Edited version of your written advice

Authorisation Number: 1051358690017

Date of advice: 6 April 2018

Ruling

Subject: Capital gains tax

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

Are you entitled to disregard any capital gain which you make on the sale of each of the subdivided lots?

Answer

No

Question 3

Will you be liable to pay capital gains tax on the compensation payment you received for the compulsory acquisition of part of your property?

Answer

No

Issue 2

Good and Services tax

Question 1

Is your supply of your subdivided Lots a taxable supply pursuant to section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

No

This ruling applies for the following periods:

Income year ended 30 June 2018

Income year ended 30 June 2019

Income year ended 30 June 2020

Income year ended 30 June 2021

Income year ended 30 June 2022

The scheme commences on:

1 July 2017

Relevant facts and circumstances

You and your spouse (You) acquired the original parcel of land prior to 20 September 1985.

The original parcel of land was XX ha in size when you acquired it.

The original parcel of land was zoned RU 4 when you purchased it.

You constructed a temporary dwelling on the property and later built another dwelling which you have used as your main residence.

You have never used the property to produce income.

Rezoning and acquisition of land

The original parcel of land was rezoned in 2011 by the relevant State Government.

The rezoning included a mixture of SP2 Infrastructure (drainage), SP2 Infrastructure (Road), RE1 Public Recreation and R2 Low Density Residential.

The part of the land you ultimately retained (the retained land) was rezoned low density residential.

In late 2015, you received notification that the Council intended to compulsorily acquire part of your land.

You did not wish to retain the part of the original parcel not acquired by Council, due to its small size and irregular shape.

You requested Council acquire the whole parcel of land.

In early 2017, Council issued a Proposed Acquisition Notice for part of the land.

You received a letter of offer from Council for the purchase of the part of the land it intended to acquire (the acquired land) in early 2017.

The total compensation payable under that offer was $X, XXX, XXX.

You did not accept that offer.

An Acquisition Notice was published for the acquired land in mid 2017.

The acquired land includes the dwelling used as your main residence.

Compensation

The amount of Compensation you will receive for the acquired land was determined by the Valuer General in late 2017.

Decision to subdivide land

You made a decision to subdivide the part of the land which would not be compulsorily acquired in early 2017, after you were informed that Council would not acquire the entire parcel.

You have not considered building a new dwelling to use as your main residence on the retained land due to your age and your understanding that the rates for the property would be higher under the new zoning.

Considerations regarding sale of retained land

You have never marketed the retained land in its entire state.

You received an offer to purchase the retained land from your neighbour in mid 2017.

You did not accept your neighbour’s offer to purchase the retained land because you believed that it was unreasonable, with reference to the market value you had been advised, and a previous offer from Council made prior to the decision to acquire only part of the land, and which was consequently withdrawn.

You did not attempt to negotiate a higher price for the property.

Subdivision

Property developers have purchased other land in your street. These developers all made direct contact with property owners to purchase their land.

All land surrounding your property that is not to be acquired by Council is or will be developed.

There is a combination of R2 & R3 development in the local area.

You did not receive any contact or interest from developers in purchasing the retained land.

When you made informal enquiries with developers, they indicated that they were interested larger parcels of land.

Your neighbour is coordinating the subdivision of the neighbouring block of land

Your neighbour made an offer for you to join the subdivision of the neighbouring lot, which you accepted.

You have not previously been involved in any property developments or subdivisions, However, your neighbour has indicated that they have been.

Design of subdivision

You will undertake a full subdivision and development of your land including building and naming roads, building retaining walls and providing for drainage, as well as installing services such as water and sewage.

The same activities will be undertaken on the neighbouring block.

You will not retain any of the subdivided lots.

You will not build any dwellings on the subdivided lots.

A Development Application (DA) for the subdivision was lodged in late 2017.

The subdivision will be undertaken in two stages.

You have not yet received development consent.

Land swap

The boundaries of your proposed lots XXX and XXX in the plan of subdivision extend on to the neighbouring lot.

The boundaries of lots YYY and YYY, which will be attributed to the neighbouring land, extend on to your land.

You will engage in a ‘land swap’ to facilitate the subdivision and sale of lots XXX, XXX, YYY and YYY.

You will dispose of your interest in the part of your land which is to be included in lots XXX and XXX.

You will acquire approximately the same amount of land from the neighbouring land, which is to form part of your lots XXX and XXX.

The land swap will be formalised as part of your contractual agreement with the owner of the neighbouring land.

Agreement with Neighbour

You have not formalised your agreement with your neighbour in writing.

Your verbal agreement with your neighbour is that once the subdivision is approved, separate tenders for work will be sought for the two properties. You will be responsible for accounts which relate to your land.

Where costs cannot be attributed to either property separately, the costs will be apportioned on an XX% / XX% basis calculated with reference to the total number of lots.

