Edited version of your private ruling

Authorisation Number: 1012500488195

Ruling

Subject: Subdivision of land

Questions and Answers:

1. Is your Land your trading stock?

No.

2. Is the profit from the disposal of your Land assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) from an isolated commercial transaction?

No.

3. In respect of the half interest in the Land acquired by you prior to 19 September 1985, is the profit from the disposal of the Land included in your assessable income under section 15-15 of the ITAA 1997?

No.

4. Will the Commissioner remit any general interest charge on any sale agreement amounts referable to the signing year where the amounts are not included in the income tax return for the signing year?

The question is invalid

This ruling applies for the following periods:

Year ended 30 June 2010

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 commences on:

1 July 2009

Relevant facts and circumstances

You acquired the Land, jointly, with your partner, prior to 19 September 1985. You acquired the entire interest in the land, after 19 September 1985, upon your partner’s death. Previously, the Land was used by you and your partner in your farming activities. There was/is a residence on the Land and you resided there during your ownership of the Land.

During the year ended 30 June 20XX, you were approached by a developer, who was seeking to develop the Land. You did not approach the developer or take any steps to develop the land yourself. Subsequently, that developer ceased negotiations and was replaced by the Developer (through an introduction by the original party).

You entered into a Development Rights Agreement (DRA) with the Developer. Broadly, the DRA authorises the Developer to undertake “Project Activities” on certain parts of the Land. The Project Activities include:

(a) procuring the amendment of the statutory development plan affecting the Land so that it is zoned primarily for residential use;

(b) obtaining the required statutory consents for the Land to be divided into residential lots;

(c) complying with all conditions stipulated in any development consent of land division consent, including entering into any design, construction and/or supply contracts for infrastructure to be installed on the Land and undertaking any civil works;

(d) procuring the subdivision of the Land, including the creation of residential lots and the preparation and lodgement of the plan of subdivision with the Registrar-General;

(e) engaging licensed land agents to market the developed lots for sale at fair market values;

(f) prepare and negotiate all agreements and instruments relating to the Development, including sales advertising, contracts and vendor’s statements.

Any Project Activities are to be undertaken by the Developer at its own risk and cost. You are obliged to grant a mortgage over the Land to secure any borrowings by the Developer to undertake the Project Activities but there is to be no recourse to you for any liabilities secured by the mortgagee. The Developer must use its best endeavours to carry out the Project Plan.

As part of your obligations under the DRA, you must enter into and complete contracts (Sale Agreements) for the sale of all of the subdivided lots created by the Developer, as negotiated by the Developer. The purchasers will be persons identified by the Developer in the course of Project Activities that it conducts. You will not be involved in the sales process (other than to sign and comply with Sales Agreements provided by the Developer).

Subject to circumstances where a transfer of a part of the land is required, including on the settlement of any of the Sale Agreements, you are to remain the legal and beneficial owner of the Land until the making of all payments payable to you, under the terms of the DRA.

The proceeds of sale of the subdivided lots are required to be paid into a Project Account. The Developer is beneficially entitled to the credit balance (from time to time) of that account, subject to a charge in favour of you for moneys payable by the Developer to you, under the DRA. The Developer is contractually restricted under the DRA as to the timing and amounts of withdrawals.

The Developer must, once all the milestones in the DRA are satisfied, pay to you a percentage of the monthly gross proceeds from the Sale Agreements, with an overriding obligation, if the annual aggregate of such payments are less than a specified annual amount, to pay the shortfall.

The monthly payments are first sourced from the Project Account but if the balance is insufficient then the Developer must make up the shortfall out of its own funds.

The Developer is entitled to the remaining credit balance (if any) in the Project Account after payment to the project’s financier and to you.

Several Sale Agreements have recently been provided for signing to you by the Developer. These have been signed in accordance with your obligations under the DRA. Settlement under these agreements is conditional upon lodgement of a plan of subdivision with the Registrar-General – which under the applicable legislation can only be done when various statutory steps have been complied with.

Separate certificates of title to individual lots can only be issued after the plan of subdivision has been lodged with the Registrar-General.

Future sales contracts will or are likely to contain similar conditions as the Developer is, it is understood, intending to develop the Land and have titles issued, and sales occur, on a staged basis.

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 102-5

Taxation Administration Act 1953 Schedule 1 Section 357-55

Reasons for decision

Section 70-10 of the ITAA 1997 states trading stock includes anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and live stock.

Taxation Determination TD 92/124, which is about circumstances when land is treated as trading stock, states land is treated as trading stock for income tax purposes if it is held for the purpose of resale; and business activity which involves dealing in land has commenced. It further states:

Both the required purpose and the business activity must be present before land is treated as trading stock. The business activity is taken to have commenced when a taxpayer embarks on a definite and continuous cycle of operations designed to lead to the sale of the land. It is not necessary that the acquisition of land be repetitive. A single acquisition of land for the purpose of development, subdivision and sale by a business commenced for that purpose would lead to the land being treated as trading stock.

