Edited version of your written advice

Authorisation Number: 1051366691226

Date of advice: 27 April 2018

Ruling

Subject: Property Development – Income vs Capital and GST registration

Issue 1

Question 1

Will the Sales Proceeds received by the Taxpayers be capital receipts?

Answer

Yes

Question 2

Will a capital gains tax (CGT) event A1 occur when each individual lot is sold?

Answer

Yes

Issue 2

Question 1

Will the Taxpayers be required to be registered for goods and services tax (GST)?

Answer

No

This ruling applies for the following periods:

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Income year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Husband and wife, collectively referred to as ‘the Taxpayers’, are the owners of the Land.

The Taxpayers are not registered for GST.

The Land was originally acquired by the Taxpayers in the 1990s.

The Land was acquired for the purpose of serving as the Taxpayers’ main residence, and still remains their main residence.

The Land comprises approximately 2 hectares on a single title, including two houses and surrounding grounds.

At the time of acquisition, the Land was zoned as rural.

The Land was rezoned to residential in 2013.

The Taxpayers were passive in the rezoning process and made no representation to Government or other relevant authorities to support the rezoning. The Taxpayers did not provide any informal or formal consent with respect to the rezoning.

The Land was advertised for sale approximately four years ago for a short period. The advertisement was arranged by a friend of the Taxpayers. While the Land was advertised, the Taxpayers never had a genuine intention to sell Land and no offers were received.

The Developer approached the Taxpayers in 20XX about the development of the Land, that is, bringing the land to a standard required by the local council and relevant authorities to then sell individual, subdivided blocks of land to the public.

Prior to being approached by the Developer, the market value of the property as a single title was around $xxx based on comparable sales.

The Developer also separately approached the landowners of the neighbouring property with respect to the development of their land.

A planning permit application (Application) for subdivision was lodged with the local council. The Application for subdivision was made in conjunction with the neighbouring property.

The Land is to be subdivided as part of a two stage development. The first stage will be the development and subdivision of the Land into 41 lots. The second stage will be the subdivision of the neighbouring land into 37 lots. No subdivided lots will straddle both parcels of land.

The subdivision will facilitate the Land being used for residential purposes. The key works to be carried out include:

● Clearing of the Land

● Construction of roads

● Construction of stormwater drainage systems

● Connection to infrastructure services.

The Taxpayers and the Developer entered into a Development Agreement (the Agreement).

The Taxpayers will remain the legal and beneficial owners of the Land during the course of the development.

The Taxpayers will not actively participate in the development process and will not be involved in the provision of the Project Services as defined in the Agreement.

The Taxpayers will be providing the Land as security for finance that the Developer will seek.

The Taxpayers have no previous experience or skill in property development.

The subdivided lots have not yet been marketed and no listing agent has been appointed.

The Agreement provides that:

● the Taxpayers have agreed to grant a licence to the Developer to enter the Land at any time to undertaken survey work or any of the Development Works.

● the parties agree that the Developer will undertake a staged subdivision of the Land to allow for residential lots to be created and then sold to facilitate the realization of the value of the Land and undertaken the necessary processes to develop the Land in accordance with council town planning permit conditions.

● the Taxpayers have resolved to dispose of the Land and to maximise the Sale Proceeds from the disposal of the Land and has requested the Developer to develop the Land in accordance with the Agreement.

● the purpose of the Agreement is to enable the Land to be subdivided and sold and not developed further, specifically no buildings will be erected on the Land or part thereof under the Agreement

● the Guarantors guarantee the proper completion of the Development, adherence to the Planning Process, the proper operation and completion of the Project by the Developer, the obtaining of the Plan of Subdivision within the powers provided to the Developer and generally the responsibilities and obligations of the Developer.

Under the Agreement, the Developer:

● must carry out and complete the Project so as to maximise the Revenue in accordance with the Project Objectives.

● provide the Project Services set out the Agreement

● pay the Project Costs, which is non-refundable by the Taxpayers in the event of default by the Developer.

● apply for all permits, applications and approvals.

● will undertake and complete, at the Developer’s cost, all preliminary civil construction works required to obtain registration of the Plan of Subdivision.

● reimburse the Taxpayers for council rates from the signing of the Agreement.

