Edited version of private advice

Authorisation Number: 1051580121629

Date of advice: 13 September 2019

Ruling

Subject: Income tax - capital gains tax - capital v revenue classification - asset sale

Question 1

Is the sale of parts of the property merely the realisation of capital assets?

Answer

No.

Question 2

Is any profit that the taxpayer makes from the sale of the parts of the property ordinary income and therefore assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period(s)

Financial years ending 30 June 2020 - 30 June 2026

The scheme commences on

Financial year ending 30 June 2012

Relevant facts and circumstances

1. History of the property

The taxpayer is the registered owner of a large rural property. The taxpayer's family has owned the property for many years.

The property was purchased by the taxpayer's distant relative to set up a farming business on the property. The property then passed through generations to the taxpayer after many years. The taxpayer inherited the property and operated the farming business on the property as a sole trader.

Around the time of the inheritance of the property, the taxpayer obtained a valuation of the property.

After a number of years, the taxpayer established a corporate entity to operate the farming business. The change was made so the company could operate the farming business and take on the trading risk associated with operating the business and the taxpayer could continue to own the land separately from the business so that this asset was protected from the company's trading risk.

Since around a decade prior to this ruling, the taxpayer has gradually been shifting from operating a farming business focused on one aspect of farming to focusing on another aspect of farming that will require less land but additional fencing and infrastructure.

The taxpayer will continue to operate the farming business after parts of the property have been sold.

A part of the property was re-zoned as a conservation zone. Other parts of the land remained zoned as rural land.

Approximately five years before this ruling, a part of the property was sold in its entirety as a 'community title' to a third party. This part of the property contained a small settlement, which could not be used for the purposes of the taxpayer's farming business and the taxpayer was concerned about legal liability for activities on the land.

The taxpayer continues to live on the part of the property that contains the taxpayer's home, farming sheds and infrastructure, and has no plans to sell this part. The taxpayer also continues to carry on the farming business on the property, and will continue carrying on the business while the taxpayer resides there. Only the part of the property that will be sold is subject to this ruling.

2. Expansion of the nearby town

When the property was originally purchased it was in an isolated location. However, over time, the nearby town has expanded to such an extent that the property is now on the northern fringes of the town.

This has led to problems arising from the encroachment of these new suburbs on the property. For instance:

·   There are significant issues regarding domestic wild dog, dingo and pigs on the property, and the taxpayer is unable to bait on the property to control them.

·   Substantial suburban development on land neighbouring the property has occurred in recent years, preventing the taxpayer from enjoying the rural lifestyle once relished.

·   Instances of unauthorised trespassing are increasing as members of the public use the property as a shortcut from the suburban developments to the small settlement. Additionally, previous instances of trespassing include members of the public using the property for motorbike racing, 4WD driving, pig hunting, shooting and cannabis growing.

3. Proposed subdivision previously

Around fifteen years ago, a developer approached the taxpayer's solicitor to enquire as to whether the taxpayer would be interested in selling parts of the property for development.

The taxpayer had previously been approached by developers seeking to develop the property, but had consistently rejected those proposals because the taxpayer:

·   continued to enjoy operating the successful farming business

·   wanted to continue to give the family a rural upbringing.

The taxpayer agreed to discuss the subdivision proposal with the developer.

The taxpayer agreed to the subdivision and entered into an option agreement (the Previous Option) with the previous developer to purchase parts of the property.

At this time, the part of the property to be sold was the lot immediately adjacent to the settlement and the taxpayer thought that this would serve as a barrier between the remaining property and the settlement. This would address the issue of the unauthorised trespassing on the property as access to the settlement could be obtained through the residential development.

Under the Previous Option

·   The developer was granted the option to enter into a series of contracts to purchase seven nominated portions which were part of the property.

·   The developer was to be responsible for the development costs.

·   The developer was granted the first right of refusal over the balance of the lots.

·   The developer was to gain development approval for each nominated portion.

·   Subject to this approval the developer could exercise its option. If this occurred the taxpayer would receive:

-  A fixed amount for that particular portions

-  50% of the net proceeds from the sale of the subdivided lots once they were sold.

