Edited version of your written advice

Authorisation Number: 1051329169430

Date of advice: 24 January 2018

Ruling

Subject: Property Subdivision and sale of the subdivided blocks

Question 1

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

Answer

No

Question 2

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

Answer

Yes

Question 3

Will you be able to fully disregard any capital gain made on the disposal of your ownership interest in the subdivided blocks of land?

Answer

Yes

This ruling applies for the following periods:

1 July 2017 to 30 June 2018

1 July 2018 to 30 June 2019

1 July 2019 to 30 June 2020

The scheme commences on:

1 July 2017

Relevant facts and circumstances

The taxpayers own an area of land with a house (the Property).

The Property was purchased by Person A prior to 20 September 1985 to be used as their home and to allow space to keep a horse.

An ownership interest in the Property was transferred to Person B a number of years later with Persons A and B (collectively referred to as the taxpayers) continuing to use the Property for private use.

Since the time of purchase the Property has been inside the town boundaries. It has not been rezoned, but the minimum land size has been reduced over time.

A real estate agent has recently valued the Property, including the house, at $X.X million. The area to be developed and sold has a current value of $X.X million, with the retained house and land being valued at $XXX,XXX.

The next door land has been subdivided in recent years. Surrounding land is still in use for agricultural production.

A number of developers have approached the taxpayers in recent years offering to buy the Property, but the taxpayers did not wish to sell their home and land.

The taxpayers have decided that the current size of the Property is too large for them to manage at their age, but they wish to stay in the house with the existing sheds.

The taxpayers are proposing to subdivide the Property into a number of new blocks that will be sold, and a residual block containing the existing house and sheds that the taxpayers will continue to use.

The proposed blocks are considerably larger than the minimum allowed size and the taxpayers have had input on how the proposed blocks will be positioned in relation to the Property.

The taxpayers have drawn up a draft subdivision plan. The subdivision will be carried out in two stages. In Stage One the taxpayers propose to initially develop the blocks that adjoin the existing road, next to their house. They will fund Stage One with their own savings.

Following the successful sale of the Stage One blocks, the proceeds will be used to fund the remaining blocks that form Stage Two. Stage Two will require a road and cul-de-sac to be constructed (the subdivision will collectively be referred to as the Project).

The taxpayers will use professional surveyors and civil engineers to carry out the work.

The subdivided blocks will be sold using a real estate agent. The taxpayers will have no involvement with the sales.

The taxpayers have not prepared detailed financial projections for the Project. They have obtained quotes for works to be done.

Stage One is estimated to cost $XXX,XXX and proceeds of the sales are estimated at $XXX,XXX. Stage Two is estimated to cost $XXX,XXX and proceeds are estimated at $X,XXX,XXX.

The taxpayers have not previously engaged in a property subdivision and have no plans to do so in the future.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 15-15

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Summary

The proceeds from the sale of the subdivided blocks of land will not be ordinary income and not assessable under section 6-5 of the ITAA 1997. The proceeds represent a mere realisation of capital assets which will fall for consideration under the capital gains tax provisions in Part 3-1 and 3-3 of the ITAA 1997.

The taxpayers acquired the property before 20 September 1985, therefore the subdivided blocks of land will also be viewed as having been acquired before 20 September 1985, being pre-capital gains tax. As the subdivided blocks of land are pre-capital gains tax assets, any capital gain made on their disposal can be disregarded.

Detailed reasoning

Income or capital

As a general principle, profits from property sales will either be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) or statutory income under the Capital Gains Tax (CGT) provisions of the ITAA 1997.

Where the profit has been made as a result of a taxpayer carrying on a business of property development or as a result of a taxpayer entering into an isolated business transaction, the profit will be assessable as ordinary income. However, where the profit is a mere realisation of a capital asset, the profit will be assessable under the CGT provisions of the ITAA 1997.

There have been several cases in which the courts have addressed the question of whether the proceeds received for the sale of an asset are revenue or capital in nature. The decision in each case depended on its own facts, and very often will be a matter of degree.

The extent of the personal involvement of the taxpayer in much of the planning, organisation and management of the activities has been held to be significant factors in the determination of whether or not a business was being carried out. For example:

● In Stevenson v FC of T (1991) 91 ATC 4476; (1991) 22 ATR 56; (1991) 29 FCR 282 (Stevenson) the degree of the taxpayer’s involvement was seen as an indicator of a business being conducted; and

● The lack of personal taxpayer involvement was seen as a relevant to the finding that a business was not being conducted in the cases of Stratham V FCT 89 ATC 4070, McCorkell v FCT 98 ATC 2199 (McCorkell) and Casimaty v FCT 97 ATC 5 (Casimaty).

