Edited version of your written advice

Authorisation Number: 1051408853082

Date of advice: 6 September 2018

Ruling

Subject: Is gain on disposal of property income or capital?

Question 1

Is the Property an asset held on capital account since acquisition such that any gain on its disposal will be assessable only under Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

If the Property is disposed of, is the capital gain disregarded in part in accordance with Subdivision 118-B of the ITAA 1997?

Answer

Yes

Question 3

Will entry into the Development Agreement cause CGT event A1?

Answer

No

Question 4

Will the entry into the Development Agreement cause CGT event D1?

Answer

Yes

Question 5

If CGT event D1 occurs, can the acquisition cost or the market value of the Property be included in the cost base of the CGT asset?

Answer

No

Question 6

Will the proceeds of the sale of the individual lots to be constructed and sold pursuant to the Development Agreement constitute your ordinary income pursuant to section 6-5 of the ITAA 1997?

Answer

No

Question 7

Will the net capital gain on the disposal of each individual lot to be constructed and sold pursuant to the Development Agreement be included in your assessable income?

Answer

Yes

Question 8

Will entry into the Co-Venture Agreement cause the Property to become trading stock in your hands under section 70 – 30 of the ITAA 1997 in the relevant year?

Answer

Yes

Question 9

If the answer to Question 8 is yes and you elect under paragraph 70-30(1)(a) of the ITAA 1997 to be treated as having sold the Property at market value, will CGT event K4 occur under section 104-220 of the ITAA 1997 in the relevant year?

Answer

Yes

Question 10

If the answer to Question 9 is yes, can any capital gain arising as a result of event K4 occurring be disregarded in part in accordance with Subdivision 118-B of the ITAA 1997?

Answer

Yes

Question 11

If the answer to Question 2 is yes, will the answer remain the same if the Property is disposed of at market value for full consideration to one or more of your relatives or an entity controlled by one or more of your relatives?

Answer

Yes

This ruling applies for the following period(s)

Year ended 30 June 2019

Year ended 30 June 2020

Year ended 30 June 2021

Year ended 30 June 2022

The scheme commences on

1 July 2018

Relevant facts and circumstances

1. You acquired the Property as a gift.

2. At the time of acquisition, the Property was comprised of a single story home and surrounding land. The total area of the home and the surrounding land exceeded 2 hectares.

3. The property was subject to an existing tenancy at the time of purchase.

4. You requested, through the real estate agent, for the Tenant to vacate the Property.

5. After you acquired the Property, a draft rezoning plan was released by the government.

6. After the Property was vacated by the tenant, you moved into the Property. You have provided copies of electricity bills addressed to you at the Property along with copies of rates notices and other correspondence addressed to you at the Property. You changed your address on your driver’s licence and on the electoral role to that of the Property.

7. The Property was rezoned R2, low-density residential.

Other interested entities

8. Two entities associated with your family were registered after the Property was acquired by you.

9. One of these entities has purchased other land (the second Property) in the area in which the Property is located.

10. Your family also control two other entities, including Entity D.

Sale options emerge

11. You entered into a put and call option (Option) in respect of the Property with Entity A. The Option gave Entity A the ability to purchase the Property for a set amount. A call option fee was paid (Call Option Fee).

12. An entity associated with your family lodged a development application in relation to a third property in the area (the Third Property)

13. Entity A advised you that they were having trouble obtaining finance for development of the Property and may give up their rights pursuant to the Option.

14. The Development Application for the subdivision of the Property by Entity A was approved by Council (the Development).

15. The development application for the subdivision of the Second Property was approved by Council.

16. Entity B has made two separate offers to you, both of which you intend to reject. The offers were that you could

a. enter into a put and call option to sell the Property to Entity B; or

b. enter into a joint venture agreement with Entity B to develop the property.

17. However, Entity B (and other developers who approached you) requested the use of the Property to provide mortgage security for the costs of the development. All income from the joint venture would be paid in priority to the secured lender before being paid to you. You considered the risk too great.

18. You have ceased living at the Property but continue to treat it as your main residence.

Entity C

19. A trust entity and associated trustee (Entity C) was established by a family member.

20. Soon after Entity C was established a representative of Entity C made an oral offer to you regarding subdivision of the Property.