After the execution of the option agreement, the taxpayer continued to use the property subject to the option in the farming business. The taxpayer had no intention to sell the remainder of the property.

Over time, it became apparent to the taxpayer that the developer would not exercise its option. The developer had faced difficulties and had decided to no longer extend its existing estate through the taxpayer's land.

After a number of years, the developer surrendered its rights under the option agreement without exercising any of the options over the relevant periods.

4. Current option agreements

Starting around a decade prior to this ruling, the current developer repeatedly approached the taxpayer over the years the Previous Option was in effect in an attempt to purchase the property.

Unbeknown to the taxpayer, the current developer was simultaneously negotiating to purchase the neighbouring property and eventually commenced purchasing large acreage blocks directly adjacent to the taxpayer's property. The taxpayer declined the current developer's previous offers as the taxpayer did not want to trigger the first right of refusal under the Previous Option and be forced to sell the property.

The current developer developed the neighbouring property into a residential estate. This development exacerbated the issues from the encroaching residential areas as previously described in this ruling.

By this time, the taxpayer had concluded that sustaining the farming business in its current form was becoming increasingly untenable. The taxpayer had also realised that the previous developer would not exercise its option. So the taxpayer began to consider the current developer's offer to purchase the property after its repeated approaches.

The taxpayer engaged a solicitor with whom there was an established relationship and began negotiations with the current developer to reach a satisfactory agreement for the current developer's purchase of the property. This negotiation covered the form of the agreement, the obligations of the parties, and the amount the taxpayer will receive under the agreement. The parties' position was substantially agreed on a few months before signing the agreement and did not change.

In the financial year ending 30 June 201X, the taxpayer granted two options to the current developer in relation to parts of the property. The current developer can exercise these options at any time within approximately 20 years.

The option agreements with the current developer allow the taxpayer to continue to use the land in the farming business until those options are exercised or the taxpayer otherwise decides to cease business.

The taxpayer stated that they sought two option agreements, as opposed to one covering all of the property, as the taxpayer wanted to undertake a 'test run' through the first option to determine whether the current developer was reputable. These two options operate independently of each other, so there is a gradual controlled decrease of available farming land.

The first option covers part of the property that mainly consists of large paddocks and this is the option to be exercised first. The taxpayer will maintain the land that is the subject of the second option in the farming business as it is closest to the existing residence and yards. This land also contains the water and irrigation sources and some facilities to be used in the farming business.

4.1 How the current option agreements operate

The operation of the current option agreements between the taxpayer and the developer will now be explained.

The taxpayer granted the developer the right to purchase a series of parcels of land subdivided from the parts of the property subject to the options. These parts of land are known for the purposes of this ruling as the nominated portions.

The exercise of each option over a nominated portion was subject to the developer gaining development approval from the local authority over that nominated portion. This development approval includes a rezoning of the parts of the property from rural to residential. The developer is responsible for obtaining the development approval and all the other associated permits and approvals required for the development.

The option agreements obligate the taxpayer to:

·   consent to the developer's applications for development approval, land reconfiguration and building approval

·   expeditiously sign any authority or consent reasonably required by the developer to make the applications

·   assist the developer with any appeal or response that may arise from lodgment of the applications

·   grant the developer access to the nominated portions of the property to carry out surveys, engineering, building and architectural investigations, and anything necessary to comply with the advertising requirements for the applications, including the erection of marketing and statutory signage.

The developer is obligated to provide the taxpayer with a complete copy of the proposed applications for the taxpayer's review before they are lodged with any authority, and the taxpayer may make suggestions or recommendations to the developer regarding those applications. Although the developer is not required to adopt any of the taxpayer's suggestions or recommendations, the developer must not lodge the applications until the taxpayer has had the opportunity to review them and provide feedback. The developer must also not lodge any applications for approvals that the taxpayer determines are not in accordance with relevant legislation.

