Edited version of your written advice

Authorisation Number: 1012702076759

Ruling

Subject: Subdivision of land

Questions and answers

1. Will the proceeds of the sale of the subdivided lots, resulting from the subdivision of your property, be assessable as ordinary income?

No.

2. Will the proceeds of the sale of the subdivided lots, resulting from the subdivision of your property, be assessable under the capital gains tax provisions?

Yes.

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 commenced on:

1 July 2014

Relevant facts and circumstances

You purchased the property prior to 20 September 1985.

The property was purchased as a residence with a small crop farm.

You have resided at the property since it was purchased.

The farming stopped a number of years ago when your spouse became ill.

Since your spouse passed away, you have continued to use the property as your main residence.

There is no mortgage over the property.

In recent years, the neighbouring properties have been developed into smaller residential lots as part of the urban sprawl.

You retired a number of years ago. You were previously a farmer. You have no experience in property development.

To help transition into and fund your retirement, you propose to conduct a subdivision of X lots.

You intend to retain and continue to live on the subdivided lot that contains your current residence.

You may also retain some of the lots adjoining your residence until such time as those lots need to be sold.

You may gift some of the lots to your family members.

You have not subdivided property in the past.

You will not build anything on the land or perform any works beyond the minimum amount necessary to satisfy the development approval conditions.

You have no formal business plan or timeline for completing the subdivision works and selling the subdivided lots.

You have no business organisation for the subdivision. There is no office, no secretary and no letterhead in relation to the subdivision activities.

You intend to use consultants and contractors to perform the subdivision activities.

You expect the cost of the subdivision to be approximately $X.

You will borrow funds of approximately $X to finance the subdivision activities.

You intend to advertise the subdivided lots for sale through local real estate agents.

You expect the subdivided lots to be sold for between $X and $X each.

You have not claimed any expenses in relation to the current subdivision as deductions for income tax purposes.

You have not claimed any input tax credits in relation to the subdivision for GST purposes. You are not registered for GST.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 6-5.

Reasons for decision

Under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), your assessable income includes the ordinary income you derived directly or indirectly from all sources, during the income year. A capital receipt is not ordinary income and therefore not assessable under section 6-5 of the ITAA 1997. It is often difficult to distinguish between a capital receipt and income.

Isolated transactions can be ordinary income.

Taxation Ruling TR 92/3: Income tax: whether profits on isolated transactions are income (TR 92/3) discusses profits on isolated transactions and states that profits on isolated transaction may be ordinary income.

In most circumstances, profit from an isolated transaction will be ordinary income when:

(a) the intention or purpose of a 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.

For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient that the transaction is business or commercial in nature.

Some of the factors to consider when looking at whether an isolated transaction is business or commercial in nature 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 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.

Profits of the sale of subdivided land can be income

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

In Scottish Australian Mining Co Ltd v FC of T (1950) 9 ATD 135; (1950) 81 CLR 188 (at ATD p 140; CLR p195) his Honour, Williams J, in considering whether the subdivision of land was a profit making venture, said:

The facts would, in my opinion, have to be very strong indeed before a court could be induced to hold that a company which had not purchased or otherwise acquired land for the purpose of profit-making by sale was engaged in the business of selling land and not merely realizing it when all that the company had done was to take the necessary steps to realize the land to the best advantage, especially land which had been acquired and used for a different purpose which it was no longer businesslike to carry out.

In Statham & Anor v FC of T 89 ATC 4070 (Statham's case) the Full Federal Court considered the subdivision of rural land which involved a large scale subdivision of 105 lots with a substantial outlay to obtain a large profit. It was considered that the mere magnitude of the realisation does not convert the activity into a business, undertaking or scheme. The Court considered the size of the subdivision, the amount of money involved, the involvement of the parties and the length of time the subdivision was to be developed over to determine whether the activities amounted to more than a mere realisation of assets. The Court determined that the owners were not in the business of selling land and that the activities amounted to a mere realisation of the asset by the most advantageous means.

In FC of T v Williams 72 ATC 4188; (1972) 127 CLR 226 (Williams's case) the High Court considered that development carried out on land to be subdivided, such as grading, levelling, road building and provision for water and power, was to enable the owner to secure the best price for the land and did not amount to carrying out a profit making scheme. The proceeds resulted from the mere realisation of a capital asset and were not income.

Casimaty v FC of T 97 ATC 5135; (1997) 37 ATR 358 (Casimaty's case) 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.

In Stevenson v FC of T 91 ATC 4476; (1991) 22 ATR 56; (1991) 29 FCR 282 (Stevenson's case) the court considered that the magnitude of the subdivision and the degree of involvement in the planning and managing of the subdivisional activities amount to the carrying on of a business. The facts in this case involved a 220 block subdivision and the taxpayer was actively involved in the planning, employment of contractors and marketing of the blocks.

