Edited version of your written advice

Authorisation Number: 1051351130385

Date of advice: 4 May 2018

Ruling

Subject: Subdivision and sale of land

Question 1

Will amounts received from the sale of the Land be assessable to you as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), or as statutory income under section 15-15 of the ITAA 1997?

Answer

Yes.

Question 2

Will fees received for supply of a call option or extensions of a call option over the Land to the Developer be assessable to you as ordinary income under section 6-5 of the ITAA 1997, or as statutory income under section 15-15 of the ITAA 1997?

Answer

Yes.

Question 3

Will your supply of the Land to the Developer be classified as a GST-Free supply of farm land under section 38-480 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

No.

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX

The scheme commences on:

10 July 20XX

Relevant facts and circumstances

You, (land holding company) carry on a farming enterprise on land you owned prior to the introduction of Capital Gains Tax. You are registered for GST.

This advice concerns approximately 45 hectares of your farm (the Land). The Land has a prospect of being zoned residential.

You have never initiated contact with developers.

You have never carried on a business of buying or selling land or developing property.

Your director is nearing retirement and wants to give effect to a succession plan between his children.

In 20XX, a Developer contacted you with a development proposal for the Land. You have had sporadic discussions and negotiations with the Developer which formalised in late 20XX. You have an agreement for a proposed sale with the Developer.

The main features of the proposed sale of the Land by you to the Developer, as contemplated in the agreement, are summarised as follows:

You will provide the Developer with a call option to acquire the Land (one call option per one stage at a time), in return for an option fee of $xx. The original option period is XY years, with two X-year rights of renewal.

Each Stage will be an area of land to accommodate between 25 and 50 residential allotments upon subdivision. It is anticipated there will be approximately four to six Residential Stages.

It is expected that the Developer will build and sell house and land packages on the blocks.

The option for the first Residential Stage is exercisable when zoning for residential use and development approvals have been obtained. The Developer can only exercise an option to acquire further Residential Stages if, the Developer has sold to ultimate purchasers at least half of the allotments in the previous stage.

The Developer is provided with a right of entry onto the Land and is charged with the responsibility of conducting all work necessary for rezoning and titling the Land.

Upon exercise of an option, a land sale contract will be entered under which you agree to sell that Stage to the Developer free of encumbrances for a purchase price that is calculated according to a formula approximately equal to 29% of the land component paid by final purchasers less taxes, commissions and adjustments to cost estimates.

You will receive the amount for each stage of the Land sale in instalments as the Developer subsequently sells each allotment in the relevant Residential Stage to the final purchaser.

The Developer will grant a mortgage to you over each Residential Stage as security for the vendor finance. You will also have a buy-back option to acquire from the Developer unsold residential allotments in a Residential Stage in certain circumstances.

As well as residential allotments, the development of the Land will comprise:

● A school

● A Waste Water Treatment Plant

● A Shopping Centre

During the option period you will continue your primary production activities on the Land. The Developer (at its cost):

● is allowed, on reasonable notice, access to the Land to carry out surveys and investigations.

● must obtain all relevant zoning and development approvals.

On exercise of an option and settlement of sale of a Residential Stage by you to the Developer, you will have no role in the development. You have provided a Licence to occupy agreement which allows you to continue to farm such land post-settlement until the Developer needs the Land for development purposes.

The Developer is solely responsible for obtaining all development approvals, undertaking all development works and sales of allotments.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 15-15

Income Tax Assessment Act 1997 subsection 995-1(1)

A New Tax System (Goods and Services Tax) Act 1999 Section 38-480.

Reasons for decision

Question 1

Will amounts received from the sale of the Land be assessable to you as ordinary income under section 6-5 of the ITAA 1997, or as statutory income under section 15-15 of the ITAA 1997?

Under section 6-5 of the ITAA 1997, your assessable income includes the ordinary income you derived directly or indirectly from all sources, during the income year.

Additionally, section 15-15 of the ITAA 1997 includes profit arising from the carrying on or carrying out of a profit-making undertaking or plan. However, this provision does not apply to a profit that is assessable as ordinary income under section 6-5 of the ITAA 1997, or which arises in respect of the sale of property acquired on or after 20 September 1985.

Carrying on a business

Subsection 995-1(1) of the ITAA 1997 defines ‘business’ as ‘including any profession, trade, employment, vocation or calling, but not occupation as an employee’.

The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the particular facts.

