Edited version of private advice

Authorisation Number: 1051814615969

Date of advice: 12 March 2021

Ruling

Subject: Income tax - capital gains tax - statutory income

Question

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

Answer

Yes. The proceeds from the sale of the Property will represent a mere realisation of a capital asset and will fall under the capital gains tax provisions in Part 3-1 and 3-3 of the ITAA 1997.

This ruling applies for the following periods:

Year ending 30 June XXXX

Year ending 30 June XXXX

Year ending 30 June XXXX

Year ending 30 June XXXX

The scheme commences on:

1 July XXXX

Relevant facts and circumstances

You are the registered owner of the Property and acquired the property on XX Month XXXX.

You are not registered for GST.

The Property is XX hectares.

The Property was acquired as your main residence. The Property has never been leased and has only been used for your residential purposes, but for this subdivision development proposal.

The Property was zoned as Rural RU2 when it was acquired. It has been rezoned to Low Density Residential R2 as part of the XXX City Council's rezoning project for XYZ Precinct approved in 20XX.

The Property has not been on the market for sale.

You are retired and have not been involved in any prior subdivisions or property developments. You also have no intention of undertaking any other subdivision activities or development projects in the future. You intend to use the proceeds for retirement purposes.

Your preference was to sell the Property as a single undeveloped parcel of land. You wanted to sell the Property and downsize to a smaller property for retirement purposes and contribute remaining proceeds from the sale of the Property to your superannuation funds.

You received various verbal offers from property developers and real estate agents (through expression of interest letters in the letterbox) for the purchase of the entire Property. You were not interested in selling the Land at that time you were residing in the property as your main residence. The verbal offers were not serious, and the price offered was much lower than the market value of the Property at that time. You did not proceed with any of these.

Indicative verbal offers include:

•                     $X million in Month 20XX;

•                     $X million in Month 20XX; and

•                     $X million in Month 20XX.

In 20XX, the project manager of the Developer undertook a property development on the same street as your Property. The project manager approached you and discussed subdividing the Property, similar to your neighbour's project. You did not approach the Developer or any other developers or real estate agents directly.

The Developer initiated the proposed subdivision of the Property, as part of searching for a subdivision project.

You undertook your own due diligence processes on the development management agreement (DMA), the proceeds you would receive for the Property and the development project processes.

The market value of the Property at the time of entering into the DMA was approximately $X million.

No valuation by an independent valuer was undertaken for your Property prior to the subdivision of the land. An internal calculation was undertaken and provided an indicative valuation of the land to be $X million.

You were provided a copy of a feasibility study prepared by ABC Group.

The estimated cost to subdivide the Property is $X million (including construction cost, council contribution and fee payable to consultants).

You entered into a DMA with the Developer on XX Month 20XX.

You will receive $X million. There is a $XXX,XXX preliminary advance payment upon certain conditions being met. The cash amount will be reduced by the value of the X subdivided lots you retain.

You have advised that, as stated in clause XX of the DMA, if required by the Developer, you must permit the registration of a mortgage on the Property in favour of a financier to fund the development undertaken by the Developer. Under clause XX the funding for the Project will be procured by the Developer.

The subdivision activity is expected to commence in Month 20XX and be completed in Month 20XX.

The property will be subdivided into XX lots.

Your existing residence will be demolished. Your new principal place of residence will not be located on the retained lots. You intend to use the two retained lots for investment purposes.

The Developer engaged ABC Group to provide development planning services including a feasibility study.

Details of the feasibility study:

Sales

XX lots (XX sqm) at $XXXX per sqm $XX

Acquisitions

Land (including legals) $XX

Construction (Civil) $XX

Section 7.11 levies and contributions $XX

Professional Fees $XX

Authority Fees $XX

Interest $XX

Commissions/Marketing $XX

Legals $XX

Total Costs $XX

Net Profit $XX

You would not receive any of the Net Profit.

ABC Group and the Developer engaged further geotechnical, environmental and civil engineering consultants to deliver supporting documentation for the Development Approval (DA).

The Developer submitted the DA for the subdivision of the Property on XX Month 20XX. The DA was approved on XX Month 20XX.

The developer may choose to engage a third-party selling agent to sell the subdivided lots, in accordance with the DMA. You will not be involved in the sale of the subdivided lots.

You advised on XX December 20XX that contrary to clause XX of the DMA there are no plans in constructing a site office, associated landscaping and carparking after the completion of the subdivision of the Property.

