Edited version of your written advice

Authorisation Number: 1051382077404

Date of advice: 6 June 2018

Ruling

Subject: Subdivision and sale of property

Question 1

Is the profit derived from the proposed subdivision and sale of the land (excluding the main residence) derived from the mere realisation of a capital asset and hence assessable as a capital gain under Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Is the profit attributable to the main residence eligible for the main residence exemption?

Answer

Yes

This ruling applies for the following periods:

Years ended 30 June 2018 – 2022

The scheme commences on:

01 July 2017

Relevant facts and circumstances

Both taxpayers are specialists in a particular industry, and have worked in that industry since completing the required education.

Neither taxpayer has had any experience in property development or activities of a similar kind.

Property 1

The taxpayers purchased property 1 approx 20 years ago, and lived there from that time. This property was their main residence until recently. The size of this property is less than 2 hectares.

The taxpayers have a number of children who pursued a particular hobby from a young age. The property enabled the children to be able to do this.

When the youngest child moved out of their home to attend university, and stopped the hobby, the taxpayers decided to move to another place of residence as their current home was too big. They sold all of the assets relating to the childrens’ hobby, and slowly moved their personal property from their home to the new residence during the year. However, they have chosen to keep this property as their main residence.

Property 2

The taxpayers purchased this property in approx. 17 years ago. This property was adjacent to their main residence and was purchased to increase the land available for the childrens’ hobby.

When the property was purchased, there was a house towards the back of the property. The taxpayer’s contemplated demolishing this house, however the ability to rent the house presented an opportunity to assist paying off the mortgage on the property. The property has been rented since the year of purchase.

Property 3

A few years ago, the taxpayers had the opportunity to purchase this property. This vacant land was purchased with the intention of improving it and allowing more room for the childrens’ hobby.

However, the plan to improve this property did not eventuate as the children started university studies, and slowly lost interest in the hobby. The property remained vacant.

All three properties share a private road which connects them to the main road of the suburb. There are only a small number of other properties that can access this private road.

Proposed subdivision and sale

In late 2016, the taxpayers found the contact details a property consultant in their letter box. With the children growing up and only one remaining at home at that time, the taxpayers were curious about the potential value of the properties, so decided to contact them.

After a few discussions with the consultant, the taxpayers engaged them as a consultant to assist them to prepare a preliminary review. The consultant was involved in the following tasks:

● Engaging a consultant to prepare a feasibility report;

● Engaging a firm to prepare a Site Investigation Report Highest and Best Use Assessment; and

● Engaging Lawyers to revisit the titles of the properties and any potential issues/restrictions on the properties.

The taxpayers, in consultation with the consultant, agreed that:

● The land will be subdivided into lots and sold.

● The consultant will act as a consultant only, driving the whole process and charging consulting fees.

● The consultant will be responsible for engaging any contractors

● The taxpayers will not be involved in the day to day subdivision or sales process. They will continue to run their businesses in the industry they are involved in.

● Although the consultant will oversee the whole process, the sale of land will be completed by a carefully selected real estate agent.

● The taxpayers’ previous main residence will not be demolished. Instead it will be kept and sold as an existing property, although with much less land than previously.

● The taxpayers will use their own funds and bank loans to support the funding requirement.

The taxpayers have also engaged professional advisors to communicate with the bank in order to facilitate funding. The taxpayers will most likely contribute at least 50% of the projected costs from their own funds.

Relevant legislative provisions

Section 6-5 of the ITAA 1997

Section 102-5 of the ITAA 1997

Section 102-20 of the ITAA 1997

Section 104-10 of the ITAA 1997

Section 108-5 of the ITAA 1997

Section 118-110 of the ITAA 1997

Section 118-120 of the ITAA 1997

Section 118-145 of the ITAA 1997

Reasons for decision

Question 1

Summary

The disposal of all three properties is considered to be the mere realisation of capital assets. Any profits attributable to the two properties which were not the main residence will be assessable as capital gains.

