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Ruling

Subject: Sale of interest in land

Question 1

Will the proceeds from the sale of an interest in land purchased with the intention of subdivision be assessable income under section 6- 5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

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?

Answer

No.

This ruling applies for the following periods:

1 July 2010 to 30 June 2011.

The scheme commences on:

1 July 2010.

Relevant facts and circumstances

The taxpayer and their spouse entered into a partnership with their son to acquire land for development and sale. The taxpayer was to be engaged as a subcontractor involved in the total development and construction.

There was an existing dwelling on the land at the time of purchase. Thereafter that dwelling was let for a period.

Subsequently, the son decided that he would take on the project by himself and, together with his wife, bought out his parents' interest. No building construction or subdivision had commenced at that time.

The son of the taxpayer is a builder. The taxpayer is not a builder by profession.

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.

Summary

The project was entered into with the intention of making a profit through resale. Any profit was made through a somewhat different means to that originally intended but that would not alter whether the profit was considered to be income as the intention to make a profit through the land had always existed. The proceeds from the sale of the interest in the property will be considered to be ordinary income and therefore assessable under section 6-5.

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 subdivision 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.

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 taxpayer's 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.

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.

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.

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

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

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

· The land was acquired with the intention of development and resale

· A partnership was established for the purpose of undertaking the land development plan

During the period of ownership rental income was earned from the existing dwelling on the property purchased

In the present case, the original plan was to acquire land for the purpose of subdividing and selling it at a profit. The fact that the land was subsequently purchased shows that the transaction was commercial in nature. The establishment of a partnership for the purpose with one of the partners being a builder shows that the project was being undertaken in a businesslike manner.

That can be contrasted with the cases discussed above. 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 your case, the land was purchased for the purpose of development and sale for a profit and with the intention to do so as soon as possible.

The existing dwelling was used to derive rental income during the period immediately following its purchase. However, where land is acquired with an existing dwelling that property is often used to derive rental income during the period between the purchase of the property and the commencement of the subdivision project as it makes commercial sense for the property to be earning income rather than lying idle for that interval. The earning of the rental income during that period does not alter the underlying intention or purpose with which the land was acquired.

On balance, it would seem that the project was entered into with the intention of making a profit through resale in circumstances which would characterise it as a commercial undertaking. The interest in the project was subsequently sold before subdivision commenced and though any profit made was made through a somewhat different means to that originally intended that would not alter whether the profit was considered to be income as the intention to make a profit through the land had always existed.

In your application you mention that you had an intention that you 'may well retain at least one or two of the buildings each after completion of the subdivision.' Unless at the time that your interest was sold such land could be separately distinguished from the land intended for development and resale the dominant purpose for which the land was acquired would still be resale. As a consequence, the proceeds from the sale of the interest in the land will be considered to be ordinary income and therefore assessable under section 6-5.

By virtue of section 118-20 any profit or gain upon disposal of the land will not be subject to the capital gains tax provisions as any such profit or gain will be otherwise assessable under section 6-5.