Edited version of your written advice

Authorisation Number: 1051310932305

Date of advice: 30 November 2017

Ruling

Subject: Subdivision and sale of land

Question 1

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

Answer

Yes.

Question 2

Will the proceeds from the sale of individual subdivided lots be subject to the capital gains tax provisions in Part 3-1 of the ITAA 1997?

Answer

No.

This ruling applies for the following period:

1 July 2016 – 30 June 2020

The scheme commenced on

1 July 2016

Relevant facts and circumstances

Background

You, (“the Landowners”), acquired an interest in a property, (“the Land”), prior to the introduction of capital gains tax.

You are not individually registered for GST however one of the Landowners has an ABN.

You have also:

● Purchased land and developed two residential units through your self-managed superannuation fund approximately 20 years ago;

● Been directors of a company. You have retired from that position and transferred the shares in that company to your son. That company subsequently began acting as trustee of a trust which conducts a business;

● Operated as a partnership returning rental income from two shops you own and lease; and

● In a recent year you applied and received an ABN for the partnership. You have added a GST registration to the partnership ABN and recorded the partnership as a ‘Residential Property Operator’.

Details of the Land are set out below:

● You purchased a 50% freehold interest in a property prior to capital gains tax (“The Land”);

● The Land was acquired under a single title and the remaining 50% was owned by a family friend;

● You purchased the balance of the freehold interest in the Land from the family friend post the introduction of capital gains tax.

● The size of the property is nearly 100 acres and was acquired as vacant land;

● You initially acquired the Land jointly with the family friend as a hobby farm for personal use. No sale of any produce occurred;

● The Land has never been rented or used for primary production;

● You advised that you had no exit strategy when the Land was acquired in each separate purchase;

● There is no mortgage over the land;

● The Land was originally zoned as Green Wedge Zone and rezoned to Urban Growth Zone by the Department of Planning and Community Development and published in the Victorian Government Gazette. You were not required to consent to the rezoning;

● The Land was not near the Urban Growth Boundary when the 50% freehold interest was purchased pre capital gains tax or when the balance of the Land was purchased post capital gains tax. You had no plans to rezone the Land when you made either purchase;

● In 2004 you built a residence on the Land and it became your principal place of residence;

● Following the earlier negotiations for the Development Management Agreement (“DMA”) in a recent year, you received an anonymous offer through a local real estate agent for the Land but you did not accept it due the fact that it was highly qualified, subject to further due diligence and lacked detail. You are aware that other landowners in the area had received similar offers but they fell through;

● Due to your age and the fact that you are the primary carer for your son, you have decided to sell the Land and move to another property. The new property is next door to another son. You intend to live there so that you will be able to share the care of your son;

● Your current residence located on the Land is to be demolished when your new residence is completed. Construction of your new residence has not yet commenced. All of the Land will be redeveloped; and

● You have never made any previous attempts to sell the Land.

Ten years ago you were introduced to a property developer at a social event. The name of the property developer’s company is A Pty Limited (“A”).

The property developer approached your son, B, at a social event and proposed the subdivision and development of your land into a residential precinct and the sale of the developed lots.

In a recent year, you and A entered into a Development Management Agreement (DMA) and a Property Finance Agreement (PFA). When we refer to A we will be referring to the company in its role as either the Development Manager under the DMA or the Financier under the PFA depending on the context.

You engaged Lawyers, C, who undertook a review of the proposed DMA. They advised that your legal and beneficial ownership was not at risk and your financial position was safeguarded.

You appointed B as your Representative (“Representative”) in the negotiations. Representative is defined in the PFA definitions as the Landowner’s Representative.

