Edited version of your written advice

Authorisation Number: 1051287296074

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Date of advice: 19 October 2017

Ruling

Subject: Property development - subdivision - capital versus income

Question:

Will the profit from the sale of the proposed subdivided blocks be treated as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

Yes.

This ruling applies for the following periods

Income year ending 30 June 2018

Income year ending 30 June 2019

Income year ending 30 June 2020

Income year ending 30 June 2021; and

Income year ending 30 June 2022.

The scheme commences on

1 July 2017.

Relevant facts and circumstances

You, being Persons A and B, purchased a property (the Property) as joint tenants prior to 20 September 1985.

The Property is located on the outskirts of a major city, has a land area of X acres and was zoned rural residential when you purchased it.

A dwelling is located on the Property in which you have resided until the present time. There are no other substantial structures on the property and it has been used for private and domestic purposes from acquisition until the present time.

The Property is located adjacent to three other properties which were the same size as the Property, or larger, when you purchased it. Those properties have all been subdivided over a number of years after 20 September 1985.

Due to the subdivisions mentioned above, there are existing access roads and sewage connected to most of the Property’s boundaries.

Neither you nor any related entities were involved in the development of the surrounding properties.

The Property is currently zoned general residential; however you did not apply to have the Property rezoned.

The Property has not been put on the market however you received some unsolicited offers from developers during your ownership period.

You sought a written offer from a developer who made an offer of $X million for the Property. You considered the offer but rejected it as you considered the offer to be below the market value of the Property. The developer made a revised offer of $X.X million shortly after the original offer. You refused the second offer as you considered the amount being offered was still below the market value of the Property.

You have not obtained any professional valuations of the Property, however you consider that the Property is currently worth approximately $X.X million.

You are retirees who are over seventy years of age who receive the aged pension. You are finding it increasingly difficult to maintain the Property in addition to Person B being house bound, with Person A acting as their primary carer.

You have decided to subdivide the Property into residential blocks and sell them to maximise the proceeds from the sale of the Property to fund your retirement.

One of your children (Person C) will assist you in carrying out the subdivision of the Property and the sale of the proposed subdivided blocks (the Project).

Person C will incorporate a project management company (the Development Company) of which they will be the director.

The Development Company will:

● manage the day to day activities in relation to the subdivision of the Property;

● consult with relevant professionals;

● engage town planners, engineers, surveyors and other contractors;

● obtain permits and approvals as required by law in your names;

● will only undertake the necessary work required to meet council approval conditions and will not construct any buildings on any of the proposed subdivided blocks;

● borrow funds to finance the Project by obtaining a capitalised loan;

● use the Property as security when obtaining the borrowed funds;

● repay the borrowed funds from the proceeds of the proposed subdivided blocks once sold;

● incur expenses while undertaking the Project and will be reimbursed for those amounts from the proceeds of the proposed subdivided blocks once sold;

● charge you for its services in relation to the Project at cost value; and

● incur the legal liability in relation to the Project.

Person C will not receive any income or any proceeds from the sale of the proposed subdivided blocks.

Person C has not undertaken any land subdivision activities in the past and has no plans to undertake any similar activities in the future.

Neither Person C nor the Development Company will be gifted or will purchase any of the proposed subdivided blocks.

The Property will be subdivided into XX blocks over a number of stages, with each subdivided block to have a land area of XXX square metres, which is consistent with the recent developments that have occurred on the neighbouring properties.

Person C discussed the proposed subdivision of the Property with the manager engaged to manage the subdivision of one of the adjacent properties. From that discussion/s the following estimates of the cost of the subdivision of the Property and the sale price of the proposed subdivided blocks have been determined:

The costs for the Project are estimated to be $X,XXX,XXX.

None of the costs, sale prices and value of the Property has been determined with input from any professional valuer, agent or developer. They are not in any written agreement.

You have not obtained any advice or information from council to ascertain what applications, approvals and permits are required to undertake the Project.

