Edited version of private advice

Authorisation Number: 1051792738625

Date of advice: 18 January 2021

Ruling

Subject: Income tax - capital gains tax - real property

Question 1

Does the portion of the Land acquired before 20 September 1985 maintain its pre-CGT asset status, as per section 149-10 of the Income Tax Assessment Act 1997 (ITAA 1997) upon its disposal?

Answer

Yes

Question 2

Will the profit from the sale of the interest in the Land purchased prior to 20 September 1985 be assessable under section 15-15 of the ITAA 1997?

Answer

No

Question 3

Are the proceeds from the disposal of the portion of the Land acquired after 19 September 1985 subject to capital gains tax (CGT) under Parts 3-1 and 3-3 of the ITAA 1997?

Answer

Yes

Question 4

Are the proceeds from the disposal of the portion of the Land acquired after 19 September 1985 assessable income under section 6-5 of the ITAA 1997?

Answer

No

This ruling applies for the following period:

Year ending 30 June 20VV

The scheme commences on:

1 July 20TT

Relevant facts and circumstances

Your wider family group owns properties to conduct primary production activities.

In partnership with another entity you purchased a property before capital gains was introduced.

The philosophy of both partners was for long term ownership of property.

The Land/Property

The land which is the subject of this ruling is an undeveloped portion of a property purchased before 1985, called the Land. When purchased the future use of the Land was not determined.

At the time of the purchase you and your partner were not land developers. From the time of its acquisition primary production activities have been conducted on the Land.

Funding for the purchase of the pre 1985 Property was predominantly acquired using existing available capital.

For many years you used the Land for primary production. Primary production activities ceased recently for health reasons.

In recent years, as the main primary producer aged, you made enquiries about development approvals for the Land.

Development approval for the Land was sought and approved in 20JJ, in case the sale of the Land was a possibility.

Communication with the Council was maintained so that the approval would not lapse. No development on the Land occurred as the Land continued to be used for primary production in conjunction with other land held by your group.

Since ceasing primary production the Land has been dormant.

Sale of land

For personal and other reasons, the controllers of the business activities decided to sell the Land. The undeveloped Land was subsequently sold in 20FF to an unrelated party.

The Trust

There have been no inclusions to the beneficiaries of the Trust deed for the period including 20 September 1985 and up to the time the land was sold.

Any distributions made by you for the period 20 September 1985 to the date of the sale of the land have been only made to family members.

Reasons for decision

Question 1

Summary

The interest in the Land acquired prior to 20 September 1985 retains its pre-CGT status.

Detailed explanation

Division 149 of the ITAA 1997 provides the rules which determine when an asset acquired by a taxpayer before 20 September 1985 is treated as being acquired after that date for capital gains tax (CGT) purposes.

Section 149-10 of the ITAA 1997 provides as follows:

A CGT asset that an entity owns is a pre-CGT asset if, and only if:

(a) the entity last acquired the asset before 20 September 1985; and

(b) the entity was not, immediately before the start of the 1998-99 income year, taken under:

(i) former subsection 160ZZS(1) of the Income Tax Assessment Act 1936; or

(ii) Subdivision C of Division 20 of former Part IIIA of that Act;

to have acquired the asset on or after 20 September 1985; and

(c) the asset has not stopped being a pre-CGT asset of the entity because of this Division.

Section 149-30 of the ITAA 1997 provides that an asset of a non-public entity stops being a pre-CGT asset at the earliest time when the majority underlying interests in the asset were not held by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985.

The definition of 'Majority underlying interests' in a CGT asset is contained in section 149-15 of the ITAA 1997, which relevantly provides:

(1) Majority underlying interests in a CGT asset consist of:

(a) more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset; and

(b) more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in any ordinary income that may be derived from the asset.

Relevantly, ultimate owners include individuals: subsection 149-15(3) of the ITAA 1997. The concept of indirect beneficial interests is described as follows in subsections 149-15(4) and (5) of the ITAA 1997:

(4) An *ultimate owner indirectly has a beneficial interest in a *CGT asset of another entity (that is not an ultimate owner) if he, she or it would receive for his, her or its own benefit any of the capital of the other entity if:

(a) the other entity were to distribute any of its capital; and

(b) the capital were then successively distributed by each entity interposed between the other entity and the ultimate owner.

