Edited version of your written advice

Authorisation Number: 1051449011275

Date of advice: 20 December 2018

Ruling

Subject: Land subdivision – capital vs revenue

Issue 1

Question 1

Will the proceeds from the sale of the subdivided residential lot be subject to capital gains tax (CGT) under Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will the profits from the sale of the subdivided residential lots be assessable as ordinary income under section 6-5 of the ITAA 1997?

Answer

Yes

Issue 2

Question 1

Did you make a taxable supply of new residential premises pursuant to section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) when you sold the residential premises you constructed?

Answer

Yes

Question 2

Did you make a taxable supply of land when you subdivided and sold the two vacant lots, pursuant to section 9-5 of the GST Act?

Answer

Yes

Question 3

Were you required to be registered for GST under section 23-5 of the GST Act?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

You purchased Property 1.

Property 1 was purchased as your main residence.

You are not registered for GST purposes.

You purchased a second property (Property 2). Property 2 was purchased as your main residence during the construction of your new residence at Property 1.

You have not undertaken any other subdivision and construction activities prior to those identified in this ruling request.

Property 1

You lived in Property 1 for a number of years. You decided to subdivide Property 1 and retain part of it for your residence. Property 1 is zoned medium density. You did not have Property 1 rezoned after purchase.

You constructed a number of dwellings on Property 1.

You subdivided Property 1 utilising your own funds and obtained finance for the construction of the new residential homes.

You undertook research into the selling price of similar lots and houses.

No business plan was prepared for this development and you personally managed the subdivision and construction of the respective properties.

You engaged contractors to subdivide the land and build a number of residential homes on Property 1.

A subdivision application was submitted. Development plan consent, land division consent and development approval was granted.

You moved into one of the dwellings on the subdivided lots.

You sold the remainder having constructed dwellings.

Property 2

You purchased Property 2. Property 2 contained an existing house and became your primary residence during the construction of houses in Property 1.

You submitted a Development Application for Property 2 and received Development Approval for the proposed subdivision and construction.

The dwelling on Property 2 was demolished.

Prior to selling the vacant lots, you engaged a builder to design homes which could be built on the respective subdivided lots. This was required so that you could obtain approval for subdivision of Property 2.

You subdivided Property 2 utilising your own funds.

You contacted a real estate agent for information regarding the sale of similar properties and vacant lots in the area.

No business plan was prepared for this development and you managed the subdivision personally.

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

A New Tax System (Goods and Services Tax) Act 1999 Section 9-5

A New Tax System (Goods and Services Tax) Act 1999 Section 9-20

A New Tax System (Goods and Services Tax) Act 1999 Section 9-40

Reasons for decision

Income Tax

Detailed reasoning

There are three ways profits from property sales can be treated for taxation purposes:

1. As ordinary income under section 6-5 of the ITAA, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock; or

2. As ordinary income under section 6-5 of the ITAA, on revenue account, as a result of an isolated business transaction entered into by a non-business taxpayer, or outside the ordinary course of business of a taxpayer carrying on a business, which is the commercial exploitation of an asset acquired for a profit making purpose; or

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

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.

Isolated transactions

According to 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 the decision of the Full High Court of Australia in FCT v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693. This ruling states that profits on isolated transactions may be income.

Profit from an isolated transaction will be ordinary income where:

● 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.

Taxation Ruling TR 92/3 outlines that the relevant intention or purpose of the taxpayer, of making a profit or gain, is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer’s intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

Profits on the sale of subdivided land can therefore be income according to ordinary concepts within section 6-5 of the ITAA 1997 if the taxpayer’s subdivisional activities have become a separate business operation or commercial transaction, or an isolated profit making venture.

At paragraphs 56 and 57, Taxation Ruling TR 92/3 explains that a profit is income where it is made in any of the following situations:

● a taxpayer acquires property with a purpose of making a profit by whichever means prove most suitable and a profit is later obtained by any means which implements the initial profit-making purpose; or

● a taxpayer acquires property contemplating a number of different methods of making a profit and uses one of those methods in making a profit; or

● a taxpayer enters into a transaction or operation with a purpose of making a profit by one particular means but actually obtains the profit by a different means.

In very general terms, a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations.

Capital gains tax provisions

CGT event A1 in section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you dispose of each subdivided block. You will make a capital gain if the capital proceeds from the disposal of the block are more than the cost base of the block. You will make a capital loss of those capital proceeds are less than the reduced cost base of the block.

Section 118-20 contains anti-overlap provisions which operate to reduce capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 of the ITAA 1997, for example, as ordinary income under section 6-5 of the ITAA 1997.