The nature of ‘business activity’ is explained in detail in Taxation Ruling TR 97/11, where the key indicators of a business are: (i) repetition and regularity of the activities; and (ii) organisation in a business like manner, which includes whether the activity is carried on in a similar manner to that of the ordinary trade in that line of business. The indicator of the volume of the operations and the amount of capital employed also assumes weighting, dependent on the circumstances.

Isolated commercial transactions

Taxation Ruling TR 92/3 is about whether profits on isolated transactions are income. Here, specifically in relation to the disposal of property, paragraphs 49(g) and 9 state:

In very general terms, a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations.

Some factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are…if the transaction involves the acquisition and disposal of property, the nature of that property (Edwards v. Bairstow ; Hobart Bridge 82 CLR at 383). For example, if the property has no use other than as the subject of trade, the conclusion that the property was acquired for the purpose of trade and, therefore, that the transaction was commercial in nature, would be readily drawn…

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, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property.

Court cases about property development

Numerous court cases have considered the assessability of profits or proceeds from the sale of land. As a general principle, if the sale of land constitutes a business or commercial transaction, then the proceeds will be assessable as ordinary income. On the other hand, if the sale is a mere realisation of the land, the proceeds will be a capital amount.

In the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135 (Casimaty), legal principles in relation to the subdivision of land were discussed at length, including the following court cases.

In Commissioner of Taxes v Melbourne Trust Limited [1914] AC 1001 (Melbourne Trust), a scheme was regarded as assessable income because it did not involve the liquidating or realising of old assets.

In the High Court of Australia case Ruhamah Property Co Ltd v Federal Commissioner of Taxation (1928) 41 CLR 148 (Ruhamah), it was observed, at 154:

A man has capacity to sell his property, but he may be realizing it and changing his form of investment and not engaging in a profit-making scheme. So it is with a company with power to sell: it may be realizing its property and changing the form of investment and not engaging in any profit-making scheme. Much must depend upon whether the company has taken the property into its trade and traded in it: whether it conducted a trading concern as opposed to a mere realization (cf. Alabama Co.'s Case (1926) 11 Tax Cas., at pp. 253-255). The nature of the company, the character of its assets, the nature of the business carried on by it and the particular sale or realization are all relevant to the issue.

The reference in Ruhamah is to The Alabama Coal, Iron, Land and Colonization Co Ltd v Mylam (1926) 11 TC 232, where it was said:

In order to see clearly…his Lordship suggested (ibid) that “there must be something in the nature of buying at any rate, and not merely selling, which is mere turning your property into money''.

In the High Court of Australia case of Scottish Australian Mining Co. Ltd. v. Federal Commissioner of Taxation (1950) 9 ATD 135; (1950) 81 CLR 188 (Scottish Australian Mining), the taxpayer company was formed to carry on a business of coal mining, for which it purchased land. After the coal mining operations ended, the company subdivided the land, built roads and a railway station, made sites available for schools, churches and parks and sold the subdivided parcels at a considerable profit. It was held the profits should not be included in the company's assessable income because the company was not formed for the purpose of dealing in land and that it had not in fact engaged in such a business.

In the Supreme Court (Tasmania) case Roberts v Federal Commissioner of Taxation (1981) 12 ATR 191; (1981) 81 ATC 4421, in upholding the taxpayers' appeal against their assessment to tax, the court, at 4425, took account of the following matters, each of which has a parallel in the situation of the taxpayer in Casimaty:

The appellants were market gardeners, the McGann land had in fact to the appellants' knowledge been successfully used as a market garden and they in fact did use it as such after purchase.

The appellants had never before been involved in the subdivision of land or the buying and selling of land for profit, but had been involved in the business of market gardening for many years.

In the Full High Court case of Federal Commissioner of Taxation v. Whitfords Beach Pty. Ltd. 82 ATC 4031 (Whitfords Beach), it was decided the subdivision was done in the course of what was truly a business venture. Essentially, the reason for this was three companies bought the shares in the company only to obtain control of the land, with the intention that the taxpayer would cause the land to be developed, subdivided and sold at a profit. Gibbs CJ concluded:

In the present case I gravely doubt whether the profits resulting from the development, subdivision and sale of the land would have been taxable if it had not been for the events that occurred on 20th December 1967. Had those events not occurred, the situation of the taxpayer would have been analogous to that of the company in Scottish Australian Mining Co. Ltd. v. F.C. of T. However, on 20th December 1967, the taxpayer was transformed from a company which held land for the domestic purposes of its shareholders to a company whose purpose was to engage in a commercial venture with a view to profit.

Although Mason J, in Whitfords Beach, contrary to Gibbs CJ, brought into question the application of Scottish Australian Mining (and the prior historical precedents), by asserting a profit making scheme could be constituted by selling alone due to the sheer the magnitude of a subdivision, the court in Casimaty appeared to fall back on the historical precedents (prior to the comments of Mason J in Whitfords Beach), when it said at 97 ATC 5149, about another court decision:

His Honour did not distil from the authorities a principle of law that a subdivision involving a hundred or more lots, the construction of roads and the reticulation of water to each lot could never amount to a mere realization of a capital asset. Any such principle would run counter to the views expressed by all but one member of the High Court in FC of T v NF Williams 72 ATC 4188; (1972) 127 CLR 226 where Gibbs J observed, at ATC 4194-4195; CLR 249:

“As owner of land who holds it until the price of land has risen and then sub-divides and sells it is not thereby engaging in an adventure in the nature of trade, or carrying out a profit-making scheme. The situation is not altered by the fact that the landowner seeks and acts upon the advice of an expert as to the best method of sub-division and sale or by the fact that he carries out work such as grading, levelling, road-building and the provision of reticulation for water and power to enable the land to be sold to its best advantage. The proceeds resulting from the mere realisation of a capital asset are not income either in accordance with ordinary concepts…even though the realisation is carried out in an enterprising way so as to secure the best price.''