21. The subdivision would occur through one of the following arrangements, whereby you and Entity C will enter into a:

a. Development Agreement; or

b. Co-Venture Agreement.

22. In either scenario, Entity C has agreed that you can obtain title to a new lot and Entity C will build a house on the lot as part of the terms of the development.

23. You and Entity A entered into a deed. The deed states that Entity A has been unable to obtain finance in order to exercise the Option. You and Entity A agreed to mutually rescind the Option and you will return the option fee paid to you by the purchaser within 14 days of the date of the deed.

24. You have provided a copy of the draft Development Agreement and Co-Venture Agreement.

The draft Development Agreement

25. The parties to the draft Development Agreement are you and Entity C. Entity C wishes to carry out the development of the Property. You will allow Entity C to carry out the development on the following terms:

a. Entity C will pay you consideration.

b. The consideration will be paid to you in the following way:

i. One-tenth of the price in cash on date of agreement; and

ii. Balance by way of vendor loan on terms reasonably acceptable to a person in Entity C's position acting commercially, or as otherwise agreed in writing.

c. The whole of the price constitutes a debt immediately due and payable to you by Entity C. Payment of the price is not conditional upon the completion of the Development.

d. The price is not refundable under any circumstances and will remain your absolute property irrespective of whether the Development is completed.

e. Entity C may obtain finance but cannot grant a mortgage over the Property.

f. You cannot sell, transfer, assign, lease, mortgage, encumber or otherwise deal with any interest in the Property without prior written consent of Entity C.

g. You must grant Entity C a registered mortgage over the Property as security.

h. You will grant a power of attorney to Entity C, which allows Entity C to do all acts and things and execute documents relating to the Property and the development, including selling the Property or lots of the Property.

i. Entity C will carry out the development at the sole risk, cost and expense of the Entity C.

j. Entity C will be solely liable for, and must indemnify and keep you indemnified in respect of:

i. all Development Expenses;

ii. all costs associated with the Property including land tax, council rates, water rates and electricity usage; and

iii. all risk and liability that may arise in connection with the Property and the Development.

k. You will remain the registered proprietor of the Property. The subdivided lots will be sold to third parties and ownership will not pass to Entity C.

l. The proceeds of each Sale will be applied in the following order:

i. firstly, to pay any legal and other fees incidental to that Sale;

ii. secondly, to the Landowner in payment of any of the Price that remains outstanding by the Developer to the Landowner;

iii. thirdly, to repay any loan from a financier entered into to finance the Development; and

iv. the balance to the Developer absolutely.

m. You will retain one lot.

The draft Co-Venture Agreement

26. The parties to the draft Co-Venture Agreement are you and Entity C. You propose to carry out the development jointly on the following terms:

a. Entity C will receive the Co-Venture amount from the net proceeds of sales

b. You will receive the balance of the net proceeds of sales.

c. You and Entity C will work together in carrying out and completing the Development and sales of the lots. You and Entity C must:

● carry out the Development in accordance with the Development Application and all applicable laws, regulations and the Building Code of Australia;

● obtain the Construction Certificate from Council or such other relevant authority;

● exercise any of the Development Powers necessary or desirable to complete the Development;

● recommend and co-ordinate the appointment and activities of such specialists, consultants, builders, tradesman, contractors and suppliers reasonably necessary to carry out the Development;

● carry out the Development to a stage of practical completion including: building roads, sewers, storm water pipe systems; connecting water, gas, electricity, telephone, internet and other services; and planting trees and carrying out landscaping;

● ensure that each stage of the Development is completed in accordance with the Development Application;

● complete the Development and obtain the Occupation Certificate; and subject to clause 9, enter into and complete contracts for the sale of the Lots to third party purchasers.

d. You cannot sell, transfer, assign, lease, mortgage, encumber or otherwise deal with any interest in the Property without prior written consent of Entity C.

e. The risk, cost and expense of the Development will be incurred by both parties jointly and severally. It is the intention that all expenses will be recovered from sales of the subdivided lots.

f. You will retain one lot.

