Edited version of private advice

Authorisation Number: 1012656014685

Ruling

Subject: Ordinary income and capital gains

Question 1

Will the profits from subdivision and sale of land constitute ordinary income?

Answer

No

Question 2

Will the profits from subdivision and sale of land constitute a capital gain?

Answer

Yes

This ruling applies for the following period

Year ending 30 June 2015

The scheme commenced on

1 July 2014

Relevant facts and circumstances

You own a lot of land (the lot).

The lot is approximately 2.5 hectares in size.

You acquired the lot with your spouse in equal shares as tenants in common.

Your spouse's portion was later transferred to a third individual and then later again to you. You now own the lot as an individual.

The lot consists of your and your spouse's main residence, stables, and workshops.

You and your spouse conducted a business on the lot.

You applied for planning approval to create three blocks.

You will retain one block that includes your main residence, sheds, and some paddocks.

Approval has been granted subject to certain conditions.

You have engaged a surveying company to undertake the subdivision work.

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Part 3-1 of the Income Tax Assessment Act 1997

Section 102-20 of the Income Tax Assessment Act 1997

Section 104-10 of the Income Tax Assessment Act 1997

Section 108-5 of the Income Tax Assessment Act 1997

Section 109-5 of the Income Tax Assessment Act 1997

Reasons for decision

Ordinary income

Under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) your assessable income includes income according to ordinary concepts. This is called ordinary income.

Indicators of ordinary income include whether:

• the amount has the characteristics of periodicity, recurrence or regularity

• it is convertible into money or money's worth

• it is associated with business activities or services rendered, as distinct from the mere sale of property

• it is solicited, as distinct from a windfall.

Isolated transactions

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) discusses profits on isolated transactions. TR 92/3 states that whether profits on isolated transactions are ordinary income depends on the circumstances of the case, but in general is ordinary income when:

a) the intention or purpose of the 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.

The ruling also states that 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.

TR 92/3 is in accordance with the Full High Court of Australia who stated in FCT v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693 (Myer Emporium) that:

Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a "one-off" transaction preclude it from being properly characterized as income.

If a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to commit the asset, either as the capital of a business or into a profit-making undertaking with the characteristics of a business operation or commercial transaction, this activity constitutes the carrying on of a business, or a business operation or commercial transaction. The profit from such activity is income even though the taxpayer did not have a purpose of profit-making at the time of acquiring the asset.

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 an 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.

Profits on the sale of subdivided land can be income according to ordinary concepts within section 6-5 of the ITAA 1997 if the taxpayer's subdivisional activities have become a separate business operation or commercial transaction, or an isolated profit making venture.

Casimaty v. FC of T 97 ATC 5135; (1997) 37 ATR 358 (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.

The original purpose for the purchase of your property was to carry on a business. You previously subdivided the adjoining lot in reducing the size of your business and assisting to fund your retirement. However the nature of that transaction and its association to this one does not indicate the characteristics of a continuing business of land development. The facts in this case do not indicate that your intention in entering into the relevant transaction was to make a profit from any future sale of the land. You wish to merely realise an asset in order to provide for your retirement.

The land that you are disposing of is no longer used for a business and is adjacent land to your main residence. There is no likelihood of further subdivision and sale of property as this transaction will involve disposing of your remaining interest in land, except for that which your main residence is on.

The activities involved in the subdivision and sale of the land do not amount to carrying on a business. The transactions do not have the character of business operations or commercial transactions. There is no indication that your subdivisional activities became a separate business operation or commercial transaction, or that you were carrying on or carrying out a profit-making undertaking or plan.

The proceeds are therefore not ordinary income and not assessable under section 6-5 of the ITAA 1997. They represent a mere realisation of capital assets as per the Casimaty case, which will fall for consideration under the capital gains tax (CGT) provisions in part 3-1 of the ITAA 1997.

Capital gains

You make a capital gain or capital loss as a result of a CGT event happening (section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997)).

A capital gain or capital loss may arise if a CGT event happens to a CGT asset. Section 108-5 of the ITAA 1997 states that a CGT asset is any kind of property, or a legal or equitable right that is not property.

Under section 104-10 of the ITAA 1997, the disposal of a CGT asset causes a CGT event A1 to occur. You dispose of an asset when a change of ownership occurs from you to another entity. According to subsection 104-10(3) of the ITAA 1997, the time of the event is when you enter into the contract for the disposal. Under section 109-5 of the ITAA 1997 the time of acquisition is also the date of contract for an A1 event.

Calculating capital gains and losses

You make a capital gain if the capital proceeds from the disposal of the asset are more than the asset's cost base. You make a capital loss if the capital proceeds are less than the asset's reduced cost base. Capital gains are taxed at the rate that applies as a result of the level of your other taxable income plus your net capital gain.