Edited version of private advice

Authorisation Number: 1051977671523

Date of advice: 21 June 2022

Ruling

Subject: Property subdivision - revenue or capital

Question 1

Will the proceeds from the subdivision and sale of the property be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of carrying on a business of property development, involving the sale of land as trading stock?

Answer

No.

Question 2

Will the proceeds from the subdivision and sale of the property be assessable under section 15-15 of the ITAA 1997 as an isolated commercial profit-making transaction?

Answer

No.

Question 3

Will the profit from the subdivision and sale of the property be assessable under the capital gains tax provisions as a mere realisation of a capital gains tax asset?

Answer

Yes.

This ruling applies for the following periods:

Income year ended 30 June 20AA

Income year ended 30 June 20BB

Income year ended 30 June 20CC

The scheme commences on:

1 July 20ZZ

Relevant facts and circumstances

You purchased a rural acreage property on the outskirts of a major country town over XX years ago and have resided in it ever since.

The property was purchased with the intention of residential use and was appealing to your family as it gave your children room for numerous types of physical activity.

Recent times have seen the local town expand and as a result, nearby development resulted in services being installed within close proximity to the property. Prior to this, the land was not able to be subdivided and sold in individual parcels as town sewerage and other connections were not available.

At the time of purchase the land itself was zoned as Low Density Residential. This zoning has not changed in the time you have owned the property. The installation of these services however, meant that the property could now access the necessary services to allow the land to be divided into smaller lots.

Whilst you and your spouse have been content living in the property, the entire residential area surrounding the property has plans to develop or has already been developed.

You and your spouse are in your early 50s and have started retirement planning. With your children at the age where they are starting to leave home, you and your spouse felt it was time to begin the process of downsizing. One of you also has ongoing health issues meaning that person has no desire to further maintain the current large parcel of land. Given that you and your spouse are fond of the area, you decided that building a new smaller main residence on your land was both appealing and cost efficient as you already owned the land.

Your neighbours are subdividing their property (similar size and scale of development) and you thought, given your street will become a main thoroughfare, a new house at the rear of your block would distance you and your family from new residents. This would create the personal privacy which you have enjoyed since moving to the area and avoid traffic and building activity. The proposed new dwelling requires a new roadway to access the rear of your block. Sacrificing the large lot you currently live on felt appropriate as your children are now of an age where they no longer use the open space as they had in their younger years.

On the advice of engineers, the most practical result was to apply for a small lot subdivision. As such, an application for subdivision was made to the local council.

Council requirements include landscaping, utilities - sewerage, telecommunications, water, gas & electricity; roadworks, footpaths, drainage and street lighting.

You are undertaking this subdivision in conjunction with your neighbour with you sharing costs 50/50 and there will be one access road into both property subdivisions.

You were initially not interested in being involved but learned that you could be included on the same planning permit as the neighbour, the project became very simplified, and your involvement would be limited.

You have provided a real estate agent's appraisal valuing your property as a whole at a similar amount to what you could sell the excess lots for in total.

The cost of the subdivision is relatively minimal and you intend to personally fund it.

You and your neighbours have contracted a town planner who is project managing the subdivision, appointing subcontractors. Your involvement has been and will be minimal. It is expected the subdivision to be completed within 18 months.

You have pre-sold excess lots above what you intend to retain via a real estate agent due to considerable demand for land in the area.

Due to lengthy delays with council, earthworks are yet to begin.

You intend to keep the two remaining blocks at the rear and eventually build on one of them. Your existing residence is valued significantly less on the smaller block, post-subdivision, than on the large lot (property was a whole).

You have no history of land development and no intentions to do further land development.

You and your spouse are employed in fields unrelated to land development or construction.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 70-10

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Summary

On the facts provided, the Commissioner is satisfied that the subdivision of the property and subsequent sale of the subdivided lots is not the carrying on of a business of property development but is the mere realisation of part of an asset (the property) and will not be assessable income under section 15-15 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of a profit-making undertaking or plan. The subdivision and sale of the land is considered to be the mere realisation of a capital asset and therefore the net capital gain will be included in your assessable income in accordance with subsection 6-10(1) of the ITAA 1997.

Taxation treatment of land subdivisions

Broadly, there are three ways proceeds from a land sub-division can be treated for taxation purposes:

(1)   As assessable income under section 6-5 of the ITAA 1997, being ordinary income, you earn as a result of carrying on a business of property development.

(2)   The net profit may be included as assessable income under section 15-15 of the ITAA 1997, being a profit made from a profit-making undertaking or plan.

(3)   Under the CGT rules in Part 3-1 and Part 3-3 of the ITAA 1997, on the basis that the disposal of the subdivided lots is the mere realisation of a capital asset.

Income

Section 6-5 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 an income year. Ordinary income includes income from carrying on a business.

Profits or gains arising from the carrying on or carrying out of a profit-making undertaking or plan may also be included in assessable income of a taxpayer under as ordinary income under either section 6-5 or 15-15 of the ITAA 1997.

