Edited version of your written advice

Authorisation Number: 1013105190871

Date of advice: 11 October 2016

Ruling

Subject: Capital gains tax - property - income v capital - capital proceeds

Question 1:

Will the profit from the sale of Lot X be treated as ordinary income under section 6 -5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

No.

Question 2:

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

Answer:

Yes.

Question 3:

Will the capital proceeds received for the sale of your ownership interest in Lot X include the portion of the $XXX,000 to reflect your ownership interest?

Answer:

Yes.

Question 4:

Will the capital proceeds received for the sale of your ownership interest in Lot X include the costs of reconfiguration of Proposed Lot 123 to create the new lots you and your relatives intend keeping?

Answer:

No. The $XXX,000 received on the disposal of Lot X was for the sale of the land. This amount also included the costs incurred by the Developer to reconfigure the Proposed Lot 123 into the new lots. Therefore, the costs of reconfiguration have already been accounted for in the capital proceeds received from the sale of Lot X and should not be included twice.

This ruling applies for the following period

Income year ending 30 June 2016.

The scheme commences on

1 July 2015.

Relevant facts and circumstances

The information and documentation provided with this private ruling should be read in conjunction with, and forms part of this ruling.

In the 1970's your parents purchased a property as joint tenants (the Property). The land area of the Property is more than 10 hectares.

Your parents built a house on the Property (the original house) which was their main residence.

After 20 September 1985, you purchased an ownership interest in the Property from one of your parents (Parent B). As a result, you and Parent A were registered as having equal shares in the Property as tenants in common.

Parent A continued to reside in the original house until the present time.

After 20 September 1985, the ownership interests in the Property changed and as a result you, your sibling and Parent A held ownership interests in the Property as tenants in common.

A number of years later, an area of less than one hectare was transferred to you and your spouse which became Lot DEF. You and your spouse constructed a residence on Lot DEF which has been your main residence since it was constructed.

The remaining part of the Property, being more than 10 hectares, became Lot ABC which you and your sibling and Parent A continued to own. The original house is located on Lot ABC.

You and your sibling and parent have not attempted to sell Lot ABC.

In 20XX, a developer approached you in relation to the purchase of part of Lot ABC.

A number of months later, you, your sibling and Parent A entered into an option agreement (the Agreement) with Company A. Under the Agreement:

• you, your sibling and Parent contracted with you and spouse to acquire part of Lot DEF to be amalgamated with Lot ABC to create the Proposed Lot 123 and the Proposed Lot 456 (known as Lot X); and

• you, your sibling and Parent A agreed for Company A to purchase the part of Lot ABC and Lot DEF, being Lot X.

As a result of the amalgamation of the boundaries of Lots ABC and DEF:

• the land area held by you and your spouse was increased from X,XXX square metres to X,XXX square metres; and

• the Lot ABC had a reduced land area.

In 20YY, a valuation report was obtained for the Proposed Allotment X with the market value determined to be $XXX,000.

In 20YY, the Council approved of the proposed subdivision.

In 20YY, you, your sibling and Parent A entered into a contract (the Contract) for the sale of part of Lot ABC and Lot DEF, being Lot X, to Company B (the Developer) for $XXX,000. Under the contract:

• the Developer:

• would subdivide Lot ABC into two lots which will be known as the Proposed Lot 123 and Proposed Lot 456;

• would on its own accord subdivide Proposed Lot 456 (known as Lot X), into new lots;

• would subdivide the Proposed Lot 123, into new lots;

• would construct and seal roads, provide underground power to one of the new lots, undertake landscaping and weed eradication;

• you, your sibling and Parent A would not receive any money, but would transfer your ownership interests in Lot X to the Developer in exchange for the subdivision of the Proposed Lot 123 into the new Lots, which will be kept by you, your sibling and Parent A.