You expect that the same contractors will undertake the work on both properties and that you may take advantage of savings through economies of scale.

Invoices for work completed will be sent directly to you for payment.

Your neighbour has engaged the services a surveying firm, who will submit the Development Application and engage contractors to undertake the necessary works.

Agreement with surveying firm

You did not have a written agreement with the surveying firm at the time of application for private ruling.

You provided consent for the surveying firm to act as your agent in lodging Development Applications and other associated actions with Council in mid 2017.

You expect that the surveying firm will maintain a set of accounts with regards to development costs, as well as manage legal documents with contractors.

Tenders and management of contractors will also be completed by the surveying firm.

The surveying firm will also deal with any insurance policies which relate to the subdivision.

You will track and document any other expenses or legal agreements which do not concern the surveying firm, such as personal tax and legal advice or services.

Costs of subdivision

You have provided an estimate of the costs of the subdivision. You will adjust your estimated costs once requirements for development consent are known.

The subdivision will be funded through a combination of the proceeds of the compulsory acquisition and loans from family members.

Undeveloped market value of retained land

The retained land was valued at approximately $X,XXX,XXX in 2017 by a private valuer in an open market valuation which was prepared for the purposes of the compulsory acquisition.

The value of the retained land was arrived at with a market value for the land of $X,XXX,XXX, reduced by XX%, to account for ‘loss of flexibility, road & subdivision location’.

The valuation report refers to the partial acquisition of the original parcel as rendering the retained land difficult to develop, and identifies joint subdivision with your neighbour as the ‘only option to dispose of residue after acquisition’.

The report also refers to the marketing material used to sell the lots.

Sale of subdivided lots

Your subdivided lots have been marketed and sold by a real estate agent engaged by your neighbour, at the instigation of your neighbour, prior to the works commencing.

Contract of sale

The contracts of sale contain special conditions relating to the vendor’s rights to rescind.

Formation of partnership and GST registration

You registered a partnership. The partnership applied to be registered for GST in late 2017, on the basis of conducting an enterprise of property development – land development or subdivision, after you were advised that it would be likely that you would be required to register for GST on the sale of the property.

You will not transfer the land to the name of the partnership for the purpose of sale, and will you not charge GST or claim input tax credits unless you are required to register.

You will not transfer the land to the name of a company for the purpose of sale.

Taxpayer involvement in scheme

All meetings with Council have been attended by your neighbour and the surveying firm.

Your family member attended a meeting with the surveying firm in late 2017 prior to the DA being lodged.

You have undertaken the following activities in preparation for the subdivision:

● engaging the services of a consultant to undertake a contamination and salinity assessment to be lodged with the Development Application;

● meeting with your neighbour to discuss the development and cost sharing;

● meeting with a solicitor to prepare contracts for the sale of the lots;

● meeting with the real estate agent regarding sale prices for the lots; and,

● meeting with a tax accountant to obtain tax advice.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 Section 9-5

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 15-15

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 103-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-10(5)

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Section 112-30

Income Tax Assessment Act 1997 Section 995-1

State Environmental Planning Policy (Sydney Region Growth Centres) 2006

Reasons for decision

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

Summary

The sale of the subdivided lots will be the mere realisation of a capital asset, and accordingly the capital gains tax provisions will apply to the disposals.

Detailed reasoning

Income

Where the profit from the sale of a property is 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.

The question of whether a business is carried on is a matter of fact and degree to be determined in the circumstances of each case.

The courts have developed a series of indicators that are applied to determine the matter on the particular facts. No one factor is decisive. The indicators must be considered in combination and as a whole. Whether a ‘business’ is carried on depends on the large or general impression.

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? (TR 97/11) sets out the relevant factors, being:

● 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.

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) provides that if a taxpayer carrying on a business makes a profit from a transaction or operation, that profit is income if the transaction or operation:

● is in the ordinary course of the taxpayer's business - provided that any gross receipt from the transaction or operation is not income; or

● is in the course of the taxpayer's business, although not within the ordinary course of that business, and the taxpayer entered the transaction or operation with the intention or purpose of making a profit; or

● is not in the course of the taxpayer's business, but:

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

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

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:

● as the capital of a business; or

● 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.

Factors which may be relevant to the determination of whether an isolated transaction amounts to a business operation or commercial transaction are:

● the nature of the entity undertaking the operation or transaction

● the nature and scale of other activities undertaken by the taxpayer;

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

● the nature, scale and complexity of the operation or transaction

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

● the nature of any connection between the relevant taxpayer and any other party to the operation or transaction

● if the transaction involves the acquisition and disposal of property, the nature of that property, and

● the timing of the transaction or the various steps in the 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.

Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number (MT 2006/1) also considers isolated transactions involving the sale of real property in the context of whether an enterprise is being carried on.

