Edited version of your written advice

Authorisation Number: 1051460592357

Date of advice: 07 December 2018

Ruling

Subject: Capital gains tax – land subdivision – income v capital

Question 1:

Will the proceeds made on the disposal of your ownership interest in Lot A be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

No.

Question 2:

Will the proceeds made on the disposal of your ownership interest in Lot A be assessable under Parts 3-1 and 3-3 of the ITAA 1997?

Answer:

Yes.

This ruling applies for the following periods:

Income year ending 30 June 20XX

Income year ending 30 June 20XX

The scheme commences on:

1 July 20XX.

Relevant facts and circumstances

Prior to 20 September 1985, you and your sibling (Person A) each acquired an ownership interest in a property (the Property) from a relative.

Another sibling (Person B) commenced using part of the Property for agricultural purposes prior to 20 September 1985.

Subdivisions and family excisions occurred in relation to the Property prior to the 20 September 1985 which resulted in the creation of a lot, which became Person A’s main residence, and other lots of land being resumed by the local council. Following the subdivisions the land area of the retained area of the Property was less than 15 hectares, being Lot A.

Person B inherited an ownership interest in Lot A after 20 September 1985 when your parent passed away.

After a number of years, you and Person A each inherited a further ownership interest in Lot A when your other parent passed away.

The original farm house located on Lot A has been rented out for more than 10 years with the tenant having exclusive use of the land immediately surrounding the house, tending to the gardens in that area and providing security.

Neither the Property, nor Lot A after the original subdivision, had been publicly advertised for sale, however they are located adjacent to significant developments being undertaken in the local area, and a number of unsolicited offers had been received over a number of years due to its proximity to schools, train station, shopping and medical facilities and general development in that area.

The offers received ranged from the purchase of the whole or part of Lot A, offers to enter into development arrangements, and in relation to settlement terms, short settlement terms, extended settlement terms, unconditional or subject to significant settlement conditions.

Advice from property lawyer firm, Company XYZ, was sought for the purpose of determining whether any of the offers received represented a good offer for Lot A, and whether the offers were commercially acceptable for you and your siblings.

None of the offers progressed to a formal sale agreement due to you and your siblings not agreeing on any offers received, or the future use of Lot A.

A number of years later Person B’s agricultural activities were reduced due to the sale of the part their property, when they kept the lot on which their main residence was located, which is adjacent to Lot A.

Around that time you and your siblings’ personal circumstances changed and the realisation of Lot A needed to be addressed with all of you either being passed retirement age, or contemplating retirement. Person B’s exposure to the sale process following on from the sale of part of their property provided you and Person A with the impetus to pursue the sale of Lot A.

The services of a consulting civil engineering firm were engaged to provide preliminary advice about the disposal of Lot A, as a whole or in part, and if it was worth you and your siblings undertaking the subdivision yourselves. Mud maps of potential subdivisions were prepared, which included the map included in the expression of interest undertaken (as discussed below).

It was determined that part of Lot A would be kept given that Person A and B’s residences are located in close proximity to the portion of Lot A proposed to be sold and there was a desire to introduce a buffer strip between their respective residences and the new subdivision. Additionally, you and your siblings were wishing to maintain a connection to Lot A given that it had been in your family for a significant period of time. Also Person B was contemplating winding up their farming activities undertaken on Lot A. The proposed part of Lot A to be kept, being the Retained Lot, has a land area of less than 5 hectares and has primary production activities on it which are listed as vulnerable, which you and your siblings are wishing to preserve.

The local council’s planning scheme was updated and the Lot A was rezoned as ‘General Residential’.

You and your siblings engaged the services of Company XYZ to provide legal advice in relation to the sale of the Sale Lot and to seek expressions of interest (EOI) for its sale.

A subsequent closed EOI was undertaken. The EOI tender document included the following information:

● the Seller is offering for sale the Sale Lot to be created from Lot A;

● interests associated with the Seller are retaining the Retained Lot;

● the Seller will not be required to make any contribution towards any road works, kerbing, channelling or paving works, including in relation to the Retained Lot;

● settlement is:

● to be effected on or before a specified period from the Option Agreement date;

● not subject to the Buyer securing a development approval for the Sale Lot; and

● subject to a separate title being created for the Sale Lot;

● the successful tenderer (the Buyer) will be responsible for the following:

● enter into a Put and Call Option Agreement (Option Agreement) with a contract annexed with the option not to be exercised until after a specified date;

