Edited version of your written advice

Authorisation Number: 1013042809093

Date of advice: 29 June 2016

Ruling

Subject: Property - subdivision - Am I carrying on a business of subdividing land? - isolated transaction - mere realisation

Question 1:

Will the profit from the sale of the subdivided lots 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 the subdivided lots 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 the subdivided lots 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 periods

Income year ending 30 June 20cc

Income year ending 30 June 20dd; and

Income year ending 30 June 20ee.

The scheme commences on

1 July 20bb.

Relevant facts and circumstances

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

After 20 September 1985, you and your spouse jointly purchased a vacant block of land with a land area of less than five acres.

The construction of a house (the House) on the Property was completed a number of years after the Property had been purchased.

You and your spouse have resided in the House from the time it was completed until the present time.

In 20aa, you and your spouse were approached by a developer in relation to the potential acquisition of part of the Property.

You and your spouse were approached in relation to the potential sale of part of the Property and an offer was received for the sale of the majority of the Property.

You and your spouse discussed the offer with real estate agents and other property owners in the area and determined that the amount offered was lower than the market value. You and your spouse had no desire to move from the Property, and had never considered the possibility of subdividing the portion of their Property. The Developer would not increase the offer and you and your spouse did not accept the offer.

You and your spouse are of a mature age and want to continue residing in your community. To reduce the maintenance requirements of the Property, you and your spouse are now considering subdividing the Property for the purpose of selling some of the subdivided lots and keeping the subdivided lot on which the House is located (the House lot).

A pre-lodgement meeting was held by the Council during which discussions were undertaken to explore development options and requirements, identify issues and provide guidance council's policies for the development of the Property. The Meeting Notes provide the following information:

• Development type - reconfiguration of a lot

• Zone - Low Density Residential Zone

• Minimum lot size - 800 square metres. However, where the slope exceeds 15%, the minimum area of the lot size is 1,000 square metres

It is expected that you will engage the services of professionals to lodge the relevant applications/permits and to undertake the activities related to the subdivision of the Property.

A preliminary layout plan of the subdivision of the Property has been prepared outlining the subdivision of the Property into the House lot and a number of vacant land lots.

The current market value of the intended subdivided portion of the Property is less than $2,000,000 (not including the House lot).

It has been estimated that the subdivided lots could sell for over $200,000 per lot and that the costs involved with the subdivision is over $50,000 per lot.

You and your spouse will use some of your own savings to fund the subdivision of the Property and will obtain a bank loan for the remaining amount, which will be repaid from the proceeds from some of the first to be sold subdivided lots.

You and your spouse will engage the services of real estate agent/s to sell the subdivided lots.

You and your spouse are not associated with any parties engaged to undertake the activities in relation to the subdivision of the Property.

You and your spouse have not undertaken any similar activities in the past and do not intend undertaking any similar activities in the future.

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

• You and your spouse will subdivide the Property, with the House on one lot and a number of vacant land lots

• You and your spouse will the subdivided lot on which the House is located and will continue to reside there

• You and your spouse will sell the vacant land subdivided lots

• You and your spouse will engage the services of others 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.

• You will engage the services of real estate agents to sell the vacant land subdivided lots; and

• You and your spouse will not undertake any activities in relation to the subdivision of the Property, or the sale of the subdivided vacant land 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 X 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:

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 due to a mere realisation of a capital asset occurring.

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, you and your spouse purchased the vacant block of land after 20 September 1985, on which you built the House (the Property), which has been your main residence until the present time.

You and your spouse intend subdividing the Property with the House being located on one subdivided lot, and the remaining Property being subdivided into lots of vacant land.

You and spouse will keep the subdivided lot on which the House is located (the House Lot) and will sell the subdivided vacant land lots.

You and your spouse will engage the services of professionals to undertake the activities in relation to the subdivision and sale of the subdivided vacant land lots.

You and your spouse have not undertaken any other subdivision activities in the past and have no intention to undertaken any similar 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 you and your spouse's activities in relation to the subdivision and sale of the lots are not those of an entity carrying on a business of developing and selling land. The activities being undertaken by you and your spouse do not display the salient indicator of a business, being transactions entered into on a continuous and repetitive basis.

The subdivision activities will be undertaken by entities that you and your spouse engage to manage the subdivision and you and your spouse will not participate in any of the activities involved in the subdivision of the Property and sale of the subdivided lots.

Therefore, any gain made on the disposal of the four 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 acquired the Property and built the House on it, which has been your main residence until the present time.

You and your spouse's intention in relation to the Property changed due to your ages and your desire to continue living on the Property, with an intention to reduce the maintenance requirements of the Property.

You and your spouse want to continue residing in the House located on the Property and the subdivided lot on which it is located on. The remaining subdivided lots of vacant land will be sold to help pay off the mortgage and the amount borrowed to fund the subdivision.

You and your spouse will engage the services of others 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 92/3, it is the Commissioner's view that the subdivision of the Property and sale of the subdivided lots of vacant land 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 of vacant land 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.

When a CGT asset (the original asset) is split into two 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). The subdivided blocks will be viewed as having been acquired on the date the original parcel of land was acquired.

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 jointly acquired the original Property after 20 September 1985. Therefore, you and your spouse are viewed as each having a 50% ownership interest in the Property. As the Property was purchased after 20 September 1985, the Property is a post-CGT asset.

When the Property is subdivided, you and your spouse will each have a 50% ownership interest in each of the subdivided lots.

CGT event A1 will occur when the subdivided lots of vacant land are sold. As you and your spouse's 50% ownership interests are post-CGT, any capital gain or capital loss made on the disposal of you and your spouse's ownership interests in each of the subdivided lots cannot be disregarded and 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 your ownership interest in the fifteen subdivided lots by 50%.