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Ruling

Subject: Subdivision of land

Question 1

Are the proceeds of sale on realisation of the subdivided residential lots comprising the land assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice/Answers

No

Question 2

Are the proceeds of sale on realisation of the subdivided residential lots comprising the land assessable under section 15-15 of the ITAA 1997?

Advice/Answers

No

Question 3

Are the proceeds of sale on realisation of the subdivided residential lots comprising the land assessable 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 15-15.

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 108-7

Income Tax Assessment Act 1997 - Section 108-80.

Income Tax Assessment Act 1997 - Section 108-70.

Reasons for decision

Question 1

The proceeds from the realisation of 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, 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:

A profit from an isolated transaction is therefore 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.'

In 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:

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?

In the majority of cases including AAT decisions it has been held that the subdivision and sale of land not bought for the purpose of resale would not result in the profit being assessable income : Scottish Australian Mining Co Ltd v FC of T (1950) 81 CLR 188 (Scottish Australian Mining Case); McClelland v FC of T (1970) 120 CLR 487; 70 ATC 4115; 2 ATR 21, FC of T v N.F. Williams (1972) 127 CLR 226; 72 ATC 4188; 3 ATR 283 and Case 62/96, 96 ATC 575, Casimaty v FC of T (1997) 37 ATR 358, 97 ATC 5135 (Casimaty's Case), McCorkell v FC of T 98 ATC 2199 (McCorkell's Case) Statham & Anor v FC of T (1988) 89 ATC 4070; 20 ATR 228 (Statham's Case).

In this case the facts support a conclusion that the land was not acquired for the purpose of profit making by sale at the time of acquisition.

TR 92/3 along with the decision in FC of T v Whitfords Beach Pty Ltd (1982) 150 CLR 355; 12 ATR 692; 85 ATC 4031 (Whitfords Beach Case) indicate that a landowner need not have an intention of making a profit by sale at the time of acquiring the property. 

Both Wilson J and Gibbs J in the Whitfords Beach Case indicated the significance of the change of intentions resulting from the change in ownership some time after the land was acquired. 

It is also significant that in both Abeles & Anor v FC of T (1991) 91 ATC 4756; 22 ATR 504 (Abeles Case) and Crow v FC of T (1988) 88 ATC 4620 (Crow's Case) the Courts, in deciding the profits were assessable income, did not accept the taxpayers contentions that the land was purchased for means other than profit making. 

The intention of the parties at the time of undertaking to subdivide the land. 

Lockhart J in Crow's Case observed that 'where a realisation of property is motivated by factors other than those normally expected in a business context, the Court will be less ready to find that the realisation had the nature of a business transaction'. 

In Statham's Case the Court thought it significant that the taxpayer only subdivided after attempting to sell the land in one lot.  In Case 62/96 the AAT believed it significant that the realisation was motivated by factors not normally associated with carrying on a business.  The sales in that case were motivated by the threat of compulsory acquisition and the fact that the remaining land was no longer suitable for the purpose for which it was originally acquired. 

In Casimaty's Case, Ryan J recognised the significance of the taxpayer's age and deteriorating health as well as the taxpayer's need to reduce his debts.  In McCorkell's Case the AAT considered the taxpayers wish to retire and the encroachment of residential developments on the taxpayers land.  

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 another 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.

We have concluded that a business of land developing is not intended to be carried on here. However, it is necessary consider whether the net profit arsing from the sale proceeds would amount to ordinary income as an isolated transaction.

Paragraph 13 of TR 92/3 also outlines a number of factors in determining whether an isolated transaction amounts to a business operation or commercial transaction. We consider the relevant factors as follows:

A) Nature of the entity undertaking the operation or transaction

B) Nature and scale of other activities undertaken by the taxpayer

C) Amount of money involved in the transaction and the magnitude of the profit sought

D) Nature, scale and complexity of the operation or transaction

F) Nature of any connection between the relevant taxpayers and any other party to the transaction

G) Nature of the property

H) Timing of the transaction or the various steps in the transaction

Conclusion

None of the factors listed at paragraph 13 of TR 92/3 are determinative on their own. In cases of this nature it is necessary to stand back and look at the totality (Sir Nicolas Browne-Wilkinson V-C in Marson (HK Inspector of Taxes) v. Morton and Others [1986] 1 WLR 1343 at p 1349; 59 TC 381 at 392).

After weighing all the circumstances, it is considered that the proposed subdivision and sale of the subdivided lots constitutes the mere realisation of a capital asset. The subdivision was carried out in an enterprising way so as to secure the best price. The profit on the sale of subdivided lots does not constitute ordinary income under section 6-5 of the ITAA 1997.

Question 2

Profit arising from a profit-making undertaking or plan

Section 15-15 of the ITAA 1997 includes in assessable income all profit from the carrying on or carrying out of a profit-making undertaking or plan.

In XCO Pty Ltd v. FC of T (1971) 124 CLR 343; 2 ATR 353; 71 ATC 4152, Gibbs J stated at CLR 350; ATR 358; ATC 4155 that:

A scheme is not a "profit-making scheme" simply because it yields a profit when none was intended; in the ordinary sense of the words a "profit-making scheme" is a plan devised in order to obtain a profit, and a scheme only answers that description if the taxpayer carries it out with the purpose of making a profit.

