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Authorisation Number: 1012041052497

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Ruling

Subject: Land subdivision - sale of vacant lot - construction of dwellings and sale - capital or income

Question 1:

Are proceeds from the sale of the lots considered assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

Yes.

Question 2:

Are proceeds from the sale of the lots considered assessable income under the capital gains tax (CGT) provisions of Part 3-1 or Part 3-3 of the ITAA 1997?

Answer:

No.

This ruling applies for the following periods:

1 July 2005 to 30 June 2006.

1 July 2006 to 30 June 2007.

1 July 2007 to 30 June 2008.

1 July 2008 to 30 June 2009.

1 July 2009 to 30 June 2010.

The scheme commences on:

1 July 2005.

Relevant facts and circumstances

The trust is a discretionary trust.

The trust has held several investment properties while operating its business.

The investment property in question was purchased after 20 September 1985 and was rented out for approximately six months. It was decided that to maximise return on investment on the property the land should be divided into blocks as the land was zoned for a higher density and the investment would be unlikely to grow in value if left as it was. A development application was lodged with the relevant planning commission shortly after purchase and this application was approved.

The property was broken into several lots and one was sold as an empty block.

Buildings were completed on the other blocks and were sold without being rented because of market conditions.

After the development the trustee, reserved a trading name for the future possibility that the company was to go into the construction and development business.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 102-5

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 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

Summary

Based on the facts provided, the profit received from the sale of the lots will be ordinary income and will be assessable under section 6-5 of the ITAA 1997.

A CGT event A1 will happen to a CGT asset when each of the lots are sold, however, the anti overlap provisions contained in section 118-20 of the ITAA 1997 reduce any capital gain to zero to prevent the taxing of the same amount twice. The amount is otherwise assessable under another provision, section 6-5 of the ITAA 1997

Detailed reasoning

Proceeds from the sale of property for tax purposes are treated as either:

§ income according to ordinary concepts under section 6-5 of the ITAA 1997 derived:

o in the course of carrying on a business, or

o from an isolated transaction for the purpose of profit making, or

§ as statutory income under the CGT legislation, (section 102-5 of the ITAA 1997), on the basis that a mere realisation of a capital asset has occurred.

Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case.

If the subdivision 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. However, the activity may be 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. 

Taxation Ruling TR 92/3 provides guidance in determining whether profits from isolated transactions are ordinary income and therefore assessable under section 6-5 of the ITAA 1997.

Isolated transaction

Profits on isolated transactions

Paragraphs 6 of TR 92/3 sets out the general principles that a profit from an isolated transaction is generally income when

§ 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 or in carrying on a business operation or commercial transaction.

TR 92/3 emphasises that a profit made by a taxpayer who is not carrying on a business is generally income when the intention of the taxpayer, in entering into the transaction, is to make a profit and the activity carried out is business or commercial in character.

Taxpayer's intention or purpose

If a transaction or operation involves the sale of property it is not necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property. This is demonstrated in the High Court decisions White v. FC of T (1968) 120 CLR 191; 15 ATD 173 and Federal Commissioner of Taxation v. Whitfords Beach Pty Ltd (1982) 150 CLR 355; 82 ATC 4044; (1982) 12 ATR 707.

Therefore if a taxpayer acquires an asset with the intention of using it for a certain purpose he can later decide to use the asset for a different purpose. If he uses the asset in a business operation or commercial transaction the profit from the activity is income even though the taxpayer did not have that purpose in mind at the time of acquiring the asset.

Commercial transaction

If a taxpayer enters into a transaction in the course of carrying on a business, it is not necessary to consider whether it is a business operation or commercial transaction.

However, it is necessary to consider this issue if the taxpayer is not carrying on a business or if the transaction or operation is not in the course of the taxpayer's business.

For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character (Whitfords Beach). This depends very much on the circumstances of the case.

Some of the factors to consider when looking at whether an isolated transaction amounts to a commercial transaction are shown in paragraph 13 of TR 92/3:

§ 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

Isolated transactions and sales of real property

The term 'profit making undertaking or scheme' like the term 'an adventure or concern in the nature of trade' concerns transactions of a commercial nature which are entered into for profit-making, but are not part of the activities of an on-going business, but which have the characteristics of a business deal. Such transactions are of a revenue nature, unlike the sale of the family home, car and other private assets.

The mere disposal of investment assets such as rental properties, business plant and machinery, the family home, family cars and other private assets does not amount to trade. However, assets can change their character but cannot have a dual character at the same time (paragraph 26 of MT 2006/1).

Paragraph 265 of MT 2006/1 lists factors which consider when land development activities amount to a business or a profit-making undertaking. If several of these factors are present it may be an indication that a business or an adventure in the nature of trade is being carried on.

Paragraph 252 of MT 2006/01 relates to supplementary work conducted on, or in connection with the property, and states:

Improving property beyond preparing an asset for sale, to bring it into a more marketable condition and gain a better price suggests an element of trade.

MT 2006/1 continues:

262. The question of whether an entity is carrying on an enterprise often arises where there are 'one-offs' or isolated real property transactions.

263. The issue to be decided is whether the activities are an enterprise in that they are of a revenue nature as they are considered to be activities of carrying on a business or an adventure or concern in the nature of trade (profit making undertaking or scheme) as opposed to the mere realisation of a capital asset…

…

265. … a list of factors can be ascertained that provide assistance in determining whether activities are a business or an adventure or concern in the nature of trade (a profit-making undertaking or scheme being the Australian equivalent, see paragraphs 233 to 242 of this Ruling). If several of these factors are present it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows:

• 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

• buildings have been erected on the land.

266. In determining whether activities relating to isolated transactions are an enterprise or are the mere realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. This may require a consideration of the factors outlined above, however there may also be other relevant factors that need to be weighed up as part of the process of reaching an overall conclusion. No single factor will be determinative rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

In terms of the factors listed in paragraph 265 of MT 2006/1 relevant to your circumstances:

(a) there is a change in purpose for which the land is held

(b) there is a coherent plan for the subdivision of land

(c) funds have been borrowed to finance this activity

(d) there was a business organisation in that the trust had a company as the trustee

(e) following demolition of the existing residence, buildings were erected on the land.

Application of law to your case

In your case, you, at the time, were not carrying on a business of property development because your activity did not display the salient indicator of a business, which are transactions entered into on a continuous and repetitive basis.

However, although you were not carrying on a business of property development, the profit from your property development will be accounted for on revenue account as an isolated commercial transaction. The nature of your activity meets the characteristics described in TR 92/3 as there were large sums of money involved, the property was only held for a short period, there was development on a sizeable scale with the construction of buildings at a substantial cost and development applications were submitted to the planning commission just after purchase.

With regard to MT 2006/1 there was a change of purpose for which the land was held; you developed the property for the primary purpose of resale; there was a coherent plan for the subdivision; there was a level of development of the land beyond that necessary for the resale of the land, and buildings had been erected on the land.

Any profits on the sale of the lots will be assessable under section 6-5 of the ITAA 1997 and section 118-20 of the ITAA 1997 will apply to reduce any capital gain to nil.