Edited version of your written advice

Authorisation Number: 1051462594260

Date of advice: 14 December 2018

Ruling

Subject: Capital Gains Tax – Main residence – absence choice - goods and services tax (GST) - subdivision

Question 1

Will the sale of subdivided lots (the lots) constitute a taxable supply pursuant to section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) for GST purposes?

Answer 1

No

Question 2

Will the proceeds from the sale of the lots be subject to the capital gains tax (CGT) provisions in Parts 3-1 and Parts 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 2

Yes

Question 3

Are you entitled to use the CGT main residence exemption absence rule in section 118-145 of the ITAA 1997?

Answer

No

Question 4

Can you apply the 50% general discount to the sale of the vacant land?

Answer

Yes

Question 5

Would the first element of the cost base of vacant subdivided land be determined using the market value of the property prior to the subdivision?

Answer

No

Question 6

Would the first element of the cost base of vacant subdivided land be determined using the market value of the property after the demolition and subdivision?

Answer

No

This ruling applies for the following periods:

For the financial year ended 30 June 2017

For the financial year ended 30 June 2018

For the financial year ending 30 June 2019

The scheme commences on:

1 July 2016

Relevant facts and circumstances

You are a resident of Australia for taxation purposes.

You purchased a property including a dwelling after 20 September 1985. The land area of the property is less than two hectares.

You moved into the dwelling when settlement occurred and treated the dwelling as your main residence.

Your employment requirements changed and you were forced to move to another geographical location and you moved out of the dwelling.

The dwelling was used to produce assessable income from when you moved out for over six years when you moved back into the dwelling. You were living in rented accommodation during this time and owned no other property.

You remained in the dwelling until you moved out of the dwelling for a further period in excess of six years. The property was used to produce assessable income for this time.

On a property inspection you became aware of damage that had occurred to the dwelling due to a faulty hot water system that had flooded the property. You were not aware of the damage as you were living in another state. As a result of the damage the property was dilapidated and uninhabitable.

You decided the dwelling would have been too difficult to re-lease without excessive amounts of renovations and repairs. You deemed it easier and more cost efficient to demolish the dwelling and subdivide the vacant land than to renovate.

The planned subdivision was approved by the local council.

You obtained a market value of the dwelling and property before the property was demolished.

The dwelling was demolished. The land was subdivided into two separate parcels of land, each comprising 50% of the original block. You used your personal savings to fund the subdivision activities.

You obtained a market value of the each of the subdivided blocks after the subdivision was completed.

You entered into a contract of sale for one of the subdivided lots.

The second subdivided lot sold two years later.

You have not undertaken any subdivision or land development activities prior to this subdivision. You do not intend to purchase any other properties with the intention to subdivide in the future.

You are not registered for GST.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 section 9-5

A New Tax System (Goods and Services Tax) Act 1999 paragraph 9-5(d)

A New Tax System (Goods and Services Tax) Act 1999 section 23-5

A New Tax System (Goods and Services Tax) Act 1999 section 188-25

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

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 subsection 112-25(3)

Income Tax Assessment Act 1997 subsection 112-30

Income Tax Assessment Act 1997 section 115-10

Income Tax Assessment Act 1997 section 115-20

Income Tax Assessment Act 1997 section 115-25

Income Tax Assessment Act 1997 section 116-25

Income Tax Assessment Act 1997 section 118-110

Income Tax Assessment Act 1997 section 118-115

Income Tax Assessment Act 1997 section 118-120

Income Tax Assessment Act 1997 section 118-130

Income Tax Assessment Act 1997 section 118-165

Reasons for decision

Question 1

Detailed reasoning

You must pay the GST payable on any taxable supply that you make.

Section 9-40 of the GST Act provides that you must pay GST on any taxable supply.

Section 9-5 of the GST Act provides that you make a taxable supply if:

a) you make the supply for consideration

b) the supply is made in the course or furtherance of an enterprise that you carry on

c) the supply is connected with the indirect tax zone; and

d) you are registered, or required to be registered.

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed.

You have demolished the dwelling, subdivided the land, and sold two lots.

The transactions will be made for consideration and the property is located in Australia therefore the transactions will meet paragraphs 9-5(a) and 9-5(c) of the GST Act. The supply of the vacant lots in your factual situation will neither be GST-free nor input taxed.

Enterprise

The term ‘carrying on an enterprise’ is defined in the GST Act and includes doing anything in the course of the commencement or termination of the enterprise.

Section 9-20 of the GST Act relevantly defines enterprise:

as 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 ATO’s view on the meaning of the term ‘enterprise’ is explained in details in 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.

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:

● 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.

This is the first time you have subdivided land, therefore, it is necessary to consider whether the subdivision activities carried out are in the form of a business or an adventure or concern in the nature of trade and carried out in a business-like and commercial manner.

The property was acquired and has been used by you as your main residence and as an investment property. However, paragraph 260 of MT 2006/1 explains that assets can change their character from being capital/investment assets to being trading/revenue assets, or vice versa, but cannot have a dual character at the same time.

