Edited version of your written advice

Authorisation Number: 1012939728900

Date of advice: 21 January 2016

Ruling

Subject: Income Tax

Question 1

Is the land trading stock for income tax purposes?

Answer

No

Question 2

Will the transfer of the subject land result in an assessable amount pursuant to section 6-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 3

Will the market value substitution rules contained in section 116-30 of ITAA 1997 apply?

Answer

No

Question 4

What is the amount of capital proceeds for the purposes of section 116-20 of ITAA 1997?

Answer

Not applicable because of the responses to questions 1, 2 and 3 above

This ruling applies for the following periods:

1 July 2015 to 30 June 2016

The scheme commences on:

1 July 2015

Relevant facts and circumstances

A Private Binding Ruling issued in relation to an intention to gift subject land to a number of councils. It determined that the subject land was not trading stock and that it was a capital asset.

Another application was made for a Private Binding Ruling relating to the sale of the subject land for nominal consideration and the Capital Gains Tax (CGT) implications of this proposed transaction.

The Trustee for the Family Trust (the Trust) carries on an enterprise providing development consultancy services

The reason for purchasing the land in 20XX was:

• to develop an environmental wetland to rehabilitate denuded farmland with worsening creek erosion that was prone to flooding and emitting polluted water into a park;

• to help finance the development of the wetland ecosystem (in addition to Government grant funding which has been received over the past Z years);

• a parcel of land was approved to be developed for environmentally sustainable housing.

Since the acquisition the land has been transformed and part sub-divided with the balance of land on one title and zoned 'Landscape' now largely consisting of wetlands designed to cater for a one in 100 year flood event, being largely a flood plain. Within the area of land, nearly Yha is devoted to a specific village with the remaining land allowing a number of residential allotments, the majority of which have been developed and sold.

The Trust has incorporated walking trails and bike tracks for the community to use and benefit from the wetlands environment.

The Trust is the developer of a residential development on land adjoining the Property. The Trust proposes to develop a small number of hectares as a Health and Wellbeing area within the Property. The Trust has offered to transfer half of the area to a not for profit joint venture controlled by a number of local shire councils, created for the purpose of developing a regional recreational centre (the Facility).

A copy of the executed 'Heads of Agreement' (the Agreement) between the entity and the councils detailing the terms of the transfer of land has been provided.

The Agreement provides that prior to the transfer of land a number of expectations are envisaged including:

• Unanimous agreement between all parties regarding the design of the Facility. You advised that your intention is that the Facility be aesthetically pleasing and environmentally friendly including the orientation of the building, the use of solar panels for heating and other alternatives.

• Submission of the design plans to ensure urban design, environmental impact, thermal efficiency and sustainability considerations are met as permitted under the funding committed to the construction of the Facility.

• Commencement of the rezoning process to accommodate the health and wellbeing area and the Facility.

• Testing and clearance of the land for soil, contamination, aboriginal heritage and native vegetation at the shared cost of the two councils followed by a professionally prepared feasibility study for the construction and operation of the Facility upon the land, also at the shared cost of the councils.

• The councils obtaining commitment from other levels of Government for such contribution to funding the development and/or operation of the Facility as they think prudent.

The provisos mentioned above (contained in the Agreement) have been waived or satisfied.

The trust intends to transfer the land free of security interests to the Councils under various terms and conditions:

The Agreement also envisaged that on completion of the Facility, the Facility will operate year round as a regional leisure centre open to the fee-paying public. The Facility will be branded as a joint initiative of the Councils with any trading profit or loss being shared equally between them.

Reasons for decision

As a general rule, capital gains tax must be paid on any gains made from the disposal of assets that were acquired on or after 20 September 1985.

Under section 118-25 of the Income Tax Assessment Act 1997 (ITAA 1997) a capital gain or loss made from a CGT asset is disregarded if, at the time of the CGT event, the asset is trading stock of the trust.

Trading stock

The term 'trading stock' is defined in section 70-10 of the ITAA 1997 as from 1 July 1997. Section 70-10 defines trading stock to include anything produced, manufactured or acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course of business.

Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'? which states that land can constitute trading stock if it is held for resale and a business activity that involves dealing in land has commenced? A single acquisition of land for the purpose of development, subdivision and sale by a business commenced for that purposes leads to the land being trading stock.