In 20YY Annexure "A" to the Contract (the Annexure) was signed by you, your sibling and Parent A which outlines the following:

• you, your sibling and Parent A acknowledged that the Developer had obtained on your behalf reconfiguration approval for the reconfiguration of Lot 123 to create a specified number of new lots

• the Developer would undertake all of the costs required to create the new lots and construct the proposed road

• the Developer would be deemed to have paid the purchase price, being $XXX,000, by undertaking all of its obligations as outlined in the Contract such as:

• obtaining all of the necessary approvals

• installing a bio-sewerage treatment device on Proposed Lot X, installing underground services from the new road to Proposed Lot X and removing trees as nominated by Parent A prior to works being undertaken on the creation of the proposed new lots

• subdividing Lots ABC and DEF into Proposed Lots D, 123 and Lot X

• the Developer would pay any income tax arising in relation to any capital gain or profit, interest or penalties imposed by the Australian Taxation Office; and

• the Developer agreed to pay any Goods and Services Tax (GST) payable by you and your sibling and parent arising in relation to the execution of the Contract, the exercise of the Agreement or the transfer of any property form either or all of you, your sibling, and/or Parent A to the Developer, or a nominee of the Developer.

Parent A's house, being the original house, will be located on one of the new lots located on Proposed Lot 123, in which they will continue to reside.

You and your spouse's house will be located on Proposed Lot D, being the portion of Lots ABC and DEF that will not be included in Proposed Lots 123 and 456.

You, your sibling and Parent A intend keeping the new lots created on Proposed Lot 123 and have no intention of selling them while Parent A is alive.

Neither you nor any related parties, have undertaken any similar activities in the past.

Neither you nor any related parties have any intention of undertaking any similar activities in the future.

For the purposes of this ruling the following will occur:

• The Developer will undertake the following in accordance with the Agreement and Contract:

• will subdivide Lot ABC into Proposed Lots 123 and 456,with Lot 456 being known as Lot X

• will subdivide Lot X for itself into new lots

• will subdivide Proposed Lot 123 for you, your sibling and Parent A into new lots;

• the activities and works undertaken by the Developer in relation to Lot X and Proposed Lot 123 will be in accordance with council requirements

• You, your sibling and Parent A will:

• transfer your ownership interests in Lot X to the Developer; and

• will retain your ownership interests in the new lots created on Lots 123.

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 102-20

Income Tax Assessment Act 1997 Section 103-10

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 112-25

Income Tax Assessment Act 1997 Section 116-20

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

Legislative references referred to herein are from the ITAA 1997.

Summary

Your activities are not viewed as being those of someone carrying on a business of developing property or of being an isolated transaction. Therefore, the proceeds from the sale of Lot X will not be ordinary income and will not be assessable under section 6-5. The proceeds represent a mere realisation of your capital asset which will fall for consideration under the capital gains tax provisions contained in Part 3-1.

Your capital proceeds for the disposal of Lot X will be the portion of the $XXX,000 that relates to your ownership interest in Lot XXX. While you will not receive the funds, it will be applied for your benefit when the Developer subdivides Proposed Lot 123 into the new lots.

Detailed reasoning

Taxation treatment of property sales

As a general principle, profits from property sales will either be assessable as ordinary income under section 6-5 or statutory income under the capital gains tax (CGT) provisions.

Where the profit has been made as a result of a taxpayer carrying on a business of property development or as a result of a taxpayer entering into an isolated business transaction, the profit will be assessable as ordinary income. However, where the profit is a mere realisation of a capital asset, the profit will be assessable under the CGT provisions of the ITAA 1997.

Income or capital

Section 995 states the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

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.

Paragraph 234 of Miscellaneous Taxation Ruling MT2006/1 (MT 2006/1) distinguishes between a business and an adventure or concern in the nature of trade (or profit-making undertaking or scheme). It provides that the term 'business' would encompass trade engaged in, or on, a regular or continuous basis. However, it goes on to say that an adventure or concern in the nature of trade may be an isolated or one-off transaction that does not amount to a business deal but has the characteristics of a business deal.

The question of whether an entity is carrying on an enterprise often arises where there are one-off property transactions. The decision to be made is whether the activities are an adventure or concern in the nature of trade as opposed to the mere realisation of a capital asset.

Taxation Ruling TR 92/3 (TR 92/3) sets out the Commissioner's view on whether profits made from isolated transactions are ordinary income. 'Isolated transactions' refers to:

• those transactions outside the ordinary course of business of a taxpayer carrying on a business; and

• those transactions entered into by non-business taxpayers.

Whether an activity is viewed as an isolated transaction depends very much on the circumstances of the case. However, where a taxpayer who does not carry on a business makes a profit from an isolated transaction, that profit is income if:

a) the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain; and

b) the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

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.

It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

Application to your situation

In your case, your parents purchased the Property in the 1970's. You purchased an ownership interest in the Property after 20 September 1985.

