Edited version of your written advice

Authorisation Number: 1012693117989

Ruling

Subject: Land subdivision

Question 1

Will the profit on the sale of the subdivided lots constitute assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will the profit from the sale of the subdivided lots be assessable under the capital gains tax (CGT) provisions in Parts 3-1 and 3-3 of the ITAA 1997?

Answer

Yes

This ruling applies for the following period(s)

Year ending 30 June 2015

Year ending 30 June 2016

Year ending 30 June 2017

The scheme commences on

1 July 2014

Relevant facts and circumstances

You each hold an interest in a property.

The property has been owned by your family for over 30 years.

There are currently some houses on the property which are rented or occupied by members of the family. The bulk of the property is vacant and is used for the private enjoyment of the family.

When the property was acquired by one entity it has been stated that you intended to stay there rather than make a profit from the resale of the property.

The proposed sub-division would result in the new lots being zoned rural residential.

No additional land is being acquired to add to the original parcel of land.

Later, other entities purchased equal interests in the property. It has been stated that at the time they purchased their interests they did not intend to sell the property in the future.

One entity would like to utilise their interest in the property to assist them financially.

Other entities would like to retain as much of the property as possible in order to pass it down to another generation of the family, however, they would also like to ensure that the first entity's financial situation is secured.

You intend to subdivide the property.

Of the houses being occupied by members of the family one will continue to be lived in by a member of the family. Some other houses will be moved during the development as they are located on lots in the first stage of the development. The houses will be rented out after the subdivision.

You intend to sell some of the lots created from the initial stages and use the gains to:

a) assist the first improve their current financial position, and

b) fund the other stages of the development.

You will decide what further lots to sell (if any) after each stage is completed.

A local council has approved the subdivision.

You have engaged a:

a) consultant engineer who will project manage the sub-division, and

b) real estate agent to sell the sub-divided blocks

You will engage the services of sub-contractors to carry out the minimum work imposed by planning authorities and as required under the development approval.

There will be no buildings erected on the land as part of the subdivision.

You intend to borrow the funds to finance stage 1 of the sub-division. You anticipate that you will be able to use the proceeds from stage 1 to fund the remainder of the subdivision.

After expenses, should you sell all of the lots, you expect to make a profit.

None of the entities who hold ownership in the property have experience in property development nor have they subdivided land before. They have no other connection with any of the parties associated with the subdivision.

Some of the entities will continue to maintain their employment status outside of the subdivision.

The land has not been brought into account as a business asset and there is no business organisation.

Interest paid on the money borrowed to fund the development will not be claimed as a business expense.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1997 section 112-25

Income Tax Assessment Act 1997 section 104-10

Reasons for decision

You intend to subdivide the property, therefore, we will need to determine whether the proceeds to be received on the sale of the subdivided lots:

• is assessable ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as you were carrying on a business of property development

• is assessable ordinary income under section 6-5 of the ITAA 1997 as you will be conducting an isolated commercial transaction with a view to a profit, or

• is a realisation of a capital asset and assessable under the capital gains tax (CGT) provisions of the ITAA 1997.

Assessable as ordinary income

Carrying on a business of property development

There is no business organisation in existence for the subdivision and the land has not been brought to account as a business asset. You have stated that none of the applicants have experience in property development nor have they subdivided land before.

Therefore, it is accepted that any proceeds received from the sale of the subdivided land would not be derived in the course of carrying on a business.

Isolated commercial transaction with a view to a profit

Profits 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 (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium).

Taxation Ruling TR 92/3 considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income.

TR 92/3 defines the term 'isolated transactions' as:

• transactions outside the ordinary course of business of a taxpayer carrying on a business, and

• transactions entered into by non-business taxpayers.

It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayers business but:

• the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain, and

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

Paragraph 42 of TR 92/3 acknowledges that in some cases, if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either:

a) as the capital of the business; or

b) into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction,

the activity of the taxpayer constitutes the carrying on of a business or a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income although the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case.  Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of subdivided land can be assessed as ordinary income within section 6-5 of the ITAA 1997. TR 92/3 lists the following factors to be considered:

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.

In addition to the above general factors, Miscellaneous Taxation Ruling MT 2006/1 provides a list of specific factors relevant to isolated transactions and sales of real property. If several of the factors are present, it may be an indication that a business or a commercial transaction is being carried on. These factors are as follows:

• there is a change of purpose for which the land is held;

• additional land is acquired to be added to the original parcel of land;

• the parcel of land is brought into account as a business asset;

• there is a coherent plan for the subdivision of the land;

• there is a business organisation - for example a manager, office and letterhead;

• borrowed funds financed the acquisition or subdivision;

• interest on money borrowed to defray subdivisional costs was claimed as a business expense;

• there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and

• buildings have been erected on the land.

No single factor is determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

Based on the information provided, specifically that;

• the land has been held for a substantial amount of time and no additional land has been acquired to add to the original parcel

• the land has mainly been used either as a farm or for the private use of the members of the family

• the land has not been bought to account as a business asset

• the subdivision is undertaken by individuals and not under a business organisation

• interest on borrowings will not be claimed as a business expense

• the level of development to be undertaken will be the minimum that is required to obtain council approval

• no buildings will be erected on the land

• you will engage third parties to manage and complete the subdivision and market the lots

• the owners of the property have never been involved in property development or land subdivision before and the entities will continue to maintain their employment status outside of the subdivision, and

• there is no connection between the owners of the property and any other party associated with the subdivision.

On balance, it would appear that the subdivision project you will undertake will not have the characteristics of an isolated business or commercial transaction. While a sizeable profit is expected from the sale of the lots, we consider that the proceeds from the sale will represent the mere realisation of a capital asset, albeit in an enterprising way.

Accordingly, the proceeds will be assessed under the capital gains tax provisions in Part 3-1 and 3-3 of the ITAA 1997, and not as ordinary income.

Assessable under the CGT provisions

Section 112-25 of the ITAA 1997 provides that when a CGT asset is split into two or more assets, such as when you subdivide a block of land into three separate blocks, the split or change is not a CGT event. Therefore, it is only on disposal of the CGT asset that a CGT event will occur.

Subsection 112-25(3) of the ITAA 1997 provides that you work out the cost base of each new asset (eg. each new block of land that has been split from the original block of land) as follows:

1) Work out each element of the cost base and reduced cost base of the original asset at the time of the event (when the land was first subdivided).

2) Apportion in a reasonable way each element to each new asset. The result is each corresponding element of the new asset's cost base.

Section 104-10 of the ITAA 1997 provides that CGT event A1 occurs when your ownership in a CGT asset (for example. property) is transferred to another entity. The time of the event is when you enter into a contract for the disposal, or, if there is no contract, the time of disposal is taken to be the time when the change in ownership occurs.

In your case, you will dispose of a CGT asset (the separate property lots), therefore CGT event A1 will happen and the capital gains tax provisions will apply. You make a capital gain from the disposal of an asset if the amount of money you received on the disposal was more than the cost base of the asset.