On the other hand, the mere realisation of a capital asset is not assessable as ordinary income, and any gain or loss on the disposal will be subject the capital gains tax rules in Part 3-1 and 3-3 of the ITAA 1997.

Section 995-1 of the ITAA 1997 defines 'business' as including any profession, trade, employment, vocation or calling. It does not include occupation as an employee.

Are you carrying on a business of property development?

Guidance on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11, which sets out the following indicators:

•         does the person carrying on the activity have an intention to carry on a business and make a profit from the activity?

•         whether the activity is or will be profitable.

•         whether the activity has a significant commercial purpose or character.

•         whether there is repetition and regularity of the activity.

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

•         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.

•         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 will be decisive in determining that a business is being carried on. Whether a business is being carried on depends on the overall impression gained' after considering all the relevant factors in relation to the activity as a whole.

On the facts provided, the overall impression gained is that you are not carrying on a business of property development. Crucially, in coming to this view, the facts disclose that:

•         objectively, your intent in subdividing and selling the property is driven by personal reasons to retain a certain lifestyle and not by an intention to carry on a business of property development and sale for profit. This is because:

• given the value of your residence as a whole, the costs of subdivision and the income from selling excess lots, you may only break even.
• the subdivision and sale of the property is being driven by personal reasons - your wish to retain lots at the rear of the property on which to eventually build a new residence to retain some privacy away from the increasing traffic brought on by neighbouring development.
• the development is a one-off - you have never been involved in property development previously and do not intend to do so in the future.
• the subdivision is relatively small, of which you will retain some initially before eventually selling your current residence; and
• the works on the land involve no more than is necessary to affect the subdivision and sale of the subdivided lots.

•         Your motivation for undertaking the subdivision and sale of your land is driven by personal reasons and not to make a profit. You did not acquire the land for profit through development but for private purposes to reside in and raise your family. This intention has not changed as you intend to keep the rear blocks and build a new residence.

These considerations support a view that viewed as a whole, what you are doing is no more than is necessary to sell off that part of the property that you do not wish to keep, rather than carrying on a business of property development, consistent with the decisions in Statham & Anor v. FC of T 89 ATC 4070 and Casimaty v FC of T 97 ATC 5135 (see below for further discussion on these cases).

As the Commissioner is satisfied you are not carrying on a business of property development, any gains made on the sale of the subdivided blocks will not be assessable as ordinary income under section 6-5 of the ITAA 1997 as income from carrying on a business.

As you are not carrying on a business, the trading stock rules in Division 70 of the ITAA 1997 do not apply to you. The subdivided lots will therefore not be trading stock within the meaning of subsection 70-10(1) of the ITAA 1997 which defines it to mean as 'anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of business and livestock'.

Isolated business transactions

Profits arising from an isolated transaction as a result of entering into a profit-making undertaking or plan will generally be ordinary income under section 6-5 of the ITAA 1997, (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693 (Myer Emporium)).

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 notes that in accordance with the principle set out in Myer Emporium 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.

Profit-making does not need to be the sole or dominant purpose for entering into the transaction. A profit-making purpose must exist at the time the transaction or operation was entered into. Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case.

Although you are not currently in the business of property development, to decide if any profit made is ordinary income, we need to consider if the transactions are made in a commercial manner.

TR 92/3 lists the following factors which are relevant in determining whether an isolated transaction amounts to a business operation or commercial transaction:

1. the nature of the entity undertaking the operation or transaction.
2. the nature and scale of other activities undertaken by the taxpayer.
3. the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained.
4. the nature, scale and complexity of the operation or transaction.
5. the manner in which the operation or transaction was entered into or carried out.
6. the nature of any connection between the relevant taxpayer and any other party to the operation or transaction.
7. if the transaction involves the acquisition and disposal of property, the nature of that property; and
8. the timing of the transaction and the various steps in the transaction.

In contrast, 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 ordinary 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.

Paragraphs 41 and 42 of TR 92/3 outline that where a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction, the activity of the taxpayer constitutes the carrying on of a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income even though the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

Numerous cases have considered the assessability of profits or proceeds from the sale of land including the following cases:

Case E20, 73 ATC 160, which involved two builders, claimed that certain properties were purchased out of the funds of the partnership as an investment to derive rents and that other properties were acquired to build houses thereon and let them. These claims were rejected, and it was held that the profits from the sale of properties sold pursuant to a forced sale were assessable. The properties were acquired with the intention of committing them to whatever profit-making purpose commended itself to the taxpayers at the appropriate time so that the profit was assessable as ordinary income.

Statham & Anor v. FC of T 89 ATC 4070 20 ATR 228 (Statham's case) where the property was subdivided and sold after a business of raising cattle had failed. The taxpayer relied on the local council to carry out the subdivision work and the local real estate agents handled the advertising and sale of the lots. The Full Federal Court held that what occurred was the realisation, by the most advantageous means, of the asset which the owners had on their hands when they abandoned the intention of farming the subject property.

