Edited version of your written advice

Authorisation Number: 1051513691447

Date of advice: 21 May 2019

Ruling

Subject: Land subdivision – ordinary income and GST

Question 1

Will the proceeds from the sale of the subdivided blocks of land be considered ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 19997) as a result of carrying on a business of property development?

Answer 1

No

Question 2

Will the proceeds from the sale of the blocks be considered ordinary income under section 6-5 of the ITAA 1997 as a result of profit from an isolated commercial or business transaction?

Answer 2

Yes

Question 3

Will any profit made from the sale of the blocks be treated as statutory income under parts 3-1 and 3-3 of ITAA 1997?

Answer 3

No

Question 4

Will the sale of the blocks be a taxable supply under section 9-5 A New Tax system (Goods and Services Tax) Act (GST Act)

Answer 4

Yes

This ruling applies for the following period:

Year ending 30 June 2019

The scheme commences on:

1 July 2018

Relevant facts and circumstances

You and your spouse (you) own as joint tenants Property A. You acquire the property after 20 September 1985. It has always been your main residence since the acquisition date.

You provided the size and value of the property. You undertook renovations when you bought the property. The property doesn’t have town water network but is near a major city.

It has always been zoned as a rural living area meaning that it is for residential use and located in a less densely populated area than cities. This can include agricultural or farming areas.

Within three years, you engaged the services of a town planner consultant on the viability of a potential subdivision of the property. The consultant was to arrange for the development application and to manage and perform the subdivision. The consultant provided you with a quote.

It was proposed that the property be subdivided into several lots. The existing dwelling that is used as your main residence is located on one of the lots. There is no plan to connect to town water.

The following year, an application to Council A was made and a meeting was held.

You provided a copy of the Negotiated Decision Notice letter issued by Council A granting the DA for subdivision.

The subdivision of the property is to be undertaken in two stages. The single block with direct access to the road is to be completed first. The proceeds from the sale of this block will enable the second stage of the subdivision to occur.

Following stage one, and pursuant to the DA, an access road will be constructed to the remaining lots. Driveways will then be constructed from the road to each of the internal blocks and the boundaries of the lots will be staked out.

The DA requires electricity and communications services to be connected to each block. A surveyor’s company was engaged to manage the bulk project. Subcontractors will be engaged to perform the operational works.

Your main residence will sit on Lot A. You will sell this Lot A (along with other vacant lots) and build a family home on another lot. You will sell the other lots as vacant land. You will engage real estate agents to sell the blocks. Completion of the project is planned for within a year.

You provided the estimated value for each block and of the property before subdivision.

You are not registered for GST.

You do not work in the building or development industry and you have not been involved in the building trade in the past. You have not undertaken any activities similar to the above mentioned in the past and do not intend to undertake any subdivisions in the future.

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

Income Tax Assessment Act 1997 section 118-20

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

A New Tax System (Goods and Services Tax) Act 1999 section 9-20

A New Tax System (Goods and Services Tax) Act 1999 section 9-40

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

A New Tax System (Goods and Services Tax) section 188-10

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

A New Tax System (Goods and Services Tax) Act 1999 section 195-1

Reasons for decision

There are three ways profits from property sales 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; or

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; or

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

Ordinary income

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 The Myer Emporium (1987) 163 CLR 199; 87 ATC 4363; (1987) 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.

Taxation Ruling 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. Taxation Ruling 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.

Capital Gain Tax (CGT) provisions

CGT event A1 in section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you dispose of each subdivided block. You will make a capital gain if the capital proceeds from the disposal of the block are more than the cost base of the block. You will make a capital loss if those capital proceeds are less than the reduced cost base of the block.

Section 118-20 contains anti-overlap provisions which operate to reduce capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 of the ITAA 1997, for example, as ordinary income under section 6-5 of the ITAA 1997.

Application to your situation

In your situation, you do not carry on a business of buying, selling or developing land. It is accepted that your activities lack repetition, scale and volume and are not of the same nature as is ordinarily carried on by a property developer that is carrying on a business.

We acknowledge that the dwelling at the property has been used as your main residence but note that you have not held the property for a considerable amount of time before considering the subdivision of the property. Rather, you acquired the property in late 20xx and by early 20xx you employed the professional services of a town planning consultant to assist with the subdivision organisation.

