Edited version of your private ruling

Authorisation Number: 1012501334412

Ruling

Subject: Property subdivision and development - assessability of sale proceeds

Question 1

Will the sale proceeds of subdivided lots be treated as income according to ordinary concepts and assessable under section 6-5 of the Income Tax Assessment Act 1997?

Answer:

No.

This ruling applies for the following periods:

Year ended 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

The scheme commences on:

1 July 2012

Question 2

Will proceeds from the disposal of subdivided lots be subject to the capital gains tax provisions contained in Part 3-1 of the Income Tax Assessment Act 1997?

Answer:

Yes.

This ruling applies for the following periods:

Year ended 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

The scheme commences on:

1 July 2012

Relevant facts and circumstances

The Rulee carries on a primary production business.

The Rulee was established by deed of settlement dated several decades ago. At this time the Rulee acquired the parcel of land upon which the business is conducted (the Land).

The Rulee carries on part of its primary production business on other parcels of land.

The area of the Land when it was acquired by the Rulee has been reduced after resumption of part of the land by the local Council.

When the Land was acquired, it was zoned rural. Urban development in the area was virtually non-existent.

The zoning of the land in the area has been changed in the past few years from rural to urban or urban deferred.

This change in zoning and surrounding residential development has made it unsuitable for the Rulee to continue to use the Land for primary production purposes, for reasons including the use of heavy transport vehicles through residential neighbourhoods and other associated activities that normally take place in a rural environment.

The Rulee does not wish to acquire new land in order to relocate the business that has been carried on the Land, but instead wishes to realise the Land in the most advantageous way.

Neither the Rulee nor the beneficiaries will have any personal or direct involvement in undertaking any of the subdivision or development activities. As individuals, they do not have the necessary skills (and nor do they wish to acquire such skills) in order to develop the Land or to become a developer.

After resumption of a portion of the land the Rulee pursued a proposal for subdivision of the Land.

The Rulee initially verbally instructed an external third party to obtain a general design and liaise with engineers, local council and other parties on a preliminary basis for feasibility of subdivision of the site, and to project manage the development (Project Manager).

The Rulee has entered into an agreement with a Coordinator under which the Coordinator is required to engage with the Project Manager and coordinate and manage all other relationships and aspects of the proposed development, in order to ensure that:

(a) the Land can be realised in the most profitable manner with maximum proceeds being derived and retained by the Rulee from the subdivision and sale of the Land; and

(b) the Rulee has no or minimal personal involvement in undertaking or managing the activities required for the subdivision and sale of the Land,.

The Coordinator has recommended to the Rulee that the best way to realise the Land to maximise the sale proceeds would be to subdivide and sell vacant residential lots.

While the Coordinator is undertaking only an administrative and supervisory role, the Project Manager has and will continue to enter into contracts with a number of independent contractors or developers to undertake the development.

The Rulee has detailed that the development, subdivision and sale of the Land is being undertaken broadly in accordance with the following features:

· The development will do no more than required by Council for subdivision approval, and will include the construction of roads and drainage, electricity, gas and water and sewerage. The Land will be subdivided into residential housing lots and sold as vacant land. No buildings will be constructed on any lots prior to sale as part of the development. The development includes work in the preparation of the Land to the point of issue of separate titles and sales of subdivided lots only.

· The whole process of subdivision and sale is expected to take place in a single stage of development over a period of approximately x to y years, from start to finish. The subdivision was approved and the development works are underway. The timing of release and sale of the subdivided lots will depend on the prevailing market conditions at the time and advice received from the Project Manager.

· A Development Plan for the Land was prepared and the Deposited Plan approved by the relevant authority.

· The Land will be divided into numerous vacant residential lots of varying sizes.

· The Project Manager will pass on all development costs to the Coordinator. The Coordinator will pay all the development costs, including the project management fee charged by the Project Manager. The Coordinator will charge the Rulee for any costs it incurs in undertaking its services plus a commercial fee for the provision of its services, based on a percentage margin of its costs.

· No interest deductions will be claimed by the Rulee on any external borrowings that the Rulee obtains to make payments or loan funds to the Coordinator to meet the costs of the development.

· Ownership of the Land (legal and beneficial) will be retained by the Rulee until the subdivided lots carved from the Land are sold. Title in the Land will not be transferred to the Coordinator or Project Manager or to any other person until sold to third party purchasers as subdivided lots.

