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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 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 108-7

Income Tax Assessment Act 1997 - Section 108-80.

Income Tax Assessment Act 1997 - Section 108-70.

Reasons for decision

Question 1

The proceeds from 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

There have been a number of court cases that deal with the issue of subdivision of land and property development. As a general principle, if the sale of the subdivided lots constitutes a business, or part of a business, the proceeds will be ordinary income. On the other hand, if the sale is a mere realisation of the land, the proceeds will be capital in nature.

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

16. If a taxpayer not carrying on a business makes a profit, that profit is income if:

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

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

36. The courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. The expression 'mere realisation' is used to contradistinguish a business operation or a commercial transaction carrying out a profit-making scheme (Myer at 163 CLR 213; 87 ATC 4368-4369; 18 ATR 699-700). If a transaction satisfies the elements set out in paragraph 35 it is generally not a mere realisation of an investment.

The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property. However, as the High Court decisions in White v. FC of T (1968) 120 CLR 191; 15 ATD 173 and Whitfords Beach demonstrate, that is not always the case. (See also Menzies J in FC of T v. N.F. Williams (1972) 127 CLR 226 at 245; 72 ATC 4188 at 4192-4193; 3 ATR 283 at 289 and Whitfords Beach Pty Ltd v. FC of T (F.C.) 79 ATC 4648 at 4659; 10 ATR 549 at 567).

Where a profit from an isolated transaction is assessable income, two elements must be existent. They are: the intention or purpose of profit-making must exist in relation to that transaction and the transaction must be a business operation or commercial transaction.

The taxpayer had no intention at the time of purchase of making a profit by subdividing the land for resale:

Without any profit making intention, the proceeds from a mere realisation of a capital asset are not income, even the taxpayer goes about the realisation in an enterprising way (Scottish Australian Mining Co. Ltd. v FC of T (1950) 81 CLR 188; 9 ATD 135 (Scottish Australian Mining); FC of T v. Whitfords Beach Pty Ltd (1982) 150 CLR 355; 82 ATC 4031; 12 ATR 692).

Recent cases of Statham v FC of T (1988) 20 ATR 288; 89 ATC 4070 (Statham), Casimaty v FC of T (1997) 151 ALR 242; 97 ATC 5135; 37 ATR 358 (Casimaty), and McCorkell v FC of T 39 ATR 1112; 98 ATC 2199 (McCorkell) demonstrates that in the absence of profit making intention the proceeds from that the sale of subdivided lots constituted a mere realisation of an asset and not proceeds made from a business.

In Stratham, the poor health of one of the partners and the depressed state of the cattle market were the cause of the sale. In Casimaty, subdivision was undertaken because the taxpayer's age, the deteriorating health as well as the taxpayer's need to reduce his debts. In McCorkell, the taxpayers wanted to retire and the encroachment of residential developments on the taxpayer's land.

However, profits on the sale of subdivided land can still be income according to ordinary concepts within section 6-5 of the ITAA 1997 if Kerry's subdivisional activities come into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction (Crow v FC of T 88 ATC 4620 (Crow)).

TR 92/3 at paragraph 42 explains situations where a profit from an isolated transaction is income even the taxpayer did not have the purpose of profit-making at the time of acquiring the property:

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:

· as the capital of a business; or

· 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 a 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.

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

E) Manner in which the operation or transaction was entered into or carried out

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

G) Nature of the property

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

Conclusion

It is a question of fact and degree in considering whether the taxpayer is carrying on a business of property development. None of the above factors are determinative on their own. After describing the process of reaching a conclusion in cases involving isolated transactions, 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 states:

I emphasise again that the matters I have mentioned are not a comprehensive list and no single item is in any way decisive. I believe that in order to reach a proper factual assessment in each case it is necessary to stand back, having looked at those matters, and look at the whole picture and ask the question - and for this purpose it is no bad thing to go back to the words of the statute - was this an adventure in the nature of trade?

After weighing all the circumstances, it is considered that the subdivision and sale of the subdivided lots constitute a mere realisation of a capital asset. It 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.

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 gains tax asset (CGT asset). Section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a CGT asset is any kind of property, or a legal or equitable right that is not property.

Subsection 104-10(1) of the ITAA 1997 provides that CGT event A1 happens if you dispose of a CGT asset. As the sale of subdivided lots activities are 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.

Section 112-25(2) of the ITAA 1997 provides that the splitting or changing of a CGT asset is not a CGT event. Therefore, the subdivision of Lot 5 into subdivided lots is not a CGT event.

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 apportions 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) only happens when the taxpayer sells a subdivided lot to another entity. The time of the event is when they enter into the contract for disposal. If there is no contract, the CGT event happens when they stop being the owners of the subdivided lot.

The taxpayer will make a capital gain from each subdivided lot if the capital proceeds from the disposal are more than the relevant cost base of each subdivided lot.