Detailed reasoning

A gain from the disposal of property will usually be treated in one of two ways, as assessable income on revenue account (under section 6-5 of the ITAA 1997), or as a disposal of a capital gains tax (CGT) asset on capital account.

A gain form the disposal of property will be stamped with the character of income where:

1. it is made in the ordinary course of carrying on a business; that is, where "what... is done is not merely a realisation or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business": California Copper Syndicate v Harris (1904) 5 TC 159 at pp.165-166; and London Australia Investment Company Limited v Commissioner of Taxation (1976-1977) 138 CLR 106;

2. it is made outside of the ordinary course of a taxpayer's business from an isolated (or "extraordinary") transaction entered into with the intention or purpose of making a profit. (This is the so-called first limb or strand of the decision in Commissioner of Taxation v The Myer Emporium Ltd (1987) 163 CLR 199 at pp.209-210); or

3. it is made from an isolated or one-off business venture or profit-making scheme: Commissioner of Taxation v Whitfords Beach Pty Ltd (1982) 150 CLR 355.

In respect of isolated or one-off business ventures or profit making schemes, Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) at paragraphs 33 – 36 states:

33. The views expressed in Whitfords Beach and Myer that profits from isolated transactions can be assessable income must be looked at in the context of the facts involved in those cases. In Myer, the taxpayer was carrying on a large business at the time it entered into the transactions and, in Whitfords Beach, the taxpayer company embarked on a substantial business venture.

34. Nevertheless, there is a strong line of reasoning through the judgments in Whitfords Beach and Myer that suggests that profits made by a taxpayer who enters into an isolated transaction with a profit-making purpose can be assessable income. In Myer, at 163 CLR 213; 87 ATC 4369; 18 ATR 699-700, the Full High Court had this to say about the nature of profits from isolated transactions:

'It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of acquisition of acquiring for the purpose of profit-making by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realisation. But it is quite another thing if the decision to sell is taken by way of implementation of an intention or purpose, existing at the time of acquisition, of profit-making by sale, at least in the context of carrying on a business or carrying out a business operation or commercial transaction.'

35. A profit from an isolated transaction is therefore generally assessable income when both of the following elements are present:

(a) The intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain.

(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.

36. 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. The expression 'mere realisation' is used to contradistinguish a business operation or a commercial transaction carrying out a profit-making scheme (Myer at 163 CLR 213; 87 ATC 4368-4369; 18 ATR 699-700). If a transaction satisfies the elements set out in paragraph 35 it is generally not a mere realisation of an investment.

From the above it can be concluded that where there was an intention from the outset to sell a property development at a profit and where the property development is made in the course of carrying on a business or as a commercial transaction, these activities are of a revenue nature and therefore assessable under section 6-5 of the ITAA 1997.

Did the sale form part of the Taxpayers’ ordinary business activities?

In this case, neither taxpayer has carried on a business of property development, nor anything that could be considered related to this activity. Both taxpayers work in a different industry and have always worked in that industry. It is clear that the proposed development and sale of the properties do not form part of any ordinary business activities of the taxpayers.

At the time of purchase was there a profit making purpose?

Where a profit making activity is a one off or isolated transaction and not part of the taxpayer’s ordinary business activities, the activities may still be revenue in nature and assessable under section 6-5 of the ITAA 1997 where at the time of purchase there was a profit making purpose.

When considering the intentions of a taxpayer at the time of acquiring the land or a property development, paragraph 38 of TR 92/3 states:

38. The intention or purpose of the taxpayer (of making a profit or gain) referred to in Myer 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. This is implicit from what the Court said, in the passage quoted in paragraph 30 above:

'..it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income..'.

From the provided facts and an objective analysis of what the taxpayers did upon acquiring the properties, it is evident that the taxpayers’ primary intention was to use the first block of land as a primary place of residence, and the remaining properties for private recreational purposes, although the 2^nd block ended up remaining as a long term rental property.

