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Ruling

Subject: Subdivision of land

Question 1

Will the profit from the subdivision of land in the circumstances described be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will the profit from the subdivision of land in the circumstances described be assessable as a capital gain under Part 3-1 of the ITAA 1997?

Answer

Yes. It will be assessable to the extent that it does not attract main residence exemption.

This ruling applies for the following periods:

1 July 2011 to 30 June 2012

1 July 2012 to 30 June 2013

1 July 2013 to 30 June 2014

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The taxpayers purchased the property a number of years ago and used it as their main residence from that time. Recently, the taxpayers decided that they wanted to live in a smaller house. They moved out at that time and let the property. It was not used for any income-producing purpose during the period that the taxpayers occupied it.

The Development Application (DA) which they have lodged involves subdivision into a certain number of lots. All of the land will be subdivided.

The taxpayers:

· Will not build anything on the land or perform works beyond the minimum amount necessary to satisfy the DA

· Have no formal business plan

· Hope to be able to sell the lots within a relatively short time

· Have no business organisation for the sub-division nor office, secretary or letterhead in relation to the subdivision activities

· Intend to use consultants and contractors to perform the subdivision activities and will take a passive role

· Engaged professional surveyors to survey the land and prepare a draft of the proposed subdivision

· Will not need to borrow funds to finance the subdivision activities

· Intend to market the land for sale through local real estate agents

· Has not claimed expenses in relation to the current subdivision as deductions for income tax expenses

· Has not claimed any input tax credits in relation to the subdivision for GST purposes.

Relevant legislative provisions

Section 6-5 Income Tax Assessment Act 1997

Reasons for decision

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

Question

Summary

The subdivision represents the mere realisation of real property, carried out in such a way as to secure the best price. Consequently, the profit derived from the subdivision and sale of the land by the taxpayer is not assessable income under section 6-5 but will be assessable under Part 3-1 as a capital gain.

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.

In the present case, the taxpayer does not operate as a property developer. The sale of land is outside the ordinary course of the activities from which the taxpayer derives income. Therefore, the activity would be best described as an isolated transaction. Whether the proceeds of that transaction constitute assessable income depends on a number of factors.

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. 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, as mentioned above, 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 TR 92/3. Paragraph 13 lists the following factors as relevant:

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 Taxation Ruling MT 2006/1 discusses inter alia the appropriate treatment of isolated transactions and sales of real property. At paragraph 265 it lists the factors which give an indication that a business or an adventure or concern in the nature of trade is being carried on in respect to property transactions. They 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 the present case, the facts which have been considered are, in précis :  

· The taxpayers acquired the property as their family home

· The property has been held for many years

· The taxpayers lived at the property for most of that time

· The property has been let in recent times

· The taxpayer intends to perform the minimum works required to satisfy the DA and generally will leave the conduct of the subdivision in the hands of relevant specialists

· The taxpayer will not need to borrow funds to meet the cost of the subdivision.

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.

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 particular circumstances. Having regard to the length of time that the property has been held and the use to which it has been put throughout the period of ownership, the evidence is consistent with the taxpayer not being in the business of property development. The details of the subdivision are also consistent with a finding that the taxpayer did not enter into the enterprise with the intention of making a profit through an isolated transaction.

Having regard to those conclusions, on balance it would seem that the subdivision is not being undertaken on a sufficient scale nor with the profit-making intention to characterize it as a commercial undertaking. It represents the mere realisation of real property, 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 by the taxpayer is not assessable income under section 6-5 but will be assessable under Part 3-1 as a capital gain.