(5) An *ultimate owner indirectly has a beneficial interest in *ordinary income that may be *derived from a *CGT asset of another entity (that is not an ultimate owner) if he, she or it would receive for his, her or its own benefit any of a *dividend or income if:

(a) the other entity were to pay that dividend, or otherwise distribute that income; and

(b) the dividend or income were then successively paid or distributed by each entity interposed between the other entity and the ultimate owner.

An 'ultimate owner' is defined to include an individual - refer subsection 149-15(3) of the ITAA 1997. Accordingly, it is necessary to trace the underlying beneficial interests in the relevant assets to natural persons.

The expression 'beneficial interests' as used in the definition of 'majority underlying interests' is not defined. At general law, a shareholder does not have any legal or equitable interest in the asset of a company. Similarly, beneficiaries in a discretionary trust do not have an interest, either individually or collectively, in the assets or the income of a trust.

Under ordinary legal concepts, where there is a discretionary trust deed, no beneficiary is entitled to income or capital of the trust until the trustee exercises its discretion to distribute income or to make an appointment of capital. Because the beneficiary of a discretionary trust does not hold an interest in any asset of the trust or in the ordinary income derived from the asset until the trustee's discretion is exercised, it would not be possible for a discretionary trust to satisfy the continuing majority underlying interests test set out in subsection 149-30(1) of the ITAA 1997.

Taxation Ruling IT 2340 Income Tax: Capital gains: Deemed acquisition of assets by a taxpayer after 19 September 1985 where a change occurs in the underlying ownership of assets acquired by the taxpayer on or before that date (IT 2340) however provides that the Commissioner will apply an approach of 'looking through' interposed entities to determine which natural persons hold the beneficial interests for the purposes of section 160ZZS of the ITAA 1936, which preceded Division 149 of the ITAA 1997. This is highlighted in paragraph 2 of IT2340 which states:

The terms "underlying interest" and "majority underlying interests", on the basis of which the provision operates, have the same meanings as they have in Subdivision G of Division 3 of Part III of the Act - which deals with the income tax treatment of interest in relation to "negatively geared" investments in rental property. In both cases (and like other provisions of the Act concerned with the measurement of ownership interests) underlying interests in relation to the assets concerned mean beneficial interests held by natural persons whether directly or through one or more interposed companies, partnerships or trusts. The clear policy of the law thus permits and requires that, for the purposes of the relevant provisions, chains of companies, partnerships and trusts are to be "looked through" in order to determine whether there has been a change in the effective interests of natural persons in the assets.

In this case, the underlying interest in the Land purchased prior to 20 September 1985 needs to be traced through intermediary entities to the ultimate owners for the whole period to the sale of that interest.

You conform to the description of a discretionary or family trust. In these circumstances, paragraphs 5 and 6 of IT 2340 are relevant as they state:

5. In relation to what are generally referred to as discretionary trusts, i.e., family trusts, the trustees of which have discretionary powers as to the distribution of trust income or property to beneficiaries, in considering the question of whether majority underlying interests have been maintained in the assets of the trust it will be relevant to take into account the way in which the discretionary powers of the trustees are in fact exercised.

6. Where a trustee continues to administer a trust for the benefit of members of a particular family, for example, it will not bring section 160ZZS into application merely because distributions to family members who are beneficiaries are made in such amounts and to such of those beneficiaries as the trustee determines in the exercise of his discretion.

In this case, for the period up to the dissolution of the Partnership the agreement in place distributes the income from the Land in equal shares to the partners of the Partnership, being you and you partner. This was in accordance with the underlying interest in the asset. Upon dissolution of the partnership you retained your proportionate interest in the capital of the Land.

In accordance with the approach taken in IT 2340, you have administered the trust for the benefit of the family only for the period just before 20 September 1985 to the time the interest in that portion of the Land is sold. Accordingly, the underlying interest held in the portion of pre-CGT Land by you has resulted in 100% of the capital and income of its interests in the Land held just before 20 September 1985 remaining to be held at the time of the sale of the Land.