A licenced real estate agent will be engaged to sell the subdivided blocks, or the subdivided blocks will be sold by tender process. The Development Company will not be responsible for devising or carrying out marketing strategies for the sale of the blocks.

You:

● do not have a written business plan for the proposed subdivision;

● do not have an office, stationery or letterhead;

● did not acquire any additional land to add to the Property;

● have not undertaken any similar activities in the past and do not intend undertaking any similar activities in the future;

● will not keep any of the proposed subdivided blocks or the existing dwelling;

● will outsource all of the activities in relation to the Project;

● will, at all times, remain the legal owners of the Property; and

● will be the registered owners of each of the proposed subdivided blocks, which you will hold until they are sold and receive proceeds upon each sale.

At this point:

● it is not anticipated that there be any written contract/agreement between you and Person C or the Development Company;

● the Development Company has not been established;

● no subdivision activities have commenced;

● no documentation has been prepared/obtained in relation to the Project;

● no persons or entities have been engaged to provide any services in relation to the Project;

● no application/s for any borrowed funding for the Project has been lodged;

● it is not known whether the Development Company will claim any tax deductions and/or Goods and Services Tax credits;

● it is not known when you will move out of the existing dwelling; and

● it is not known if the existing dwelling will be demolished or will be sold with one of the proposed subdivided blocks.

The Project will commence within the next X to X years and take approximately X years to complete.

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 70-10

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 will either be carrying on a business of property development or undertaking a profit making scheme. Any profit arising from the sale of the proposed subdivided blocks will be assessable as ordinary income under section 6-5 of the ITAA 1997.

Detailed reasoning

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 of the ITAA, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock;

2. As ordinary income under section 6-5 of the ITAA, on revenue account, as a result of entering into a profit-making undertaking or scheme (including an isolated transaction); or

3. As statutory income under the capital gains tax legislation.

Carrying on a business of property development

Section 995-1 of the ITAA 1997 states the term ‘business’ includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

The question of whether a business is being carried on is a question of fact and degree. Over the years the courts have developed a series of indicators to determine if a business is being carried on.

Taxation Ruling TR 97/11 provides the Commissioner’s view of the factors used to determine if you are in business for tax purposes. In the Commissioner’s view, the factors that are considered important in determining the question of business activity are:

● whether the activity has a significant commercial purpose or character

● 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 regularity and repetition of the activity

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

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

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

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

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.

Further, Taxation Determination TD 92/124 states that a 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.” That is, the land will become trading stock when you are demonstrably fully committed to the business of land development. When that occurs is determined by a consideration of the facts of the case.

Section 70-10 of the ITAA 1997 provides that 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. This can include land.

Isolated transactions

Profits arising from an isolated transaction as a result of entering into a profit-making undertaking or scheme will be ordinary income under section 6-5 of the ITAA 1997, on revenue account, (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693 (Myer Emporium)). This is distinguished from a ‘mere realisation’ which is not ordinary income.

Taxation Ruling TR 92/3 (TR 92/3) sets out the ATO view as to the application of the decision in Myer Emporium and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income.

Paragraph 16 of TR 92/3 states that 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.

Paragraph 13 of TR 92/3 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.

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.

Profits on the sale of subdivided land can therefore be income according to ordinary concepts within section 6-5 of the ITAA 1997 if the taxpayer’s subdivisional activities amount to a business operation or commercial transaction.

Paragraph 42 of TR 92/3 provides that if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either:

a) as the capital of a business; or

b) 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 or a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income although the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

In addition to the above factors, for the purposes of determining whether the activities undertaken in relation to real property and development equate to a profit-making undertaking or scheme, Miscellaneous Taxation Ruling MT 2006/1 (MT 2006/1) aligns itself with TR 92/3 and provides a list of factors which, if present may be an indication that a business or profit-making undertaking or scheme is being carried on.

In determining whether activities relating to isolated transactions are a profit making undertaking or are the realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. This may require a consideration of the factors outlined above; however there may also be other relevant factors that need to be weighed up as part of the process of reaching an overall conclusion. No single factor will be determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

Capital gains tax provisions

The capital gains tax (CGT) provisions are contained in Parts 3-1 and 3-3 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 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.

