Edited version of private advice

Authorisation Number: 1052003486928

Date of advice: 8 July 2022

Ruling

Subject: Sale of investment properties - mere realisation

Question 1

Was the sale of the properties to be treated as statutory income under the capital gain provisions in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period:

Financial year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

After 19 September 1985 the taxpayer and their spouse purchased a vacant block of land in a holiday area. Their intention at that time was to build dwellings on it and then derive rental income by holding them as investment properties in the long term. The dwellings were built.

The taxpayers had never purchased vacant land to build their own investment properties before.

One of the taxpayers became unemployed.

Due to their financial situation and the lack of opportunity for tenants at that time it was decided to sell the dwellings. It took longer to sell and they received less than they expected for the sale.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 15-15

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 subsection 112-25(2)

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Question 1

Summary

Yes. The sale of the subdivided properties was a mere realisation of a capital asset, the gain is statutory income under the capital gain tax (CGT) provisions contained in Part 3-1 of the ITAA 1997.

Detailed reasoning

Generally, there are three ways profits from a subdivision can be treated for taxation purposes:

•         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

•         as ordinary income under section 15-15 of the ITAA 1997, on revenue account, as a result of an isolated commercial 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 acquire by a profit-making purpose.

•         as statutory income under the capital gains tax (CGT) regime (sections 10-5 and 102-5 of the ITAA 1997) on the basis that a mere realisation of a capital asset has occurred.

Carrying on a business of property development

Subsection 995-1(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? (TR 97/11) provides the Commissioners view on what constitutes the carrying on of a business. Although TR 97/11 deals with the issues of determining whether a taxpayer is carrying on a business of primary production, the same principles can be applied to the question of whether a taxpayer is in the business of property development.

In the Commissioner's view found in paragraph 13 of TR 97/11, 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.

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.

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.

Paragraph 6 of TR 92/3 provides that a profit from an isolated transaction is generally income when both of the

following elements are present:

•         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.

In general, whether a profit from an isolated transaction is income according to ordinary concepts depends very

much on the individual circumstances of the case.

Paragraph 13 of 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 determining whether activities relating to isolated transactions are a profit-making undertaking or are the

realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. This may require a consideration of the factors outlined above; however, there may also be other relevant factors that need to be weighed up as part of the process of reaching an overall conclusion. No single factor will be determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

Mere Realisation of capital asset

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

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

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

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

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

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

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

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

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

From these and other cases, the Courts have established a number of factors in determining whether proceeds from the sale of subdivided land was income from carrying on a business, carrying out an isolated commercial transaction, or was from the mere realisation of a capital asset:

•         whether the landowner held the land for a considerable period of time prior to any subdivision and sale

•         the purposes for acquiring the property, and whether it was used for any other purposes prior to sale

•         whether the landowner conducted farming or other activities on the land prior to beginning the process of developing and selling the land

•         whether the landowner originally acquired the property as an investment, such as long-term capital appreciation or to derive income

•         whether the land was originally acquired near the urban fringe of a major city or town

•         if the property has been rezoned, whether the landowners actively sought that rezoning

•         whether a potential buyer made any offers to the landowners before they commenced discussion to enter into a proposed or final development agreement

•         whether the landowners had tried to sell the land without subdivision

•         whether the landowner had any history of buying and profitably selling developed land or land for development

•         the extent to which the development goes further than that required to obtain council approval

•         whether the operations will be planned, organised, and carried on in a business-like manner

•         the scope, scale, duration, and degree of complexity of the proposed development

•         the reasons for selling the land

•         the level of involvement that the taxpayer had in the development, marketing, and sale of the property

•         the level of legal and financial control maintained by the landowners in the proposed or final development agreement

•         whether any finance must be obtained in order to fund the development activities, and

•         the level of financial risk borne by the landowner in acquiring, holding and/or developing the land.

Application to these circumstances

Based on the information provided and the above factors, it is accepted that the taxpayer's primary intention in acquiring the land was to build dwellings on it and hold them as investment properties in the long term to be leased out. They were not acquired with the intention of reselling in a short period of time.

The size and scale do not reflect a business of land development. The Commissioner considers that the taxpayers were not undertaking a business operation or commercial transaction when they developed the land by building the dwellings on it.

The sale of the properties was a mere realisation of a capital asset. It is the disposal of a CGT asset that is subject to capital gains tax. CGT event A1 happens if you dispose of a CGT asset.

Note: when a CGT asset (the original asset) is split into two or more assets (the new assets), such as when land is subdivided, the subdivision of the land into subdivided lots is not a CGT event (subsection 112-25(2) 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. The cost base of the original asset is apportioned between the newly created assets.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).