Edited version of private advice

Authorisation Number: 1052129844808

Date of advice: 28 June 2023

Ruling

Subject: CGT and GST - sale of subdivided vacant lots

Question 1

Are the proceeds from the sale of the subdivided vacant lots assessable under the capital gains tax provisions in Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Are the sales of the subdivided vacant lots subject to GST pursuant to section 9-40 of the A New Tax System (Goods and Services) Act 1999 (GST Act)?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June XXXX

Year ending 30 June XXXX

Year ending 30 June XXXX

The scheme commenced on:

1 July XXXX

Relevant facts and circumstances

The trust (You) operates a XX enterprise.

XXX is the director of the corporate trustee.

You were registered for GST and report your GST obligations on a quarterly and cash basis.

You purchased real property that contains an existing dwelling.

The purchase was funded by way of a loan.

It was your intention to rent out the existing dwelling immediately and then organise a subdivision of the Property into six lots and erect houses on the five remaining vacant lots to be rented out, to provide income for director and his wife, who are the trust beneficiaries, especially later in life. The plan was to do this on a progressive basis as funds became available.

Prior to purchasing the Property, you sought advice in relation to the Property's purchase price and subdivision plans. You received verbal advice regarding the renting viability/demand, property market values and estimated subdivision costs based on similar subdivisions in the area at that time.

You were also aware that at the time, rental properties in that area were in short supply and or low standard.

Development/subdivision activities

You formally engaged the services of the developer to proceed with the development/subdivision. The developer organised and lodged all development applications with the local Council and Water Authority. The developer also arranged for the civil works on the property.

The development application process took longer than expected to get approval from the Council. The permit allowed for the six-lot subdivision.

Lots 1, 2, 4, 5 and 6 are all vacant lots. Lot 3 contains the existing residential property which continued to be leased throughout the subdivision process.

Due to the local Council and Water authority requirements, the development/subdivision ended up exceeding the projected costs.

You have not been involved in property development in the past, nor the director and his spouse.

Funding of subdivision

There were various enquiries made on your behalf for the subdivision. Despite your efforts you were unsuccessful in securing a loan to proceed with the subdivision.

The director and his spouse decided to sell their residential property to fund for the subdivision by way of a loan to you. There was no formal written loan agreement in place.

Sale of subdivided vacant lots

Lot 4

In order to provide funds to continue the development/subdivision plan, you entered into a contract of sale of Lot 4 to the son of the director and his spouse. The sale price was below the market value.

The contract of sale states that the consideration amount includes GST.

Lot 1

To enable a reduction in your borrowings and pay back part of the director loan account, you entered into a contract of sale of Lot 1 to an unrelated party.

The contract of sale states that the consideration does not include any amount of GST and that the transferor/vendor does not make a taxable supply under the contract for the purposes of GST with the reason listed for this being: vacant land.

Although the contract stated that GST did not apply to the sale of Lot 1, you provided the purchaser with a GST withholding notice in accordance with section 14-255 of Schedule 1 to the Taxation Administration Act 1953 (Withholding Notice). The Withholding Notice identified, amongst other things, the total GST amount that withheld by the purchaser.

Lot 5

As the director and his spouse had been renting for several years, they decided that they would buy a vacant block and erect a dwelling for use as their principal place of residence. To that end, they purchased Lot 5 from you.

At settlement the director and his spouse paid the GST withholding amount.

You did not engage the services of a real estate agent to market any of the vacant lots for sale including the lot which was sold to the unrelated third party.

Retained Lots

You have retained Lots 2 and 6 (vacant lots) and Lot 3 containing the original residential premises. You have continued to rent out Lot 3 and planned to construct a house on each of the two remaining lots to be rented out. This would result in you having three rental properties to provide income for your beneficiaries.

You have not commenced building houses on the retained vacant lots. Your ability to do this is dependent on being able to obtain funding from the banks.

BAS reporting

You have not claimed any input tax credits in relation to the expenses incurred in the purchase, subdivision/development of the Property nor reported the sales and applicable GST on the supply of the subdivided vacant lots on your business activity statement.

Leasing of the original residence

You have leased the original dwelling at Lot 3 since the property was purchased, to one of director's sons and his spouse at market value whilst renovations were undertaken to get it to a satisfactory state. They continued to lease the dwelling until the director and his spouse moved into Lot 3 to allow further renovations to the original dwelling. The director and his spouse continue to reside at Lot 3 and pay rent at market value. They expect move into Lot 5 soon. Lot 3 will be rented to a new tenant when they move into Lot 5.