Upon completion of the subdivision there may be two scenarios:

•                     If subdivision is completed before the sunset date of XX Month 20XX you will remain as the owner of the Property and transfer the subdivided lots to each buyer directly;

•                     If the subdivision is completed after the sunset date. You will transfer the subdivided Property to the developer; and the developer will then transfer the lots to each buyer.

Development Management Agreement

The parties to the agreement are XXXX and XXXX (Landowner) and Company Pty Ltd (Developer).

A.            The Landowner is the registered owner of the land.

B.            The Developer has experience in property development and project management.

C.           The Landowner wishes to engage the Developer to carry out the development of the Land.

The Developer has agreed to carry out the Development Services in accordance with this Agreement.

Clause

1.1 Definitions

Consultant means any consultant (other than a Contractor) engaged by the Developer for the performance of work or the provision of services in or to the Project.

Contractor means any contractor engaged by the Developer to carry out Project Works.

Cost means any charge, cost, expense, outgoing, payment or other expenditure of any nature including legal fees on a full indemnity basis (whether calculated on a time charge basis or otherwise.

Development Fee means the total of all Receipts, less:

(a)          The land price; and

(b)          Any other amount payable to Landowner under this Agreement, including under clauses 12.3(c) and 12.4.

Development Services means the management of all aspects of Project, including the following activities to be undertaken by the Developer (either itself or through suitably qualified and experienced agents or contractors):

.....

Land means Lot XX in Deposited Plan XXXX known as at XX Street Name, Suburb State XXXX

Land Price means $XXX subject to clause 7.4.

Preliminary Advance means $XXX payable in accordance with clause 2.6.

Price List means the price list for the Subdivided Lots approved by the Landowner under clause 11.3.

Project means obtaining the development approvals, undertaking and managing the development, subdivision, marketing and sale of, the Land primarily for residential and mixed use purposes and ancillary uses in accordance with the Project Objectives, Approvals, all Laws and Requirements and this Agreement.

Project Approvals means all Approvals required to undertake the Project.

Project Buyer means a person who wants to acquire a Subdivided Lot or an interest in a Subdivided Lot, by means of sale or other Disposal.

Project Completion means the transfer by the Landowner to a Project Buyer or the Developer of the last Subdivided Lot, excluding the Retention Lots.

Project Costs means all Costs of any nature whatever paid or payable in respect of the Project and the Land including all Taxes and Holding Costs relating to the Land or the Project during the term of this Agreement (except to the extent to which this Agreement specifies otherwise) and all Costs of Funding but excluding all administration Costs, salaries and wages and other similar overheads of the Developer incurred in discharging its Obligations under this Agreement which are to be met by the Developer from its own funds.

Project Documents means all or any of the following:

(a)          The project plans;

(b)          Consents or applications to obtain Approvals for the Project;

(c)          The Works Contracts;

(d)          The contracts with Consultants;

(e)          The contracts for the Disposal of the Land; and

(f)           Any other document which the parties agree is a Project Document for the purposes of this Agreement,

in each case on terms which are consistent with the Agreement.

Project Plans means the plans for the Project to be prepared by the Developer in respect of the Land as amended by the Developer from time to time.

Project Works means the works required to be undertaken to complete the Project in accordance all Approvals for the Project.

Receipts means:

(a)          All GST inclusive receipts from a sale or other Disposal of Subdivided Lots;

(b)          All deposits forfeited under any Sale Documents, less all reasonable Costs incurred in forfeiting the deposits;

(c)          All proceeds recovered from the enforcement of Sale Documents, less all reasonable Costs incurred in recovering the proceeds from a Project Buyer; and

(d)          Any other receipts of any nature in relation to the Subdivided Lots (excluding insurance proceeds).

Retention Lots means X proposed lots in the draft plan of subdivision approved under the Development consent, as agreed or determined pursuant to clause 7.1.

Security means a charge, mortgage, lien or other interest.

Sunset date means 5.00pm on the date that is X years after the Agreement Date.

Subdivided Lot means any saleable lot created by the subdivision of the Land.

Unsold Land means any land forming part of the Land (which may be comprised of Subdivided Lots or lots created for the purpose of subdivision or both) excluding Retention Lots, that has not been Disposed of.

Works Contract means a contract for the execution of Project Works.

Clause

2.5 Overriding Objectives

The objectives of the parties under this Agreement are to:

(a)          minimise the risk for the Landowner;

(b)          implement the Project in an efficient and timely manner;

(c)           the most effective structure for the Project on the most commercially advantageous terms;

(d)          undertake the Project, in accordance with the Project Documents as amended from time to time; and

(e)          otherwise complete the Project.