Under subsection 149-30(2) of the ITAA 1997 the Commissioner is satisfied or thinks it reasonable to assume, that at all times on and after 20 September 1985 and at the time of the sale of the Land to the unrelated party, the majority underlying interests in the Land were had by ultimate owners who had Majority underlying interest in the Land immediately before 20 September 1985. Subsection 149-30 (1) and 149-30(1 A) of the ITAA 1997 do not apply to stop the interest in the Land purchased by you before 20 September 1985, from being a pre-CGT asset as set out in section 149-10 of the ITAA 1997.

Question 2

Summary

The sale of the interest in the Land acquired prior to 20 September 1985 does not result in assessable income under section 15-15 of the ITAA 1997.

Detailed explanation

Subsection 15-15(1) of the ITAA 1997 states:

Your assessable income includes 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.

This interest in the Land was purchased prior to 20 September 1985. For the reasons outlined in relation Question 3 & 4 below, the receipts from the sale of the Land does not constitute ordinary income and is not assessable under section 6-5 of the ITAA 1997.

In XCO Pty Ltd v. FC of T (1971) 124 CLR 343; 2 ATR 353; 71 ATC 4152, Gibbs J stated at CLR 350; ATR 358; ATC 4155 that:

A scheme is not a "profit-making scheme" simply because it yields a profit when none was intended; in the ordinary sense of the words a "profit-making scheme" is a plan devised in order to obtain a profit, and a scheme only answers that description if the taxpayer carries it out with the purpose of making a profit.

Therefore, a taxpayer must have held a profit-making purpose, which may not be a dominant purpose, in carrying on or carrying out a profit-making undertaking or plan. In Steinberg v FCT (1975) 134 CLR 640; 5 ATR 565; 75 ATC 4221 (Steinberg), Gibbs J stated at ATC 4232 that:

I am in agreement with the view expressed by Mason J that "it is not an essential element of a profit-making scheme in s 26(a) that every step which culminates in the making of a profit should be planned or foreseen before the scheme is put into operation'. Schemes may be precise or vague; every detail may be arranged in advance, or the working out of the plan may be left for decision in the light of circumstances as they arise. It is no objection to a plan that it allows room for manoeuvre. When property is bought with the purpose of making a profit in the easiest or most advantageous way that may present itself, and the taxpayer adopts "one of the many alternatives' that his plan leaves open, thereby returning himself a profit, he will rightly be said to be carrying out a profit-making scheme.

Case law has concluded that the mere realisation of a capital asset which was not acquired for the purpose of profit making by sale does not constitute a profit-making undertaking or scheme within meaning of section 15-15 of the ITAA 1997, even though the realisation is effected in the most advantageous manner.

In your case, you are not considered to be carrying on a business of property development in relation to the portion of the Land acquired prior to 20 September 1985, nor have you been carrying on or carrying out a profit-making undertaking or plan in relation to that Land. Consequently, any profit arising from the sale of the portion of the Land acquired prior to 20 September is not included in assessable income under section 15-15 of the ITAA 1997.

Question 3 & 4

Summary

The proceeds from the disposal of the portion of the Land acquired after 19 September 1985 are not assessable income under section 6-5 of the ITAA 1997 as the disposal of that portion of the Land represents a realisation of a capital asset. The proceeds from the disposal of that portion of the Land will be included in assessable income pursuant to 6-10 in accordance with Parts 3-1 and 3-3 of the ITAA 1997.

Detailed reasoning

Taxation treatment of property sales

The profits or gains made from the disposal of real property can be assessed for income tax purposes in a number of ways, including:

•         As ordinary income under section 6-5 of the ITAA 1997, resulting from:

•         carrying on a business; or

•         an isolated or commercial transaction that was entered into with a profit-making intention; or

•         as statutory income pursuant to the capital gains tax (CGT) provisions in Part 3-1 and 3-3 of the ITAA 1997 (section 6-10 of the ITAA 1997)

Profits or gains made in the ordinary course of business

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 principles established in Federal Commissioner of Taxation v The Myer Emporium Ltd (1987) 163 CLR 199 ('Myer'). Paragraph 32 of TR 92/3 states that a profit or gain made in the ordinary course of a business includes:

•         a profit or gain arising from a transaction which is itself a part of the ordinary business of a taxpayer (judged by reference to the transactions in which the taxpayer usually engages); and

•         a profit or gain arising from a transaction which is an ordinary incident of the business activity of the taxpayer, although not a transaction entered into directly in its main business activity.

