Edited version of your written advice

Authorisation Number: 1013111985015

Date of advice: 24 October 2016

Ruling

Subject: Land subdivision and sale.

Question 1

Will the proceeds from the development and sale of the subdivided lots be assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Alternatively, will the proceeds from the development and sale of the lots be subject to taxation under the Capital Gains Tax (CGT) provisions in Parts 3-1 and 3-3 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Years ending 30 June 20YY to 30 June 20YY

The scheme commences on:

1 July 20YY

Relevant facts and circumstances

A and B jointly own land, herein referred to as “the land”.

They purchased the land post September 1985.

The land is approximately XXX hectares in size in total spread over several separate titles.

A and B purchased the land with the intention of using the land in connection with A's primary production business.

A has only ever used the land for the purpose of carrying on his/her primary production business during the entire ownership period.

At the time of acquisition by A and B, the land was zoned by the council for farming use.

The land was rezoned some years after purchase for farming use, but has an overlay Future Low Density Residential. A and B had no involvement in the above mentioned rezoning of the land.

Since acquisition of the land, improvements relating to the primary production business were made.

Both A and B are approaching retirement and farming activities are winding down. Landholdings have become excess to their needs. A and B are now considering subdividing and selling some of the land to provide for their retirement. This equates to about one-third of their total land holdings.

Recently, A and B were approached by C Pty Ltd (C) (a professional land development company) who expressed interest in undertaking a subdivision and development of the land into residential lots for separate sale to the public on A and B's behalf in return for a fee.

A and B have subsequently been in commercial negotiations with C in relation to the terms and conditions upon which they might be prepared to engage C to undertake this land subdivision project.

A, B and C have now reached an “in principle agreement” to the terms and conditions upon which C will be appointed to undertake the subdivision project. A draft land development contract (Draft Development Agreement) has been prepared to reflect the agreed terms and conditions.

The following matters are covered by the Draft Development Agreement:

(a) C will attend to all matters required to effect the development and sale of the land.

(b) A and B will remain owners of the land throughout the development. No title in the land will pass to C or any other entity to effect the development. A and B will individually enter into contracts of sales with purchasers of subdivided land lots.

(c) C will be responsible for paying all development costs. It will have the right to be reimbursed these amounts from the sale proceeds only as they are received on behalf of A and B.

(d) In consideration for the development services provided by C, it will be entitled to a “development fee” as set out in the development agreement.

C has proposed that the land will be developed into approximately XX residential lots.

The land development will not go beyond minimum council mandated stipulations.

The development project is anticipated to take X years to complete.

It is A and B's intention to continue to use land being developed in connection with A's primary production business for some time after formally committing to the land subdivision. This may continue until such time as works to the land make this impossible.

A and B will not be borrowing personally to finance the subdivision.

A and B do not have a history of land or property development for profit. They have only ever acquired land in connection to A's vocation.

A and B have never been involved to any extent in applying for a rezoning of the land. It is noted that the developer must obtain a rezoning of the land before the proposed land subdivision can progress.

The Draft Development Agreement between A, B and C was provided in respect of this private ruling application and forms part of the facts.

A and B may from time to time be asked to sign documentation pertaining to re-zoning applications or planning permits, as is required in reflection of their status as the legal owners of the land. Such documentation will be prepared in all cases by the developer or its appointed agents.

A and B will be responsible for signing of contracts for the sale of subdivided land lots. However, the preparation of the sale contracts and the selling campaign will be co-ordinated by the developer and/or its appointed agents.

It is expected that there will be minimal (if any) conferences that A and B will need to be involved in as it is the developer that will take an active role in the land development and is responsible for making decisions in relation to the land development.

It is anticipated that the general purpose of any conferences requiring the attendance of A and B will be generally only called to inform them of the project progress and to facilitate the signing of any documentation the landowners might need to sign.

It is expected that there would be very minor hours of A and B's time committed for meetings and conferences per month, and there may be many months that there will be no time involvement.

To date, A and B have not been involved in any conferences with external parties and forums in relation to the development.

No planning documents were prepared at the time of making the decision to develop and sell the land, including financial or economic modelling, budgets and business plans.

A and B will not be responsible for maintaining a set of accounts, and copies of legal agreements. Rather, it is the developer that will be responsible for maintaining a set of accounts and copies of legal agreements.

A and B were approached by C who expressed interest in undertaking the subdivision and development of the land. Prior to being approached by C, A and B were not contemplating selling the land in whole or subdividing the land.

The preliminary steps A and B took prior to entering into the Draft Development Agreement with C, involved seeking legal advice and taxation advice.

Another developer approached A and B at around the same time as C with an offer, however this was declined.

The development will not include buildings, shops or any amenities that are not mandated by the planning authorities.

The estimated market value of the subdivided lots is unknown.

