Edited version of your written advice

Authorisation Number: 1013136931811

Date of advice: 6 December 2016

Ruling

Subject: Income or Capital

Question 1

Will the proceeds of sale on realisation of the Land be assessable income to the Taxpayers under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Is the Land trading stock such that the proceeds of sale will be assessable to the Taxpayers under section 6-5 of the ITAA 1997?

Answer

No

Question 3

If the answer to Questions 1 and 2 is no, will the proceeds from the sale be subject to taxation to the Taxpayers under the Capital Gains Tax (CGT) provisions in Parts 3-1 and 3-3 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 201X

Year ended 30 June 201X

Year ended 30 June 201X

Year ended 30 June 20XX

The scheme commences on:

1 July 201X

Relevant facts and circumstances

1. The Taxpayers collectively own a large parcel of rural land (the Land).

2. The Taxpayers and another entity (Buyer) entered into a Contract for the Sale of Land.

3. The Buyer became the registered proprietor of the Land following settlement under the Contract of Sale.

4. Pursuant to the Contract of Sale, the purchase price for the Land was agreed. The Purchase Price was payable in instalments over the course of a number of years as outlined in the Contract of Sale.

5. Payment of the Purchase Price was secured by a first and second mortgage over the Land in favour of the Taxpayers (Mortgage).

6. The Buyer paid the first three instalments of the Purchase Price on time. However, by letter, the Buyer advised the Taxpayers that they would be unlikely to be able to make payment of the fourth instalment by the due date, and raised a number of alternative arrangements for consideration by the Taxpayers.

7. In order to grant the Buyer further time to make payment of the fourth instalment, the Taxpayers and the Buyer entered into a Contract Deed of Variation (Deed of Variation) to break down the fourth instalment into three instalments due over an extended period of time.

8. By letter, the Buyer provided a written report to the Taxpayers and provided further verbal communication informing them of the following:

a. That the Buyer would not be able to make payment of the next instalment amount; and

b. That the Buyer would be very unlikely to be able to make payment of the remaining instalments on the dates specified in the Amended Contract of Sale.

9. The Taxpayers and the Buyer commenced negotiations to find an alternative means to satisfy the unpaid Purchase Price and entered into a Settlement and Contract Variation Deed (Deed of Settlement).

10. Pursuant to the terms of the Deed if Settlement, the Buyer's obligations under the Amended Contract of Sale and Mortgage were discharged and, in exchange, the Taxpayers:

a. Accepted the transfer of Land back from the Buyer (in the same ownership proportions as the Taxpayers held the Land prior to the sale of Land under the Contract of Sale) in partial satisfaction of the balance of the original Purchase Price owed by the Buyer; and

b. Varied the original Purchase Price payable under the Amended Contract of Sale and released the Buyer from any obligation to pay the remaining balance of the original Purchase Price.

11. The initial sale of the Land to the Buyer was treated as a realisation of the capital asset owned by the Taxpayers and each of the Taxpayers recorded a capital gain in their income tax returns for the relevant income year.

12. In accordance with the Deed of Settlement, the Buyer transferred the Land in the same ownership proportions as the Taxpayers had held the Land prior to the sale of the Land under the Contract of Sale, back to the Taxpayers.

13. The Taxpayers did not pay anything to the Buyer to acquire the Land. In return for acquiring the Land from the Buyer, the Taxpayers gave up their rights to the outstanding Purchase Price otherwise payable by the Buyer.

14. The acquisition of the Land by the Taxpayers on this date is referred to as the “Acquisition” throughout this ruling.

15. The Land comprises of primary production land in Australia.

16. The Land has at all times throughout its ownership history been used by the Taxpayers wholly and exclusively for the purpose of running a primary production business.

17. The Taxpayers have operated the same primary production business on the Land since the Land was first acquired. The Taxpayers have continued to use the Land in the same primary production business even following the sale of the Land to the Buyer pursuant to an agreement reached between the Buyer and the Taxpayers.

18. Following the Acquisition, the Taxpayers continued to operate the same primary production business on the Land as had always been run by the Taxpayers on the Land.

19. A family homestead is located on an adjacent lot which is not part of the Land.

20. One of the Lots contains a dwelling which has been periodically rented out by the Taxpayers for a number of years. The dwelling is a basic layout and the rental income derived from the dwelling is negligible in comparison to the income derived from the primary production business run on the rest of the Land.

21. Since the Acquisition, the Taxpayers have not made any attempt to sell, subdivide, develop or otherwise deal with any part of the Land other than to use the Land in their primary production business.

22. The Land was zoned as rural land at the time the Taxpayers sold the Land to the Buyer and the Land is still zoned as rural land.