Your position

27. The offer from Entity C is the only joint venture offer that does not require the Property to be used as loan security for the development costs.

28. Entity C proposes to finance the Development by borrowing at interest from an associated entity, Entity D.

29. You will have no direct involvement with Entity D.

30. Neither you nor your associated entities have any experience in property subdivision. The proposed subdivision of the Property would be the first subdivision within your family.

31. You do not intend to provide the Property as security either in relation to the proposed development of the Property or for any form of finance in the future. Nor do you intend to provide a personal guarantee.

32. You have no intention of gifting land and/or other property (including money) after the proposed subdivision of the Property and as far as you are aware no members of your family or entities controlled by your family have any intention of gifting land and/or other property as part of the arrangements relating to the proposed subdivision of the Property.

33. It is your position that:

a. The Property is currently an asset held on capital account

b. You are entitled to the main residence exemption on the house and up to two acres of the surrounding land (subject to the period you rented the house before moving into it)

c. In the event you enter into the Development Agreement, CGT event A1 would happen. The proceeds of the individual lots would not constitute ordinary income of yourself as you would have previously received the entirety of the funds you were entitled to (10% deposit and vendor loan).

d. If you enter into the Co-Venture Agreement, the Property will become trading stock and you will elect under paragraph 70-30(1)(a) of the ITAA 1997 to be treated as having sold the Property at its market value.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5.

Income Tax Assessment Act 1997 section 70-10

Income Tax Assessment Act 1997 section 70-30

Income Tax Assessment Act 1997 paragraph 70-30(1)(a)

Income Tax Assessment Act 1997 subsection 70-30(2)

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 subsection 104-35(1)

Income Tax Assessment Act 1997 subsection 104-220(2)

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

Income Tax Assessment Act 1997 section 110-35

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 118-110

Income Tax Assessment Act 1997 section 118-115

Income Tax Assessment Act 1997 section 118-120

Income Tax Assessment Act 1997 section 118-145

Income Tax Assessment Act 1997 section 118-165

Income Tax Assessment Act 1997 section 118-185

Reasons for decision

Question 1

Summary

The Property has been a capital asset since you acquired it.

Detailed reasoning

Generally, the proceeds from the sale of land will be taxed in one of three ways:

(1) As ordinary income, where the land is held as trading stock and sold as part of a business;

(2) As ordinary income, where the land is not trading stock and is sold as part of an isolated profit making scheme or undertaking; or

(3) On capital account, where the proceeds of sale are a mere realisation of a capital asset.

Taxation Determination TD 92/124 ‘Income tax: property development: in what circumstances is land treated as 'trading stock'?’ provides that land will be treated as trading stock if it is held for the purpose of resale and a business activity which involves the dealing in land has commenced. Both the required purpose and the business activity must be present.

TD 92/124 further provides that the 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.

In Federal Commissioner of Taxation v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693 (Myer Emporium), the Full High Court expressed the view that profits made by a taxpayer who enters into an isolated transaction with a profit making purpose can be assessable income.

Taxation Ruling TR 92/3 ‘Income tax: whether profits on isolated transactions are income’ discusses profits on isolated transactions and the application of the principles outlined in Myer Emporium. According to paragraph 1 of TR 92/3, the term isolated transaction refers to:

● those transactions outside the ordinary course of business of a taxpayer carrying on a business, and

● those transactions entered into by non-business taxpayers.

Paragraph 6 of TR 92/3 provides that a profit from an isolated transaction will generally be income when both the following elements are present:

● the intention or purpose of a taxpayer in entering into the transaction was to make a profit or gain, and

● the transaction was entered into, and the profit was made, in the course of carrying on a business operation or commercial transaction.

According to paragraph 7 of TR 92/3, the relevant intention or purpose is to be discerned from an objective consideration of the facts and circumstances of the case. Further, paragraph 8 of TR 92/3 indicates that a profit making purpose need not be the sole or dominant purpose for entering into the transaction. It is sufficient if profit making is a significant purpose.

Paragraph 9 of TR 92/3 indicates that the requisite purpose must exist at the time of entering into the relevant transaction or operation. If the transaction involves the sale of property, it is usually necessary that the purpose of profit making exists at the time of acquiring the property.