In determining whether profits or gains made from the disposal of real property are made in the ordinary course of business, one must establish if a taxpayer is carrying on a business and what the nature of the business is.

The definition of 'business' for income tax purposes is wide and includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee (subsection 995-1(1) of the ITAA 1997).

The principles in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? ('TR 97/11') provide guidance on whether a taxpayer is carrying on a business and can be applied in various contexts. Specifically, paragraph 13 of TR 97/11 provides a list of indicators that are relevant in determining whether a taxpayer is carrying on a business. In general, the indicators 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 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.

No one indicator is decisive but rather different indicators must be considered in combination and as a whole. The question of whether a business is being carried on is determined in an objective manner based on the weighing up of all the relevant facts and circumstances of each case.

Isolated transaction with a profit making intention

In some instances a profit or gain made from an isolated or commercial transaction could constitute ordinary income if the taxpayer's purpose or intention in entering into the transaction was to make a profit, notwithstanding that the transaction was not part of its daily business activities.

This was discussed in Myer, where the full bench of the High Court stated that:

But a gain made otherwise than in the ordinary course of carrying on the business which nevertheless arises from a transaction entered into by the taxpayer with the intention or purpose of making a profit or gain may well constitute income. Whether it does depends very much on the circumstances of the case. Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a "one-off" transaction preclude it from being properly characterized as income (F.C. of T. v. Whitfords Beach Pty. Ltd. 82 ATC 4031 at pp. 4036-4037, 4042; (1982) 150 C.L.R. 355 at pp. 366-367, 376). The authorities establish that a profit or gain so made will constitute income if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit.

And further:

The important proposition to be derived from [Californian Copper Syndicate] and [Ducker v. Rees Roturbo Development Syndicate Ltd (1928) A.C. 132] is that a receipt may constitute income, if it arises from an isolated business operation or commercial transaction entered into otherwise than in the ordinary course of the carrying on of the taxpayer's business, so long as the taxpayer entered into the transaction with the intention or purpose of making a relevant profit or gain from the transaction.

And further:

The proposition that a mere realization or change of investment is not income requires some elaboration. First, the emphasis is on the adjective "mere" (Whitfords Beach, at ATC pp. 4046-4047; C.L.R. p. 383). Secondly, profits made on a realization or change of investments may constitute income if the investments were initially acquired as part of a business with the intention or purpose that they be realized subsequently in order to capture the profit arising from their expected increase in value - see the discussion by Gibbs J. in London Australia, at ATC pp. 4403-4404; C.L.R. pp. 116-118. 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 realization. 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.

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.

Even where the requisite intention may not exist on entering into the transaction, the High Court held in Whitfords Beach Pty Ltd v Federal Commissioner of Taxation (1983) 14 ATR 247 (Whitfords) there can be a change of intention.

In Whitfords there was a change of intention at the time a company holding a large parcel of land originally acquired for long-term investment, adopted a new set of articles that changed the intended usage of the land.

In Rosgoe Pty Ltd v Commissioner of Taxation (2015) FCA 1231, Logan J reinforced that the intent at acquisition and later, on sale of the property should be considered separately and the transactions as distinct activities:

When, later, the property was sold, the profit here arose not from the purchase but from the sale and because the sale was not part of the profit-making scheme the profit did not arise 'from the carrying on or carrying out' of that scheme.

The intention and purpose needs to be carefully considered in each and every case. In Westfield vCommissioner of Taxation [1991] 91 ATC 4234 ('Westfield'), Hill J said at 4241:

What was said in Myer has been applied in a number of cases in this court since. Among them are Moana Sand Pty Limited v Federal Commissioner of Taxation (1988) 88 ATC 4897, and Federal Commissioner of Taxation v Cooling (1990) 22 FCR 42. It does not, however, follow from the judgment in Myer, or for that matter, from the judgments in any later cases, that every profit made by a Taxpayer in the course of his business activity will be of an income nature. To so express the proposition is to express it too widely, and to eliminate the distinction between an income and a capital profit.

The relevant intention or purpose of the taxpayer (of making a profit or gain) is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case. Generally, in cases where a person's subjective purpose or intention is a relevant issue, the person's evidence as to their subjective purpose or intention can be considered but it must be tested closely, and received with the greatest caution.

