Edited version of your private ruling

Authorisation Number: 1012074089268

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Ruling

Subject: Subdivision of pre-CGT land

Question 1

If the taxpayers' proposed activities constitute an 'enterprise' for the purposes of the GST Act, would that preclude a finding that the taxpayers are not carrying on a business for the purposes of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Are the taxpayers carrying on a business, such that potential gains from the sale of sub-divided lots will give rise to assessable income under section 6-5 of the ITAA 1997?

Answer

No.

Question 3

If the answer to question 2 is no, would potential gains from the sale of subdivided lots be regarded as income from isolated transaction(s) and therefore, should be included in the taxpayers' assessable income under either section 6-5 or section 15-15 of the ITAA 1997?

Answer

Yes.

Question 4

If the answer to question 3 is yes, and the profit on the sale of the subdivided lots constitutes assessable income under section 6-5 of the ITAA 1997, can you use the market value of the property at the time of entering into the Development Application (DA) for subdivision as your cost in calculating the profit on the sale of each subdivided lot?

Answer

Yes.

This ruling applies for the following period

The 2011-12 income year

The 2012-13 income year

The 2013-14 income year

The scheme commenced on

1 July 2011

Relevant facts

You purchased vacant land prior to September 1985. This property became your principal residence and it has continued to be your family home since then.

You have not used the property for producing assessable income and it was not purchased with the intention of profit making on sale. Improvements you have made include the building of the family home, a swimming pool, tennis court and a barn.

You are approaching retirement and you are finding the 'broad acre' lifestyle increasingly tiring because of the work required to maintain the gardens and grounds surrounding the family home.

The local Council has recently rezoned the area in which the property is located from 'rural' to 'residential'. No rezoning request was made by you or on your behalf. The rezoning was a result of a State Planning release.

At various times you have been approached to sell your property. However, no action has ever been taken. More recently, activity by your neighbours has been the catalyst for you to consider selling your property. You engaged a consultant to advise you on how to sell your property and realise the increased value of your land and how a subdivision of the property could proceed.

You are proposing to subdivide the land in order to capitalise on the increased value brought about by the rezoning and by other subdivisions in the area.

The proposed subdivision will occur in two stages. The reason for the staged development is that the lots with frontages to the road can be subdivided and sold as they have access to both the road and essential services.

To achieve the stage 2 subdivision, you will be required to construct an access road and connect services to those lots. This will require cooperation from the owners of the adjacent properties.

You do not intend to undertake any more work than the minimum required by council to register the subdivision. You will not construct or cause to be constructed houses on the subdivided lots and will not be involved in the marketing and selling of the subdivided lots. Your interests are to sell the property.

Works required by the Council for the subdivision include:

· half road upgrade to the extent of property frontage;

· relocation of services affected by the road upgrade;

· construction of a cycle way to the extent of the property boundary, and

· upgrading services, including sewer, water, electrical and earthworks including the regrading of the lots to meet Council requirements.

You have no history as either property developers or property investors and do not intend to undertake speculative development activities in the future. Because of your lack of experience in that industry and the risks associated with such ventures.

You have engaged a project manager to oversee the subdivision process; liaise with appropriate authorities and to negotiate with contractors.

The current market value of the property with DA approval to subdivide into lots to be between $X - $Y million.

You estimate that the total cost to complete the subdivision of your property will be approximately $Z million. To fund the subdivision, you will need to borrow funds, but the amount of the loan required has not been determined and no loan application has been made as yet. You are risk adverse and if possible, your intention is to reduce the need for borrowing by a sale of the stage 1 lots.

The project manager has advised that stage 1 of the subdivision will require expenditure of approximately $W million and a portion of that will need to be borrowed. The amount of the required borrowing has not yet been determined and no loan application has been made yet. It is estimated that a further $V million will be needed to subdivide stage 2. At this time it is intended that the primary source of funding for stage 2 will be from the proceeds of the sale of the stage 1 lots.

The estimated total sale proceeds is $XX million.

You currently intend to preserve your existing family home within the boundary of one of the subdivided lots and continue to live in that house for some years.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 15-15

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

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

The legislative references referred to herein are from the ITAA 1997 unless otherwise stated.