However, paragraph 42 of TR 92/3 provides that if an asset is acquired with the intention of using it for personal enjoyment, but later ventured into a profit making undertaking with the characteristics of a business operation or commercial transaction, the profit from the activity will be income although you did not have the purpose of profit making a the time of acquiring the asset.

In determining whether an isolated transaction amounts to a business operation or commercial transaction, paragraph 13 of TR 92/3 outlines a number of factors which may be 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.

Where the proceeds from the sale of land are neither part of a business of property development or a profit making undertaking they will be taxed only under the capital gains tax provisions as a mere realisation of a capital asset Part 3-1 of the ITAA 1997.

In your case, you were approached by Entity A and entered into an option contract to dispose of the Property to Entity A. Entity A lodged a development application with Council. The Option Contract was rescinded by mutual agreement. You are now considering entering into the Development Agreement or the Co-Venture Agreement with Entity C.

It is considered that if you were to dispose of the Property, the Property would not be:

● Trading stock sold as part of a business as you have not yet engaged in a definite and continuous cycle of operations designed to lead to the sale of the land.; nor

● Sold as part of an isolated profit making scheme or undertaking as you are not currently carrying on a business operation in connection with the Property.

You currently hold the Property on capital account and have done so since acquisition.

Any consideration received from the disposal of the Property would be treated as capital proceeds in accordance with Part 3-1 of the ITAA 1997.

Question 2 and Question 11

Summary

You are entitled to claim the main residence exemption on the house and two hectares of the land from the time you began living in the Property. Unless you choose to treat another dwelling as your main residence from the time you vacated the Property, you can continue to treat the Property as your main residence for up to six years if you use it to produce assessable income, or indefinitely if it is not used to produce assessable income. If the dwelling is demolished before the Property is disposed of, the main residence exemption could not apply to disposal of the Property.

Detailed reasoning

Section 102-20 of the ITAA 1997 provides that a taxpayer makes a capital gain or capital loss only when a CGT event happens to a CGT asset. A capital gain or capital loss an individual makes from a CGT event that happens to a dwelling that was the taxpayer's main residence can be disregarded if certain requirements are met.

The meaning of dwelling is defined in section 118-115 of the ITAA 1997 as any building, or part of a building, that consists mainly of residential accommodation and the land it is built on.

In order to obtain a full exemption from CGT, the dwelling must have been:

● the taxpayers main residence for the entire period they owned it (sections 118-110 and 118-185 of the ITAA 1997),

● must not have been used to produce assessable income (section 118-190 of the ITAA 1997), and

● any land on which the dwelling is situated should not be more than two hectares.

A taxpayer may continue to treat the dwelling as their main residence for up to six years after it ceases to be their main residence if it is used to produce assessable income and indefinitely if it is not used to produce assessable income in accordance with section 118-145 of the ITAA 1997.

It is ATO practice to consider a variety of relevant factors in determining whether you have established a dwelling as your main residence. These indicators may include, but are not limited to:

● the length of time you have lived in the dwelling

● the place of residence of your family

● whether you have moved your personal belongings into the dwelling

● the address to which you have your mail delivered

● your address on the Electoral Roll

● the connection of services such as telephone, gas and electricity, and

● your intention in occupying the dwelling.

In your case you became the owner and moved into the Property immediately after vacation by the tenant. You have provided copies of electricity bills addressed to you at the Property. You have also provided copies of rates notices and other correspondence addressed to you at the Property from the time you established the Property as your main residence. You changed your address on your driver’s licence and on the electoral role. It is accepted that you established the Property as your main residence from the time you moved in.

Apportioning the main residence exemption

Section 118-185 of the ITAA 1997 states that if a dwelling was your main residence for only part of your ownership period, you will only get a partial exemption for a CGT event that occurs in relation to the dwelling. The capital gain or loss is calculated using the following formula:

Where:

● non-main residence days is the number of days in your ownership period when the dwelling was not your main residence.

