Edited version of your written advice

Authorisation Number: 1051501413453

Date of advice: 9 April 2019

Ruling

Subject: Income tax: Capital gains tax: Sale of the subdivided lots

Question 1

Will the profit from the sale of the subdivided lots of the Properties be treated as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (‘ITAA 1997’)?

Answer

No

Question 2

Are the proceeds from the disposal of the Properties assessable income pursuant to section 15-15 of the ITAA 1997, being income arising from the carrying on or carrying out of a profit-making undertaking or plan?

Answer

No

Question 3

Did the rulee hold these assets as trading stock under section 70-30 of the ITAA 1997?

Answer

No

This ruling applies for the following period:

Year ended 30 June 2018

The scheme commences on:

20 May 2015

Relevant facts and circumstances

X Family Trust

Trust X was formed in 1979. Company Y was the trustee.

Company Y was incorporated in 1978, with three individuals and each person held four shares in Company Y.

There were no shareholding changes in Company Y between 1979 and 2000. When Individual A passed away in 2000, th shares were transferred to Individual B (one of the existing Company Y shareholders). When Individual B passed away in 2016, the shares were distributed from the estate to the two sons in equal shares. The first son was also a Company Y shareholder. Currently, the first son holds eight shares and second son holds four shares in Company Y.

The beneficiaries of Trust X included the two deceased individuals as ‘Primary Beneficiaries’, and the two sons and their wives and children as ‘Secondary Beneficiaries’. The trustee has never exercised its discretionary powers to appoint additional beneficiaries.

When Individual A passed away in 2000, the two sons became the successor appointers of Trust X.

Acquisition and use of the Land

In 1979, Individual A intended to acquire farmland and a cottage to carry out a farming business and using it as a private residence respectively.

An advisor recommended that the Land be purchased by Trust X. Trust X purchased the Land for $ consideration in 1979.

The Land had a small shearing shed already on the property. The machinery shed was built in 1979 to support the farming activity. There were numerous improvements over subsequent years.

Mixed farming activities were undertaken at the Land. The farming activities included growing crops such as hay, barley, and wheat, as well as grazing cattle and sheep. The land operated as a working farm and was fully equipped with farming equipment. The farm also had dams and paddocks with water troughs. The main revenues from the farming activities were sales of lamb and hay.

The Land was continually used for the purpose of primary production. Additionally, it was also used for various other ancillary activities. These activities included:

▪ Individual A lived in the cottage for two to three years until 1981, and their future spouse then lived there for approximately one further year, until they both moved to Sydney in 1982.

▪ The cottage was rented out to a number of tenants since 1982. The cottage was always available for rent and is currently being rented out.

▪ A University leased part of the Land for a period of time to do trials.

▪ The Land was used for share farming from approximately the mid-1980s until the mid-1990s.

▪ After Individual A passed away, the entirety of the Land was leased to a neighbour for share farming. The family ceased all farming activities on the property. The neighbour has continued to undertake share farming activities and are expected to continue to do so as long as there is sufficient residual land.

The council’s rezoning proposal

In 2006 the Council drafted a Plan, which outlined the council’s vision for the future development of the area over the next 25 years.

A public consultation initiated by the Council to update local residents was held. Individual B attended a landowners‘ meeting held by the Council in early 2007.

The Council issued a letter to Company Y in 2007, outlining its intentions to conduct a local environmental study on the Land. The letter stated that the purpose of the study was to assess possible zoning changes that would be incorporated into the draft Local Environmental Plan for the area.

During 2009 and 2010 the Council publicly exhibited a Local Environment Plan and a Development Control Plan.

Trust X had no involvement in the rezoning process, which was carried out by the Council. The Land was rezoned in 2010.

Master Plan for the Land

In late 2009, a real estate agent contacted the family and stated that a interstate based developer was interested in purchasing the Land.

Trust X requested an Engineering Consulting Company to prepare an overall neighbourhood plan (the Master Plan) covering both the Land and the surrounding land. The costs were shared between Trust X and the land holders surrounding the area for the preparation of the Master Plan.

The family’s intention in obtaining the Master Plan was to receive an indication of the potential value of the Land.

The Engineering Consulting Company delivered the Master Plan in late 2011. In early 2012, the Master Plan was presented by council officers to the Council Committee, and subsequently to the councillors for adoption.

The Master Plan was approved around mid-2012.

Offers to purchase The Land

From 28 September 2009 onwards, various local real estate agents approached Trust X to discuss the possible sale of the Land. Trust X did not undertake any advertising or marketing for the sale of the Land. Trust X preferred to sell the Land in an outright sale. The following deals were considered by Trust X:

′ On and around late 2009, a interstate developer expressed interest in the Land. The proposal did not proceed as the valuation did not meet the expectations of the family.

′ In early 2013, a developer approached Trust X regarding a joint venture for the development of the Land. The offer was declined in late 2013. The family was not satisfied with the structure of the proposal or the valuations provided.