From the cases involving the subdivision of land and from Taxation Ruling TR 92/3 (TR 92/3), it would appear that the following are the most important factors to consider when determining whether profits made as a result of an isolated business transaction are assessable income:

(a) the intention or purpose of the 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 or in carrying out a business operation or commercial transaction.

In determining whether an isolated transaction amounts to a business operation or commercial transaction the following factors are relevant:

a) the nature of the entity undertaking the operation or transaction;

b) the nature and scale of other activities undertaken by the taxpayer;

c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

d) the nature, scale and complexity of the operation or transaction;

e) the manner in which the operation or transaction was entered into or carried out;

f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

g) if the transaction involves the acquisition and disposal of property, the nature of that property; and

h) the timing of the transaction or the various steps in the transaction.

The courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment.

Application to your situation

The taxpayers acquired their respective ownership interests in the Property before 20 September 1985. The taxpayers lived on the Property and use it for domestic purposes. Age has reduced the taxpayers’ ability to make use of and maintain the Property. When the subdivision is completed the taxpayers will continue to use the house and remaining land as their main residence.

By carrying out the subdivision by themselves rather than selling the Property, the taxpayers have retained control over the size and shape of the blocks.

It is unlikely that at the time of buying the Property the possibility of subdividing and selling at a profit in the future was a significant motive in the taxpayers purchase. It is likely that at some point since that date, as surrounding land was subdivided and sold, the taxpayers would have become aware of this possibility and formed some future intent to sell the land for a significant gain.

The taxpayers are financing the initial stage with their savings, and then paying for the remainder of the project with the proceeds of the initial sales rather than borrowing to finance it. This is allowing them to carry out the Project with a lower level of financial planning than might otherwise be required, and at their own pace.

The taxpayers are proposing to spend a little over half the value of the land that will be developed in relation to the Project. They will be undertaking the minimum work required by the local council to permit the subdivision. Due to the zoning, the larger size of the blocks and the way the subdivision is being undertaken the taxpayers will be able to avoid some of the costs that would normally be involved with a project of this scale. While there is a degree of transformation of the land taking place, it would appear that more than half of the value of the blocks being sold is still the underlying land.

The taxpayers will engage professionals to undertake the subdivision activities and not undertake any of the activities themselves. No other subdivision activities have been undertaken by the taxpayers in the past and they do not intend to undertake any similar activities in the future

Based on the information provided, there is nothing to suggest that the subdivision of the Property was the beginning of a continuing business of property subdivision. The taxpayers’ activities do not display the indicators of a business, being transactions entered into on a continuous and repetitive basis. Therefore, it is the Commissioner’s view that their activities in relation to the subdivision are not those of an entity carrying on a business of buying, subdividing and selling subdivided land.

Making an assessment based on the factors set out in TR 93/2, it is the Commissioner’s view that the subdivision of the Property and sale of the subdivided blocks of land will not be considered commercial in nature. On balance, the taxpayers are not engaged in a profit making undertaking, instead disposing of surplus land in an enterprising fashion, while retaining their house and surrounds for their own use.

Therefore, as they are not carrying on a business, and the subdivision activities are not will an isolated profit-making transaction, the subdivision and sale will be a mere realisation of the taxpayers property. Any profit arising from the sale of the subdivided blocks will be accounted for under the capital gains tax provisions in Part 3-1 and Part 3-3 of the ITAA 1997.

Capital gains tax

The capital gains tax (CGT) provisions are contained in Part 3-1 and Part 3-3. 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. However, any capital gain or capital loss made on the disposal of a CGT asset will be disregarded if the asset was acquired before 20 September 1985.

When a CGT asset (the original asset) is split into two 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, according to subsection 112-25(2). Where the original land was acquired before 20 September 1985, each new block retains its pre-CGT status.

Application to your situation

The taxpayers acquired their ownership interests in Property before 20 September 1985. Therefore, the Property is a pre-CGT asset.

When the Property is subdivided, the subdivided blocks of land will retain the pre-CGT status of the Property.

While CGT event A1 will occur when the sale contract on each subdivided block of land is entered into, as each subdivided block of land is a pre-CGT asset, any capital gain made on the disposal of the subdivided blocks of land will be disregarded

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