In your case you had a tenant in the Property for part of your ownership period and you cannot apply the main residence exemption to that period of ownership. You were also absent from the property for a period. However this period of absence does not affect your eligibility for the main residence exemption, unless you choose to treat another property as your main residence from that time.

Therefore, you will need to apportion the gain to allow for the non-main residence days prior to moving in to the Property, using the above formula. You will not be entitled to the main residence exemption on the percentage of gain related to non-main residence days.

Land in excess of two hectares

In addition, any capital gain attributable to the Property in excess of two hectares is not disregarded as it is not covered by the main residence exemption.

The main residence exemption extends to a maximum of two hectares of land adjacent to the dwelling (including the area of the land on which the dwelling is built).The two hectares of land does not need to be connected to the land under the dwelling, it can be chosen from anywhere on your property as long as it is used for private or domestic purposes in association with the dwelling.

Tax Determination TD 1999/67 ‘Income tax: capital gains: if your land (including land on which your dwelling is situated) exceeds 2 hectares, can you select which 2 hectares the main residence exemption in Subdivision 118-B applies to and, if so, how do you calculate any capital gain or capital loss you make on the remainder of your land?’ applies when calculating the capital gain or capital loss where a property exceeds two hectares.

If your selected area of land can be separately valued, you calculate your capital gain or capital loss by apportioning the cost base or reduced cost base between the dwelling and two hectares and the land in excess of two hectares, on the basis of the valuation. If your selected area of land (in excess of two hectares) cannot be separately valued, your capital gain or loss on the remainder of your land may be calculated by apportioning the capital proceeds and the cost base or reduced cost base (if applicable) on an area basis.

If the main residence is destroyed before disposal of the Property

If the dwelling is demolished before you dispose of the Property, the main residence exemption would cease to apply. Section 118-165 of the ITAA 1997 provides that the main residence exemption does not apply to a CGT event that happens in relation to land, to which the exemption can extend under section 118-120 of the ITAA 1997 if that CGT event does not also happen to the dwelling.

CGT event A1 would happen when the block, or subdivided lots, are disposed of, but this CGT event would not happen to the dwelling if CGT event C1 (about loss or destruction) had already happened to the dwelling when it was demolished. Therefore, section 118-165 of the ITAA would apply to deny you a main residence exemption on the capital gain made on the disposal of the Property.

Sale to related entity

The provisions discussed above are equally applicable if the Property is disposed of to a related entity at market value for full consideration.

Question 3

Summary

Entry into the Development Agreement will not cause CGT event A1 to occur.

Detailed reasoning

Subsection 104-10(1) of the ITAA 1997 states that ‘CGT event A1 happens if you dispose of a CGT asset.’ The meaning of ‘dispose’ for the purposes of determining whether a CGT event took place is set out in subsection 104-10(2) of the ITAA 1997. A disposal will be considered to have taken place when there is a change of ownership through an act or event or an operation of law. There will not be a change of ownership where the entity stops being the legal owner of an asset but continues to be its beneficial owner.

Section 104-10(3) of the ITAA 1997 provides that the timing of CGT event A1 is when you enter into the contract for the disposal, or if there is no contract, when the change of ownership occurs.

‘Ownership’ is not defined in the ITAA 1997, although the meaning of ‘ownership interest’ is set out in section 118-130 of the ITAA 1997. Subsection 118-130(1) of the ITAA 1997 provides that an entity has an ownership interest in land or a dwelling if they have a legal or equitable interest in it or a right to occupy it. Subsection 118-130(3) of the ITAA 1997 further provides that where there is a contract for the happening of a CGT event, the ownership interest continues until legal ownership ends.

It is your position that property is not the land itself, but rather the rights attaching to the land. In Yanner v. Eaton (1999) 201 CLR 351; [1999] HCA 53 the High Court considered the meaning of property. In the joint judgment of Gleeson CJ, Kirby, Hayne and Gaudron JJ, their honours stated at paragraph 17:

… ‘property’ does not refer to a thing; it is a description of a legal relationship with a thing. It refers to a degree of power that is recognised in law as power permissibly exercised over the thing. The concept of property may be elusive. Usually it is treated as a bundle of rights.