′ In late 2013, another developer approached the family to enter into a joint venture arrangement. The proposal did not proceed as the valuation did not meet the expectations of the family.

′ In late 2013, a different developer also approached the family to discuss a joint venture arrangement. The proposal did not proceed because the parties were unable to agree in relation to issues of land value and deal structure.

′ In 2012, a real estate agent approached Trust X regarding an interest from a party to purchase the Land. Negotiations continued during 2013 and 2014. However, the deal did not proceed because the party ultimately decided not to proceed with the purchase.

′ In 2014, the family was approached by the Developer to develop the Land. The Developer submitted a proposal to Trust X. The arrangement involved entering into a development agreement with a fixed level of consideration being paid to Trust X for the sale of each lot developed. Convenient

The Development and the Development Agreement

The Development Agreement was executed by Company Y and the Developer in mid-2015.

The features of the arrangement include:

Company Y appoints the Developer to undertake the Development. The Developer is responsible for the control, management, co-ordination and supervision of all activities required for the Development.

Total revenue for Trust X is estimated at $XX million over 6 to 7 years.

There are three development phases with pre-agreed prices for each lot sold (Lot Amount).

Company Y does not play any active role in undertaking or executing the Development.

The family’s main involvement in the development has been a review of the sales reports provided by the Developer approximately every 3 months and raising queries regarding particular details of those reports.

Trust X has only received the Lot Amount that it was entitled to under the Development Agreement. During the income year ended 30 June 2018, Trust X did not receive any other payments nor incurred any other costs, other than some transaction costs and water rates. These expenses were reimbursed by the Developer.

The Developer could increase the sales price for the lots if it incurred any unexpected costs. It does not require permission from Trust X, nor would it be required to pay Trust X any additional proceeds it receives from the sales of lots.

Under the Development Agreement, the Developer must pay and fund all costs and charges associated with the Development. The Development will be undertaken at the Developer’s sole risk, including the risk of obtaining the Approvals.

Company Y agrees to grant security to the Developer over any part of the Development Land. Company Y agrees to allow any security granted to be registered on the title.

Aside from the Securities provided, Company Y did not enter in, provide, or act as a guarantor for any loan in relation to, or for the purpose of, the Development.

Company Y appointed three Solicitors from a Legal Firm as attorneys to execute documents in relation to the Development. It includes signing sales documents and development documents.

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 15-15(1)

Income Tax Assessment Act 1997 subsection 15-15(2)

Income Tax Assessment Act 1997 Division 70

Income Tax Assessment Act 1997 section 70-10

Income Tax Assessment Act 1997 section 70-30

Reasons for decision

Question 1

Summary

The proceeds from the disposal of the Properties are not assessable income according to ordinary concepts under section 6-5 of the ITAA 1997.

The proceeds represent a mere realisation of a capital asset which will fall for consideration under the CGT provisions in Part 3-1.

Detailed reasoning

The sales of the Properties are not regarded as part of carrying on a business of property subdivision and sale. Therefore, the proceeds are not assessable income under section 6-5 of the ITAA 1997.

The decision of the Full High Court in Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199 is relevant when considering whether a person or entity is carrying on a business, or alternatively is earning ordinary income by way of deriving a profit from an isolated profit-making undertaking or scheme.

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

The question of whether a business is being carried on is a question of fact and degree. Over the years the courts have developed a series of indicators to determine if a business is being carried on.

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? sets out the Commissioner’s view of the indicators used to determine whether an entity is carrying on a business.

Paragraph 13 of TR 97/11 explains that the courts have held that the following indicators are relevant:

● whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators;

● 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 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, and having regard to paragraph 16 of TR 97/11, it becomes evident that no one indicator will be decisive. Whether a business is being carried on depends on the large or general impression gained from looking at all the indicators, and whether these factors provide the operations with a ‘commercial flavour’ (Ferguson v Federal Commissioner of Taxation (1979) 37 FLR 310).

Application to your situation

Individual A’s primary intention at the time of acquiring the rural property in 1979 was to carry out a farming business and use it as a private residence. Trust X has held the Land for a substantial period of time and used it to engage in mixed farming activities. It has also been leased for share farming. Currently, the Land is leased for share farming and is expected to continue to do so as long as there is sufficient residual land.

Trust X did not initiate the rezoning of the Land and was not involved in the rezoning process. It, however, requested the preparation of the Master Plan covering both the Land and the surrounding land. The cost for the preparation of the Master Plan was shared between Trust X and the surrounding land holders. Trust X intended to use the Master Plan to determine the potential yield of the Land.

Even though the nature, scale and complexity of the Development might not be considered small, the Developer had full legal and financial control of it. Consistent with the terms of the Development Agreement, all the financial risk and reward of the Development was borne by the Developer. No term of the Development Agreement (i.e. in substance or form) constituted, created or could be construed as giving rise to an agency relationship, partnership or a joint venture.

