Edited version of private advice

Authorisation Number: 1051493427541

Date of advice: 27 June 2019

Ruling

Subject: Property Development

Question 1

Do the property development activities amount to the carrying on a property development business?

Answer

No

Question 2

Will the profits from the property development activities be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as an isolated profit making transaction?

Answer

Yes

Question 3

Will the profits from the property development activity be calculated with reference to the market value of the property at the time it was ventured into the profit making scheme.

Answer

Yes

Question 4

Will the sale of the subdivided lots be accounted for under the capital gains tax (CGT) provisions?

Answer

Yes, however any resulting capital gain will be reduced to the extent that any amounts are included in your assessable income under another provision.

This ruling applies for the following period:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You own land that was acquired pre-CGT. Part of this land was developed by an unrelated third party in XXXX. The third party approached you to undertake the prior development.

Historically, farming activities were conducted on the land consisting of dairy farming and beef production in addition to hay making and the farming of various other crops.

There is a residential property on the land, which has been primarily occupied by various family members.

Part of the land has been rezoned as residential; the remainder of the land is below the flood standard and is not suitable for residential use.

You do not hold any other substantial assets.

It is likely that the remaining land, not included in the property development activities described below, will be disposed of at some point in the future.

The Property Development Activities

As a result of the long term illness and subsequent death of two of the shareholders, the shareholders made the decision that it would be difficult to continue farming operations in the future.

The shareholders therefore agreed that the property should be realised in the most advantageous manner.

The directors and shareholders do not have any experience in property development or the building industry.

The directors and shareholders are not capable of undertaking the entire subdivision themselves due to their inexperience in this area.

It was therefore considered that you would best maximise the return on the land by obtaining approval to undertake a subdivision of the land into residential lots, and then engaging a third party to undertake the subsequent subdivision works and sale of the subdivided lots.

You submitted an application for re-zoning.

The subdivision application in relation to the re-zoned land was and approved as a four stage development, subject to various conditions being met. The development consent was later amended to alter the numbering of the four stages.

You undertook the following activities in order to obtain approval for the subdivision and satisfy approval conditions with a view to making the project viable to a property developer:

·         Re-zoning application

·         Survey work, stormwater strategy

·         Development application

·         Commissioning of environmental, heritage, traffic, and archaeological studies/reports as required to satisfy approval conditions.

There was no attempt to dispose of the property in its entirety.

Several parties approached you to undertake a joint venture but this did not proceed.

Legal and accounting advice was sought in 20XX as to the potential tax consequences of engaging a third party to undertake the development.

You entered into a Project Management Agreement (PMA) with X ("the Project Manager").

Under this agreement, the Project Manager will develop and market the residential lots in return for a fee.

You have borrowed the funds necessary for the development. This has been repaid from the sale of the lots in the first stage of the development.

It is intended that the subdivision be undertaken in four stages. The Project Manager considers it most appropriate to undertake Stage 3 first (XX residential lots). Accordingly, you lodged a Section 96 application with the council to modify the consent to allow alteration of the stages only. Stage 3 therefore became the new Stage 1.

The Project Manager has no beneficial or equitable interest in the Land for the term of the PMA.

The Project Manager is responsible for all outgoings in relation to the development from the date of the PMA. This does not include land rates and other taxes which relate to the englobo (undeveloped) part of the land.

The Project Manager will obtain the required funding for the project. The borrower under the Project Finance Facility will be you.

The Land (as defined in the PMA) may be (and will be) used as security for the Development Finance. The security provided by you is limited to a registered mortgage over the land and adjoining land owned by you.

You must not grant any security encumbrance over the land or otherwise deal with or dispose of the land, except as permitted under the PMA. The Project Manager may register a caveat over the Land noting its interest under the PMA.

The Project Manager undertakes to carry out its responsibilities as an independent party and assumes all the risks of doing so.

You must provide permanent access to the Land at all reasonable times and shall not hinder the Project Manager from carrying out its activities.

You have executed a Power of Attorney to appoint the Project Manager as its representative to execute any sale contract on developed lots, execute any document required under a sale contract and do all things required under any standard sale contract. Contracts and Transfers for sales made have been signed by the Project Manager as attorney.

You must pay to the Project Manager the Fee as calculated in accordance with the PMA.

All decisions relating to the subdivision are made in isolation by the Project Manager in accordance with the terms of the PMA, e.g. subdivision layout, selection of contractors, funding, sales and marketing etc.

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 104-10

Income Tax Assessment Act 1997 Subsection 108-70(3)

Income Tax Assessment Act 1997 Section 108-80

Income Tax Assessment Act 1997 Section 118-20

Reasons for decision

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; and/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.

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? 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:

·         whether the activity has a significant commercial purpose or character

·         whether the taxpayer has more than just an intention to engage in business

·         whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

·         whether there is regularity and repetition of the activity

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

·         whether the activity is planned, organised and carried on in a businesslike manner such that it is described as 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 sporting activity.

No one factor is decisive. The indicators must be considered in combination and as a whole.

In your situation, the Commissioner is satisfied you are not carrying on a business of property development. However, the profits from the sale of the property may still be assessable as ordinary income, if those profits are considered to be from an isolated commercial transaction.