2.6 Preliminary Advance

(a)          The Developer must pay the Preliminary Advance to the Landowner as follows:

(i)            $XXX on the Agreement Date;

(ii)           $XXX by 5.00pm on the date being X months after the application for the development consent is lodged with the Council.

(iii)         $XXX by 5:00pm on the date being X days after the application for the construction certificate is lodged with the Council.

(b)          The Preliminary Advance is credited to and shall form part of the Land Price payable to the Land Owner.

(c)           For the avoidance of doubt, and despite and other clause of this Agreement, the Preliminary Advance will not be refundable.

3.2 No joint venture etc.

This agreement does not constitute, and the parties do not intend to create, a joint venture, partnership, agency, trust or other arrangement with each other and this Agreement must not be construed as anything other than a development management agreement strictly on the terms contained in this Agreement.

5 Conditions Precedent

5.1 Development Consent Condition

(a) The Project is subject to and conditional upon the Developer obtaining the Development Consent on terms acceptable to the Developer (acting reasonably).

(b) The Developer must keep the Landowner informed as to the progress of the Developer's application for the Development Consent.

(c) The Developer must notify the Landowner when a Development Consent has been obtained on terms and conditions acceptable to the Developer acting reasonable. This condition precedent is satisfied when the Developer gives a notice under this clause 5.1(c)

(d) If the date being XX months after the date of this Agreement, the Developer has not been able to satisfy tis condition precedent, either party may terminate this Agreement.

(e) On termination of this Agreement under this clause 5.1, the parties are released from the Obligation to perform this Agreement. If required by the Landowner the Developer must give to the Landowner all documents, plans and reports obtained by the Developer in relation to the Land.

6 Funding

6.1 Procurement

Funding for the Project will be procured by the Developer. The Developer will be responsible for all Project funding.

6.2 Mortgage

(a) If required by the Developer, the Landowner must sign all such documents to permit the registration of a mortgage on the Land in favour of a financier to secure funding required for undertaking the Project, provided that the principle amount secured by the mortgage does not exceed XX% of the value of the Land (as determined by a valuer appointed by or acceptable to the financier) at the time the mortgage is to be granted.

(b) The landowner must maintain clear title for Land free from any Encumbrances to facilitate the Grantee obtaining funding. The Developer will remain solely responsible for arranging and guaranteeing all Project funding for the Project.

(c) All Costs associated with procuring the Project funding under clause 6.2(a) shall be payable by the Developer.

7.1         Determination of Retention Lots

(a) The parties acknowledge and agree that the Developer expects that the conditions of the Development Consent will require either 2, 3 or 4 of the Subdivided Lots:

•                    to be retained for vehicular and pedestrian access to other Subdivided Lots; and

•                    To be burdened by easements, restriction on use and other affectations in connection with this requirement.

(b) X of the Subdivided lots referred to in clause 7.1(a) shall not be sold and shall be retained by the Landowner.

(c) After the condition precedent in clause 5.1 is satisfied, the parties must attempt to agree on which X of the Subdivided Lots referred to in clause 7.1(a) shall be retained by the Landowner.

(d) If by the date being X months after the condition precedent in clause 5.1 is satisfied the parties have not agreed in writing as to which X of the subdivided Lots that are required to be retained for access under the Development Consent. The Developer's notice shall specify those lots by reference to the approved subdivision plan.

7.2         Retention lots cannot be sold

Despite any other provision of this Agreement, the Retention Lots:

(a)          May not be sold or otherwise disposed of: and

(b)          Will be retained by the Landowner on Project Completion.

7.3         Value of Retention Lots

(a) At any time after the application for the Development Consent is Lodged, the Develop may procure a valuation of the Retention Lots by a registered valuer.

(b) The Developer will nominate a valuer and submit the details of the valuer to the Landowner for approval. The Parties must use reasonable endeavours to agree on a valuer to be appointed under this clause within XX days after the date the Developer nominates a proposed valuer. The valuer must have not less than X years' experience in valuing land lots in new land subdivisions.

(c) If the parties do not agree on a valuer within XX days after the date the Developer nominates a proposed valuer, the valuer to be appointed will be nominated by the president of Australian Property Institute (State division), at the request of either party.