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? (TR97/11) 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:

● Does the activity have a significant commercial purpose or character?

● Does the taxpayer have more than a mere intention to engage in the activity?

● Is there an intention to make a profit from the activity or a genuine belief that a profit will be made? Will the activity be profitable?

● Is there repetition and regularity in the activity?

● Is the activity of the same kind and carried on in a similar way to that of the ordinary trade?

● Is the activity organised in a businesslike manner?

● What is the size or scale of the activity?

● Is the activity better described as a hobby, recreation or sporting activity?

No one factor is decisive. The indicators must be considered in combination and as a whole. Whether a ‘business’ is carried on depends on the large or general impression.

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.

Are your activities conducted in the form of a business?

(i) Significant commercial purpose or character

This indicator requires you to show that the activity is carried on for commercial reasons and in a commercially viable manner. Evidence of proper research into the activity so as to establish its commercial viability is also important.

You argue that the enterprise will effectively be carried on by the Developer, while you are merely selling 45 hectares of broadacre unimproved land. We do not believe this to be the case because even though the Developer will undertake the building, advertising, selling activities, etc. you will not be paid until the development of each block is complete and sold to the ultimate final purchaser. This arrangement makes it mandatory that there is a clear future vision and steps taken by you to protect your interests at every step in the process, all the way until the final sale of each block. This includes:

● having option contracts in place where exercising each option is restricted until at least half of the previous residential stage is sold;

● ensuring roadworks and stormwater works estimates are accurate (you bear 50% of cost blowouts);

● having a mortgage in place to ensure the Developer does not sit on the land for several years without developing it.

These steps are not required if you are simply selling broadacre land. It is clear that you have to be involved till the final sale of each block occurs because if that never eventuates or there are significant cost blowouts in the development process, you will not be paid much. Therefore, we conclude that this indicator is met.

(ii) Intention

You should be able to show a clear purpose of how the activity will be able to succeed. However, a mere intention to carry on a business is not enough. Your actions must substantiate a sufficient level of commitment to the activity to demonstrate that you are carrying on a business (or commencing the business).

From the documents provided, it is clear that you intend that this project succeeds. You have structured the arrangement so that the Developer can develop each residential stage successfully and once over half of it is sold, move to the next stage and so on. You have estimated possible costs for works, and took steps like a mortgage on the property to protect your interests. You negotiated a terms sheet and a licence to occupy agreement to have access to the land for the possibly long timeframe before the land is developed. If you did not have a clear intention for this project to succeed, you would not need to go through so much effort and planning. Therefore, we must conclude that this indicator is met.

(iii) Prospect of profit

You should be able to demonstrate how a profit is likely to be made, and that the expectation of profit is reasonable. It is fairly clear that there is a prospect of profit in a project of this magnitude. This indicator is met.

(iv) Repetition and regularity

A common feature of business is that activities are repeated on a regular basis. You should be able to show that you have at least undertaken the minimum level of action required to maintain the activity at a commercial level. You explained that you will not be involved in the ongoing development of the blocks and advertising and selling of the properties. You are merely selling the broadacre land. We believe you will have an ongoing role throughout the project, especially in unforeseen circumstances such as costs blowouts. You have a vested interest in the final sale to the ultimate purchasers (when you receive payment for each block). There are also several residential stages and each stage will accommodate between 25 and 50 residential allotments upon subdivision. So there is renewed involvement from you with every option that is being exercised at every residential stage and any issues that arise. So although you will not play an active role in this development, we do see that you will play a role up to the final sale. Nonetheless, we accept that your arrangement does not meet this indicator.

(v) Activities characteristic of the industry

An activity is more likely to be a business if it is carried on in a similar manner to other participants in the same industry. An arrangement like yours, where a land-owner entails the services of a developer to develop the land, even the use of options contracts to control the handover of land stages, is very common in the industry. We have concluded that this indicator is met.

(vi) Business-like manner

Activities that are conducted in a systematic and organised manner are more likely to amount to a business than ones which are conducted on an ad hoc basis. There are many facts in your arrangement that contribute to this indicator, including:

● The enlisting of lawyers and preparation of term sheet and options contracts.

● Obtaining cost estimates for works for developing the land.

● The structuring of the transactions and taking steps to protect your interests by obtaining a mortgage over the property.

● Negotiating a formula by which you will work out the return you receive on each block sold.

Therefore, we conclude that this indicator is met.

