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Authorisation Number: 1012115811220

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Ruling

Subject: sub-division - Income and capital gains tax - property sub-division

Question 1

Will the profit on the sale of the subdivided lots constitute assessable income under section 6-5 of the ITAA 1997?

Answer

Yes

Question 2

Will the capital gains tax (CGT) provisions in Parts 3-1 and 3-3 of the ITAA 1997 apply in relation to the sale of the subdivided lots?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commences on:

1 July 2011

Relevant facts and circumstances

You, the company, have an Australian Business Number (ABN). Your registration for the goods and services tax (GST) was cancelled a few years ago.

You own a parcel of land which you intend to sub-divide and sell.

A related entity owns another parcel of land adjoining your parcel of land.

Both you and the related entity own the respective properties under separate titles.

The related entity also wishes to sell their parcel of land.

For ease of subdivision, the related party will transfer parts of their land to you.

For the same reason, you will transfer part of your land to the related party.

As the subdivided lots in the two properties may have some common development work, you intend to engage the same team of consultants and contractors to carry out subdivision work.

However, you will be responsible for the subdivision of the land belonging to you and the related party for the land belonging to them.

You will lend money to the related party to enable them to make payments to consultants and contractors for work carried out in their sub-division work.

The transfer of the respective parcels of land between you and the related party will be for consideration and the appropriate stamp duty will be paid.

The subdivision of the land is to be undertaken to realise a better sales outcome than selling the properties as they are.

You and the related entity previously entered into sale contracts with an unrelated entity a couple of years ago. At this time you agreed to sell your share of the undeveloped land for $xx million subject to certain conditions. This sale did not proceed due to the global financial crisis and the inability of the purchaser to obtain sub-division approval within the desired timeframe.

Both you and the related party attempted to sell the land as it is, but could not find a buyer who was willing to buy at the price you wanted.

You and the related entity then lodged a planning application for the sub-division. This was approved subject to certain conditions, including provision of easements for drains, work to facilitate the supply of services such as electricity, construction of access paths, roads and other, grading, water management and landscaping, and so on.

You will engage engineering consultants to undertake the subdivision work and they will engage contractors to execute the necessary construction. You will neither engage employees for this project nor have a separate project office.

You will manage the payments to consultants and contractors and maintain the cash flow of the project

You will engage real estate agents to market and sell the subdivided lots.

Your share of the estimated cost of subdivision is over $x million.

Your estimated gross revenue from the sale of subdivided lots is over $xx million.

The majority of the lots are yours. The expected average price is $xx per lot.

When the subdivision plan is approved, subdivision work will be undertaken progressively and lots will be sold as they become available to fund the remaining development work.

The initial funding requirement is about $100,000.

You or/and entities related to you have previously undertaken sub-division activities in various capacities.

Prior sub-division activities undertaken by you and/or your associates include;

a property was sold to finance the sub-division of another property.

a property was sub-divided and sold to fund the purchase of new properties.

an unsuccessful attempt to sub-divide another property in association with other unrelated parties.

property was sold for the sum of $xx million. You advise the price was good due to interest in land with future potential for industrial development. It is unclear if this was sold with any developmental approvals.

you also attempted to sell the land which is the subject of this sub-division. The land was included in the local authorities recent development plan.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 160P(6)

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 70-10

Income Tax Assessment Act 1997 Subsection 70-30(1)

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 108-70

Income Tax Assessment Act 1997 Section 108-80

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 126-5

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Income tax treatment of land subdivisions

There are three ways profits from a land subdivision can be treated for income tax purposes:

As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of carrying on a business of property development.

As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of an isolated business transaction entered into by a non-business taxpayer or outside the ordinary course of business of a taxpayer carrying on a business, which is the commercial exploitation of an asset acquired for a profit making purpose.

As statutory income under the capital gains tax (CGT) legislation, (sections 10-5 and 102-5 of the ITAA 1997), on the basis that a mere realisation of a capital asset has occurred.

Ordinary income as a result of carrying on a business of property development

The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11, which uses the following indicators to determine whether a taxpayer is carrying on a business:

whether the activity has a significant commercial purpose or character;

whether there is repetition and regularity of the activity;

whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business;

whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit;

the size, scale and permanency of the activity; and

whether the activity is better described as a hobby, a form of recreation or a sporting activity.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

You purchased the property for use in farming activities. Although you have previously subdivided or developed property for profit, the repetition, scale and volume of your activity is not of the same nature as is ordinarily carried on by a property developer that is carrying on a business.

An entity in the business of property development would ordinarily conduct considerable research into the profitability and viability of a subdivision prior to purchasing a property. In your case, the properties have initially been purchased for and used in your primary production activities. This particular property was acquired by you over 30 years ago and the subdivision process commenced in recent years.

