Edited version of your written advice

Authorisation Number: 1013021423675

Date of advice: 24 May 2016

Ruling

Subject: Property - subdivision - 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 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.

This ruling applies for the following period

Income year ending 30 June 2017

The scheme commences on

1 July 2016.

Relevant facts and circumstances

You and a number of other parties (referred to collectively as "You") jointly purchased the property for over $300,000. Settlement on the purchase of the Property occurred in 20XX

Your intention when the Property was purchased was to rent the existing dwelling located on the Property for around 12 months while getting approvals to subdivide the Property land and construct new dwellings on the subdivided lots. The new dwellings would be sold after they were constructed.

The original tenant moved into the existing dwelling soon after settlement occurred and has continued to reside at the Property with the current lease expended to end around mid-20YY.

You have not lodged any subdivision applications as at the present time.

You are considering demolishing the existing dwelling and subdividing the Property land into subdivided blocks, which you would then sell as vacant blocks of land.

It is estimated that the demolition costs will be over $35,000 and that each of the subdivided blocks will sell for over $250,000 each.

The market value of the Property is estimated to be over $345,000.

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

For the purposes of this ruling the following will occur:

• You will obtain the subdivision approval to subdivide the Property into subdivided two blocks

• You will subdivide the Property into two blocks

• You will sell the two subdivided blocks as vacant land

• You will engage the services of a real estate agent/s to sell the two subdivided blocks; and

• You will make a gain on the disposal of the two subdivided blocks of land.

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

Reasons for decision

Summary

The proceeds from the sale of the subdivided blocks will not be ordinary income and will not be assessable under section 6-5. The proceeds represent a mere realisation of a capital asset which will fall for consideration under the capital gains tax provisions in Part 3-1 of the ITAA 1997.

Detailed reasoning

Taxation treatment of property sales

Profits from a land sub-division can be treated in at least three ways for taxation purposes:

(1) As ordinary income under section 6-5 of the ITAA 1997 as a result of carrying on a business of property development, involving the sale of land as trading stock.

(2) As ordinary income under section 6-5 of the ITAA 1997 as a result of an isolated commercial transaction entered into by a non-business taxpayer or outside the ordinary course of business of a taxpayer carrying on a business.

(3) As capital gains under Part 3-1 and Part 3-3 of the ITAA 1997 from the mere realisation of a capital asset.

Carrying on a business

The term 'business' ordinarily refers to trade engaged in on a regular or continuous basis. Whereas an isolated (one-off) commercial transaction, does not amount to a business but has the characteristics of a 'business deal'.

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.

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.

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.

Mere realisation

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.

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). Each new subdivided block retains the acquisition date that the original asset was acquired on.

The mere realisation of a capital asset has been described as "liquidating or realising the old assets" (Commissioner of Taxes v Melbourne Trust Limited [1914] AC 1001).

In the High Court of Australia case of Federal Commissioner of Taxation v NF Williams 72 ATC 4188; (1972) 127 CLR 226, at ATC 4194-4195; CLR 249, Gibbs J explained mere realisation of land as follows:

An owner of land who holds it until the price of land has risen and then subdivides and sells it is not thereby engaging in an adventure in the nature of trade, or carrying out a profit-making scheme. The situation is not altered by the fact that the landowner seeks and acts upon the advice of an expert as to the best method of subdivision and sale or by the fact that he carries out work such as grading, levelling, road-building and the provision of reticulation for water and power to enable the land to be sold to its best advantage. The proceeds resulting from the mere realization of a capital asset are not income either in accordance with ordinary concepts…even though the realization is carried out in an enterprising way so as to secure the best price…

In the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135, at 97 ATC 5152, Ryan J described a salient characteristic of the mere realisation of land as follows:

…[to not] undertake any works on, or development of, the land beyond what was necessary to secure the approval by the municipal authorities of the successive plans of subdivision and enhance the presentation of individual allotments for sale as vacant blocks.

In distinguishing mere realisation from a commercial transaction, Ryan J further said:

Had he constructed dwelling houses, internal fencing or other improvements, it would have been easier to impute to him an intention to carry on a business of land development and improvement.

Application to your situation

In this case, you acquired the Property with the intention of demolishing the existing dwelling, subdividing the Property land, and constructing new dwellings on the subdivided lots which you would sell.

The Property has been rented out since it was acquired, with the current lease expected to end around mid-20YY.

Your intention in relation to the Property has now changed and you will now demolish the existing dwelling, subdivide the Property land into two blocks which you will sell as vacant land.

After reviewing the information and documentation provided, it is the Commissioner's view that the activities you intend undertaking are not those of an entity carrying on a business of buying, subdividing and selling subdivided land.

You have not undertaken any similar activities in the past and do not intend to undertake any similar activities in the future. There is nothing to suggest that the subdivision and sale of the subdivided lots would be the beginning of a continuing business of property development.

The activities you intend undertaking do not display the salient indicator of a business, which are transactions entered into on a continuous and repetitive basis.

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.

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 the sale of the two subdivided lots will not considered to be commercial in nature.

Accordingly, it is considered that any gain made on the disposal of the two subdivided lots will represent a mere realisation of the Property to its best advantage.

Therefore, any gain arising from the sale of the two subdivided lots will be accounted for under the CGT provisions in Part 3-1. Each of the subdivided lots being viewed as having been acquired on the same date that the Property was acquired and any capital gain made on the sale of the two subdivided lots will be calculated in accordance with the CGT provisions.