Edited version of private ruling

Authorisation Number: 1011767194408

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Ruling

Subject: Subdivision

Question 1

Will the gains made on the disposal of the subdivided lots be assessable pursuant to section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will the gains made on the disposal of the pre capital gains tax (CGT) subdivided lots be assessable under section 15-15 of the ITAA 1997?

Answer

No, the gains will be assessable under section 6-5.

Question 3

Will the disposal of the pre-CGT subdivided lots trigger CGT event A1 under section 104-10 of the ITAA 1997?

Answer

Yes.

Question 4

Will any capital gains made on the disposal of the pre CGT subdivided lots be disregarded under subsection 104-10(5)(a) of the ITAA 1997?

Answer

While any capital gain may be disregarded, the sale proceeds will be assessable under section 6-5.

Question 5

Will the gains made on the disposal of the post-CGT subdivided lots be assessable under section 15-15 of the ITAA 1997?

Answer

No, the gains will be assessable under section 6-5.

Question 6

Will the disposal of the post-CGT subdivided lots trigger CGT event A1 under section 104-10 of the ITAA 1997?

Answer

Yes, but gain will be reduced under section 118-20.

Question 7

Will any capital gains made on the disposal of the post-CGT subdivided lots be eligible for the CGT 50% discount under Subdivision 115-A of the ITAA 1997?

Answer

No.

This ruling applies for the following period

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

The scheme commenced on

1 July 2011

Relevant facts

Acquisition of the Property

The Property was initially purchased prior to September 1985 by yourself and your partner as joint proprietors.

You purchased the Property with the intention of using the Property to graze and hold animals, to build a dwelling and to occupy the Property as your main residence.

Use of the Properly

The Property is characterised by large expansive paddocks predominantly used for grazing purposes. You let your neighbours horses graze on the property.

A residential dwelling was constructed on the Property together with a number of outbuildings (sheds and associated facilities) to the rear of it. The Property is relatively even with a gentle gradient present in the north western corner of the Property.

You occupied the dwelling as your main residence for the majority of your ownership. The Property was also used as a rental property for a period of time.

Your partner passed away and 50% interest in the Property passed by survivorship to you. From that point in time, you had full ownership of the Property. However, for tax purposes, you have two separate CGT assets, which are best described as follows:

(a) Your original pre-CGT 50% interest in the Property and

(b) Your post-CGT 50% interest in the Property, acquired for its deemed market value

at that date.

For the purpose of the remainder of this ruling, the term:

· "Pre-CGT Subdivided Lots" means the Subdivided Lots referrable to your pre-CGT 50% interest in the Property; and

· "Post-CGT Subdivided Lots" means the Subdivided Lots referrable to your post-CGT 50% interest in the Property.

Rezoning of property

The Property is located within a development area and in order to facilitate the development of this area, the Council prepared the Strategy Plan ("SP"). The underlying concept of the SP was to ensure the sustainable development of the surrounding area. The SP comprises six integrated neighbourhoods distributed around a mix-use town centre, interconnected by transport and open space networks. The SP strives to achieve the sustainable development of a healthy functioning community through sensitive planning.

Decision to subdivide

You have come under increasing pressure from developers of surrounding properties and the Council to develop the Property.

You received a letter from one of your neighbours which set out the owner's intention to develop their land and the requirement to prepare a development plan. In addition, the letter set out the owner's intention to include the Property in their development plan. The letter included an overall development plan, which directly affected the Property. You were concerned that the draft development plan would not maximise the potential value of the Property. Rather, it had been prepared by the owners of the neighbours land for the purpose of maximising the value of their property.

You later received a letter from the Council, which forwarded a letter from developers, who also sought your cooperation in the preparation of the development plan. In particular, requests were made to access the Property to conduct a range of physical inspections. The message to you was clear act now or your property will be acted upon.

You sought professional advice and were advised that you had to take positive actions in order to protect the value of the Property. If you were not to act, your opinions would be left out of any development plans and the value of the Property could be negatively impacted due to the fixed position of proposed infrastructure, such as access roads.