In order to obtain development approval, the taxpayer granted the developer access to the option lots and allowed advertising to be erected on them during the option period. The developer's access to the option lots at this time was only granted to the extent necessary to obtain development approval; any works or disturbance to the property must be rectified at the developer's expense.

The taxpayer continues to operate the farming business on the option lots during this time.

4.2 When the options are exercised

Once development approval was granted, the developer will exercise the option over a nominated portion, which has been subdivided from the option lots. Immediately after the exercise of the option, the taxpayer and the developer are deemed to have entered into the contract of sale for the nominated portion of the property. At this time, the taxpayer grants the developer a licence to possess and occupy the nominated portion before settlement. The developer then erects a stock-proof fence surrounding the nominated portion and the taxpayer ceases to conduct the farming business on that part of the property. The stock-proof fence must be erected to the taxpayer's satisfaction.

Once the taxpayer exercises each option, but prior to settlement of the sale, it will further subdivide the nominated portion over which it had exercised the option and sell these subdivided lots. The subdivided lots will be sold as vacant residential lots to the general public. Additionally, major infrastructure work will be undertaken on the land at this time.

The Plan of Development provides that there will be two planning areas for the development of the property, which include residential areas and open space areas. The residential area is the predominant use to which the land is put, including low-density development to medium-density development depending on market demands. There may also be the development of a child care centre, educational establishments, a residential care facility or a shop. The open space area is a park and recreation area which also assists with storm water management.

In addition to the work identified above, the infrastructure work that will be done on the property includes:

·   development and installation of water, stormwater and wastewater infrastructure

·   sewerage works and connection

·   laying of roads and pathways, including a pedestrian and bicycle network

·   excavation of land for drainage

·   laying of electricity and telecommunications cables and associated infrastructure

·   development of parkland and playgrounds.

The developer will conduct the works involved in subdividing the option lots into nominated portions, and then into the subdivided lots, including the infrastructure work. The developer will finance the subdivision and development and also manage the marketing and sale of the final subdivided lots to the public.

4.3 Other obligations of the parties

Under the Contract of Sale for the property, the taxpayer is required to provide a mortgage over the nominated portion of land as security for the funding of the subdivision and development works as requested by the developer.

The taxpayer must also grant the developer and its representatives a power of attorney allowing it to deal with any nominated portion over which it has exercised its option, and to promptly execute any document in relation to the development approval process.

The developer is obligated to provide the taxpayer with a monthly report on the progress of the subdivision and development, which must include the following information:

·   the project program

·   the sale status of the subdivided lots

·   the marketing status for the development

·   such other information as may be reasonably required by the taxpayer

·   a report containing details on the use of the Power of Attorney

·   a copy of the current Master Plan for the development.

The Master Plan is a plan that the developer provides to the taxpayer that details the following information on a conceptual basis:

·   the staging of the development

·   the layout of the proposed road network for the development of the option lots which, amongst other things, demonstrates the manner in which the road network will connect

·   provision of infrastructure services (access, sewerage, drainage, telecommunication and electricity) to service the development of the option lots

·   the proposed location of infrastructure services

·   the proposed yields for the development of the option lots

·   the extent of land to be used for residential, open space, flood mitigation, drainage, road, or any other purpose.

4.4 The settlement process

The subdivision and development of the property will occur in stages, as each option over a nominated portion of the property is exercised. As mentioned above, the subdivision and infrastructure works will be conducted on the nominated portion before settlement, requiring the taxpayer to grant the developer a licence to possess and occupy the land, after the developer erects a stock-proof fence.

Once the subdivision and infrastructure works are complete and third-party buyers are found for the completed subdivided lots, settlement for the sale of each nominated portion from the taxpayer to the developer will occur gradually each time that the developer sells one of the lots created in the nominated portion. Once the developer procures a purchaser of a subdivided lot, the taxpayer has agreed to transfer the subdivided lot directly to the third-party purchaser and not to the developer.

Final settlement for the sale of each nominated portion will be the earlier of:

·   Just prior to the final subdivided lot being sold to third parties

·   Five years after title for the nominated portion is first registered.

