Edited version of private advice

Authorisation Number: 1051776799282

Date of advice: 23 November 2020

Ruling

Subject: Property subdivision - one off commercial transaction

Question 1

Will the profit from the sale of the lots be treated as ordinary income under section 6 -5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of the taxpayer carrying on a business of property development?

Answer

No.

Question 2

Will the profit from the sale of the lots be treated as ordinary income under section 6-5 ITAA 1997 as a result of an "isolated transaction" carried out for profit and commercial in character?

Answer

Yes.

Question 3

Will the whole of the profit from the sale of the lots be treated as statutory income under the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997?

Answer

No.

Question 4

Will your sale of the lots be a taxable supply pursuant to section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (the GST Act)?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20YY

The scheme commences on:

1 May 20XX

Relevant facts and circumstances

The taxpayers began a search for a property, of land size of between 1-2 hectares to construct a main residence upon. The taxpayers are neither registered for GST individually or as a partnership

After searching for some time, it appeared the area did not have any building blocks available of the size the taxpayers required as they were too large. They found a property (the Property) which they liked but it was too large for their needs.

The taxpayers came to find through real estate agents that council zoning in the area had changed to allow such larger lots to be subdivided into smaller lots. This change had occurred in the year prior to purchase and lifted the restriction on land size, allowing for larger parcels of land to be subdivided into smaller lots of no less than 1 hectare.

Given the absence of smaller blocks and a need to relocate, the taxpayers made initial enquiries if a subdivision was possible of the Property. They were advised it was possible.

The taxpayers bought the Property with the knowledge that the surplus land in excess of their requirements could be subdivided and sold off. The property was purchased to be the main residence of the taxpayers

The taxpayers have resided on the property since acquisition and intend on doing so for the foreseeable future and have renovated the existing buildings.

Within a month of the Property settling, the taxpayers commenced the process of subdividing the property to effectively create 3 titles. The existing title with the dwelling on it is to remain as the taxpayer's main residence, the two newly created titles are to be sold as vacant land.

Within 12 months of purchase conditional approval was given by the council for the subdivision. A town planner, surveyor and environmental engineer were initially engaged to prepare a submission to council for approval.

Contractors were subsequently engaged to complete the access roadway, electrical and telecommunications conditions as required by council.

The development of the land was only to the extent of council requirements for the approval. The works are completed. The taxpayers did not seek any borrowings from financial institutions to fund the subdivision costs relying on earnings derived from their business, which they operate through a company structure.

The subdivided land is currently for sale.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

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

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

A New Tax System (Goods and Services) Tax Act 1999 Section 23

A New Tax System (Goods and Services) Tax Act 1999 Section 188-10

A New Tax System (Goods and Services) Tax Act 1999 Section 188-25

Reasons for decision

Summary

The net proceeds of sales by the of subdivided lots of land will be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of an "isolated transaction" carried out for profit and commercial in character.

In addition, the sales of the subdivided lots are considered a taxable supply under section 9-5 of A New Tax System (Goods and Services) Tax Act 1999 (theGST Act).

Detailed reasoning

Income tax

Proceeds from the sale of land will be taxed for income tax purposes in one of the following ways:

•         as ordinary income where the land is held as trading stock and sold as part of a business under section 6-5 of the ITAA 1997;

•         as ordinary income, where land is not trading stock and is sold as part of an isolated commercial transaction entered into with a profit-making intention under section 6-5; or

•         on capital account, where the proceeds of sale are a mere realisation of a capital asset under the CGT provisions in Part 3-1 and Part 3-3 of the ITAA 1997.

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 of the ITAA 1997 states the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

The Commissioner's 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? which 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 flavour.

Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock? (TD 92/124) 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.

Isolated 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 of the ITAA 1997, 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 ('TR 92/3') discusses the application of the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are ordinary income and therefore assessable under section 6-5. It refers to isolated transactions' as:

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

•         those transactions entered into by non-business taxpayers.

TR 92/3 also provides that profits from an isolated transaction will be income when:

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

For an isolated transaction to be considered to be of a business or commercial nature, it is usually necessary that a taxpayer has the purpose of profit-making at the time of acquiring the property. In Myer Emporium, the Full High Court said the following about the nature of profits from isolated transactions and the purpose of profit-making at the time of acquisition:

It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of acquisition of acquiring for the purpose of profit-making by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realisation. But it is quite another thing if the decision to sell is taken by way of implementation of an intention or purpose, existing at the time of acquisition, of profit-making by sale, at least in the context of carrying on a business or carrying out 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. Matters listed in TR 92/3, which are relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction include:

(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.

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.

Mere realisation

Where the sale is a 'mere realisation' the sale is on capital account to which the CGT rules will generally apply. These proceeds are not ordinary income.

