Edited version of your written advice

Authorisation Number: 1012965188481

Date of advice: 18 February 2016

Ruling

Subject: Capital gains tax: subdivision/active asset

Question 1

Will the proceeds from the sale of the dwelling and land located at Property A as a single parcel be assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as an isolated commercial transaction with a view to a profit?

No.

Question 2

Will the proceeds from the sale of the dwelling and land located at Property A as a single parcel, be assessable under the capital gains provisions in Parts 3-1 and 3-3 of the ITAA 1997?

Yes.

Question 3

Is the sale of the dwelling and land located at Property A, exempt from capital gains tax (CGT) under subdivision 152B of the ITAA 1997 (Small business 15 year exemption)?

Answer

No.

This ruling applies for the following period(s)

1 July 2015 to 30 June 2016

The scheme commences on

1 July 1987

Relevant facts and circumstances

This private ruling request relates solely to the property at Property A. There may be other taxation implications for the vacant land (Property B), however, they have not been considered in this ruling request.

Person A and Person B are relatives both aged over 60.

Before 20 September 1985 their Parent purchased a property at Property A which consisted of a dwelling situated on a large parcel of land.

The property was the family's main residence. The parents also farmed the land by growing and selling their own produce.

The relatives paid the mortgage and living expenses of the dwelling. Their Parent made little money farming the land and also working part time as a labourer for their children.

After 20 September 1985 Person A and Person B purchased the property from their Parent who returned overseas, including paying the relevant amount of stamp duty of purchase, and had the title transferred into their own names.

Initially the property was left vacant. Shortly thereafter, their Parent returned to Australia where both Parents continued to occupy that house rent free as the family home until their death.

The Parent made many choices which the relatives had no input into.

Their Parent used the property for gardening purposes until they passed away a number of years ago.

Person A and Person B worked as contractors. The property was variously used to:

• Store materials;

• Fabricate and store scaffolding;

• Repair, maintain and store equipment and repair relative's motor vehicles;

• Hold waste from building jobs prior to disposal at Council tips;

• Deliveries of building supplies were delivered to the property for storage and distribution to the building sites.

The relatives also helped their Parent with the market garden and attended to maintenance of the farm machinery.

Aerial photos provided with your application, show a largely cleared block of land with a dwelling and some building materials occupying small areas of the land. There is also a photo of a vehicle owned by a relative parked on the block.

Person B and Person A completed their business activities off-site at various locations where they were contracted to.

A few years ago Person A and Person B purchased an adjoining block of land being Property B.

The relevant Council had placed a condition on any future subdivision of the property requiring the adjoining block to be developed in conjunction with the property.

Person B still uses the property for storage; however, Person A retired a number of years ago.

Person B's business qualifies as a small business entity.

In recent years the property has been cleared and is now largely grass and tree covered areas with old storage sheds and old equipment.

The house sheds and poultry sheds were erected prior to the purchase. The family did not improve the property by adding any structures from the original date of purchase to todays' date. The property has not been leased out at any time.

Property B has not been utilised for any business related purpose.

Property A and Property B will be sold together to Person A's child, at market value. You have estimated the value of the blocks together at an amount.

There is a current development approval; however, the construction certificate is pending. No subdivision works have commenced on the properties and it is not intended that any works will be completed prior to sale.

Person A's child has co-ordinated all consultants. Neither Person A nor Person B has participated in any co-ordination of the proposed development. Person A's child has paid Person A's 50% portion of the development cost so far.

Person A's child will be undertaking the project management and will engage all consultants and complete development together with an engineer and surveyor once he obtains ownership.

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 104-10 of the Income Tax Assessment Act 1997

Division 152 of the Income Tax Assessment Act 1997

Section 328-130 of the Income Tax Assessment Act 1997

Reasons for decision

Question 1 and 2

Summary

The proceeds from the sale of the dwelling and land at Property A when sold as a single parcel, is not ordinary income and not assessable under section 6-5 of the TAA 1997. The proceeds represent a mere realisation of a capital asset which will fall for consideration under the CGT provisions in Part 3-1 of the ITAA 1997.

Detailed reasoning

As a general principle, profits from property sales will either be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) or statutory income under the capital gains tax (CGT) provisions of the ITAA 1997.

Where the profit has been made as a result of a taxpayer carrying on a business of property development or as a result of a taxpayer entering into an isolated business transaction, the profit will be assessable as ordinary income. However, where the profit is a mere realisation of a capital asset, the profit will be assessable under the CGT provisions of the ITAA 1997.

The first question to address, therefore, is whether you are carrying on a business, and for this, paragraph 13 of Taxation Ruling 97/11 provides the following indicators:

• whether the activity has a significant commercial purpose or character;

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

• whether the taxpayer has a purpose of profit as well as the 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 ordinary trade in that line of business; and

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

Applied to your circumstances, when you initially purchased the original land in the 1980's it appears reasonable that your intention was not necessarily to make a gain or profit. This is evidenced by the length of time you have held the asset, and the use of the land in housing your parents until their death. Where you are selling the block as a single parcel (i.e. as opposed to in subdivided blocks) there appears no significant commercial purpose or character to the transaction, and you did not have the intention to engage in business. There is neither repetition nor regularity of this type of transaction; in fact, in your circumstances, it appears to be a 'one-off' event. However, it may be the same kind of transaction to that of ordinary trade in that line of business.

