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Authorisation Number: 1012848019296

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Subject: Sale of subdivided land

Question 1

Will the taxpayer's disposal of a Lot be treated as:

a) A mere realisation of an asset, with the proceeds being on capital account; or

b) The carrying on of a business of property development, or an isolated profit making undertaking, with the proceeds being on revenue account?

Answer

The taxpayer has commenced the carrying on of a business of property development.

Question 1(a)

When will CGT event K4 occur, and the relevant land commenced to be held as trading stock, in relation to:

a) The taxpayer's interest in the portion of land which comprises the proposed stage 1 of the subdivision ("Stage 1 Land"),

b) The taxpayer's interest in the portion of land which comprises the proposed stage 2 of the subdivision ("Stage 2 Land"),

c) The taxpayer's interest in the portion of land which comprises the proposed stage 3 of the subdivision ("Stage 3 Land").

Answer

The taxpayer commenced a land development business when you first engaged contractors to commence earthworks on stage one of your land development and as such the relevant land commenced to be held as trading stock:

a) Stage one on the day you first engaged contractors to commence earthworks for that stage of the subdivision,

b) Stage two on the day you engaged a contractor to commence the preparation of the detailed engineering plans and to tender for the provision of earthworks for that stage of the subdivision,

c) Stage three on the day you engaged a contractor to commence the preparation of the detailed engineering plans and to tender for the provision of earthworks for that stage of the subdivision.

Question 2

Will the taxpayer be liable to pay GST on its sale of the lots subdivided from the land on which a farming business has been carried on?

Answer

No. The taxpayer will not be liable to pay GST on its sale of the lots provided the purchaser intends that a farming business be carried on, on the lots.

Question 3

Will the taxpayer be entitled to claim input tax credits for acquisitions made in relation to the proposed subdivision?

Answer

Yes. The taxpayer will be entitled to claim input tax credits for acquisitions made in relation to the proposed subdivision provided all the requirements of a creditable acquisition are met.

This ruling applies for the following periods:

1 July 2013 - 30 June 2014

1 July 2014 - 30 June 2015

1 July 2015 - 30 June 2016

1 July 2016 - 30 June 2017

1 July 2017 - 30 June 2018

1 July 2018 - 30 June 2019

1 July 2019 - 30 June 2020

Relevant facts and circumstances

The taxpayer was incorporated in the late 1960s.

The director of the taxpayer first purchased a lot of land in the late 1960s and subsequently purchased other lots of land. The taxpayer became the registered proprietor of one lot in the early 1970s and another in the early 1980s. Prior to any commencement in changing the use of the land there has been no change to the pre-Capital Gains Tax (CGT) status of the land as it has been continuously owned by the same taxpayer and the majority underlying ownership interests have not changed.

At the time of purchase the land was virgin bush with minimal basic improvements. The intention of the director was to clear the land for the purpose of farming which commenced upon purchase of the initial land.

A number of dwellings were constructed on the land such as the manager's homestead and farm infrastructure and buildings.

The taxpayer has been carrying on, and continues carrying on, a farming business on the land since the early 1970s. The director carries out the farming duties but wishes to retire as he/she is past retirement age and the financial returns from the farming activities are diminishing and becoming more uncertain.

The director's children, who are shareholders in the taxpayer, do not have any involvement in the running of the farm business and have expressed no desire to be involved.

The director therefore desires to cause the taxpayer to sell the land so that the director will have liquid assets to assist in the distribution of his estate.

The taxpayer has unsuccessfully attempted, over a period of approximately five years, to sell the land as one parcel. A number of offers were made and accepted by the taxpayer within that period but each offer failed to reach settlement. The taxpayer engaged the services of professionals in the marketing of the land for sale as a whole. To attract potential purchasers, the taxpayer applied for development approval and marketed the land for sale as a development opportunity but this also failed to attract any further offers so the taxpayer ultimately decided to undertake subdivision of the land and sell the allotments individually.

