Edited version of your written advice

Authorisation Number: 1051309242218

Date of advice: 16 November 2018

Ruling

Subject: Revenue or Capital - Property Subdivision

Question

Will the proceeds from the sale of the individual lots at the property at an address, be subject to the Capital Gains Tax provisions in Part 3-1 of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following periods:

1 July 2017 to 30 June 2018

1 July 2018 to 30 June 2019

The scheme commences on:

1 July 2017

Relevant facts and circumstances

The Taxpayers purchased the Property as joint tenants on a date in 201W an amount.

From 201V 201W the Taxpayers rented the house to an unrelated third party.

In 201W the Taxpayers demolished part of the house and began to rebuild. The work was finished in 201X. The Taxpayers spent an amount on the rebuilding.

The Taxpayers were approached by a relevant local Council to consider rezoning the Property to general residential in 201W. This would have increased the number of lots the Property could be subdivided into and consequently the value. After initially attending consultation, the Taxpayers opted not to participate, and retained the low density zoning.

In 201W, while the rebuilding was underway, the Taxpayers moved into the house and made it their main residence. The Taxpayers incurred further costs in fencing, landscaping and constructing a shed after the work on the house was completed.

From a date in 201Y the Taxpayers became engaged in a series of disputes with their neighbour over water drainage as a result of the work the Taxpayers had done on the Property. This dispute continued a date in 201Z, and included threats of violence against the Taxpayers and their family.

One of the Taxpayers experienced health issues and as a result of the disputes they decided to move out and sell the Property.

The Taxpayers moved out on a dare 201Z and rented the Property to an unrelated party.

The Taxpayers now live in a different property that is owned by one of the Taxpayers in equal shares with a colleague, and pay partial rent to the other owner. The Taxpayer and their colleague previously subdivided the rear part of this property, and sold the vacant land in 201Z.

The Taxpayers have previously invested a third share in a small property development with their relatives. The Taxpayers have retained ownership of one third of the townhouses in this development as long term rental investments.

The Taxpayers received no offers to purchase the Property as a whole.

The Taxpayers will subdivide the Property into seven smaller blocks. The Taxpayers will build an access road along one boundary to provide access to each of the seven blocks. One block will contain the existing house.

The remaining six blocks will have power, communications, water and sewerage connected. There will be excavation of drainage works.

The Taxpayers will engage a project manager to undertake the subdivision and associated activities, and will not be personally involved in supervision of the project. As well as using their savings, the Taxpayers will borrow money to help finance the project.

The Taxpayers will not be involved with marketing or selling the blocks personally.

The market value of the Property, including the house, before subdivision is an amount. Projected costs for the subdivision are an amount.

The Taxpayers expect to sell the block with the house on it for an amount and the remaining six blocks for an amount each. Total proceeds are projected to be an amount.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Part 3-1

Reasons for decision

The Taxpayers hold the Property on capital account and any gain or loss on the subdivided lots will be subject to the Capital Gains Tax (CGT) provisions.

Detailed reasoning

There are three ways profits from property sales can be treated for taxation purposes:

1. As ordinary income under section 6-5 of the ITAA, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock;

2. As ordinary income under section 6-5 of the ITAA, on revenue account, as a result of entering into a profit-making undertaking or scheme;

3. As statutory income under the capital gains tax legislation.

Under section 6-5 of the ITAA 1997, your assessable income includes the ordinary income you derived directly or indirectly from all sources, during the income year. Additionally, section 15-15 of the ITAA 1997 includes profit arising from the carrying on or carrying out of a profit-making undertaking or plan. However, this provision does not apply to a profit that is assessable as ordinary income under section 6-5 of the ITAA 1997, or which arises in respect of the sale of property acquired on or after 20 September 1985.

Carrying on a business

Subsection 995-1(1) of the ITAA 1997 defines ‘business’ as ‘including any profession, trade, employment, vocation or calling, but not occupation as an employee’.

The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the particular facts.

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? provides the Commissioner’s view of the factors used to determine if you are in business for tax purposes. In the Commissioner’s view, the factors that are considered important in determining the question of business activity are:

● whether the activity has a significant commercial purpose or character

● whether the taxpayer has more than just an intention to engage in business

● whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

● whether there is regularity and repetition of the activity

● whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business

● whether the activity is planned, organised and carried on in a businesslike manner such that it is described as 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 sporting activity.