Application to your situation

We note that during your ownership of the properties, the purpose for which you held the properties changed. Following advice from a real estate agent at the time, you decided to demolish the house in Property 2 and subdivide the land into a number of residential blocks for the purposes of sale as vacant land. You also decided to sell the other blocks in Property 1 which you originally planned to be your rental property. Although your stated initial intention may not have been for the purpose of profit making at the time you acquired both properties, the short periods of ownership and subdivision activities support that you held these for development and resale for a profit. You have ventured into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction.

You do not work in a related industry to property development. However, the activities undertaken are in the nature of business operations or commercial transactions as you demolished existing houses, subdivided the lands and built new residential homes, albeit undertaken by the various contractors you engaged (across Property 1 and Property 2). The plans of subdivision were coherent and included significant improvements to the land including the construction of a dwelling. You further obtained financing for the purpose of construction. You undertook the necessary research into similar lots and houses for the purpose of making an informed decision as to the commercial viability of the project. You have also maintained detailed records of the expenditures incurred on the project. This provides further evidence of the commercial nature of the activities.

You owned Property 1 for only a number of years and subsequently subdivided and developed shortly after acquisition. With Property 2, planning activities were already carried out within months from acquiring the property. You ventured into subdivision and development activities for properties you owned for a relatively short period of time. Additionally, while you engaged various entities, you retained control of the subdivision and construction activities that occurred at both Property 1 and Property 2. Your scenario is in contrast to one who owns a property for a considerable period of time and later sells with minimal works involved to realise the capital asset.

Despite your circumstances and the uncertainties on market forces, it is noted that you funded the subdivision for both properties yourself and you borrowed funds to finance the construction of houses. You entered into the subdivision and development activities baring financial risk, a further indication of a profit-making activity. You contended that you aimed to avoid losses by demolishing the house on Property 2 and subdividing this into residential blocks to make a profit. However, the return on Property 2 was low and is a reflection of the risk you had committed to. The costs incurred in the development of Property 1 were relatively higher than the initial unimproved value of the property.

On balance, it is accept that you do not carry on a business of property development; however you have entered into a profit making undertaking or scheme. The proceeds from the sale of the land are from an isolated transaction and are on revenue. This means that you have derived ordinary income which is assessable under section 6-5 of the ITAA 1997.

Whilst CGT event A1 will occur on the disposal of the subdivided blocks, the disposal of each lot will be viewed as an isolated transaction. Any profit from the sale will be assessable as ordinary income under section 6-5 of the ITAA 1997 as an isolated transaction. Any capital gain arising from each CGT event will be reduced to the extent any profit is also assessable under section 6-5 of the ITAA 1997.

Issue 2

In this reasoning of issue 2 unless otherwise stated,

● all legislative references are to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)

● reference material(s) referred to are available on the Australian Taxation Office (ATO) website www.ato.gov.au

Section 9-40 provides that you are liable for GST on any taxable supplies that you make.

Section 9-5 provides you make a taxable supply if:

(a) you make the supply for consideration; and

(b) the supply is made in the course or furtherance of an enterprise that you carry on; and

(c) the supply is connected with the indirect tax zone; and

(d) you are registered, or required to be registered for GST.

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed.

The definition of ‘taxable supply’ refers to ‘you’. We must therefore establish who is making the supply pursuant to section 9-5.

You purchased Property 1 and Property 2.

You purchased Property 1 as your principle residence. However, you subsequently changed your intention in regard to this property deciding to demolish the existing house, subdivide the land and build separate residential homes. One home would be retained as your principle residence with the rest being a rental property. You subsequently decided to dispose of the remaining houses rather than retain it as a rental property.

Your intention in buying Property 2 was to initially live in the property while your new principle residence was being constructed and then subdivide and sell the property. You proceeded with this activity and sold the vacant lots you created on Property 2. You advised that you undertook this activity to enable you to fund the construction of Property 1.

General Law Partnerships

A partnership is defined in section 195-1 by reference to the definition of ‘partnership’ in subsection 995-1(1) of the Income Tax Assessment Act (ITAA) 1997. That definition states:

Partnership means:

(a) an association of persons (other than a company or a limited partnership) carrying on business as partners or in receipt of ordinary income or statutory income jointly; or

(b) a limited partnership.

The first limb of paragraph (a) of the definition refers to ‘an association of persons (other than a company or a limited partnership) carrying on business as partners’. This reflects the general law definition of a partnership, which is ‘the relation which subsists between persons carrying on a business in common with a view of profit. This is referred to as a general law partnership.

Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number (MT 2006/1) discusses partnerships and states:

Partnership

110. As explained in paragraphs 41 to 43 of this Ruling, the definition of partnership is wide and has the meaning given by section 995-1 of the ITAA 1997. Partnerships, except incorporated limited partnerships,⁴⁴ are not recognised under the general law as a separate legal person distinct from the members of the partnership. They are an entity for ABN purposes because of the operation of paragraph 184-1(1)(e) of the GST Act. This means that the business the partners carry on in association with each other is taken to be an enterprise carried on by the partnership.⁴⁵ As a result, a partner (that is required to carry on an enterprise to be entitled to an ABN), will not be entitled to an ABN unless they carry on some other enterprise independently of the partnership and in their own capacity.

We consider that you are a general law partnership in regard to the disposal of Property 1 and lots in Property 2.

Taxable supply

In your case, the supply of Property 1 and Property 2 (together ‘the Properties’) will be for consideration, the respective properties are located in Australia and neither supply will be GST-free or input taxed.

As you were not registered for GST, the question in this case is whether you were making a supply of the Properties in the course or furtherance of an enterprise that you carried on. If so, we must then determine whether you were required to be registered for GST.

Section 9-20 provides that the term ‘enterprise’ includes, among other things, an activity or series of activities done in the form of a business or done in the form of an adventure or concern in the nature of trade. The phrase ‘carry on’ in the context of an enterprise includes doing anything in the course of the commencement or termination of the enterprise.

Miscellaneous Taxation Ruling MT 2006/1 (MT 2006/1) provides the Tax Office view on the meaning of 'enterprise' for the purposes of entitlement to an Australian Business Number (ABN). Goods and Services Tax Determination GSTD 2006/6 provides that the discussion in MT 2006/1 equally applies to the term 'enterprise' as used in the GST Act and can be relied on for GST purposes.

Paragraph 178 of MT 2006/1 lists a number of indicators considered when attempting to determine whether an activity or series of activities amount to a business:

● a significant commercial activity;

● a purpose and intention of the taxpayer to engage in commercial activity;

● an intention to make a profit from the activity;

● the activity is or will be profitable;

● the recurrent or regular nature of the activity;

● the activity is carried on in a similar manner to that of other businesses in the same or similar trade;

● activity is systematic, organised and carried on in a businesslike manner and records are kept;

● the activities are of a reasonable size and scale;

● a business plan exists;

● commercial sales of product; and

● the entity has relevant knowledge or skill.

Furthermore, paragraph 234 of MT 2006/1 distinguishes between activities done in the form of a ‘business’ and those done in the form of ‘an adventure or concern in the nature of trade’. This paragraph provides that:

● a business encompasses trade engaged in, on a regular or continuous basis.

● an adventure or concern in the nature of trade includes an isolated or one-off transaction that does not amount to a business, but which has the characteristics of a business deal.

Paragraph 244 of MT 2006/1 explains that an adventure or concern in the nature of trade includes a commercial activity that does not amount to a business but which has the characteristics of a business deal.

Paragraph 262 of MT 2006/1 acknowledges that the question of whether an entity is carrying on an enterprise often arises where there are ‘one-offs’ or isolated real property transactions. Paragraph 263 continues stating that the issue to be decided is whether the activities being conducted are an enterprise in that they are of a revenue nature as they are considered to be activities of carrying on a business or an adventure or concern in the nature of trade (profit making undertaking or scheme) as opposed to the mere realisation of a capital asset.

The cases of Statham & Anor v. Federal Commissioner of Taxation (Statham) and Casimaty v. FC of T (Casimaty) established a number of factors which can be used to determine whether activities are a business or an adventure or concern in the nature of trade with reference to real property transactions including:

● there is a change of purpose for which the land is held;

● additional land is acquired to be added to the original parcel of land;

● the parcel of land is brought into account as a business asset;

● there is a coherent plan for the subdivision of the land;

● there is a business organisation – for example a manager, office and letterhead;

● borrowed funds financed the acquisition or subdivision;

● interest on money borrowed to defray subdivisional costs was claimed as a business expense;

● there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and

● buildings have been erected on the land.

No single factor will be determinative of whether the activity or activities will constitute either a business or an adventure or concern in the nature of trade.

The following discussion is centred on applying the facts of this case to the above indicators to determine whether your activities will constitute a business or an adventure or concern in the nature of trade.

Property 1

You purchased Property 1. This was your principle residence for a short period.

You decided to subdivide the land into a number of lots and build new residential homes on each of the lots. One property would become your principle residence with the rest becoming a rental property.

However, following the completion of construction of the planned rental property, you decided to sell this property.

