Edited version of your private ruling

Authorisation Number: 1012512661535

Ruling

Subject: Property development: ordinary or statutory income

Question 1

Are profits made on the subdivision of the property and subsequent sale of the lots considered statutory income under section 10-5 of the Income Tax Assessment Act 1997 (ITAA 1997) and section 102-5 of the Income Tax Assessment Act 1997 (ITAA 1997) under the capital gains tax (CGT) legislation on the basis that a mere realisation of a capital asset has occurred?

Answer

Yes

Question 2

Are profits made on the subdivision of the property and subsequent sale of the lots considered ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), as a result of carrying on a business of property development?

Answer

No

This ruling applies for the following period

Year ended 30 June 20AA

Year ended 30 June 20BB

The scheme commenced on

1 July 20AA

Relevant facts and circumstances

In January 19SS, the landowners purchased a property.

The landowners advised the Tax Office that they have acquired a number of other properties over a number of years with the intention of holding them for long term capital growth and to build a pool of investment properties for rental income.

At the time of purchase the property comprised of native vegetation and it was zoned as rural by the council.

In certain month 19TT, the residential house the landowners built on the property was completed and they used it as their main residence.

In 19UU, the landowners moved to another location due to work commitments.

In late 19UU, the landowners received an offer to purchase the land. They accepted the offer and a contract was signed but the sale did not push through.

In 19VV, the landowners moved back to live in the property.

In certain month 19WW, the landowners moved away from the property to be closer to work and schools.

Shortly after, in 19WW, the property was rented to tenants up to the present time.

The landowners advised the Tax Office that they have never conducted a business on the property.

In 20XX, the landowners received notification from the council that the property has been re-zoned from rural to residential.

The landowners advised the Tax Office that they have since been approached by land developers to purchase the property on two separate occasions, which they declined.

In 20YY, the property was transferred from the joint names of the landowners to sole ownership of the taxpayer. The taxpayer advised the Tax Office that the reason for the transfer is for asset protection as the property carries no debts and the other landowner has their own business.

In 20ZZ, the council approved the application of the taxpayer to subdivide the property into several lots. The original house and the surrounding native bushland will be retained by the taxpayer.

The taxpayer had made a decision to undertake the subdivision themselves. The taxpayer advised the Tax Office that they do not have a formal business plan and are not registered for the Goods and Services Tax (GST). The taxpayer also advised that the spouse will be in charge of commissioning various consultants on their behalf to carry out the necessary work in relation to the initial planning stages of the subdivision.

Further, external consultants have been employed in all stages of the development. Consultants have been used for town planning, surveying, geotechnical (soil testing), civil design drawings and legal matters.

The taxpayer had engaged a civil contracting firm as the head contractor to undertake the subdivision and arrange and complete all major works.

The taxpayer advised the Tax Office that there is no intention to build anything or perform any works on the property beyond the minimum requirements necessary to satisfy the development application.

The taxpayer advised the Tax Office that they will directly negotiate the sale of one or more blocks with the landowners of a neighbouring property and engage a solicitor to draw up the sale documents. All other blocks will be sold through a real estate agent.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Question 1

Summary

The taxpayer is not carrying on a business of property development, therefore, the income derived from the subdivision of the property and sale of the lots is considered statutory income under the CGT provisions.

Detailed reasoning

There are three ways profit from property sales can be treated for taxation purposes: 

1) as ordinary income under section 6-5 of the ITAA 1997 as a result of

carrying on a business of property development;  

2) as ordinary income under section 6-5 of the ITAA 1997, as a result of an

isolated business transaction entered into by a non-business taxpayer or

outside the ordinary course of business of a taxpayer carrying on a

business;  

3) as statutory income under section 10-5 of the ITAA 1997 and section 102-

5 of the ITAA 1997 under the capital gains tax1997 (CGT) legislation, on the

basis that a mere realisation of a capital asset has occurred.

Carrying on a business of property development

Section 995-1 of the ITAA 1997 defines business as including any profession, trade, employment, vocation or calling, but not occupation as an employee.

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.

Taxation Ruling TR 97/11: Income tax: am I carrying on a business of primary production, provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. These factors are:

· whether the activity has a significant commercial purpose or character

· whether the taxpayer has more than just an intention to engage in business

· whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

· whether there is regularity and repetition of the activity

· whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business

· whether the activity is planned, organised and carried on in a business-like manner such that it is described as making a profit

· the size, scale and permanency of the activity, and

· whether the activity is better described as a hobby, a form of recreation, or sporting activity.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impression gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

The taxpayer's intention in holding the property was for long term capital gain and to derive rental income. The taxpayer has had no previous history of engaging in property development, was not registered for GST and had no business plan drawn up to engage in property development. The taxpayer engaged a contractor to undertake the subdivision and arrange and complete all major works. Aside from one or more blocks to be sold directly to the landowners of a neighbouring property, all other blocks will be sold off by a real estate agent. The taxpayer advised the Tax Office that this is a one off property development activity.

The taxpayer is not considered to be carrying on a business of property development, therefore, the income derived from the subdivision of the property and sale of the lots is considered statutory income under the CGT provisions.

Question 2

Summary

The taxpayer is not considered to be carrying on a business of property development. The acquisition, subdivision and sale of the property by the taxpayer do not amount to a commercial business transaction but from the sale of an investment property. Therefore, any profit gained from the sale of the lots is not assessable as ordinary income under section 6-5 of the ITAA 1997.

Detailed reasoning

The Commissioner's view on whether profit from isolated transactions is assessable as ordinary income is found in Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income. Isolated transactions are:

· those transactions outside the ordinary course of business of a taxpayer carrying on a business; and

· those transactions entered into by non-business taxpayers.

TR 92/3 states profits on an isolated transaction will be ordinary income when:

· the intention or purpose of a 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 operation or commercial transaction.

The intention of the taxpayer is determined by an objective consideration of the facts and circumstances (paragraph 38 of TR 92/3). Further, paragraph 40 of TR 92/3 indicates that a profit making purpose need not be the sole or dominant purpose for entering into the transaction. It is sufficient if profit making is a significant purpose.

Paragraph 41 of TR 92/3 indicates that you must have the requisite purpose at the time of entering into the relevant transaction or operation. If the transaction involves the sale of property, it is usually necessary that you have the purpose of profit making at the time of acquiring the property.

If a taxpayer is not carrying on a business and makes a profit that profit is income if:

· the taxpayer had a profit-making intention when entering the transaction or operation, and

· the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

A transaction may be characterised as a business operation or commercial transaction if the transaction is business or commercial in character.

Paragraph 13 of TR 92/3 lists some matters which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction:

· 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;

· the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

· 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.

The taxpayer's intention in holding the property was for long term capital gain and to derive rental income. They had no previous history of engaging in property development, was not registered for GST and had no business plan drawn up to engage in property development. The taxpayer had engaged a contractor to undertake the subdivision and arrange and complete all major works. Aside from one or more blocks to be sold directly to the landowners of a neighbouring property, all other blocks will be sold off by a real estate agent. The taxpayer advised the Tax Office that this is a one off property development activity.

The taxpayer is not considered to be carrying on a business of property development. The acquisition, subdivision and sale of the property by the taxpayer do not amount to a commercial business transaction but from the sale of an investment property. Therefore, any profit gained from the sale of the lots is not assessable as ordinary income under section 6-5 of the ITAA 1997.