● will appoint agent(s) to market the sale of the Land.

● obtain finance to fund works related to Project Costs.

● may register a caveat and a mortgage secured by the Land only and non-recourse the Taxpayers.

● must demonstrate to the Taxpayers prior to the start of civil construction on site works and construction finance drawdown that the Sales Proceeds minus Project Costs guarantees surplus funds in excess of $7,200,000.00 required to be paid as the Owners Proceeds and a favourable Tax Ruling.

● reimburse the Taxpayers for any costs or liabilities incurred in entering any contracts.

● Pursuant to the Agreement, order of distribution of proceeds from the sale of Land will be as follows:

● Repayment of monies owed under the Taxpayers’ 1st mortgage plus development costs.

● The Owners Proceeds being $xxx paid promptly from each lot settlement.

● The balance as the Development Fee.

The Taxpayers will receive a fixed amount, being the Owners Proceeds of $xxx. Any variation in proceeds is a risk borne by the Developer and therefore the Developer is not guaranteed the $xxx.

Relevant legislative provisions

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Reasons for decision

All further legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated.

Issue 1

Question 1

Summary

The share of the Sales Proceeds from the proposed sale of Land to be received by the Taxpayers are considered a mere realisation of a capital asset and therefore are capital receipts.

Detailed reasoning

The issue for determination is whether the proceeds from the subdivision and sale of the Land will be treated as:

● assessable ordinary income under section 6-5 from carrying on a business of property development, or from a profit-making undertaking or scheme, or

● the mere realisation of a capital asset, where the receipts are treated as a capital gain under Part 3-1 and Part 3-3.

The determination of the appropriate tax treatment of the proceeds of sale of property will be a question of fact and degree determined on a case by case basis. The facts specific to each transaction must be discretely and closely examined.

Mere realisation v disposal in the course of business or profit making undertaking

Generally, when you enter into an arrangement to develop and sell your land, the key question to be determined is whether the ultimate sale is a ‘mere realisation’, or whether it is a disposal either in the course of business or as part of a profit-making undertaking or scheme.

Where the disposal of land is considered a ‘mere realisation’ of a capital asset, the receipts will not be considered ordinary income but will be treated as a capital gain to which the capital gains tax (CGT) rules under Part 3-1 and Part 3-3 will apply.

A sale that is more than a ‘mere realisation’ will be on revenue account and assessable under section 6-5.

The expression 'mere realisation' is used to distinguish a mere realisation from a business operation or a commercial transaction carrying out a profit-making scheme. Profits made on the realisation of capital assets can still be ordinary income if the activities go beyond a mere realisation and instead become a separate business operation or commercial transaction even though the taxpayer did not have a purpose of profit-making at the time of acquiring the asset.

In McClelland v FC of T 70 ATC 4115, the Privy Council held that the question to be answered was whether the facts revealed a mere realisation of capital, albeit in an enterprising way, or whether they justify a finding that the taxpayer went beyond this and engaged in a trade of dealing in the asset, albeit on one occasion only.

Lord Justice Clark, in distinguishing between proceeds that is mere realisation of capital and ordinary income, stated in California Copper Syndicate v Harris (1904) 5 TC 159 at pp 165-166 that:

…What is the line which separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be determined being – is the sum of the gain that has been made a mere enhancement of values by realising a security, or is it a gain made in an operation of business in carrying out a scheme of profit-making?

A leading authority on ‘mere realisation’ of a capital asset is the case of Scottish Australian Mining Co. Limited v FCT (1950) 81 CLR 188 (Scottish Australian Mining). In this case, the taxpayer was formed for the purpose of mining coal and purchased land in 1863 to carry on that business. After mining operations ceased in 1924, the taxpayer subdivided the land; built roads and a railway station; made sites available for schools, churches and parks; and sold the subdivided parcels at a considerable profit. The court held that the profits should not be included in assessable income as the taxpayer had not acquired the land for the purpose of profit-making by sale, nor was it engaged in the business of selling land. It had merely taken ‘the necessary steps to realise the land to the best advantage’.