23. The Taxpayers have not bought and sold any other land following the execution of the Deed of Settlement.

24. Since the Acquisition, the Taxpayers have not attempted to sell the Land, or any portion of it, and instead, have continued to use the Land in the same primary production business which the Taxpayers have always operated on the Land.

25. The area in which the Land is located was historically comprised almost solely of rural land.

26. The Land was included within a 'Development Investigation Area'. The Land has been included in these plans as it has been identified as an area suitable for urban development to meet the long-term residential land requirements for the next XX years.

27. The Land has been identified by local councils and planning authorities as the most appropriate and most likely area to be developed for urban purposes once the existing residential stock has been consumed.

28. Having regard to the increasing urbanisation of the area surrounding the Land, the Land is slowly becoming unsuitable for primary production and it is only a matter of time before the Land will no longer be suitable for that use.

29. In addition, one of the Taxpayers has health issues and requires considerable medical care and support.

30. The Taxpayers consider that selling the Land will help generate funds which can be used to provide the considerable medical care and support needed.

31. The Taxpayers now wish to realise the Land in the most advantageous way, to ensure they have maximum sale proceeds available to care for and support the Taxpayer and to compensate for the fact that the primary production business will no longer be viable.

32. The Taxpayers do not wish to have any personal or direct involvement with the sale of the Land as they will continue to run the primary production business and care for the Taxpayer.

33. To date, no works have been undertaken to prepare the Land for en globo sale or for subdivision. The personal involvement of the Taxpayers to date has been minimal.

34. The Taxpayers will not undertake any development on the Land and will not subdivide the Land before any sale.

35. The Taxpayers will not market or sell the Land and have engaged a third party to act as their agent. The agent will be responsible for requesting expressions of interest, approaching suitable purchasers, assessing offers and selecting the potential purchaser of the Land.

36. The Taxpayers will not bear the upfront costs of the sale of land. The agent will incur direct costs in advertising the Land for sale and those costs will be reimbursed by the Taxpayers. Other than meeting the costs of the agents and any other advisors (including legal and accounting fees), the Taxpayers will not incur any other costs or expenses or make large capital investments in the sale of the Land.

37. The Taxpayers have not obtained any formal valuations of the Land.

38. The Taxpayers have no current intention to undertake any further activities of land or property development, nor to commence any enterprise of land or property development.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 25

Income Tax Assessment Act 1936 section 25A

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 15-15

Income Tax Assessment Act 1997 subdivision 70-10(1)

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 subsection 112-25(2)

Reasons for decision

Question 1

Summary

The proceeds from the proposed sale of land are not considered to be assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

The Taxpayers intend to enter into an agreement with a third party to act as their agent in the sale of their land.

Section 6-5 of the ITAA 1997 includes in your assessable income, where you are an Australian resident, all ordinary income which you derive during an income year. Ordinary income is defined as income according to ordinary concepts.

Ordinary income generally includes income that arises in the ordinary course of a taxpayers business. However, in certain circumstances proceeds not within the ordinary course of the taxpayers business may form part of their ordinary income.

We therefore need to determine whether the proceeds to be received from the sale of the Land are:

● assessable ordinary income under section 6-5 of the ITAA 1997 as income from carrying on a business of property development; or

● assessable ordinary income under section 6-5 of the ITAA 1997 as income from an isolated commercial transaction with a view to a profit.

The decisions in Casimaty v. Federal Commissioner of Taxation (1997) 97 ATC 5135; 37 ATR 358 (Casimaty) and McCorkell v Federal Commissioner of Taxation 98 ATC 2199; (1998) 39 ATR 1112 (McCorkell) demonstrate that if a taxpayer does not intend to make a profit when he or she acquires farming land then the likelihood that any profit made on the eventual sale of land as ordinary income is greatly diminished.

The Commissioner accepts that where the activities are no more than the realisation of a capital asset as per the Casimaty and McCorkell cases, any realised gain on the transaction will be a capital gain under the CGT provisions in Part 3-1 of the ITAA 1997.

However, profits made on the sale of land can still be ordinary income if the activities become a separate business operation or commercial transaction.

For example, in Case W59 89 ATC 538; 20 ATR 3728 Deputy President Mr I.R. Thompson considered the appellant was carrying on a business of subdividing, developing and selling land. This was because the appellant had a significant degree of personal involvement in planning, negotiating with local councils and other bodies, obtaining finance, employing contractors, and selling the blocks. In addition to this the subdivision and development was substantial (the land had been divided into over 180 small blocks).