You did not engage a property manager to manage the Property during this period of time.

Income generated and expenses incurred from the leasing of Lot 3 were reported in the Trust's income tax return.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-10

A New Tax System (Goods and Services Tax) Act 1999 Section 9-5

A New Tax System (Goods and Services Tax) Act 1999 Section 9-20

A New Tax System (Goods and Services Tax) Act 1999 Division 38

A New Tax System (Goods and Services Tax) Act 1999 Division 40

A New Tax System (Goods and Services Tax) Act 1999 Subsection 195-1

Reasons for decision

Question 1

Are the proceeds from the sale of the subdivided vacant lots assessable under the capital gains tax provisions in Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

The proceeds from the sale of the subdivided vacant lots are assessable under the capital gains tax provisions and gives rise to CGT event A1 under section 105-10 of the ITAA 1997. You are not 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.

Detailed reasoning

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

•         ordinary income under section 6-5 of the ITAA 1997 as business income,

•         ordinary income under section 6-5 of the ITAA 1997 as an isolated 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

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? 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.

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.

Profits from an isolated transaction

Profits arising from an isolated commercial transaction will be ordinary income if the purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of a taxpayer's business (FC of T v Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693).

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income provides guidance in determining whether profits from isolated transactions are ordinary income and assessable under section 6-5 of the ITAA 1997.

The term isolated transaction 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.

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.

Paragraph 6 of TR 92/3 and also paragraphs 16 and 35 provide that a profit from an isolated transaction or operation 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 operation or commercial transaction.

Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. Paragraph 13 of TR 92/3 lists the following factors:

•         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

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

No single factor is determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

At paragraph 41, the taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property.

Further at paragraph 43, if a transaction or operation is outside the ordinary course of a taxpayer's business, the intention or purpose of profit-making must exist in relation to the transaction or operation in question.

Mere realisation

Paragraph 36 of TR 92/3 states that '[t]he 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. The expression 'mere realisation' is used to contradistinguish a business operation or a commercial transaction carrying out a profit-making scheme'.

Therefore, if the sale of the land is not considered to be an isolated commercial transaction, it will be treated as the mere realisation of a capital asset, with the proceeds or profit of the sale on capital account and assessed under the CGT rules.

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.

CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1) of the ITAA 1997). The land is considered to be a CGT asset under Section 108-5 (1) of the ITAA 1997.

Subsection 104-10(4) of the ITAA 1997 provides that a capital gain will arise if the capital proceeds from the disposal are more than the asset's cost base and a capital loss will arise if the capital proceeds are less than the asset's reduced cost base.

Application to your circumstances

On the facts provided, the overall impression gained is that you are not carrying on a business of property development.

•         The activity lacks significant commercial purpose or character. The existing house has been rented out and the intention was to construct houses on the subdivided lots and receive rental income.

•         The size and scale are not significant. The subdivision is relatively small, being only six lots.

•         There is no regularity or repetition of the activity. The subdivision was limited to the subject property and will not be repeated.

•         The activity cannot be said to be carried out in a business-like manner. The Trust failed to secure the bank loan and had to sell other lots to fund the subdivision.

•         The works on the land involve no more than is necessary to affect the subdivision and sale of the subdivided lots.

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

•         The property subdivision was a one-off activity. You have never been involved in property development in the past and have no intention of doing so in the future.

•         Objectively, the intention of the property subdivision was mainly to build houses to be rented out that will provide income to the beneficiaries especially in later life.

•         The total monetary outlay is relatively small, and you may not likely to profit from the undertaking.

•         You have failed to secure a loan for the subdivision. The director and his spouse had to sell their residential property to fund the subdivision.

•         Three lots had been sold without the house being built to continue funding the subdivision and to pay the loan made to you by the director and his spouse.

There is a lack of a profit-making motive and in addition the prospect of profit is minimal. You are not 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 sale of the subdivided vacant lots is considered to be assessable as statutory income under the CGT provisions in Part 3-1 of the 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.

Question 2

Are the sales of the subdivided vacant lots subject to GST pursuant to section 9-40 of the A New Tax System (Goods and Services) Act 1999 (GST Act)?