As a condition of the subdivision and despite an appeal by the taxpayer, the taxpayer was required to install the water supply to the allotments at a significant expense to the taxpayer. To mitigate this cost the taxpayer decreased the size of each allotment so increasing the number of allotments to be offered for sale.

The allotments are to be presented for sale as basic rural residential lifestyle blocks of land so the taxpayer will only attend to removal of debris from the land and further only undertake the minimal work required to meet the conditions in the Subdivision Approval.

The taxpayer has engaged the services of professional agencies to carry out the entire process of obtaining subdivision approval, the subdivision itself and sale of the allotments.

The taxpayer and the director have previously been involved in property development as either financiers or joint venture partners with third parties. All of these property developments have been done in a relatively short time span whereby the land was purchased with the intention of development without holding the land for a substantial amount of time. In all of these property developments the land was held as trading stock and the proceeds were returned as ordinary income.

The subdivision will be done in three stages to:

• ensure that the costs of the subdivision are manageable and that the taxpayer is not incurring the whole of the capital expenditure before any land is sold;

• allow the taxpayer to continue to carry on its farming business on the remainder of the land while stage 1 is underway, to provide revenue and additional cash flow for the taxpayer; and

• allow the taxpayer to control the vegetation on the land by continuing to run livestock on the remainder of the land.

In all other aspects, the taxpayer intends that only minimum amount of works required by the subdivision approval will be undertaken on the land.

The taxpayer anticipates that it may be required to incur costs of several millions of dollars.

Stage 1 of the subdivision has commenced with most of the subdivided lots are now under contract.

The taxpayer has only removed the farm fencing from a small portion of the land to install road, water and electricity services infrastructure. Once the installation of that infrastructure is completed, the taxpayer proposes to return some livestock to maintain the existing vegetation prior to the settlement of the sale of the lots.

All the farm buildings and infrastructure remain untouched and in active use in the taxpayer's farming business. The taxpayer continues to use the remainder of the land to carry on its farming business.

Most of the lots in stage 1 that are under contract have been treated by the taxpayer as taxable supplies to which the taxpayer and the purchasers agreed to apply the margin scheme.

One of the lots under contract was treated by the taxpayer as a GST-free supply of farmland. The purchaser intends to use the lot for farming business. The contract for this particular sale contains clauses under which the taxpayer and the purchaser agree that the sale of the lot is a supply of farmland and that the purchaser warrants that it intends to carry on a farming business on the lot from the date of supply.

The taxpayer is registered for GST.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 section 9-5

A New Tax System (Goods and Services Tax) Act 1999 section 11-5

A New Tax System (Goods and Services Tax) Act 1999 section 38-480

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 15-15

Income Tax Assessment Act 1997 section 70-30

Income Tax Assessment Act 1997 section 104-220

Reasons for decisions

Question 1

Whether there is a business being carried on depends on the "large or general impression gained" (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1952) 10 ATD 226; (1952) 5 AITR 548) from looking at all the indicators, and whether these factors provide the operations with a 'commercial flavour' (Ferguson v. FC of T 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884).

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? provides a number of indicators that are relevant in determining whether primary production activities constitute the carrying on of a business. However, paragraph 11 of TR 97/11 states:

The indicators are no different, in principle, from the indicators as to whether activities in any other area constitute the carrying on of a business.

Therefore these indicators can also be applied to your activities to determine as to whether they constitute the carrying on of a business and are summarised as follows:

a) does the activity have a significant commercial purpose or character?

b) does the taxpayer have more than a mere intention to engage in business?

c) is there an intention to make a profit or a genuine belief that a profit will be made? Will the activity be profitable?

d) is there repetition and regularity in the activity? i.e., how often is the activity engaged in? How much time does the taxpayer spend on the activity?

e) is the activity of the same kind and carried on in a similar way to that of the ordinary trade?

f) is the activity organised in a businesslike manner?

g) what is the size or scale of the activity?

h) is the activity better described as a hobby, a form of recreation or a sporting activity?