(d) the parties acknowledge that the Retention Lots are lots that must be retained for the purposes of creating temporary access to the development the Land, pending development of adjoining land and creation of a public road to allow permanent access to the development on the Land. The valuer must be instructed to value the Retention Lots on the basis that they are:

(i) unencumbered land lots available for immediate sale and residential development; and

(ii) not subject to any easements or restrictions which affect their proposed use (including for the purposes of temporary access to the development)

8.1 Developer's Obligations

The Developer's Obligations under this Agreement are to:

(a)          Pay all council rates and water service rates payable for the Land from the date of this Agreement;

(b)          Undertake or procure others to undertake all Development Services in accordance with all Laws and Requirements;

(c)           Enter into and perform, procure the entry into and performance of all Project Documents;

(d)          Make or join in as a party to, all applications for, or procure, all Project Approvals;

(e)          Execute, or procure the execution of, all documents required by any relevant Authority to complete the Project;

(f)            Enter into, or procure the entry into, all relevant Project documents with suitably qualified Consultants to enable it to carry out all Development Services an efficient, workman like and professional manner;

(g)          Identify and procure Project buyers;

(h)          Execute or procure the execution of contracts for the Disposal of Subdivided Lots for amounts determined in accordance with the provisions of this Agreement;

(i)            Authorise the collection and distribution of the proceeds of any Disposal of Subdivided Lots in the manner set out in this Agreement;

(j)            Deal with the Subdivided Lots in the manner set out in this Agreement; and

(k)           Do anything else which is reasonable required to complete the Project.

Relevant legislative provisions

Reasons for decision

Summary

The proceeds from the sale of the subdivided land are not ordinary income and not assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997). The proceeds represent a mere realisation of a capital asset which will fall for consideration under the capital gains tax provisions in Part 3-1 of the ITAA 1997.

Detailed reasoning

There are three ways profits from sale of land can be treated for taxation purposes:

1.            As ordinary income under section 6-5 of the ITAA 1997, 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 1997, 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 with a view to a profit; or

3.            As statutory income under the capital gains tax legislation, sections 10-5 and 102-5 of the ITAA 1997, on the basis that a mere realisation of a capital asset has occurred.

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

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?(TR 97/11) 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.

Even where the sale of subdivided land is not regarded as part of carrying on a business, an isolated business or commercial transaction for the purpose of profit making by sale may have occurred. In Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199 (Myer Emporium) the High Court stated at 211:

...a receipt may constitute income, if it arises from an isolated operation or commercial transaction entered into otherwise than in the ordinary course of the carrying on of the Landowner's business, so long as the Landowner entered into the transaction with the intention or purpose of making a relevant profit or gain from the transaction.

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (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 of the ITAA 1997. Paragraph 16 of TR 92/3 provides:

16. If a taxpayer not carrying on a business makes a profit, that profit is income if:

(a) The intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain: and

(b) The transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

TR 92/3 at paragraph 38 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 also 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.

Whether a particular transaction has a business or commercial character depends on the circumstances of the case. Paragraph 13 of the ruling outlines the following factors which may be relevant when considering whether an isolated transaction amounts to a business operation or commercial transaction:

•                     the nature of the entity undertaking the operation or transaction

•                     the nature and scale of other activities undertaken by the taxpayer

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

•                     the nature, scale and complexity of the operation or transaction

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

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

•                     if the transaction involves the acquisition and disposal of property, the nature of the property, and

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

Paragraph 36 of TR 92/3 notes that the courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment.

Application to your situation

To determine whether the proposed subdivision and sale of your Property will amount to carrying on a business or carrying out an isolated commercial transaction it is relevant to consider the facts of the proposed subdivision and sale in light of the relevant factors:

•                     The property has been owned by you since XXXX and was originally purchased as a private residence. You have remained on the Property as your main residence from XX Month XXXX.

•                     The Property has never been leased or rented.

•                     The Property was rezoned from Rural RU2 to Low Density Residential R2 in XXXX as part of the City Council's rezoning project for XYZ Precinct. You had no involvement in the rezoning process.

•                     You wish to subdivide and sell the Property in order to downsize to a smaller property for retirement purposes and contribute any proceeds from the sale to your superannuation funds.

•                     The Property has not been on the market for sale since you acquired it.

•                     Various verbal offers were made by property developers and real estate agents (through expression of interest letters in the letterbox) to you, for the purchase of the Property. The offers were lower than the market value of the Property. You did not proceed to the negotiation and contracting stage in respect to any of the offers.

•                     In XXXX, the project manager of the Developer undertook a property development on the same street as the Property. The project manager approached you and discussed subdividing the Property, similar to your neighbour's project. You did not approach the Developer or any other developers or real estate agents directly, the Developer approached you.

•                     You entered into Development Management Agreement (DMA) with the Developer on XX Month XXXX. You undertook your own due diligence processes on the DMA, price offered for the Property and the development project processes. You did not obtain any further advice from third party consultants prior to entering into the DMA, nor did you apply for any planning permission from any relevant authorities.

