Edited version of your written advice

Authorisation Number: 1013121748646

Date of advice: 9 November 2016

Ruling

Subject: Property - subdivision - income v capital

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)?

Answer:

No.

Question 2:

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 20WW

Income year ending 30 June 20XX

Income year ending 30 June 20YY

Income year ending 30 June 20ZZ

The scheme commences on

1 July 20VV

Relevant facts and circumstances

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

After 20 September 1985, you and your partner entered into a contract to jointly purchase the Property with settlement occurring a number of months later.

The land area of the Property was less than 10 hectares and was zoned Rural B.

An existing house was located on the Property when it was purchased, in which you and your partner have continued to reside in until the present time.

The local council merged with another council and the Property was rezoned as Park Residential.

Due to your ages and some health issues, the upkeep of the Property is becoming too much for you and your partner. You and your partner have decided to subdivide the Property into a specific number of lots to fund your retirement. All of the lots of vacant land will be sold. You and your partner will keep the subdivided lot on which the existing house located on, which you and your partner will keep as your main residence.

In 20UU, you and your partner engaged the services of a professional who lodged a development application for the subdivision of the Property into a specified number of lots.

The development application was approved by the council a number of months later.

As a result of the approved subdivision of the Property each of the subdivided lots was given an individual street address.

Infrastructure has been completed on the Property in accordance with the development permit, such as:

● the construction of a sealed road to provide access to three lots

● a vehicle crossing

● connection of electricity, water and telecommunications to all lots

● installation of retaining walls, spoon drains and headwalls constructed and trenches dug

You and your partner intend selling the vacant lots of land over a period of years.

You and your partner have engaged the services of professionals to undertake the activities arising in relation to the subdivision of the Property.

You estimate that the market value of the property prior to subdivision was $X,XX,000.

It has cost you and your partner $XXX,XXX to subdivide the Property.

You and your partner will fund the subdivision of the Property and sale of the subdivided lots.

In 20VV, some of the lots were listed for sale with a real estate agent, and are currently still on the market. The expected sale prices for the lots as provided by the real estate agent range from over $300,000 to less than $800,000.

You and your partner have not previously been involved in activities involving the acquisition, subdivision and sale of subdivided land and have no intention of undertaking any similar project in the future.

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 three subdivided lots will not be ordinary income and not assessable under section 6-5. The proceeds will represent a mere realisation of capital assets which will fall for consideration under the capital gains tax provisions in Part 3-1.

You and your partner acquired the Property after 20 September 1985; therefore the subdivided lots will also be viewed as having been acquired after 20 September 1985, being post-CGT. Any capital gain made on the sale of each of the subdivided lots will be determined under the general capital gains tax provisions.

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 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

You and your partner purchased the Property in 19AA which you have used as your main residence since then.

The Property was rezoned as Park Residential as a result of the merging of the local council with another council.

Due to you and your partner's ages, and some health issues, you are finding it difficult to maintaining of the Property and have decided to subdivide the Property. The vacant land lots will be sold to fund you and your partner's retirement, and you will keep the subdivided lot on which your existing house is located.

You and your partner have engaged the services of professionals to undertake the activities in relation to the subdivision of the Property and will not undertake any activities in relation to the subdivision of the Property. Only the minimum activities required under the development application will be undertaken in relation to the subdivision.

You and your partner have engaged the services of a real estate agent to sell a number of the vacant lots of land.

No other subdivision activities have been undertaken by you and/or your partner in the past and neither of you 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. The activities do not display the salient indicator of a business, being transactions entered into on a continuous and repetitive basis given that you and your partner will not personally be engaged in repetitive property development activities. Instead you and your partner have engaged the services of professionals to subdivide and sell the subdivided lots. The subdivision activities will not go beyond what is necessary to enhance the presentation of the individual lots for sale as vacant lots.

Therefore, it is the Commissioner's view that the activities in relation to the subdivision are not those of an entity carrying on a business of buying, subdividing and selling subdivided land.

You and your partner had purchased the Property for the purpose of residing which can be regarded as having the feature of a “passive investment”. It follows any sale proceeds from the sale the subdivided lots will not be from an isolated commercial transaction or profit-making undertaking because the Property was not purchased explicitly for the purpose of resale, and because there will be essentially no change in the purpose of the Property (since its purpose, as a subdivision, will continue to be both your residential address, where you will retain a residential allotment of the land, and a passive investment).

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 your subdivision activities will become a separate business operation or commercial transaction, or that you and your partner will be carrying on, or carrying out a profit-making undertaking or plan.

Therefore, as it is not viewed that you and your partner 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, but that it will be a mere realisation of the Property which will be accounted for under the capital gains tax provisions in Part 3-1.

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

As you and your partner'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 your respective 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 your ownership interests in the 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 subdivided lots will be calculated in accordance with the CGT provisions.