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Ruling

Subject: Property subdivision

Question:

Will the proceeds of subdivision of farming land by the sale of individual lots amount to more than a mere realisation of the property and hence deem the receipts to be assessable income in accordance with section 6-5 or section 15-15 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

No.

This ruling applies for the following period

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

The scheme commenced on

1 July 2013

Relevant facts

The company owns farmland and either receives rent from external parties or allows various farming land to be used by related entities on the basis that all expenses are paid by the lessee.

The total land owned by the company is approximately X hectares.

The company is in negotiations to develop and sell farming land which was purchased prior to 1985.

The total land held in the development area is approximately X hectares and is surrounded by residential development on three sides.

The land has been farmed by company director's family for more than 50 years.

Due to other land development in the area, farming has become increasingly difficult and is impractical to continue. Some of the problems include movement of farm machinery and livestock through the suburban streets, interference by local residents, livestock mauled by township dogs, crop spraying drift issues, risk of accidents and traffic restrictions.

The X hectares are the only land that is wholly within the township zone.

The company had attempted to sell the property as a whole but could not achieve the desired sale value.

The company is now obliged to develop and sell a portion of the land that is zoned residential. This area of land has always been used for agricultural purposes.

The remaining land in the area is zoned rural, recreation and tourist accommodation and could be rezoned to residential or other higher land use values to increase its sale value. All other land surrounding it is already zoned residential and mostly built upon.

This land is on the opposite side of a busy main road from the remaining land, and is now unsafe for farming vehicles and machinery to enter and exit.

The main director, will continue farming operations on other land owned by the company and associated entities.

The company and its directors have not previously been involved with land development activities.

The company had sought and obtained planning approval from the local council almost 20 years ago. Some construction work was undertaken by contractors; such as: upgrading of three existing roads, and associated kerbing, paving, effluent disposal, storm water and street lighting by the local council. Potable water service, telephone and electricity have been in existence for many decades to councils existing road reserves.

The company never carried out any works in its own right.

All of the requirements for the land division had not been completed by the company and recently the local council declared the original planning approval was still valid and issued a Completion of Work Notice.

The company is required to complete the developments as approved by the end of 2013. This will involve the construction of two internal roads and the associated infrastructure.

It is proposed that this development work will be undertaken by independent contractor/s and overseen by an independent contracted project manager.

The marketing and sale of the blocks will be undertaken by an independent real estate agent.

It is anticipated that the company and its directors will only be involved in management meetings with the project manager and real estate agent to monitor the progress and costs of the subdivision and not in the direct operational aspects of the development or sale of the 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 - Subsection 104-10(5).

Reasons for decision

Under section 6-5 of the ITAA 1997, your assessable income includes the ordinary income you derived directly or indirectly from all sources, during the income year. Additionally, section 15-15 of the ITAA 1997 includes profit arising from the carrying on or carrying out of a profit-making undertaking or plan. However, this provision does not apply to a profit that is assessable as ordinary income under section 6-5 of the ITAA 1997, or which arises in respect of the sale of property acquired on or after 20 September 1985.

Although the legislation does not define income according to ordinary concepts, a substantial body of case law has evolved to identify various factors that indicate the nature of ordinary income. 

In FC of T v The Myer Emporium (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693 (Myer Emporium), the Full High Court expressed the view that profits made by a taxpayer who enters into an isolated transaction with a profit making purpose can be assessable income.

Taxation Ruling TR 92/3 considers the assessability of profits on isolated transactions in light of the principles outlined in Myer Emporium. 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 6 of TR 92/3 provides that a profit from an isolated transaction will generally be income when both the following elements are present:

· your intention or purpose 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 or in carrying out a business operation or commercial transaction.

Additionally, if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to commit the asset, either:

· as the capital of a business or  

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

· this activity constitutes the carrying on of a business, or a business operation or commercial transaction. The profit from such activity is income even though the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

Some of the 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: 

(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.

Profits on the sale of subdivided land can therefore be income according to ordinary concepts within section 6-5 of the ITAA 1997, or as a profit making undertaking or plan within section 15-15 of the ITAA 1997, if the taxpayer's subdivisional activities have become a separate business operation or commercial transaction, or an isolated profit making venture.  

In contrast, paragraph 36 of TR 92/3 notes that 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. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment.

In this case, the property was originally purchased prior to 1985 to either rent to external parties or to allow the farming land to be used by related entities for primary production activities. The company has never been in the business of land development and will have minimal involvement in the subdivision of the land. Therefore, any proceeds received from the development of the property will not be ordinary income and not assessable under sections 6-5 or 15-15 of the ITAA 1997. The proceeds will represent a mere realisation of a capital asset which will fall for consideration under the CGT provisions in Part 3-1 of the ITAA 1997.

However, as the land was acquired prior to 20 September 1985, any capital gain or capital loss made will be disregarded for CGT purposes.