Edited version of private ruling

Authorisation Number: 1011892238506

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Ruling

Subject: Subdivision of land

Question 1

Will the proceeds from the sale of the subdivided lot be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice/Answers

No.

Question 2

Will the proceeds from the sale of the subdivided lot be subject to the capital gains tax (CGT) provisions in Parts 3-1 and 3-3 of the ITAA 1997?

Advice/Answers

Yes.

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

You and your spouse are the joint owners of a parcel of land.

The property was purchased by you before 20 August 1991 and it became your principal place of residence several years later after you had erected and moved into the residence.

The zoning of the land allows the erection of a single dwelling on a minimum area of one hectare.

The property is currently developed with the erection of a principal residence.

You are contemplating subdivision of the property into two lots, selling the vacant lot and retaining the developed lot as your principal place of residence.

You originally acquired the land to build a residence. The land was used for private purposes until the residence was built.

You always wanted to subdivide the land and you obtained a letter from council at the time of the purchase confirming that you could subdivide the land.

There is no business organisation as you are handling the subdivision apart from having a surveyor draw up the plans.

You are not undertaking any level of development of the land beyond that necessary to secure council approval for the subdivision.

You have never been involved in land development and you have no plans to carry out any subdivisions in the future.

You did not bring the parcel of land into account as a business asset. You have treated it as a private asset.

You did not claim any interest on borrowed funds when you purchased the land.

At this stage you are not sure whether you will borrow funds to finance the subdivision. However, even if you borrow the funds, you will not be claiming the cost of subdivision as a business expense.

You are selling the subdivided lot for superannuation purposes.

You have incurred expenses in relation to the subdivision.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5
Income Tax Assessment Act 1997 Section 104-10
Income Tax Assessment Act 1997 Paragraph 108-5(2)(a)
Income Tax Assessment Act 1997 Section 110-25
Income Tax Assessment Act 1997 Subsection 110-55(3)
Income Tax Assessment Act 1997 Division 114
Income Tax Assessment Act 1997 Division 115
Income Tax Assessment Act 1997 Section 118-110
Income Tax Assessment Act 1997 Section 995-1

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 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 of the ITAA 1936 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

Under section 6-5 of the ITAA 1997, your assessable income includes the ordinary income you derived directly or indirectly from all sources, during the income year. Although the legislation does not define income according to ordinary concepts, a substantial body of case law has evolved to identify various factors that indicate the nature of ordinary income.

Profits from the sale of property can be assessable under section 6-5 of the ITAA 1997 in the following ways:

(a) As ordinary income under section 6-5 of the ITAA 1997 as a result of carrying on a business of property development and involving the sale of property as trading stock.

(b) As ordinary income under section 6-5 of the ITAA 1997 as a result of an isolated business transaction which, although outside the ordinary course of business of a taxpayer, is entered into for the commercial exploitation of an asset acquired for a profit making purpose, that is, the profit is derived in the course of carrying out a business operation or commercial transaction.

Carrying on a business

Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

The question of whether a business is being carried on is a question of fact and degree, The courts have developed a series of indicators that are applied to determine the matter on the particular facts.

Taxation Ruling TR 97/11 provides the Commissioner's view of the factors used to determine if you are in business for tax purposes.

Isolated transactions

Taxation Ruling TR 92/3 discusses profits on isolated transactions and the application of the principles outlined in the decision of the Full High Court of Australia in FCT v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693. This ruling states that profits on isolated transactions may be income.

Profit from an isolated transaction will be ordinary income where:

· 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.

If a transaction or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property.

Some factors to consider when looking at whether an isolated transaction amounts to a business operation or commercial transaction are listed at paragraph 13 of TR 92/3. They are:

· 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 or the various steps in the transaction.

Profits on the sale of subdivided land can therefore be income according to ordinary concepts within section 6-5 of the ITAA 1997 if the taxpayer's subdivisional activities have become a separate business operation or commercial transaction, or an isolated profit making venture.

Applying the above guidelines to your circumstances

We accept that you are not carrying on a business of property development, however it needs to be determined whether any profit from the sale of the subdivided lot can be said to be the result of an isolated transaction.

You have stated that you had always wanted to subdivide the land and that you obtained a letter from the council at the time of the purchase confirming that you could subdivide the land. One of your intentions or purposes in acquiring the land, was therefore to make a profit or gain from the subdivision of the land.

The sale of the subdivided lot and the resulting profit, however, also needs to be made in the course of carrying on a business operation or commercial transaction. Applying the factors at paragraph 13 of TR 92/3 as listed above to your circumstances leads to the following conclusions:

· you are undertaking the subdivision in your own name

· you have never been involved in land development and you have no plans to carry out any land development in the future

· the expected gain is not large in view of the time frame

· the property is only being subdivided into two lots and the subdivision is therefore of a small scale and not very complex

· the subdivision is being carried out in your name and not as a separate business

· there don't appear to be any connections to other parties in relation to the subdivision

· the subdivision involves property which has been used for private purposes over a lengthy period of time and

· you did not take any steps to proceed with the subdivision immediately following the purchase of the property and are now only proceeding some years later.