Application to the taxpayer's circumstances

These indicators are considered in light of the taxpayer's circumstances as follows:

a) Significant commercial purpose or character:

The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators. A way of establishing that there is a significant commercial purpose or character is to compare the activities with those of a taxpayer who is carrying on a similar activity that is a business. Any knowledge, previous experience or skill of the taxpayer in the activity, and any advice taken by the taxpayer in the conduct of the business should also be considered but are not necessarily determinative.

The taxpayer contends that sale of the land is a mere realisation of a pre-CGT asset.

The Commissioner considers that the taxpayer's activities exhibit a significant commercial purpose or character and this indicator suggests the taxpayer commenced carrying on a business of land development.

b) Intention to engage in a business:

Brennan J in Inglis v. FC of T 80 ATC 4001 at 4004-4005; (1979) 10 ATR 493 at 496-497 said that:

'The carrying on of a business is not a matter merely of intention. It is a matter of activity. ... At the end of the day, the extent of activity determines whether the business is being carried on. That is a question of fact and degree.'

The taxpayer contends that its intention remained unchanged from acquisition in that the land was used for farming and farming activities continue while subdivision occurs. The land has in effect become surplus to requirements.

The controller of the taxpayer does not wish to continue farming and his/her children (also shareholders of the taxpayer) do not wish to take on the business.

The taxpayer has sought to sell the land as a farm operation. Three different contracts for sale were entered into but vendors did not complete the contracts for various reasons.

After planning approval was obtained, the land was marketed for sale as a development opportunity. No offers were presented for this option.

The Commissioner considers that the taxpayer committed the land to subdivision on the date on which it engaged a contractor to commence civil works on the property. At this point the taxpayer's intention appears to change from holding farm land to holding land as trading stock of a land development business.

The Commissioner considers that this is a positive indicator of carrying on a business of land development.

c) Is there an intention to make a profit or a genuine belief that a profit will be made?

It is important that the taxpayer can be shown to make a profit from the activity. Stronger evidence of an intention to make a profit occurs when the taxpayer has conducted research into his/her proposed activity, consulted experts or received advice on the running of the activity and the profitability of it before setting up the business.

The taxpayer has confirmed that it anticipates significant sales proceeds. Expected subdivision costs are approximately a third of the anticipated sales proceeds. Gross profit of approximately 70% of the anticipated sales proceeds is anticipated. The net profit will take into account the market value of the land at the time it was converted to trading stock.

The taxpayer had accepted significant offers to sell the land as farm land and ongoing business.

The Commissioner considers that the taxpayer changed its initial subdivision plans to maximise profit. The new plan was to increase allotments (smaller blocks sizes) after increase in cost due to development requirements set by council and Planning Commission.

The Commissioner therefore considers that this is a positive indicator of carrying on a business of land development.

d) Is there repetition and regularity in the activity?

It is often a feature of a business that similar sorts of activities are repeated on a regular basis. The repetition of activities by the same person over a period of time on a regular basis helps to determine whether there is the 'carrying on' of a business.

The taxpayer contends that this is a one-off project designed to dispose of land that it will cease to use for farming purposes.

Both the taxpayer and/or the director have been previously involved in property developments as either financiers or joint ventures with third parties. In all of these other developments the land was held as trading stock and the proceeds returned as ordinary income.

The Commissioner notes that the taxpayer and the company director both have previous experience in land developments of this nature.

There is also repetition and regularity in the current land development designed to be carried out over 3 years or more.

The Commissioner considers that this is a positive indicator of carrying on a business of land development.

e) Is the activity of the same kind and carried on in a similar way to that of the ordinary trade?

An activity is more likely to be a business when it is carried on in a manner similar to that in which other participants in the same industry carry on their activities.

The taxpayer contends that the land was cleared by the early 1970s for farming purposes. The taxpayer is not levelling or clearing land and nor constructing or demolishing dwellings.

The taxpayer facilitated rezoning to allow for subdivision.