Similarly, the decision in Federal Commissioner of Taxation v Whitfords Beach Pty Ltd 82 ATC 4031; (1982) 150 CLR 355, considered that in the operation of a business, it is relevant to take into account the purpose with which the taxpayer acted and, since the taxpayer was a company, the purposes of those who control it are its purposes. Therefore, in this case, when the shares in the taxpayer were purchased by three development companies, it transformed the company which held land for the domestic purposes of its shareholders to a company whose purpose was to engage in a commercial venture with a view to profit. In addition to taking other factors into consideration, including the scale and magnitude of the subdivision, it was concluded that the taxpayer's activities involved more than a mere realisation of an asset.

The principle has been established that 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. The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium). 

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) discusses the application of the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are ordinary income and therefore assessable under section 6-5 of the ITAA 1997.

According to Paragraph 16 of TR 92/3:

16. If a taxpayer not carrying on a business makes a profit, 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 Taxpayers did not purchase the land subject to sale with the intent of entering into a profit making transaction. Their intent at the time of purchase was to bring about an enduring benefit for the Taxpayers' primary production business. The sale of the Land is considered to be outside the ordinary course of the activities from which the Taxpayers' derive their income. The Land is being sold as a result of changes to the land use in the surrounding area and in order to provide funds to assist with ongoing medical assistance, the Land is not being sold in the ordinary course of carrying on a business and is therefore best described as an isolated transaction.

Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. In Myer Emporium, the High Court did not set out guidelines as to what constitutes a business operation or commercial transaction. However, the main indicia that has resulted from TR 92/3 and relevant case law is as follows:

(a) whether the landowner held the land for a considerable period of time prior to any subdivision and sale;

(b) whether the landowner conducted farming or other non-developmental activities, prior to beginning the process of developing and selling the land;

(c) whether the landowner originally acquired the land as a private residence or for recreational purposes;

(d) whether the landowner originally acquired the property as an investment, such as long term capital appreciation or to derive income;

(e) whether the land was originally acquired near the urban fringe of a major city or town;

(f) if the property has been recently rezoned, whether the landowners actively sought that rezoning;

(g) whether a potential buyer made any offers to the landowners before they commenced discussion to enter into a proposed or final development agreement;

(h) whether the landowners had tried to sell the land without subdivision;

(i) whether the landowner had any history of buying and profitably selling developed land or land for development;

(j) whether the operations will be planned, organised and carried on in a business-like manner;

(k) whether the landowners have changed their business activity relating to the land from one business to another (eg. from farming to property development);

(l) the scope, scale, duration and degree of complexity of the proposed development;

(m) who initiated the proposal to develop the land for resale;

(n) whether the development and pre-sale arrangement is sophisticated;

(o) whether the landowners will be actively involved in any development activities;

(p) the level of legal and financial control maintained by the landowners in the proposed or final development agreement; and

(q) the level of financial risk borne by the landowner in acquiring, holding and/or developing the land.

The selling of the Land by the Taxpayers' is considered below with reference to these factors:

● The Taxpayers have owned the Land for a significant period of time.

● The Taxpayers have lived and farmed the property continuously. The Taxpayers continued to use the Land in the same primary production business after the sale of the Land to the Buyer and throughout the period during which the Buyer was the registered owner of the land. The Taxpayers have also continued to use the Land in the same primary production business following the Acquisition.

● Profit making by development, subdivision or sale was not contemplated by any of the Taxpayers at the time of acquisition of their respective interests in the Land. The Taxpayers did not, prior to the sale of the Land to the Buyer or following the Acquisition, undertake any steps to develop or subdivide the Land and did not attempt to resell the Land following the initial sale to the Buyer.

● The Taxpayers' reason for selling the Land is the need to secure proceeds to fund the ongoing medical and support needs associated with looking after one of the Taxpayers and to realise the Land before it is no longer viable as a primary production asset.

● The Taxpayers will not be actively involved in the sale of the Land. The marketing and sale of the Land will be conducted by an external third party who has been appointed by the Taxpayers to arrange the sale.

● The Taxpayers do not bear the upfront costs of the sale of land. The third party will incur direct costs in advertising the Land for sale and those costs will be reimbursed by the Taxpayers. Other than meeting the costs of the third party and any other advisors (including legal and accounting fees), the Taxpayers will not incur any other costs or expenses or make large capital investments in the sale of the Land.

● None of the Land will be developed prior to a sale. The Land will be sold as is and it will be for a purchaser to develop the Land if they so choose.

● The Taxpayers have no previous involvement in property development.

● The Taxpayers have not applied for any rezoning of the Land. The Land was zoned as rural land at the time the Taxpayers sold the Land to the Buyer and the Land is still zoned as rural land.