Other factors

Many other cases in the courts have considered whether subdivision and sale of land was a mere realisation of capital assets, albeit in an enterprising way, or whether the taxpayer went beyond this and conducted a profit-making scheme or transaction.

Some of the important elements for consideration that are consistent across the cases include:

● whether the taxpayer had any direct involvement in the subdivision and selling of the properties;

● whether the works carried out were no more than was necessary to secure the approval of authorities and enhance the presentation of the individual lots for sale;

● whether the taxpayer has a site office or building on the land;

● whether the taxpayer was involved in advertising or promoting the land for sale;

● whether there was any businesslike structure or organisation involved (eg. office, staff, letterhead, etc.);

● whether the taxpayer maintained their original occupation

● the size and scale of the activity, while important, is not the sole determining factor;

● subdividing and selling land in the most advantageous way does not necessarily change the character of the sale from a mere realisation of a capital asset.

In consideration of these factors to the taxpayers’ situation, the following points are noted:

● The taxpayers will have no direct involvement in the subdivision of the land, other than hiring the consultant to oversee the process.

● The taxpayers will continue to run their other businesses in their chosen industry.

● The consultant will engage any contractors to perform work required.

● The taxpayers will not erect a site office or any other buildings on the land.

● The taxpayers have no business structure or organisation (office, staff, etc.) in respect to the subdivision and sale of property.

● The taxpayers will not advertise or sell the land; this will be done by engaging real estate agents to do so.

● Although there is a substantial capital cost involved in the subdivision process, and bank finance will be used, at least half of the amount required will likely come from the taxpayers’ personal funds.

The Commissioner considers that the circumstances surrounding the proposed sale of the property indicate that the taxpayers’ decision to sell the properties constitutes a mere realisation of capital assets and is not connected with any intention to sell the properties from the outset as a profit making activity.

Therefore, any gains realised on the proposed sale of the properties will not constitute assessable income under section 6-5 of the ITAA 1997.

Section 102-5 of the ITAA 1997 provides that your assessable income includes an amount that is a net capital gain. Under section 102-20 of the ITAA 1997, you can only make a capital gain or loss when a CGT event happens. The gain or loss is made at the time of the CGT event and can only be made in respect of a CGT asset.

Note 1 of section 108-5 of the ITAA 1997 lists land and buildings as an example of a CGT asset. From the reasoning above, the Commissioner considered the decision to develop and sell the properties as a mere realisation of CGT assets. When the proposed sale of the properties occurs, CGT event A1 will happen as per section 104-10 of the ITAA 1997.

Therefore, any gains realised from the proposed sale of the 2^nd and 3rd properties will be a capital gain under section 102-5 of the ITAA 1997.

Question 2

Summary

Any gain attributable to the main residence is eligible for the main residence exemption.

Detailed reasoning

Section 118-110 of the ITAA 1997 provides that any capital gain or loss you make from certain CGT events that happen to a dwelling is disregarded if:

● you are an individual, and

● the dwelling was your main residence throughout your ownership period.

As per question one, it is considered that the disposal of this property is a CGT event A1 and, but for the exemption, would be considered assessable as a capital gain.

Section 118-120 of the ITAA 1997 extends the land under the dwelling to adjacent land up to 2 hectares, providing the land is used primarily for private or domestic purposes.

Section 118-145 of the ITAA 1997 provides that if a dwelling that was your main residence ceases to be so, you may choose to continue to treat it as if it was your main residence. Providing you do not use the dwelling for the purposes of producing assessable income (for example, renting out the property), you can treat the dwelling as your main residence indefinitely. If this choice is made, you cannot treat any other dwelling as your main residence while you apply this section.

In this case, property 1 was purchased as a main residence approx. 20 years ago, and used as such by the taxpayers and their family. This property is less than 2 hectares in size.

Although the taxpayers moved out recently, they have chosen to keep this property as their main residence as per section 118-145 of the ITAA 1997.

Therefore, all of the property of the main residence can qualify for the main residence exemption.