Edited version of your written advice

Authorisation Number: 1051455143988

Date of advice: 19 December 2018

Ruling

Subject: Property - subdivision - Am I in business? – isolated transaction – mere realisation.

Question 1

Will the profit from the sale of the subdivided blocks of land be treated as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will the profit from the sale of the subdivided blocks of land be treated as statutory income under the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The taxpayer is a Unit Trust (the taxpayer).

The taxpayer has had no history of subdivision or development activity in relation to real property.

The investors/unitholders in the Unit Trust have previously undertaken several land acquisitions for long term investment by way of rental returns via another entity. Land was acquired and subdivided, and residential construction erected for the sole purpose of producing rental income for the long term.

The taxpayer is not registered for GST.

The other entity is not registered for GST.

The taxpayer purchased the Property with contracts for sale exchanged in late 20XX. The sale was not treated as a taxable supply for GST purposes.

A Development Application (DA) was lodged with the local Council for the proposed subdivision of the property (the Property). The application proposed the subdivision into two blocks.

There was an existing owner occupied residential dwelling on the property.

A short time later the Council issued a DA approval for the subdivision of the Property subject to certain conditions. Those conditions included a Driveway Condition which stated:

The full length of the driveway shall be designed with a minimum Xmm thick reinforced concrete and minimum of Ym wide pavement/kerb face to kerb face width….

Design of the access handle shall comply with the following requirements of Rural Fire Services….

A subdivision plan was submitted indicting potential dwelling footprints. The DA was limited to subdivision and demolition aspects only.

In mid 20XX a Construction Certificate issued.

The taxpayer acquired the Property on the expectation that subdivision approval would be likely and a dwelling suitable for long term rental return could be built on each lot under a complying development certificate (CDC).

The taxpayer’s appraisal was that the residential dwellings could be rented out and yield approximately $XX per annum in rent based on current market conditions. Under these circumstances, the property would be generating positive cash flow for the foreseeable future the taxpayer contemplated holding it.

The taxpayer was aware of similar small scale residential projects in surrounding suburban areas involving the acquisition of property, subsequent subdivision and construction of dwellings for the purpose of generating ongoing rental income. The taxpayer aimed to replicate this approach.

The taxpayer also looked to replicate the approach that had been undertaken by the other entity.

The taxpayer significantly favoured going through DA for subdivision, but not for dwelling construction. It preferred building on the subdivided lots under a CDC in order to potentially minimise dwelling construction difficulties in the XYZ foreshore, including potential development objections/submissions and neighbour complaints.

The taxpayer’s appraisal of the Property’s rental potential was a cash flow positive investment.

In mid 20XX, physical works limited to demolition, clearing and provision of essential services commenced in accordance with the DA approval. Driveway construction also commenced.

It was discovered that the neighbouring property’s retaining wall illegally encroached on the property’s access driveway by up to Xcms. This had not been disclosed to the taxpayer.

The removal of the retaining wall could potentially compromise the structural integrity of the dwelling on the neighbouring property.

The illegal encroachment had significant adverse impacts on the taxpayer’s ability to comply with the DA approval.

The taxpayer received a quote of $W for additional works including the removal of the illegal encroachment as well as shoring up the retaining wall. Contractors began to require release and indemnity deeds from the neighbouring property owners and the taxpayer before any works could commence.

Construction costs in respect of subdivision works were projected to increase by $XX.

An application for Modification to Development Consent was lodged.

The taxpayer believed that these unexpected circumstances took away or at the very least, severely limited the option of building on the subdivided lots under a CDC.

Quotes the taxpayer had obtained from home builders were either increased or withdrawn.

The taxpayer decided that given the issues arising from the illegal encroachment including further costs, additional time, resource requirements and the likelihood a CDC would not be available or its availability would be significantly limited, the build and let approach was no longer feasible.

Shortly after, physical works on the Property began to be wound down and eventually ceased. Dwelling construction had not begun. Construction of the access driveway had commenced as required by DA approval. Provisions for the supply of usual residential services had also been established for the purpose of making the subdivided lots serviceable.

The Council approved the amendments requested to the DA, however by this stage the taxpayer had determined it was no longer viable to continue any construction activity on the Property. Their re-appraisal of the project indicated it would now be cash flow negative.

Later changes to the Coastal management SEPP confirmed the taxpayer’s concerns that building under a CDC would be difficult if not impossible.

