Edited version of your written advice

Authorisation Number: 1012997749069

Date of advice: 14 April 2016

Ruling

Subject: Am I in business? - isolated transaction - mere realisation

Question 1:

Will the profit from the sale of subdivided blocks of land be treated as ordinary income under section 6 -5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of you carrying on a business of property development?

Answer:

No.

Question 2:

Will the profit from sale of subdivided blocks of land, be treated as ordinary income under section 6-5 of the ITAA 1997 as a result of an "isolated transaction" carried out for profit and commercial in character?

Answer:

No.

Question 3:

Will the profit from the sale of subdivided blocks of land be treated as statutory income under the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997?

Answer:

Yes.

Relevant facts and circumstances

Documentation has been provided with this private ruing which forms part of, and should be read in conjunction with this scheme.

You and your spouse jointly purchased the Property before 20 September 1985, with the intention of building your family home, raising your children, and enabling them to have horses and motorbikes. The land area of the Property is over 4 hectares.

Your family home (the house) was built on the Property in the following year after the Property had been purchased in which you and your family reside. The house is located at the rear of the Property with a driveway down the middle of the Property.

Before your retirement, you worked until the 19X0's and then raised your children. Your spouse worked for a government agency before resigning around X years after the Property had been purchased, when they had established their own business. 

Around the time your spouse commenced their business, they transferred their X% ownership interest in the Property into your name due to liability concerns with the business.

Your spouse retired from their business over 20 years after the Property had been purchased.

You and your spouse are both at retirement age and wish to reduce the time you spend maintaining the Property as you are finding it to be too onerous and costly. Your children have grown up and have moved from the Property and you have not further use for all of the Property's land.

You intend subdividing the Property into over 20 subdivided lots and the proceeds of the subdivided lots will be used for funding your retirement.

You have not attempted to sell the Property as a whole property.

Over 30 years after the Property was purchased, you commenced looking into subdividing the Property and were advised by a real estate agent that the best estimated gross figure that you could expect to receive for the Property would be over $XX for the proposed subdivided lots.

You had a meeting with a surveying company (the Company) and engaged their services to undertake the subdivision of the Property (the Project), commencing on the receipt of the formal Planning Permit and endorsed subdivision layout documents.

The Company will undertake the project on an 'open-book cost-plus' arrangement under which you will be charged at the cost rate plus 10% of the profit margin.

The Company will undertake the following activities in relation to the Project:

• Liaising, meeting and providing professional advice and progress reports

• Liaison and correspondence with Council and related authorities

• Undertaking detailed inspection and assessment of site specific requirements

• Arranging and attend meetings with Council and relevant authorities

• Submitting and co-ordinating all service authority applications

• Preparing preliminary and detailed design documentation for internal roads, traffic management infrastructure, stormwater drainage, sewer and water supply

• Submitting detailed design documentation to Council and authorities for approval

• Preparing schedules of quantities

• Preparing tender packages

• Calling for and obtaining tender submissions

• Reviewing submitted tenders and providing recommendations

• Assisting in obtaining design approvals from Council and authorities

• Pre-paring and submitting al pre-construction information

• Providing construction supervision, administration and project management for roads, traffic management infrastructure, stormwater drainage, sewer, water supply, gas , electrical and communications/national broadband network

• Obtaining Statement of Compliance certificates from Council and authorities; and

• Preparing and collating documentation for you.

The subdivision will be at the absolute minimum that the council requires before it grants the titles for the subdivided lots.

It is proposed that the subdivision will occur as a single stage development.

It is estimated that cost of the Project will be over $XX and the subdivided block on which the house is located will be valued at around $XX.

You will not undertake any activities in relation to the subdivision of the Property other than keeping books to keep abreast with the costs of the subdivision.

There will not be a site office, secretary, or any business letterhead.

Around one month after you had engaged the services of the Company, an Application for Planning Permit for a Subdivision was lodged in relation to the subdivision of the Property.

You will keep the existing house and the land it is located on (the house block), and the subdivided blocks on either side of the subdivided house block for privacy.

You will not be involved in the selling of the subdivided lots and a local real estate agent has been appointed to handle all of the marketing and sales.

You and your spouse have not previously engaged in the business of buying, subdividing and sale of land and do not intend undertaking any subdivision activities in the future.

Some major companies in the area in which the Property is located have laid off hundreds of employees and reduced capital expenditure which has depressed the land sales market, which had been struggling due to the reduced population due to the changing industry environment in the area, with the population in the area reducing over the past years.

A company which is a major employer in the area is operating at a loss and has just lost a power subsidy from the Government, creating rumours that it may close.

The real estate is now saying that the best gross amount you could expect to receive for the sale of the subdivided lots would be around $XX. There are numerous other vacant lots for sale in the area at present, and there is a strong probability that it may take a number of years for your subdivided lots to sell.