The following summarised facts have been taken from your correspondence, the DMA, draft Project and Marketing Plan, draft Project Feasibility Plan, draft Sales Contract and the PFA:

● The proposal is to develop in excess of 600 residential lots over many stages;

● The average lot size is over 300 square metres;

● The development will include roads, footpaths, utilities and parklands. No buildings will be constructed. A mobile land sale sales office will be transported and installed on site and removed when no longer required. There will also be ancillary on-site parking and advertising signage;

● There will be no commercial lots in this development;

● The Development Manager, being the Financier, is self-funded primarily via private equity;

● The draft Project and Marketing Plan produced recently advised that gross sales revenue would be over $100 million and total costs would be nearly $70 million.;

● The development has been given the branding name “D”;

● The lots will be sold off the plan and 100% of the lots in stage one will be sold off the plan prior to the commencement of the development. You have provided a copy of a standard D Stage 1 Sale Contract;

● A deposit of up to 10% of the purchase price is to be provided;

● Contracts are expected to be negotiated for the sale of lots in Stage 1 from

● September 2017;

● The draft sale contract for the sales to third party purchasers of the lots provides that any sales under this contract that are taxable supplies are GST inclusive and the parties agree that the supply is under the margin scheme. Such clauses are included as a precautionary measure in the event that GST applies to any sale, and is not an acknowledgment by the applicants that GST applies to the sale of any particular lot;

● Landscaping of the front yard was offered as part of the Contract of Sale of Stage 1 lots. A choice between three separate gardens is offered;

● The Development Manager will manage marketing and sales of the development and will appoint a licensed real estate agent;

● All correspondence between you and the Development Manager occurs through your Representative. Your Representative and the Development Manager are required to meet monthly or as otherwise agreed. In fact, meetings have been held sporadically. Minutes provided reflect all meetings that have been held;

● You will remain the registered proprietor of the Land during the development;

● The Development Manager has no beneficial interest in the land; and

● There will be no land swaps under this development. However, the parklands and reserve will be subject to the Victorian State Government Infrastructure Contribution Scheme (“ICPS”).

A summary of the various meetings between government entities, the Landowners, B and A (represented by E as per the PFA) are set out below:

● On 7 February 2017 the Development Manager presented a draft concept master plan to the Council (“the Council”). The Council responded on 22 February 2017 and a copy of the email was supplied with your application;

● An email dated 22 February 2017 setting out advice from the Council in regards to their preliminary review of the site plan submitted by A;

● A memorandum between your Representative and A seeking approval from the Landowner’s in regards to preliminary budget planning dated 14 March 2017;

● The PFA required meetings between your Representative and A which were called ‘Project Update Meeting - Minutes’ and had the following agenda items:

○ Urban Design issues;

○ Planning;

○ Engineering;

○ Surveying;

○ Environmental;

○ Financials;

○ Landscaping;

○ Sales and marketing of the project; and

○ Potential acquisitions by other developers of neighbouring properties.

● You supplied copies of the minutes for March, June and July 2017;

● March 2017 minutes:

○ B approved the preliminary budget;

○ A requested B to discuss with the Landowners the installation of a sales office and specifically access, service and security with the existing home; and

○ It was noted that neighbouring property acquisitions are ongoing.

● June 2017 minutes:

● The Landowners were presented with the final concept plan and B was advised:

n that due to funding of Stage 1 the number of lots withheld may need to be reviewed and additional discussions will occur once financials are finalised;

n Precinct Structure Plan (PSP) is expected to be approved in July 2017,

n signage permits have been approved;

n the subdivision permit will be submitted in July/September 2017; and

n other details in regards to Engineering, Surveying and Environmental.

● B was also asked to review and provide any comment or suggestions on the proposed design guidelines;

● A and B discussed the sales office with the outcome that B’s business would do preparatory work in regards to power, water and landscaping for the sales office etc;

● It was agreed that the Certificate of Title to the land is to be held in a solicitors trust;

● The Landowners had agreed to sign a Power of Attorney to allow the contracts/transfers of land to be signed by E;

● Draft pricing for Stage 1 needs to be approved by the Landowners prior to the launch;

● B was asked to follow up on the GST ruling and inform A;

● A agreed to provide the Landowners with ‘sensitivity analysis to include escalation’; and

● B requested A to send the DMA and PFA.