You engaged a company to prepare a Strategic Planning Advice Report regarding the draft development plan, to ensure that your future property plans would not be compromised by the draft development plan.

The Council approved the draft development plan ("Development Plan").

The need to develop the Property

In light of the rezoning of the Property and the rapid pace at which the surrounding area is being developed, you intend to dispose of the Property. You have been advised that the maximum capital value of the Property would be realised by undertaking a land development project on the Property that is consistent with the Development Plan and adjacent property development. Broadly, this would involve having the Property approved for residential subdivision ("the Subdivided Lots") and selling the Subdivided Lots to the public, in accordance with the arrangement described below.

You have no expertise relevant to property subdivision activities. You will not be directly involved in the planning and contracting work for the subdivision or in the sale of the Subdivided Lots. Your role will be in a decision making capacity only. Your offspring will act as your representative in dealing with the planners and developers.

You have not nor has they ever been, in the business of property development or trading in properties. They have no connected entities that have been involved in property development.

The value of the land prior to subdivision is between $X million and $X million.

The proposed development activities

As stated above, you will not be acting as developer, but will commission a developer firm ("Developer") and project manager ("Project Manager") to manage the project from the preliminary planning through to the sale of the Subdivided Lots.

The following is a description of the tasks and responsibilities to be undertaken by the Developer/Project Manager, including basic assumptions for the scope of the development work.

Role of the Developer/Project Manager

The Project Manager will be engaged by your as the prime consultant, with carriage of the development project from pre-planning through to sales of the lots. The Project Manager will coordinate the work of all sub-consultants, provide and maintain project schedules, organize and document regular project meetings as appropriate, and provide and maintain project cash flow projections. The Project management firm may provide sub-consultant expertise 'in-house". The Project Manager will report regularly to you and consult you on decisions important to the execution of the project.

Project Funding

The project shall be funded by a combination of pre-sales and a loan against the title that is secured by you. Depending on market conditions, you may elect to enter into a joint venture agreement with the Developer/Project Manager firm, where the latter would fund the construction costs for a share of the profit.

The approximate cost of the subdivision is expected to be $X million and the expected total proceeds from the subdivided lots are approximately $Y million.

If the subdivided lots are not sold off in stages, you will get a loan facility that you can draw on for $X million to fund the project.

Project Staging

Given the fact that there will be approximately xx to xx residential lots to be developed and the current soft market conditions, the project may be split into two stages of pre-sales and construction. The taxpayer may elect to run the stages concurrently or separately, depending on which option is expected to achieve a better sales outcome.

Project Description/Urban Design Assumptions

The land development project for the Property is intended to be typical of similar projects in the area. The Property is considered an "infill" development, and is situated amongst larger ongoing subdivision projects. A public reserve along the south boundary of the property is being built as part of an adjoining project. Consequently, the subdivision and site improvements will be relatively simple. The paved roads and services connections to each residential lot will be built according to the Council subdivision plan and local construction regulations. Some basic amenities, such as a subdivision entrance sign or marker, and the planting of Street trees, may be included as a standard marketing strategy.

The size and format of the Subdivided Lots will be tailored to current market demand. The smaller lots will be located to the south of the property along the "Drainage Reserve". The larger lots will be located to the north-west corner of the property, where a hillside slope will potentially require some additional site grading and the construction of retaining walls to make these lots sellable. Residential design guidelines for the Subdivided Lots will likely be included in the development.

Project outline and tasks

The first task is for the Project Manager to provide in-house urban design consulting or select an urban design sub-consultant through a tender process.

The Project Manager will then select a real estate agent/consultant through a tender process and rely upon that agent for information concerning the prevailing market conditions. The Project Manager will also lead the development of layout designs for the site and provide regular feedback to you.

The next steps (as required by the Council rules) will involve the lodgement of a Planning Permit Application and following that, a Functional Layout Plan. Both of these applications to the Council will be prepared by the Project Manager.

