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Ruling

Subject: Subdivision of land

Question 1

Will the profit from subdivision of land be assessable 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 on capital account and subject to the capital gains tax (CGT) provisions in Parts 3-1 to 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

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 taxpayer purchased land prior to CGT. He subsequently built his family's primary residence on the property. The taxpayer and his family have resided at that property to the present day. During that period, the land has only ever been used as a private residence.

The taxpayer wishes to dispose of the property. He is considering subdividing the property into a number of blocks. As part of the subdivision, he would be required to construct roads, allocate a park and connect services. Land will be required to be allocated for an easement for powerlines. The taxpayer's original residence will be demolished as part of the subdivision.

The blocks will be marketed to individual buyers and sold separately. There will be no structures built on the property which will be sold as vacant land. The property and subdivided blocks will remain in the taxpayer's individual name until final settlement on each block.

The taxpayer will engage a project manager to organise the works where necessary. The project manager will fund all permits and applications. Once the land is available for subdivision, the equity in the land will be utilized by the manager to secure bank finance to complete the construction. The manager will be acting at arm's length from the taxpayer.

The taxpayer is retired and lives from passive investments. He has never been involved in the business of land development.

Relevant legislative provisions

Section 6-5 Income Tax Assessment Act 1997

Section 118-20 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

On balance, it would seem that the nature of the project, including the scale of the undertaking and the level of costs compared with the undeveloped value of the land, are sufficient to take it 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.

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:

o those transactions outside the ordinary course of business of a taxpayer carrying on a business, and

o 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. For example, if a taxpayer is seeking to dispose of the property on which they have lived for many yeas in the most advantageous manner that intention is not, of itself, inconsistent with having a profit making 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

o the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain, and

o 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, 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. At paragraph 13 of TR 92/3 the Commissioner lists some matters which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction as follows:

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.

At paragraph 14 it states that it is not necessary that the profit be obtained by a means specifically contemplated. It is sufficient that the taxpayer enters into the transaction with the purpose of making a profit in the most advantageous way.

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

o You have not been involved in any land development previously

o The land involved has been your private residence for many years

o The land has not been used for any income producing purpose during the period of your ownership

o The land has been held for many years and has not been recently acquired for quick development and resale

o Borrowings will play a role in financing the development

o The development is significant in scale

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

o The combined subdivision sale costs are nearly double the undeveloped market value of the property

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. In the present case, the land had been acquired prior to the implementation of CGT. It has not been used to produce income during the period of ownership. Also, there is no previous history of land development on your part. Those facts are consistent with there being no commercial intention beyond the realisation of the original asset.

On the other hand, the scale of the undertaking is relatively substantial and the amounts being spent on the subdivision are roughly twice the undeveloped value of the land. At face value, the expenditure incurred goes beyond the minimum required to realise the asset and in fact will be met in part by borrowings. Whilst no one fact is determinative of characterisation, incurring costs so much greater than the market value of the original asset would suggest that the arrangement involves more than mere realisation of the asset. Those facts support a conclusion that the subdivision activities have become a business operation or commercial transaction in their own right which is distinct from the realisation of the original asset.

On balance, having regard to all of the facts, it would seem that the project is an undertaking on a sufficient scale to take it 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. There will be no assessable capital gain, by virtue of section 118-20.