Edited version of your written advice

Authorisation Number: 1013012943055

Date of advice: 11 May 2016

Ruling

Subject: Subdivision of property

Question 1

Will the proceeds from the sale of the subdivided blocks of land be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will the proceeds from the sale of the subdivided blocks of land be assessable as a capital gain?

Answer

No.

Question 3

Can the small business 15 year exemption be applied to the sale of the subdivided blocks?

Answer

No.

Question 4

Can the small business active asset concession be applied to the sale of the subdivided blocks?

Answer

No.

Question 5

Can the small business retirement exemption be applied to the sale of the subdivided blocks?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2016

Year ended 30 June 2017

Year ended 30 June 2018

Year ended 30 June 2017

Year ended 30 June 2019

Year ended 30 June 2020

Year ended 30 June 2021

The scheme commences on

1 July 2015

Relevant facts and circumstances

You purchased a property in XXXX.

You carry on a business on this property.

The property has at all times been used as you and your spouse's principle place of residence and to conduct a business on a continuous basis.

The property comprises of approximately X.

You and your spouse are over the age of 55.

You and your spouse were previously offered $X for an outright sale of the property. You applied for and received a private ruling from the Commissioner.

You are now considering an offer from a developer where broadly the features and terms of that relationship are:

• The property will be subdivided and developed into a master planned community with an estimated X residential lots.

• The total proceeds from the sale of those residential lots is estimated to be $X.

• The development is estimated to take up to X years to complete.

• The developer will undertake the applications for permits and registrations of the subdivision, the development works, sales and marketing activities, the preparation of budgets and costings for the property.

• The legal and beneficial ownership of the property will remain with you. You retain the authority to give the relevant consents and approvals to enable the development.

• You will attend regular meetings with the developer to be updated on the progress of the development.

• The developer will meet the costs of development, but will recoup these expenses from you.

• Upon the commencement of the development agreement, you must commence paying the developer a management fee each calendar month until the finalisation of the development. This fee is calculated as X% of the estimated total proceeds received from the development, which includes the various incomes from the development. You will be issued an invoice requiring this payment.

• Upon finalisation of the development, the developer will provide a final account of the total proceeds for the development. This final account will be used to reconcile the developer's entitlement to payments under the agreement.

• The priority in applying the total proceeds per the final account is:

• firstly, to the Developer in payment of the Development Costs & Management Fee

• secondly, to you.

• Where requested by the Developer, you must consent to and effect a mortgage against the Property to secure the payment of the Development Fee and the Development Costs as well as your performance of your obligations under this Agreement.

• It is forecasted that you will yield approximately $X in payments over X years, which represents the surplus remaining from the total income of the development (which is estimated to exceed $X) after all development costs and fees are paid to the developer.

• As the development will take place in several stages you will progressively reduce the business until the land is no longer sufficient for the business to continue at which point you will fully retire.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 subsection 152-10(1)

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 subdivision 152-C

Income Tax Assessment Act 1997 section 152-215

Income Tax Assessment Act 1997 Section 152-105

Income Tax Assessment Act 1997 subdivision 152-D

Income Tax Assessment Act 1997 section 152-330

Reasons for decision

Broadly, there are three ways profits from a land development, subdivision and sale can be treated for taxation purposes: 

• As ordinary income under section 6-5 and Division 70 of the ITAA 1997, on revenue account, as a result of carrying on a business of property development, involving the sale of land and buildings as trading stock.

• As ordinary income under section 6-5 of the ITAA 1997, 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, where the land was acquired or subsequently held for the purpose profit making.

• As statutory income under the CGT legislation, (section 102-5 of the ITAA 1997), on the basis that a mere realisation of a capital asset has occurred.

While holding an asset for a considerable period of time may seem to indicate that it is a long term capital asset, the intention of the taxpayer at the time of acquisition and throughout the ownership period is a crucial aspect. 

Federal Commissioner of Taxation v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693) (Myer Emporium)is one of the leading cases which shows that the intention at the time of purchasing the asset is an important consideration in determining whether the proceeds received on disposal are on a capital or revenue account. According to the Myer Emporium case, the relevant intention or purpose of the taxpayer is not a subjective test. Rather, it is the intention or purpose as discerned from an objective consideration of the facts and circumstances of the case. Also, if the taxpayer is a company or trust, the courts determine its purposes by looking at the people who control the entity (see Whitfords Beach).

Further, the decisions in Casimaty v. Federal Commissioner of Taxation (1997) 97 ATC 5135, 37 ATR 358 and McCorkell v. Federal Commissioner of Taxation 98 ATC 2199; (1998) 39 ATR 1112 demonstrate that if a taxpayer does not intend to make a profit when he or she acquires farming land then the likelihood that any profit made on the eventual sale of land is ordinary income is greatly diminished.

In this case, you originally purchased the property in XXXX to conduct a farming business. The property was acquired with the intention of primarily using it for primary production operations and long term investment. We accept that at the time of purchasing the property there was no intention to subsequently sell it for a profit.