•                     In accordance with the DMA you will not be actively be involved in the development and sale of the subdivided lots and will have no say in what costs are incurred, how the work is to be performed or who is to perform the work. You have granted the Developer power to negotiate and enter into as attorney on behalf of the Landowner (and extend, vary or cancel) contracts, dealings, transactions and other engagements in relation to the Project including relating to the Disposal of Subdivided Lots.

•                     Under the DMA the Developer is responsible for obtaining all development approvals, undertaking and managing the development, subdivision, marketing and sale of, the Property. The Developer may also engage any Consultants and Contractors as necessary to assist the Developer and the same shall be engaged directly by the Developer and not in the name of the Landowner. The Developer may choose to engage a third-party selling agent to sell the subdivided lots, in accordance with the DMA.

•                     To date the Developer has engaged ABC Group to provide development planning services for the Developer. ABC Group then provided you with a high level outline of the development project processes and feasibility studies. Further geotechnical, environmental and civil engineering consultants were engaged to deliver supporting documentation for the Development Approval (DA).

•                     The Developer submitted the DA for the subdivision of the Property on XX Month XXXX. The DA was approved on XX Month XXXX.

•                     The Property is XX hectares. The DA is for a subdivision of XX lots. The subdivision activity is expected to commence in Month 20XX and be completed in Month 20XX. The estimated current market value of the Property prior to subdivision was approximately $X million. The estimated cost to subdivide the Property is $X million (including construction cost, council contribution and fee payable to consultants). You will receive $X million reduced by the value of the X subdivided lots you will retain. The payment will be made progressively once the DA is lodged and when the sale proceeds are received by the developer. The X retained lots will be valued at the time they are transferred to you.

•                     You will retain legal ownership of the Property until the subdivision is complete. Upon completion of the subdivision there may be two scenarios:

-                     If subdivision is completed before the settlement date of X Month 20XX the landowner will remain as the owner of the Property and transfer the subdivided lots to each buyer directly.

-                     If the subdivision is completed after the settlement date. The landowner will transfer the subdivided Property to the developer; and the developer will then transfer the lots to each buyer.

•                     You main residence will be demolished as part of the development project. No other dwellings will be constructed. Construction will be limited to civil works as required under the DA.

•                     You do not bear the costs of the proposed development. The Developer will assume greater financial risk and be responsible for funding the entire project. However; you will allow the Developer to register a mortgage on the property in order to secure funding for the project.

•                     The Development Fee to be paid by you to the Developer is the balance after all selling costs, Landowner payments, and tax liability have been made.

•                     Neither you nor any related entities have been involved in property development or subdivision of land in the past. You do not intend to engage in any further subdivision and the proceeds will be used for retirement purposes.

Based on the factors of the arrangement to subdivide and sell the Property, as outlined above it is considered that you have not ventured into a business of property development, subdivision and sale of land for profit. Therefore, the proceeds from the disposal of the subdivided blocks will not be assessable ordinary income under section 6-5 of the ITAA 1997 as income from carrying on a business of property development.

Further, a balanced view of the characteristics of the Property and of the proposed arrangement, with no one factor determinative in isolation, leads to a conclusion that the proposed subdivision will not amount to engaging in an isolated business or commercial transaction undertaken for the purpose of profit. The proposed arrangement has some characteristics indicative of an isolated business or commercial transaction. For example, you are assuming risk by providing your Property as security for the external finance. You also chose not to sell your Property outright but instead to pursue the development as a means of obtaining a greater sale price. It is however considered that these factors are outweighed by the other indicia that indicate that you are instead entering the development arrangement to dispose of a capital asset and that you are merely realising your Property in the most enterprising manner. This is indicated by factors which include the reason for acquiring the Property, the length of time the Property has been held, the unimproved nature and the use of the property since it was acquired, the passive nature of your involvement in the proposed development, that you will not bear any costs of the development, that you are guaranteed a specific price for your Property rather than sharing in the proceeds, and the limited scope and size and duration of the development. As such, the proceeds you receive from the sale of the subdivided blocks will not be assessable ordinary income under section 6-5 of the ITAA 1997 as income from an isolated commercial transaction with a view to a profit.

It is considered that the proceeds from the disposal of the subdivided blocks will represent a mere realisation of a capital asset in the most enterprising way available so as to maximise the proceeds of sale. The proceeds from the disposal of the subdivided blocks will be assessable under Parts 3-1 and 3-3 of the ITAA 1997.

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