If third-party buyers for the subdivided lots are not found, the developer is obligated to continue settlement for the unsold remainder and the taxpayer will transfer those lots to the developer after five years from the date the nominated portion is first registered.

The taxpayer will receive:

·   A percentage of the gross proceeds from the sale of each lot up to a purchase price of $X

·   A higher percentage of the gross proceeds from any amount of the sale price over $XX.

For any unsold lots, the taxpayer will receive the same percentages based on the advertised list price for each lot from the developer upon their transfer to the developer.

The taxpayer and the developer agreed on the way the proceeds of sale would be distributed based on the average price received by the developer for the lots sold in its existing developments and its feasibility studies.

4.5 The development generally

Recently, the developer exercised its first option over one nominated portion of the property. The nominated portion will be subdivided into hundreds of lots. Each lot has a pre predicted purchase price. The taxpayer estimates that they will receive a certain amount in proceeds from the sale of this nominated portion and the developer will receive a larger amount in proceeds from the sale of these lots.

It is anticipated that the developer will create more nominated parcels and exercise further options over those potentially creating thousands of lots over a period spanning decades. The number of nominated portions is subject to future planning over the life of the development and engineering constraints. The developer will conduct engineering design on a staged basis, so the exact number of nominated portions and subdivided lots may not be known for years.

The entire property for which an option has been granted has received approval to be rezoned as residential, however, the lot remains within the rural zone. According to the developer, the development approval allows residential development to proceed subject to reconfiguration and operational works approval.

5. The taxpayer's business activities

The taxpayer:

·   never previously advertised the property for sale as unsubdivided rural land

·   has never previously been involved in subdividing lots into residential lots

·   does not have a written business plan

·   does not have an office, stationary or letterhead

·   has not purchased any additional land to carry out the subdivision

·   has not claimed any borrowing costs as a deduction

·   has not brought the property to account as a revenue asset so far

·   has not erected, and will not erect, any buildings on any of the lots.

6. The option agreements and the contract of sale

The two options granted by the taxpayer to the developer were provided and are part of the specified scheme for the purposes of section 359-5 of Schedule 1 to the Taxation Administration Act 1953.

Relevant legislative provisions

Section 359-5 of Schedule 1 to the Taxation Administration Act 1953

Section 6-5 of the Income Tax Assessment Act 1997

Subsection 995-1 of the Income Tax Assessment Act 1997

Reasons for decision

Question 1

Summary

The sale of parts of the property is not merely the realisation of capital assets. The taxpayer is either carrying on a business or has ventured into a commercial profit-making transaction. The income from the development is ordinary income and assessable under 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

7. Taxation treatment of property sales

Generally, when you enter into an arrangement to sell your property, the key question to be determined is whether the ultimate sale is a 'mere realisation', or whether it is a disposal either in the course of business or as part of a profit-making undertaking or scheme.

Where the sale of property is considered a mere realisation of a capital asset, the receipts will be treated as a capital gain to which the capital gains tax (CGT) rules as statutory income as the sale of a capital asset.

A sale that is more than a mere realisation will be on revenue account under section 6-5 of the ITAA 1997.

Section 6-5 of the ITAA 1997 includes in your assessable income all ordinary income that you derive during an income year. Ordinary income is defined as income according to ordinary concepts.

Income according to ordinary concepts generally includes income that arises in the ordinary course of a taxpayer's business. In certain circumstances proceeds not within the ordinary course of the taxpayer's business may form part of their ordinary income.

Thus, the following needs to be considered in order to determine whether the proceeds to be received from the sale of the property are assessable ordinary income under section 6-5 of the ITAA 1997 as income from either:

·   carrying on a business of property development

·   a profit-making undertaking or scheme.

Whether a disposal of property is a mere realisation or something more, is determined by examining and weighing all the facts and circumstances considered as a whole. It is important to weigh all the facts and indicia together, and not in isolation. Nor is it simply a matter of tallying how many indicia point towards a particular outcome.