The taxpayer engaged a real estate agent to sell the vacant subdivided blocks.

Delays were encountered with Council and the registration of the subdivision.

Since then the subdivided blocks have been sold.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 112-25

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Legislative references referred to herein are from the ITAA 1997.

Summary

The proceeds from the sale of Lot 79 and Lot 79A will not be ordinary income and not assessable under section 6-5. The proceeds represent a mere realisation of capital assets which will fall for consideration under the capital gains tax provisions in Part 3-1.

Detailed reasoning

Question 1

There are three ways profits from property sales can be treated for taxation purposes:

1. As ordinary income under section 6-5, 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, 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; or

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

Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case.

We will consider each of these in relation to your situation as follows:

Section 995-1 states the term ‘business’ includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

To determine whether an activity, or series of activities, amounts to a business, the activity needs to be considered against the indicators of a business established by case law.

In the High Court of Australia case of Hope v. Bathurst City Council (1980) 144 CLR 1; (1980) 29 ALR 577; (1980) 80 ATC 4386; [1980] HCA 16, a business was described in the following ways:

It is the words “carrying on'' which imply the repetition of acts and activities which possess something of a permanent character.

…activities engaged in for the purpose of profit on a continuous and repetitive basis.

Transactions were entered into on a continuous and repetitive basis for the purpose of making a profit…manifested the essential characteristics required of a business.

For a one-off land subdivision to be considered to be of a business or commercial nature, it is usually necessary that a taxpayer has the purpose of profit-making at the time of acquiring the property.

The Commissioner’s view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 (TR 97/11) which uses the following indicators to determine whether a taxpayer is carrying on a business:

● whether the activity has a significant commercial purpose or character;

● whether there is repetition and regularity of the activity;

● whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business;

● whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at 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 a 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.

Application to your circumstances

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

Therefore, any gain made on the disposal of the subdivided lots will not be assessable as ordinary income from the carrying on of a business.

Isolated business transactions

Profits from isolated transactions will be assessable as ordinary income where the intention or purpose in entering into the transaction was to make a profit or gain and the transaction was entered into and the profit was made in the course of carrying out a business operation or commercial transaction.

Taxation Ruling TR 92/3 (TR 92/3) sets out the Commissioner’s view of the general principles and factors that have been considered in determining whether an isolated transaction is of a revenue nature.

The direction provided within TR 92/3 and in case law indicates that profits in this context are more likely to be considered ordinary income if they are made in the ordinary course of carrying on a business. Further, ordinary income may be derived from an isolated transaction which becomes commercial in nature, or as a result of profits on a transaction in which the initial intention was to make a profit on sale.

Paragraph 36 of TR 92/3 notes that 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. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment.

Application to your circumstances

In this case, the taxpayer had not acquired the Property for the purpose of subdivision and resale. Instead, it was originally acquired for the purpose of subdividing, developing and holding for long term investment via rental returns. The taxpayer’s intentions in relation to the Property changed due to the discovery of the neighbour’s encroaching retaining wall. The subsequent cost, time and resource requirements necessary to comply with the development application approval, and the likelihood that a CDC would not be available meant that the development became cash flow negative and the taxpayer decided not to proceed.

The subdivision is not considered to be an isolated business transaction or a property development undertaking.

Question 2

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

CGT event A1 happens if you dispose a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property.

When a CGT asset (the original asset) is split into 2 or more assets (the new assets), such as when land is subdivided, the subdivision of the land into subdivided blocks is not a CGT event. Each new subdivided block retains the acquisition date that the original asset was acquired on.

You make a capital gain if the proceeds from the sale of the CGT asset are more than the asset’s cost base. You make a capital loss if the proceeds from the sale of the CGT asset are less than the cost base of the asset.

Application to your situation

As the taxpayer’s activities are not viewed as being either those of someone carrying on a business of subdivision and sale of land, or undertaking an activity of a commercial nature, it is considered that any gain made on the disposal of the subdivided lots will represent a mere realisation of the Property to its best advantage.

Therefore, any gain arising from the sale of the subdivided lots will be accounted for under the CGT provisions in Part 3-1 and 3-3. Each of the subdivided lots will be viewed as having been acquired on the same date that the Property was acquired. Any capital gain made on the sale of the subdivided lots will be calculated in accordance with the CGT provisions.