Edited version of your private ruling

Authorisation Number: 1012435178477

Ruling

Subject: Taxation treatment of profit or gain made from the sale of subdivided land

Questions and answers:

1. Will any portion of the proceeds from the sale of the subdivided land be included in your assessable income because of sections 6-5, 15-15 or 70-30 of the Income Tax Assessment Act 1997?

No.

2. Will the capital gains tax provisions apply to include any assessable gain made from the sale of the subdivided land in your assessable income?

Yes.

This ruling applies for the following period:

1 July 2012 to 30 June 2014.

The scheme commenced on:

1 July 2012.

Relevant facts and circumstances:

You and your spouse jointly acquired a large parcel of land (the property) prior to 20 September 1985.

You acquired the property as joint tenants.

You lived on the property and used the land for primary production purposes.

Your spouse passed away after 20 September 1985 and their interest in the property passed directly to you as the surviving joint tenant. You have been the sole owner of the property since your spouse passed away.

The property has continued to be your main residence since your spouse passed away and you have continued to use it for primary production activities.

You are over 55 years of age and wish to retire.

The annual turnover from the primary production activities on the property is less than $2 million.

You want to ensure the best price you can for your retirement.

A developer has made a proposal to you to subdivide the land at the property.

No dwellings will be constructed on the subdivided lots.

You will retain ownership of all subdivided lots until they are sold.

You will not be involved in any of the work associated with the subdivision of the property or the eventual marketing and sale of the subdivided lots.

The developer will incur all costs associated with the subdivision and you will reimburse the developer as the sale of the sale of the subdivided lots occurs.

You acquired the property for the purpose of making a living from your primary production activities, not for the purpose of selling it for a profit. The sale of the land in the proposed manner is intended to fund your retirement.

The developer is at arms length to you and your family.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1997 Section 15-15

Income Tax Assessment Act 1997 Section 70-10

Income Tax Assessment Act 1997 Section 70-30

Income Tax Assessment Act 1997 Part 3-1

Reasons for decision

Assessable income - general

Sections 6-5 and 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provide that the assessable income of a resident taxpayer includes all the ordinary and statutory income they earn from all sources in or out of Australia in an income year.

Amounts of ordinary income are specifically included in a taxpayer's assessable income by the provisions of section 6-5 of the ITAA 1997.

Section 6-10 of the ITAA 1997 specifies that an amount that is not ordinary income (and therefore not assessable under the provisions of section 6-5 of the ITAA 1997) will be assessable as an amount of statutory income if the amount is included in a taxpayer's assessable income by another provision of the tax law.

A list of the provisions that include specific amounts in a taxpayer's assessable income is contained in section 10-5 of the ITAA 1997. The list includes:

· section 15-15 of the ITAA 1997, which includes in your assessable income any profit arising from a profit making undertaking or plan,

· section 70-30 of the ITAA 1997, which has implications for capital gains tax (CGT) purposes if you start holding as 'trading stock' an item you already own, and

· section 102-5 of the ITAA 1997, which includes in your assessable income any assessable gain made when CGT event happens to a CGT asset that you own.

Application of the provisions of sections 6-5, 15-15 and 70-30 of the Income Tax Assessment Act 1997 to profits from the sale of subdivided land

In order to determine whether or not any portion of the proceeds from the sale of the subdivided land would be included in your assessable income because of the provisions of sections 6-5, 15-15 or 70-30 of the ITAA 1997, we must consider:

· whether or not any part of the profit would be considered ordinary income and therefore be assessable under the provisions of section 6-5 of the ITAA 1997,

· whether or not any part of the profit from the sale of the subdivided land would be considered to have arisen from a profit making undertaking or plan, and therefore be assessable under the provisions of section 15-15 of the ITAA 1997, and

· whether or not the subdivided land would be considered 'trading stock' in the context of section 70-30 of the ITAA 1997.

Looking firstly the issue of 'trading stock', it is important at the outset to consider the definition of 'trading stock' in subsection 70-10(1) of the ITAA 1997 to determine whether or not section 70-30 of the ITAA has any implications in your circumstances.

Subsection 70-10(1) of the ITAA 1997 provides that for an item to be considered 'trading stock', it must be held '…. in the ordinary course of a business'

Taxation Determination TD 92/128 Income tax: property development : if land is acquired for development, subdivision and sale but after some initial development the project ceases and is recommenced in a later income year, how is a profit on the sale of the land treated for income tax purposes? provides some guidance on this issue and states:

Land can only be treated as trading stock if a business of trading in land is actively being carried on. There must be present the continuity of activity which characterises a business.