8. The concept of 'mere realisation'

The High Court affirmed the doctrine of 'mere realisation' in Scottish Australian Mining Co Ltd v Federal Commissioner of Taxation (1950) 81 CLR 188 (Scottish Australian Mining) and has been relied upon by numerous cases since. The Full High Court in Scottish Australian Mining found that based on the facts of that case, the subdivision of land was considered no more than a mere realisation of a capital asset, and its subdivision was merely an enterprising way to realise an asset to its best advantage. For many years, the nature of the 'mere realisation' doctrine was so broad that it was considered that only in exceptional circumstances would an isolated transaction fall within the ordinary concepts of income.

However, in 1982 the landmark High Court case of Federal Commissioner of Taxation v Whitfords Beach Pty Ltd (1982) 150 CLR 355; 82 ATC 4031 (Whitfords Beach) altered the previously accepted 'mere realisation' doctrine. In this case, Mason J. said:

Deane J. was right in pointing to the circumstance that the asset was divided and improved in the course of a business of dividing and improving the asset. In this respect I do not agree with the proposition which appears to be founded on remarks in some of the judgments that sale of land which has been subdivided is necessarily no more than the realization of an asset merely because it is an enterprising way of realizing the asset to the best advantage. That may be so in the case where an area of land is merely divided into several allotments. But it is not so in a case such as the present where the planned subdivision takes place on a massive scale, involving the laying-out and construction of roads, the provision of parklands, services and other improvements. All this amounts to development and improvement of the land to such a marked degree that it is impossible to say that it is mere realization of an asset. We need to bear in mind that the subdivision of broad acres into marketable residential allotments involves much more in the way of planning, development and improvement than was formerly the case.

Like Wilson J., I have difficulty with the decision of Williams J. in Scottish Australian Mining Co. Ltd. v. F.C. of T. (1950) 81 C.L.R. 188. The taxpayer there, after giving up its mining business in 1924, devoted itself to the subdivision of its land. This entailed the construction of roads, the building of a railway station, the granting of land to public institutions such as schools and churches and the setting aside of land for parks. I should have been inclined to the view that the taxpayer had ceased to carry out its mining business and that it had commenced to carry on the business of land development.

...

From what I have said it will be seen that it is my opinion that what the respondent did amounted to more than realization of an asset and constituted the carrying on of the business of land development. Accordingly, the gross income is assessable under sec. 25(1).

Therefore the Full High Court's decision in Whitfords Beach has greatly narrowed the scope of the 'mere realisation' doctrine developed in Scottish Australian Mining, which so many preceding cases had relied upon.

Whitfords Beach highlights that mere realisation may still be possible where blocks are merely subdivided into several blocks with minimal development activity. However, if the size and scale of the activity reaches such a level, such as the construction of roads, the provision of parklands, the introduction of infrastructure, and other activities, this can amount to the development and improvement of the land to such a marked degree that it is no longer possible to consider it as a mere realisation of an asset.

The decision in Whitfords Beach also highlights that the requirements of modern day residential subdivision, which involve much more development and improvement of the land than was formerly the case, make it far more difficult for contemporary residential subdivisions to satisfy the 'mere realisation' doctrine.

Thus, the option agreements and the contract of sale have been thoroughly examined to determine the roles and responsibilities of the taxpayer and the developer and the extent of each party's involvement in the development.

9. Carrying on a business of property development

The question of whether a business is being carried on is a question of fact and degree to be determined on a case by case basis. The courts have developed a series of indicators that are applied to determine the matter on the facts.

Subsection 995-1(1) of the ITAA 1997 defines 'business' to include 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'. This definition simply states what activities may be included in a business; it does not provide any guidance for determining whether the nature, extent, and manner of undertaking those activities amount to the carrying on of a business.

Profits made on the sale of land can be considered ordinary income under section 6-5 of the ITAA 1997 if the activities become a separate business operation. Paragraph 11 of Taxation Ruling TR 92/3 Income Tax: Whether profits on isolated transactions are income (TR 92/3) states:

The transaction may take place in the course of carrying on a business even if the transaction is outside the ordinary course of the taxpayer's business.

