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Ruling

Subject: Land subdivision

Question 1

Will the proceeds of the sale of a newly constructed house and land package resulting from the subdivision of the property under option 1, be assessable under the capital gains tax provisions?

Answer:

No

Question 2

Will the proceeds of the sale of a newly constructed house and land package resulting from the subdivision of the property under option 1, be assessable as ordinary income?

Answer:

Yes

Question 3

Will the proceeds of the sale of one vacant block of land resulting from the subdivision of the property under option 2 be assessable under the capital gains tax provisions?

Answer:

Yes

Question 4

Will the proceeds of the sale of two vacant blocks of land resulting from the subdivision of the property under option 3 be assessable under the capital gains tax provisions?

Answer:

Yes

This ruling applies for the following period

Year ended 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts and circumstances

You are joint owners of a property.

The property consisting of a large older house was acquired over 20 years ago.

The property has always been used as your principal place of residence.

You were thinking about selling the property to downsize.

You were advised that if the property was developed, that is, the house was demolished and the property subdivided into two equal blocks they would be worth more than simply selling the property. As well, you were advised that most potential purchasers would only be interested in developing the property and building new houses for sale on the subdivided blocks.

You are now seriously considering the possibility of demolishing the house and developing the property yourselves under one of the following three options:

· Option 1 - Subdivide the property into two equal blocks, build a house on each subdivided block, one for you to live in and the other to sell.

· Option 2 - Subdivide the property into two equal blocks, build a house for you to live in on one of the new subdivided blocks and sell the other subdivided block as vacant land.

· Option 3 - Subdivide the property into two equal blocks and sell both subdivided blocks as vacant land.

You are currently in the process of speaking to real estate agents, builders, the local council and your accountant in order to determine which option would be the most viable. At this stage you consider that option 1 may be the most viable as you would get a new home for yourselves with more equity as the new house and land would be valued higher than the original home.

As yet, you do not know the local Council's minimum requirements for the subdivision but it should be easy to subdivide.

You intend to engage a builder to do the plans and development application and, if necessary, to also construct the new houses. You consider that the planning and development approval should take about 6 months.

To fund the development under option 1 you intend to borrow a sum of money for 12 months which will be repaid when the second house is sold.

You have never been involved with the real estate industry nor done any property development work before.

In the past, you were both salary and wage earners. Also, you had earlier conducted a business from the property. The business was carried on under the partnership and was registered for GST. The GST registration was cancelled a few years ago when the business ceased. You are now both retired.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 106-5

Income Tax Assessment Act 1997 Section 112-25

Income Tax Assessment Act 1997 Subsection 112-25(3)

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Section 110-35

Income Tax Assessment Act 1997 Section 115-25

Reasons for decision

Summary

The proceeds to be received on the sale of the newly constructed house and land package resulting from the subdivision of the property under option 1 will assessable as ordinary income. While the activity is not considered to be a business of property development, it constitutes a profit-making undertaking or scheme (or an adventure or concern in the nature of trade) and is therefore considered an isolated commercial transaction conducted with a view to a profit. The activities undertaken for the development go beyond that of a mere realisation of a capital asset as they involve significant change and value adding to the original asset.

The proceeds to be received on the sale of either one vacant block of land or both vacant blocks of land resulting from the subdivision of the property under options 2 and 3 are considered to be mere realisations of a capital asset. This is because, the activities undertaken are only the minimal activities required to subdivide and dispose of the land.

Detailed reasoning

You intend to demolish your existing house and develop the property under one of the following three options:

· Option 1 - Subdivide the property into two equal blocks, build a house on each subdivided block, one for you to live in and the other to sell.

· Option 2 - Subdivide the property into two equal blocks, build a house for you to live in on one of the new subdivided blocks and sell the other subdivided block as vacant land.

· Option 3 - Subdivide the property into two equal blocks and sell both subdivided blocks as vacant land.

Therefore, we will need to determine whether the proceeds received from each of the proposed developments:

· is assessable ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as you were carrying on a business of property development

· is assessable ordinary income under section 6-5 of the ITAA 1997 as you conducted an isolated commercial transaction with a view to a profit, or

· is a realisation of a capital asset and assessable under the capital gains tax provisions of the ITAA 1997.

Assessable as ordinary income

Income from carrying on a business of property development

The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the facts provided.

Taxation Ruling TR 97/11 provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. Indicators include commercial significance or character, regularity and repetition, organisation, size, scale and permanency.

No one factor is decisive. The indicators must be considered in combination and as a whole. Whether a 'business' is carried on depends on the large or general impression gained.