The Commissioner is satisfied you are not carrying on a business of property development.

Ordinary income as a result of an isolated transaction

Based on the information provided, your sub-division activity will be an isolated activity and is not one of a series of activities done in the form of a property development business.

In very general terms, a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations.

Taxation Ruling TR 92/ 3 discusses profits on isolated transactions and the application of the principles outlined in the decision of the Full High Court of Australia in FC of T v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693. This ruling states that profits on isolated transactions may be income.

Profit from an isolated transaction will be ordinary income where:

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 operation or commercial transaction.

Some factors to consider when looking at whether an isolated transaction amounts to a business operation or commercial transaction are listed at paragraph 13 of TR 92/3. They are:

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.

Applying the factors in paragraph 13 of TR 92/3 as listed above to your circumstances leads to the following conclusions:

You are a company and are undertaking the sub-division in concert with a related entity. Land is being transferred between you and the related entity to change the property boundaries and enable the planned subdivision. The business structures under which assets are held and business activities undertaken indicate transactions entered into are commercial in nature.

The company was established over 30 years ago to hold property for use in farming enterprises.

The sub-division will create for you a number of properties which you expect to sell for an average of $xx. The gross turnover is therefore approximately $xx million. Expenditure is expected to be around $x million. The undeveloped sale price of the property a couple of years ago was $xx million. By sub-dividing the property you expect to achieve an increased profit of more than $1 million.

The works to be done to develop the sub-division are substantial and indicate a high level of complexity of the activity.

You will engage engineering consultants to undertake the subdivision work and they will engage contractors to execute the necessary construction. You will manage the payments to consultants and contractors and maintain the cash flow of the project. Real estate agents will be engaged to market and sell the subdivided lots.

You will be entering into this activity in association with a company related to you. All facets of the development are undertaken with the related entity, including the moving of boundaries to enable the planned development to proceed.

You acquired the property over 30 years ago and it has been used for primary production since that time.

The local authorities development plan for the area encompassing your property was endorsed on xx. The document provided shows expressions of interest were sought from effected landowners during the development of the plan. You entered into a contract to sell the property a few months after, subject to sub-division approval. When this sale didn't proceed, you prepared and lodged development plans yourself. These were lodged on xx.

A consideration of the above factors leads to the overall impression that the subdivision and development of your property is business or commercial in nature. The disposal of the subdivided lots would be beyond that of a mere realisation of a capital asset and would amount to an isolated profit making transaction.

There is a demonstrated intention to profit and the transaction will be carried out in a commercial manner. The way the assets have been held, with the establishment of related companies and corporate trustees indicate that transactions entered into are done so with a commercial purpose.

You state that you attempted to sell the land in its present state but failed to find a buyer prepared to pay the price you expected. Your decision to subdivide the land was to obtain a higher price than what you can obtain by selling the land as it is. Thus, there is a risk involved in this strategy and an expectation of profit by undertaking the subdivision work.

The facts of this case show an extensive list of work to be done. Your share of the subdivision will create xx lots of vacant land and it may cost about $x million to complete. Therefore, we consider this as a significant development project and the costs involved in the subdivision are substantial. You also informed us that you intend to use your own funds for this purpose. You further informed us that the gross sales proceeds from the sale of the subdivided land would be about $xx million. Thus your investment in subdivision work constitutes a significant financial risk. You also informed us that you intend to undertake the subdivision progressively by selling the first lots of land that is subdivided to fund the development of the rest. There is, therefore, a high frequency of transactions, considerable business decisions to make and significant involvement in the project. Further, you intend to market and sell the properties by engaging an agent.

While the original property has been held as a capital asset and the work involved in the subdivision development will not go beyond what the local council requires, we consider that it is a commercial scale development with a high level of activities involved. The arrangement is one by which property of a given value is worked up or added to in such a way as to produce a greater amount on resale even though such property had originally been obtained for some quite different purpose and even though the transaction did not constitute the carrying on of a business.

Thus, it changes the nature of the land from that of a capital asset. The subdivision development will be a one-off activity that has the characteristics of a commercial deal. 

Consequently, the proceeds from your subdivision development and sale of the resulting vacant subdivided lots will be a profit from an isolated transaction under the guidelines of TR 92/3 as discussed above, and will be included in your assessable income as ordinary income under section 6-5 of the ITAA 1997.

Statutory income under the capital gains tax provisions

Section 118-20 of the ITAA 1997 contains anti-overlap provisions which operate to reduce any capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 of the ITAA 1997 as a result of the sale, for example, as ordinary income under section 6-5 of the ITAA 1997.

Accordingly, whilst CGT event A1 under section 104-10 of the ITAA 1997 will occur, any capital gain arising from this CGT event will be reduced to nil as any profit is otherwise assessable under section 6-5 of the ITAA 1997.