Edited version of your written advice

Authorisation Number: 1013003131596

Date of advice: 27 April 2016

Ruling

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

Question 1:

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

Answer:

No.

Question 2:

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

Answer:

Yes.

Question 3:

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

Answer:

Yes. However, section 118-20 of the ITAA 1997 will apply to reduce the capital gain to the extent that the profit from the sale of the subdivided lots is otherwise included as assessable income under section 6-5 of the ITAA 1997.

This ruling applies for the following periods

Income year ending 30 June 2016

Income year ending 30 June 2017; and

Income year ending 30 June 2018.

The scheme commences on

1 July 2015.

Relevant facts and circumstances

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

You and your spouse jointly purchased adjacent properties (Property A and Property B) with settlement occurring for both properties after 20 September 1985. The land area of each property was less than two hectares.

Both properties remained vacant since they were purchased.

Around eighteen years after the properties were purchased; the area in which the properties are located was rezoned from Low Density Residential to Residential upon the signing of a section 173 Agreement under the Planning and Environment Act 1987.

Around nineteen years after the properties were purchased, your spouse passed away.

Around twenty-two years after the properties were purchased your spouse's ownership interest in the properties was transferred into your name.

Around twenty-two years after Property B was purchased, it was sold as broad acre land for over $X,XXX,XXX.

Around twenty-three years after Property B was purchased, settlement on the sale of the property occurred.

The purchaser subdivided Property B into residential lots which have been sold.

Around twenty-five years after Property A was purchased, the rezoning of the area in which Property A is located was updated.

You propose selling Property A due to your retirement, and because you are unable to continue maintaining Property A due to the decline in your health.

You did not attempt to sell Property A as broad acres on the advice of a local real estate agent, whom you contacted around twenty-six years after the property was purchased, when you were considering the sale of the property. You were advised that you would not get the optimal sale price as broad acres, that it would be advantageous to subdivide Property A, and that all of the surrounding properties have been subdivided and homes have been established on the subdivided land.

The subdivision of Property A will be undertaken to meet the conditions as outlined in the council's development approval and will involve the following activities:

• Construction of roads and curbing;

• Provision of water, electricity, gas and sewerage;

• Boundary fencing; and

• Tree planting on the nature strips only.

Due to your age and lack of experience in development activities you have decided to engage the services of another party (the Surveyor) to undertake all of the activities involved in the planning approval stage.

The Surveyor suggested that the size of Property A allowed for over XX subdivided blocks (the lots) of varying sizes and that the subdivision will most likely need to be undertaken in two stages due to the funding required to subdivide Property A with the lots facing the main road to be put on the market first. This will involve approximately one third of the total subdivision and the funds from the sale of the first lots will pay off the required borrowings.

The Surveyor has prepared a Planning Submission which outlines that the subdivision proposal is for a multi-lot subdivision consisting of over 15 proposed subdivided lots. The subdivision will be staged in two parts as follows:

• First stage, which will include the subdivided lots with frontage to the main road; and

• Second stage, which will include the remaining lots.

The Surveyor has lodged an application for a Planning Permit for the subdivision.

The entire project will be outsourced including the planning, development and sale of the subdivided lots.

Your only involvement in the subdivision will only be in relation to the final decision making, after being consulted by the Surveyor and you will not be physically involved in any way.

Once the subdivision approval has been granted, the Surveyors will tender out the subdivision project and a civil construction entity will be engaged to undertake the subdivision of Property A.

The relevant rates notice Property A provides that the property at a rateable value of over $1,000,000. However, it is estimated that Property A has a market value similar to that of Property B which was sold for more than $X,XXX,XXX.

The development feasibility estimate prepared by the Surveyor outlines that the subdivision will cost over $700,000 (Goods and Services tax (GST) included), being a cost of over $40,000 (GST included) for each lot.

It is estimated that the cost of the subdivision project will be over $X00,000, but less than $1,000,000. It is expected that each subdivided lot will have a sale price of around $XXX,000.