In its concluding remarks, the court in Casimaty discussed the concept of ‘a change in the purpose or object’ of the relevant land, where it distinguished the taxpayer’s case from other cases, where a change in purpose had actually occurred (as follows):

In coming to that conclusion, I have been influenced primarily by the indisputable fact that he acquired and continued to hold “Acton View” for use as a residence and the conduct of the business of a primary producer. Apart from the activities necessarily undertaken to obtain approval from time to time for subdivision of parts of the property, there is nothing to suggest a change in the purpose or object with which “Acton View'' was held.

In this respect, the present is to be contrasted with those cases in which particular circumstances provided an occasion for imputing to the landholder a change of purpose. In Whitfords Beach those circumstances were the passing of control of the landholding company from the owners of the fishing shacks to the three development companies. In Official Receiver v Federal Commissioner of Taxation (Fox's Case) the critical circumstance was that control of the land passed to the Official Receiver who sought the instructions of the creditors as to whether he should dispose of the land in its undeveloped state or undertake its extensive development to increase the return to the creditors. In the Melbourne Trust Case one critical consideration was the formation of the realization company as a distinct entity with shareholders unrelated to the failed banks or their creditors.

Thus, in addressing the subject of ‘a change in the purpose or object’, the court in Casimaty appeared to not simply state the mere subdivision of land was inherently a change of purpose. Instead, the court in Casimaty only cited cases where a change of the use of the asset coincided with a change in controlling interests, which echoes Ruhamah, as previously cited, which emphasised a change in the form of investment (rather than a change in purpose) , as follows:

A man has capacity to sell his property, but he may be realizing it and changing his form of investment and not engaging in a profit-making scheme.

In its final conclusion, the court in Casimaty highlighted the taxpayer did not undertake development of the land beyond what was necessary to enhance the presentation of individual allotments for sale as vacant blocks (such as constructing houses, internal fencing or other improvements; setting up his own sales organization or advertised or conducted sales himself instead of entrusting those activities entirely to traditional agents; which would have been easier to impute to him an intention to carry on a business of land development and improvement).

As was done in Casimaty, we note the cases and principles cited above, which support the happening of mere realisation, are distinguished from cases, such as Stevenson v FC of T 91 ATC 4476; (1991) 29 FCR 282 (Stevenson), in which it was decided the taxpayer was carrying on a business due to his active personal involvement in the planning, financing, undertaking and selling of the subdivision.

Section 15-15

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

Section 15-15 of the ITAA 1997 explicitly states it does not apply to a profit that arises in respect of the sale of property acquired on or after 20 September 1985.

However, it also states if you sell property you acquired before 20 September 1985 for profit-making by sale, your assessable income includes the profit. see section 25A of the Income Tax Assessment Act 1936.

Application of law in your case

In your case, your land will not be your trading stock because we consider you will not be carrying on a business of property development. This is because (unlike the case of Stevenson) you, personally, will not be engaged in repetitive development, financing and marketing activities in relation to property development. Instead, you have contracted a property developer to develop, finance and sell the subdivision your land. Further, the subdivision will not go beyond what is necessary to enhance the presentation of individual allotments for sale as vacant blocks.

Also, you did not originally acquire your land for the purpose of subdivision and resale. Instead, you originally acquired your land for the purpose of residing and farming, which can also be regarded as having the feature of a ‘passive investment’. It follows any sale proceeds from the sale your land will not be from an isolated commercial transaction or profit-making undertaking because the land was not purchased explicitly for the purpose of resale and because there will be essentially no change in the purpose of the land (since its purpose, as a subdivision, will continue to be both your residential address, where you will retain a residential allotment of the land, and a passive investment).

Since any profits from sale will be from a mere realisation of a capital asset rather from than from a profit-making undertaking, section 15-15 of the ITAA 1997 will not apply.

In summary, you did not acquire new land for the subdivision, you have and will not contribute any significant activity or financing to the subdivision and you will not go beyond what was necessary to enhance the presentation of individual allotments for sale as vacant blocks. It follows, as provided for in the legal cases cited above, your subdivision will simply be the mere realisation of old assets, which will be accounted for under the capital gains tax (CGT) tax provisions.

Invalid questions

Section 357-55 in Schedule 1 of the Taxation Administration Act 1953 provides the provisions of Acts and regulations which are relevant for private rulings.

The Commissioner cannot provide a private ruling in relation to the administration of the general interest charge. However, you may refer to Taxation Determination TD 94/89 for guidance.