The taxpayer incurred a significant cost to install water supply facility for the subdivision as this was required by Council.

The taxpayer contends it is only causing bare minimum work to be completed on the land to fulfil conditions imposed by Planning Commission and Council for the subdivision. The taxpayer submits it can rely on the decision in Casimaty v FC of T - [1997] FCA 1388; 151 ALR 242; 37 ATR 358.

The Commissioner contends that the development appears to be carried on in a manner similar to other land developers.

The Commissioner considers that this is a positive indicator of carrying on a business of land development.

f) Is the activity organised in a businesslike manner?

A business is characteristically carried on in a systematic and organised manner rather than on an ad hoc basis. An activity should generally conform with ordinary commercial principles to amount to the carrying on of a business.

The taxpayer advises that it engaged independent parties to undertake the planning approval stage (submissions to Council, etc), manage and undertake the subdivision activities (engineering, etc), and an agent to market and sell the Lots.

The taxpayer states that it does not seek to control how these functions are carried out. The taxpayer submits that it can distinguish its activities from those described in Stevenson v FCT 91 ATC 4476.

The Commissioner notes that the taxpayer engaged the services of professionals and approved funding for the activities of rezoning the land, planning the subdivision, carrying out civil works and marketing of allotments for sale. All these activities conform to ordinary commercial principles of a land development.

The Commissioner therefore considers that this is a positive indicator of carrying on a business of land development.

g) What is the size or scale of the activity?

The size or scale of the activity is not a determinative test, and a person may carry on a business though in a small way (Thomas at ATC 4099; ATR 171).

The scale of the activities may be small but still result in more produce than is required for the taxpayer's own domestic needs. Where this is so, and there is also an intent to profit from the activities and a reasonable expectation of doing so, a business may be carried on despite the scale.

The taxpayer confirmed that it will subdivide a significant number of acres into a large number of subdivided lots of various sizes. The taxpayer contends that the density and complexity of the development is low as compared to the Stevenson case.

The development will be completed in three stages with sales anticipated to be finalised within three years to limit reliance on borrowings. Approximately 25% of the lots have been sold in the 20XX calendar year.

The cost of subdivision will be significant. The taxpayer has borrowed the majority of this amount to fund the capital works.

The Commissioner contends that the taxpayer changed plans to increase the size and scale of the activity and produce more allotments. This will also increase profit from the activity to more than cover the increased cost due to development requirements.

The Commissioner therefore considers that this is a positive indicator of carrying on a business of land development.

h) Is the activity better described as a hobby, a form of recreation or a sporting activity?

The taxpayer has not provided any argument to support that the activity is better described as a hobby, a form of recreation or a sporting activity.

The Commissioner considers that your activities are not better described as a hobby or a form of recreation.

Conclusion:

The taxpayer contends that the subdivision is a mere realisation of the land as it is surplus to its requirements.

The Commissioner contends that the activity as reflected in the indicators above goes beyond mere realisation of a pre-CGT asset.

Therefore the Commissioner considers that the indicators reflect that a land development business was commenced by the taxpayer when it committed to the subdivision. This occurred on the day the taxpayer engaged a contractor to commence earthworks on one parcel of its land being stage one of the subdivisions. The Commissioner considers that the taxpayer commenced a land development business at this time.

As the Commissioner considers that a business of land development has commenced, we have not had to consider whether the taxpayer's activity would generate profits from an isolated transaction as assessable income as described in TR 92/3 Income Tax: whether profits on isolated transactions are income and Section 15-15 of the ITAA 1997.

Trading stock issues applying to the taxpayer's circumstances

The trading stock provisions, found in Division 70 of the Income Tax Assessment Act 1997 (ITAA 1997), applies to the taxpayer's land. Section 70-10 of the ITAA 1997 discusses the meaning of trading stock. It states:

Trading stock includes:

(a) anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and

(b) live stock.