In FC of T v Whitfords Beach Pty Ltd 82 ATC 4031, Gibbs CJ said (at p.4034) that:

When the owner of an investment chooses to realize it, and obtains a greater price for it than he paid to acquire it, the enhanced price will not be income within ordinary usages and concepts, unless, to use the words of the Lord Justice Clerk in California Copper …'what is done in not merely a realisation or charge of investment, but an act done in what is truly the carrying on, or carrying out, of a business'.

In Statham & Anor v FC of T 89 ATC 4070; (1988) 20 ATR 228 (Statham), the Court held that the sale by subdivision of farming land constituted a mere realisation of the asset and not proceeds of a business. The Court said (at ATC pp 4076-4077; ATR pp 235-236) that:

The questions which the Tribunal had to determine were whether the subdivision of the land in question amounted, on the one hand, merely to the advantageous and enterprising realisation of a capital asset or, on the other hand, to a business of land development carried on by the owners (sec 25(1)) or to an undertaking or scheme in which an essential element was the purpose of profit-making (sec 26(a)).

The Court considered the following factors in making the decision:

(a) the owners were at first content to sell the land as one parcel, but were unable to do so;

(b) no moneys were borrowed by them, although a guarantee was provided to Kingaroy Shire Council by way of bank guarantee;

(c) only very limited clearing and earthworks were involved;

(d) the owners relied upon the Kingaroy Shire Council to itself to carry out road works, kerbing, electricity and sewerage works which were required to be done;

(e) the owners did not erect buildings on the land; not even, for example, a site office;

(f) they had no business organisation, no manager, no office, no secretary, and no letterhead;

(g) Dr Bickerton maintained his medical practice;

(h) the owners did not advertise the land for sale;

(i) apart from the Kingaroy Shire Council's activities, the owners did not engage any contractors, although they did obtain some professional advice;

(j) the books kept in relation to the sales of land were kept by Mrs Bickerton; and

(k) the land was sold simply by listing it with the local real estate agents.

The Court found the sale had a very few hallmarks of a business enterprise and held that what occurred was:

the mere realisation, by the most advantageous means, of the asset which the owners had on their hands when they abandoned the intention of farming the subject property.

In the case of Abeles and Anor v Federal Commissioner of Taxation (1991) 91 ATC 4756 (Abeles), the taxpayers embarked upon a business-like and efficient program of subdivision through their agent. The Court found that you cannot engage the services of professionals and hide behind them; they are your agent and their conduct is your conduct.

Application to your circumstances

Having regard to the cases highlighted above, the Commissioner is of the view that the Taxpayers are merely realising a capital asset.

Taking into consideration the Taxpayers’ intent under the Agreement and the content of the Agreement, the Commissioner considers that the circumstances surrounding the proposed sale of subdivided Land indicate that there was no intention or purpose on the part of the Taxpayers to carry on a business of development and sale of land.

This position is primarily supported by the following facts:

● The Land was not originally purchased for the purpose of subdivision; it was purchased to serve as their main residence.

● The Taxpayers will receive a fixed amount of $xxx from the sale of the Land – an amount determined by the Developer and accepted by the Taxpayers. Any variation in proceeds is a risk borne by the Developer.

● While the Land will be used as security for the Project Costs, it is the Developer that bears the financial risk of the Project.

● The Guarantor is a director of the Developer, and guarantees the proper completion of the Development and generally the responsibilities and obligations of the Developer under the Agreement.

● The Taxpayers will not actively participate in the development process and will not be involved in with the provision of the Project Services.

● The Taxpayers have not previously been involved in the subdivision and sale of land or activities that would otherwise amount to property development activities.

While the Taxpayers will be engaging the Developer to undertake the development of the Land, the Commissioner considers the Taxpayer’s situation different from the facts in Abeles. In Abeles, the taxpayer assumed the financial risk and the arrangement that was entered into was in the nature of a joint venture where costs and expenses were shared. This can be distinguished from the Taxpayers’ case, where it is the Developer that will be assuming the financial risk, with all financing and costs to be borne by the Developer. Any upside in the profit from the project will be entirely enjoyed by Developer, with the Taxpayer expected to derive a fixed amount of $xxx irrespective of the actual cost or final selling price of the lots.

