Edited version of your written advice

Authorisation Number: 1051446410298

Date of advice: 13 December 2018

Ruling

Subject: Subdivision of property and capital gains tax (CGT)

Question 1

Will the sale of the subdivided blocks of land amount to the mere realisation of a capital asset?

Answer

No

Question 2

Will any profit from the sale of the subdivided blocks of land be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as an isolated profit making transaction?

Answer

Yes

This ruling applies for the following periods:

1 July 20xx to 30 June 20xx

1 July 20xx to 30 June 20xx

1 July 20xx to 30 June 20xx

1 July 20xx to 30 June 20xx

1 July 20xx to 30 June 20xx

The scheme commences on:

xx September 20xx

Relevant facts and circumstances

The property is currently vacant land and prior to inheritance, the property was occasionally used as farming land.

Xxxx inherited the property, and are tenants in common with equal shares of the property. You listed it for sale in late 20xx and removed it from the market in late 20xx.

You have not previously been involved in land development, and the development proposes to subdivide the land into smaller blocks and sell at a profit.

You signed a Development Agreement (the agreement).

The development of the land is for predominantly residential, with associated open space and civil infrastructure. The land will be rezoned as part of the development.

The subdivision is expected to establish xxxx blocks and estimated each block to be sold for $xxxx at a cost of development of approximately $xxxx each.

The project is expected to take xx years, with completion due by XX December xxxx, as outlined in schedule 1 of the agreement.

You estimate $xx would be received if your land was not developed, given the existing zoning constraints.

Relationship between the participants

The Development Manager (Manager) agrees to undertake the land development with the intent of maximising the sum of the Sale Proceeds and in return for the payment of the Development Management Fee.

Under the agreement, the participants agree that their rights, duties, obligations and liabilities to third parties are several and not joint and several or collective. Each participant is responsible only for its obligations arising under, or consequent upon, the agreement. Each participant is liable only for such share of the costs, expenses, risks and liabilities resulting from operations carried out under the agreement.

Management of the development

The agreement outlines the following:

● You irrevocably granted to the Manager the exclusive right to undertake the development including the right to subdivide, develop, market and sell, or arrange the subdivision, development, marketing and sale, of the land during the term in accordance with the terms of the agreement.

● During the term, you must not grant management rights to any other person.

● When a developed lot is sold, the project manager, acting on your behalf, arranges for the sale of the freehold interest in the developed lot owned by you to be made by you to the purchaser. The certificate of title for the lot is transferred from you as owner to the purchaser in accordance with normal land sale procedures.

● Sale proceeds are deposited by the Manager into an account created and maintained by the Manager in accordance with the agreement.

● You have authorised the Manager to distribute the Sales Proceeds in accordance with the agreement.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Detailed reasoning

There are three ways profits from a land sub-division can be treated for taxation purposes:

(1) As ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock; or

(2) As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of an isolated commercial 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; and/or

(3) As statutory income under the capital gains tax 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

In your situation, the Commissioner is satisfied you are not carrying on a business of property development. The repetition, scale and volume of your activity are not of the same nature as is ordinarily carried on by the property developer who is carrying on a business.

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 - Income tax: whether profits on isolated transactions are income, 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:

(a) the nature of the entity undertaking the operation or transaction

(b) the nature and scale of other activities undertaken by the taxpayer

(c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained

(d) the nature, scale and complexity of the operation or transaction

(e) the manner in which the operation or transaction was entered into or carried out

(f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction

(g) if the transaction involves the acquisition and disposal of property, the nature of that property, and

(h) 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 – The New Tax System: the meaning of entity carrying on an enterprise for the purpose of entitlement to an Australian Business Number, provides a list of specific factors relevant to isolated transactions and sales of real property. If multiple 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 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; 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.

A number of cases have considered the factors relevant in determining if a property development In the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135 (Casimaty), the legal principles in relation to the subdivision of land were discussed at length. In concluding his judgment that the subdivision of the taxpayer was a mere realisation of a capital asset, Justice Ryan said:

A related consideration is the fact that the development and subdivision of (the property) was undertaken piecemeal in response to the exigencies of increasing debt and deteriorating health. No coherent plan was conceived at the outset for the subdivision of the whole property, even in stages, to maximise the return from the aggregate of the individual lots.

Nor did the taxpayer undertake any works on, or development of, the land beyond what was necessary to secure the approval by the municipal authorities of the successive plans of subdivision and enhance the presentation of individual allotments for sale as vacant blocks. Had he constructed dwelling houses, internal fencing or other improvements, it would have been easier to impute to him an intention to carry on a business of land development and improvement.

Similarly, it was found in Statham & Anor v Federal Commissioner of Taxation ATC 4070 (Statham & Anor) that the disposal of the taxpayer’s subdivided land was a mere realisation of a capital asset. In that case, the taxpayers decided to sell the land following a failed business; after lodging plans for subdivision with their local council, they left development works for the subdivision in the hands of the council.

Your circumstances can be distinguished from the above cases due to the scale of the activities, and the commercial nature on which the agreement is based. Unlike in Casimaty, where the taxpayer undertook the development in a piecemeal manner with no coherent plan, in this case under the agreement there is a clear intention over the next X years to develop the property into X blocks in a deliberate and organised manner. The commercial agreement between you and the developer is unlike the nature of the arrangement in Statham and Anor.

The change of intention

Whilst we acknowledge that your acquisition of the property was not with the intent of subdivision, you have however changed that intention subsequent to abandoning your intention to dispose of the property in its current undeveloped state.

TR 92/3 gives an example; 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.

Application to your circumstances

The Commissioner considers the following factors important in determining that your development activities were not a mere realisation of a capital asset.

● You changed the purpose of the land;

● There is a coherent plan for the subdivision of the land;

● The agreement you signed for the subdivision is commercial and complex in nature.

● You have entered into a commercial agreement to subdivide and rezone the land;

● You intend to make a profit from the property development;

● There is a business organisation in charge of the development (the development of the land has been given to professional land developers).

The Commissioner considers that the land development agreement is an isolated profit making operation and that the profits are assessable as ordinary income under section 6-5 of the ITAA 1997.