Paragraph 265 of MT 2006/1 provides a list of factors that provide assistance in determining whether activities are a business or an adventure or concern in the nature of trade (a profit-making undertaking or scheme being the Australian equivalent). If several of these factors are present it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are:

● there is a change of purpose for which the land is held

● additional land is acquired to be added to the original parcel of land

● the parcel of land is brought into account as a business asset

● there is a coherent plan for the subdivision of the land

● there is a business organisation - for example a manager, office and letterhead

● borrowed funds financed the acquisition or subdivision

● interest on money borrowed to defray subdivisional costs was claimed as a business expense

● there is a level of development of the land beyond that necessary to secure council approval for the subdivision

● buildings have been erected on the land.

Mere realisation

Profit on the mere realisation of a capital asset is not considered to be income, even if the taxpayer goes about the realisation in an enterprising way.

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…

Application to your circumstances

Upon weighing all of the relevant facts in relation to each of the indicators above, on balance, it is arguable that you were carrying on a business of property development or in the alternative, a profit-making undertaking. However, due to the unique circumstances of your case, and in particular the circumstances surrounding the compulsory acquisition of part of the land, we do not consider the activity has been undertaken as a business or profit making undertaking. Accordingly, the disposal of the subdivided lots will be considered to be the mere realisation of a capital asset.

Conclusion

The sale of your subdivided lots will not be assessable as income. The sale of the subdivided lots will be a mere realisation of a capital asset, being the disposal of a long-held privately owned property which was used as your main residence for the entire ownership period. Any gain made on the sale of the property will be assessable under the capital gains tax provisions of the ITAA 1997.

Question 2

Are you entitled to disregard any capital gain which you make on the sale of each of the subdivided lots?

Answer

No

Summary

You are not entitled to disregard the capital gain which you make in relation to the sale of all of the subdivided lots, because you will acquire part of lots XXX and XXX as post CGT assets under the land swap arrangement. Therefore, the capital gains tax provisions will apply to the sale of these lots, to the extent that they were acquired post CGT.

The disposal of the remaining lots, and part of lots YYY and YYY will not attract CGT consequences as you are considered to have acquired your interest in these lots when you acquired the original parcel of land, prior to the commencement of CGT.

Detailed reasoning

Capital gains tax

The capital gains tax (CGT) provisions contained in Part 3-1 and Part 3-3 of the ITAA 1997 include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own.

Any capital gain or loss that relates to an asset which you acquired prior to 20 September 1985 is disregarded.

Subdivision

When a CGT asset is split into 2 or more assets, such as when land is subdivided, the division of the land into subdivided blocks is not a CGT event.

The date you acquired the subdivided blocks is the date you acquired the original parcel of land. Where the original land was acquired before 20 September 1985, each new lot retains its pre-CGT status, and any capital gain or capital loss made on its disposal is disregarded.

Change in ownership interests

Taxation Determination TD 92/148 Income tax: capital gains: is there a disposal and an acquisition where joint owners of a block of land subdivide that land into two smaller blocks with each owning one block? (TD 92/148) provides that as a result of a transaction after subdivision, where each owner who had a 50% share of the un-subdivided land now has sole ownership of an individual block, each owner is taken to have disposed of his or her 50% interest in the subdivided block which is now owned by the other.

In that case, there has been a corresponding acquisition by each owner from the other of that interest in the land now owned by each of them which was previously owned by the other.

TD 92/148 notes that if the original land had been acquired pre-CGT, there would be no disposals subject to CGT. However, in respect of each subdivided block, each individual owner would now hold (in that case) a 50% pre-CGT interest and a 50% post-CGT interest.

Application to your circumstances

In your case, you acquired the original parcel of land prior to the commencement of CGT. The original parcel of land has since been divided into three lots for the purpose of compulsory acquisition. Because subdivision itself is not a CGT event, the lots retained their pre CGT status throughout this process.

You will subdivide the lot which you retained. You will complete a “land swap” to facilitate the design of the subdivision.

You will dispose of part of your land to the owner of the neighbouring lot, to be included in their proposed lots YYY and YYY.

As consideration for disposing of your interest in this land, you will acquire land which belongs to the neighbouring lot, to be included in the boundaries of your proposed lots XXX and XXX. This area will be approximately the same size as the land that you dispose of.

Because you are taken to have acquired your ownership of the lots when you acquired the original parcel of land, the part of the land which you dispose of to the owner of the neighbouring lot will maintain its pre CGT status when you dispose of your ownership interest in it.

However, the interest in the part of lots XXX and XXX that you will acquire in return for the land you dispose of will be new assets which you acquired after 20 September 1985.

If you acquire land on or after 20 September 1985 that is adjacent to land that you already owned as at 20 September 1985, it is taken to be a separate CGT asset from the original land, even if you amalgamate the two titles.