Taxation Determination TD 92/128 refers to the remarks of Jacobs and Aickin JJ. in F C of T v. St. Hubert's Island Pty Ltd as being of use in determining whether or not a business of trading in land is actively being carried out. In this regard:

· Aickin JJ said, at 78 ATC 4123:

In my opinion items of property (including land) can only be regarded as trading stock in circumstances in which the business in which they are employed involves some continuity or repetition of both buying and selling, so that one is able to say in a real sense that the stock is being turned over by a process of buying and selling.

· Jacobs said, at 78 ATC 4117:

It seems to me that the essential question in the present case is - what must be found before it can be said that the taxpayer was carrying on the business of trading in the land? More particularly, did the taxpayer commence to carry on the business of trading in the land by acquiring the land for the purpose of developing and improving it, of subdividing it and of selling it off in subdivided lots? If it did not commence to carry on the business of trading in the land at that time of acquisition I do not consider that it can be said to have commenced to trade in the land or to carry on the business of trading in the land at any subsequent point of time.

Considering the comments of Jacobs and Aickin JJ. in F C of T v. St. Hubert's Island Pty Ltd in light of the facts of your case, we do not consider you are in the business of trading land. Importantly, when you acquired the land (as a joint tenant initially and later in your own right) your intention was not to sell the land for a profit, but rather, to make a living of the land from your primary production activities which you have done for many years. As you are not in the business of trading land, the blocks of land that will result from the subdivision of the property cannot be 'trading stock' as defined in Subsection 70-10(1) of the ITAA 1997. As a result, section 70-30 of the ITAA 1997 has no application to your circumstances.

It remains therefore for us to consider the application of sections 6-5 and 15-15 to any profit you make from the sale of the subdivided land. In this regard, the following Australian Taxation Office (ATO) documents provide guidance:

· Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income.

· Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number.

Taxation Ruling TR 92/3 notes that an 'isolated transaction' is one that is outside the ordinary course of the business of a taxpayer carrying on a business, or one that is a transaction entered into by a non-business taxpayer.

Your ordinary business is primary production and we have already established that we do not consider you to be in the business of trading in land. Accordingly, we consider the eventual sale of the subdivided lots will be isolated transactions entered into by a non-business taxpayer.

TR 92/3 specifies that profit from an isolated transaction will be ordinary income when both of the following elements are present:

· the intention or purpose of the taxpayer 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.

As stated above, we do not consider you to be in the business of trading in land. Therefore, it cannot be said that any profit you derive from the sale of the subdivided lots will be made in the course of carrying on or carrying out a business operation or commercial transaction. Accordingly, and noting your intention in subdividing and selling the land at the property is to provide for your retirement, it cannot be said that any profit you make will be assessable as ordinary income under the provisions of section 6-5 of the ITAA 1997.

Miscellaneous Taxation Ruling MT 2006/1 deals in part the taxation consequences of isolated transactions relating to the sale of land and states in paragraph 263:

The issue to be decided is whether the activities are an enterprise in that they are of a revenue nature as they are considered to be activities of carrying on a business or an adventure or concern in the nature of trade (profit making undertaking or scheme) as opposed to the mere realisation of a capital asset.

MT 2006/1 refers to the cases of Statham & Anor v. Federal Commissioner of Taxation (Statham) and Casimaty v. Federal Commissioner of Taxation (Casimaty) as cases that provide guidance on when activities to subdivide land may amount to a profit-making undertaking or scheme. In both cases, farm land was subdivided and sold and based on the facts of those cases, the courts held that the sales of the subdivided lots were a mere realisation of a capital asset.

MT 2006/1 notes that from the Statham and Casimaty cases a list of factors can be ascertained that provide assistance in determining whether an activity is a profit-making undertaking or scheme (the profits of which would therefore be assessable under the provisions of section 15-15 of the ITAA 1997). Those factors are:

· 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.

Based on the facts of your case, we do not consider any of the above factors apply to your circumstances.

As none of the above factors apply to you, you are not considered to be entering into a profit making undertaking or scheme by subdividing and selling the land. Rather, we consider you are merely taking steps to realise the maximum value of a capital asset, namely your property. As a result, any profit from the sale of the subdivided lots would not be included in your assessable income under the provisions of section 15-15 of the ITAA 1997, however, and as discussed below, as the realisation of a capital asset, any profit made from the disposal of the subdivided land may be assessable under the CGT provisions of the tax law.

Capital gains tax - general

The CGT provisions are contained in Part 3-1 of the ITAA 1997. Broadly, the provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own.

Land is a CGT asset and any disposal of land to another person or entity gives rise to a CGT event. The most common event is CGT event A1 which happens either at the time a contract for sale is entered into, or at the time you cease being the owner of an asset if there is no contract.

