Edited version of private ruling

Authorisation Number: 1011868644756

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Ruling

Subject: Capital gains tax on subdivided property

Question 1

Will the profit on the sale of the subdivided lots be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will the profit on the sale of the subdivided lots be subject to the CGT provisions under Parts 3-1 and 3-3 of the ITAA 1997?

Answer

No

This ruling applies for the following periods:

The 2010-11 income year
The 2011-12 income year
The 2012-13 income year
The 2013-14 income year
The 2014-15 income year
The 2015-16 income year

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You and your spouse are joint owners of land.

This land was purchased before 20 September 1985.

The primary reason for purchasing the property was to build your main residence on the land. The running of a part time farm was a secondary motivation.

Soon after acquiring the land, you built your main residence on the land and you have lived there continuously since.

For a period of time you used approximately half of the land to run a small scale farm.

You are employed and your spouse is a stay at home mother with children. The farm was a part time activity for both of you.

After a period of time, the farming activities reduced and has now ceased altogether due other factors.

An unrelated party applied for rezoning of the land a few years before.

A portion of the land was rezoned from rural to residential. This was subsequently increased to a greater percentage zoned residential.

You are now proposing to subdivide of the rezoned land, and to sell a number of the subdivided blocks. You propose:

· to create a number new lots. You envisage that most lots will be sold to the general public and one lot to a relative

· the subdivision and sale is to take place in a number of stages to manage funding requirements and risks.

· you and your spouse will remain living in your main residence and will retain some of the adjoining rural zoned land

· some part of the rural land may become public space

· you envisage a professional land development company will act as an agent and oversee the subdivision and sale process. They will attend to all aspects, including:

o obtaining the necessary permits

o liaising with authorities

o engaging contractors

· the subdivision works will be to the minimum required by council

· you have estimated the average development costs per lot

· you have estimated the average sale price per lot

· you have a valuation for the current 'as is' value

· if you subdivide, sale proceeds less costs would result in a profit

· subdividing the land would result in additional profit

· neither you nor your spouse have any direct or indirect history of any other property development

· you find the current land size to be surplus to your needs. You have no intention of continuing any farming activity. Your children are not interested in carrying on any farming activities. You are subdividing and selling to financially provide for your retirement.

The land was all zoned rural when you purchased it.

You were considering subdivision opportunities for your land when you wrote to the council years before in regard to a proposed planning scheme. At this time you requested that the scheme be amended to include your title fully within the residential zone.

Later, the adjoining land owner, as part of a rezoning application, commissioned a flood study of surrounding land to the 1/100 year flood line. You believe this study to be inaccurate. As part of your neighbours rezoning application, a portion of your land was automatically rezoned in the process. You did not object to the rezoning and requested to rezone all of your land in the same process.

Your initial request to council was initially unsuccessful due to the 1/100 year flood line. You prepared a counter proposal. Later, after a new regional flood study was completed, rezoning was agreed by council. You requested a further amendment to the flood line.

After this, you contacted the council regarding the drafting of a rezoning proposal. Council proposed rezoning of the land. You requested an amendment. This doubled the residential zoned area.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5,
Income Tax Assessment Act 1997 Subsection 6-25(1),
Income Tax Assessment Act 1997 Section 15-15,
Income Tax Assessment Act 1997 Paragraph 15-15(2)(a),
Income Tax Assessment Act 1997 Section 102-5,
Income Tax Assessment Act 1997 Section 118-20 and
Income Tax Assessment Act 1997 Paragraph 118-20(1)(a).

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

Question 1

Summary

On balance, it would seem that the project is an undertaking on a sufficient scale to take it beyond the realms of a mere realisation of an asset and characterize it as a commercial undertaking. 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 of the ITAA 1997.

Detailed reasoning

Section 6-5 of the ITAA 1997 includes in your assessable income, where you are an Australian resident, all ordinary income which you derive during an income year. Ordinary income is defined as income according to ordinary concepts.

Ordinary income generally includes income that arises in the ordinary course of a taxpayer's business. However, in certain circumstances proceeds not within the ordinary course of the taxpayer's business may form part of their ordinary income.

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 of the ITAA 1997.