The property is close to a major city and although no rezoning was required, you decided to subdivide it into several rural living blocks. The development is planned, organised and carried on in a businesslike manner in order to make a profit; showing that the subdivision has a significant commercial purpose. Additionally, you have taken actions to obtain development approval within a few years of acquiring the land. This process took a number of years as before you received final approval.

The development will require significant infrastructure activities, including the construction of a road, electricity and communications services, the demolition of your main residence, the building of a new dwelling on a different lot. Although you contend that you have engaged a project co-ordinator who will engage relevant consultants to perform other aspects of the subdivision, you retain ultimate control of the activities and decisions made in relation to the property.

The development will occur in more than one stage, indicating a level of sophistication and complexity to the activities. You will use the proceeds from the sale of one lot to fund the subdivision work required for the other blocks, indicating that you are carrying a level of risk in order to complete the second stage. The costs involved in the subdivision activities total over a million dollar and you expect your final profit will be over several million dollars. You will ultimately bear all the risk associated with the subdivision activities.

You contend that your situation has similarities with Scottish Australian Mining Co Ltd v Federal Commissioner of Taxation (1950) 81 CLR 188 (Scottish Australian Mining). However, the decision in FC of T v Whitfords Beach Pty Ltd (1982) 150 CLR 355 (Whitfords Beach) significantly narrowed the scope of the ‘mere realisation’ doctrine developed by Scottish Australian Mining, which so many of the proceeding cases relied upon. The case highlights that while ‘mere realisation’ may still be possible where blocks are merely subdivided to several blocks with minimal activity, however where the size and scale of the activity reaches such a level (such as constructing roads, the provision of parklands, services and other), this all amounts to a development and improvement of the land to such marked degree that it’s no longer possible to say it’s a mere realisation of an asset.

In Casimaty, Ryan J found that the taxpayer was not carrying on a business of property development, but was merely selling off the family farm, that had been gifted to him by his father, in a piecemeal fashion. In Casimaty, the property was subdivided in a number of stages, at different times, so that there was ‘no coherent plan conceived at the outset’.

Your situation can be distinguished from Casimaty in that you are not undertaking the subdivision in a piecemeal fashion. You have a coherent plan in place for the development of the blocks. Furthermore, it is considered that the scale of activities involved in the development being undertaken is such that the development cannot be considered to be a mere realisation.

On balance of the facts we find that the subdivision will constitute an isolated profit-making scheme. Accordingly the profits from the transaction will be considered ordinary assessable income under section 6-5 of the ITAA 1997.

While CGT event A1 will occur on the disposal of the subdivided blocks, the disposal of each lot will be viewed as an isolated transaction. Any profit from the sale will be assessable as ordinary income under section 6-5 of the ITAA 1997 as an isolated transaction. Any capital gain arising from each CGT event will be reduced to the extent any profit is also assessable under section 6-5 of the ITAA 1997.

Goods and Services Tax (GST)

Section 9-40 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that you are liable for GST on any taxable supplies that you make.

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 (Australia), and

(d) you are registered, or required to be registered for GST.

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

You intend to subdivide the land into residential lots. For the supply of your subdivided land to be a taxable supply, all of the requirements in section 9-5 of the GST Act must be satisfied.

In this case, you will be selling vacant residential lots for consideration in Australia. Therefore, paragraphs 9-5(a) and 9-5(c) of the GST Act will be satisfied. Further, the supply of the lots in your situation will neither be GST-free or input taxed.

Accordingly, we must determine whether:

(a) your sale of the lots are in the course or furtherance of an enterprise that you are carrying on, and

(b) if so, whether you are required to be registered for GST.

Enterprise

Section 9-20 of the GST Act provides that the term ‘enterprise’ includes, among other things, 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 phrase ‘carry on’ in the context of an enterprise includes doing anything in the course of the commencement or termination of the enterprise.

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 provides guidance on what activities will amount to an enterprise.

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’. In particular:

● 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.