Indicators of carrying on a business

Paragraph 178 of MT 2006/1 outlines the main indicators of carrying on a business and they are:

● a significant commercial activity

● a purpose and intention of the taxpayer to engage in commercial activity

● an intention to make a profit from the activity

● the activity is or will be profitable

● the recurrent or regular nature of the activity

● the activity is carried on in a similar manner to that of other businesses in the same or similar trade

● activity is systematic, organised and carried on in a businesslike manner and records are kept

● the activities are of a reasonable size and scale

● a business plan exists

● commercial sales of product; and

● the entity has relevant knowledge or skill.

In addition it is relevant to consider:

● the length of time the property had been held and to what purpose it had been put to in that time; and

● the personal involvement in the development activity.

In determining whether activities relating to isolated transactions are an enterprise or are the mere realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. This may require a consideration of the factors outlined above; however there may also be other relevant factors that need to be weighed up as part of the process of reaching an overall conclusion. No single factor will be determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

Application to your situation

In accordance with MT 2006/1 we considered the following factors and determined that that the property subdivision was not a business or adventure or concern in the nature of trade based on the following:

● You purchased a parcel of land with a dwelling on it and owned it for a total of 25 years. The dwelling and property was your main residence for approximately 10 years. It was also used to derive rental income for a period of 15 years, before demolishing the dwelling and subdividing the land into two vacant lots.

● When acquiring the dwelling, it was your intention to live in the dwelling as your main residence. This intention changed when you were required to move to another geographical location for employment. You retained the dwelling for rental purposes. During the second period of rental the structure of the dwelling deteriorated and was uninhabitable which resulted in your decision to demolish the dwelling.

● Your intention was always to maintain the dwelling on your land but for the damage to the dwelling, you would have continued renting this property.

● You have not completed any previous subdivisions or similar projects and do not intend to engage in any property subdivision activities in the future.

We consider that you are not carrying on an ‘enterprise’ as defined in section 9-20 of the GST Act and you are neither registered nor required to be registered for GST in regard to your activities relating to the sale of your vacant land.

The demolition and subdivision of the land into a small number of lots does not constitute running an enterprise and the sale of the subdivided lots will not be taxable supplies pursuant to section 9-5 of the GST Act.

Question 2

Detailed reasoning

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

1. As ordinary income under section 6-5 of 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, on revenue account, as a result of entering into a profit-making undertaking or scheme (including an isolated transaction).

3. As statutory income under the capital gains tax legislation.

Isolated profit making 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 case).

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.

Paragraph 1 of 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 (TR 92/3 paragraph 6):

● 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.

The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property.

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.

Application to your situation

Taking all of the available facts into consideration, the proceeds received from the sale of the subdivided land were not derived in the course of carrying on a business of buying, selling or developing land. You have held the property for a substantial period of time, during which the dwelling on the property was used as your main residence and to earn assessable income.

Therefore, the proceeds you receive from the development of your property are not ordinary income and not assessable under sections 6-5 of the ITAA 1997. Similarly, proceeds from the sale of the subdivided land are not considered an isolated profit making transaction, but a mere realisation of a capital asset and will be considered statutory income and subject to the capital gain tax provisions within the ITAA 1997.

Questions 3, 4, 5 and 6

Detailed reasoning

Main residence exemption

Subdivision 118-B of the ITAA 1997 provides that a capital gain or loss you make from certain CGT events concerning a dwelling that is your main residence are disregarded if all of the conditions are met:

● the dwelling must have been your home for the whole period you owned it

● you must not have used the dwelling to produce assessable income, and

● any land on which the dwelling is situated must be two hectares or less.

Section 118-115 of the ITAA 1997 includes a dwelling to be a unit of accommodation that is a building that consists wholly or mainly of residential accommodation and any land immediately under the unit of accommodation.

Taxation Determination TD 1999/73 explains land under a unit of accommodation qualifies for the main residence exemption only if the land and the unit of accommodation are sold together as a dwelling.

Section 118-120 of the ITAA 1997 specifies that the main residence exemption can extend to adjacent land where:

● The same CGT event happens to both the land and the dwelling.

● The land was used primarily for private or domestic purposes in association with the dwelling.

● The total combined area for the dwelling and adjacent land is less than two hectares.

Section 118-130 of the ITAA 1997 states you have an ownership interest in a dwelling if:

● for a dwelling that is not a flat or home unit – you have a legal or equitable interest in the land on which it is erected, or a licence or right to occupy it; or

● for a flat or home unit – you have

● a legal or equitable interest in a stratum unit in it, or

● a licence or right to occupy it, or

● a share in a company that owns a legal or equitable interest in the land on which the flat or home unit is erected and gives you a right to occupy it.

If you own more than one dwelling during a particular period, only one dwelling can be your main residence at any one time

Section 118-165 of the ITAA 1997 provides that the main residence exemption does not apply to the sale of land if the CGT event (the disposal) does not also happen in relation to the dwelling.