The services of a local real estate agent will be engaged to sell the subdivided lots.

You have obtained a bank line of credit facility up to around $X,000,000 which will be used solely for the funding of the subdivision.

Neither you nor any related entities have undertaken any similar development activities in the past, and neither you nor any related entities have any intention to undertake similar activities in the future.

For the purpose of this private ruling the following will occur:

• You will engage the services of professionals to undertake all of the activities in relation to the subdivision of Property A;

• Property A will be subdivided in two stages;

• You will not personally undertake any activities in relation to the subdivision of Property A other than in relation to the decision making; and

• You will engage the services of real estate agent/s to sell the subdivided lots in two stages, with the sale of the subdivided lots in Stage 1 and the sale of the remaining subdivided lots in Stage 2.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Summary

You are not carrying on a business of property development because your activities do not display the salient indicator of a business, which are transactions entered into on a continuous and repetitive basis. However, any profit or loss from the sale of the subdivided lots will still be accounted for on revenue account as an isolated commercial transaction because you are subdividing Property A for the primary purpose of making a profit on their sale.

Detailed reasoning

Legislative references referred to herein are from the ITAA 1997.

Taxation treatment of property sales

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

1. 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

2. 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

3. 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.

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, you and your spouse purchased Property A after 20 September 1985, for the purpose of building a family home and having a garden.

Due to your age and health, you propose subdividing Property A into lots which will be sold.

There will be no corporate branding, no office, no manager, no secretary and no staff. You will engage the services of other parties to undertake al of the management and co-ordination of the subdivision of Property A and will not be physically involved in the subdivision. All marketing and sales will be undertaken by a real estate agent/s.

You have not previously undertaken any similar subdivision activities in the past and do not have any intention to undertake any similar activities in the future.

After reviewing the information and documentation provided, it is the Commissioner's view that the activities being undertaken in relation to the subdivision of Property A are not those of an entity carrying on a business of subdividing and selling land.

Accordingly, we do not consider that any proceeds you will receive from the sale of the subdivided lots will be derived in the course of carrying on a business.

Therefore, we will consider whether or not the proceeds from the sale of the subdivided lots will be viewed as being received in relation to an isolated business transaction or a mere realisation as follows:

Isolated business transactions

Profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693 (Myer Emporium)). 

Taxation Ruling TR 92/3 (TR 92/3) considers the principles outlined in Myer Emporium and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income.

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.

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.

Miscellaneous Taxation Ruling MT 2006/1 provides a list of specific factors relevant to isolated transactions and sales of real property. If several of the factors are present, it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows:

• there is a change of purpose for which the land is held;

• additional land is acquired to be added to the original parcel of land;

• the parcel of land is brought into account as a business asset;

• there is a coherent plan for the subdivision of the land;

• there is a business organisation - for example a manager, office and letterhead;

• borrowed funds financed the acquisition or subdivision;

• interest on money borrowed to defray subdivisional costs was claimed as a business expense;

• there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and

• buildings have been erected on the land.

In determining whether activities relating to isolated transactions are an enterprise or are the mere realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. This may require a consideration of the factors outlined above; however there may also be other relevant factors that need to be weighed up as part of the process of reaching an overall conclusion. No single factor will be determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

Application to your situation

You and your spouse purchased Property A after 20 September 1985, in conjunction with the adjoining property, Property B.

It has been stated that you and your spouse's intention when you purchased the properties, was to build your family home and have a vegetable garden. However, while Property A has been held for a long time, it had remained vacant and no family home was ultimately built on it and Property B was sold around twenty-two years after the properties were purchased.

The simplest way you could have divested yourself of Property A would have been to dispose of it without seeking any rezoning or subdivision approvals and without actually undertaking the associated works. The acts of seeking approvals and undertaking of the subdivision work must in some way contribute towards a finding that the overall activity constitutes something more than a 'mere realisation' of a capital asset.