● July 2017 meeting:

● B was updated on the progress in regards to the Planning, Engineering, Surveying, Environmental and Sales and Marketing;

● B approved the proposed release strategy of retaining seven lots and delaying the release of the lots abutting the neighbour’s property; and

● A advised that a soft launch of the project will commence on 14 July 2017 and a full sales launch around mid-August.

● Letter dated 7 April 2017 from the Victorian Planning Authority to Landowners regarding Infrastructure Contributions Plan Estimates of Land Value;

● On the 18th May a permit to erect and display five promotional signs and four pole signs; and

● The Development Manager addressed the Council’s concerns and presented a final Masterplan to Council on 30 May 2017 and received in principle support for the Masterplan from the Council.

Project Finance Agreement (PFA)

The PFA outlined the following matters:

● The Landowner is the registered proprietor of the Land;

● The Landowner requested the Financier to fund all Project Costs and separately, the Landowner has agreed to enter into the Development Management Agreement (DMA) with the Financier.

● A Finance Fee will be paid to the Financier of an agreed sum;

● The Finance Fee is paid in addition to any reimbursement of Project Costs relating to Stage 1;

● A Project Control Group must be established with representatives of both A and B;

● All decisions, declarations, determinations, approvals and agreements of the Project Control Group must be unanimous;

● Minutes of these meetings must be kept;

● The Proceeds must be distributed in the following order of priority:

(a) any GST to be remitted to the Australian Taxation Office as a result of the sale of the Property;

(b) Selling Costs associated with the sale of Lots;

(c) Project Costs to the Financier as specified in the Development Management Agreement;

(d) Finance Fee; and

(e) any balance of the Proceeds to the Landowners;

● The Landowner charges his interest in the Property in favour of the Financier to secure the payment of the Project Costs associated with Stage 1 to the Financier and the Financier is entitled to lodge a caveat over the title to the Property to secure its interest as chargee.

Development Management Agreement (DMA)

The DMA outlined the following matters:

● The Landowner intends to undertake the Project;

● The Landowner has engaged the Development Manager to provide Services in relation to the Project;

● The Project is defined as the development of the land into a residential, commercial and/or mixed-use precinct and the sale of Land (or part of the Land and/or developed Lots) to comply generally with the Project Plan and Project Feasibility;

● A Development Management Fee is paid to the Development Management for agreeing to provide the Services under the DMA. The Services are defined as:

(a) maintain supervision control and coordination of the Project;

(b) complete the Services in a thorough, lawful, professional and workmanlike manner;

(c) carry out the Services diligently with a view to achieving Practical Completion of the Project to the standard required by this document in a thorough and professional manner with all reasonable expedition in accordance with the provisions of this document and all relevant Legislative Requirements;

(d) use its reasonable endeavours to ensure the timely, effective and efficient coordination and integration of all Services to enable the Project to be completed;

(e) at all times must act in a commercially prudent and reasonable manner in accordance with suitable and usual methods and practice for the types of service being undertaken by it and within the standards of care and diligence normally exercised by a Development Manager or persons qualified to act in the performance of comparable matters on similar projects; and

(f) at all times ensure that it has the necessary resources, skills, employees or consultants (of an appropriate standard and with appropriate experience to undertake the Development Works in respect to the Project) to ensure that the Development Manager complies with its obligations under this document;

● A Project Plan and Project Feasibility must be provided to the Landowner within 30 days of the Precinct Structure Plan being endorsed;

● The Development Manager must obtain the Landowner’s consent for excessive costs, appointment of consultants, contractors and subcontractors;

● The Development Manager will be entitled to reimbursement from the Landowner for any Project Costs and Claims paid by the Development Manager with 10 Business Days of receiving copies of invoices from the Development Manager;

● The Development Manager will need to take out professional indemnity insurance and the Landowner Public Liability Insurance to cover the Land, the Project and all employees and contractors undertaking the Project;

● Schedule 1 of the DMA further outlines the Services to be provided by the Development Manager under the DMA; It includes that the Development Manager will, amongst other things, lodge development applications on the Landowner’s behalf and arrange and administer the payment of all Project Costs on behalf of the Landowner.