The estimated value of the development expenditure (subdivision costs, marketing fees, administrative costs) is unknown. It is the developer that will be responsible for incurring the development costs.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 25

Income Tax Assessment Act 1936 section 25A

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10,

Income Tax Assessment Act 1997 section 15-15,

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 subsection 112-25(2)

Reasons for decision

Question 1

Summary

The proceeds from the proposed development and sale of the subdivided lots are not considered to be assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

A and B intend to enter into a Development Agreement with C Pty Ltd (C) to subdivide a parcel of their farming land for sale. The intention is to subdivide into approximately XX residential lots. This constitutes approximately one-third of the total land.

We therefore need to determine whether the proceeds to be received from the sale of the subdivided lots are:

● assessable ordinary income under section 6-5 of the ITAA 1997 as income from carrying on a business of property development;

● assessable ordinary income under section 6-5 of the ITAA 1997 as income from an isolated commercial transaction with a view to a profit; or

● a realisation of a capital asset and assessable as a capital gain under Parts 3-1 and 3-3 of the ITAA 1997.

Section 6-5 of the ITAA 1997 includes in your assessable income, where you are an Australian resident, all ordinary income which you derive during an income year. Ordinary income is defined as income according to ordinary concepts.

Ordinary income generally includes income that arises in the ordinary course of a taxpayers business. However, in certain circumstances proceeds not within the ordinary course of the taxpayers business may form part of their ordinary income.

The decisions in Casimaty v. Federal Commissioner of Taxation (1997) 97 ATC 5135; 37 ATR 358 (Casimaty) and McCorkell v Federal Commissioner of Taxation 98 ATC 2199; (1998) 39 ATR 1112 (McCorkell) demonstrate that if a taxpayer does not intend to make a profit when he or she acquires farming land then the likelihood that any profit made on the eventual sale of land as ordinary income is greatly diminished.

The Commissioner accepts that where the activities are no more than the realisation of a capital asset as per the Casimaty and McCorkell cases, any realised gain on the transaction will be a capital gain under the CGT provisions in Part 3-1 of the ITAA 1997.

However, profits made on the sale of subdivided land can still be ordinary income if the activities become a separate business operation or commercial transaction.

 For example, in Case W59 89 ATC 538; 20 ATR 3728 Deputy President Mr I.R. Thompson considered the appellant was carrying on a business of subdividing, developing and selling land. This was because the appellant had a significant degree of personal involvement in planning, negotiating with local councils and other bodies, obtaining finance, employing contractors, and selling the blocks. In addition to this the subdivision and development was substantial (the land had been divided into over 180 small blocks).

Similarly, the decision in Federal Commissioner of Taxation v Whitfords Beach Pty Ltd 82 ATC 4031; (1982) 150 CLR 355, considered that in the operation of a business, it is relevant to take into account the purpose with which the taxpayer acted and, since the taxpayer was a company, the purposes of those who control it are its purposes. Therefore, in this case, when the shares in the taxpayer were purchased by three development companies, it transformed the 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. In addition to taking other factors into consideration, including the scale and magnitude of the subdivision, it was concluded that the taxpayer's activities involved more than a mere realisation of an asset.

The principle has been established that profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business (FC of T v. The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium). 

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) discusses the application of the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are ordinary income and therefore assessable under section 6-5 of the ITAA 1997.

According to Paragraph 16 of TR 92/3:

16. If a taxpayer not carrying on a business makes a profit, that profit is income if:

(a) the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain: and

(b) the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

A and B did not purchase the land subject to subdivision and sale with the intent of entering into a profit making transaction. Their intent at the time of purchase was to farm the land and in fact, have always farmed the land since purchase and are continuing at present. The subdivision and sale of the land lots is considered to be outside the ordinary course of the activities from which they derive their income. The transaction will not occur within the ordinary course of business being carried on by A and B as they are not involved in the property development industry. Therefore, the activity would be best described as an isolated transaction.

Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. In Myer Emporium, the High Court did not set out guidelines as to what constitutes a business operation or commercial transaction. However, the main indicia that has resulted from TR 92/3 and relevant case law is as follows:

(a) whether the landowner held the land for a considerable period of time prior to any subdivision and sale;

(b) whether the landowner conducted farming or other non-developmental activities, prior to beginning the process of developing and selling the land;

(c) whether the landowner originally acquired the land as a private residence or for recreational purposes;

(d) whether the landowner originally acquired the property as an investment, such as long term capital appreciation or to derive income;

(e) whether the land was originally acquired near the urban fringe of a major city or town;

(f) if the property has been recently rezoned, whether the landowners actively sought that rezoning;

(g) whether a potential buyer made any offers to the landowners before they commenced discussion to enter into a proposed or final development agreement;

(h) whether the landowners had tried to sell the land without subdivision;

(i) whether the landowner had any history of buying and profitably selling developed land or land for development;

(j) whether the operations will be planned, organised and carried on in a business-like manner;

(k) whether the landowners have changed their business activity relating to the land from one business to another (eg. from farming to property development);

(l) the scope, scale, duration and degree of complexity of the proposed development;

(m) who initiated the proposal to develop the land for resale;

(n) whether the development and pre-sale arrangement is sophisticated;

(o) whether the landowners will be actively involved in any development activities;

(p) the level of legal and financial control maintained by the landowners in the proposed or final development agreement; and

(q) the level of financial risk borne by the landowner in acquiring, holding and/or developing the land.