The Supplementary Explanatory Memorandum for the Tax law Improvement Bill 1997 explains that the definition of 'trading stock' which was altered by the Tax Law Improvement Act 1997 was changed from a test when an asset is acquired to a test determined according to the asset's current use. This was changed because under the Income Tax Assessment Act 1936 definition of 'trading stock', some assets would always stay trading stock if they were first acquired for that purpose. Therefore, the meaning was changed to give effect to section 70-30 of the ITAA 1997.

Subsection 70-30(1) of the ITAA 1997 states:

If you start holding as trading stock an item you already own, but do not hold as trading stock, you are treated as if:

(a) just before it became trading stock, you had sold the item to someone else (at arm's length) for whichever of these amounts you elect: • its cost (as worked out under subsection (3) or (4)); • its market value just before it became trading stock; and

(b) you had immediately bought it back for the same amount.

When the taxpayer must make the election

Subsection 70-30(2) of the ITAA 1997 states:

You must make the election by the time you lodge your *income tax return for the income year in which you start holding the item as *trading stock. (If you do not make the election by then because you do not realise until later that you started to hold the item as trading stock, you must make the election as soon as is reasonable after realising that.)

However, the Commissioner can allow you to make it later (in either case).

The taxpayer can elect to use the market value of the land at that time when it lodges its tax return for the income year in which it first converted a part of its land to trading stock. Subsequent conversions of land to trading stock will require the taxpayer to make elections at the time it lodges tax returns for the relevant income years.

If the taxpayer chooses to adopt the market value for valuing the land then this will give rise to Capital gains Tax Event K4.

Application of CGT to the taxpayer's circumstances

Section 104-220 states:

CGT event K4 happens if:

(a) you start holding as trading stock a CGT asset you already own but do not hold as trading stock; and

(b) you elect under paragraph 70-30(1)(a) to be treated as having sold the asset for its market value.

104-220(2)

The time of the event is when you start.

104-220(3)

You make a capital gain if the asset's market value (just before it became trading stock) is more than its cost base. You make a capital loss if that market value is less than its reduced cost base.

Exception

104-220(4)

A capital gain or capital loss you make is disregarded if you acquired the asset before 20 September 1985

Therefore, should the taxpayer elect under paragraph 70-30(1)(a) of the ITAA 1997 to be treated as having sold the land for its market value then, as you purchased the land prior to 1985, paragraph 104-220(4) of the ITAA 1997 will be applicable and any capital gain or loss the taxpayer makes from CGT event K4 will be disregarded.

Question 1(a)

Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'? states:

1. Land is treated as trading stock for income tax purposes if:

• it is held for the purpose of resale; and

• a business activity which involves dealing in land has commenced.

2. 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.

3. 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 taxpayer divided its land into three parcels and is planning the subdivision of each parcel in different stages. The Commissioner considers that the taxpayer commenced a land development business on the day it first engaged a contractor to commence earthworks on one parcel of its land being stage one of the subdivision. At this time the other parcels of the land were still being used for farming purposes and therefore had not yet been committed to the subdivision of these parcels.

The committed another parcel of land to the subdivision process, being stage two, by engaging a contractor to commence the preparation of the detailed engineering plans and to tender for the provision of earthworks.

The committed the remaining parcel of land, stage three, to the business of subdivision by engaging a contractor to commence the preparation of the detailed engineering plans and to tender for the provision of earthworks.

Therefore the dates on which each parcel of land was committed to the business of subdivision and hence commenced being treated as trading stock is:

• Stage one on the day the taxpayer first engaged contractors to commence earthworks for that stage of the subdivision

• Stage two on the day the taxpayer engaged a contractor to commence the preparation of the detailed engineering plans and to tender for the provision of earthworks for that stage of the subdivision

• Stage three on the day the taxpayer engaged a contractor to commence the preparation of the detailed engineering plans and to tender for the provision of earthworks for that stage of the subdivision.

Question 2

An entity is liable to pay GST on any taxable supply that it makes.

Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) states:

You make a taxable supply if:

(a) you make the supply for *consideration; and

(b) the supply is made in the course or furtherance of an *enterprise that you *carry on: and

(c) the supply is *connected with Australia; and

(d) you are *registered, or *required to be registered.

However, the supply is not a *taxable supply to the extent that it is *GST-free or *input taxed.

The taxpayer will supply the lots for consideration. The supply will be made in the course of an enterprise carried on by the taxpayer. The supply will be connected with Australia as the lots are located in Australia. The taxpayer is registered for GST. All the requirements in paragraphs 9-5(a) to 9-5(d) of the GST Act are satisfied.

Therefore, the supply of the lots will be a taxable supply unless it is GST-free or input taxed.

There is no provision in the GST Act under which the supply of the lots would be input taxed.

Under section 38-480 of the GST Act, the supply of a freehold interest in, or the lease by an Australian government agency of or the long term lease of, land is GST-free if:

(a) the land is land on which a farming business has been carried on for at least the period of 5 years preceding the supply; and

(b) the recipient of the supply intends that a farming business be carried on, on the land.

Farming business carried on for at least the period of 5 years preceding the supply

Paragraph 38-480(a) of the GST Act is satisfied where farming has been carried on for 5 years without any break except for temporary cessation of the daily activities.

According to Goods and Services Tax Determination GSTD 2011/2, the cessation of routine farming activities in the course of selling the land does not necessarily result in the cessation of the farming business carried on. However, an enterprise terminates if the activities related to the enterprise cease. Ordinarily, this occurs when all the enterprise assets are disposed of, or converted to another purpose or use, and all the obligations of the enterprise are satisfied.

The taxpayer has been carrying on a farming business on the land for about 40 years. The subdivision will occur in stages in order for the taxpayer to continue to carry on its farming business while each of the development stages is underway. A small portion of the land has been cleared for the installation of road, water and electricity infrastructures. Once the infrastructures have been installed, the taxpayer will return some livestock to maintain the existing vegetation prior to the settlement of the sale of the lots.

We consider that the activities undertaken by the taxpayer does not result to the cessation of the farming business as those activities are in the course of selling the land. Accordingly, the farming business is carried on for at least the period of 5 years until the day of supply

Recipient intends that a farming business be carried on

Paragraph 38-480(b) of the GST Act is satisfied where there is evidence of the purchaser's intention that a farming business be carried on, on the land.

In most cases, if the vendor obtains a written statement or warranty from the purchaser stating the intention is that a farming business be carried on, then the vendor will be able to demonstrate that it has made a reasonable enquiry about the purchaser's intention, unless the vendor has reason to believe the information is incorrect.

Where the sale is treated by the taxpayer as a sale of farmland, the contract for sale contains a clause that requires a warranty from the purchaser that it intends that a farming business be carried on, on the property. In such case, the requirement in paragraph 38-480(b) of the GST Act is satisfied.

Therefore, the sale of the lots will be GST-free and the taxpayer will not be liable to pay GST on the sale provided the purchaser intends that a farming business be carried on, on the lots.

Question 3

Creditable acquisitions give rise to input tax credit entitlement.

Section 11-5 of the GST Act states:

You make a creditable acquisition if:

(a) you acquire anything solely or partly for a *creditable purpose; and

(b) the supply of the thing to you is a *taxable supply; and

(c) you provide, or are liable to provide, *consideration for the supply; and

(d) you are *registered, or *required to be registered.

Where the taxpayer acquires anything in relation to the proposed subdivision, the acquisition is for a creditable purpose. The taxpayer will provide or be liable to provide consideration for its acquisition. Furthermore, the taxpayer is registered for GST. The requirements in paragraphs

11-5(a), 11-5(c) and 11-5(d) of the GST Act are satisfied. Therefore, if the supply of the thing acquired is a taxable supply, the requirement in paragraph 11-5(b) is also satisfied, and the taxpayer makes a creditable acquisition. Accordingly, the taxpayer will be entitled to the input tax credit.