When a CGT asset (the original asset) is split into 2 or more assets (the new assets), such as when land is subdivided, the subdivision of the land into subdivided blocks is not a CGT event.

Where the original land was acquired before 20 September 1985, each new lot retains its pre-CGT status and any capital gain or capital loss made on its disposal is disregarded.

Application to your situation

Taking all of the available facts into consideration, and on weighing the various factors, your activities in subdividing the Property and the proceeds from the sale of the proposed subdivided blocks will either be those from the carrying on of a business or from the undertaking of an isolated transaction.

In your case you have approached the subdivision of your property in a business like way. Person C will establish a company and you will enter into an arrangement with that company for it to undertake the activities in relation to the Project. Person C, via the company, will seek expert advice from town planners, engineers, surveyors and other contractors.

The use of a corporate structure to carry out the work, and the fact that you will – through Person C’s company– maintain the management of the Project rather than relying on a property developer, are indicators of a businesslike organisation and profit making intent.

The activities to be undertaken to subdivide the Property and sell the proposed subdivided blocks will be the same as those undertaken by and carried out in a similar manner to that of a taxpayer in business as a property developer.

You have a purpose of profit as well as a prospect of profit from undertaking the Project. You have estimated you will make a net profit of $X.X million (total proceeds less cost of development), which is considerably more what you would receive if you sold the property unsubdivided.

The Development Company will borrow a significant amount (approximately $X.X million) of money to undertake the Project activities, using the Property, which you own, as security. What you propose doing involves substantially more than merely realising your asset to the best advantage. You will be significantly improving the Property, increasing its value from an estimated $X.X million (based on your own valuation) to between $X.X and $X.X million (according to the figures you have provided).

The Property was not put on the market as a whole and you have made a considered decision to subdivide the whole Property and sell the proposed subdivided blocks. You advised that you received and rejected an offer of $X million, then $X.X million to sell the Property as a whole.

There is an intention to subdivide the Property into XX subdivided blocks in numerous stages with access roads to adjoining subdivisions. The Project involves applying for the relevant approvals from council, obtaining the relevant surveys, and completing the conditions as outlined in the council’s development approval such as construction of roads, pathways, and connection of utilities, etc. While the Project will be smaller when compared to other developments, size is not the determinative factor, and all of the factors need to be taken into consideration when determining the nature of the Project. The activities being undertaken will be significantly more complex than what would have been involved if the Property was disposed of as a whole.

There will be a change in the nature of the Property with the proposed subdivision transforming the whole property from a larger semi-rural block of around X acres into XX small residential blocks of XXX square metres each. Additionally, you will not keep any of the subdivided blocks or the dwelling in which you currently reside, so the Property will no longer be your main residence.

Your choice to subdivide the whole property, engage a company to undertake the subdivision, and engage the services of a real estate agent to sell the subdivided blocks demonstrates that there is an intention to profit from the subdivision of the Property and that it will be undertaken in a commercial manner with a level of repetition occurring.

The decision to pursue the subdivision shows your choice to engage in exposure to the risks of the development, including the profits, losses and its general success for the purpose of maximising the potential profit made on the sale of the subdivided blocks. The Development Company will secure a loan to carry out the work and the Property, which you continue to own, will be used as security for the loan. You will retain all the rewards and carry most of the risks from the sale. The assumption of the risks and the receipt of the subsequent rewards (or losses) is a strong indicator of profitmaking activity.

Addressing the specific points you have made in your ruling request:

● You state that neither you nor Person C has been a property developer before. We acknowledge and accept this; however, you are approaching the Project in a business like way and undertaking commercial transactions.

● You did not acquire the Property with property development in mind and occupied it as your main residence. We acknowledge and accept this; however, you have changed your purpose by deciding to subdivide the Property.

● Additionally, you did not have any active involvement in the rezoning of the Property. Again we acknowledge and accept this, however, you are now venturing into a commercial business like scheme which is made possible by the rezoning of the Property.