For the purposes of this ruling:

• the Planning Permit for Subdivision will be approved within the period covered by this private ruling

• The Company will undertake the absolute minimum that council requires to satisfy the development application

• The Company will undertake the project in accordance with the project documents

• You will not undertake any activities in relation to the subdivision of the Property or the sale of the subdivided lots

• You will engage the services of a real estate agent to sell the subdivided lots.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 112-25

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1997 Division 115

Reasons for decision

Legislative references referred to herein are from the ITAA 1997.

Summary

The proceeds from the sale of the subdivided lots will not be ordinary income and not assessable under section 6-5. The proceeds represent a mere realisation of capital assets which will fall for consideration under the capital gains tax provisions in Part 3-1.

Detailed reasoning

Taxation treatment of property sales

There are three ways profits from property sales can be treated for taxation purposes:

• As ordinary income under section 6-5, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock; or

• As ordinary income under section 6-5, on revenue account, as a result of an isolated business transaction entered into by a non-business taxpayer, or outside the ordinary course of business of a taxpayer carrying on a business, which is the commercial exploitation of an asset acquired for a profit making purpose; or

• As statutory income under the capital gains tax legislation, sections 10-5 and 102-5, on the basis that a mere realisation of a capital asset has occurred.

Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case.

We will consider each of these in relation to your situation as follows:

Carrying on a business of property development

Section 995-1 states the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

To determine whether an activity, or series of activities, amounts to a business, the activity needs to be considered against the indicators of a business established by case law.

In the High Court of Australia case of Hope v. Bathurst City Council (1980) 144 CLR 1; (1980) 29 ALR 577; (1980) 80 ATC 4386; [1980] HCA 16, a business was described in the following ways:

It is the words "carrying on'' which imply the repetition of acts and activities which possess something of a permanent character.

…activities engaged in for the purpose of profit on a continuous and repetitive basis.

Transactions were entered into on a continuous and repetitive basis for the purpose of making a profit…manifested the essential characteristics required of a business.

For a one-off land subdivision to be considered to be of a business or commercial nature, it is usually necessary that a taxpayer has the purpose of profit-making at the time of acquiring the property.

The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 (TR 97/11) which uses the following indicators to determine whether a taxpayer is carrying on a business:

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

• 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 on in a businesslike manner such that it is directed at 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 a sporting activity.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

Application to your situation

In this case, the Property was purchased by you and your spouse before 20 September 1985, with the intention of building your family home and raising your family on the property.

You and your family have resided in the house built on the Property from the following year after the Property was purchased.

Around 19 years after the Property was purchased your spouse transferred their X% ownership interest in the Property into your name.

You intend subdividing the Property into a number of subdivided lots. You will keep the subdivided block of land on which the existing house is located, and the two subdivided blocks on either side of your house block. The remaining subdivided blocks of land will be sold.

You have entered into a contract with the Company who will undertake and manage all of the activities in relation to the subdivision of the Property.

No other property development activity has been undertaken by you and you do not intend undertaking any subdivision activities in the future.

Based on the information provided, there is nothing to suggest that the subdivision of the Property was the beginning of a continuing business of property development.

After reviewing the information and documentation provided, it is the Commissioner's view that your activities in relation to the Project are not those of an entity carrying on a business of developing and selling land.

Based on the information and documentation provided, you have not at any time prior to, or during this project been involved in the carrying on of a business related to acquiring, subdividing and selling land.

The activities being undertaken do not display the salient indicator of a business, which are transactions entered into on a continuous and repetitive basis. The subdivision activities are being undertaken by the Company and you will not participate in any of the activities involved in the subdivision of the Property.

Therefore, any gain made on the disposal of the subdivided lots will not be assessable as ordinary income from the carrying on of a business.

Isolated business transactions

Profits from isolated transactions will be assessable as ordinary income where 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 out a business operation or commercial transaction

Taxation Ruling TR 92/3 (TR 92/3) sets out the Commissioner's view of the general principles and factors that have been considered in determining whether an isolated transaction is of a revenue nature.

Paragraph 1 of TR 92/3 outlines that isolated transactions are:

a) those transactions outside the ordinary course of business of a taxpayer carrying on a business; and

b) those transactions entered into by non-business taxpayers.

The ruling outlines at paragraph 6 that whether a profit from an isolated transaction will be ordinary income will depend on the circumstances of the case, however a profit from an isolated transaction will be ordinary income when:

a) the intention or purpose of a taxpayer in entering into the transaction was to make a profit or gain; and

b) the transaction was entered into, and the profit was made in the course of carrying on a business operation or commercial transaction.

TR 92/3 outlines that the relevant intention or purpose of the taxpayer, of making a profit or gain, is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

If a transaction or operation is outside the ordinary course of a taxpayer's business, the intention or purpose of profit-making must exist in relation to the transaction or operation in question.