Paragraph 13 of Taxation Ruling TR 97/11: Income tax: am I carrying on a business of primary production? (TR 97/11)states that the following indicators are relevant as to whether a person is carrying on a business:

·   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.

Paragraph 16 of TR 97/11 provides that no one indicator is decisive. The indicators must be considered in combination and as a whole, and whether a business is carried on depends on the large or general impression.

10. Application to the taxpayer's circumstances

The factors in TR 97/11 will now be applied to the taxpayer's circumstances.

10.1 Significant commercial purpose or character.

The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of the activity, the repetition and regularity of the activity and the profit indicators.

Paragraph 29 of TR 97/11 provides that a way of establishing that there is a significant commercial purpose or character is to compare the activities with those of a taxpayer who is carrying on a similar activity that is a business. Any knowledge, previous experience or skill of the taxpayer in the activity, and any advice taken by the taxpayer in the conduct of the business should also be considered but are not necessarily determinative.

The taxpayer has engaged the developer to develop the property. The developer has extensive experience in developing land and has created a neighbouring residential development to the property.

The taxpayer received regular updates on the progress of the development and sales status and is involved in the approval process. The development of the project was significant and included construction of roads, the provision of parklands, the introduction of infrastructure, and other activities. Under the terms of the option agreements and contract of sale:

·   The taxpayer has engaged the developer to conduct the subdivision and development of the land on a staged basis.

·   The taxpayer has granted access to the property to the developer for it to perform its role.

·   The developer will undertake all work associated with the subdivision and development of the property.

·   The developer has applied for all necessary approvals from local authorities and conducted feasibility studies, environmental plans, and other required documentation.

·   The developer must provide the taxpayer a copy of each application for development approval prior to lodging the application for the taxpayer's review and comment, although they are not compelled to adopt any feedback.

·   The developer must also not lodge any applications for approvals that the taxpayer determines are not made in accordance with applicable legislation.

·   The developer must provide the taxpayer with a monthly report on the progress of the subdivision and development, which must include the following information:

·   the project program

·   the sale status of the subdivided lots

·   the marketing status for the development

·   such other information as may be reasonably required by the taxpayer

·   a report containing details on the use of the Power of Attorney

·   a copy of the current Master Plan for the development.

·   The developer must pay the taxpayer a percentage of the gross proceeds of sale where the sale price is up to $X and a higher percentage of any part of the sale price over $XX. The taxpayer will receive the first allocation of the development proceeds. The developer will also pay a fixed amount on exercise of the option over a nominated portion.

Additionally, the taxpayer has assumed some of the risk of the subdivision and development of the property. This is evident through the taxpayer's receipt of a percentage of the gross proceeds of sale of the subdivided lots. The amount of money the taxpayer may receive from the sale of the property may decrease or increase as market conditions fluctuate, and there is no guaranteed minimum return or upfront payment that the taxpayer will receive for the value of the land.

Having regard to the above, it is considered that the taxpayer's activities have a significant commercial purpose and character.

10.2 Intention to engage in business

In Inglis v. FC of T (1979) 80 ATC 4001Brennan J stated:

The carrying on of a business is not a matter merely of intention. It is a matter of activity.... At the end of the day, the extent of activity determines whether the business is being carried on. That is a question of fact and degree.

The taxpayer inherited the property and it has been held by the taxpayer's family for many years. The taxpayer has stated that the entry into the agreement with the developer to subdivide and develop the property was prompted by the following factors:

·   There are significant issues regarding domestic wild dog, dingo and pigs on the property, and the taxpayer is unable to bait on the property to control them.

·   Substantial suburban development on land neighbouring the property has occurred in recent years, preventing the taxpayer from enjoying the rural lifestyle once relished.

·   Instances of unauthorised trespassing are increasing as members of the public use the property as a shortcut from the suburban developments to the settlement. Additionally, previous instances of trespassing include members of the public use the property for motorbike racing, 4WD driving, pig hunting, shooting and cannabis growing.