We consider that there was a change of purpose for which the land was held, when you decided to subdivide the land and build a new residential home on the subdivided lots with the intention of commencing a rental enterprise. You subsequently decided to dispose of the newly constructed residence rather than commencing the rental enterprise. That is, your enterprise activities changed to one of property development. You had a purpose and intention to engage in a commercial activity to make a profit in both cases.

The activities undertaken are in the nature of an enterprise as you demolished the existing house, subdivided the land and built new residential homes. There was a level of development of the land beyond that necessary to secure council approval. You further obtained financing for the purpose of construction and undertook the necessary research into similar lots and houses for the purpose of making an informed decision as to the commercial viability of the project.

You have also maintained detailed records of the expenditure incurred on the project and this would have informed your decision regarding the price of Property 1.

Consequently, the sale of Property 1 will be in the course of an enterprise of property development for the purposes of section 9-5.

Example 29 in MT 2006/1 provides an example which is similar to your situation:

Example 29

273. Tobias finds an ocean front block of land for sale in a popular beachside town. He devises a plan to enable him to afford to live there. He decides to purchase the land and to build a duplex. He plans to sell one of the units and retain and live in the other. The object of his plan is to enable him to obtain private residential premises in an area that would otherwise be unaffordable for him.

274. Tobias carries out his plan. He purchases the land, and lodges the necessary development application with the local council. The development application is approved by the council, Tobias engages a builder and has the duplex built. He sells one unit, and lives in the other.

275. Tobias is entitled to an ABN. His intentions and activities have the appearance of a business deal. They are an enterprise.

276. Further, there is a reasonable expectation of profit or gain (see paragraphs 378 to 405 of this Ruling) as his plan has enabled him to be able to keep and live in one of the units.

Property 2

You purchased Property 2 as a residence pending the completion of your new primary residence at Property 1.

You submitted a Development Application for Property 2 and received Development Approval for the proposed subdivision and construction.

You contacted real estate agents in the area in which Property 2 was located for information regarding the sales of similar properties and vacant lots.

Property 2 was demolished. The purpose of subdividing it into lots and selling the subdivided vacant lots was to fund the cost of construction of the residence located at Property 1.

Prior to selling the vacant lots, you engaged a contractor to design homes which could be built on the respective subdivided lots. This was required so that you could obtain approval for subdivision of Property 2.

No business plan was prepared for this development and you managed the subdivision personally. No external financing was necessary in order to undertake the subdivision process.

We consider that there was a change of purpose for which the land was held when you decided to subdivide the land. You had a purpose and intention to engage in a commercial activity to make a profit when you did so.

The activities undertaken are in the nature of an enterprise as you demolished the existing house, engaged contractors, subdivided the land and engaged another contractor to design and obtain Development Approval for homes which would support the subdivision process and promote marketing of the vacant lots. You further undertook the necessary research into similar lots and houses for the purpose of making an informed decision as to the commercial viability of the project.

You have also maintained detailed records of the expenditure incurred on the project and this would have informed your decision regarding the price of the vacant lots.

Consequently, the sale of the subdivided, vacant lots on Property 2 will be in the course of an enterprise of property development for the purposes of section 9-5.

Was the Partnership required to be registered for GST under section 23-5 of the GST Act?

Section 23-5 states:

You are required to be registered under this Act if:

(a) you are *carrying on an *enterprise; and

(b) your *GST turnover meets the *registration turnover threshold.

Section 23-10 states further:

(1) you may be *registered under this Act if you are carrying on an *enterprise (whether or not your *GST turnover is at, above or below the *registration turnover threshold).

(2) You may be *registered under this Act if you intend to carry on an *enterprise from a particular date.

We have already established that you were carrying on an enterprise of property development when you subdivided Property 1 and built new houses in it and then subdivided Property 2 with the intention of selling the vacant Lots to fund the constructions for Property 1.

The registration turnover threshold is currently $75,000.

Subsection 188-10 provides that you have a GST turnover that meets the turnover threshold if:

● your 'current GST turnover' (your turnover for the current month and the previous 11 months) totals $75,000 or more and the Commissioner is not satisfied that your projected turnover is below the turnover threshold; or

● your 'projected GST turnover' (your total turnover for the current month and the next 11 months) is likely to be $75,000 or more.

As discussed above, the phrase ‘carry on’ in the context of an enterprise includes doing anything in the course of the commencement or termination of the enterprise.

As such, at the time that you commenced your enterprise of property development, you were entitled to register for GST pursuant to section 23-10.

At the time that Property 1 was sold, as the sales proceeds would exceed the turnover threshold, you were required to register for GST.

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