Summary

The facts in your case support the view that the development of your land, subdivision and subsequent sale constitute an isolated transaction with a profit making purpose.

Detailed reasoning

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

o income according to ordinary concepts under section 6-5 derived:

in the course of carrying on a business, or

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

o subject to capital gains tax.

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

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.

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. Therefore, the activity would be best described as an isolated transaction.

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, profits on the sale of subdivided land can still be income according to ordinary concepts within section 6-5, or as a profit making undertaking or plan within section 15-15 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.

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

· you are operating a small business.

· you have not been involved in any property development activity in the past and this is your first subdivision project.

· the approximate cost of the subdivision is expected to be $Z million and the expected total proceeds from the subdivided lots are approximately $XX million. The value of the DA approved pre subdivided land is between $X and $Y million. The amount of the costs of the project is approximately half of the current pre subdivision value of the land. As such the costs associated with the subdivision are considered significant.

· The subdivision will generate an extra profit of approximately $U million.

· The subdivision will require infrastructure comprising, road upgrade, relocation of services affected by the road upgrade, construction of a cycle way to the extent of the property boundary and upgrading services, including sewer, water, electrical and earthworks including the regrading of the lots to meet Council requirements. Development costs are approximately $Z million.

The decision in FCT v Whitfords Beach Pty Ltd (1982) 150 CLR 355; 12 ATR 692; 82 ATC 4031 (Whitfords Beach case) indicates that profits from a large subdivision are likely to be income.

This test alone may not be conclusive however a more satisfactory test is the ratio of development expenditure to the value of the undeveloped land.

In this case, the value of the pre subdivided DA approved land is between $X and $Y million and the approximate cost of the subdivision is expected to be $Z million. The expected proceeds from the subdivided lots are approximately $XX million.

You state that the disposal of your land by subdivision and sale constitute the realisation of a capital asset that was acquired, not for profit making purposes.

Whilst it is acknowledged that this may be the case, Taxation Ruling TR 92/3 at paragraphs 41 & 42 addresses this issue as follows; for example, if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either; or

1. as the capital of the business; or

2. into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction,

the activity of the taxpayer constitutes the carrying on of a business or business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income although the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

Miscellaneous Taxation Ruling MT 2006/1 talks about isolated transactions and sales of real property. From the Statham and Casimaty cases 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. 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; and

· buildings have been erected on the land.

Example 30 in MT 2006/1 found the subdivision activities were an enterprise based on the following factors:-

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

· there is a comprehensive plan for the development of the property;

· the subdivision is developed in a businesslike manner for example there is a project manager, significant development costs, a comprehensive marketing campaign including an estate name for the land; and

· a substantial loan has been taken out to finance the development.

In your case by undertaking a land subdivision of this scale you have taken on a financial risk akin to a normal business undertaking.

· you will not be acting as the developer, but will commission a project manager to manage the project from the preliminary planning through to the sale of the subdivided lots as a commercial undertaking.

· the property in this case is a few hectares of land that will be subdivided into lots.

· you have provided a history of the land since acquisition. You have provided the details from the time the land was acquired. You built a house and lived at the property. The land was rezoned and properties in your area were being developed.

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.

In particular the amount of the proposed expenditure being half the current value of the land. 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.

Subsection 15-15(1) states that your assessable income includes profit arising from the carrying on or carrying out of a profit-making undertaking or plan. Subsection 15-15(2) goes on to say this section does not apply to a profit that is assessable as ordinary income under section 6-5; or if it arises in respect of the sale of property acquired on or after 20 September 1985.

Calculating the profit

In situations where the sale of an asset is not a mere realisation, it is the net profit from the isolated transaction which will be assessable as ordinary income - see FC of T v. Whitford Beach Pty Ltd (1982) 150 CLR 355; 82 ATC 4031.

In determining the net profit that will arise from the sale of a block of land, the sale proceeds are reduced by an appropriate amount based on the market value of the block at the time the land was ventured into the profit-making scheme.

You will therefore be able to use the market value of the property at the time of entering into the DA for subdivision in calculating the profit on the sale of each subdivided lot.