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Ruling

Subject: Subdivision of Land

Question 1

Will the sale proceeds from the sale of subdivided residential lots be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice/Answers

No

Question 2

If the answer to (1) is no, will the sale proceeds from the sale of the subdivided residential lots be assessable to the landowner under the capital gains tax provisions of Part 3-1 of the ITAA 1997?

Advice/Answers

Yes

This ruling applies for the following period

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

The scheme commenced on

1 July 2006

Relevant facts

The taxpayer owns land that has been used for business purposes over a number of years.

The business has been relocated and the land has been subdivided into residential blocks.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 6-5

Income Tax Assessment Act 1997 - Section 104-10

Income Tax Assessment Act 1997 - Section 112-25

Income Tax Assessment Act 1997 - Section 108-5

Income Tax Assessment Act 1997 - Section 108-70

Reasons for decision

Issue 1

Question 1

The proceeds from realising an asset may fall into one of the following situations:

It gives rise to income according to ordinary concepts under section 6-5 of the Income Tax Assessment 1997 (ITAA 1997); or

It gives rise to profit from the carrying on or carrying out of a profit-making undertaking or plan under section 15-15 of the ITAA 1997 if the asset was acquired before 20 September 1985; or

It gives rise to a gain under capital gains tax (CGT) provisions in Part 3-1 of the ITAA 1997.

Income according to ordinary concepts

Taxation Ruling TR 92/3 discusses the circumstances under which profits or gains from an isolated transaction are income:

Paragraph 6 of TR 92/3 provides that a profit from an isolated transaction is generally assessable income when both of the following elements are present:

(a) The intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain.

(b) The transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

The dividing line between realisations that give rise to assessable income and those that involve the mere realisation of a capital asset is narrow. In IRC v. British Salmson Aero Engines Ltd [1938] 2 KB 482 at 498 Lord Greene MR said:

There have been many cases which fall on the border-line. Indeed, in many cases it is almost true to say that the spin of a coin could decide the matter almost as satisfactorily as an attempt to find reasons.

The starting point in this area of the law is Californian Copper Syndicate (Limited and Reduced) v Harris (1904) 5 TC 159 the Lord Justice Clerk (the Right Honourable J.H.A. Macdonald) said at p 165-166:

It is quite a well settled principle, in dealings with questions of Income Tax, that where the owner of an ordinary investment chooses to realise it, and obtains a greater price for it than he originally acquired it, the enhanced price is not profit ... assessable to Income Tax. But it is equally well established that enhanced values obtained from realisation or conversion of securities may be so assessable where what is done is not merely a realisation or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business. ... What is the line which separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be determined being - Is the sum of gain that has been made a mere enhancement of values by realising a security, or is it a gain made in an operation of business in carrying out a scheme of profit-making?'

Federal Commissioner of Taxation v St Hubert's Island Pty Ltd (1978) 138 CLR 210 (St Hubert's Island) is authority for the proposition that a single venture of selling off land in subdivided lots can amount to the carrying on of a business.

Taxation Ruling TR 97/11 provides guidance on whether a taxpayer is carrying on a business of primary production. However, the principles enunciated in TR 97/11 are equally applicable to the question of whether a business is being carried on in other context. Paragraph 13 of TR 97/11 provides a list of indicators as to what will be considered. 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.

It is difficult to discriminate between mere realisation and the conduct of a business by reference directly to the magnitude of the physical activity or the physical effect of the activity, However, the magnitude of a substantial subdivisional enterprise entailed such a degree of systematic organisation, planning, management and repetition of purposeful profit-making activity that the carrying on of a business may be discerned in such case.

For the purposes of determining the question of whether any profits or gains fall to be considered as ordinary income, it is not necessary to decide, as a matter of legal distinction, whether or not a joint-venture or partnership exists. Nevertheless, it is worth referring to the comments of the High Court of Australia in United Dominions Corporation Ltd v Brian Pty Ltd [1985] HCA 49; (1985) 157 CLR 1. In the joint judgement of Mason, Brennan and Deane JJ it was said, (at CLR 10), that:

The term 'joint venture' is not a technical one with a settled common law meaning. As a matter of ordinary language, it connotes an association of persons for the purposes of a particular trading, commercial, mining or other financial undertaking or endeavour with a view to mutual profit, with each participant usually (but not necessarily) contributing money, property or skill. Such a joint venture (or, under Scots' law, "adventure") will often be a partnership. The term is, however, apposite to refer to a joint undertaking or activity carried out through a medium other than a partnership: such as a company, a trust, an agency or joint ownership.

