Edited version of your written advice

Authorisation Number: 1051441066492

Date of advice: 19 October 2018

Ruling

Subject: CGT - property subdivision

Question 1

Will the sale of the subdivided block from the property be treated as a taxable capital gain?

Answer

Yes

Question 2

Will the sale of the subdivided block from the property be treated as ordinary income?

Answer

No

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You and your spouse (you) purchased the property after 20 September 1985.

Settlement occurred within a year.

The size of the property is less than two hectares.

You provided the value of the property at the time of acquisition.

The property has not been rezoned since acquisition.

You acquired the property to build your main residence after demolishing the existing dwelling.

The property had an existing tenant who moved out after you purchased the property.

You were living in a leased property and moved to the property when your lease ended.

You considered subdividing the property and selling the vacant part of the property.

You lodged a development application with Council A to subdivide the block.

The land of the subdivided property is less than two hectares.

You provided the value of the property at the time of subdivision.

For the subdivision, you employed the services of several professional businesses and a real estate agent.

You personally undertook some minor activities.

The subdivided land has been sold.

You will build a new house on the land you retained.

You have never undertaken a subdivision or property development activity in the past and do not intend to undertake this type of activity again.

You have a business in in a field unrelated to property development.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 112-25

Reasons for decision

There are three ways profits from a land subdivision can be treated for taxation purposes:

1. As ordinary income under section 6-5 of the ITAA 1997, 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 1997, on revenue account, as a result of an isolated business transaction entered into by a non-business taxpayer or outside the ordinary course of business of a taxpayer carrying on a business, which is the commercial exploitation of an asset acquired for a profit making purpose.

3. As statutory income under the capital gains tax (CGT) legislation, (sections 10-5 and 102-5 of the ITAA 1997), on the basis that a mere realisation of a capital asset has occurred.

Ordinary income – carrying on a business

Section 995 of the ITAA 1997 states the term ‘business’ includes any profession, trade, employment, vocation or calling, but does not include 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 (TR 97/11) 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.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

Ordinary income – isolated or commercial transaction

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. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium).

Taxation Ruling TR 92/3 considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income.

TR 92/3 defines the term ‘isolated transactions’ as:

● transactions outside the ordinary course of business of a taxpayer carrying on a business; and

● transactions entered into by non-business taxpayers.

It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayers business but:

● the intention or purpose of the taxpayer in entering into the profit-making 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.

Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of subdivided land can be assessed as ordinary income within section 6-5 of the ITAA 1997. TR 92/3 lists the following factors to be considered:

● 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.

In addition to the above general factors, Miscellaneous Taxation Ruling MT 2006/1 provides a list of specific factors relevant to isolated transactions and sales of real property. If several of the 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 as follows:

● 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;

● 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; and

● buildings have been erected on the land.

No single factor is determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

Capital gains tax

Capital gains tax (CGT) is the tax that you pay on certain gains you make. You may make a capital gain as a result of a CGT event, happening to an asset in which you have an ownership interest. The most common CGT event, CGT event A1 (section 104-10 of the ITAA 1997), occurs when you dispose of your ownership interest in a CGT asset to another entity.

Application to your situation

In your case, you do not carry on a business of buying, selling or developing land.

We note the size of the land was large and suitable for subdivision. Within few months of moving in, you decided to subdivide the property. You planned to keep the part of the land with the house and sell the excess vacant land. It took few years to finalise the development and to sell the property. You made a small gain on the sale of the subdivided block. Despite your involvement with the development of the subdivision and the timing factors, the Commissioner considers that the scale of the subdivision lacks commercial in nature. You assigned most of the work to professionals. The property was not rezoned and was acquired for main residence purposes. No buildings have been erected on the subdivided block.

On balance, the sale of the subdivided lot is considered to be a mere realisation of a capital asset. Profits from the sale of the subdivided lot will not be assessable as ordinary income under section 6-5 of the ITAA 1997.The proceeds will be subject to the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997.