As stated previously, whether an isolated transaction is business or commercial in character, and therefore whether the income from that transaction is assessable as ordinary income, will depend on the circumstances of each case. Taking into account the circumstances of the Taxpayer's purchase of the property and its use for primary production and the subsequent proposed sale of the Land, profits arising from the sale of the property will not be ordinary income from an isolated business or commercial transaction.

Conclusion

Based upon the facts of the proposed sale outlined above, in light of the factors set out in TR 92/3 and relevant case law, it is not considered the Taxpayers have ventured into a business activity of property development and sale of land for profit. Therefore, proceeds from the proposed sale of land will not be assessable ordinary income under section 6-5 of the ITAA 1997 as income from carrying on a business of property development.

We also do not consider that the passive involvement of the Taxpayers in the proposed sale amounts to them engaging in a business-like operation or commercial transaction. As such, the profits or gains to be made by the Taxpayers from the proposed sale of land will not be assessable ordinary income under section 6-5 of the ITAA 1997 as income from an isolated commercial transaction with a view to a profit.

Question 2

Summary

The Land is not considered to be trading stock, and as such, no part of the sale proceeds on the sale of the Land will be assessable as ordinary income under section 6-5 of the ITAA 1997.

Detailed reasoning

Division 70 of the ITAA 1997 deals with the tax treatment of trading stock. Trading stock is defined in subsection 70-10(1) of the ITAA 1997 to include:

(a) anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and

(b) live stock.

In relation to the circumstances in which land is considered to be trading stock, Tax Determination 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'? provides:

1. Land is treated as trading stock if:

(a) it is held for the purpose of resale; and

(b) A business activity which involves dealing in land has commenced.

2. Both the required purpose and the business activity must be present before land is treated as trading stock. The business activity is taken to have commenced when a taxpayer embarks on a definite and continuous cycle of operations designed to lead to the sale of the land.

3. It is not necessary that the acquisition of land be repetitive. A single acquisition of land for the purpose of development, subdivision and sale by a business commenced for that purpose would lead to the land being treated as trading stock.

For the reasons outlined in Question 1 above, the Land was not acquired in the Acquisition and held by the Taxpayers for the purpose of resale and was instead acquired out of necessity and held for the purpose of operating a primary production business. In addition, for the reasons outlined in Question 1 above, the Taxpayers are not conducting a business activity which involves dealing in land.

Accordingly, the Land was not acquired by the Taxpayers as trading stock and was instead acquired as a capital asset.

As the Land is not trading stock, no part of the sale proceeds on the sale of the Land will be assessable as ordinary income under section 6-5 of the ITAA 1997.

Question 3

Summary

The proceeds from the sale of Land will be subject to taxation under the Capital Gains Tax (CGT) provisions in Parts 3-1 and 3-3 of the ITAA 1997.

Detailed reasoning

A capital gain or a capital loss may arise if a capital gains tax event (CGT event) happens to a capital gains tax asset (CGT asset).

Section 108-5 of the ITAA 1997 provides that a 'CGT asset' is any kind of property, or a legal or equitable right that is not property.

Division 104 of the ITAA 1997 lists all the 'CGT events' that could happen in relation to a CGT asset. Subsection 104-10(1) of the ITAA 1997 provides that CGT event A1 happens if you dispose of a CGT asset.

A CGT asset is disposed of if a change of ownership occurs from you to another entity (subsection 104-10(2) of the ITAA 1997). The time of the CGT event is specified in subsection 104-10(3) of the ITAA 1997 and, as is relevant, is the time when you enter into the contract for the disposal.

Subsection 104-10(4) of the ITAA 1997 states you make a capital gain if the capital proceeds from the disposal are more than the asset's cost base, and you make a capital loss if the proceeds are less than the assets reduced cost base. However, a capital gain or loss will be disregarded if the asset was acquired before 20 September 1985 (subsection 104-10(5) of the ITAA 1997).

Section 102-5 of the ITAA 1997 includes in assessable income an amount that is a net capital gain. A net capital loss cannot be deducted from your assessable income (subsection 102-10(2) of the ITAA 1997) but must be applied in determining your net capital gain.

For the reasons outlined in Question 1 above, the sale of the Land will be a mere realisation of a capital asset owned by the Taxpayers. CGT Event A1 will happen at the time the Taxpayers enter into the contract for the disposal/sale of the Land, on the basis that the Taxpayers will dispose of a CGT asset. In accordance with subsection 104-10(4) of the ITAA 1997, the Taxpayers will make a capital gain on the sale of the Land if the proceeds from the sale exceed the cost base of the Land, and will make a capital loss if the proceeds are less than the assets reduced cost base. The Land was acquired from the Buyer post-CGT, therefore the Land is not a pre-CGT asset and therefore no part of any capital gain or capital loss arising on the sale of the Land will be disregarded.