● pay a Call Option Fee of a specified percentage of the Purchase Price within a set period of the Buyer and Seller entering into the Option Agreement. The Call Option Fee is to be released to the Seller on the condition that the Seller is not in default at the Settlement Date;

● settle the purchase of the Sale Lot within a specified period of the entry into the Option Agreement;

● construct a fence to separate the Retained Lot from the Sale Lot;

● prepare all documentation and do all things necessary to obtain approval for the reconfiguration of the Lot A;

● procure separate titles for the Sale Lot and the Retained Lot;

● incorporate road reserves and infrastructure that will be able to be accessed by the Retained Lot;

● conduct the necessary road works to upgrade a surrounding road, including kerbing, channelling and pavements, and including to the front of the Retained Lot;

● payment of local authority rates assessed against the Sale Lot prior to Settlement date;

● preparation of contract documents;

● provide access to the Seller to a specified area of the Sale Lot’, and to have access to water to irrigate the crops from the dams located on the Sale Lot until such time as the Buyer gives notice that development of that part of the Sale Lot will be physically commencing and the Buyer requires the farming activity to cease. The Buyer will not be liable to the Seller for any loss of crop/s.

As a result of the EOI process an offer was received for the Sale Lot, which was the highest offer. The offer has not been finalised into a contract at this time due the contractual terms requiring confirmation of the Goods and Services Tax status of the sale.

You and your siblings, being Persons A and B, will not undertake any activities in relation to the subdivision of Lot A other than signing any relevant documentation required to effect the subdivision. It is anticipated that the services of Company XYZ will be retained to provide legal advice to confirm that the subdivision activities are undertaken in accordance with the sale contract once it has been negotiated and entered into.

You and your siblings will retain your ownership interests in the Retained Lot, with the Purchaser becoming the registered owner of the Sale Lot.

Lot A is currently zoned ‘Residential’ and is held as tenants in common by you and Persons A and B.

You and your siblings have not undertaken any property development businesses in the past.

Assumption

The following assumptions have been made for the purpose of providing this ruling:

● the subdivision of Lot A that is the subject of this private ruling will be undertaken in accordance with the terms as outlined in the EOI tender document; and

● the diagram of the proposed subdivision provided with the EOI will be a true reflection of the subdivision of the Property.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Legislative references referred to herein are from the ITAA 1997.

Summary

Any profit made from the sale of your ownership interests in the Property will not be ordinary income and not assessable under section 6-5. The proceeds represent a mere realisation of capital assets which will fall for consideration under the capital gains tax provisions in Parts 3-1 and 3-3.

You acquired ownership interests in the Property both before and after 20 September 1985. Therefore you have both pre-capital gain tax and post-capital gains tax assets. Any capital gain or capital loss made on the sale of your pre-capital gains tax ownership interest in the Property can be disregarded. Any capital gain or capital loss made on the sale of your post-capital gains tax ownership interest will be calculated using the general CGT provisions.

Detailed reasoning

Taxation treatment of property sales

There are three ways profits from a land sub-division can be treated for taxation purposes:

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

(2) As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of an isolated commercial 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.

(3) As statutory income under the capital gains tax (CGT) legislation, (sections 10-5 and 102-5), on the basis that a mere realisation of a capital asset has occurred.

Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case.

Carrying on a business of property development

Section 995-1 states the term ‘business’ includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

The Commissioners view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? (TR 97/11). Although Tax Ruling TR 97/11 deals with the issues of determining whether a taxpayer is carrying on a business of primary production, the same principles can be applied to the question of whether a taxpayer is in the business of property development.

Paragraph 13 of TR 97/11, uses the following indicators to determine whether a taxpayer is carrying on a business:

● whether the activity has a significant commercial purpose or character;

● whether there is repetition and regularity of the activity;

● whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business;

● whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit;

● the size, scale and permanency of the activity; and

● whether the activity is better described as a hobby, a form of recreation or a sporting activity.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavor.

Isolated business transactions

Profits arising from an isolated transaction as a result of entering into a profit-making undertaking or scheme will be ordinary income under section 6-5, on revenue account, (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693 (Myer Emporium)). This is distinguished from a ‘mere realisation’ which is not ordinary income.

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) sets out the Commissioner’s view on the application of the decision in Myer Emporium and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 as ordinary income.

Paragraph 1 of Taxation Ruling TR 92/3 provides that the term isolated transactions refers to:

a) those transactions outside the ordinary course of business of a taxpayer carrying on a business; and

b) those transactions entered into by non-business taxpayers.

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

a) the intention or purpose of a 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 operation or commercial transaction.