The present facts support a conclusion that there is an intention to profits for sharing.

Consequently, it is necessary to consider individually whether each of Landowners have merely realised a capital asset or entered into a business or profit making undertaking (A.R.M. Constructions Pty Limited & Ors v F.C. of T. 87 ATC 4790;19 ATR 337)

Taxation Ruling 92/3 Profits on isolated transactions

The Ruling sets out our views as to the application of the decision of the Full Court of the High Court of Australia in FC of T v. The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693.

Paragraph 15 of TR 92/3 provides that if a taxpayer carrying on a business makes a profit from a transaction or operation, that profit is income if the transaction or operation:

(a) is in the ordinary course of the taxpayer's business (see paragraph 32 for an explanation of the circumstances in which a transaction is in the ordinary course of business) - provided that any gross receipt from the transaction or operation is not income; or

(b) is in the course of the taxpayer's business, although not within the ordinary course of that business, and the taxpayer entered the transaction or operation with the intention or purpose of making a profit; or

(c) is not in the course of the taxpayer's business, but

(i) the intention or purpose of the taxpayer in entering into the transaction or operation was to make a profit or gain; and

(ii)  the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

Paragraph 44 of TR 92/3 states that it is not our view, nor has it ever been, that all receipts or profits of a business are income. For example, when a taxpayer derives a profit from a transaction outside the ordinary course of carrying on its business and the taxpayer did not enter that transaction with the purpose of making a profit, the profit is not assessable income.

In this case it is accepted that the sale and subdivision of land is not in the ordinary course of the business nor is it an ordinary incident of the business.

Therefore, the profits on sale or subdivision will give rise to ordinary income under section 6-5 of the ITAA 1997 if the intention or purpose (objective) of the trustee in entering into the transaction or operation was to make a profit or gain.

Conclusion

Based on the facts provided, the taxpayer did not acquire its land holdings for the purpose of making a profit by its sale. Nor has the motivation for the sale and subdivision of the land been made to take advantage of market conditions or opportunities.

Taking the above factors into account, we do not regard the taxpayer as having ventured into a new business of profit making though subdivision of land. Whilst the taxpayer has sought to realise the asset in the most advantageous way (subdivision), this does not preclude the undertaking from being the realisation of structural asset of the business.

Consequently, the proceeds from the realisation of the land will not give rise to ordinary income under section 6-5 of the ITAA 1997.

Question 2

Capital gains tax

A capital gain or a capital loss may arise if a capital gains tax event (CGT event) happens to a capital gain tax asset (CGT asset). Section 108-5 of the ITAA 1997 provides that a CGT asset is any kind of property, or a legal or equitable right that is not property.

Section 112-25(2) of the ITAA 1997 provides that the splitting or changing of a CGT asset is not a CGT event. The subdivision of the land into subdivided blocks is not a CGT event. Taxation Determination TD 7 also provides that 'where pre-CGT land is subdivided after 19 September 1985 the land will maintain its pre-CGT acquisition date because there is no change in ownership'.

For subdivision of the post-CGT land, the cost base and reduced cost base of each new asset is calculated in accordance with the method statement in subsection 112-25(3) of the ITAA 1997. The method statement provides that a taxpayer first determines each element of the cost base and reduced cost base of the original asset at the time of the split and then apportion in a reasonable way each element to each new asset. The Tax Office would accept any approach that is appropriate in the circumstances of the particular case, e.g., on an area basis or relative market value basis (Taxation Determination TD 97/3).

Subsection 110-25(5) of the ITAA 1997 provides that the fourth element of the cost base of a CGT asset is the capital expenditure incurred to increase the asset's value, provided the expenditure is reflected in the state or nature of the asset at the time of the CGT event.

Expenditure incurred for capital improvements to post-CGT land is a separate CGT asset, not part of the land, if a balancing adjustment provision applies to it (subsection 108-70(1) of the ITAA 1997).

In this case, CGT event A1 (section 104-10 of the ITAA 1997) happens when the taxpayer disposes of a post-CGT subdivided lot to another entity. The time of the event is when the taxpayer enters into the contract for disposal. If there is no contract, the CGT event happens when the taxpayer stops being the owner of the separate asset or a post-CGT subdivided lot.

The taxpayer will make a capital gain in respect of post-CGT subdivided lots if the capital proceeds from the disposal are more than its relevant cost base.