Summary

The sale of a capital asset used in a leasing enterprise is considered to be made in the course of that enterprise pursuant to paragraph 9-20(1)(c) of the GST Act. The supplies of the subdivided vacant lots meet all the requirements of section 9-5 of the GST Act and are therefore taxable supplies. Hence you are liable for GST on these supplies under section 9-40 of the GST Act.

Detailed reasoning

Section 9-40 provides that you are liable for GST on any taxable supplies that you make.

You make a taxable supply where you satisfy the requirements of section 9-5 of the GST Act, which provides:

You make a taxable supply if:

a)    the entity makes the supply for consideration

b)    the supply is made in the course or furtherance of an enterprise that the entity carries on

c)    the supply is connected with Australia, and

d)    the entity is registered, or required to be registered, for GST

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed.

Division 38 and 40 provide for certain supplies to be GST-free and input taxed respectively.

We consider Division 38 and 40 have no application to the supplies of the subdivided vacant lots. Accordingly, your supplies of these lots were not GST-free or input taxed.

For the sale of the subdivided vacant lots to be taxable supplies, all the requirements in section 9-5 must be satisfied.

In this case, the supplies of the subdivided vacant lots were for consideration. These supplies are connected with Australia as all of the properties are located in Australia. You were registered for GST at the time of the supplies and continue to be registered for GST.

It remains to be determined whether the supplies of these lots satisfy paragraph 9-5(b). That is, were the supplies of the subdivided vacant lots made in the course or furtherance of your landscaping enterprise or any other enterprise that you were carrying on?

Based on the facts of this case, we consider the supplies of the subdivided vacant lots were not made in the course or furtherance of your landscaping enterprise, so it remains to be determined whether the activities associated with leasing and subdivision of the Property from which the subdivided vacant lots were created, and the eventual sale of those lots, were undertaken in relation to another enterprise that you carried on.

Supply in the course or furtherance of enterprise

The term 'enterprise' is defined for GST purposes in section 9-20 and includes, among other things, an activity or series of activities done on a regular or continuous basis, in the form of a lease, licence or other grant of an interest in property (paragraph 9-20(1)(c)).

Section 195-1 states that the phrase 'carrying on' in the context of an enterprise includes 'doing anything in the course of the commencement or termination of the enterprise'.

This definition ensures that activities done in the course of the commencement or termination of the enterprise are included in determining whether the activities of the entity amount to an enterprise.

The meaning of 'enterprise' is considered in Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number (MT 2006/1) and in Goods and Services Tax Determination GSTD 2006/6 Goods and services tax: does MT 2006/1 have equal application to the meaning of 'entity' and 'enterprise' for the purposes of the A New Tax System (Goods and Services Tax) Act 1999? (GSTD 2006/6) which provides that the discussion on 'enterprise' in MT 2006/1 applies to the GST Act.

Paragraphs 303 to 322 of MT 2006/1 discuss activities done on a regular or continuous basis, in the form of a lease, licence or other grant of an interest in property.

Goods and Services Tax Determination GSTD 2000/9 Goods and services tax: if you let out residential premises do you need to get an ABN for PAYG purposes or register for GST?explains at paragraph 7 that the letting of a property is an activity in the nature of a lease, licence or other grant of an interest in property. If it is done on a regular and continuous basis, the activity will meet the definition of enterprise.

The leasing of a property (whether commercial or residential property) will fall within the scope of an 'enterprise' for GST purposes. This is the case regardless of the fact that proceeds generated from the rental of residential premises are not subject to GST. Furthermore, the activities associated with the commencement or termination of a leasing enterprise will also fall within the scope of an enterprise for GST purposes.

Based on the facts of this case we consider the leasing of the residential premises and the subsequent subdivision of land for the purpose of constructing further residential premises for lease, and the eventual sale of the subdivided vacant lots were all activities done in the course or furtherance (including commencement and termination of) of the leasing enterprise/s that you carry on. The sale of a capital asset used in a leasing enterprise is considered to be made in the course of that enterprise pursuant to paragraph 9-20(1)(c) of the GST Act. The requirement in paragraph 9-5(b) of the GST Act is satisfied in this case.

Consequently, the supplies of the subdivided vacant lots meet all the requirements of section 9-5 of the GST Act and are therefore taxable supplies. You are liable for GST on these supplies under section 9-40 of the GST Act.

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