The following documents are relied on in this ruling and their contents, including appendices, form part of these facts:

1. Applications for Private Binding Ruling;

2. Development Management Agreement (DMA);

3. Property Finance Agreement (PFA);

4. A draft Sale Contract for Stage 1;

5. The draft C Feasibility (20 Pages);

6. The draft C Project Plan;

7. Various minutes detailing meetings between the Landowner’s and A;

8. Various emails and letters correspondence between A, the Council, various state government bodies and the Landowner’s;

9. Various certificates and documents including:

a. The caveat placed on the Land by A and

b. Growth Areas Infrastructure Contribution Certificate.

10. Details of the staged development, commencement and completion dates. Including a timeline of activities completed or in progress for the development.

Relevant legislative provisions

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 108-5

Income Tax Assessment Act 1997 subsection 104-220(1)

Income Tax Assessment Act 1997 section 104-220(4)

Income Tax Assessment Act 1997 section 118-20

Reasons for decision

Question 1

Summary

The proceeds from the sale of the individual subdivided lots will be assessable under section 6-5 of the ITAA 1997.

Detailed reasoning

The proceeds from the sale of subdivided lots can be treated as:

● assessable ordinary income under section 6-5 of the ITAA 1997 from carrying on a business of profitable resale or property development, subdivision and sale; or from an isolated business or commercial transaction; 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 taxpayer’s business. However, in certain circumstances proceeds not within the ordinary course of the taxpayers business may form part of their ordinary income.

In contrast, the mere realisation of capital assets, such as land, does not give rise to income according to ordinary concepts if the realisation is merely carried out in the most advantageous manner (Californian Cooper Syndicate v Harris (1904) 5 TC 159). The Commissioner accepts that where the activities are no more than the mere realisation of a capital asset, any realised gain on the transaction will be a capital gain under the CGT provisions in the ITAA 1997.

The expression ‘mere realisation’ is used to distinguish a mere realisation from a business operation or a commercial transaction carrying out a profit-making scheme. Profits made on the realisation of capital assets can still be ordinary income if the activities go beyond a mere realisation and instead become a separate business operation or commercial transaction even though the taxpayer did not have a purpose of profit-making at the time of acquiring the asset.

Taxation Ruling TR 97/11 Income Tax: am I carrying on a business of primary production?

(TR 97/11) provides guidance on the relevant factors to determine whether a business exists including where the activity is carried on in a similar way to that of the ordinary trade, size and scale of activity and whether the activity is organised and carried on in a business-like manner.

Even where the sale of subdivided land is not regarded as part of carrying on a business, an isolated transaction for the purpose of profit making by sale may have occurred. Taxation Ruling TR 92/3 Income Tax: whether profits on isolated transactions are income (TR 92/3) provides guidance to determine whether profits from isolated transactions are ordinary income.

While holding an asset for a considerable period of time may seem to indicate that it is a long term capital asset, the intention of the taxpayer at the time of acquisition and throughout the ownership period is a crucial aspect.

Federal Commissioner of Taxation v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693) (Myer Emporium) is one of the leading cases which shows that the intention at the time of purchasing the asset is an important consideration in determining whether the proceeds received on disposal are on a capital or revenue account. According to the Myer Emporium case, the relevant intention or purpose of the taxpayer is not a subjective test. Rather, it is the intention or purpose as discerned from an objective consideration of the facts and circumstances of the case. Also, if the taxpayer is a company or trust, the courts determine its purposes by looking at the people who control the entity.

Further, 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 is ordinary income is greatly diminished.