● You have argued that this arrangement would be more properly characterised as a family dealing between you and Person C. Whilst the agreement between you and Person C is that they will incorporate a company to undertake the Project, you will be benefiting from the arrangement. The subdivision works will be carried out by licenced professionals and the subdivided blocks will be sold through a registered real estate agent. These actions are more than just a “family arrangement”.

● You state that you are seeking to maximise the amount received from the sale of the Property to fund your retirement as you will lose the benefit of the aged pension when you sell your main residence. Rejecting an offer from a developer to purchase your property and instead deciding to sub divide the land yourselves (via the Development Company), indicates that you have ventured into a development business or profit-making undertaking. You have a purpose of profit as well as a prospect of profit from undertaking the Project.

● You state that you are merely realising your asset to your best advantage. In subdividing your Property into XX blocks, there will be significant costs with the requirement to outsource work to specialised contractors. You are doing more than merely realising your asset and are going well beyond a mere realisation. You are significantly improving the Property, and it will take approximately X years to complete. The duration and complexity of the sub-division and sale of the blocks indicates that you have ventured into a development business or profit-making undertaking.

There are numerous cases that consider the issue where the potential outcome is between ‘carrying on a business’, ‘profit making undertaking’ or ‘realisation of an asset’. You have cited five cases in your ruling application to support your contention that the profits from the sale of the proposed subdivided blocks will be on capital account. These are discussed below.

Whitfords Beach Pty Ltd v Federal Commissioner of Taxation (1983) 14 ATR 247

● While the Project will be smaller in size than in Whitfords, the Project will be of a sufficient scale to be characterised as a commercial or profit-making undertaking; and

● Your intended usage of the Property will change and it will no longer be your main residence but will be subdivided for the purpose of selling the subdivided blocks to maximise the profit on the sale of the Property.

Statham & Anor v FC of T 89 ATC 4070

● The taxpayer in Statham attempted to sell their property as a whole without any success, while you have not attempted to sell the whole property; and

● Written offers were received for the whole property which you chose not to accept, making the choice to subdivide the whole property and sell the subdivided blocks to maximise the profit made on the sale of the Property.

Casimaty v FC of T 97 ATC 5135

● In Casimaty the taxpayer did as little as possible to ensure the sale of the subdivided blocks and portions of the broad acre farm were subdivided into semi-rural blocks with only basic fencing around the borders of the blocks. In your case the activities involved with the subdivision will substantially increase the Property’s value, will be more involved and will include things such as constructing road/s, gutters, footpaths, etc.; and

● There was no coherent plan conceived for the subdivision of the whole property in Casimaty and the taxpayer had acquired and had continued to hold and use the residence and conduct the business of a primary producer on the property. Therefore, there was no change of purpose of object for which the property had been held. In your case there will be a change in purpose in relation to the Property as it will be held for the purpose of subdividing it to make a profit on the sale of the subdivided blocks, rather than being used as a main residence.

McCorkell v FC of T 98 ATC 2199

● In McCorkell the taxpayer tried to sell his land but was unable to attract a satisfactory offer. In your case you have not tried to sell the Property as a whole and have in fact refused the offers that were received for the whole Property as you considered them to be too low; and

● In McCorkell the taxpayer may have been forced to sell his land anyway if complaints about spraying had limited his ability to carry on business as an orchardist. This was not the case in your situation and you have chosen to subdivide the Property to maximise the profits from the sale of the subdivided blocks.

Stevenson v FC of T (1991) 22 ATR 56

● The sale of farm land in Stevenson was held to be on revenue account because the taxpayer planned and managed all of the subdivision activities. He had engaged the services of a real estate agent and had also been directly involved with the sale of the subdivided blocks. Although you personally are not undertaking the activities of subdivision, you have agreed for Person C to carry out the necessary activities to subdivide and sell the proposed sub-divided blocks. This demonstrates you have entered into a business or a profit making undertaking.

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