Therefore, a taxpayer must have held a profit-making purpose, which may not be a dominant purpose, in carrying on or carrying out a profit-making undertaking or plan. In Steinberg v FCT (1975) 134 CLR 640; 5 ATR 565; 75 ATC 4221 (Steinberg), Gibbs J stated at ATC 4232 that:

I am in agreement with the view expressed by Mason J that "it is not an essential element of a profit-making scheme in s 26(a) that every step which culminates in the making of a profit should be planned or foreseen before the scheme is put into operation'. Schemes may be precise or vague; every detail may be arranged in advance, or the working out of the plan may be left for decision in the light of circumstances as they arise. It is no objection to a plan that it allows room for manoeuvre. When property is bought with the purpose of making a profit in the easiest or most advantageous way that may present itself, and the taxpayer adopts "one of the many alternatives' that his plan leaves open, thereby returning himself a profit, he will rightly be said to be carrying out a profit-making scheme.

Case law has concluded that the mere realisation of a capital asset which was not acquired for the purpose of profit making by sale does not constitute a profit-making undertaking or scheme within meaning of section 15-15 of the ITAA 1997, even though the realisation is effected in the most advantageous manner:

The acquisition of the land was not with the intention of reselling at a profit. Without a profit-making purpose, section 15-15 of the ITAA 1997 will not apply as the taxpayer is realising a capital asset in the most advantageous manner.

Question 3

Capital gains tax

Pre CGT land

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.

Subsection 104-10910 of the ITAA 1997 provides that CGT event A1 happens if you dispose of a CGT asst. As the sale of subdivided lots is no more than the realisation of a capital asset, any realised gain on the transaction will be a capital gain for the purposes of subsection 104-10(4) of the ITAA 1997.

Taxation Ruling TR 93/32 provides guidance on the division of net income between co-owners. Ownership conveys an entitlement to exercise the maximum legally permissible rights over what is owned. Generally a legal interest in land is achieved by the owner being the registered proprietor of the legal title to the land. Where there is more than one person with a concurrent legal interest in the same land, those persons are co-owners of the land.

Section 108-7 of the ITAA 1997 provides that individuals who own a CGT asset as joint tenants are treated as if they each owned a separate CGT asset constituted by an equal interest as a tenant in common.

A capital gain or capital loss from CGT event A1 is disregarded if the asset was acquired before 20 September 1985 (subsection 104-10(5) of the ITAA 1997).

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'.

Capital Improvements

Section 108-70 of the ITAA 1997 treats capital improvements as separate assets in some circumstances. Subsections 108-70(2) or 108-70(3) of the ITAA 1997 may have application depending on whether the improvements (that is, the subdivision and development works) are related to each other.

Section 108-70 treats capital improvements as separate assets in the following categories of situations:

· Improvements to land

· Unrelated improvements to pre CGT assets (subsection 108-70(2)).

· Related improvements to pre CGT assets

Section 108-80 of the ITAA 1997 sets out factors to be considered when determining if capital improvements are related to each other and provides as follows:

108-80 In deciding whether capital improvements are related to each other, the factors to be considered include:

· the nature of the CGT asset to which the improvements are made; and

· the nature, location, size, value, quality, composition and utility of each improvement; and

· whether an improvement depends on a physical, economic, commercial or practical sense on another improvement; and

· whether the improvements are part of an overall project; and

· whether the improvements are of the same kind; and

· whether the improvements are made within a reasonable period of time of each other.

Improvements made as a result of the subdivision and development of land is generally considered to be related to each other in accordance with section 108-80 of the ITAA 1997.

Under subsection 108-70(3) of the ITAA 1997, capital improvements to a pre-CGT asset that are related to each other may be treated as a separate CGT asset if the total of their cost bases when a CGT event happens in relation to the asset, is :

More than the improvement threshold for the year in which the event happens; and

More than 5% of the capital proceeds from the event.

Where the total subdivision and land development costs are considered related to each other, the total cost of these capital improvements is to be allocated over all of the subdivided blocks. Accordingly, if the capital improvement expenditure applicable to each subdivided block is less than the improvement threshold for the relevant year and 5% of the capital proceeds, then for the purposes of any subsequent disposal, by the rulee of any of these blocks, the capital improvement is not taken to be a separate CGT asset.

Where the related capital improvements constitute a separate CGT asset, any capital gain or capital loss in respect of the separate CGT asset will not be disregarded under paragraph 104-10(5)(a) of the ITAA 1997.

The capital gain or capital loss on your interests in the capital improvements will be calculated by taking away your share of the cost base which relates to your interests in the improvements, from your share of the proceeds of the sale that are reasonably attributed to your interests in the improvements.

In determining how you would apportion the proceeds on the disposal of a composite asset, i.e. pre CGT land / post CGT improvement) you can obtain an independent valuation or do your own apportionment. If you do your own apportionment, you must be able to justify it.

Consideration will need to be given to the application of subsection 108-70(3) to the pre CGT land.

Post CGT land

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 from his share in the post-CGT interest in the land, if the capital proceeds from the disposal are more than its relevant cost base. There is no reduction under section 118-20 of the ITAA.