) was created a number of years after the Property was purchased. The Persons are your directors.

You are the trustee of the Trust, which was created at the time you were created. The Trust's beneficiaries are the Persons.

You will purchase the Property from the Persons, subdivide the Property into subdivided lots, including one on which the house will be located on.

You will lease the subdivided lot on which the house is located to the Persons for a market value rental amount.

You will sell the subdivided vacant lots of land.

The Persons created the Trust primarily for asset protection and to limit their personal exposure. The Trust's sole purpose is to purchase the Property from them, undertake the subdivision, and sell subdivided vacant lots of land (the Project). There is no intention by the Persons to use you or Trust for any other purpose/s and you and the Trust arrangement will be wound up once the Project has been completed.

It is anticipated that you will use the market value as a fair purchase price when purchasing the Property and will borrow the full amount to cover the purchase price of the Property and stamp duty.

You have engaged the services of professionals (the Professional) to provide a quotation for the Project. The quotation outlined that the subdivision would be undertaken in numerous stages and specified fees for the relevant activities. The quotation outlined that the Profession could on request provide a lump sum estimate to provide project management services by their in-house Project Manager, which would be covered under a separate agreement.

You received estimates from a real estate agent which outlined that:

• the current market value of the Property was less than $1,000,000

• the price of one acre lots in the area range were under $400,000; and

• a house lot consisting of 1-2 acres had an estimated market value of over $700,000.

You engaged the services of the Professional to undertake all activities in relation to the Project.

The Professional has prepared the subdivision application which will be lodged shortly, and dependant on the approval of the subdivision application the infrastructure works are expected to commence within the relevant income year, with the completion of the subdivision estimated to be completed a number of months later.

The infrastructure that will be undertaken as a result of the subdivision will include power, fencing and roads.

A plan of the proposed four lot subdivision of the Property has been prepared which outlines that a carriageway easement will be created down the side of the subdivided lots to allow access to the rear subdivided lots.

You will engage the services of real estate agent/s to sell the subdivided vacant lots of land.

You believe that the sale price for the subdivided vacant lots of land will be less than $400,000 per lot.

You intend to sell the subdivided vacant lots of land as quickly as possible, dependent on the property market, to reduce the loan.

You and your associates have not undertaken any similar activities in the past and do not intend undertaking any similar activities in the future.

For the purposes of this ruling the following will occur:

• You will purchase the Property

• You will engage the services of other parties to undertake the activities in relation to the subdivision of the Property and sale of the three subdivided vacant lots of land

• The subdivided block on which the house is located will be leased to the Persons; and

• You and your associates have not undertaken any similar activities in the past and will not undertake any similar activities in the future.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 960-100

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Summary

You are not carrying on a business of property development because your activities do not display the salient indicator of a business, which are transactions entered into on a continuous and repetitive basis. However, any profit or loss from the sale of the subdivided lots will still be accounted for on revenue account as an isolated commercial transaction because you are subdividing the Property for the primary purpose of making a profit on their sale.

Detailed reasoning

Legislative references referred to herein are from the Income Tax Assessment Act 1997 (ITAA 1997).

Taxation treatment of property sales

There are three ways profits from property sales can be treated for taxation purposes:

1. As ordinary income under section 6-5, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock; or

2. As ordinary income under section 6-5, on revenue account, as a result of an isolated business transaction entered into by a non-business taxpayer, or outside the ordinary course of business of a taxpayer carrying on a business, which is the commercial exploitation of an asset acquired for a profit making purpose; or

3. As statutory income under the capital gains tax (CGT) legislation on the basis that a mere realisation of a capital asset has occurred.

Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case.

We will consider each of these in relation to your situation as follows:

Carrying on a business of property development

Section 995 of the ITAA 1997 states the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

To determine whether an activity, or series of activities, amounts to a business, the activity needs to be considered against the indicators of a business established by case law.