A number of years later, an ownership interest in the Property was registered to your sibling. As a result, you and your sibling had the same ownership interests in the Property and Parent A had a larger ownership interest in the Property.

You obtained a further ownership interest in the Property when a portion of the Property was transferred to you a number of years later. You and your spouse constructed a house on the combined land, being Lot DEF, in which you and your spouse have resided until the present time.

The remaining part of the Property became known as Lot ABC, on which Parent A resides in the original house.

In 20YY, a developer (the Developer) approached you, your sibling and Parent A and offered to undertake all of the work in relation to the subdivision of Lot ABC into two lots, being Proposed Lots 123 and 456. Once the subdivision of Lot ABC had been completed, you, your sibling and Parent A would transfer your ownership interests in Lot X to the Developer which it will further subdivide. The Developer will subdivide Proposed Lot 123 for you, your sibling and Parent A. The subdivision works will be undertaken by the Developer as an inducement to transfer the title of Lot X to it. Only subdivision activities in accordance with the relevant council permits/approvals will be undertaken by the Developer.

The market value of Lot X is $XXX,000. You, your sibling and Parent A will not be paid any monetary consideration by the Developer for Lot X, or for any activities it undertakes in relation to the amalgamation of the lots, the subdivision of the amalgamated lots into Proposed Lot 123 and Proposed Lot 456, or the subdividing of Proposed Lot 123 into the specified number of new lots.

No other subdivision activities have been undertaken by you or any related entities in the past and you do not intend to undertake any similar activities in the future.

In this case, you and relatives are selling Lot X to the Developer without undertaking any activities to improve its value prior to it being sold. While the Developer is undertaking the subdivision activities in relation to Lot 123 on you and your relatives' behalves instead of paying you the purchase price, these activities are not being undertaken by you and your relatives, or on your behalf in relation to Lot X.

Based on the information provided, there is nothing to suggest that the sale of the Lot X was the beginning of a continuing business of property development. Your activities do not display the salient indicator of a business, being transactions entered into on a continuous and repetitive basis. Therefore, it is the Commissioner's view that your activities in relation to the sale of Lot X are not those of an entity carrying on a business of selling land.

Making an overall assessment on the factors set out in TR 93/2, it is the Commissioner's view that the sale of your ownership interest in Lot X will not be considered commercial in nature but will be a mere realisation of a capital asset, being your ownership interests in a long-held privately owned property.

In conclusion, the activities involved in the sale of Lot X will not amount to carrying on a business. The transactions will not have the character of business operations or commercial transactions. There is no indication that your activities will become a separate business operation or commercial transaction, or that you will be carrying on, or carrying out a profit-making undertaking or plan.

Therefore, as it is not viewed that you are carrying on a business, or that the activities will be an isolated transaction, any profit arising from the sale of Lot X will be a mere realisation of your ownership interest which 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.

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

Section 116-20 outlines that capital proceeds from a CGT event are the total of the:

• money you have received, or are entitled to receive, in respect of the event happening, and

• market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event).

This is further clarified in section 103-10, which states that if money or other property has been applied for a taxpayer's benefit in relation to a CGT event (including the discharge of all or part of a debt owed) or has been applied at the taxpayer's direction, the CGT provisions apply as if that money or other property has actually been received by the taxpayer.

Application to your situation

In this case you, your sibling and Parent A have agreed to sell Lot X to the Developer for $XXX,000.

You, your sibling and Parent A will not receive the $XXX,000. Instead, the Developer will

• will undertake all of the subdivision activities to subdivide the amalgamated lots into two lots, being Proposed Lot 123 and Proposed Lot 456 (known as Lot X); and

• will subdivide Proposed Lot 123 on behalf of you, your sibling and Parent A into new lots

in exchange for you, your sibling and Parent A transferring your ownership interests in Lot X to the Developer, who will subdivide Lot X further into new lots for themselves.

When applying section 103-10 to your situation, we would view that you had received the portion of the $XXX,000 attributable to your ownership interest in Lot X in exchange for that ownership interest and for the Developer to undertake the amalgamation activities and the subdivision activities for the further subdivision of Proposed Lot 123 into the new lots for you, your sibling and Parent A.

The costs incurred by the Developer to reconfigure the Proposed Lot 123 into the new lots for you, your sibling and Parent A are included in the $XXX,000. Therefore, your capital proceeds for the sale of your ownership interest in Lot X will be the portion of the $XXX,000 that relates to your ownership interest only.