Edited version of your written advice

Authorisation Number: 1012719652885

Ruling

Subject: Isolated Commercial Transactions

Question 1

Will the profits on the sale of the land be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period(s)

Income year ended 30 June 2014

The scheme commences on

1 July 2013

Relevant facts and circumstances

You are a partnership and have subdivided and sold land.

The land was originally owned by X, who operated a primary production business.

In 20xx, X died and the property passed to the child, Y.

In 20xx, Y died and the property passed to their siblings A & B who they were in a partnership with.

The partnership had debts of $x at that time.

In 20xx A & B sold a share of the property to two associates to raise capital to subdivide and sell the land.

After the land transferred a partnership was established between A & B & the associates for the sole purpose of construction, subdivision and sale of the land.

The partnership registered for GST and has claimed input credits on the development costs.

The development was limited to the following

• approval application to council

• subdivision

• fencing

• construction of a driveway and gate

• clearing of trees

Partnership income tax returns have been lodged each year with nil outcome, all costs related to the subdivision have been capitalised with the base land cost of $x.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Reasons for decision

Generally the profits from transactions involving the sale of real property will be assessable as ordinary income under section 6-5 of the ITAA 1997 where they are income from a business activity or profits from an isolated commercial transaction. In those instances where the profits of the sale would have been ordinary income any losses will generally be deductible. Alternatively, where the sale of real property is not part of a business or an isolated commercial transaction any profit or loss will be subject to the capital gains tax provisions.

Carrying on a business

The question of whether a business is being carried on is a question of fact and degree to be determined on a case by case basis. The courts have developed a series of indicators to determine the matter, which are summarised in Taxation Ruling TR 97/11. Although TR 97/11 specifically refers to primary production, the same principles apply to all businesses. Some indicators of carrying on a business which the courts have considered to be relevant include:

• whether the activity has a significant commercial purposes or character

• whether the taxpayer has more than just an intention to engage in business

• 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 businesslike 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.

Applying the above indicators to your circumstances, it is clear that you are not in the business of developing or selling property. Consequently the proceeds will not be assessable as income from a business activity.

Isolated commercial transactions

However the profits of any sale of property may still be assessable as ordinary income from an isolated commercial transaction. The Commissioner's view on whether profits on isolated transactions are assessable income under ordinary concepts is contained in Taxation Ruling TR 92/3. Profit from an isolated transaction is ordinary income where both:

• the intention and purpose for the taxpayer in entering into the transaction was to make a profit or gain and the transaction was entered into; and

• the profit was made in the course of carrying on a business or in carrying out a business operation or commercial transaction.

As was held in FC of T v The Myer Emporium Ltd (1987) 163 CLR 1999 the relevant intention is your intention taking into account objective consideration of all the facts and circumstances of the case.

It is a general principle that where a person purchases land not for the purpose of resale, and then sells the land either in its entirety or in separate lots that the party is merely realising their assets (see Californian Copper Syndicate v Harris (1904) 5 TC 159 and does not have a profit making purpose or intention.

However this may not always be the case where there is an intervening act and a clear change in purpose for the use of the land such as in White v FCT (1968) 120 CLR 191 or Whitfords Beach v FCT 150 CLR 366; 82 ATC 4031.

Subdivision of land

Numerous court cases have considered the application of the above principles in relation to the subdivision of land originally purchased and used for primary production. In Statham v FCT 89 ATC 4070 it was held that a significant staged, subdivision of property previously used as a cattle beef farm was a mere realisation. In reaching this conclusion the Federal Court had regard to the following:

• the owners were content to sell the land as once parcel but were unable to do so

• no money was borrowed by them, although a bank guarantee was provided

• only very limited clearing and earthworks were involved

• the owners relied upon the council to carry out roadwork's, kerbing, electricity and sewerage works

• the owner did not erect building on the land

• there was no business organisation or structure

• the taxpayer maintained their occupation

• the owners did not advertise the land

• the owners did not engage contractors

Another case similarly favourable to the taxpayer was the case of McCorkell v FCT 98 ATC 2199. In that case the AAT held that the subdivision and sale of a commercial orchid was a mere realisation of a capital asset. In reaching this conclusion the Deputy President had regard to the following factors:

• the taxpayer was not directly involved in the planning and contracting of work

• the taxpayer had no involvement in marketing the land

• taxpayer relied on consultants

• taxpayer did no more than necessary than to secure the necessary approvals and enhance the presentation of the properties ready for sale

• urban developments were beginning to encroach on the land and consequently it was concluded that it was reasonable that the taxpayer consider his options available to him to realise the property to his best advantage.

These cases can be contrasted against the decision in Stevenson v FCT 91 ATC 4476 which was unfavourable to the taxpayer. In that case the taxpayer decided to develop and sell the majority of his farm. The case was an appeal from an AAT decision which had determined the sale to not be a mere realisation based on the following:

• the taxpayer was the sole decision maker in relation to the development

• the taxpayer personally sought and obtained finance for the development

• the taxpayer personally dealt with the council and prospective purchasers

• the taxpayer controlled the marketing of the subdivided properties

• the taxpayer personally undertook work on the development to save in labour costs.

In upholding the decision of the AAT the Federal Court agreed with the Tribunal that the fact that the owner of the asset undertook much of the planning and managing of the activities, they had crossed the line between merely realising the asset into carrying on a business.

In Whitfords Beach, the original shareholders in the taxpayer company were the occupiers of fishing shacks on a beachfront reserve. The company was originally formed to purchase undeveloped land to provide access to the fishing shacks. Thirteen years later other parties purchased the share capital in the taxpayer company and commenced the subdivision and development of the land. In finding that the profits on the sale of the vacant lots were assessable the High Court had regard to the change in ownership of the company, Chief Justice Gibbs provided at 4031, 4039:

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.

Application to your circumstances

We note the following of your circumstances:

• While the property has been in the family for a significant period of time, the property only passed to the original two partners under the will in 20xx. The additional two partners did not acquire their share of the ownership interest until 20xx and have not conducted any farming enterprise on the property.

• The partnership was established for the sole purpose of subdivision, construction and sale of the land. This partnership was registered for GST and you have claimed input credits on the development costs.

• You have dealt directly with the various contractors and the council as opposed to appointing another party to manage the development on your behalf.

• You have directly contributed capital.

• The development is on a limited scale with the subdivision of the property into x lots, with the only significant work being done the removal of trees, erecting of fencing, and the construction of a driveway and gate.

In applying the above case law to your factual circumstance we consider that your circumstances are more on point with Whitfords Beach and Stevenson, while we acknowledge that the extent of the development would normally suggest a mere realisation. As in Stevens you have sourced your own capital, dealt with the council and contractors directly, and you are personally responsible for the marketing and sale of the property.

Further the Commissioner considers your circumstances are similar to Whitfords Beach in that the change in the ownership of the land and the establishment of the partnership solely for the purpose of developing the land have converted what would have ordinarily been the mere realisation of farming assets inherited under the will into a profit making undertaking of subdividing and selling land.

Consequently the sale of the vacant lots will be an isolated commercial transaction, profits of which will be assessable as ordinary income under section 6-5 of the ITAA 1997.