(vii) Size and scale

In general, the larger the scale of the activity, the more likely it will be that a business is being carried on. However, you may still be carrying on a business even if the activities are small. As mentioned above, the agreements provided estimate approximately 4 to 6 Residential Stages. Each Residential Stage will be an area of land to accommodate between 25 and 50 residential allotments upon subdivision. The total area of the Land to be developed as part of this project is around 45 hectares. We consider this to be a significant size and scale. Therefore, we consider that this indicator is met.

(viii) Hobby or recreation

The pursuit of a hobby is not the carrying on of a business for taxation purposes. We accept that a development of this magnitude is not a hobby or recreation.

Our conclusion

We accept that your director is nearing retirement and wants to give effect to a succession plan between his children. We also accept that your main enterprise is farming and that you did not approach any developers to develop the land in question. We also acknowledge that the way in which the arrangement is structured, specifically you being paid at the final sale of each subdivided block to the ultimate purchaser, leaves you exposed to significantly higher risk than if you had sold the broadacre land to the developer and received the payments up front.

For example, if during excavation during a residential stage, Aboriginal artefacts are found and you could not build in that part of the land, this will lead to a change in the plans and the number of lots being sold. This scenario will impact directly on your income. This would not be the case if you simply sold broadacre land to the developer and got paid up front. It would be solely the developer’s sole responsibility and affect their return on the project, not your own return. In structuring the transaction in this manner, you are left exposed to cost blowouts and market forces influencing the final price of the subdivided blocks. For these reasons, and after considering the above indicators and weighing them up, we have concluded that your arrangement will amount to carrying on an enterprise of land development. This means that any receipts will be included in your assessable income under section 6-5 of the ITAA 1997 as ordinary income, or failing that, under section 15-15 of the ITAA 1997 as profit arising from the carrying on or carrying out of a profit-making undertaking or plan.

Question 2

Will fees received for supply of a call option or extensions of a call option over the Land to the Developer be assessable to you as ordinary income under section 6-5 of the ITAA 1997, or as statutory income under section 15-15 of the ITAA 1997?

We have deemed you to be carrying on an enterprise or business of land development in question 1 above. Your assessable income includes income according to ordinary concepts as per section 6-5 of the ITAA 1997. The legislation, however, does not define the expression income according to ordinary concepts. Ordinary income generally includes three categories, namely, income from rendering personal services, income from property, and income from carrying on a business.

The receipts from the supply of a call option or extensions of a call option over the land by the Developer will be related to your enterprise, and included in your assessable income under section 6-5 of the ITAA 1997 as ordinary income, or failing that, under section 15-15 of the ITAA 1997 as profit arising from the carrying on or carrying out of a profit-making undertaking or plan.

Question 3

Will your supply of the Land to the Developer be classified as a GST-Free supply of farm land under section 38-480 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

We have already agreed that you are considered to be carrying on an enterprise of land development for GST purposes and the supply of land and a call option and related extensions of a call option are considered taxable supplies.

This question looks at whether section 38-480 of the GST Act applies to this transaction. Section 38-480 of the GST Act states that the supply of a freehold interest in land is GST-free if:

a) a farming business has been carried on for at least the period of 5 years preceding the supply on that land; and

b) the recipient of the supply intends that a farming business be carried on, on the land.

We are satisfied that a farming business has been carried on that land for the last 5 years. You have provided a licence to occupy agreement that allows you to continue farming on the land in question until the Developer requires the land to develop each residential stage. The Developer (at its own cost) is allowed, on reasonable notice, access to the Land to carry out surveys and investigations and for other activities related to obtaining development approvals. You believe that the Licence might apply for a period of several years rather than months.

We accept that this may be the case considering that there are several options and only one can be exercised at any time and each subsequent option cannot be exercised unless the previous stage has been at least 50% sold to ultimate purchasers. However, we are uncertain that what is supplied will be farming land at all. In looking at the nature of the land being supplied, we look at when the settlement date will occur. This is because the contract allows the settlement date to be a considerable length of time after the option is exercised and the developer is allowed access to the land.

This could potentially mean that the Developer could carry out certain activities (such as clearing land, etc.), and the development process could effectively ‘commence’ to a degree before settlement of the land occurring, in effect leading to the land being supplied on settlement date, to be partially developed land that could no longer be described as farm land. As we are not able to ascertain accurately the condition of the land upon settlement, we are unable to conclude that the supply of land in this transaction can be classified as a GST-Free supply of farm land under section 38-480.

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