We accept that there had been no-profit making motive when you had acquired Property A. However, the question before us is whether your intention changed when you committed this one-off undertaking in relation to the subdivision of Property A and sale of the subdivided lots.

You sold Property B as broad acres and could also sell Property A as broad acres without doing anything to it, which would be a mere realisation. However, no attempt was made to sell Property A, as broad acres and Property A will be subdivided into lots.

The change of your plans in relation to Property A are aimed at increasing the number of lots available for sale, with the maximum possible number of subdivided blocks, with the expected increase in the profits from the sale of the lots being more than enough to cover the increased costs due to the subdivision.

It is estimated that Property A would have been valued at over $X,XXX,XXX, similar to the sale price received for the sale of Property B. You have obtained a line of credit for around $X,000,000 and it is estimated that the subdivision project will cost over $X00,000 to less than $1,000,000. The subdivided lots will be sold for around $XXX,000 each, for gross proceeds over $4,500,000.

The subdivision is significant with your expected return being increased by around $2,500,000 net proceeds based on the figures provided. Therefore, the value of the property being entered into the subdivision is less than one-third of the expected sale price.

You are providing the property and obtaining finance to fund the subdivision of Property A. Therefore, you personally bear the risk attached to this strategy, and will also personally reap the rewards if it is successful.

In your case, you have approached the transaction in a businesslike way, engaging the services of other parties to manage the subdivision, lodge the relevant applications, undertake surveys and investigations and prepare reports. The inherent nature of the subdivision of Property A is such that it is quite complex given that many preliminary approvals were sought. The process of physically undertaking the subdivision works involves complexities requiring specialist knowledge, the engagement of specialist contractors and the co-ordination of the said parties.

You have decided to subdivide Property A and there has been a change in the purpose for which Property A is being held. The subdivision will transform Property A from broad acres to small residential allotments. There is a demonstrated intention to profit from the subdivision of Property A and the transaction has been undertaken in a commercial manner.

In conclusion, it is viewed that your actions are of a commercial nature because:

• you would be able to sell Property A for substantial profit without subdividing it;

• you will be borrowing a significant amount of money to develop Property A;

• you have approached the development in a businesslike way;

• there is a coherent plan for the subdivision of Property A; and

• you expect to make a significant profit from the transaction.

Accordingly, the Project will have the characteristics of a commercial transaction. As you will be carrying out an isolated commercial transaction with a view to a profit, the profit made will be assessable as ordinary income under section 6-5.

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 under section 104-10 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.

A capital gain will be made if the cost base of the asset is less than the capital proceeds in accordance with section.

The capital gain can be reduced by the 50% CGT discount if the conditions listed in Division 115 are met.

Section 118-20 contains anti-overlap provisions which operate to reduce any capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 as a result of the sale, for example, as ordinary income under section 6-5 of the ITAA 1997.

Application to your situation

Making an overall assessment on the factors set out in TR 92/3, it is the Commissioner's view that the subdivision and sale of the subdivided lots will not be a mere realisation of capital assets.

Therefore, as the disposal of the subdivided lots is viewed as an isolated transaction, any profit made on their sale will be included in your assessable income under section 6-5.

CGT event A1 will occur on the disposal of the subdivided lots. The capital gain for the event is worked out by comparing the cost base of the asset with the capital proceeds for its disposal. If the conditions under Division 115 are met, the capital gain can be reduced by 50% by applying the CGT discount.

Any capital gain made on the disposal of the subdivided lots will be reduced to the extent that the profit from the sale of the subdivided lots is included in your assessable income under section 6-5.

Note: You are viewed as having two CGT assets in relation to Property A, being your original 50% ownership interest acquired when the property was first purchased and a 50% ownership interest acquired when your spouse's ownership interest in Property A was transferred into your name after they passed away. Any capital gain calculation will need to be done in relation to each ownership interest.