On balance, our view is that you are not carrying on a business.

However, there is still scope for your transaction to be classed as income gained by a transaction entered into by a non-business taxpayer. Taxation Ruling TR 92/3 considers the assessability of profits on isolated transactions in light of the principles outlined in FC of T v The Myer Emporium (1987) 163 CLR 199. According to Paragraph 1 of TR 92/3, the term isolated transactions refers to:

• those transactions outside the ordinary course of business of a taxpayer carrying on a business, and

• those transactions entered into by non-business taxpayers.

Paragraph 6 of TR 92/3 provides that a profit from an isolated transaction will generally be income within section 6-5 of the ITAA 1997, when both the following elements are present:

• the intention or purpose 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.

Some of the factors to consider when looking at whether an isolated transaction amounts to a business operation or commercial transaction 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.

If a transaction satisfies the elements set out above it is generally not a mere realisation of an investment.

Applying these factors to your circumstances, you have decided to sell the block as a single parcel rather than proceed with completing a subdivision. You have completed a subdivision submission and had it approved, however, both partners have had no actual involvement in the subdivision aside from providing the land. Instead, the block will be sold to one of the partner's child who will undertake a subdivision

You anticipate a total sale price of approximately $x (including the block at Property B).

You have obtained development approval for the subdivision. However, no development works have been completed and will not be completed prior to sale.

You have held the original property for a significant period of time before the transaction will take place, reducing the commercial character of the transaction. However, you have also recently purchased another property, Property B, so that the subdivision could take place. This property had no other use for you other than to incorporate it into the subdivision and increase the value of your original block as a part of this subdivision. This is indicative that the transaction has a significant commercial character.

Despite this, overall, it is considered that the sale of Property A as a single parcel is not entered into with a view to profit or with the characteristics of a commercial operation. You entered into this transaction as individual taxpayers, and not within the structure of a company, and you have not previously entered any transaction of this type. You initially had the dwelling transferred to you from your Parent in the 1980's and held it for your parents to live in until they passed away a few years ago. Your Parent did not consult you on the transfer. You will sell the block as a whole and no development activity or works will have been completed on it. Further, your child has managed this project on your behalf and you have not resorted to commercial project management. Therefore, the proceeds you receive from the sale of your property at Property A are not ordinary income and not assessable under sections 6-5 of the ITAA 1997. The proceeds represent a mere realisation of a capital asset which will fall for consideration under the CGT provisions in Part 3-1 and 3-3 of the ITAA 1997.

Question 3

Summary

The land at Property A was not an active asset for CGT purposes.

Detailed reasoning

Basic Conditions

To qualify for the small business CGT concessions, you must satisfy several conditions that are common to all the concessions. These are called the basic conditions. Subdivision 152-C of the ITAA 1997 applies the small business 50% active asset reduction provided the basic conditions are satisfied.

A capital gain that you make may be reduced or disregarded under section 152-10 of the ITAA 1997 if the following basic conditions are satisfied:

• A CGT event happens in relation to a CGT asset of yours in an income year,

• The event would have resulted in a gain,

• The CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997, and

• At least one of the following applies;

• you are a small business entity for the income year,

• you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997,

• you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership, or

• you do not carry on a business, but your CGT asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you.

Passively-held assets

The conditions in subsection 152-10(1A) are satisfied in relation to the CGT asset in the income year if:

a) your affiliate, or an entity that is connected with you, is a small business entity for the income year; and

b) you do not carry on a business in the income year (other than in partnership); and

c) if you carry on a business in partnership - the CGT asset is not an interest in an asset of the partnership; and

d) in any case - the small business entity referred to in paragraph (a) is the entity that, at a time in the income year, carries on the business (as referred to in subparagraph 152-40(1)(a)(ii) or (iii) or paragraph 152-40(1)(b)) in relation to the CGT asset.

Application to your situation

In your case a CGT event will happen when you sell your property at Property A and the event will result in a gain. Person B is still currently carrying on a business, however, Person A retired a number of years ago. Therefore, Person A holds interest in the land as a passive asset. This does not preclude Person A from accessing the small business CGT concessions where a CGT affiliate is a small business entity for the relevant income year and the land is held to be and active asset. These tests are considered below.

Who are Person B and Person A's affiliates?

An affiliate is defined by section 328-130 of the ITAA 1997 as being an individual or company who acts or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the individual or company. Relevant factors that may support a finding that a person acts in such a manner include:

• the existence of a close family relationship between the parties;

• the lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other;

• the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations; and

• the actions of the parties.

Generally, another person would not be acting in concert with you if they:

• have separate bank accounts;

• do not consult you on business matters;

• conduct their business affairs independently in all regards.

