Edited version of your written advice

Authorisation Number: 1013113266920

Date of advice: 26 October 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:

No.

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.

This ruling applies for the following periods

Income year ending 30 June 20XX

Income year ending 30 June 20YY; and

Income year ending 30 June 20ZZ.

The scheme commences on

1 July 20WW

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 this ruling.

After 20 September 1985, you and/or your spouse purchased a Property (the Property) which has a land area of more than one hectare.

An existing dwelling was located on the Property which was constructed prior to 20 September 1985. The dwelling consisted of the original house, with a second two storey addition being constructed at a later stage. The second storey is a self-contained addition that can be locked off from the main house.

You and your spouse lived at the Property for many years from the time you purchased it.

After 20 September 1985, you and your spouse moved to another location due to employment opportunities, where you resided in another property (Property B).

For a number of years after you and your spouse had moved from the Property, the original portion of the house was rented out with you and your spouse maintaining access to the two storey addition which you used on weekends.

After a number of years, the Property had been left vacant for a period of time and was then only used by you or your spouse during monthly visits due to their work commitments, or used by friends during occasional visits.

A number of years later you and your spouse had obtained an estimate of the cost for the subdivision of the Property into a specified number of lots. The estimated cost was $XXX,XXX.

From 20VV, you or your spouse's work became full time in the area where the Property is located and the Property was used as you or your spouse's main residence, with your or your spouse renting a unit in another location due to their employment.

In 20UU, you and your spouse sold Property B, with you or your spouse renting other accommodation so that they remained close to their employment.

You and your spouse are both approaching retirement age and want to subdivide the Property to supplement your retirement income.

You and your spouse have decided to subdivide the Property into lots. The existing dwelling on the Property will be located on Lot 1, which you will keep and will reside in after your retirement. The other subdivided lots will be sold.

In 20WW, a real estate agent advised that they estimated that a minimum of $XXX,000 per lot would be achievable on the sale of the subdivided lots.

In 20WW, the Property was valued at $XXX,000, including Goods and Services Tax (GST), with vacant possession.

In 20WW, you and your spouse engaged the services of professionals (the Developer) who lodged a development application for the subdivision of the Property which was approved subject to conditions.

In 20WW, the Developer provided a fee estimate for the total cost to subdivide the Property into subdivided lots, being $XXX,XXX (GST inclusive).

You and your spouse will fund the subdivision of the property with funds borrowed from a bank and have obtained a non-binding documentation from a bank in relation to a loan of $XXX,000 to assist with the subdivision of the residential lots located at the Property and which will cover the following costs:

● refinance current home loan

● construction

● construction contingency

● valuation/progress claim costs; and

● capitalised interest.

You estimated that each of the subdivided lots available for sale will be sold for $XXX,XXX on average, for a total amount of $X,XXX,XXX.

You and your spouse will personally undertake minor preparation work such as the removal of existing fencing and small sheds on the Property.

You and your spouse will engage the services of a real estate agent to sell all of the lots with the exception of the lot on which the existing house is located, which you and your spouse will keep with the intention of living in when you retire.

The proceeds from the sale of the subdivided lots will be used to repay the borrowed funds from the bank.

You and your spouse have not undertaken any similar activities in the past and do not have any intentions to undertake any similar activities in the future.

For the purposes of this private ruling, the following will occur:

● The development of the Property will be undertaken in accordance with the development permit;

● You and your spouse will keep Lot 1 and will sell the other subdivided lots;

● You and your spouse will reside in the existing dwelling located on Lot 1; and

● You and your spouse will engage the services of others to undertake the subdivision and manage and co-ordinate the subdivision of the Property; and

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

Assumption

The sale price for each of the subdivided lots that will be sold will be reasonably reflect the estimated sale prices as provided with this private ruling.

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 104-10

Income Tax Assessment Act 1997 Subsection 104-10(3)

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

Legislative references referred to herein are from the ITAA 1997.

Summary

The proceeds from the sale of the 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

Income or capital

As a general principle, profits from property sales will either be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) or statutory income under the capital gains tax (CGT) provisions of the ITAA 1997.