The above factors make sustaining the farming business in its current form increasingly untenable for the taxpayer. The taxpayer will continue to carry on the farming business on the remaining land in a modified form.

However, paragraph 42 of TR 92/3 indicates a taxpayer's intention may change to profit-making after the time of acquisition of the asset. Whitfords Beach shows that if a commercial transaction or operation involves the sale of land, it is not always necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property, as the purpose can change.

In Whitfords Beach the land was originally acquired by the company so its shareholders could get access to their beach shacks. But on the day that the ownership of the company changed, the company's purpose in relation to the land also changed, as determined by reference to the intention of the new controllers at the time (Mason J at [35] to [36]).

Further, the Federal Court in Stevenson v Commissioner of Taxation (1991) 29 FCR 282 (Stevenson) where doubt was raised in relation to the position that a landowner may only form a profit-making intention in respect of any asset at the time of acquisition. Although the landowner in Stevenson did not acquire land with an intention to resell it many years later, the landowner subdivided his land into 180 lots and the scale of the borrowings used to finance the subdivision and sale of the land resulted in the commitment of the use of the land to a profit-making undertaking scheme or business activity.

It is considered that the taxpayer committed the property to subdivision and development from the moment of entering into the option agreements with the developer.

The date the option agreements were executed was also the date at which the taxpayer granted access to the property to the developer for the purposes of obtaining the required development approvals. This allows the developer and its nominated consultants from the date of the option agreement a license to access the property at any time for the purposes of progressing the subdivision and development, demonstrating the taxpayer's change of intention from that point forward.

The taxpayer did not merely sell the property as an unsubdivided rural property, but chose to engage a developer for the property's subdivision into a substantial development including the construction of roads, the provision of parklands, the introduction of infrastructure, and the conducting of other activities. The taxpayer had previously shown an intention to do this with the entry into the agreement with the previous developer. The taxpayer has never attempted to sell the property as unsubdivided rural property and accept an upfront amount for the value of the land.

It is considered that this is a positive indicator of carrying on a business of property development.

10.3 An intention to make a profit or a genuine belief that a profit will be made

Paragraph 47 of TR 97/11 provides that the prospect of profit is a very important indicator. Strong evidence of an intention to make a profit occurs when the taxpayer has conducted research into the proposed activity, consulted experts or received advice on the running of the activity and the profitability of it before setting up the business.

The taxpayer engaged the developer for the subdivision and development of the land. The developer is an expert in residential subdivision and development and it conducted feasibility studies and research into the development's profitability. This research shaped the structure and obligations of each party to the option agreements and contract of sale.

Regarding the development profitability, the developer has exercised its first option over one nominated portion. The taxpayer estimates she will receive an amount in proceeds from the sale of this nominated portion. It is anticipated that at more nominated portions will be created over the course of the development. It is estimated that over the course of the development the taxpayer will receive a large amount of money assuming the sold price of each lot is a certain amount. Based on the previous valuation of the property and allowing for appreciation in the value of the property, it is clear that the taxpayer will profit from the subdivision and development activity and the disposal of the property in this manner.

It is considered that the taxpayer has an intention to make a profit from the property development, or a genuine belief that a profit will be made, well in excess of the property's value as unsubdivided rural land. The taxpayer has engaged an expert in property development to enhance the profitability of the endeavour. These are positive indicators of carrying on a business of property development.

10.4 Repetition and regularity of the activity

There will be repetition and regularity of the activities given that there will be the marketing and sale of thousands of lots in various stages over decades, despite the subdivision and development being a 'one-off' venture for the taxpayer.

10.5 The activity is of the same kind and carried on in a similar way to others

Paragraph 63 of TR 97/11 provides that an activity is more likely to be a business when it is carried on in a manner similar to that in which other participants in the same industry carry on their activities.