Absences

Section 118-145 of the ITAA 1997 provides that you can choose to continue to treat a dwelling as your main residence after it ceases to be your main residence.

If you use the part of the dwelling that was your main residence for the purpose of producing assessable income, the maximum period that you can treat it as your main residence under this section while you use it for that purpose is six years. You are entitled to another maximum period of six years each time the dwelling again becomes and ceases to be your main residence.

If the main residence is destroyed before disposal of the property (demolition of dwelling)

If the dwelling is demolished before you dispose of the property, the main residence exemption would cease to apply. Section 118-165 of the ITAA 1997 provides that the main residence exemption does not apply to a CGT event that happens in relation to land, to which the exemption can extend under section 118-120 of the ITAA 1997 if that CGT event does not also happen to the dwelling.

CGT event A1 would happen when the block, or subdivided lots, are disposed of, but this CGT event would not happen to the dwelling if CGT event C1 (about loss or destruction) had already happened to the dwelling when it was demolished. Therefore, section 118-165 of the ITAA 1997 would apply to deny you a main residence exemption on the capital gain made on the disposal of the land.

Where you demolish a dwelling and do not build a replacement dwelling on the land but instead sell the property as vacant land, the main residence exemption is lost as the exemption attaches to the dwelling and not the land.

Although the main residence exemption can apply to vacant land after a dwelling that is your main residence is accidentally destroyed (section 118-160 of the ITAA 1997), voluntarily demolishing your home is not considered to be accidentally destroyed.

Discount capital gain

The discount method of calculating the capital gain may be applied if:

● you are an individual

● the CGT event happened to your asset after 11:45am on 21 September 1999

● you acquired the asset at least 12 months before the CGT event

● you did not choose to use the indexation method.

Subdivision of land

If you subdivide a block of land, each block that results is registered with a separate title. For CGT purposes, the original land parcel is divided into two or more separate assets. Subdividing land does not result in a CGT event if you retain ownership of the subdivided blocks. Therefore, you do not make a capital gain or a capital loss at the time of the subdivision.

However, you may make a capital gain or capital loss when you sell the subdivided blocks. The date you acquired the subdivided blocks is the date you acquired the original parcel of land and the cost base of the original land is divided between the subdivided blocks on a reasonable basis.

Cost base on subdivision of land

If a taxpayer subdivides a block of land, each block that results is registered with a separate title. For CGT purposes, where the original land parcel is divided into two or more separate assets, the acquisition date of each of the subdivided lots will be the same as the acquisition date of the original asset.

The cost base of a CGT asset is generally the cost of the original asset when a taxpayer bought it. However, it also includes certain other costs associated with acquiring, holding and disposing of the asset.

In working out the cost base of the subdivided blocks, Subsection 112-25(3) of the ITAA 1997 provides that each element of the cost base of the original asset is worked out at the time of the split and apportioned in a ‘reasonable way’ to each element of the new asset’s cost base.

Taxation Determination TD 97/3 states that the Commissioner will accept any approach that is appropriate in the circumstances of each particular case, for example, on an area basis or relative market value basis.

A reasonable apportionment of the original cost of the land itself can usually be achieved on an area basis if all the land is of similar size and market value or on a relative market value basis if this is not the case.

Expenditure forming part of the cost base of the asset is not apportioned if that amount is wholly attributable to a particular asset. For example, if a dwelling existed on an original block of land before it was subdivided into two blocks, the cost of the dwelling would only be included in the cost base of the block on which the dwelling stood.

The costs of subdivision should also be apportioned between the blocks. If the blocks are of unequal market value the Commissioner considers that costs such as survey, legal fees and application fees associated with the subdivision should be apportioned in accordance with relative market value of the blocks. However, any costs solely related to one block should be attributed to that block (for example, the costs of construction and costs of connecting electricity and water to the block should be attributed solely to that block).

Application to your situation

In your case, you would not be entitled to a partial exemption when CGT event A1 happens to the vacant subdivided land because the main residence exemption attaches to the dwelling and not the land. As you have demolished the dwelling and sold the vacant land there is no dwelling to claim the exemption against under Subdivision 118-B of the ITAA 1997. Any gain made on the sale of the subdivided lots will need to be determined in the income year in which they are sold.

Consequently the main residence absence rule will not apply and you cannot use the market value of the property prior to the subdivision activities for the purpose of calculating your capital gain or loss. As the subdivided lots are not being sold with a dwelling, the main residence and adjacent land exemptions will not be applicable. Therefore, the full gain made on the disposal of the subdivided lots cannot be disregarded.

Therefore, you will need to use the relevant portion of the original purchase price of the property (both the land and the dwelling) when calculating your capital gain or loss on the sale of vacant subdivided land. The cost base of the land will need to be apportioned on a reasonable basis, such as an area basis or relative market value, when calculating the capital gain being made on the disposal of the subdivided lots.

As you are an individual, if you meet the conditions contained in Division 115, the 50% CGT discount can be applied to any gain made on the disposal of your post-CGT ownership interests in the two subdivided lots.