The sub-division 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 as you have no direct or indirect history of any other property development. 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 TR 92/3 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

At paragraphs 56 and 57 of TR 92/3 the ruling explains that a profit is income where it is made in any of the following situations:

· a taxpayer acquires property with a purpose of making a profit by whichever means prove most suitable and a profit is later obtained by any means which implements the initial profit-making purpose, or

· a taxpayer acquires property contemplating a number of different methods of making a profit and uses one of those methods in making a profit, or

· a taxpayer enters into a transaction or operation with a purpose of making a profit by one particular means but actually obtains the profit by a different means.

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 is now to make a profit, even if this was not an intention or purpose at the time of acquisition.

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, other factors may be considered to provide an exception to this. For example 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

Profits on the sale of subdivided land can still be income according to ordinary concepts within section 6-5 of the ITAA 1997, or as a profit making undertaking or plan within section 15-15 of the ITAA 1997 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.

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

· you have no direct or indirect history of any other property development

· you will be engaging a professional land development company, as an agent, to oversee the subdivision and sale processes

· the proposal is complex, being undertaken in a number of stages over a number of years and involving a number of lots

· it can be said that the activity has a significant commercial component and that there is an intention to make a profit

· you have estimated development costs of approximately $X

· you have estimated a total sale price of $Y

· you have been actively involved in rezoning of the property from rural to residential

· you have been actively involved in adjusting the 1 in 100 year flood level as it relates to your property

· you have farmed the land (for profit) since acquisition, but have only lived there since after this

· while the land was purchased in your own names, the profit making activities have been conducted through a another entity.

It is typically difficult to apply a blanket rule to sub-division cases and, as a consequence, each case needs to be decided on its own facts. The present case can be distinguished from both Casimaty and McCorkell. In Casimaty, the conclusion was primarily influenced by the fact that the taxpayer acquired and continued to hold his property for use as a residence and the conduct of primary production for more than twenty years. Apart from the activities necessarily undertaken to obtain subdivision approval, there was nothing to suggest a change in the purpose or object with which the property was held, namely primary production. In your case, your farming activities changed, which may indicate a change in the purpose for which the property was held. In McCorkell, the property had been in the family and used for primary production purposes at least as far back as the taxpayer's birth in 1917.

In the present case, it is necessary to weigh the various facts to determine whether the profit made represents ordinary income. One of your motivations when you acquired the property was to generate profit from farming activities. Consideration is also given to the fact that whilst you have no previous history of land development, the sub-division of a single block into a large number of blocks, is a substantial undertaking. An assessment of your estimated costs shows that the cost of subdividing exceeds the existing land value. You are investing 1.8 times its value. This is significant value adding and indicates a commercial transaction.

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 characterise it as a commercial undertaking. 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 of the ITAA 1997. The profit will not be covered by the more specific provision, section 15-15 of the ITAA 1997, as paragraph 15-15(2)(a) of the ITAA 1997 states that the section does not apply to a profit assessable as ordinary income under section 6-5 of the ITAA 1997.

Question 2

Summary

Any liabilities under the capital gains tax provisions on the profit on the sale of the subdivided lots will be reduced to nil as the amounts will be assessable under section 6-5 of the ITAA 1997.

Detailed reasoning

Subsection 6-25(1) of the ITAA 1997 discusses the relationships among the various rules about ordinary income. Subsection 6-25(1) of the ITAA 1997 prevents an amount of income being included in your assessable income more than once.

Section 118-20 of the ITAA 1997 talks about reducing capital gains if an amount is otherwise assessable. Paragraph 118-20(1)(a) of the ITAA 1997 provides for a capital gain you make from a CGT event to be reduced if another provision of the Act includes an amount in your assessable income.

The proceeds of the sales from the subdivision will be included in your assessable income under section 6-5 of the ITAA 1997. Section 118-20 of the ITAA 1997 reduces any capital gain to the extent the amount is included in assessable income. You will not be assessed under both provisions.

Any liabilities under the capital gains tax provisions on the profit on the sale of the subdivided lots will be reduced to nil as the amounts will be assessable under section 6-5 of the ITAA 1997.