You make an assessable gain from the disposal of a CGT asset if the amount you receive for the disposal (the capital proceeds) are greater than the asset's cost base. A capital loss results if the capital proceeds are less than the asset's reduced cost base.

Generally, the disposal of a CGT asset that was acquired prior to 20 September 1985 (pre-CGT) does not give rise to an assessable gain or loss. However, certain events may happen over the life of a pre-CGT asset that can result in the asset, or a portion of it, becoming a post-CGT asset. As discussed below, one example of when this can happen is when land owned by two individuals as joint tenants passes wholly to one of the joint tenants on the death of the other joint tenant.

CGT implications of land passing to a surviving joint tenant on the death of another joint tenant

When two individuals own land as joint tenants, they are considered to individually own an equal 50% share in the land for CGT purposes.

Where that land was acquired before 20 September 1985, each individual's 50% share in the land is a pre-CGT asset in their hands.

When one of those joint tenant's dies, the deceased person's interest in the land passes to the surviving joint tenant and when this happens:

· the surviving joint tenant is taken to have acquired the deceased person's 50% share in the land for its market value at the date of death,

· where the date of death is on or after 20 September 1985, the 50% share in the property transferred to the surviving joint tenant becomes a post-CGT asset the hands of the surviving joint tenant (with the remaining 50% retaining its pre-CGT status), and

· 50% of any gain or loss from any subsequent disposal of the land by the surviving joint tenant would be assessable under the CGT provisions.

Considering the above in light of your facts, we can see that the 50% share of the property you acquired as a joint tenant with your spouse prior to 20 September 1985 remains a pre-CGT asset in your hands. However, the 50% share of the property that was transferred to you on your spouse's death has become a post-CGT asset in your hands. Accordingly, your assessable income will include any assessable gain or loss made from the disposal of that 50% of the property.

Cost base of CGT assets - general

Generally, when a person acquires a CGT asset the cost base/reduced cost base of the asset includes the cost of acquiring it, as well as certain other costs associated with acquiring, holding and disposing of the asset.

There are five elements that make up the cost base of a CGT asset. These are:

· The first element: money or property given for the asset.

· The second element: incidental costs of acquiring the asset or that relate to the CGT event.

· The third element: costs of owning the asset.

· The fourth element: capital costs to increase or preserve the value of your asset or to install or move it.

· The fifth element: capital costs of preserving or defending your ownership of or rights to the asset.

The reduced cost base of a CGT asset has the same five elements as the cost base, except for the third element. The third element of the reduced cost base relates to balancing adjustments which do not apply to real estate.

As stated above, a surviving joint tenant who acquires a deceased joint tenant's 50% interest in land after 20 September 1985 is taken to have acquired that 50% interest in the land for its market value at the date of the deceased's death. In effect, 50% of the market value of the land at the date of death becomes the first element of the cost base/reduced cost base for the interest in the land that passed to the surviving joint tenant.

Considering the above, the first element of your cost base/reduced cost base for the property will be 50% of the market value of the property at the date of your spouse's death. For example, if the market value of the property at the date of death was $100,000.00, the first element of your cost base/reduced cost base would be $50,000.00.

Capital gains tax - subdividing land

The CGT consequences of subdividing land are discussed in the Guide to Capital Gain Tax 2012 which notes that:

· when an original parcel of land is subdivided, each subdivided lot becomes a separate CGT asset in its own right,

· subdividing land does not of itself result in a CGT event, provided you retain ownership of the subdivided blocks,

· you may make a capital gain or loss when you sell the subdivided blocks, and

· the date you acquired the subdivided blocks is the date you acquired the original parcel of land.

The cost base/reduced cost base of subdivided land includes the initial cost of acquiring the land (the first element), divided amongst each subdivided block on a reasonable basis. Apportionment on an area basis would be considered reasonable.

After you have subdivided the land:

· 50% of each subdivided block will remain a pre-CGT asset in your hands because you will be taken to have acquired 50% of each subdivided block at the time you acquired your original interest in the property.

· The remaining 50% of each subdivided block will be a post-CGT asset in your hands, because you will be taken to have acquired the remaining 50% of each subdivided block at the time your spouse passed away.

· The first element of your cost base for each subdivided block will be 50% of the market value of the land at the date of your spouse's death, divided amongst each subdivided block on a reasonable basis.

Conclusion

Your assessable income will include any assessable gain or loss made from the disposal of the subdivided blocks in the year each block is disposed of.

In determining the extent of any assessable gain or loss made on the disposal of each subdivided block, the first element of the cost base of each subdivided block (the cost of acquiring each block) will be the equivalent of 50% of the market value of the land at the date of your spouse's death, divided amongst each subdivided block on a reasonable basis.