In your view entry into the Development Agreement would constitute disposal of the Property, by assigning your rights in the Property to Entity C. In your view, the date of entry into the Development Agreement is when the disposal would occur, causing CGT event A1.

Under the terms of the Development Agreement, you will receive consideration for granting Entity C:

● The exclusive right to carry out the development on the terms and conditions set out in this agreement; and

● All of the Landowner’s rights, title and interest in any intellectual property, design documents and plans relating, or ancillary to, the development.

Entity C will carry out the development at the sole risk, cost and expense of Entity C. You cannot sell, transfer, assign, lease, mortgage, encumber or otherwise deal with any interest in the Property without prior written consent of Entity C. You must grant Entity C a registered mortgage over the Property as security and you will grant a power of attorney to Entity C, which allows Entity C to do all acts and things and execute documents relating to the Property and the development, including selling the Property or lots of the Property. You will remain the registered proprietor of the Property until the subdivided lots are sold to third parties by Entity C acting on your behalf under the power of attorney. Ownership will not pass to Entity C.

Upon entry into the Development Agreement, you do not agree to transfer your interests in the property to Entity C. The Development Agreement states that you cannot enter into certain dealings with the Property without the approval of the developer, not that you cannot enter the dealings at all.

By entering the Development Agreement you would agree to restrict your ability to deal in the Property. You would not dispose of the legal ownership or beneficial interests in the Property until sales of the lots are made to third parties. It is these subsequent contracts, to be entered into by Entity C on your behalf under power of attorney, which will result in the true ‘disposal’ of the Property. As you will retain legal ownership and beneficial interests in the Property upon entry into the Development Agreement, CGT event A1 will not occur in relation to the Property when you enter into the Development Agreement.

Question 4 and Question 5

Summary

Entry into the Development Agreement will cause CGT event D1. The timing of CGT event D1 is the timing of entry into the Development Agreement. The capital proceeds are the full consideration referred to in the Development Agreement. After accounting for your incidental costs, which do not include the market value or acquisition cost of the Property, the gain from CGT event D1 would have to be accounted for in the year that the Development Agreement is signed even if you have not yet received all of the capital proceeds.

Detailed reasoning

CGT event D1 happens under subsection 104-35(1) of the ITAA 1997 when an entity creates a contractual or other legal or equitable right in another entity. If you enter into the Development Agreement, you will create rights in Entity C to develop the Property. The creation of these rights is a D1 event.

Pursuant to subsection 104-35(2) of the ITAA 1997 CGT event D1 happens at the time the agreement is entered into. You will make a capital gain as a result of this CGT event happening if the capital proceeds from creating the rights are more than the incidental costs that relate to the event. The capital proceeds include the money you have received, or are entitled to receive, in respect of the event happening.

Section 110-35 of the ITAA 1997 outlines the incidental costs that can relate to a CGT event. Incidental costs include remuneration for the services of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal adviser. The market value of the land is not an incidental cost, nor is the acquisition cost of the land to which the rights are related.

In your case, if you enter into the Development Agreement you are entitled to payment. You will receive 10% immediately, with the rest to be funded by a vendor loan at commercial rates. The whole of the price constitutes a debt immediately due and payable to you by Entity C. Payment of the price is not conditional upon the completion of the Development. The price is not refundable under any circumstances and will remain your absolute property irrespective of whether the Development is completed. After accounting for your incidental costs, which do not include the market value or acquisition cost of the Property, the gain from CGT event D1 would have to be accounted for in the year that Development Agreement is signed. This is the case even though Entity C may not pay all the funds to you at this time.

Question 6 and Question 7

Summary

CGT event A1 will occur at the time Entity C sells the individual lots to third parties on your behalf. Income from the sale of the individual lots would not constitute ordinary income, but the net capital gain from each lot would be added to your assessable income in the financial year in which the relevant sale contracts are entered into.

Detailed reasoning

As discussed above, CGT event A1 does not occur when you enter into the Development Agreement but will happen on sale of the individual lots to the third parties.

Section 6-5 of the ITAA 1997 deals with receipts of ordinary income. It does not operate to include in assessable income amounts of a capital nature. Any receipts that you received from the sale of the individual lots would be capital in nature and not assessable under 6-5 of the ITAA 1997.