The transaction may take place in the course of carrying on a business even if the transaction is outside the ordinary course of the taxpayer's business.

Paragraphs 41 and 42 of the ruling outline that where a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction, the activity of the taxpayer constitutes the carrying on of a business operation or commercial transaction carrying out a profit-making scheme, as the case may be.

Whether a particular transaction has a business or commercial character depends very much on the circumstances of the case. Paragraph 13 of the ruling outlines the following factors which may be relevant when considering whether an isolated transaction amounts to a business operation or commercial transaction: 

• the nature of the entity undertaking the operation or transaction

• the nature and scale of other activities undertaken by the taxpayer

• the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained

• the nature, scale and complexity of the operation or transaction

• the manner in which the operation or transaction was entered into or carried out

• the nature of any connection between the relevant taxpayer and any other party to the operation or transaction

• if the transaction involves the acquisition and disposal of property, the nature of the property, and

• the timing of the transaction or the various steps in the transaction.

The direction provided within TR 92/3 and in case law indicates that profits in this context are more likely to be considered ordinary income if they are made in the ordinary course of carrying on a business. Further, ordinary income may be derived from an isolated transaction which becomes commercial in nature, or as a result of profits on a transaction in which the initial intention was to make a profit on sale.

Paragraph 36 of TR 92/3 notes that the courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment.

Application to your situation

In this case, you and your spouse had not acquired the Property for the purpose of subdivision and resale. Instead, it was originally acquired for the purpose of residing on the Property after you had built a house, and raising your family.

Your intention in relation to the property changed due to the period of life you and your spouse are now in and with the maintaining of the Property now being too onerous and costly. Your children have grown up and you no longer have use for a property of that size.

You want to continue residing in the house located on the Property and have a small amount of land around the house. The house is located at the rear of the Property and a driveway runs down the middle of the Property.

It is reasonable given that you want to keep the house with some of the land, and taking into consideration where the house is located on the Property, that you would be limited to how that could be achieved.

The Company has been contracted to undertake the subdivision activities and they will only undertake the minimum required by Council under the development approval for the subdivision of the Property.

Making an overall assessment on the factors set out in TR 93/2, it is the Commissioner's view that the subdivision of the Property and sale of the subdivided lots will not be considered commercial in nature but will be a mere realisation of a capital asset, being a long-held privately owned property.

Therefore, any profit arising from the sale of the subdivided lots will be accounted for under the capital gains tax provisions in Part 3-1.

Capital gains tax

The capital gains tax (CGT) provisions are contained in Part 3-1. Broadly, the provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own.

CGT event A1 happens if you dispose a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property. However, any capital gain or capital loss made on the disposal of a CGT asset will be disregarded if the asset was acquired before 20 September 1985.

When a CGT asset (the original asset) is split into 2 or more assets (the new assets), such as when land is subdivided, the subdivision of the land into subdivided blocks is not a CGT event, according to subsection 112-25(2). Where the original land was acquired before 20 September 1985, each new block retains its pre-CGT status.

You make a capital gain is the proceeds from the sale of the CGT asset are more than the asset's cost base. You make a capital loss if the proceeds from the sale of the CGT asset are less than the cost base of the asset.

You can apply a 50% CGT discount to any capital gain made on the disposal of the CGT asset if you are an individual who meets the following conditions:

• The CGT event occurred after 21 September 1999

• The cost base of the CGT asset was not calculated using the indexation method; and

• The asset must have been acquired at least 12 months before the CGT event.

Application to your situation

In this case you and your spouse acquired the original property before 20 September 1985. Therefore, you and your spouse are viewed as each having a 50% ownership interest in the Property.

Your spouse transferred their 50% ownership interest into your name around 19 years after the Property was purchased. The transfer of your spouse's ownership interest in the property to you has resulted in you having a 50% ownership interest in the property that was acquired before 20 September 1985 (pre-CGT) and a 50% ownership interest in the property that was acquired after 20 September 1985 (post-CGT).

When the property is subdivided, you will have two ownership interests in each subdivided block, being a 50% interest that is pre-CGT and a 50% interest that is post-CGT.

CGT event A1 will occur when the subdivided lots are sold. As 50% of your ownership interest in each of the subdivided blocks is pre-CGT, any capital gain or capital loss made on the disposal of that 50% ownership interest in the subdivided blocks of land can be disregarded for CGT purposes.

However, the capital gain or capital loss made on the disposal of your other 50% ownership interest, being the post-CGT ownership interest, in each of the subdivided lots cannot be disregarded and any capital gain or capital loss made on the disposal of that interest in the subdivided lots will be calculated in accordance with the CGT provisions.

Note: If you meet the conditions as listed above for the 50% CGT discount to apply, you can reduce any capital gain made on the disposal of the subdivided blocks by 50%.