From the facts provided, and in applying the business indicators to your circumstances, we make the following observations:

· you have not previously been engaged in property development

· you do not intend to commence a property development business

· you will have minimal involvement in the construction and sales processes for the development (as you are engaging other parties for these purposes).

· this is a one-off activity that is unlikely to be repeated.

Therefore, the large and general impression gained after examining your activity against the business indictors indentified in TR 97/11, is that you are not considered to be carrying on a business of property development under any of the proposed options.

Income from an isolated transaction

Paragraph 234 of Miscellaneous Taxation Ruling MT2006/1 distinguishes between a business and an adventure or concern in the nature of trade (or profit-making undertaking or scheme). It provides that the term 'business' would encompass trade engaged in, or on, a regular or continuous basis. However, it goes on to say that an adventure or concern in the nature of trade may be an isolated or one-off transaction that does not amount to a business deal but has the characteristics of a business deal.

The question of whether an entity is carrying on an enterprise often arises where there are one-off property transactions. The decision to be made is whether the activities are an adventure or concern in the nature of trade as opposed to the mere realisation of a capital asset.

Taxation Ruling TR 92/3 sets out the Commissioners view on whether profits made from isolated transactions are ordinary income. '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.

Whether a profit from an isolated transaction is income according to ordinary concepts depends very much on the circumstances of the case. However, where a taxpayer who does not carry on a business makes a profit from an isolated transaction, 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.

Intention or purpose

The relevant intention or purpose of the taxpayer (of making a profit or gain) is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

Option 1

In undertaking the proposed plan, you would realise a significant profit from the sale of the house and land package, over and above what would be expected from a simple subdivision and sale of the land. This is because the development will result in a saleable house and land package and a new house for you. In addition, the expected revenue from the sale of the house and land package will be sufficient to repay your borrowings that covered the costs of the development of both properties. Therefore, it would be reasonable to conclude that a significant purpose in undertaking the development is to make a profit or gain.

Option 2

In undertaking the proposed plan, the expected profit to be realised will be significantly less than that under option 1 as you will only be selling a vacant block of land. However, the profit made from selling the vacant block of land will still be sufficient to cover the costs of the construction of your house. Therefore, it would be reasonable to conclude that a significant purpose in undertaking the development is to make a profit or gain.

Option 3

In undertaking the proposed plan, the expected profit to be realised will also be significantly less than that under option 1 as you will only be selling two vacant blocks of land. However, it is likely that you will need to then purchase further land, and construct a new house with the profit made from the sale of the vacant blocks. Therefore, it would be reasonable to conclude that there was no profit making intention present when entering into the development transaction.

Carrying out a commercial transaction

For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character. Paragraph 13 of TR 92/3 lists factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction. Relevant factors include:

· 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;

· 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.

In addition to the above general factors, MT 2006/1 provides a list of specific factors relevant to real property and development, if several of these factors are present it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows:

· there is a change of purpose for which the land is held;

· additional land is acquired to be added to the original parcel of land;

· the parcel of land is brought into account as a business asset;

· there is a coherent plan for the subdivision of the land;

· there is a business organisation - for example a manager, office and letterhead;

· borrowed funds financed the acquisition or subdivision;

· interest on money borrowed to defray subdivisional costs was claimed as a business expense;

· there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and

· buildings have been erected on the land.

No single factor is determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

Option 1

Paragraphs 284 to 287 of MT 2006/1 provide an example of a subdivision of land that amounts to an enterprise by way of constituting an isolated profit-making scheme or transaction. This example reads as follows:

284. Prakash and Indira have lived in the same house on a large block of land for a number of years. They decide that they would like to move from the area and develop a plan to maximise the sale proceeds from their land.

285. They consider their best course of action is to demolish their house, subdivide their land into two blocks and to build a new house on each block.

286. Prakash and Indira lodge the necessary development application with the local council and receive approval for their plan. They arrange for:

· their house to be demolished ;

· the land to be subdivided ;

· a builder to be engaged ;

· two houses to be built ;

· water meters, telephone and electricity to be supplied to the new houses ; and

· a real estate agent to market and sell the houses.

287. Prakash and Indira carry out their plan and make a profit. They are entitled to an ABN in respect of the subdivision on the basis that their activities go beyond the minimal activities needed to sell the subdivided land. The activities are an enterprise as a number of activities have been undertaken which involved the demolition of their house, subdivision of the land and the building of new houses.

In your case, the proposed development is similar to the example given above. Your proposed plan is to demolish your existing home and replace it with 2 new residential houses, 1 of which will be sold, with one being retained as your main residence. In addition;

· a substantial amount of money has been borrowed to finance the development, indicating that the value of capital risked is significant.