As previously stated, 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 that the Applicant was carrying on a business of subdividing, developing and selling land. The tribunal made this finding because the taxpayer 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, the subdivision and development was substantial (the land had been divided into over 180 small blocks).

Similarly, the High Court’s decision in Federal Commissioner of Taxation v Whitfords Beach Pty Ltd 82 ATC 4031; (1982) 150 CLR 355 (Whitford’s Beach), 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.

It follows from the decision in Whitford’s Beach that a taxpayer, who had originally acquired property for farming operations purposes, could subsequently embark on a profit making scheme. This means that a taxpayer could embark on a profit making scheme after property was acquired for a different purpose.

The basic distinction between a development and sale of land as part of a business, or alternatively, a ‘profit making undertaking or scheme’ is that the latter will generally be a one-off event and not carried out in an overly organised or systematic manner. However, the overriding purpose and intention of the person entering into the venture must be to make a profit.

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’ (Taxation Determination TD 92/124 and ATO Interpretative Decision ATO ID 2004/532).

In Whitfords Beach Pty Ltd v Federal Commissioner of Taxation (1983) 83 ATC 4277 the Full Federal Court determined the relevant time when the taxpayer's land was ventured in the taxpayer's business. The taxpayer’s intention at 20 December 1967 was to develop, subdivide and sell the whole of the land. It was envisaged from the outset that there would be a comprehensive plan relating to the entire land but that development and subdivision would occur in stages. At 20 December 1967, the land remained incapable of subdivision but the joint managers proceeded with their intention, including appointing a project manager to undertake relevant activities. In 1969 a new government direction led to the encouragement of development and housing in the area which included the taxpayer’s land. Planning and subdivision approvals were negotiated and in October 1969 rezoning of the taxpayers land occurred. The first subdivision application was approved in April 1970 and in December 1970 the first survey plan for 272 lots was lodged at the titles office. Once the first stage was in the course of development and subdivision, further areas were developed and subdivided, and numbers of different stages proceeded at the same time. The first sales of lots were made in 1971.

The taxpayer’s proposition in this Full Federal Court case was that at least the initial activities from 20 December 1967, up to June 1969, was merely preparatory to, and did not form part of, its business of development, subdivision and sale of the land. The Full Federal Court held however, that the relevant date as to when the land is ‘committed to’ or ‘ventured into’ a land development business is when the intention to take steps to develop and subdivide the land is formed, and activities directed to that end began; and this will typically begin when the taxpayer commits to the project by engaging the relevant parties to undertake the planning work. The Full Federal Court stated at 4283:

Although what was done between December 1967 and June 1969 was, in a sense, preliminary to subdivision and development in the narrower sense of the steps which were directly involved in such operations, the activities in that period were an integral part of the business, and were seen as necessary at the time, even if some of what was done was subsequently rendered unnecessary because of changed circumstances. At least some of the activities during that period related to roads and services, etc., which were of relevance to the development of the whole land, irrespective of the order in which the various parts were later brought forward for development, and some of the activities were material to the determination of the appropriate or most desirable order of development of the land. Changes of plan, whether because of the Western Australian government's intervention in 1969 or for any other reason, and any consequential lack of ultimate utility of any of the steps which had previously been taken, do not in any way indicate that those steps were not taken in the course of the taxpayer's business in accordance with the taxpayer's proposals or hopes at the particular time.

From June 1969 on, the position is even clearer. Whilst at any given time more attention may have been focused on one section of the land than other sections, it was the entire project which progressed stage by stage with operations in respect of some of the stages overlapping. The evidence is overwhelming that, although the project was to extend over a number of years and was to involve development in stages, there was from 20 December 1967 both a persistent intention to develop, subdivide and sell all of the deferred urban and rural land and a continuous course of conduct directed to the implementation of that intention. The conclusion seems inescapable that the taxpayer's business of developing, subdividing and selling the land commenced as soon as the intention to take steps for that purpose in relation to the entire land was formed and activities directed to that end were commenced on 20 December 1967.

