Edited version of private advice

Authorisation Number: 1012667474511

Ruling

Subject: Land subdivision - complex unit trust - revenue account

Question:

Will the lot sales of subdivision land by you (the 'Landholding Entity') be treated as capital receipts?

Answer:

No.

This ruling applies for the following periods:

Year ending 30 June 2015

Year ending 30 June 2016

Year ending 30 June 2017

Year ending 30 June 2018

The scheme commences on:

1 July 2014

Relevant facts and circumstances

You are a unit trust with various individual, family trust and corporate unit holders, who become unit holders at various times in correlation to new purchases of land.

Initially, you bought parcels of rural zoned loaned that abutted newly zone and developed residential areas. The relevant land purchase contracts included deferent settlement periods of up the three years and provisions giving some subdivided blocks to vendors.

You entered into numerous option agreements to purchase neighbouring land in the event you were able to sell the land you had already purchased. However, attempts of sale did succeed (which occurred just prior to the Global Financial Crisis).

In your tax returns and financial statements, you declared you were a business entity, earning some business (rather than rental) income and holding various land holdings as 'inventories'. You expensed (rather than capitalised) the interest paid on those properties that did not earn rental income.

You derived rent from rental properties that were in varying states of disrepair and did not invest in improving or repairing them.

You more recently sold one of your land holdings due to difficulties with the neighbour who bought it, which included a first right of refusal in the sale contract if the buyer decided to sell.

Even more recently, a new large investor took up units in your unit trust, whose finance was used to purchase a relatively costly land holding that was subdividable into residential lots, after which you entered into a proposed development and subdivision proposal with a developer, who would receive a fixed percentage of the gross sales.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 102-5

Reasons for decision

Detailed reasoning

Income tax treatment

Profits from a land sub-division can be treated in at least three ways for taxation purposes:

(1) As capital gains under Part 3-1 and Part 3-3 of the ITAA 1997, from the mere realisation of a capital asset.

(2) As ordinary income under section 6-5 of the ITAA 1997, as a result of carrying on a business of property development, involving the sale of land as trading stock.

(3) As ordinary income under section 6-5 of the ITAA 1997, as a result of an isolated commercial transaction entered into by a non-business taxpayer or outside the ordinary course of business of a taxpayer carrying on a business.

Mere realisation

The mere realisation of a capital asset was described in Commissioner of Taxes v Melbourne Trust Limited [1914] AC 1001 as "liquidating or realising the old assets". In The Alabama Coal, Iron, Land and Colonization Co Ltd v Mylam (1926) 11 TC 232, a commercial transaction was distinguished from a mere realisation as "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 Federal Commissioner of Taxation v NF Williams 72 ATC 4188; (1972) 127 CLR 226, Gibbs J explained mere realisation of land as follows:

An owner of land who holds it until the price of land has risen and then subdivides 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 subdivision 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 realization of a capital asset are not income either in accordance with ordinary concepts…even though the realization is carried out in an enterprising way so as to secure the best price…

In the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135, at 97 ATC 5152, Ryan J described a salient characteristic of the mere realisation of land as follows:

…[to not] undertake any works on, or development of, the land beyond what was necessary to secure the approval by the municipal authorities of the successive plans of subdivision and enhance the presentation of individual allotments for sale as vacant blocks.

In distinguishing mere realisation from a commercial transaction, Justice Ryan further said:

Had he constructed dwelling houses, internal fencing or other improvements, it would have been easier to impute to him an intention to carry on a business of land development and improvement.

Business transactions & isolated (commercial) transactions

The term 'business' ordinarily refers to trade engaged in on a regular or continuous basis. Whereas an isolated (one-off) commercial transaction does not amount to a business but has the characteristics of a 'business deal'.

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 businesslike 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.

Taxation Ruling TR 92/3 explains, for an isolated commercial transaction to occur, it is usually necessary the taxpayer has the purpose of profit-making at the time of acquiring the property and that the property has no use other than as the subject of trade (paragraphs 9 and 49(g)). Paragraph 49 of TR 92/3 states:

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 the following:

(a) the nature of the entity undertaking the operation or transaction…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;

(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. This factor would include whether professional agents and advisers were used and whether the operation or transaction took place in a public market;

(f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction. For example, the relationship between the parties may suggest that the operation or transaction was essentially a family dealing and not business or commercial in nature;

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

(h) the timing of the transaction or the various steps in the transaction... 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.

In the Full High Court of Australia 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 (on 20^th December 1967) 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.

In the Federal Court of Australia case of Crow v. Federal Commissioner of Taxation (1988) 19 ATR 1565; (1988) 88 ATC 4620 (Crow's Case), the taxpayer had been a builder but purchased in 1962 a farm property ("Waterloo Farm'') of 390 acres, which remained the taxpayer's home and principal farming property (although on 24 June 1964 the taxpayer submitted to the local municipal council a plan of subdivision of the farm into 38 lots which was approved by the council on 10 July 1964 but the taxpayer did not proceed with the subdivision). Shortly afterwards, he took a lease with an option to purchase of another property ("the Clifton land'') of 556 acres about five kilometres away from Waterloo Farm. In 1968, he obtained approval of a plan of subdivision of part of the Clifton land and sold off various portions of that land between 1968 and 1980 after which none of it remained in his ownership. In the meantime, the taxpayer had purchased another property of 62 acres (`"the Cremorne property'') which adjoined Waterloo Farm. He subdivided and sold off about half of the Cremorne property, consolidating and retaining the rest with Waterloo Farm. In 1972, the taxpayer acquired yet another property ("Rokeby'') part of which was sold off under threat of compulsory acquisition, to the Tasmanian Housing Department. In 1973, another property ("Acton Park'') adjoining Rokeby was acquired, subdivided and sold off in its entirety between 1978 and 1981 and, in 1975, the taxpayer exercised an option to purchase part of another tract of land at Mount Rumney which he also subdivided and sold off during 1981. His Honour concluded that the taxpayer's subdivisional activities amounted to carrying on the business of land development. A salient factor here was there was a series of repeated acquisitions of separate parcels of land.