In general, whether a profit from an isolated transaction is income according to ordinary concepts depends very much on the individual circumstances of the case.

Paragraph 13 of TR 92/3 lists the following factors which are relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction include:

● the nature of the entity undertaking the operation or transaction;

● the nature and scale of other activities undertaken by the taxpayer;

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

● the nature, scale and complexity of the operation or transaction;

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

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

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

● the timing of the transaction or the various steps in the transaction.

In determining whether activities relating to isolated transactions are a profit making undertaking or are the realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. This may require a consideration of the factors outlined above; however there may also be other relevant factors that need to be weighed up as part of the process of reaching an overall conclusion. No single factor will be determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

Capital gains tax

The capital gains tax (CGT) provisions are contained in Parts 3-1 and 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 under section 104-10 happens if your ownership interest in a CGT asset is disposed of. Under subsection 104-10(1), CGT event A1 occurs when you enter into a contract to dispose of the CGT asset.

Under subsection 104-10(2), any capital gain or capital loss you make is disregarded if you acquired the CGT asset prior to 20 September 1985.

When a CGT asset (the original asset) is split into 2 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

In your case, you acquired an ownership interest in the Property in 1979, being a pre-CGT ownership interest.

The Property was subdivided prior to 20 September 1985, with the remaining land being Lot A.

You inherited a further ownership interest in Lot A after 20 September 1985, being a post-CGT ownership interest.

Your siblings, Persons A and B, hold the other ownership interests in Lot A.

Part of Lot A has been used by Person B in relation to their agricultural activities since prior to 1985. The house located on Lot A has been rented out for more than 10 years.

You and your siblings have either retired, or are considering retiring in addition to you contemplating winding up your agricultural activities on Lot A. Due to your personal circumstances, you and your siblings have decided to sell part of Lot A, the Sale Lot, as Person A and B’s main residences are located adjacent to Lot A and you wish to keep a buffer between the new developments and their respective homes.

It is proposed that part of Lot A will be sold, being the Sale Lot which has a land area of less than 15 hectares. The remaining portion of Lot A, being the Retained Lot, has a land area of less than 5 hectares.

An EOI process was undertaken to sell the Sale Lot, with a tender document being prepared in addition to a diagram of the proposed subdivision of Lot A, which was provided with the tender document.

An offer of was received in response to the EOI. In accordance with the terms of the EOI, as outlined in the tender document, the buyer will undertake all activities in relation to the subdivision of the Property such as:

● prepare contract documents;

● enter into an Option Agreement and contract annexed to the agreement;

● organise the subdivision of Lot A into the Sale Lot and Retained Lot;

● pay and conduct necessary road works, kerbing, channelling and paving works;

● construct a fence between the Sale Lot and Retained Lot;

● prepare documentation, and do all activities required to obtain approval for the reconfiguration of the Property; and

● obtain separate titles for the Sale Lot and Retained Lot.

You and your siblings will not be involved in the subdivision activities except to sign any relevant documentation in relation to the subdivision activities.

No other subdivision activities have been undertaken by you and/or your siblings in the past.

Based on the information provided and after weighing up the indicators as outlined in TR 97/11, there is nothing to suggest that the subdivision of Lot A and the sale of the Sale Lot was the beginning of a continuing business of property subdivision. Your activities do not display the salient indicator of a business, being transactions entered into on a continuous and repetitive basis. Therefore, it is the Commissioner’s view that your activities in relation to the sale of the Sale Lot are not those of an entity carrying on a business of buying, subdividing and selling subdivided land.

Making an overall assessment on the factors set out in TR 93/2 and applying them to the facts of your situation, it is the Commissioner’s view that the sale of the Sale Lot will not be considered commercial in nature but will be a mere realisation of a capital asset, being ownership interests in a long-held privately owned property.

Therefore, as the sale of your ownership interests in the Sale Lot it is not viewed as being the carrying on of a business, or that the it will be an isolated transaction, any profit arising from the sale of your ownership interests in the Sale Lot will be a mere realisation of your assets which will be accounted for under the CGT provisions in Parts 3-1 and 3-3.

Note: A CGT event A1 will occur on the disposal of each of your ownership interests in Lot A. Any capital gain made on the sale of your pre-CGT ownership interest in the Sale Lot will be disregarded.

Any capital gain made on the sale of your post-CGT ownership interest in the Sale Lot that you inherited will be calculated using the general CGT provisions. If you meet the conditions contained in Division 115 you will be entitled to reduce any capital gain made on the sale of your post-CGT ownership interest by applying the 50% CGT discount to the capital gain amount.

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