The relevant intention or purpose of the taxpayer is not the subjective intention or purpose of the taxpayer but rather it is the taxpayer’s intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

Paragraphs 262 to 302 of MT 2006/1 consider isolated transactions and sales of real property. Paragraph 263 of MT 2006/1 states that the issue to be decided is whether the activities are an enterprise, in that they are of a revenue nature, as opposed to the mere realisation of a capital asset.

Paragraph 264 of MT 2006/1 discusses two court cases, Statham & Anor v. Federal Commissioner of Taxation 89 ATC 4070 (Statham) and Casimaty v. FC of T 97 ATC 5135 (Casimaty), involving subdivision and development of properties that were originally held as capital/investments assets, where the court decided that the sale of the post-subdivision lots was the mere realisation of capital/investment assets.

From the Statham and Casimaty cases a list of factors can be ascertained that provide assistance in determining whether activities are a business or an adventure or concern in the nature of trade. Paragraph 265 of MT 2006/1 provides the following list of factors:

● 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

● buildings have been erected on the land.

In determining whether activities relating to isolated transactions are an enterprise or the mere realisation of a capital asset, it is necessary to examine the facts and circumstances of this case. This requires 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 is 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

You initially bought the land as your place of residence but by subdividing and selling the lots you have changed the purpose for which the land was held for.

Whilst you contend that you have limited involvement in aspect of the development activities, this is not the only determinative factor that should be considered. It is noted that there is a demonstrated change of purpose for which the land is held. You have a coherent plan into place for the subdivision activities. You will be engaged in significant commercial activities such as negotiating or making decision with other entities in order to subdivide the property into numerous residential lots for sale. You will be engaged in this venture in a commercial and business-like manner by entering into all the agreements to enable the subcontractor to carry out the land subdivision on your behalf. They will be required to provide all the relevant information as requested by you from time to time. This demonstrates your purpose and intention of engaging in commercial activities. The activities carried out will be of a reasonable size. They will be taken in different stages. They are the types of activities routinely undertaken by owners or their service providers engaged in property development. You will demolish a dwelling and erect a new building on a different lot and you will conduct substantial infrastructure works as required.

In conclusion, on balance, these activities indicate a commercial approach and there is a clear intention maximising profit return. Your subdivision activities have the characteristics of activities that would constitute an adventure or concern in the nature of trade. Therefore, you are considered to be carrying on an enterprise as defined in section 9-20 of the GST Act, and the sale of the new residential apartments will satisfy the requirements of paragraph 9-5(b) of the GST Act.

Registration

Section 23-5 of the GST Act provides that you are required to be registered for GST if:

(a) you are carrying on an enterprise, and

(b) your GST turnover meets the registration turnover threshold.

The registration turnover threshold is currently $75,000.

Section 188-10 of the GST Act provides that you have a GST turnover that meets a particular turnover threshold if:

(a) your current GST turnover is at or above the turnover threshold and the Commissioner is not satisfied that your projected GST turnover is below the turnover threshold, or

(b) your projected GST turnover is at or above the turnover threshold.

Of relevance here is your projected GST turnover. Section 188-20 of the GST Act provides that your projected GST turnover at a time during a particular month is the sum of the values of all the supplies that you have made or are likely to make during that month and the next 11 months other than input taxed supplies.

In working out your projected GST turnover, paragraph 188-25(a) of the GST Act requires that you disregard any supply made or likely to be made, by you by way of transfer of ownership of a capital asset of yours.

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.

Goods and Services Tax Ruling GSTR 2001/7 Goods and Services Tax: meaning of GST turnover, including the effect of section 188-25 on projected GST turnover discusses the meaning of a ‘capital asset’ at paragraphs 31 to 36.

Capital assets are often referred to as structural assets used by an entity to produce an income. Capital assets are to be distinguished from revenue assets. If the means by which you derive income is through the disposal of assets, those assets will be revenue or trading assets rather than capital assets.

We have considered section 188-25 of the GST Act and this section does not apply as the sale of the lots has the character of a revenue asset, rather than a realisation of a capital asset.

As the sale proceeds for the sale of the lots will exceed the registration turnover threshold you will be required to be registered for GST.

The supply of your subdivided land is considered to be a taxable supply as all of the requirements of a taxable supply under section 9-5 of the GST Act will be met.