Edited version of your written advice

Authorisation Number: 1013031151679

Date of advice: 9 June 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:

1 July 2015 to 30 June 2016

1 July 2016 to 30 June 2017

1 July 2017 to 30 June 2018

1 July 2018 to 30 June 2019

1 July 2019 to 30 June 2020

The scheme commences on

1 July 2015

Relevant facts and circumstances

The arrangement that is subject of the private ruling is described below.

Person A and Person B (the Individuals) signed a contract to jointly purchase a block of land (the Property) for the purpose of building their main residence.

Settlement on the purchase of the Property occurred more than10 years ago.

The land area of the Property was XX hectares.

A few years ago, the Individuals began to incur expenses towards the building of a dwelling on the Property. Expenditure included building plans, council fees, earthworks, head-works and a garage. They sold their existing house to help fund the construction costs.

Subsequently, the Individuals circumstances changed. They relocated, bought a new house and put the building of dwelling on the Property on hold.

The Individuals became aware of pending changes to local planning rules in the suburb in which the property is located. After the finalisation of the changes, the Individuals commissioned a feasibility study to assess subdividing the Property and selling surplus land. Following the study, the Individuals determined that they could maximise the value of the Property by subdividing it into multiple lots and selling the subdivided lots separately.

The Individuals are the directors of a Company (You) which is the Trustee of the Trust. For the purposes of this ruling, you will refer to the Company as Trustee for the Trust.

The Trust is a discretionary trust of which the Individuals are the primary beneficiaries, and their children are the secondary beneficiaries.

You and the Trust have been created for the purpose of subdividing and selling the surplus land on the Property given the potential risks associated with the subdivision for the Individuals.

The Individuals will sell the Property to you at its current market value before the development application is approved.

Valuations of the Property have been obtained which indicate that the current market value of the Property is within a range.

A Feasibility Investigation (the Report) was prepared which outlined the following:

• The Report identified that the Property presented an excellent opportunity for residential subdivision with it being in close proximity to the coastline, which would allow for the creation of several waterfront allotments, which would be considered of a premium quality

• An internal road is proposed to run through the centre of the Property, and road works will be undertaken. Some of the servicing works are required.

• A concept plan was prepared with identified that the subdivision of the Property would be undertaken in four stages of work

A Development Permit has been prepared which outlines the following in relation to the subdivision of the Property.

You will retain ownership of one of the lots, and the Individuals will use it to build a dwelling that will become their main residence.

You will spend around $X,X00,000 on development costs in relation to the subdivision, with peak borrowing requirements around $X00,000.

You will borrow the money to fund the subdivision activities.

It is estimated that You will sell the subdivided lots for around $X,000,000, with an expected gain of around $XX0,000.

It is intended that the development and sale will be conducted in four stages over a number of years to reduce the need for borrowings, and to avoid flooding the market with available property. You will sell the subdivided lots along the existing road, and use the proceeds of the sale to fund the next stage of the development.

Neither you nor the Individuals will be involved in marketing the subdivided lots. The service of a real estate agent will be engaged to sell the subdivided lots.

You have not previously been involved in the buying and selling of land in the past and do not have any intention to undertake any similar activities in the future.

For the purposes of this ruling the following will occur:

• The Individuals will sell the Property to you for its market value before the Development Permit has been approved

• You will undertake the subdivision and sale of the Property in accordance with the Development Permit provided with this ruling and will:

• Undertake the subdivision and sale of the subdivided lots in four stages

• Subdivide the Property into a number of lots.

• Sell a number of the subdivided lots.

• Keep one of the subdivided lots.

• Will incur the expenses in relation the subdivision and development of the Property, such as road works, stormwater drainage and connection of electricity and telephone services; and

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

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 15-15

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

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 the Property 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 of the ITAA 1997 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 will purchase the Property from the Individuals for the sole purpose of subdividing it into subdivided lots. You will sell most of the subdivided lots and will keep one subdivided lot.

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 the Property 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 you will undertake in relation to the subdivision of the Property are not those of an entity carrying on a business of buying, 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 will subdivide the Property and sell the majority of the subdivided lots. The simplest way you could have divested yourself of the Property would be to dispose of it without seeking any subdivision approvals and without actually undertaking the associated works. In this case, however, the Individuals will sell the property to you as the Trustee of the Trust. 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 the Property as Individuals. However, the question before us is whether your intention changed when you as the Trustee of the Trust committed this one-off undertaking in relation to the subdivision of the Property and sale of the subdivided lots. It was the sole intention when the company and trust was set up that the property would be purchased, subdivided and the majority of the subdivided lots would be sold. There is clearly an intention to make a profit when the property is purchased by you.

You could sell the Property as vacant land without doing anything to the Property, which would be a mere realisation. However, no attempt was made to sell the Property as vacant land and the Property will be subdivided into XX lots.

The subdivision of the Property is aimed at increasing the number of lots available for sale, with the maximum possible number of subdivided lots, 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 has been stated that the market value of the Property is an amount. You will spend double the value of the property on the costs associated with the subdivision of the Property. It is estimated that the sale proceeds from the sale of the subdivided lots will be $X,000,000.

The subdivision is significant with your expected return being increased by $XX0,000 net proceeds, or more, 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.

The projected expenditure on the subdivision is double the estimated market value of the Property if it were sold as-is to a third party. There is a significant investment of resources in the subdivision and a significant assumption of risk by you in the pursuit of a return that will be considerably larger than what could have been achieved by selling off the Property as a whole. This level of risk is acknowledged by the statement that the reason for selling the Property to you is to reduce risk to the Individuals. The adoption of risk in the pursuit of profit is an indicator of a profit making intention.

For a property sub-division to be considered revenue, it is not necessary that a profit making intention be the sole motivation, only that it be a significant motivation The amount of money that needs to be invested to bring the development to a conclusion compared to the market value of the land if it was sold as is, the size of the profits expected and the level of risk assumed in the pursuit of return all indicate that on balance profit making is a significant intention for the trust.

In this case, you have approached the transaction in a businesslike way, engaging the services of a professional company to undertake surveys and investigations and prepare reports.

The inherent nature of the subdivision of the Property is such that it 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.

The subdivision will transform the Property from vacant land into small residential allotments. There is a demonstrated intention to profit from the subdivision of the Property and the transaction has been undertaken in a commercial manner.

In conclusion, we have made the following observations:

• You purchased the Property with the intention of subdividing it and selling all but one of the subdivided lots

• You would be able to sell the Property for substantial profit without subdividing it;

• You have approached the development in a businesslike way;

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

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

Accordingly, the subdivision of the Property by you 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 on the sale of the subdivided lots 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.