Edited version of private ruling

Authorisation Number: 1011884711803

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Ruling

Subject: Subdivision of land

Question 1

Is the gain on disposal of a block of newly sub-divided land considered to be ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is the gain on disposal of the blocks of newly sub-divided land considered to be a capital gain for the purposes of section 102-5 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

1 July 2010 to 30 June 2011.

1 July 2011 to 30 June 2012.

The scheme commences on:

1 July 2010.

Relevant facts and circumstances

The taxpayer owns a property which has been their main residence since it was purchased. The property and buildings have not been used by the taxpayer for any business purposes.

The taxpayer is planning to subdivide the property into several separate titles with title to the existing home to be maintained and remain the main residence. The other lots will be sold to independent parties.

The taxpayer has not undertaken subdivision activity in the past.

The taxpayer is currently engaged in obtaining approvals from the relevant authorities. There will be some borrowings which will be used solely for sub-dividing the land and any associated works.

An independent registered valuer will be retained to determine the apportionment of the value of the subdivision between the retained main residence portion of the original lot and the excised lots.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5 and
Income Tax Assessment Act 1997 Section 102-5 .

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 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 of the ITAA 1936 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

Unless otherwise stated, all legislative references in the following Reasons for Decision are to the Income Tax Assessment Act 1997 (ITAA 1997).

Question

Summary

Weighing the various facts, on balance, the sub-division would not be held to be a profit-making undertaking but rather constitute the mere realisation of a capital asset, carried out in an enterprising way so as to secure the best price. Consequently, the profit derived from the subdivision and sale of the land is not assessable income under section 6-5 but would represent a capital gain for the purposes of section 102-5.

Detailed reasoning

Section 6-5 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.

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 experience as a property developer. 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

At paragraphs 56 and 57 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 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 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 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.

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 have not been involved in any land development previously

· The number of lots being created is relatively small

· You have lived on the property for a number of years

· The activities being undertaken are only those necessary to effect the sub-division and sale of the land

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 compared to 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 approval from time to time for subdivision of parts of the property, there was nothing to suggest a change in the purpose or object with which the property was held, namely primary production. 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. On balance, given the length of time which the land has been held and the use to which it has been put, its sale would not be held to be a profit-making undertaking but rather constitute the mere realisation of a capital asset, carried out in an enterprising way so as to secure the best price.

Consequently, the profit derived from the subdivision and sale of the land is not assessable income under section 6-5. However, any gain on disposal of the blocks would be a capital gain for the purposes of section 102-5. The gain applicable to each block would be determined by deducting its cost base from the consideration received. The cost base would include a suitable proportion of the costs of sub-division.

Please note that the main residence exemption under subdivision 118-B will not be available for any excised lots that are disposed of separate to the block that contains the dwelling that is your main residence.