No one factor is decisive. The indicator must be considered in combination and as a whole. Whether a ‘business’ is carried on depends on the large or general impression.

As to when such a business is taken to have commenced, Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'? also states that a 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.” That is, the land will become trading stock when you are demonstrably fully committed to the business of land development. When that occurs is determined by a consideration of the facts of the case.

Trading Stock

Section 70-10 of the ITAA 1997 provides that trading stock includes anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business.

Taxation Determination TD 92/124 states that land will be treated as trading stock for income tax purposes if it is held for the purpose of resale and a business activity which involves dealing in land has commenced. Where such a business exists, the proceeds from the sale will be assessable under section 6-5.

Isolated transactions

Alternatively, Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income discusses profits on isolated transactions and the application of the principles outlined in the decision of the Full High Court of Australia in FCT v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693. This ruling states that profits on isolated transactions may be income.

Profit from an isolated transaction will be ordinary income where:

● the intention or purpose of a taxpayer 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 on a business operation or commercial transaction.

● Taxation Ruling 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.

Profits on the sale of subdivided land can therefore be income according to ordinary concepts within section 6-5 of the ITAA 1997 if the taxpayer’s subdivisional activities amount to a business operation or commercial transaction.

Paragraph 42 of Taxation Ruling TR 92/3 provides that if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either:

a) as the capital of a business; or

b) 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 or a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income although the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

At paragraphs 56 and 57, Taxation Ruling TR 92/3 explains that a profit is income where it is made in any of the following situations:

● a taxpayer acquires property with a purpose of making a profit by whichever means prove most suitable and a profit is later obtained by any means which implements the initial profit-making purpose; or

● a taxpayer acquires property contemplating a number of different methods of making a profit and uses one of those methods in making a profit; or

● a taxpayer enters into a transaction or operation with a purpose of making a profit by one particular means but actually obtains the profit by a different means.

CGT provisions

CGT event A1 in section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you dispose of each subdivided block. You will make a capital gain if the capital proceeds from the disposal of the block are more than the cost base of the block. You will make a capital loss of those capital proceeds are less than the reduced cost base of the block.

Subsection 104-10(5) of the ITAA 1997, however, contains an exception, where any capital gain or capital loss made is disregarded if the asset was acquired before 20 September 1985.

Application to the taxpayers’ situation

The Taxpayers purchased the Property with the intent of making it their main residence and living on it. The Taxpayers spent a considerable amount of time and money in rebuilding the cottage that was on the Property when they purchased it into a house that they wished to live in. The Taxpayers moved into the house on a date in 201W, and a date in 201Z they lived there.

At the time that the Taxpayers purchased the Property, the planning rules would have allowed a subdivision of the property into several blocks. It is likely that the Taxpayers were aware of this potential for subdivision at the time of purchase, but it was not their primary motivation for the purchase. Shortly after the Taxpayers purchase, the state planning rules were changed to allow subdivision of low density residential land into blocks greater than 0.2 ha, potentially allowing them to subdivide into a larger number of blocks.

The Taxpayers rejected the opportunity to rezone the Property to general residential in 201W. This is evidence that the Taxpayers intended to continue to live on the Property and were not attempting to maximise its resale value at that time.

From a date in 201Y the Taxpayers became embroiled in a dispute with their neighbour. By a date in 201Z the Taxpayers feared for their family’s safety and health, and they made a decision to move out and sell. At this point the Taxpayers were faced with having potentially overcapitalised the Property with the house renovations and risked not recovering their money. The Taxpayers came up with the scheme to subdivide the Property to maximise their return.

The Taxpayers engaged a project engineer to investigate subdivision. They have drawn up plans to divide the Property into a number of lots. This is at the low end of the scale for property development. The Taxpayers will be conducting the development in their own names rather than through a commercial structure. The Taxpayers are spending a little over half the value of the Property on the development. All of these factors do not indicate a commercial undertaking.

While the scheme to subdivide and sell the Property is undoubtedly an attempt to maximise the return on the sale of the Property, it is clear that the Taxpayers intention at purchase was to treat the Property as their main residence. They passed up the opportunity to rezone the Property to a more valuable zoning in 201W.

The Taxpayers intention in holding the Property changed in 201Z when they moved out and began to investigate their options to sell, however given the small scale of the development and the particular circumstances that lead to the change of intention, we consider that they will continue to hold the Property on the capital account.