In order for an item to be classified as trading stock, therefore, it needs to be held by the taxpayer in the course of carrying on a business or directly related to a business activity.

Carrying on a business

The term 'business' is defined in section 995-1(1) of the ITAA 1997 to include (but not limited to) any profession, trade, employment, vocation or calling; and excludes any occupation as an employee.

In determining whether a taxpayer carries on a business, various courts and tribunals have held that the following factors are the key determinants: Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? which provides the Commissioner's view of the factors used to determine if you are in business for tax purposes.

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

The circumstances of the subject land will therefore determine whether it was acquired for the purpose of carrying on a business or, alternatively, for the purpose of carrying out a business or commercial transaction with the intention of making a profit or gain by sale. If either of these circumstances exists, a parcel of land will satisfy the definition of 'trading stock' and be on revenue account.

Whether the activity has a significant commercial purpose or character

The reason for purchasing the land was:

• to develop an environmental wetland to rehabilitate denuded farmland with worsening creek erosion that was prone to flooding and emitting polluted water into a marine park

• to help finance the development of the wetland ecosystem (in addition to Government grant funding which has been received over the past number of years)

• land was approved to be developed for environmentally sustainable housing.

The original land transfer involved a number of titles all of which have since been cancelled as the land was developed over the last 10 years. Planning approval was granted to sub-divide portion of the land for residential homes and open space. The remaining land was identified and zoned 'Landscape' and cannot be residentially zoned for sub-division. There was a commercial purpose or character and a profit making motive indicated in this activity in relation to the land subdivided for residential homes and open space. However, the subject land is not capable of being subdivided and therefore, does not form part of the business of land development and subdivision.

The facts lead to the conclusion that, in terms of the subject land, the Trust is neither carrying on a business nor carrying out a business or commercial transaction with the intention of making a profit or gain by sale. Accordingly, the subject land does not meet the definition of trading stock in section 70-10 of the ITAA 1997.

As the land is not trading stock under section 70-10 of the ITAA 1997 it is necessary to determine whether it a capital asset.

A capital gains tax asset (CGT asset) is defined in section 108-5 of the ITAA 1997 as any kind of property, or a legal or equitable right that is not property. Examples of CGT assets include land. Since the subject land is not considered to be trading stock under section 70-10 of the ITAA 1997 and it was acquired after 19 September 1985, the subject land is a CGT asset under subsection 100-25(2) of the ITAA 1997 for the purposes of Part 3-1 of the ITAA 1997.

Capital Gains Tax Disposal of land for nominal consideration

It is proposed to sell, for nominal consideration, an interest in a block of land, to a not for profit joint venture controlled by local shire councils for the purpose of the development of the Facility.

CGT event A1 happens if a taxpayer disposes of a CGT asset. Property, including land, falls within the definition of CGT assets. A taxpayer disposes of a CGT asset if a change of ownership occurs from that taxpayer to another entity, whether because of some act or event or by operation of law (subsection 104-10(2) of the ITAA 1997).

Under subsection 116-30(2) of the ITAA 1997, if the capital proceeds are more or less than the market value of the asset and the parties to the CGT event are not dealing with each other at arm's length, the capital proceeds are replaced with the market value of the CGT asset ('market value substitution rule').

Capital proceeds are defined in Division 116 of the ITAA 1997. Subject to specific exemptions, the amount of the capital proceeds from a CGT event is generally the sum of the money received or receivable plus the market value of any other property received or receivable as a result of the CGT event happening (section 116-20(1) of ITAA 1997).

Dealing with each other at arm's length

Whether or not the parties, in this case the proposed vendor and purchaser, were dealing with each other at arm's length is a question of fact and there is no one indicator that is decisive.

In defining 'arm's length' subsection 995-1(1) of the ITAA 1997 states that 'in determining whether parties have dealt at arm's length, consider any connection between them as well as any other relevant circumstances'.

Whether parties deal at arm's length is fundamentally about the character of the dealing. Non-arm's length parties may nevertheless deal at arm's length with each other and conversely parties who are at arm's length may not deal at arm's length (see Re RAL and Federal Commissioner of Taxation (2002) 50 ATR 1076 at [41]-[51], Re Hains v. FC of T 81 ALR 173 and Furse No 5 Will Trust v. FC of T (1991) 21 ATR 1123 at 1132).