In the High Court of Australia case of Hope v. Bathurst City Council (1980) 144 CLR 1; (1980) 29 ALR 577; (1980) 80 ATC 4386; [1980] HCA 16, a business was described in the following ways:

It is the words "carrying on'' which imply the repetition of acts and activities which possess something of a permanent character.

…activities engaged in for the purpose of profit on a continuous and repetitive basis.

Transactions were entered into on a continuous and repetitive basis for the purpose of making a profit…manifested the essential characteristics required of a business.

For a one-off land subdivision 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.

The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 (TR 97/11) which uses the following indicators to determine whether a taxpayer is carrying on a business:

• whether the activity has a significant commercial purpose or character;

• 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.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

Application to your situation

In this case, you will purchase the Property from the Persons for the sole purpose of subdividing it. You will sell some of the subdivided lots, being vacant land, and will keep one subdivided lot on which the existing house is located which will be leased to the Persons.

You and your associates have not previously undertaken any similar subdivision activities in the past and do not have any intention to undertake any similar activities in the future.

After reviewing the information and documentation provided, it is the Commissioner's view that the activities you will undertake in relation to the subdivision of the Property and the sale of the subdivided lots of vacant land are not those of an entity carrying on a business of buying, subdividing and selling land. Also, there is nothing to indicate that your activities are those of an entity commencing a business in buying and selling property.

The subdivision of the Property is viewed as a small, one off project that is not being carried out in a manner similar to other property development businesses.

Based on the information and documentation provided we do not consider that any proceeds you will receive from the sale of the three subdivided lots will be derived in the course of carrying on a business.

As the proceeds from the sale of the subdivided lots will not be assessable as ordinary income because you are carrying on a business, we will consider whether or not the proceeds will be viewed as being received in relation to an isolated business transaction or a mere realisation as follows:

Isolated business transactions

Profits from isolated transactions will be assessable as ordinary income where the 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 out a business operation or commercial transaction

Taxation Ruling TR 92/3 (TR 92/3) sets out the Commissioner's view of the general principles and factors that have been considered in determining whether an isolated transaction is of a revenue nature.

Paragraph 1 of TR 92/3 outlines that isolated transactions are:

a) those transactions outside the ordinary course of business of a taxpayer carrying on a business; and

b) those transactions entered into by non-business taxpayers.

The ruling outlines at paragraph 6 that whether a profit from an isolated transaction will be ordinary income will depend on the circumstances of the case, however a profit from an isolated transaction will be ordinary income when:

a) the intention or purpose of a 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 operation or commercial transaction.

TR 92/3 outlines that the relevant intention or purpose of the taxpayer, of making a profit or gain, is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

If a transaction or operation is outside the ordinary course of a taxpayer's business, the intention or purpose of profit-making must exist in relation to the transaction or operation in question.

The transaction may take place in the course of carrying on a business even if the transaction is outside the ordinary course of the taxpayer's business.

Paragraphs 41 and 42 of the ruling outline that where a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction, the activity of the taxpayer constitutes the carrying on of a business operation or commercial transaction carrying out a profit-making scheme, as the case may be.

Whether a particular transaction has a business or commercial character depends very much on the circumstances of the case. Paragraph 13 of the ruling outlines the following factors which may be relevant when considering whether an isolated transaction amounts to a business operation or commercial transaction: 

• 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 the property, and

• the timing of the transaction or the various steps in the transaction.

The direction provided within TR 92/3 and the above cases indicates that profits in this context are more likely to be considered ordinary income if they are made in the ordinary course of carrying on a business. Further, ordinary income may be derived from an isolated transaction which becomes commercial in nature, or as a result of profits on a transaction in which the initial intention was to make a profit on sale.

Application to your situation

In this case, you will purchase the Property for its market value and will subdivide the Property, selling the majority of the subdivided lots of vacant land. The simplest way you could have divested yourself of the Property would be to dispose of it without seeking any subdivision approvals and without actually undertaking the associated works. The acts of seeking approvals and undertaking the subdivision work must in some way contribute towards a finding that the overall activity constitutes something more than a 'mere realisation' of a capital asset.