· Under the Coordinator Agreement, the Rulee will be entitled to the balance of any proceeds received from the sale of subdivided lots carved from the Land, after the deduction of legal fees and agents fees from the sale, the repayment of any borrowings, development costs and fees charged by the Coordinator.

· All the financial books and accounts will be handled by the Coordinator or Project Manager.

· A real estate agent has been engaged to advertise and sell the subdivided land.

· No site office is to be constructed, unless that is recommended and undertaken by the real estate agent appointed as selling agent for the subdivided lots.

Neither the Rulee nor beneficiaries have previously undertaken or been involved in any subdivision activities or land or property development. Neither the Rulee nor beneficiaries have any intention to undertake any future activities of land or property development, nor to commence any enterprise of land or property development, nor to expand the commercial operations of the primary production business to include such activities.

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 104-10 of the Income Tax Assessment Act 1997

Subsection 104-10(4) of the Income Tax Assessment Act 1997

Section 112-25 of the Income Tax Assessment Act 1997

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

Reasons for decision

Question 1 - Ordinary income

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.

If the proceeds from the sale of the developed and subdivided lots that are the subject of this ruling are ordinary income, the proceeds will be assessable under section 6-5 of the ITAA 1997.

Although the ITAA 1997 does not provide specific guidance on what is meant by 'income according to ordinary concepts', a substantial body of case law has evolved to identify various factors that indicate whether an amount is income according to ordinary concepts.

The principle has been established in the Australian courts that profit arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business (FCT v. Myer Emporium Ltd 87 ATC 4363; 1987 163 CLR 199; 18 ATR 693 (Myer Emporium)).

The ATO view on the application of the principles outlined in the decision of the Full High Court of Australia in Myer Emporium is set out in Taxation Ruling TR 92/3. This ruling states the ATO view that profits on an isolated transaction may be income. Profit from an isolated transaction will be ordinary income when:

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

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

Intention or purpose

Paragraph 9 of TR 92/3 states:

9. 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.

In the Rulee's case the Land was acquired several decades ago with the purpose of using it to carry on a primary production business, which it has done ever since. There is no evidence of a purpose of profit-making at the time of acquiring the Land.

The decision in Casimaty v. FC of T 97 ATC 5135; (1997) 37 ATR 358 (Casimaty) demonstrates that in circumstances where there is an absence of profit-making intention when land is acquired, the likelihood of any profit made on the eventual sale of land being income according to ordinary concepts is greatly diminished. Casimaty considered the sale of farming land. The proceeds were held to not be income according to ordinary concepts, but rather constituted the mere realisation of a capital asset, carried out in an enterprising way so as to secure the best price. Consequently, the profit derived from the subdivision and sale of the land by the taxpayer was not assessable income under section 6-5 of the ITAA 1997.

Similarly, in FC of T v. Williams 72 ATC 4188; (1972) 127 CLR 226 (Williams), the High Court considered that development carried out on land to be subdivided, such as grading, levelling, road building and provision for water and power, was to enable the owner to secure the best price for the land and did not amount to carrying out a profit making scheme. The proceeds resulted from the mere realisation of a capital asset and were not income.

As per Casimaty and Williams the Rulee's intention in acquiring the Land was not one of a profit-making purpose. The intention was to use the Land to carry on a primary production business.

However, profits made on the sale of subdivided land can still be income according to ordinary concepts, or a profit-making undertaking or plan, if the activities become a separate business operation or commercial transaction.

Business operation or commercial transaction

For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient that the transaction is business or commercial in character (see Whitfords Beach at 150 CLR 379; 82 ATC 4044; 12 ATR 707).  

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.

The points above are expanded upon at paragraph 49 of TR 92/3. The factors at (a) and (h) are of particular relevance to the Rulee's situation:

(a) the nature of the entity undertaking the operation or transaction (Ruhamah Property Co. Ltd. v. F C of T (1928) 41 CLR 148 at 154; Hobart Bridge Co. Ltd. v. FC of T (1951) 82 CLR 372 at 383; FC of T v. Radnor Pty Ltd 91 ATC 4689; 22 ATR 344). For example, if the taxpayer is a corporation with substantial assets rather than an individual, that may be an indication that the operation or transaction was commercial in nature. However, if the taxpayer acts in the capacity of trustee of a family trust, the inference that the transaction was commercial or business in nature may not be drawn so readily [emphasis added];

(h) the timing of the transaction or the various steps in the transaction (Ruhamah Property 41 CLR at 154). For example, if the relevant transaction consists of the acquisition and disposal of property, the holding of the property for many years may indicate that the transaction was not business or commercial in nature. [emphasis added]

The Rulee is a family trust operating a primary production business and has held the Land for several decades, which in recent years has been re-zoned. As per (a) and (h) above, these factors indicate the subdivision and sale of the Land are unlikely to be commercial in nature. That is, the Rulee:

· acts in the capacity of trustee of a family trust; and

· has held the property for many years.

