Edited version of private ruling

Authorisation Number: 1011905480216

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Ruling

Subject: Subdivision of land

Question 1

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

Yes.

Question 2

Will the proceeds from the sale of the subdivided land be a capital gain under section 104-10 of the ITAA 1997?

No.

Question 3

Will you be entitled to a discount under Subdivision 115-A of the ITAA 1997?

No.

This ruling applies for the following period:

1 July 2009 to 30 June 2010.

The scheme commences on:

1 July 2009.

Relevant facts and circumstances

The taxpayers are property investors who bought a residential property. In order to acquire the property they took out a loan which stated that the purpose of the loan was "for personal investment."

They engaged a real estate agency as the property manager. That agent let the premises and collected rent on behalf of the owners for four months until they decided to demolish the existing building.

The taxpayers engaged a salvage firm to demolish the building. They then engaged a subdivision consultancy to subdivide the land and engaged a separate firm to build a house on each of the newly created lots.

The construction progress payments were financed by further loans for each building. The bank made progress payments directly to the builder. As the construction loans were granted for only a percentage of the total construction costs a further loan was set.

The taxpayers state that their initial intention was to rent out both properties however decided to sell them in order to reduce overall borrowings due to the high cost of interest. They engaged a real estate agency to list the properties for sale and they sold having never been rented. They state that they verbally informed the estate agent that if there were any potential tenants who expressed an interest in renting the properties they could consider that option.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5 .

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.

Summary

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 or profit-making undertaking. As a consequence, the proceeds from the sale of the properties will be considered to be ordinary income and therefore assessable under section 6-5. As the proceeds are not capital in nature, there will be no assessable capital gain and, consequently, no discount capital gain is available.

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 sub-division and sale of land is outside the ordinary course of the activities from which you derive your income and you have no experience as a property developer. Therefore, the activity under consideration would be best described as an isolated transaction.

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 case). 

Taxation Ruling TR 92/3 discusses the application of 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.

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 even the 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 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, in both Casimaty and McCorkell the properties were originally acquired for primary production purposes and were subsequently used as such for significant periods of time, a fact which was critical to the decision in each case. In any event, profits on the sale of subdivided land can still be income according to ordinary concepts within section 6-5 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.

Miscellaneous Tax ruling MT 2006/1 discusses isolated transactions and sales of real property from paragraph 262 onward. At paragraph 265, it presents a list of factors which, if present, may be an indication that a business or an adventure or concern in the nature of trade is being carried on. Those factors are:

· there is a change of purpose for which the land is held;

· additional land is acquired to be added to the original parcel of land;

· the parcel of land is brought into account as a business asset;

· there is a coherent plan for the subdivision of the land;

· there is a business organisation - for example a manager, office and letterhead;

· borrowed funds financed the acquisition or subdivision;

· interest on money borrowed to defray subdivisional costs was claimed as a business expense;

· there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and

· buildings have been erected on the land.

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

· You have not been involved in any land development previously.

· Borrowings primarily financed the development

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

· The expenditure on the sub-division was greater than the cost of the original property purchased only a short time earlier

· The original land was only held for a short time before attempts to sub-divide it commenced

· The original house was only rented for a short time before attempts to sub-divide commenced

· The lots were sold within a small number of years of acquisition of the original property

· Neither of the new properties was rented before disposal

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 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, you proceeded with plans to sub-divide the land a very short time after you acquired it. That can be contrasted with the cases listed above, where the assets which were realised had been held for long periods. Whilst you have no previous history of land development, the expenditure incurred goes well beyond the minimum required to realise the asset and in fact involves both significant borrowings and significant action to first demolish the original house then build the new dwellings.

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. 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. As the proceeds are not capital in nature, no discount capital gain is available.