Casimaty v FC of T 97 ATC 5135; (1997) 37 ATR 358 (Casimaty's case) where due to the growing debt and the ill health of the taxpayer, primary production land was progressively subdivided and sold off over a period of 18 years. There was no coherent plan conceived for the subdivision of the whole property. The taxpayer had acquired and had continued to hold and use the residence and conduct the business of a primary producer on the property. Therefore, there was no change of purpose of object for which the property had been held. In his judgment, Ryan J in the Federal Court held that the profits resulted from the mere realisation of a capital asset and as such the profits were not assessable as ordinary income.

Richardson v FC of T 97 ATC 5098, in which the taxpayer was an engineer who operated a building and project management business through a company (IR Pty Ltd). The company was also the trustee of a family trust of which the taxpayer was a beneficiary. As part of the construction of a building for another company, IR Pty Ltd (as trustee of the family trust) sold a parcel of land and purchased another for the same consideration. The parcel of land was then used as a rental property until sold. The profit made on disposal was ordinary income of the trust as the family trust had a purpose or intention of profit-making when entering into the relevant transactions and the acquisition was made as part of the trust's business of deal making.

McCurry & Anor v FC of T 98 ATC 4487, in which two brothers bought a block of land in 1986 for $32,000. They subsequently borrowed $80,000 to enable them to construct three townhouses. They could not sell the townhouses and, in mid-1987, they and members of their family moved into two of the townhouses. The third townhouse was used partly as a storeroom for a news agency business purchased by the family and partly as accommodation for visitors. The townhouses were sold in December 1988, but the family remained in two of them as tenants. The court found that profit-making by sale (rather than the receiving of rental income) was the dominant factor. Accordingly, the net profit arising from sale of the property was ordinary income.

As displayed in the above cases, a taxpayer can embark on a profit-making scheme after property was acquired for a different purpose.

In determining whether activities relating to isolated transactions are a profit-making undertaking, 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.

Application to your circumstances

In this case, you acquired the property for private purposes to use as a residential property and you have done so since acquisition.

In the context of considering the above authorities and factors when determining whether the project would be viewed as a profit-making undertaking, the following general observations have been made:

•         there is a plan for the use and development of the land.

•         the original intention was to keep the land for private purposes to use as a residential property.

•         there has not been a change in the purpose of owning the land. While you are subdividing and selling some of the property, you intend to build a new residence on at least one rear lot, and retain another, to maintain the privacy and lifestyle you currently enjoy.

•         you have not been involved in property development or subdivision in the past and have no intention of doing so in the future.

•         the total monetary outlay is relatively insignificant, and you are unlikely to profit from the undertaking.

•         there is not an intention to profit from the development of the land.

•         submissions have been made to the relevant authority regarding potential development on the land.

•         the parties have worked with relevant entities to undertake the various activities.

•         you will retain your current residence in the short term, there is no intention to demolish existing structures.

•         you have joined with your neighbour who is undertaking a similar subdivision and are sharing costs.

A balanced view of these observations, with no one feature being determinative in isolation, reasonably leads to a conclusion the intention for subdividing and selling the land does includes a profit-making undertaking but is merely for private reasons.

The scale of the development is small with only a small number lots available for sale, some which were pre-sold, a few available and eventually only one more available - your existing residence as you intend to keep the remaining lots at the rear of the property and eventually build your new residence.

There is a lack of a profit-making motive and in addition the prospect of profit is minimal. Furthermore, it can be said that minimal development work has to be undertaken as in Statham's case and Casimaty's case.

You will not be carrying on a business of property development and are not involved in a commercial profit-making undertaking. The activity is a mere realisation of a capital asset.

Based on the facts of this situation, the project is not considered to be a profit-making commercial undertaking and the profits from the sale of the lots is considered to be assessable as statutory income under the CGT provisions in Part 3-1 of the ITAA 1997.

Conclusion

The proceeds are therefore not ordinary income and not assessable under either sections 6-5 or 15-15 of the ITAA 1997. The proceeds will be a mere realisation of capital assets, which will fall for consideration under the CGT provisions in Part 3-1 of the ITAA 1997.

Capital gains tax

Under section 6-10 of the ITAA 1997, assessable income also includes statutory income. Capital gains are included as assessable income under section 102-5 of the ITAA 1997.

Section 102-20 of the ITAA 1997 states that a capital gain or capital loss is made only if a CGT event happens to a CGT asset. The property is a CGT asset (section 108-5 of the ITAA 1997).

CGT event A1 happens if you dispose a CGT asset.

Land, or an interest in land, is a CGT asset under section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997).

The sale of the land is a disposal which gives rise to CGT event A1 (subsection 104-10(2) of the ITAA 1997). You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act, event or by operation of law.

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