Once the Functional Layout Plan has been approved by Council, the Project Manager will provide in-house civil engineering services or select a civil engineering sub-consultant through a tender process. The Project Manager will manage the development of the engineering design and prepare a cost analysis. In addition, the Project Manager will organise regular civil engineering meetings and report minutes, progress and actions to you. The Project Manager will then lead the process of project tender to qualified civil contractors and provide a summary and report to you.

The next step will involve the commencement of pre-selling the Subdivided Lots. To achieve this end, the Project Manager will engage a real estate agent to prepare marketing material and then advertise the Subdivided Lots to potential purchasers.

Subject to satisfactory pre-sales and financing, construction activities will commence upon the award of the tender to a civil contractor. The Project Manager will oversee the construction work, attend regular site meetings with the engineers and contractors and report minutes, progress and actions to you.

In general terms, the suburban development of the Property will require grading and ground preparation for the installation of roads, kerbs and footpaths as required by Council. Preliminary analysis reveals that there may be some low lying areas on the Property that are near the 100 year flood level. If this is the case, these areas will require additional earth fill to raise the ground level. Some individual lots may require grading to level and the construction of retaining walls to make them marketable for home building.

New services connections must be made from the point of city services to each of the Subdivided Lots. New sewer lines, water service pipes, water drainage systems, electrical distribution, gas and telecommunication will be required. These are underground services that require trenching. The civil engineer will determine the most efficient layout for the services.

There are also infrastructure improvements provided by others that are funded by a mandatory development contribution from you.

The Project Manager will review the contractor progress claims, claims for variations and be responsible for approving all payments.

Once the construction work is complete, a Statement of Compliance will need to be obtained from, the Council. The Project Manager will liaise with the Council to obtain the Statement of Compliance and will also coordinate the registration of the plan of subdivision to allow separate titles to be allocated to the Subdivided Lots.

Settlement of the lots is expected to take place 14 days after the registration of the plan of subdivision.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 15-15

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 115-5

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

The legislative references referred to herein are from the ITAA of 1997 unless otherwise stated.

Question 1

Summary

The facts in your case support the view that the development of your land, subdivision and subsequent sale constitute an isolated transaction with a profit making purpose.

Detailed reasoning

Proceeds from the sale of property for tax purposes are treated as either:

· income according to ordinary concepts under section 6-5 derived:

o in the course of carrying on a business, or

o from an isolated transaction for the purpose of profit making, or

· subject to capital gains tax.

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

The principle has been established that profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's 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 the taxpayer's business (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium). 

Taxation Ruling 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.

The subdivision and sale of land is outside the ordinary course of the activities from which you derive your income. The transaction will not occur within the ordinary course of business being carried on by you. Therefore, the activity would be best described as an isolated transaction.

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 8 of the ruling explains that it is 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.

Paragraph 15 of TR 92/3 provides that if a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayers business but

· the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain, and

· the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case.  Casimaty v FC of T 97 ATC 5135; (1997) 37 ATR 358 (Casimaty's case) and McCorkell v FC of T 98 ATC 2199; (1998) 39 ATR 1112 (McCorkell's case) demonstrate that in circumstances where there is an absence of profit making intention when farming land is acquired, the likelihood of any profit made on the eventual sale of land being income according to ordinary concepts is greatly diminished.

However, profits on the sale of subdivided land can still be income according to ordinary concepts within section 6-5, or as a profit making undertaking or plan within section 15-15 if the taxpayer's subdivisional activities have become a separate business operation or commercial transaction. The Commissioner's guidelines in this regard are set out in paragraph 13 of Taxation Ruling TR 92/3.

Paragraph 13 of TR 92/3 lists the following factors:

a) the nature of the entity undertaking the operation or transaction 

b) the nature and scale of other activities undertaken by the taxpayer

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

d) the nature, scale and complexity of the operation or transaction

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

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

g) if the transaction involves the acquisition and disposal of property, the nature of that property, and

h) the timing of the transaction or the various steps in the transaction.