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.

There have been several cases in which the courts have addressed the question of whether the proceeds received for the sale of an asset are revenue or capital in nature. The decision in each case depended on its own facts, and very often will be a matter of degree.

The extent of the personal involvement of the taxpayer in much of the planning, organisation and management of the activities has been held to be significant factors in the determination of whether or not a business was being carried out. For example:

● In Stevenson v FC of T (1991) 91 ATC 4476; (1991) 22 ATR 56; (1991) 29 FCR 282 (Stevenson) the degree of the taxpayer's involvement was seen as an indicator of a business being conducted; and

● The lack of personal taxpayer involvement was seen as a relevant to the finding that a business was not being conducted in the cases of Stratham V FCT 89 ATC 4070, McCorkell v FCT 98 ATC 2199 (McCorkell) and Casimaty v FCT 97 ATC 5 (Casimaty).

From the cases involving the subdivision of land and from Taxation Ruling TR 92/3 (TR 92/3), it would appear that the following are the most important factors to consider when determining whether profits made as a result of an isolated business transaction are assessable income:

(a) the intention or purpose of the 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 or in carrying out a business operation or commercial transaction.

In determining whether an isolated transaction amounts to a business operation or commercial transaction the following factors are relevant:

a) the nature of the entity undertaking the operation or transaction;

b) the nature and scale of other activities undertaken by the taxpayer;

c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

d) the nature, scale and complexity of the operation or transaction;

e) the manner in which the operation or transaction was entered into or carried out;

f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

g) if the transaction involves the acquisition and disposal of property, the nature of that property; and

h) the timing of the transaction or the various steps in the transaction.

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 your case, you and your spouse purchased the Property prior to 20 September 1985. You and your spouse have used the Property as your main residence for part of your ownership periods, have left it vacant and used it on an occasional basis, or have rented out part or the whole of the Property during other parts of your ownership periods.

You and your spouse are approaching retirement age and have decided to subdivide the Property and will keep the subdivided lot on which the existing dwelling is located, being Lot 1, and will sell the other subdivided lots to fund your retirement.

The market value of the land prior to the subdivision is $XXX,000. It is estimated that it will cost $XXX,XXX, GST inclusive, to subdivide the Property and that the subdivided lots will be sold for $XXX,XXX for each lot.

You and your spouse will borrow the funds to subdivide the Property and will repay the loan with proceeds received from the sale of the subdivided lots.

No other subdivision activities have been undertaken by you and your spouse in the past and you and your spouse do not intend to undertake 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 subdivision. 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 you and your spouse's activities in relation to the subdivision of the Property are not those of an entity carrying on a business of buying, subdividing and selling subdivided land.

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 will not be considered commercial in nature but will be a mere realisation of a capital asset, being a long-held privately owned property.

In conclusion, the activities involved in the subdivision and sale of the subdivided lots 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 the subdivision 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 and your spouse are carrying on a business, or that the subdivision activities will be an isolated transaction, any profit arising from the sale of the subdivided lots will not be assessable under section 6-5.

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 lots is not a CGT event, according to subsection 112-25(2). Each new subdivided lot will be viewed as having been acquired on the same date that the original asset was acquired.

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 and your spouse will subdivide the Property, keeping Lot 1 on which your existing dwelling is located where you and your spouse intend to reside.

You and your spouse will sell the other subdivided lots and intend using the services of professionals to subdivide the Property and to sell the subdivided lots.

As you and your spouse's activities are not viewed as being either those of someone carrying on a business of subdivision and sale of land, or undertaking an activity of a commercial nature, it is considered that any gain made on the disposal of you and your spouse's ownership interests in the subdivided lots will represent a mere realisation of the Property to its best advantage.

Therefore, any gain arising from the sale of you and your spouse's ownership interests in the subdivided lots will be accounted for under the CGT provisions in Part 3-1.

Each of the subdivided lots will be viewed as having been acquired on the same date that the Property was acquired.

CGT event A1 will occur when you sell each of the subdivided lots. Any capital gain or capital loss made on the sale of the subdivided lots will be calculated in accordance with the CGT provisions.