In FC of T v Whitfords Beach Pty Ltd 82 ATC 4031; (1982) 150 CLR 355; (1982) 12 ATR 692; (1982) 39 ALR 521; (1982) 56 ALJR 240 (the Whitfords Beach case) where the court found that the taxpayer's activities in relation to the subdivision of the land amounted to more than realisation of a capital asset and constituted the carrying on of a business of land development. The taxpayer in this case was a company which was originally formed to acquire land to secure the shareholders continued access to their properties and at some stage subdivide the land and give each shareholder a separate title to a lot.

Application to your circumstances

The factors listed at paragraph 13 of TR 92/3 need to be considered in relation to your activities in subdividing your land to determine whether the proceeds are income in nature.

a) The nature of the entity undertaking the operation or transaction

You purchased the property prior to 30 September 1985 as your main residence and farm. You ran a farming business on the property until a number of years ago. You have continued to live in the residence since it was purchased.

We are satisfied that from the long use of the property as a main residence and a farm that your intention at the time of purchase was not to make a profit from the subdivision and sale of the property.

b) The nature and scale of other activities undertaken by the taxpayer

You have never been involved in a subdivision before. You owned and operated a farming business from when the property was purchased until a number of years ago.

c) The amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained

You intend to obtain a loan of approximately $X and sell each lot for approximately $X to $X. Whilst the amounts are significant, this is not determinative and is merely listed in TR 92/3 as a factor to be considered. Furthermore, these amounts are small when compared with cases where subdivisions have been held to be profit raking schemes, for example the Whitfords Beach case where CPI indexed profits was $39,000,000.

In McCorkell v Commissioner of Taxation 1998 AATA 562, the taxpayer borrowed money to conduct subdivision activities. In that case, the existence of borrowed funds did not mean the taxpayer's activities amounted to a profit making undertaking or scheme - the Court was satisfied that the taxpayer was merely realising a capital asset.

d) The nature, scale and complexity of the operation or transaction

You intend to subdivide your property into X lots. You will only carry out the minimum work as required.

There are a significant number of authorities where developments of a larger scale have been held not to constitute a commercial or profit making undertaking (e.g. Allied Pastoral Holdings v FCT 83 ATC 4015 (the Allied Pastoral case), Statham's case, Case No QT96/187 and Casimaty's case).

In the Allied Pastoral case, a project that generated a profit of approximately $648,000 in 1974 was held not to be a profit making undertaking. In real terms, the projected 'profit' anticipated by the Applicant on the subdivision and sale of the land will be far less than in Allied Pastoral.

In Casimaty's case, the land was subdivided into a total of 80 lots which were developed in eight separate stages involving internal road works, the court considered that the profits from the subdivision and sale were capital receipts and not ordinary income.

In your case, the scope of the project is not comparable to the large scale of projects referred to in cases such as the Whitfords Beach case or Stevenson's case.

It can be argued that the nature and scale of your operation can be characterised as merely realising a capital asset in order for you to retire from farming.

e) The manner in which the operation or transaction was entered into or carried out

You will engage experts to carry out the majority of the work.

f) The nature of any connection between the relevant taxpayer and any other party to the operation or transaction

You will engage professionals to undertake all necessary work involved in the subdivision. You intend to gift some of the lots to family members.

g) If the transaction involves the acquisition and disposal of property, the nature of that property

The property was used by you as a main residence and farm. As your intention is to retire from farming you have decided to realise the land as a capital asset of your farming business.

h) The timing of the transaction or the various steps in the transaction

You have held an interest in the land for approximately X years, and used it as your main residence for the entire time and in a farming business for the vast majority of that time.

The reasons for the decision to realise the land relate to your retirement and ceasing your farming business.

It can be argued that the length of time involved coupled with the scale of the subdivision is not consistent with a businesslike approach and supports the contention that the development is simply the ordered realisation of a capital asset.

Conclusion

Unlike the circumstances in the Whitfords Beach case, the property in your case was purchased to use as your main residence and in your business which is indicative that the subdivision and sale of the property is a realisation of a capital asset.

The scale and size of the subdivision is relatively small with the land being subdivided into X lots. Decisions such as Williams's case and Casimaty's case, where both the size and the scale of the projects were significantly larger than your case, strongly suggests that the intended subdivision is not commercial in nature but a mere realisation of a capital asset. The fact that you have not been in the business of land development before adds further weight to this contention.

The circumstances of your case suggest that the subdivision of the land is not ordinary income under section 6-5 of the ITAA 1997 it is a capital receipt as you have merely realised capital asset.

Therefore, the proceeds of the sale of the subdivided lots will not be assessable as ordinary income, but will be assessable under the capital gains provisions.