Edited version of your written advice

Authorisation Number: 1012888747364

Date of advice: 2 October 2015

Ruling

Subject: Wether the development and sub division is on capital or revenue account

Question 1

Are the proceeds from the sale of the sub divided lots assessable as ordinary income under subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Are the profits from the disposal of the sub divided lots subject to capital gains tax provisions under Part 3-1 of the ITAA 1997?

Answer

Yes. But the anti-overlap rule in section 118-25 of the ITAA 1997 provides that a capital gain you make from a CGT event is disregarded if at the time of the CGT event the asset is trading stock.

This ruling applies for the following periods

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ending 30 June 2016

Year ending 30 June 2017

Year ending 30 June 2018

The scheme commenced on

1 July 2012

Relevant facts

The entity was established as an investment vehicle.

The entity structure, when established, contained only a small number of members.

The entity purchased freehold land and a small number of buildings for a substantial amount.

There was one dwelling on each of the properties when purchased. The dwellings were never rented out after purchase.

After acquisition a feasibility analysis was commissioned to determine whether it would be a more prudent investment decision to sub-divide both titles of land as compared to holding the freehold in the long term and renting out the dwellings.

The feasibility analysis concluded that it would be a more prudent investment decision to subdivide the land compared to holding the investment long term. There would be no construction of dwellings and the existing buildings would remain in their current form and sold as part of the subdivision.

After much deliberation it was decided to apply for a permit for a large lot sub division. This application was lodged with the local Council.

The sub division is being constructed and sold in a number of stages. The first few stages have now been constructed and titles for those stages have issued. Construction of the remaining stages is currently underway. The construction phase of the latter stages is expected to be completed next calendar year. The demand for lots will determine when the subdivision is finalised, however it is anticipated to be no later than the 2017-18 financial year.

The original members of the entity at the time of the establishment of the entity did not have sufficient funds to finance the investment, therefore to finance the investment other investors were sought to acquire part ownership in the entity. The investors were non-third parties. This option had to be sought as the entity could not secure sufficient commercial finance from a financial institution to fund the subdivision. The entity's only investment activity is this subdivision.

The subdivision has been funded from a combination of finance from entity members investing in the entity and the banks. There are a large number of extra investing members. No entity member has direct involvement in the development process.

The entity expects to make a large amount of taxable profit upon sale of all the lots.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 70-10

Income Tax Assessment Act 1997 Section 118-25

Reasons for decision

Question 1

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) includes in a taxpayer's assessable income, where the taxpayer is an Australian resident, all ordinary income derived by the taxpayer both in and out of Australia during the income year. 'Ordinary income' is defined as income according to ordinary concepts.

Taxation Ruling TR 97/11 discusses whether you are carrying on a business of primary production. The factors considered in TR 97/11 are equally applicable to other businesses.

Paragraph 13 of TR 97/11 lists the following indicators as relevant:

• 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 repetition and regularity of the activity

• whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business

• whether the activity is planned, organised and carried out in a business-like manner such that it is directed at making a profit

• the size, scale and permanency of the activity

• whether the activity is better described as a hobby, a form of recreation or a sporting activity

• whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators.

Other indicators which support the main indicators include:

• whether records are kept

• whether a business plan exists

• whether there has been commercial sales of the product

• the taxpayer's knowledge or skill.

In this case an entity was specifically set up for investment purposes. This development is the only investment the entity has engaged in. Initially the entity was set up with a small number of investors, however because of the funding required to purchase the properties more members were sought and funded the investment. Funds were also sought and received from banks. There was more than just an intention to engage in business.

The entity was initially set up as an investment vehicle with a view to making profit. It has been estimated that the trust will make a substantial taxable profit therefore the entity has a purpose of profit making as well as the prospect of making a profit.

Even though this is the only development or investment activity the entity has undertaken, the business activity has been ongoing for a number of years commencing from the purchase of the blocks to the sale of the sub divided lots forecast to be sold by 2017-18. As the lots will also be developed and sold in a number of stages many of the activities required to develop the lots will be repeated, therefore there is repetition and regularity in many activities related to the development. There is also commerciality with all the activities in respect to the purchase of the land, the approval process, the subsequent subdivision and the sale process.

Within a short period of time after purchasing the blocks of land the entity undertook a feasibility study which indicated that it would be more prudent to subdivide the blocks of land as opposed to renting out the dwellings long term. The trust applied for and received approval from the Council to subdivide the land into a large number of lots. Funding for the purchase, and subsequent sub division, came from original members and further members and banks. The entity arranged for the financing, council application, development and subsequent sale of individual lots. The activities undertaken by the entity are of the same kind and carried out in a similar manner to that of the ordinary trade in that line of business.

The land purchased and the purchase prices are both substantial.

The size and scale of this subdivision indicates it is far more than a hobby or a form of recreation. It is assumed the lots will be sold to the general public.

It has been stated that the additional members will dispose of their membership in the entity once the development has been realised and the original members would continue the investments in the entity. This assertion does not affect the fact that the entity is in business of property development for this particular development. As the entity is in business the income received from the development is ordinary income and assessable under section 6-5 of the ITAA 1997.

Question 2

Section 70-10 of the ITAA 1997 in part states "trading stock" includes anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business.

Section 118-25 of the ITAA 1997 in part states a capital gain you make from a CGT event is disregarded if, at the time of the CGT event, the asset is your trading stock.

In this case the individual lots are considered trading stock and when they are sold any capital gain that is made is disregarded.