APPLYING THE LAW TO THE FACTS IN YOUR CASE.

Whether a business is being carried on is a question of fact determined on a case by case basis with regard to a range of indicia including the intention of the landowner when they purchased the land and their subsequent use of the land.

You acquired the Land for personal use as a hobby farm partly prior to capital gains tax and then the second parcel post the introduction of capital gains tax. You later in 2004 built a residence on part of the Land and resided there.

It is accepted that you originally acquired your Land, in two parcels on capital account for hobby farm purposes and later for use as your residence. It is also accepted that you have used the land for these purposes since acquisition. However, this does not mean that at some later stage you did not change your intention and venture into a business of profitable resale or property subdivision.

We consider that you entered into the carrying on of a business of profitable resale or property development, subdivision and sale at the time where you embarked on a definitive and continuous cycle of activities designed to lead to the sale of the Land. The following factors established by case law and the above two taxation rulings, considered as a whole, support this conclusion.

● The level of active involvement of the Landowners in the activities.

The form and substance of the agreements support the conclusion that you are involved in the subdivision and property development business directly or through their Representative.

In accordance with the PFA, the Financier and Landowner must establish a Project Control Group. The Project Control Group is involved in making decisions, declarations, approvals and agreements in respect of the Project.

Members of the Project Control Group must consist of your Representative and E, representing the Financier. Each member may appoint a further representative each, if they wish. You have provided Minutes of three monthly meetings conducted. In accordance with the PFA, all decisions, declarations, determinations, approvals and agreements of the Project Control Group must be unanimous.

The Minutes of Project Update Meetings provided indicate that you and/or your Representative attended various meetings regarding the carrying out and planning for the Project.

● For instance, in March 2017, your Representative approved preliminary budgets.

● In June 2017, the Landowners were presented with the final concept plan and their Representative was requested to review it and provide comment. The Landowners agreed to sign a Power of Attorney to allow the contracts and transfers of land to be signed by the Development Manager’s Representative. Pricing of lots were to be agreed by the Landowners.

● In the July 2017 meeting minutes, your Representative was updated of the progress of the Project from planning through to sales and marketing. Your Representative also approved the release strategy of retaining seven lots.

The DMA details the development and management services to be provided by the Development Manager. It is clear from this clause that the Project Feasibility, Project Plan and Services provided by the Development Manager are all subject to consideration and agreement with the Landowners. The DMA also outlines the limitations on authority in that the Landowner’s consent must be obtained for excessive Development Costs and appointment of consultants, contractors and subcontractors pursuant to the provision of Services by the Development Manager.

The DMA also states that all actions of the Development Manager are made on the Landowner’s behalf. This would include engagement of consultants, contractors, lodgement of applications for planning approvals, council permits and environmental approvals.

Conducting the business through a Development Manager/Financier such as A does not preclude you from also carrying on a business. Appointing A to manage the Project does not alter the fact that you, or through your Representative, are actively involved in all major decisions of the Project. This is evident from the minutes of the Project Control Group and the clauses within the PFA and DMA.

The clauses in the PFA and DMA indicate that decisions in regard to the Project are made by both the Development Manager and your Representative. Also, all major decisions on expenditure, stages, other major decisions of the Project, must be approved by you, the Landowners.

Therefore, we believe you and your Representative did not have a passive role in this Project. You have both made important decisions in this subdivision and development business.

● The level of financial risk borne by the landowners and profit motive.

Generally the greater the level of financial risk assumed by the landowner in respect of the development of their land, the more likely that the landowner is carrying on a business or is engaged in a profit making undertaking.

You have argued that the financial risk is borne by the Development Manager/Financier. However, ultimately the risk is borne by you, the Landowners. Whilst you engaged the Financier/Development Manager to undertake the C Project, and such an engagement may in some cases limit your direct involvement in the Project, in your case the Financier/Development Manager will incur little risk because the ultimate costs of the Project and subdivision will be your burden, as the Landowners.