You will therefore hold a pre CGT interest and a post CGT interest in each of lots XXX and XXX, to the extent that the land has been acquired post CGT.

Accordingly, when you dispose of your ownership interest in lots XXX and XXX you will be liable to pay CGT on the portion of the asset which you have acquired post CGT.

Although you will not pay money to acquire the land, the market value of the property you gave, or are required to give, in respect of acquiring the land will be included in the cost base of the assets when calculating any capital gain. Other allowable costs relating to the part lots may be included in their cost base, apportioned on a reasonable basis.

Conclusion

You may disregard any capital gain you make on the disposal of your interest in the subdivided lots which you acquired prior to 20 September 1985.

You will be liable to pay CGT on the disposal of assets which you acquired after 20 September 1985. In your case, this will apply to the parts of lots XXX and XXX which you will acquire as part of the land swap arrangement.

Question 3

Will you be liable to pay capital gains tax on the compensation payment you received for the compulsory acquisition of part of your property?

Answer

No

Summary

You are not required to pay capital gains tax on the compensation related compulsory acquisition of the lots, because the compensation relates wholly to an asset which you acquired prior to 20 September 1985.

Detailed reasoning

There may be capital gains tax consequences when you receive compensation.

The Commissioner's policy on the treatment of compensation payments is set out in Taxation Ruling TR 95/35 Capital gains: treatment of compensation receipts (TR 95/35).

TR 95/35 states that a compensation receipt, or compensation, includes any amount (whether money or other property) received by a taxpayer in respect of a right to seek compensation or a cause of action, or any proceeding instituted by the taxpayer in respect of that right or cause of action, whether or not:

● in relation to any underlying asset;

● arising out of Court proceedings; or

● made up of dissected amounts.

An underlying asset is defined as the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity.

The look-through approach is the process of identifying the most relevant asset. It requires an analysis of all of the possible assets of the taxpayer in order to determine the asset to which the compensation amount is most directly related. It is also referred to as the underlying asset approach.

If there is more than one underlying asset, the relevant asset is the asset which leads directly to the payment of the amount of compensation.

Paragraph 3 of TR 95/35 defines an undissected lump sum compensation receipt as any amount of compensation received where the components of the receipt have not been and cannot be determined or otherwise valued or reasonably estimated. If the amount of compensation received is an undissected lump sum, the whole amount is treated as being consideration received for the disposal of the right to seek compensation.

Paragraph 4 of TR 95/35 provides that if an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying asset, or part of an underlying asset, the compensation represents consideration received on the disposal of that asset. In these circumstances, we consider that the amount is not consideration received for the disposal of any other asset, such as the right to seek compensation.

Paragraph 6 of TR 95/35 similarly provides that if an amount of compensation is received by a taxpayer wholly in respect of permanent damage suffered to a post-CGT underlying asset of the taxpayer or for a permanent reduction in the value of a post-CGT underlying asset of the taxpayer, and there is no disposal of that underlying asset at the time of the receipt, we consider that the amount represents a recoupment of all or part of the total acquisition costs of the asset.

Paragraphs 5 and 9 of TR 95/35 provide that compensation received by a taxpayer for the disposal or permanent damage or reduction in value of an asset has no CGT consequences if the underlying asset to which it relates was acquired by the taxpayer before 20 September 1985.

Application to your circumstances

In your case, you received an amount of compensation which included specified amounts for the market value of the acquired land, disturbance, and disadvantage resulting from relocation. An unspecified amount for the reduction in value to the part of the land which you retained was included in the payment for market value of the acquired land. As the payment you received relates to more than one CGT event the payment must be reasonably apportioned across each of the CGT events.

Following the underlying asset approach, the retained land and the acquired land are clearly identifiable as the assets which have either been disposed of, have suffered permanent damage, or have been permanently reduced in value, giving rise to the payment of compensation.

Because you acquired your ownership interest in the subdivided lots at the time you acquired the original parcel of land, they retain their pre CGT status and are therefore exempt assets. You will not be liable to pay capital gains tax on the compensation receipt.

Issue 2

Good and Services tax

Question 1

Is your supply of the subdivided Lots a taxable supply pursuant to section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

No

Reasoning

Section 9-5 of the GST Act provides that you make a taxable supply if:

(a) you make the supply for consideration

(b) the supply is made in the course or furtherance of an enterprise that you carry on

(c) the supply is connected with the indirect tax zone (Australia), and

(d) you are registered, or required to be registered for GST.

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed.

We have determined at Question 1 that your subdivision does not constitute the carrying on of a business (enterprise) or a profit making undertaking. Accordingly, the disposal of the subdivided lots will not be made in the course or furtherance of an enterprise that you carry on. As paragraph 9-5(b) of the GST Act will not be satisfied, your supply of the subdivided lots will not be a taxable supply.