The fact the Taxpayer does not bear the risk or enjoy the fruits from the development project, would make it difficult for the Commissioner to claim (as was claimed in the case of Abeles) that the activities of the Developer, being the development of the lots and selling of the subdivided lots to third parties (i.e. the business of subdivision development & sale) are the activities of the Taxpayer. The Agreement is not creating an agent and or joint venture relationship with the Developer. The Taxpayer’s activities in respect to this development project are not that of joint venturer, but are passive with the Agreement merely providing for the sale of the land for a predetermined price of $xxx at a future time (yet to be determined).

Therefore the Commissioner considers that the Taxpayers in their proposed endeavour to sell the land will not be carrying on, or carrying out, a business, but will be merely realising the Land via the Agreement. Consequently, any gains realised on the proposed sale of the subdivided Land will constitute capital receipts.

Question 2

Summary

As the sales proceeds are considered capital receipts, the disposal of each individual lot will result in CGT event A1 occurring.

Detailed reasoning

Section 102-20 provides that a capital gain or loss can only be made if a CGT event occurs.

In accordance with section 104-10(1), CGT event A1 happens if you dispose of a CGT asset.

CGT assets are defined in section 108-5, which includes any kind of property. Land is specifically included as an example of a CGT asset in section 108-5. As such, each individual lot, being land, is considered a CGT asset.

Subsection 104-10(2) provides that the disposal of a CGT occurs if there is a change of ownership from one entity to another. The sale of land will result in a change of ownership of the land.

The timing of the CGT event is when you enter into the contract for the disposal or if there is no contract, when the change of ownership occurs (subsection 104-10(3)).

Accordingly, the disposal of each individual lot will result in CGT event A1 occurring, with the timing of that event being when each of those individual contracts are signed to sell those respective individual lots.

Issue 2

Question 1

The Taxpayers are not registered for GST.

Section 23-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides you are required to be registered for GST if:

(a) you are carrying on an enterprise, and

(b) your GST turnover meets the registration turnover threshold.

The Taxpayers will be making supplies of subdivided lots of land.

Of relevance is whether their activities of the Taxpayers amount to carrying on an enterprise. If the Taxpayers are not carrying on an enterprise, they are not required to be registered for GST.

Enterprise

Section 9-20 of the GST Act provides that the term ‘enterprise’ includes, among other things, an activity or series of activities done in the form of a business or in the form of an adventure or concern in the nature of trade. The phrase ‘carry on’ in the context of an enterprise includes doing anything in the course of the commencement or termination of the enterprise.

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) provides guidance on what activities will amount to an enterprise.

Paragraph 234 of MT 2006/1 distinguishes between activities done in the form of a ‘business’ and those done in the form of ‘an adventure or concern in the nature of trade’. In particular:

′ A business encompasses trade engaged in on a regular or continuous basis.

′ An adventure or concern in the nature of trade may be an isolated or one-off transaction that does not amount to a business, but which has the characteristics of a business deal.

We do not consider the Taxpayers activities are in the form of a business and will consider whether they are done in the form of an adventure or concern in the nature of trade.

Paragraphs 178, 247-257 and 265 of MT 2006/1 set out a number of factors that can be looked at to determine whether a particular set of activities amounts to an enterprise.

We have reviewed the Taxpayers factual circumstances and have taken into consideration the following factors:

● The Taxpayers purchased the Land in the 1990s for the purpose of serving as their main residence and it remains their main residence.

● The Taxpayers were passive in the rezoning of the Land to residential.

● The Taxpayers have no previous experience or skill in property development and did not actively seek to sell the Land. They were approached by the Developer who made them an offer. In addition the land adjacent to their land is also being developed.

● The Taxpayers will not actively participate in the development process and will not be involved in the provision of the Project Services as defined in the Agreement.

● The Developer will seek their own finance however the Taxpayers will be providing the Land as security for the finance.

● The Taxpayers will have no control over the subdivision and will receive the fixed sum of $xxx regardless of the outcome of the subdivision. In addition they will not share in any additional gain made from the sales of the subdivided lots of land.

● No buildings will be erected on the Land.

After considering all the facts and circumstances we consider that the Taxpayers activities amount to a ‘mere realisation’ of a capital asset, and do not constitute the carrying on of an enterprise.

As we consider that the Taxpayers sales of the subdivided lots of land are not in the course of an enterprise, the Taxpayers are not required to be registered for GST.