The Landowner and the Financier have entered into the PFA in order to allow the Financier to make funds available to the Landowner for the purpose of undertaking the Project. Therefore, the Financier has agreed to provide the finance to fund the Project Costs associated with Stage 1 in return for a payment of a Finance Fee and a reimbursement of the Project Costs.

The Finance Fee is an agreed amount as per the PFA and you are “at risk” as a result regardless of the success or failure of the Project, the amount of the Finance Fee is payable by the Landowner.

You ultimately bear the financial risk and the Project Costs are reimbursed to the Financier from the sale proceeds before payment of any Proceeds to the Landowners. The PFA outlines how the proceeds will be distributed.

The Landowner agrees in the PFA to charge his interest in the Property in favour of the Financier to secure payment of the Project Costs associated with Stage 1 and the Financier is entitled to lodge a caveat to secure his interest as chargee. The Certificate of Title of the Land is also held in a solicitor’s trust. This demonstrates that you will be at substantial risk if you don’t repay the money provided by the Financier to finance the Project Costs.

You bear substantial risk as a result of entering into the DMA. The DMA states in regard to Termination of the DMA, that the Landowners must pay to the Development Manager all Development Management Fees and other monies which remain unpaid after termination. Termination may occur by written agreement of the parties, on practical completion or by default of either party.

You are also required to take out public liability insurance covering the Land, the Project, the Development Manager, its employees, agents and consultants, contractors and subcontractors engaged in the Development Works..

Under these clauses, you are exposed to potential losses from the development sales and will only receive any balance of sales proceeds after all costs are recovered by the Financier/Development Manager. You clearly had a view to profit and assumed substantial risk by engaging in the C Project.

● The scope, scale, duration and degree of complexity of the subdivision and development.

When considering the scope, duration and degree of complexity of the subdivision and development the evidence supports that the eventual sales are less likely a mere realisation. This is because the more significant the development, as in this case, the more likely the active involvement of the Landowners, a business-like application of skill, the bearing of risk and a profit-making purpose.

The DMA and PFA were both entered in January 2015. You are considered to have had a profit making intention when you entered into these arrangements. The eventual C Estate Project contemplated under the DMA is the carrying out of capital and other infrastructure works to subdivide, construct, improve or develop the Land for the purpose of a residential subdivisional estate. In accordance with the draft Project Plan prepared by A in August 2017, the proposed development is for over 600 lots over many stages, netting approximate revenue of over $100 million.

Marketing and advertising for the project is also extensive. The branding name of C has a website dedicated to the sales and advertising of Stage 1 lots. The detailed Project Plan for the C Project dated August 2017 is a very detailed Plan dedicating contents to approvals, services, consultants, contractors, market analysis, competitor analysis, product mix and pricing, sales strategy, marketing, risk and opportunities.

This is considered a large development, the duration of which is in excess of 7 years. This is extensive and the scope and scale of the subdivision is complex with multi-stages. This Project goes well beyond what is necessary to prepare the land to be sold in smaller parcels.

The development involves extensive works. This indicates that you are more likely to be involved in a business of land development. Works are far more extensive than merely clearing, making roads, drains and services. Amenities are to be built, parks, gardens and landscaping of both development area and individual lots.

In the Federal Court judgment of Deane J in Whitfords Beach Pty. Ltd. v. Federal Commissioner of Taxation 79 ATC 4648 when distinguishing between revenue and capital, Justice Deane discusses a goldsmith who inherits a gold bar. Selling the gold bar as a whole would be on capital account, while dividing the gold and fundamentally transforming it into jewellery before selling it would be revenue. He goes further by stating at paragraph 4666:

In a case where the asset has been divided and divided parts improved in the course of a business of dividing and improving such assets, it would be rare that one could say that the profits from sale of the individual improved items, after making allowance for the value of the original asset) represented part of the proceeds of mere realisation of the capital asset as distinct from profits made in the ordinary course of that business. Where the activities of dividing and improving are of sufficient scale and scope, the fact that no prior independent business existed will not prevent those activities themselves constituting a business of which the profits arising on sale are the ordinary proceeds.