A consideration of the above factors leads to the overall impression that the subdivision of your property is not business or commercial in nature. The subdivision constitutes the realisation of a capital asset. Your share of any profit from the sale of the subdivided lot will therefore not be a profit from an isolated transaction under the guidelines of TR 92/3 as discussed above.

Conclusion

As any profit from the sale of the subdivided lot is not the result of carrying on a business of property development or as a result of an isolated transaction, any profit from the sale will not be assessable as ordinary income under section 6-5 of the ITAA 1997.

Question 2

The sale of the subdivided lot will be subject to the CGT provisions in Parts 3-1 and 3-3 of the ITAA 1997.

The relevant CGT asset in this case will be your interest in the subdivided lot to be sold, which is a CGT asset under paragraph 108-5(2)(a) of the ITAA 1997. The date you acquired your interest in this subdivided lot is the date you acquired your interest in the original parcel of land, and the cost base of the original land is divided between the subdivided lots on a reasonable basis.

Subdividing land does not result in a CGT event if you retain ownership of the subdivided lots and you therefore do not make a capital gain or a capital loss at the time of the subdivision. CGT event A1 under section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you dispose of your interest in each of the subdivided lots.

You will make a capital gain if the capital proceeds from the disposal of the subdivided lot is more than the cost base of the lot. You will make a capital loss if those capital proceeds are less than the reduced cost base of the lot.

Cost base

Under section 110-25 of the ITAA 1997, the cost base of a CGT asset has five elements. These elements are:

· money or property given for the asset

· incidental costs of the CGT event or of acquiring the CGT asset

· costs of owning the asset (assets acquired after 20 August 1991)

· capital costs associated with increasing or preserving the value of your asset and

· capital costs of establishing, preserving or defending your title or rights to your assets.

Under subsection 110-55(3) of the ITAA 1997, the third element in the case of the reduced cost base differs from the third element of a cost base, and relates to balancing adjustment amounts. The other elements are the same for both cost base and reduced cost base.

Rates expenses are costs of owning the land and are included in the third element of the cost base. However, in your case, as you acquired your land before 20 August 1991, you will not be able to include your rates expenses in the cost base of the land or the subdivided lots.

Subdivision costs are included in the fourth element of the cost base if they increase or preserve the value of the land.

The amounts for each of the above elements which relate to each subdivided block are added together to determine the cost base or reduced cost base for each subdivided lot.

Indexation method

Division 114 of the ITAA 1997 provides that indexation is available where the asset was acquired on or before 11.45am (by legal time in the ACT) on 21 September 1999, and at least 12 months before the CGT event.

Under the indexation method, you increase each amount included in an element of the cost base, (other than those in the third element - costs of owning the asset) by an indexation factor.

The indexation factor is worked out using the consumer price index (CPI).

Discount method

Under Division 115 of the ITAA 1997, you can use the discount method to calculate your capital gain from the disposal of your interests in the subdivided blocks if:

· you are an individual, a trust or a complying superannuation entity

· a CGT event happens to an asset you own

· the CGT event happened after 11.45am (by legal time in the ACT) on 21 September 1999

· you acquired the asset at least 12 months before the CGT event and

· you did not choose the indexation method.

Provided that the above requirements are satisfied in relation to your interest in the subdivided lot to be sold, you can use the discount method to calculate your capital gain from the disposal of your interest in the lot.

The discount percentage for individuals is 50%.

Main residence exemption

Subsection 118-110(1) of the ITAA 1997 provides that a capital gain or loss is disregarded when one of the CGT events specified in subsection 118-110(2) of the ITAA 1997 happens to a CGT asset that is a dwelling or your ownership interest in it.

If you sell any of the land adjacent to your dwelling separately from the dwelling, the land is not exempt. It is only exempt when sold with the dwelling. The main residence exemption will therefore not apply in relation to the sale of the subdivided lot.

Calculation of capital gain or loss

You will calculate your capital gain or capital loss for your interest in the subdivided lot to be sold as follows:

Step 1

Calculate your capital gain or capital loss for your interest in the subdivided lot by subtracting the cost base of the interest from the capital proceeds for that interest.

Step 2

Apply the discount percentage of 50% to the capital gain calculated in step 1 if you have not used the indexation method to calculate your capital gain.

Any capital gain or capital loss remaining after the above steps is included in the calculation of your net capital gain for the income year. Your net capital gain is included in your income tax return for the year and is taxed at your marginal tax rate.