In the Federal Court of Australia case of Stevenson v Federal Commissioner of Taxation 91 ATC 4476; (1991) 29 FCR 282 (Stevenson), it was decided farmer that held his farmland for many years was carrying on a business due to his active personal involvement in the planning, financing, undertaking and selling of the subdivision of his farmland.

In the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135, reference was made to Turner v Last (HM Inspector of Taxes) (1965) 42 TC 517, per Cross J at 522-523. In that case the court upheld the taxpayer's assessment to tax of profits on the sale of farming land despite the taxpayer's contention that the whole of the land had been purchased with the intention of farming, on the ground that the inference that the taxpayer in fact intended to resell the land at a profit could reasonably be drawn from evidence that the taxpayer's financial position before the purchase would not allow him to hold the land indefinitely, that the land had a development potential and that the taxpayer had bought the land for more than its agricultural value.

Land purchased for development

Taxation Determination TD 92/126, TD 92/127 and TD 92/128 each provide if land is acquired for development, subdivision and sale and, after some initial development or no development of the project, the land is subsequently sold, the sale will be treated on revenue account.

Application of law in your case

In your case, we consider the sale of land will fall on revenue account for the following reasons:

• Per paragraphs 9 and 49(g) of TR 92/3, the deferred settlement agreements on the initial property purchases and the obligation to give subdivided blocks to the vendor or otherwise additional payment if subdivision plans were not approved gives rise to the strong impression and conclusion that the land was acquired for the purpose of relatively prompt resale and/or subdivision. This strong impression is accentuated by: (i) the entering into numerous option agreements with other landholders in contemplation of the sale of your initial land purchases relatively soon after their settlement; (ii) the actual subdivision planning conducted on one property; (iii) the disposal of that property after problems with subdivision and; (iii) the purchase of a new property, after the introduction of a new investor, for a comparatively high price, which was land that can be subdivided into residential lots; and (iv) subdivision planning in association with developer, which included the new purchased property plus further options to purchase more land.

• Per paragraph 49(h) of TR 92/3, the timing of the various steps in the transaction indicate an intention of business dealing since the initial properties were purchased with deferred settlement periods of two to three years, in what was a rising property market before it was curtailed by the Global Financial Crisis in 2008. The impression gained is the holding of the properties for many years prior to the current proposed development and subdivision was probably influenced by the Global Financial Crisis rather than by the intention or plan of the Landholding Entity to hold the land for long term.

• Per paragraphs 49(a) and (f) of TR 92/3, the nature of the entities undertaking the operation or transaction and the relationship between them indicate business or commercial dealing (rather than an individual or family dealing). The Landholding Entity is a fixed trust with a number of unrelated investors and beneficiaries. Further, when some new land was sought, new investors entered. The very name of the Landholding Entity and its corporate trustee infers the entities were established for dealing in property. Similar to the case of Whitfords Beach, the strong impression arises that the Landholding Entity was established for the purpose of acquiring land for resale at a profit (rather than for renting, farming, family residential or a passive investment). The disinterest in the rental potential of the properties adds to the impression of an intention to sell in a short time frame.

• Similar to Crow's Case and per paragraph 49(d) of TR 92/3, the nature, scale and complexity of the operation indicate a business or commercial dealing due to the multiple acquisitions of land and various option agreements in place (which would be exercised if the sale of certain lands occurred), including the right to purchase as a condition of the land sold and further options to purchase if the current development proposal proceeded. The various option agreements in place particularly give a strong impression of land dealings or trading (rather than passive investing), similar to Crow's Case.

• The appointment of a Development Manager shows the Landholding Entity itself is not engaged in a business of (repeatedly) subdividing land. However, per TD 92/126, TD 92/127 and TD 92/128, the appointment of a Development Manager does not in any way change the character of the property purchased. Since we have concluded the purchase of properties fell on revenue account, their disposal will remain on revenue account, regardless of how they are developed or disposed of.

• Whilst not strictly determinative, similar to Turner v Last, there is an impression or possibility the new major investor was introduced because the other unit holders were not in a financial position to hold the land, long term, or otherwise, were not in a position to realise shorter term returns as they wished thus they embarked on acquiring new and better land that was ready for subdivision.

In conclusion: (i) the nature of the multiple entities undertaking the operation; (ii) the multiplicity, timing and complexity of the various purchase and sale transactions; and (iii) the multiple option to purchase agreements result in the strong impression and conclusion that the Landholding Entity is engaged in business dealings in respect to land that are taxable on revenue (rather than capital) account.