In applying these principles to your case, the following facts have been considered:  

· you are a tradesperson and will commission a developer firm and project manager to manage the project from the preliminary planning through to the sale of the Subdivided Lots.

· you have not been involved in any property development activity in the past and this is your first subdivision project.

· the approximate cost of the subdivision is expected to be $X million and the expected total proceeds from the Subdivided Lots are approximately $Y million. The value of the pre subdivided land is between $A million and $B million. The amount of the costs of the project exceeds the current pre subdivision value of the land. As such the costs associated with the subdivision are considered significant.

The subdivision will generate an extra profit of $Z million, this equates to an extra xx%.

· the scale of the development is between xx to xx lots. The subdivision will require infrastructure comprising, roads, water and electricity to the allotments. An entrance sign or marker and the planting of street trees, may be included as a standard marketing strategy. Development costs are approximately $X million.

The decision in FCT v Whitfords Beach Pty Ltd (1982) 150 CLR 355; 12 ATR 692; 82 ATC 4031 (Whitfords Beach case) indicates that profits from a large subdivision are likely to be income.

This test alone may not be conclusive however a more satisfactory test is the ratio of development expenditure to the value of the undeveloped land.

In this case, the value of the pre subdivided land is between $X million and $X million and the approximate cost of the subdivision is expected to be $X million. The expected proceeds from the subdivided lots are approximately $X million.

· you state that the disposal of your land by subdivision and sale constitute the realisation of a capital asset that was acquired, not for profit making purposes.

Whilst it is acknowledged that this may be the case, Taxation Ruling TR 92/3 at paragraphs 41 & 42 addresses this issue as follows; for example, if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either; or

c) as the capital of the business; or

d) 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 or business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income although the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

By undertaking a land subdivision of this scale you have taken on a financial risk akin to a normal business undertaking:

· you will not be acting as the developer, but will commission an unrelated developer firm and project manager to manage the project from the preliminary planning through to the sale of the Subdivided Lots as a commercial undertaking.

· the property in this case is xx hectares of land that will be subdivided into between xx to xx lots.

· you have provided a history of the land since acquisition. You have provided the details from the time the land was acquired. You built a house and lived at the property for many years. The land was rezoned and properties in your area were being developed.

Developers showed an interest in your property and after advice you, decided you could obtain a better return by engaging specialists to plan and undertake the development.

On balance, it would seem that the project is an undertaking on a sufficient scale to take it well beyond the realms of a mere realisation of an asset and characterize it as a commercial undertaking.

In particular the amount of expenditure incurred exceeding the land value and the number of lots, are deciding factors. As a consequence, the proceeds from the sale of the land will be considered to be ordinary income and therefore assessable under section 6-5.

Questions 2 and 5

Subsection 15-15(1) states that your assessable income includes profit arising from the carrying on or carrying out of a profit-making undertaking or plan. Subsection 15-15(2) goes on to say this section does not apply to a profit that is assessable as ordinary income under section 6-5; or if it arises in respect of the sale of property acquired on or after 20 September 1985.

As the proceeds of the sale will be assessable as ordinary income under section 6-5 as mentioned above, this provision does not apply.

Questions 3, 4 and 6

A taxpayer can only make a capital gain or capital loss if a CGT event happens. A CGT event A1 happens when there is a disposal of a CGT asset section 104-10.

There are some circumstances where, even though a CGT event has occurred, a CGT liability does not arise due to an exemption or exception that applies to disregard any capital gain or capital loss that may arise from a CGT event (section 100-30).

The anti-overlap provisions found in section 118-20 deals with reducing capital gains if an amount is otherwise assessable. A capital gain you make from a CGT event is reduced if, because of the event, a provision of this Act includes an amount, for any income year, in your assessable income.

As the proceeds of the sale will be assessable as ordinary income under section 6-5, the anti-overlap provisions found in section 118-20 take effect to reduce your capital gain by the amount that is otherwise assessable under section 6-5.

Question 7

As discussed in Question 1 the gains will be assessable under section 6-5, therefore, the discount provisions under Subdivision 115A will not apply.