You, the Trust, and the Persons are viewed as separate entities for taxation purposes. It has been stated that your principal purpose, and the sole intention of the company and trust arrangement, is for you to purchase the Property, subdivide it and sell the subdivided vacant land lots.

While the Persons have used the Property as their main residence, it is not their intention in relation to the Property that we must take into consideration. As held in Federal Commissioner of Taxation v. N.F. Williams., High Court of Australia, 01 November 1972 72 ATC 4188 (1972) 217 CLR 226 (1972) 3 ATR 283 (1972) 46 ALJR 611, the intentions and purposes of the original owners were not relevant.

Therefore, we must look objectively at your intention when you purchased the Property and when you subsequently subdivided and sold a number of the subdivided vacant lots of land.

Based on the information provided, it is viewed that the activities being undertaken by you have a clear intention to make a profit on the sale of the subdivided lots of vacant land given that it is your sole role to purchase the Property, subdivide it, and sell the subdivided lots of vacant land.

For a property subdivision to be considered revenue, it is not necessary that a profit making intention be the sole motivation, only that it be a significant motivation The amount of money that needs to be invested to bring the development to a conclusion compared to the market value of the land if it was sold as is, the size of the profits expected and the level of risk assumed in the pursuit of return all indicate that on balance profit making is a significant intention for the trust.

The subdivision of the Property is aimed at increasing the number of lots available for sale, with the expected increase in the profits from the sale of the lots being more than enough to cover the increased costs due to the subdivision.

The return for the sale of the subdivided lots of vacant land is expected to be more than the market value of the whole property without taking into account the value of the lot on which the existing house is located on.

You will borrow the amount to cover the purchase price of the Property and stamp duty and it is anticipated that you will obtain funds to finance the Project. Therefore, you will be assuming the risk in relation to the pursuit of a return that will be considerably larger than what could have been achieved by selling off the Property as a whole. This level of risk is acknowledged by the statement that the reason for selling the Property to you is to reduce risk to the Persons. The adoption of risk in the pursuit of profit is an indicator of a profit making intention.

In this case, you have approached the transaction in a businesslike way, engaging the services of the Professional to undertake the necessary activities in relation to the subdivision of the Property. Also the entities involved, being you and the Trust, are of a more complex nature than individuals undertaking the same activities.

The subdivision will transform the Property from a large rural block of land on which a house is located into small residential allotments and a lot on which the existing house is located. There is a demonstrated intention to profit from the subdivision of the Property and the transaction has been undertaken in a commercial manner.

In conclusion, we have made the following observations:

• You and the Trust were created for the sole purpose of purchasing and subdividing the Property, with the intention to sell the subdivided vacant lots of land and lease the lot on which the existing house is located to the Persons

• You have approached the development in a businesslike way

• there is a coherent plan for the subdivision of the Property and sale of the subdivided vacant lots of land; and

• You expect to make a profit from the sale of the subdivided lots of vacant land.

Accordingly, the subdivision of the Property by you will have the characteristics of a commercial transaction. As you will be carrying out an isolated commercial transaction with a view to a profit, the profit made on the sale of the subdivided vacant lots of land will be assessable as ordinary income under section 6-5.

Capital gains tax

The capital gains tax (CGT) provisions are contained in Part 3-1 of the ITAA 1997. Broadly, the provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own.

CGT event A1 under section 104-10 happens if you dispose a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property.

Section 118-20 contains anti-overlap provisions which operate to reduce any capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 of the ITAA 1997 as a result of the sale, for example, as ordinary income under section 6-5 of the ITAA 1997.

Application to your situation

Making an overall assessment on the factors set out in TR 92/3, it is the Commissioner's view that the purchase, subdivision and sale of the subdivided lots of vacant land will not be a mere realisation of a capital asset.

Accordingly, whilst CGT event A1 under section 104-10 will occur on the disposal of the subdivided lots of vacant land, their disposal will be isolated transaction, and any capital gain arising from this CGT event will be reduced to the extent that the profit is included in your assessable income under section 6-5.

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