If the Property is subdivided and the individual lots are sold to third parties, CGT event A1 will happen at the time each contract is executed. The operation of section 116-20 of the ITAA 1997 provides that the capital proceeds of each A1 event will be the contract price of each individual lot. The Development Agreement sets out the order in which the proceeds of each sale will be applied. Any payment you receive will be applied to offset any outstanding amount owed to you for entry into the Development Agreement. However, for the purposes of Part 3-1, you will be taken to receive the contract price of each lot sold.

Section 6-25 of the ITAA 1997 will not apply so that the capital gain assessed under CGT event D1 in section 104-55 of the ITAA 1997 is not also assessed under CGT event A1 in section 104-10 of the ITAA 1997. Section 6-25 of the ITAA 1997 provides that sometimes the same amount may be included in assessable income by more than one provision about assessable income and prescribes that the amount is to be included only once in assessable income for an income year, and is not included in assessable income for any other income year.

The phrase ‘same amount’ is not defined and thus it takes its ordinary meaning. The definition of ‘same’ from the Macquarie Dictionary is:

1. identical with what is about to be or has just been mentioned: the very same person.

2. being one or identical, though having different names, aspects, etc.: these are one and the same thing.

3. agreeing in kind, amount, etc.; corresponding: two boxes of the same dimensions.

If a payment is made upon entry into the Development Agreement and subsequent to that the individual lots of the Property are sold, the capital gain, assessable under CGT event D1, will not be ‘identical’ with the capital gain assessed under CGT event A1. This is because the relevant payment for CGT event D1 is made as a result of you entering into the Development Agreement and allowing Entity C to develop and subdivide the Property. The relevant payments made under CGT event A1 are made for sale of the individual lots.

For completeness, section 118-20 does not apply to reduce the capital gain made under CGT event A1 when an individual lot is subsequently sold. Section 118-20 reduces a capital gain from a CGT event if a provision of ITAA 1997 (outside Part 3-1) includes an amount in assessable income. In this case it is provisions within Part 3-1 (i.e. CGT event D1 in section 104-35, and CGT event A1 in section 104-10) that includes the respective amounts as assessable income.

Questions 8, 9 and 10

Summary

Upon entry into the Co-Venture Agreement, the Property will become trading stock, triggering CGT event K4, at the time you enter into the Co-Venture Agreement. Any capital gain can be partly disregarded in accordance with the main residence exemption provisions.

Detailed reasoning

Under the trading stock provisions of the ITAA 1997, there are consequences when an asset you already own is ventured into a business. Section 70-30 of the ITAA 1997 provides that you are treated as having sold the asset just before the time it became trading stock, for its cost or market value, and immediately bought it back.

Subsection 70-10(1) of the ITAA 1997 provides that trading stock includes:

(a) anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and

(b) livestock

The High Court has accepted that land can be trading stock (see Federal Commissioner of Taxation v St Hubert’s Island Pty Ltd (1978) 138 CLR 210 the St Hubert’s Island case) which considered the meaning of “trading stock” in the Income Tax Assessment Act 1936 (ITAA 1936)).

As discussed above the Commissioner’s view on when land is trading stock is provided in TD 92/124, which provides:

1. Land is treated as trading stock for income tax purposes if:

a. It is held for the purpose of resale; and

b. A business activity which involves dealing in land has commenced.

2. Both the required purpose and the business activity must be present before land is treated as trading stock…

Held for the purpose of sale

Land can only be treated as trading stock if it is held for the purposes of resale. This issue was discussed by Finn J in R & D Holdings Pty Ltd v Deputy Federal Commissioner of Taxation 2006 ATC 4472. Finn J made the following comments about the decision in St Hubert’s Island (at 4480):

46. The significance of this case for present purposes is that it is authority for the propositions that (i) land acquired for the purpose of development, subdivision (or strata division) and sale by allotments (or lots) can constitute trading stock of a business having that purpose irrespective of whether the land has been so developed and subdivided; and (ii) that business will be carried on for so long as the taxpayer engaged in the effectuation of the purpose of development, etc of the land. The emphasis in St Hubert’s Island on the need to have the relevant intention of sale at the time of acquisition of the property in question is, though’ without significance for s 70-10 purposes which as I have earlier noted links the intention or purpose of sale with the purpose (or purposes) for which the property is held. (emphasis in the original)

Land will be held for the purpose of sale where the sale of land is a normal operation in the course of carrying on a business.

