Edited version of your written advice

Authorisation Number: 1012694096730

Ruling

Subject: Income versus Capital

Question 1

Will the proceeds from the subdivision and sale of your land be considered assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will the proceeds from the development and sale of your land be subject to the Capital Gains Tax (CGT) provisions in Part 3-1 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

The scheme commenced on

1 July 2013

Relevant facts and circumstances

You and your spouse operate a private company. You are both directors of the company.

The company is not a land development company and has no history of property development. It is registered for GST.

You purchased a vacant residential block many years ago with a view to building your family home on it. You built your home on it a few years later and you have continued to reside at this address as your principal residence. No business has been conducted on the property.

You have not lodged any application to rezone but over the last ten years the council has allowed subdivisions in the area which is on the outskirts of a growing city. Various subdivision activities have commenced around your property with part of this work involving new roads.

In 20XX you decided that you wanted to sell off some of the land around the house to pay for your new home and get away from the development.

You made enquiries to council as to what was required to be done so the blocks could be sold off individually. The council required certain infrastructure roads, sewerage, power, etcetera before the subdivision could be approved. You obtained and paid for some advice from an external consultant in relation to a subdivision plan of several blocks (including your residential block) and paid some other preliminary costs.

You considered selling off the whole of the land to a developer but you considered the costs too expensive.

In late 20XX you paid a deposit to your company to commence the process of organising the subdivision to do the bare requirements to meet council specifications and requirements. It will all be sold as bare blocks with the exception of the existing home.

The company organised various contractors to undertake the subdivision work. The company paid all the expenses of the subdivision and will oncharge these costs to you with a small commercial management fee upon completion.

The company will be treating income and expenses on revenue account and claiming GST on taxable acquisitions and remitting GST on income.

The land secures the loan that the company has. The company is organising the sale of the blocks. There will be no name for the subdivision or marketing campaign.

You have no prior direct or indirect experience or history in land development activity. You formerly owned and operated a construction business for many years.

The approximate value of the undeveloped property was $x.

A large portion of the development will be funded by borrowings to be repaid as the blocks are sold.

The subdivision project is nearing completion and you have interest in a number of blocks.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5,

Income Tax Assessment Act 1997 Part 3-1,

Income Tax Assessment Act 1997 Section 10-5 and

Income Tax Assessment Act 1997 Section 102-5.

Reasons for decision

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

(1) As 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.  

(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 the capital gains tax (CGT) legislation, (sections 10-5 and 102-5 of the ITAA 1997), on the basis that a mere realisation of a capital asset has occurred.

Carrying on a business of property development

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 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.

In applying these factors to your circumstances, you do not have any history of being involved in property development. You have not demonstrated the regularity or continuity usually associated with a property development business.

It is considered that you are not carrying on a business of property development.

Isolated transactions

Profits on the sale of land can be income according to ordinary concepts, or the result of a profit making undertaking or plan, if your activities become a separate business operation or commercial transaction. In determining whether a transaction amounts to a business operation or commercial transaction, the Commissioner's guidelines are set out in paragraph 13 of Taxation Ruling TR 92/3.

The factors relevant to your case are as follows:

• 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 cases of Casimaty v. Commissioner of Taxation 97 ATC 5135; (1997) 37 ATR 358 (Casimaty's case) and McCorkell v FC of T Re 39 ATR 1112; 98 ATC 2199 demonstrate 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.

In Casimaty's case the taxpayer acquired a farming property on which he erected a homestead and conducted a primary production business. Because of growing debt and ill health, the taxpayer had to subdivide and sell off a large part of the property. The proceeds from the subdivisions and sales were not assessable as the taxpayer acquired and continued to hold the property for use as a residence and the conduct of the business of primary production. A related consideration was the fact that the land was developed and subdivided on a piecemeal basis in response to the exigencies of increasing debt and deteriorating health. Accordingly, the subdivisions were considered to have occurred as part of the mere realisation of a capital asset.

The fact that in realising an asset a taxpayer engages in activities which are planned, organised and may produce profits considerably more than could otherwise have been obtained, does not mean that an advantageous realisation converts into a profit-making scheme.

Application to your circumstances

You acquired the property for the purpose of building a principal place of residence on the property and the property has solely been used for this purpose during the period of your ownership.

Your involvement in the development process will be limited to engaging an associated company to act on your behalf to prepare development plans, consult with authorities, carry out construction works, market lots for sale and organise the subsequent sale of the blocks.

The relevant factors that relate to your case can be summarised as follows:

• there is not a complex structure involved

• you had not previously undertaken any other property subdivisions or developments

• the land was not purchased for investment purposes

• the subject land has been held for a significant period of time and prior to subdividing the property was solely used as your principal residence.

• you as individuals will have little involvement in the steps of subdividing and the subsequent sale of the land as you will engage an associated company to manage the development, from the beginning of the process, throughout the development process to the sale of the individual blocks.

On balance, we consider that the proceeds from the sale of your land will not be assessable under section 6-5 of the ITAA 1997 as either ordinary income or a profit-making scheme. They represent a mere realisation of a capital asset in the most enterprising way available so as to maximise the proceeds of sale.

Accordingly, any profit on the sale of subdivided lots will fall for consideration under the CGT provisions in Part 3-1 of the ITAA 1997.