The selling of the subdivided land by A and B is considered below with reference to these factors:

● A and B have held the property for a considerable time prior to the development being contemplated. The property was acquired post CGT and development negotiations only started recently. The land has been farmed for approximately XX years and is continuing.

● A and B have lived and farmed the property for many years. The reason for subdividing and selling part of the land relates to their retirement and scaling down the farming business.

● A and B have not actively been involved in the development and sale of the subdivided lots. Their involvement has been passive in nature and they have engaged C to attend to all matters necessary to effect the land development and sale.

● A will continue to be engaged in his/her primary production activities on the land lots subject to the land subdivision and development until such time as the land development activity impedes this. It is the developer who bears all risk in the development activity.

● The proposed development land was zoned by council for farming use when acquired post CGT. It is situated approximately XX kilometres from a major city. The council subsequently re-zoned the land to a farming use zone but with a Future Low Density Residential overlay.

● A and B were approached by property developer, C. They have not previously tried to sell or develop the land.

● A and B land being developed is approximately one-third of total land owned. Four lots are being developed, equating to approximately XX residential lots. The duration of the development is planned for X Years.

● A and B have not applied for any rezoning of the land. The intention is for the developer to apply for rezoning in regards the development.

● The land will remain owned by A and B throughout its development until such time as the subdivided lots are sold. The land will not be transferred to any other entity to effect the development and sale.

● A and B do not bear the costs of the development. These will be paid by the developer and recouped from the sale income as proceeds come home. A and B will not lend personally to finance the subdivision.

● A and B will not keep records. The developer will keep itemised accounts and record all costs and payments made, and make them available to A and B.

● The land development activity will not go beyond minimum council mandated stipulations.

Conclusion

Based upon the facts of the proposed subdivision and sale outlined above, in light of the factors set out in TR 92/3 and relevant case law, it is not considered A and B have ventured into a business activity of property development and sale of land for profit. Therefore, proceeds from the proposed subdivision and sale of the lots will not be assessable ordinary income under section 6-5 of the ITAA 1997 as income from carrying on a business of property development.

We also do not consider that the passive involvement of A and B in the development amounts to them engaging in a business-like operation or commercial transaction. As such, the profits or gains to be made by A and B from the proposed subdivision and sale of the lots will not be assessable ordinary income under section 6-5 of the ITAA 1997 as income from an isolated commercial transaction with a view to a profit.

Question 2

Summary

The proceeds from the development and sale of the subdivided lots will be subject to taxation under the Capital Gains Tax (CGT) provisions in Parts 3-1 and 3-3 of the ITAA 1997.

Detailed reasoning

A capital gain or a capital loss may arise if a capital gains tax event (CGT event) happens to a capital gain tax asset (CGT asset). Section 108-5 of the ITAA 1997 provides that a CGT asset is any kind of property, or a legal or equitable right that is not property.

Taxation Determination TD 97/3 Income tax: capital gains: if a parcel of land acquired after 19 September 1985 is subdivided into lots ('blocks'), do Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 treat a disposal of a block of the subdivided land as the disposal of part of an asset (the original land parcel) or the disposal of an asset in its own right (the subdivided block)? (TD 97/3) answers the question: if a parcel of land is subdivided into lots (blocks) do Parts 3-1 and 3-3 of the ITAA 1997 treat the disposal of a block as an asset in its own right?

The disposal of a subdivided block is treated as the disposal of an asset in its own right and not as a disposal of part of an asset (the original parcel of land). The subdivided and the newly created blocks are treated as separate assets under the capital gains provisions.

Paragraph 4 of TD 97/3 states that when an original parcel of land is split into two or more blocks, and you are the beneficial owner of the original land and each of the new blocks, subsection 112-25(2) of the ITAA 1997 provides that each element of the cost base and reduced cost base of the original asset is apportioned in a reasonable way and included in the corresponding element of the cost base and reduced cost base of each new asset.

As discussed above in relation to the Casimaty and McCorkell cases, in which farming land was subdivided and sold, the Full Federal Court held that the proceeds were not assessable under either section 25 or 25A of Income Tax Assessment Act 1936 (ITAA 1936) (note: section 25 (repealed) and section 25A of ITAA 1936 only apply up to and including the 1997 financial year). For 1998 financial year and following, sections 6-5, 6-10 and 15-15 of the ITAA 1997 have application). The subdivision of the land sale in these cases amounted to a mere realisation of a capital asset. The reasoning of the judges in these cases is not distinguishable from this case.

A and B as the landowners are considered to be undertaking the realisation of a capital asset and CGT event A1 (section 104-10 of the ITAA 1997) will happen when they dispose of the subdivided land.

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