Isolated Transaction

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.

It is not always necessary that the taxpayer has the purpose of profit making at the time of acquiring the property. TR 92/3 provides that if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either:

• as the capital of a business; or
• into a profit making undertaking or scheme with the characteristics of a business operation or commercial transaction,

the activity of the taxpayer constitutes the carrying on of a business or a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income although the taxpayer did not have the purpose of profit making at the time of acquiring the asset.

Paragraphs 13 and 49 of TR 92/3 provide a list of factors that may be relevant when considering whether an isolated transaction amounts to a business operation or commercial transaction. These are:

(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.

A number of cases have considered the factors relevant in determining if a property development In Casimaty v Federal Commissioner of Taxation 97 ATC 5135 (Casimaty), the legal principles in relation to the subdivision of land were discussed at length. In concluding his judgment that the subdivision of the taxpayer was a mere realisation of a capital asset, Justice Ryan said:

A related consideration is the fact that the development and subdivision of (the property) was undertaken piecemeal in response to the exigencies of increasing debt and deteriorating health. No coherent plan was conceived at the outset for the subdivision of the whole property, even in stages, to maximise the return from the aggregate of the individual lots.

Nor did the taxpayer undertake any works on, or development of, the land beyond what was necessary to secure the approval by the municipal authorities of the successive plans of subdivision and enhance the presentation of individual allotments for sale as vacant blocks. Had he constructed dwelling houses, internal fencing or other improvements, it would have been easier to impute to him an intention to carry on a business of land development and improvement.

Similarly, it was found in Statham & Anor v Federal Commissioner of Taxation ATC 4070 (Statham & Anor) that the disposal of the taxpayer's subdivided land was a mere realisation of a capital asset. In that case, the taxpayers decided to sell the land following a failed business; after lodging plans for subdivision with their local council, they left development works for the subdivision in the hands of the council.

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.

Any capital gain from CGT event A1 is disregarded if the asset was acquired prior to 20 September 1985 (paragraph 104-10(5)(a) of the ITAA 1997).

However, under subsection 108-70(3) of the ITAA 1997, capital improvements to a pre-CGT asset that are related to each other may be treated as a separate CGT asset if the total of their cost bases when a CGT event happens (for example a disposal) in relation to the asset is:

·         more than the improvement threshold for the relevant income year, and

·         more than 5% of the capital proceeds from the event.

Section 118-20 of the ITAA 1997 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.

Any capital gain you make will be reduced under 118-20 of the ITAA 1997 to the extent that the profit from the sale of the properties is otherwise included as assessable income including under section 6-5 of the ITAA 1997.

Application to your circumstances

Taking all of the facts into consideration, and on weighing the various factors, you are considered to have entered into a profit making scheme or undertaking.

We acknowledge that while the land was original acquired for a primary production purpose, we consider that there has been a change in the purpose for which the property is held. The primary production activities have significantly decreased. An offer was made to undertake a joint venture to develop the land and subsequently it was determined that the company would engage a developer directly. There were never any attempts made to sell the property in its entirety.

You submitted that the development works go no further than what is necessary to prepare the land to be sold as smaller parcels. Although you contend that there will be no additional structures or amenities added to the land beyond what the council requires, this must be considered in the context of the level of activity required for the development and not simply based on the fact that the parties carried out what council required them to do. While you contend that your role will be passive, ultimately you, as the legal owner, bared significant financial risk in entering into the transaction.

The Project Management Agreement shows that the development will be carried out in a planned, organised and business-like manner; thereby indicating a significant commercial purpose. We note that the land will be developed over four stages over a number of years. You remain the legal owner of the land throughout the development process

Significant expenses will be incurred in relation to the development compared to the property's market value. There was a degree of financial risk involved in the development which rested directly with you as legal owner of the land. Although the funds borrowed have in fact been repaid out of profits from the sales from stage one of the project, the land was initially used as security for the finance facility.

Your circumstances can be distinguished from Casimaty and Statham and Anor due to the scale of the activities, and the commercial nature on which the agreement is based. Unlike in Casimaty, where the taxpayer undertook the development in a piecemeal manner with no coherent plan, in this case under the agreement there is a clear intention over the next several years to develop the property into X blocks in a deliberate and organised manner comprising of four stages. The commercial agreement between you and the developer is unlike the nature of the arrangement in Statham and Anor.

Conclusion

Proceeds from the sale of the subdivided blocks will constitute a profit from an isolated transaction and should be included as ordinary income under section 6-5 of the ITAA 1997.

In this case, the profit making transaction arose after there was a change of intention for which the property was held. In determining the net profit that will arise from the sale of the blocks of land, the sale proceeds can be reduced by an appropriate amount based on the market value of the land at the time it was ventured into the profit-making scheme.

CGT event A1 will occur on the disposal of the subdivided blocks, the disposal of each lot will be viewed as an isolated transaction. The property was acquired prior to 20 September 1985 and accordingly, the capital gain from the land would be disregarded. However, you should consider whether capital improvements made to the land constitute separate post-CGT assets under 108-70(3) of the ITAA 1997.

Any capital gain that may arise will be reduced to the extent any profit is also assessable under section 6-5 of the ITAA 1997.

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