Granby Pty Ltd v. Federal Commissioner of Taxation (1995) 129 ALR 503 (Granby) concerned the calculation of a cost base for CGT purposes. Former paragraph 160ZH (9)(c) of the ITAA 1936 provided that in determining such cost base, certain consequences would follow if the consideration paid by the taxpayer was less than the market value of the asset at the time of the acquisition, and the taxpayer and the person from whom it had acquired the asset were not dealing with each other at arm's length in connection with the acquisition. At 506, Lee J said:

The expression 'dealing with each other at arm's length' involves an analysis of the manner in which the parties to a transaction conducted themselves in forming that transaction. What is asked is whether the parties behaved in the manner in which parties at arm's length would be expected to behave in conducting their affairs. Of course, it is relevant to that inquiry to determine the nature of the relationship between the parties, for if the parties are not parties at arm's length the inference may be drawn that they did not deal with each other at arm's length.

and at 507 said:

That is not to say, however, that parties at arm's length will be dealing with each other at arm's length in a transaction in which they collude to achieve a particular result, or in which one of the parties submits the exercise of its will to the dictation of the other, perhaps, to promote the interests of the other.

Importantly, the market value substitution rule requires consideration to be given to the nature of the dealing between parties to a transaction and not simply their relationship (ACI Operations Pty Ltd v Berri Ltd (2005) 15 VR 312).

In the present circumstances, there is no direct connection between the Taxpayer (as the vendor) and the purchaser.

In Collis v. FC of T 96 ATC 4831; (1996) 33 ATR 438 ('Collis') the Federal Court found that arm's length parties were not dealing at arm's length as one party was indifferent to the allocation of the sale price to subdivisions for the parcel of land.

The decision in Collis shows that even where parties are at arm's length, it does not necessarily follow that they have dealt with each other at arm's length, i.e. the separate minds and wills of the parties need to be applied to the bargaining process.

In the present circumstances, the following factors support the finding that the proposed purchaser and vendor are dealing at arm's length:

The purchaser and the vendor are at arm's length as neither control or are related to the other.

However, it also needs to be determined whether the vendor and the purchaser have dealt with each other at arm's length in connection with the proposed sale of the land.

The following circumstances are relevant in making this determination:

(a) Significant negotiating or bargaining in relation to the proposed sale has taken place since the execution of the Heads of Agreement and negotiations had been ongoing a few years prior to the Agreement.

(b) The vendor has already sold a high proportion of the residential allotments which are adjacent to the proposed regional aquatic centre. While it is recognised that this amenity is likely to enhance the value of the development and may make the remaining allotments more attractive to residential purchasers, this is not a significant factor and does not lead to an inference that the dealing is not at arm's length.

(c) The condition that the purchaser pays any capital gains tax (CGT) liability constitutes dealing at arm's length as it is part of normal commercial dealing. Additionally, the land is being sold for nominal consideration rather than market value and, although the purchaser is providing the vendor with a benefit, it is not considered material in this factual circumstance.

(d) The grant of an option to purchase back the Site free of security interests for $X.00, exercisable if either:

a. before substantial development work for the Facility is commenced on the Site, the councils publicly abandon the proposal for the Facility;

b. X months after the Date of Settlement, substantial development work for the Facility has not commenced on the land.

This condition is considered to be part of normal commercial practice.

On balance, it is considered that the potential purchaser and vendor will be dealing with each other at arm's length. There is no indication of collusion between the parties they are merely acting in each other's own best interests, bargaining between the parties has occurred over an extended period.

Conclusion

Currently, there is no contract, and no change in ownership has occurred, therefore there is no CGT event (s104-10(3) (b). We understand that there is an intention to execute the contract of sale in January 2016. Until a contract is signed there is no legally binding agreement and this advice is subject to review of the final contract.

However, on the basis of the information provided, section 116-30 (2) of ITAA 1997, (the market value substitution rule) does not apply to the proposed transfer of the land to the Authority Therefore, the amount of the capital proceeds from the CGT event will be the nominal consideration received for the transfer of the hectares to the Authority for the purpose of developing a regional recreational facility.