The change of intention

Numerous cases have concerned the assessability of profits or proceeds from the sale of land. The two leading Australian cases dealing with the change of intention and the disposal of capital assets on revenue account are Scottish Australian Mining Co Ltd v Federal Commissioner of Taxation (1950)81 CLR 188 and Whitfords Beach Pty Ltd v Federal Commissioner of Taxation (1983) 14 ATR 247. These cases are much relied on in argument in the present case.

It follows from the decision in Scottish Australian Mining Co Pty Ltd v FCT and Whitfords Beach Pty Ltd that a taxpayer, who had originally acquired property for farming operations purposes, could subsequently embark on a profit making scheme. This means that a taxpayer could embark on a profit making scheme after property was acquired for a different purpose.

Treating the land as trading stock

The meaning of trading stock is given in section 70-10 of the ITAA 1997, and includes anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business.

Thus a thing can only be trading stock where it is capable of sale or exchange in the ordinary course of a business.

The decision of the High Court in Federal Commission of Taxation v. St Hubert's Island Pty Ltd (in liq) (1978) 138 CLR 210; 78 ATC 4104; (1978) 8 ATR 452 clearly established the principle that land can come within the definition of 'trading stock'. In that case, the High Court determined that land acquired for the purpose of development, subdivision and sale by a taxpayer carrying on a business of property development is trading stock.

The Commissioner's view is set out in Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'? (TD 92/124). Paragraph 1 of the TD 92/124 states that the land is treated as trading stock for income tax purposes if:

• it is held for the purpose of resale; and

• a business activity which involves dealing in land has commenced.

Paragraphs 2 and 3 of TD 92/124 further explain:

Both the required purpose and the business activity must be present before land is treated as trading stock. The business activity is taken to have commenced when a taxpayer embarks on a definite and continuous cycle of operations designed to lead to the sale of the land.

It is not necessary that the acquisition of land be repetitive. A single acquisition of land for the purpose of development, subdivision and sale by a business commenced for that purpose would lead to the land being treated as trading stock.

Carrying on a business of property development

The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the facts.

Taxation Ruling TR 97/11 provides the Commissioners view of the factors used to determine if you are in business for tax purposes, these factors are:

• 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 a prospect of profit from the activity

• whether there is regularity and repetition 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

• whether the activity is planned, organised and carried on in a businesslike manner such that it is described as 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 sporting activity.

No one indicator is decisive. The indicators must be considered in combination and as a whole. Whether a 'business' is carried on depends on the large or general impression.

In the context of considering the above authorities and factors, the following general observations of the arrangement can be made:

• The scope and scale of the property development the subdivision is significant, and goes well beyond a simple realisation of the land in an enterprising way. The estimated revenue from the sale of over X residential lots is $X.

• A natural consequence of the scope and scale of the arrangement is the highly sophisticated manner which it will be carried on over a lengthy period of time - estimated to be up to X years.

• Given the initial primary production business being carried on the property, the complete lack of nexus of the (significant) development to that previous activity indicates a clear change of intention to cease, or progressively scale down, one activity and commence a new discrete activity.

• You were offered $X in an outright purchase of your property. This offer was considered seriously to the extent a private ruling was obtained from the Commissioner with respect to the tax consequences of that disposal. This shows a conscious decision to pursue the development in lieu of the outright sale offer.

• The decision to pursue the development shows a choice to engage in exposure to the risks of the development, including the profits, losses and its general success.

• The legal title to the property remains with you also noting the authority to provide the relevant consents and approvals remains with you (notwithstanding the agreement variously requires such consent and approvals are not unreasonably withheld).

• Prior to any monies being paid to you all development costs and management expenses must be met from the total sale proceeds, indicating it is the return to risk (profits) of the development which you share.

• Similarly, the expenses of the development can be recouped from you by the developer to the extent of the full value of the total sales income and any remaining title you hold in the property, indicating it is the risk to losses of the development which you also share. We also note the explicit requirement to mortgage the property to secure the payment of development costs and performance under the contract when necessary.

A balanced view of these observations, with no one feature being determinative in isolation, reasonably leads to a conclusion the intention for holding the property has or will change upon the commencement of the development to one of carrying on a business.

Such a business of property development is taken to have commenced, TD 92/124 states that a business activity is taken to have commenced when a taxpayer embarks on a "definite and continuous cycle of operations designed to lead to the sale of the land." That is, the property will become trading stock when you and your spouse are demonstrably fully committed to the business of land development. When that occurs is determined by a consideration of the facts of the case.

In this case, we consider that the business of property development is taken to have commenced when the development agreement is signed.

As the proceeds from the sale of the subdivided blocks are assessable income under section 6-5 of the ITAA 1997 the proceeds will not be assessed as a capital gain. In order to be eligible for the small business CGT concessions a CGT event must happen in relation to an asset that you own. Noting that the property would cease being a CGT asset upon the commencement of the business, you are not eligible for the small business concessions in relation to the proceeds from the sale of the subdivided blocks.