· the development represents significant value adding to the original asset, with the expected revenues from the sale of the house and land package being sufficient to cover the costs of the development.

Based on the information provided, it is considered that the transaction is commercial in character due to the magnitude of profit, the significant value adding expected to be achieved and, the amount of capital risked in carrying out the project. The number of activities undertaken goes beyond the minimal activities needed to simply subdivide and sell the land. This indicates that the transaction is beyond that of a mere realisation of a capital asset and is in the form of an adventure or concern in the nature of trade (or profit-making undertaking or scheme).

Option 2

In your case, the proposed development constitutes the subdivision of the land into two blocks. One block will be sold as vacant land and one will be retained, on which you will construct a new house for yourself. In this scenario, we consider that the activity undertaken is simply a way of disposing of some of the land on which your home is situated. Therefore we consider that the activity does not amount to a profit-making undertaking or scheme, and is merely a realisation of a capital asset.

Option 3

In your case, the proposed development constitutes the subdivision of the land into two blocks. Both blocks will be sold as vacant land, with no construction undertaken, apart from the minimal activities needed to sell the subdivided land. Accordingly, the activity does not amount to a profit making undertaking or scheme, and is merely a realisation of a capital asset.

Assessable as a capital gain

Option 1

As discussed earlier, your proposed option 1 development amounts to a profit-making undertaking or scheme and therefore is assessable as ordinary income. It will not be assessed under the capital gains tax provisions.

Options 2 and 3

The proposed option 2 and 3 developments amount to the realisation of a capital asset and will be assessed under the capital gains tax provisions. The following information relates to the capital gains implications for options 2 and 3 only. Further information that may also be helpful in understanding the capital gains tax implications can be found in the Guide to capital gains tax 2011-12 located on our website at www.ato.gov.au.

Calculating your capital gain

You make a capital gain from the disposal of an asset if the amount of money you received on the disposal was more than the cost base of the asset.

Section 106-5 of the ITAA 1997 discusses capital gains in relation to partnerships. It provides that any capital gain from a CGT event happening to a partnership asset is made by the partners individually, with each partner's gain calculated by reference to the partnership agreement, or partnership law if there is no agreement. Each partner has a separate cost base for the partner's interest in the CGT asset of the partnership.

Disposal of a CGT asset

Section 104-10 of the ITAA 1997 provides that CGT event A1 occurs when your ownership in a CGT asset (eg. property) is transferred to another entity. The time of the event is when you enter into a contract for the disposal, or, if there is no contract, the time of disposal is taken to be the time when the change in ownership occurs. In your case, you will dispose of a CGT asset (the property), therefore CGT event A1 will happen and the capital gains tax provisions will apply.

Section 112-25 of the ITAA 1997 provides that when a CGT asset is split into two or more assets, such as when you subdivide a block of land into three separate blocks, the split or change is not a CGT event. Therefore, it is only on disposal of the CGT asset that a CGT event will occur.

Subsection 112-25(3) of the ITAA 1997 provides that you work out the cost base of each new asset (eg. each new block of land that has been split from the original block of land) as follows:

1) Work out each element of the cost base and reduced cost base of the original asset at the time of the event (when the land was first subdivided).

2) Apportion in a reasonable way each element to each new asset. The result is each corresponding element of the new asset's cost base.

Cost base for a CGT asset

Section 110-25 of the ITAA 1997 provides that there are five elements of the cost base;

1) money paid, or market value of property given, to acquire the asset

2) incidental costs of acquiring the asset, or that relate to the CGT event that happens to the asset

3) certain non-capital costs of ownership

4) capital expenditure on improvements

5) capital expenditure in respect of title or right to the asset

Section 110-35 of the ITAA 1997 provides that incidental costs include remuneration for the services of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal adviser.

50% CGT discount

A 50% discount may be applied to a discount capital gain realised by an individual. In order to be considered a discount capital gain, the asset that gave rise to the capital gain must have been owned for a period of at least 12 months prior to the CGT event (section 115-25 of the ITAA 1997).

Accordingly, if you held the asset for a period of at least 12 months prior to its disposal, you may be entitled to apply the 50% CGT discount to any capital gain made on disposal of the property.

Conclusion

Option 1

On a weighing of the facts of your case we find that the development will be entered into, and any profits made, in the course of carrying out an isolated commercial transaction with a view to a profit. Accordingly, the proceeds will be considered ordinary assessable income under section 6-5 of the ITAA 1997.

Option 2 and 3

On a weighing of the facts of your case we find that the developments will be merely a realisation of a capital asset and therefore the proceeds will be assessable under the capital gains tax provisions of the ITAA 1997.