Capital gain from mere realisation

For CGT to apply there needs to be a CGT event that happens to a CGT asset. A CGT asset is defined in section 108-5, with note 1 indicating land is a CGT asset.

Division 104 sets out the CGT events that can happen to a CGT asset and section 104-10 provides that CGT event A1 occurs on the disposal of an asset. As a consequence of CGT event A1, subsection 104-10(4) provides that you make a capital gain if the capital proceeds from the disposal are more than the assets cost base or conversely you make a capital loss if the capital proceeds are less than the assets reduced cost base.

The mere realisation of a capital asset will be subject to the CGT provisions. 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. 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.

In Westfield, the company was in the business of designing, constructing, letting and managing shopping centres. The company acquired land in the early 1970s and further land via an option which it subsequently sold and realised at a substantial gain. The Full Federal Court held that the disposal of land was on capital account as the necessary intention or purpose of making a profit on the sale of the land was absent. This was because the main aim of the company was to secure contracts to design, develop and operate/manage a shopping centre on the land. The disposal of the land was incidental to these purposes. The fact that the transaction was commercial or a business transaction was, of itself, insufficient.

The Full Federal Court in reaching its decision considered the judgement in Myer and stated at 4241 that Myer 'emphasises that where a transaction occurs outside the scope of ordinary business activities, it will be necessary to find, not merely that the transaction is "commercial" but also that there was, at the time it was entered into, the intention or purposes of making a relevant profit'.

Other aspects of the judgement in Westfield discussed when profits from transactions outside the ordinary course of business of an entity constituted ordinary income at 4243:

Once it is clear that the activity of buying and selling, which generated the profit, was not an activity in the ordinary course of business, or, for that matter, an ordinary incident of some other business activity, the profit in question will only form part of the assessable income of the appellant, by virtue of its being income in accordance with the ordinary concepts of mankind, if the appellant had a purpose of profit-making at the time of acquisition.

And further at 4243

...

While a profit-making scheme may lack specificity of detail, the mode of achieving that profit must be one contemplated by the taxpayer as at least one of the alternatives by which the profit could be realised. Such was the case in [Steinberg v Federal Commissioner of Taxation (1972-5) 134 CLR 640]. But, even if that goes too far, it is difficult to conceive of a case where a taxpayer would be said to have made a profit from the carrying on, or carrying out, of a profit-making scheme, where, in the case of a scheme involving the acquisition and resale of land, there was, at the time of acquisition, no purpose of resale of land, but only the possibility (present, one may observe, in the case of every acquisition of land) that the land may be resold. The same may be said to be the case where s. 25(1) of the Act is involved. As the court observed in Myer, in the passage already set out, the property, which generates the gain, must be acquired in an operation of business or commercial transaction:

"... for the purpose of profit-making by the means giving rise to the profit."

In determining whether a receipt is on revenue or capital account, the authorities establish that it is necessary to conduct "a wide survey and an exact scrutiny of the taxpayer's activities": Commissioner of Taxation v Stone (2005) 222 CLR 289 at [19]; Federal Commissioner of Taxation v Montgomery (1999) 198 CLR 639 at 663 [69]; both citing Western Gold Mines NL v Commissioner of Taxation (WA) (1938) 59 CLR 729 at 740 per Dixon and Evatt JJ.

This 'wide survey' is particularly important where the sale of the asset is by a taxpayer conducting a business. Jacobs J noted in London Australia at 127:

The identification and characterization of the business carried on by the taxpayer is the essential task.

Under the principle in Grollo Nominees Pty Ltd v Commissioner of Taxation (1997) 73 FCR 452 at 514-515 there will be occasions when it is appropriate to take into account the activities of the broader group of which the taxpayer is a part.

The facts all indicate the intention to hold the Land for the purpose of long-term primary production activities. Maintaining the approvals later in the ownership period was to ensure that the Land could potentially be disposed of for the most advantageous manner.

Conclusion

It is accepted that the Land was not acquired with the intention of profit making by sale, but rather to be held as a long-term investment for the purpose of gaining income from primary production.

The sale of the property is considered a mere realisation of capital asset. Consequently, the portion of Land acquired post 1985 will be subject to capital gains tax pursuant to under Parts 3-1 and 3-3 of the ITAA 1997.

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