Edited version of private advice

Authorisation Number: 1051820968084

Date of advice: 15 April 2021

Ruling

Subject: Capital gains tax

Question 1

Will the proceeds received from the sale of the subdivided blocks be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will the capital gain made from the sale of subdivided blocks be disregarded under Parts 3-1 and 3-3 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20xx

Year ending 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts

You own pre-CGT land. You built a pre-CGT dwelling on the land in xxxx. You have resided in the home since it was built and it is your main residence.

There have been no significant improvements to the dwelling since construction.

You initially used some of your land for farming, however in xxxx you ceased the faming activity and started leasing the land.

The current lease has been with the same lessee since xxxx.

Over the last xx to xx years, the relevant Council decided to rezone the land to facilitate further plans for urban development in the area.

You have been approached by council in the past to assist facilitating council planning in the area.

You intend to sell the land due to your age and downsizing as the land is now too large. There have been no offers from potential buyers. This motivated you into subdividing your land. You have no intention to enter into a development agreement in anticipation of sale.

You are not required to undertake any physical work such as roads, driveways, drainage, or connection of water or electricity mains or any other infrastructure.

In xxxx, you considered subdividing the land. You provided a copy of the draft concept, however, no formal application had been lodged with the local municipal council at that time.

You envisage selling all your property including your main residence. No formal market valuation has been obtained, however you have received an opinion a Real Estate which indicates the current market value of the land ranges between $xxxx and xxxx.

You engaged a surveyor for the costings of the subdivision and at this stage there is no formal documentation. You have provided estimation for the subdivision which is a total of $xxxx.

You propose to create xx lots.

The land subdivision requires you to undertake certain activities.

You are contemplating an extension of the sewer line to each new block. This is not a requirement by council with costings approximately $xxxx to service all lots.

Following the subdivision you look to sell the lots either individually or in one line to a single purchaser if the opportunity presents itself.

You have taken certain steps in relation to the proposed subdivision.

The real-estate agent will receive a commission based on the sale price obtained for the land.

Since xxxx, you have encountered some difficulty marketing the land. You have been advised to take further steps to improve the marketability of the land.

You do not intend to undertake any physical construction. You intend to only fund the design, preparation and lodgement of a Plan of Proposed Subdivision. You are hoping this will attract potential purchasers.

The extension of the sewer lines to each new block has not been completed and will ultimately be the responsibility of the purchasers of the lots.

You have commissioned consultants to amend the Plan of Subdivision to include the proposed change and submit the Plan of Proposed Subdivision to the local Council authority.

You will not fund or be involved in the physical works. These works would be funded and undertaken by the purchaser of each lot.

The amended plan of proposed sub-division has been lodged with the local council. Council is yet to approve the amended plan of proposed sub-division.

Contracts have been exchanged for some of the lots. The contracts are subject to the condition that council approve the amended plan for sub-division.

$xxxx has been incurred to date.

You will be not be borrowing funds to fund the subdivision activities.

You or any related entities have not previously been involved in any subdivision or property development activities.

You or any related entities do not intend to be involved in any future subdivision or property development activities.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-70

Income Tax Assessment Act 1997 section 112-25

Reasons for decision

Generally, an amount received in relation to subdividing land would be assessable either as:

•         ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as business income,

•         ordinary income under section 6-5 of the ITAA 1997 as an isolated commercial transaction with a view to a profit, or

•         statutory income under the capital gains tax (CGT) provisions contained in Part 3-1 of the ITAA 1997 as a mere realisation of a capital asset.

Ordinary income

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

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.

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? outlines some factors that indicate whether or not a business of primary production is being carried on. These factors equally apply to other types of businesses. The question of whether a business is being carried on is a question of fact and degree. In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators should be considered in conjunction with the other factors.

In the Commissioner's view, the factors that are considered important in determining the question of business activity are:

•         whether the activity has a significant commercial purpose or character

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

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

•         whether there is regularity and repetition of the activity

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

•         whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

•         the size, scale and permanency of the activity, and

•         whether the activity is better described as a hobby, a form of recreation or sporting activity.

Based on the information provided and the above factors, we do not consider that any proceeds from your activities and sale of the subdivided lots would be derived in the course of carrying on a business.

Profits from an isolated transaction

In FC of T v The Myer Emporium (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693 (Myer Emporium), the Full High Court expressed the view that profits made by a taxpayer who enters into an isolated transaction with a profit making purpose can be assessable income.

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income considers the assessability of profits on isolated transactions in light of the principles outlined in Myer Emporium. According to Paragraph 1 of TR 92/3, the term isolated transactions refers to:

• those transactions outside the ordinary course of business of a taxpayer carrying on a business, and
• those transactions entered into by non-business taxpayers.

Taxation Ruling TR 92/3 provides guidance in determining whether profits from isolated transactions are income and therefore assessable.

A profit from an isolated transaction will generally be income when:

•         the intention or purpose of a taxpayer in entering into the transaction was to make a profit or gain, and

•         the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying on a business operation or commercial transaction.

TR 92/3 lists the following factors which are relevant in determining 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 that property; and

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

In contrast, paragraph 36 of Taxation Ruling 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.

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.

After considering your full circumstances, it is not considered that you were carrying on an isolated commercial transaction.

Capital gains tax

A capital gain or a capital loss may arise if a CGT event happens to a CGT asset you own. Land, or an interest in land, is a CGT asset.

Split assets - subdivision of land

Where pre-CGT land is subdivided and the original owner of the land remains the owner of the subdivided lots, no CGT event happens. (section 112-25 of the ITAA 1997). Each new subdivided lot will be viewed as having been acquired on the same date that the original asset was acquired. That is, each new lot is a separate CGT asset and retains its pre-CGT status. You do not make a capital gain or a capital loss at the time of the subdivision.

However, in cases where some work has been undertaken to improve the land, subsections 108-70(2) and 108-70(3) of the ITAA 1997 may have application. Capital improvements that are related to each other are taken to be a separate CGT asset if the total of their cost bases (assuming each one is a separate CGT asset) when a CGT event happens to the original asset is:

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

•         more than 5% of the capital proceeds from the event (108-70(3)).

Note: If the improvements are a separate asset, the capital proceeds from the event must be apportioned between the original asset and the improvements: see section 116-40 of the ITAA 1997.

Disposal of a CGT asset - CGT event A1

CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1) of the ITAA 1997). You dispose of a CGT asset if a change in ownership occurs from you to another entity, whether because of some act or event or by operation of law (subsection 104-10(2)). However, a capital gain or loss you make is disregarded if you acquired the CGT asset before 20 September 1985 (subsection 104-10(5).

Application to your situation

You are not considered to be carrying on a business of property development, or to have been carrying on or carrying out a commercial profit-making undertaking or plan. Therefore, any proceeds received from the sale of the subdivided lots will not be ordinary assessable income under section 6-5 of the ITAA 1997.

The subdivision, development and sales of the land will be considered to be the mere realisation of a capital asset. CGT event A1 will happen when each of the subdivided lots are sold. You will make a capital gain at that time. If the capital improvement expenditure for a lot is less than the improvement threshold for the relevant year and less than five per cent of the capital proceeds from any subsequent disposal of a lot, the capital improvement will not be taken to be a separate CGT asset and will continue to form part of the asset with pre-CGT status and the capital gain you make on that lot will be disregarded.

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