In your case, the Commissioner considers that the scope, scale and complexity of your Project goes beyond a mere realisation of a capital asset. It is carrying on of a business of property development, subdivision and sale. Amenities are to be built, roads, parks, gardens and landscaping of the development area and individual lots will be an essential part of the Project.

● Relevant knowledge and skill

You and your Representative have some knowledge and experience in the building industry. You have previously undertaken a development of two residential units some twenty years ago. Your Representative has also been involved as a director of a business. He is currently the sole director.

Where you do not have sufficient knowledge and skill, you have engaged the relevant experts via the PFA and DMA to ensure your subdivision is undertaken in a businesslike manner so that can maximise profits on the sale of the lots.

In isolation a landowner and their representatives’ history and experience in land acquisition and development is not determinative of whether the landowner is carrying on a business or engaged in a profit making undertaking in relation to the Land. However, the more extensive a landowner and their representative’s history, together with other indicators of carrying on a business, the more likely future sales of land are considered as more than a mere realisation.

Conclusion

Although you have likely purchased the parcels of Land on capital account, the evidence supports the fact that you changed your intention and ventured the Land into a business of profitable resale or property development, subdivision and sale. The sale of the individual subdivided lots will therefore be sold on revenue account. We consider your profits to be income because: the Landowners had the intention or purpose to enter into a profit-making transaction and make profit or gain; and the transaction or conduct of a business operation has commenced.

It is considered that you commenced business activities, for instance, in January 2015 when you executed the agreements for the subdivision and development of your Land with A. These activities indicate a change of intention in relation to your Land. Whilst you did not submit your draft Concept Masterplan with Council until 7 February 2017, it is evident that the intention to take steps to develop and subdivide the land had been formed and activities directed to that end had begun with the execution of both the PFA and DMA.

Accordingly, on the balance of probabilities, weighing all the facts as a whole, the Commissioner is satisfied that you have commenced the business of property development and sale. Accordingly, the proceeds from the sale of the individual subdivided lots will be assessable under section 6-5 of the ITAA 1997.

Question 2

Summary

The proceeds from the sale of individual subdivided lots will not be subject to the capital gains tax provisions in Part 3-1 of the ITAA 1997.

CGT consequences of the sale of individual subdivided lots

A CGT asset is defined in section 108-5 of the ITAA 1997 and includes any kind of property. Specifically, each subdivided lot of land is a CGT asset.

A capital gain or a capital loss will arise when a CGT event A1 happens to each subdivided lot of land.

However, section 118-20 of the ITAA 1997 provides that a capital gain you make is reduced if the amount is otherwise assessable under another provision of the ITAA 1997.

Therefore, whilst a CGT event may in fact happen, if an amount is otherwise included as ordinary assessable income under section 6-5 of the ITAA 1997 then any capital gain will be disregarded to the extent of that ordinary income included.

Therefore, the receipts from the disposal of each subdivided lots of land will not be subject to the capital gains tax provisions.

Other CGT consequences - the original land

However, you should also consider other CGT consequences that might apply to you under this arrangement.

For instance, it is accepted that the purpose of landholding could alter (e.g. from holding the property for hobby farming and residential use to using it in carrying on a business of property subdivision and sale) and in such circumstances the properties change from being held as capital assets to revenue assets or trading stock.

Relevantly, CGT event K4 under subsection 104-220(1) might happen to you when the Land starts being trading stock. The time of the event is when you start holding it as trading stock (refer to Question 1 above).

Further, subsection 104-220(4) provides that a capital gain or loss you make is disregarded if you acquired the asset before 20 September 1985. Since you acquired part of your land before this date – you would not make a capital gain when CGT event K4 happened to you.

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