Whether a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer, is a question of fact dependent on all the circumstances of the particular case. No single factor will necessarily be determinative.

Relevant factors that may support a finding that a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer, include:

Generally, another business would not be acting in concert with you if they:

• have different employees

• have different business premises

• have separate bank accounts

• do not consult you on business matters

• conduct their business affairs independently in all regards.

Application to your situation

It is accepted that Person B and Person A are CGT affiliates. Although, they have worked independently as contractors and presumably maintained separate bank accounts, their joint ownership of the land and family relationship indicates that they could reasonably be expected to act in accordance with each other's wishes.

It is not accepted that Person A and Person B's Parent is their CGT affiliate. Despite the close family relationship, you have stated that their Parent acted in the way that they wished and did not consult or act in accordance with Person A and Person B's wishes. Therefore, their Parent is not a CGT affiliate of Person A and Person B and their use of the land cannot be considered for the purposes of the small business CGT concessions.

Active Asset

For the sale of the property to qualify for any of the small business CGT concessions, the CGT asset must also satisfy the active asset test in section 152-35 of the ITAA 1997.

In this case, the active asset test is satisfied if:

• You have owned the property for more than 15 years and the asset was an active asset of yours for at least 7.5 years during the test period.

The test period:

• begins when you acquired the asset;

• ends at the earlier of:

• the CGT event, and

• when the business ceased, if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows).

The meaning of an active asset is given in subsection 152-40 (1) of the ITAA 1997. Paragraph 152-40(1) (a) states that a CGT asset is an active asset at a given time if at that time, you own it and:

• use it in the course of carrying on a business, or

• hold it ready for use in the course of carrying on a business by:

i. you; or

ii. your affiliate; or

iii. another entity that is connected with you

Accordingly, for the land in this case to be considered an active asset it must satisfy one of the above conditions.

Application to your situation

The central issue to be determined in this case is whether the land was being used, or held ready for use, in the course of carrying on your bricklaying business. The land was used, as a matter of fact, as a venue for storing materials as well as providing accommodation for your parents until they passed away.

Was the land being used?

The term use is not explained in either the legislation or the Explanatory Memorandum to the New Tax System (Capital Gains Tax) Bill 1999 which introduced Division 152 into the ITAA 1997. The Shorter Oxford English Dictionary uses an expression make use of a thing, especially for a particular end or purpose to express the ordinary meaning of the word use. The ordinary English meaning of the term would cover the storage of materials on the land. This was a physical use of the land that was connected with the conduct of the relevant business. However, this does not mean that the use to which the land was being put was contemplated by subsection 152-40(1) of the ITAA 1997 because the use may not have had the required connection with the relevant business. 

The relevant connection

Paragraph 152-40(1) (a) of the ITAA 1997 requires an asset to be used in the course of carrying on a business. This requirement does not require exclusive use of the asset for business purposes but a use that is sufficient to establish the required connection between the asset and the operations of the business. The degree of connection required is expressed by the words in the course of, which connotes the idea that the use of the asset is an integral part of the process by which the business is carried on.

In the present case, the land was acquired when your Parent transferred the land to you in the 1980's for reasons that are unclear. The purpose of you keeping the land and dwelling for the significant period was to provide a home to your parents who used the land for their own purposes until they passed away. It is acknowledged that during your period of ownership you and your relative also used the land to store relevant materials for your business as well as a delivery point for stock. . The question now is whether storing materials on the land in small areas and using the driveway as a delivery point for materials was integral to the process by which the building and contracting business was conducted. If it was, the use of the land in the particular circumstances constituted a use as contemplated by paragraph 152-40(1) (a) of the ITAA 1997 and the land would qualify as an active asset.

Conclusion

The land was not an active asset of Person A and Person B. The reasons are:

• The land was used in a manner that was incidental to the conduct of the relevant business. However, the land was not used in the course of carrying on the relevant business as required by paragraph 152-40(1) (a) of the ITAA 1997.

• The degree of connection required by paragraph 152-40(1) (a) ITAA 1997 is expressed by the words 'in the course of' which mean 'integral to the process by which the business was carried on'.

• The relevant question, in this case, is whether storing materials on the land was integral to the process by which the business was conducted? The answer is that the activity was not integral to the process by which the business was conducted, but was instead merely incidental.

• The main purpose of the land was to provide your parents a place to live and conduct their own activities on the land.

• The land was merely a convenient place to store miscellaneous materials on a small scale and as a matter of convenience. No other business activities were conducted on the land and all the essential activities were conducted elsewhere off site as relevant. All the profit generating work was undertaken away from the land. The land was not used in generating income.

• The land was undeveloped throughout the entire time of ownership; therefore, it was not in a state of preparedness from which the business could be carried on.

• The requisite degree of connection has not been established. An incidental connection between the business and the asset is insufficient to establish that it was used or held ready for use in the course of carrying on the business.

ATO view documents

ATO ID 2002/354

ATO ID 2002/753

Advanced guide to capital gains tax concessions for small businesses