Trust X only received a fixed price for each lot sold. The terms of the Development Agreement verified that Company Y is entitled to receive the aggregate of Company Y Lot Amounts only. In the income year ended 30 June 2018, Trust X only received the Lot Amount it was entitled to under the terms of the Development Agreement. It did not receive any other payments nor incurred any other costs, other than transaction costs for sales and water rates. These costs were reimbursed by the Developer under the terms of the Development Agreement.

Trust X had minimum involvement in the Development of the Land. It only reviewed quarterly sales reports from the Developer and raised queries regarding particular details of those reports. The routine tasks required of the landowner (e.g. executing sales documents) were carried out by the Solicitor under a power of attorney. Furthermore, it did not directly undertake marketing and advertising activities on the Land.

Trust X has not at any stage taken out any finance to fund its development or disposal of the Land.

There has been no history of similar subdivision or development that Trust X or the directors of Company Y individually, were engaged in. It had also investigated the sale of the Land as one parcel before proceeding with the current arrangement.

Accordingly, on the balance of probabilities, weighing all the facts as a whole, the Commissioner is satisfied that Trust X was not carrying on a business of subdivision, development and sale. On the facts, what occurred was the mere realisation, by the most advantageous means, of the asset. Therefore, the proceeds would not be assessable income under section 6-5 of the ITAA 1997.

Question Two

Summary

The proceeds from the disposal of the Properties are not assessable income pursuant to section 15-15 of the ITAA 1997, being income arising from the carrying on or carrying out of a profit-making undertaking or plan.

Detailed reasoning

Subsection15-15(1) of the ITAA 1997 includes in assessable income profit arising from the carrying on or carrying out of a profit-making undertaking or plan. However, subsection 15-15(2) of the ITAA 1997 provides that such a profit will not be assessable under the section if it:

(a) is assessable as ordinary income under section 6-5; or

(b) arises in respect of the sale of property acquired on or after 20 September 1985.

As determined in Issue 1 above, the receipts from the sale of the properties do not constitute ordinary income and are not assessable under section 6-5 of the ITAA 1997.

Even where the sale of land is not regarded as part of carrying on a business of property subdivision and sale, a transaction entered into with the purpose of profit-making by sale could give rise to assessable income. Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income is relevant and should be considered.

The basic distinction between a development and sale of property as part of a business, or alternatively, a ‘profit making’ undertaking or scheme is that the latter will generally be a one-off event and not carried out in an overly organised or systematic manner. However, the overriding purpose and intention of the entity entering into the venture must be to make a profit.

In TR 92/3, the Commissioner states:

6. Whether a profit from an isolated transaction is income according to the ordinary concepts and usages of mankind depends very much on the circumstances of the case. However, a profit from an isolated transaction is generally income when both of the following elements are present:

a) the intention or purpose of the 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 or in carrying out a business operation or commercial transaction.

7. 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.

8. It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

9. The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property.

The Commissioner considers that Company Y has not entered into a venture to make a profit. The same facts and indicia considered in Question 1 previously apply here also. The Land was originally acquired for the purpose of carrying on a farming business and as a residence. It has been held for a substantial period of time, during which it was used in mixed farming activities. On the facts, what occurred was the mere realisation, by the most advantageous means, of the asset which Company Y had when it abandoned the intention of farming and leasing it for share farming.

Accordingly, the proceeds would not be assessable income under section 15-15 of the ITAA 1997. Instead, the proceeds represent a mere realisation of a capital asset which would fall for consideration under the CGT provisions in Part 3-1 of the ITAA 1997.

Question Three

Summary

The rulee did not hold these assets as trading stock under section 70-30 of the ITAA 1997.

Detailed reasoning

Division 70 of the ITAA 1997 deals with the tax treatment of trading stock. The term ‘trading stock’ is defined very widely to include anything produced, manufactured or acquired, that is held for manufacture, sale or exchange in the ordinary course of business (section 70-10 of the ITAA 1997). This is taken to include tangible items, such as land.

Further, Taxation Determination TD 92/124 Property Development: in what circumstances is land treated as ‘trading stock’? provides that land is treated as trading stock for income tax purposes if it is held for the purpose of resale and a business activity which involves dealing in land has commenced.

It is also accepted that the purpose of landholding could alter (e.g. from holding the properties for farming to using them in carrying on a business of property subdivision and sale). However, the Land in this case (comprising the subdivided lots) has not changed from being held as a capital asset to revenue asset or trading stock.

The principle in Californian Copper Syndicate v Harris (1904) 5 TC 159 provides that the mere realisation of capital assets, such as land, does not give rise to income according to ordinary concepts if the realisation is carried out in the most advantageous manner.

Question 1 above determines that Company Y has not engaged in a business of subdivision, development and sale. Rather, Company Y was merely realising a capital asset in the most advantageous way.

Accordingly, section 70-30 of the ITAA 1997 does not apply to make the Land already owned by Company Y as being held as trading stock.

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