A sale that is more than a 'mere realisation' will be on revenue account and proceeds will generally be assessable as either income from carrying on of a business or income from a profit-making undertaking or scheme.

The expression 'mere realisation' is used to distinguish a mere realisation from a business operation or a commercial transaction carrying out a profit-making scheme.

Profits made on the realisation of capital assets can still be ordinary income if the activities go beyond a mere realisation and instead become a separate business operation or commercial transaction even though the taxpayer did not have a purpose of profit-making at the time of acquiring the asset.

In McClelland v. FC of T [1970] HCA 39, for example, the Privy Council held that the question to be answered was whether the facts revealed a mere realisation of capital, albeit in an enterprising way, or whether they justify a finding that the taxpayer went beyond this and engaged in a trade of dealing in the asset, albeit on one occasion only.

Lord Justice Clark, in distinguishing between proceeds that are mere realisation of capital and ordinary income, stated in California Copper Syndicate v Harris (1904) 5 TC 159 at pp 165-166 that:

...What is the line which separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be determined being - is the sum of the gain that has been made a mere enhancement of value by realising a security, or is it a gain made in an operation of business in carrying out of a scheme of profit-making?

In FC of T v. Whitfords Beach Pty Ltd 82 ATC 4031, Gibbs CJ similarly said (at 4034), that:

When the owner of an investment chooses to realize it, and obtains a greater price for it than he paid to acquire it, the enhanced price will not be income within ordinary usages and concepts, unless, to use the words of the Lord Justice Clerk in California Copper...'what is done is not merely a realisation or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business'.

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 considers at paragraphs 262 to 270 whether isolated property transactions, including those involving the subdivision and sale of land, are considered to be a profit making undertaking or scheme, as opposed to the mere realisation of a capital asset.

Paragraphs 264 to 266 of MT 2006/1 state:

264. The cases of Statham & Anor v. Federal Commissioner of Taxation (Statham) and Casimaty v. FC of T (Casimaty) provide some guidance on when activities to subdivide land amount to a business or a profit-making undertaking or scheme. In these cases, farm land was subdivided and sold. Minimal development work was undertaken to meet council requirements and to improve the presentation of certain allotments. On the particular facts of these cases the courts held that the sales were a mere realisation of a capital asset.

265. From the Statham and Casimaty cases a list of factors can be ascertained that provide assistance in determining whether activities are a business or an adventure or concern in the nature of trade (a profit-making undertaking or scheme being the Australian equivalent, see paragraphs 233 to 242 of this Ruling). If several of these factors are present it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows:

•         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.

266. In determining whether activities relating to isolated transactions are an enterprise or are the mere 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.

Application to your circumstances

There is a change of purpose for which the land is held

There was no change for which the land was held but it was acquired for dual purposes. Based on the facts as presented, the property was acquired primarily as a main residence but also with the intention of subdividing and selling a portion of the land as taxpayers wanted a smaller block and to offset acquisition and subdivision costs. According to the taxpayers, suitable smaller blocks were not previously available. Though not the dominant purpose for acquiring the land, the subdivision of the land was still a significant purpose of acquiring the land.

Additional land is acquired to be added to the original parcel of land

There was no additional land acquired to enhance the scale of the activity.

The parcel of land is brought into account as a business asset

The land has not been brought to account as a business asset. There has been no accounting/tax treatment suggesting the land is a business asset. It is assumed subdivision costs were paid out of company profits and not claimed by the company as business expenses.

There is a coherent plan for the subdivision of the land

In this instance there was a coherent plan in place for the subdivision of the land and the taxpayers engaged a number of professionals to conduct the various aspects of the subdivision and development. Action was taken almost immediately once the land was acquired.

There is a business organisation - for example a manager, office and letterhead

Although the taxpayers conduct a separate consultancy business through a company, they do not portray themselves as property developers in any form. The very nature of subdivisions of property involve business-like organisation and activity. A number of professionals were engaged to sub-divide, develop and market the properties

Borrowed funds financed the acquisition or subdivision

Funds were borrowed from a financial institution to acquire the property. Subdivision costs were funded by borrowings from the taxpayer's consultancy business.

Interest on money borrowed to defray subdivisional costs was claimed as a business expense

The taxpayer's consultancy business funded the subdivision costs. The taxpayers borrowed the subdivision costs from their company.

There is a level of development of the land beyond that necessary to secure council approval for the subdivision

The taxpayers completed the minimum council requirements, no further structures were constructed, or developments undertaken.

Buildings have been erected on the land

While they have renovated the existing house they use as their main residence, as above no further structures have been established on the subdivided properties.