The remaining factors listed at paragraph 13 of TR 92/3 are examined below:

(b) the nature and scale of other activities undertaken by the taxpayer

The Rulee carries on part of its primary production business on other parcels of land.

The Rulee has never been involved in any prior subdivisions or land development that would indicate the characteristics of a continuing business of land development. The Rulee has no equipment or expertise related to property development activities.

(c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained

The estimated cost for the development and sale of the Land is substantial.

(d) the nature, scale and complexity of the operation or transaction

No buildings will be constructed on any lots prior to sale as part of the development. The development includes work in the preparation of the Land to the point of issue of separate titles and sales of subdivided lots only.

The whole process of subdivision and sale is expected to take place in a single stage of development over a period of approximately x to y years, from start to finish.

(e) the manner in which the operation or transaction was entered into or carried out;

and

(g) if the transaction involves the acquisition and disposal of property, the nature of that property

The Land was obtained several decades ago for primary production purposes. At this time the Land was zoned rural. The zoning of the land in the area has been changed in the past few years from rural to urban or urban deferred.

The Council resumed a portion of the Land.

This change in zoning and surrounding residential development has made it unsuitable for the Rulee to continue to use the Land for primary production purposes, for reasons including the use of heavy transport vehicles through residential neighbourhoods and other associated activities that normally take place in a rural environment.

(f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction

The Rulee - or more particularly its beneficiaries - will not have any personal or direct involvement in undertaking any of the subdivision or development activities. A Project Manager has been engaged to obtain a general design and liaise with engineers, local council and other parties on a preliminary basis for feasibility of subdivision of the site, and to project manage the development.

The Coordinator is required to engage with the Project Manager and coordinate and manage all other relationships and aspects of the proposed development. The Coordinator recommended to the Rulee that the best way to realise the Land to maximise the sale proceeds would be to subdivide and sell vacant residential lots.

While the Coordinator undertakes only an administrative and supervisory role, the Project Manager has and will continue to enter into contracts with a number of independent contractors or developers to undertake the development.

Conclusion

The original purpose for the purchase of the Land was to carry on a primary production business. There is no evidence of a profit-making motive in the original acquisition of the Land several decades ago. That is, the facts in do not indicate that the Rulee's intention in acquiring the Land was to make a profit from any future sale. There now exists, a desire to merely realise a capital asset in order to secure the best price.

On balance it is considered that the factors listed at paragraph 9 of TR 92/3 tend to indicate a lack of business or commercial character. That is, the Rulee:

· acts in the capacity of trustee of a family trust;

· has held the property for many years;

· has never been involved in any prior subdivisions or land development;

· has no equipment or expertise related to property development activities; and

· will have no direct involvement in the planning and contracting work for the residential subdivision or in selling the lots.

In short, it is considered that there was no profit-making intention in originally acquiring the Land several decades ago. In addition, the current subdividing and development of the Land and related transactions do not have the character of business operations or commercial transactions. There is no indication that a separate business operation or commercial transaction has commenced. Consequently the proceeds ultimately received will not be treated as ordinary income and will not be assessable under section 6-5 of the ITAA 1997.

Question 2 - Capital gains tax

Since the subdivision and disposal of the Land is the realisation of a capital asset, the proceeds are not assessable as ordinary income. Any gain or loss made upon disposal of the subdivided lots will be subject to the capital gains tax (CGT) regime under Part 3-1 of the ITAA 1997. 

According to section 112-25 of the ITAA 1997, the splitting of an asset without beneficial change in ownership does not give rise to a CGT event. In the case of the Rulee, the subdivision of the Land into separate lots does not result in any change of beneficial ownership. Consequently no CGT event occurs at this point.

It should be noted, however, that the cost base or reduced cost base of each individual lot is to be determined in accordance with subsection 112-25(3) of the ITAA 1997, which states:

You work out the *cost base and *reduced cost base of each new asset as follows:

CGT event A1 in section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen upon disposal of each subdivided lot. Under subsection 104-10(4) of the ITAA 1997, the Rulee will make a capital gain if the capital proceeds from the disposal of the lot are more than the cost base of the lot.