As discussed above, the Commissioner accepts your position that the Property was a capital asset from the time of acquisition.

You entered into the Option Agreement to allow Entity A to purchase and develop the Property. Entity A applied for a development application. The Option Agreement has since been rescinded and you are considering several options in relation to the Property. You currently hold the land on capital account.

Entry into the proposed Co-Venture Agreement would manifest your intention to develop the Property through subdivision, reselling the land for profit. Upon entry into the Co-Venture Agreement, the Property would then be held for the purpose of sale, regardless of the fact the land would not be in the condition in which it is proposed that it should be sold.

Business activity has commenced

Once it is established that land is held for the purpose of sale, it is necessary to consider whether a business activity which involves dealing in land has commenced. TD 92/124 provides 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.

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? sets out the Commissioners view on when an entity is carrying on a business. While TR 97/11 specifically considers whether an entity is carrying on a business of primary production, the Commissioner considers the indicators of business outlined below also apply to other areas:

26. From the judgments it is clear that the relevant indicators of whether a business of primary production is being carried on by a taxpayer are:

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

● does the taxpayer have more than a mere intention to engage in business?

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

● is there repetition and regularity in the activity? i.e., how often is the activity engaged in? How much time does the taxpayer spend on 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, a form of recreation or a sporting activity?

Upon entry into the Co-Venture Agreement, you and Entity C will work together in carrying out and completing the Development and sales of the lots. Under the Co-Venture Agreement you and Entity C will be required to:

1. Carry out the Development in accordance with the Development Application and all applicable laws, regulations and the Building Code of Australia;

2. Obtain the Construction Certificate from Council or such other relevant authority;

3. Exercise any of the Development Powers necessary or desirable to complete the Development;

4. Recommend and co-ordinate the appointment and activities of such specialists, consultants, builders, tradesman, contractors and suppliers reasonably necessary to carry out the Development;

5. Carry out the Development to a stage of practical completion including: building roads, sewers, storm water pipe systems; connecting water, gas, electricity, telephone, internet and other services; and planting trees and carrying out landscaping;

6. Ensure that each stage of the Development is completed in accordance with the Development Application; and

7. Complete the Development and obtain the Occupation Certificate; and subject to clause 9, enter into and complete contracts for the sale of the Lots to third party purchasers.

The development and sale of the subdivided lots will have a significant commercial character and will be organised in a business-like manner. The development will be carried on in a business-like manner and development of the Property will be directed at making a profit. In carrying out your responsibilities under the Co-Venture Agreement, you will be carrying out the business of property development.

Case law establishes that in considering when a business has commenced or whether activities that have been or are being undertaken are merely preliminary to commencement of the business, the element of commitment is important: Softwood Pulp and Paper Limited v Federal Commissioner of Taxation 76 ATC 4439, Goodman Fielder Wattie Ltd v Federal Commissioner of Taxation (1991) 101 ALR 329.

In your case, when you enter into the Co-Venture Agreement, you will have committed the Property to the business of developing the Property. Therefore entry into the Co-Venture Agreement will mean that a business activity in relation to the development of the Property will have commenced.

Section 104-220 of the ITAA 1997 provides that CGT event K4 happens when you start holding as trading stock a CGT asset that you already own and you elect to be treated as having sold the asset for its market value under paragraph 70-30(1)(a) of the ITAA 1997.

The time of CGT event K4 is the time that you start to hold the CGT asset as trading stock. This will happen at the time that the nature of the Property changes from being a capital asset to trading stock of the development business.

In your case, the Property will be treated as trading stock when the land is ventured into the business of development. This will occur once you enter into the Co-Venture Agreement.

Therefore, the Property will become trading stock, triggering CGT event K4, at the time you enter into the Co-Venture Agreement.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).