Income Tax Summary

It is accepted that the taxpayers' primary intention was to acquire land of a suitable size to use as their primary residence. The acquisition of a larger block which could be subdivided was another dominant purpose as it was their means of achieving their primary aim. This had the added advantage of offsetting acquisition and subdivision costs to reduce the cost of acquiring their own home.

While the taxpayers had no experience in property development, they engaged experts to undertake the subdivision of the land and a real estate agent to sell the lots.

It is considered that while the proposed size and scale of the activity does not reflect a business of land development, the subdivision and subsequent development was carried out in a business-like manner.

Having regard to these factors, the Commissioner considers that, on balance, the taxpayers did undertake an isolated commercial transaction in developing the land. They acquired the land with the intention to subdivide it and did so, commencing the process within days of acquisition.

We consider the profits from the sale of the two blocks will be assessable as ordinary income under subsection 6-5(1) of the ITAA 1997.

As it is considered that the profits will be assessable as ordinary income, the capital gain tax provisions do not need to be considered.

GST Treatment

Section 9-5 of the GST Act provides that 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 to the indirect tax zone (Australia); and

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

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

In this case, the sale of the Lots will be made for consideration and is located in Australia. As such we will consider whether the sale of the Property is made in the course or furtherance of an enterprise that you carry on and if so, as you are not registered for GST, whether you are required to be registered.

Enterprise

The term 'enterprise' is defined for GST purposes in section 9-20 of the GST Act and includes, among other things, an activity or series of activities done:

•         in the form of a business (paragraph 9-20(1)(a)) or

•         in the form of an adventure or concern in the nature of trade (paragraph 9-20(1)(b)).

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 discussed above at paragraphs 22 and 23, 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.

In the form of a business

Paragraphs 170 to 179 of MT 2006/1 discuss factors to consider when determining whether an activity or series of activities are done in the form of a business. Paragraph 178 of MT 2006/1, with reference to Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production?

In your case, and as discussed above, we consider the facts do not support you are carrying on an enterprise in the form of a business.

We will consider whether your activities are an activity in the form of an adventure or concern in the nature of trade.

In the form of an adventure or concern in the nature of trade

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 245 of MT 2006/1 refers to 'the badges of trade' with paragraphs 247 to 257 discussing the various 'badges of trade' that may be taken into account when determining whether assets have the characteristics of 'trade' and held for income producing purposes, or held as an investment asset or for personal enjoyment.

While an activity such as the selling of an asset may not of itself amount to an enterprise, account should be taken of the other activities leading up to the sale to determine if an enterprise is carried on.

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.

Paragraph 23 above lists the factors from MT 2006/1 we consider in determining whether an activity is a business or an adventure or concern in the nature of trade with reference to real property transactions.

We consider that it is relevant that you conducted research on whether subdivision was possible and when you found that it was you acquired a property that had excess land to your needs

Paragraphs 252, 253 and 266 of MT 2006/1 provide the following commentary:

252. Improving property beyond preparing an asset for sale, to bring it into a more marketable condition and gain a better price suggests an element of trade.

253. Trade involves operations of a commercial character. As assets can be sold for reasons other than trade, the circumstances behind the sale need to be considered. For example, a quick resale may have occurred as a result of sudden financial difficulties.

266. In determining whether activities relating to isolated transactions are an enterprise or are the mere 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.

Example 28 and 29 at paragraphs 271 to 276 of MT 2006/1 provides an example which we consider to be on foot with yours.

Examples of subdivisions of land that are enterprises

Example 28

271. Stefan and Krysia discover that the local council has recently changed its by-laws to allow for smaller lots in the area. They decide to take advantage of the by-law change. They purchase a block of land with the intention to subdivide it into two lots and to sell the lots at a profit. They carry out their plan and sell both lots of land at a profit.

272. Stefan and Krysia are entitled to an ABN in respect of the subdivision on the basis that their activities are an enterprise being an adventure or concern in the nature of trade. Their activities are planned and carried out in a businesslike manner.

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

Therefore in weighing up all of the facts of this case, and in line with our ruling the profits are assessable as ordinary income, we consider that your activities amount to an enterprise.

GST registration

Section 23-5 of the GST Act provides that you are required to be registered for GST if you are carrying on an enterprise and your GST turnover meets the registration turnover threshold, currently $75,000.

We have already established that you are continuing to carry on an enterprise of subdivision.

Relevantly, your GST turnover will not exceed the registration turnover threshold if your projected turnover is at or below $75,000. In your case the sale of the blocks will be revenue assets and therefore included in your turnover. As these amounts exceed $75000 your projected turnover will exceed the registration turnover threshold and you will be required to be registered for GST.

Conclusion

As you are required to be registered for GST and you meet the other requirements of section 9-5 your supply of the Property will be a taxable supply.

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