In considering this, it is noted that the taxpayer will receive a percentage of the gross proceeds of the sale of the subdivided residential lots. The developer will receive the remainder, after directing amounts to any goods and services tax (GST) and mortgage amounts to be paid. The taxpayer stated that they will not be undertaking an active role in the subdivision. Rather, the taxpayer stated that they engaged the developer to assist with every aspect of the subdivision and development including planning, surveying, engineering, engaging with local authorities, engaging and managing contractors and marketing and selling the subdivided lots.

Although this may be the case, in engaging the developer and executing the option agreements and contracts of sale, the taxpayer is carrying on a development activity with the developer in a similar manner to that which is common in the industry, particularly with farmland subdivision and development.

It is considered that these are positive indicators of carrying on a business of land development.

10.6 Organisation in a businesslike manner and the use of system

A business is characteristically carried on in a systematic and organised manner rather than on an ad hoc basis. Paragraph 68 of TR 97/11 provides that an activity should generally conform with ordinary commercial principles to amount to the carrying on of a business.

The taxpayer engaged the developer to undertake the planning approval stage, to manage and undertake the subdivision activities, to develop the land, and to market and sell the lots.

The taxpayer has stated that they have minimal involvement in the subdivision. However, as the owner of the property until the final sale of the subdivided residential lot to a third party, the taxpayer will be signing documentation and all things as required for the continued development and sale of the property.

It is also noted that a key condition of both the option agreements and the contract of sale is that the taxpayer grants the developer a power of attorney. In this sense, the taxpayer has appointed the developer as an agent. O'Loughlin J in Abeles and Anor v Federal Commissioner of Taxation (1991) 91 ATC 4756 (Abeles) stated:

In the application of these principles to the facts of this case, I have concluded that the taxpayers exceeded the bounds of the mere realisation of their land in an enterprising way. No doubt they were aided by Mr. Markham in making their decisions; perhaps, arguably, he induced them, first to agree to subdivide and then to participate in the larger plan that involved the six blocks and the four groups of owners. But, in these particular circumstances, they cannot hide behind Mr. Markham. He was their agent and his conduct was their conduct. Through Mr. Markham, the brothers went beyond a mere simple subdivision and sale of their 10 acres; they entered into an arrangement that was in the nature of a joint venture, sharing costs and expenses rateably; they even participated in variations to the boundaries of their land in order to present, and participate in, the best plan of subdivision. Their financing commitment was heavy; their established line of credit was $90,000 more than they paid for the land five years earlier; they allowed for the subdivision being a lengthy project and arranged with the finance company to accrue interest on the borrowed moneys. Although the size of a project is not a conclusive factor, it is one of numerous matters that are to be weighed in the balance. In this case, the readiness of the brothers to involve themselves with the other owners was more consistent with a business enterprise than a private realisation. The taxpayers, through their agent, Mr. Markham, chose to embark upon a business-like and efficient program of subdivision.

In the present case, it is considered that the developer is the taxpayer's agent, so ultimately the developer's conduct is the taxpayer's conduct. Through the developer, the taxpayer has chosen to embark upon a businesslike program of property development and subdivision through entering into the option and development agreements.

The taxpayer is carrying on the development activity as part of this venture in a businesslike manner through the involvement of the developer.

It is considered that this is a positive indicator of carrying on a business of property development.

10.7 The size and scale of the activity

Paragraph 77 of TR 97/11 provides that the larger the scale of the activity, the more likely it will be that the taxpayer is carrying on a business. However, the size or scale of the activity is not a determinative test, and a person may carry on a business in a small way. However, if the scale of the activities result in more than is required for one's domestic needs combined with an intention to profit from the activities, or a reasonable expectation of doing so, a business may be carried on despite the scale.

Referring to Mason J's judgment in Whitfords Beach, it is evident that a project's 'massive scale', including the 'laying out and construction of roads, the provision of parklands, services and other improvements,' can be so significant that in Whitfords Beach, Mason J found it 'impossible' it say that the disposal of land was a mere realisation of that asset.

In the present case, the taxpayer and the developer will subdivide the land into thousands of lots in various stages. The development of the land will include major infrastructure works, such as:

·   development and installation of water, stormwater and wastewater infrastructure

·   sewerage works and connection

·   laying of roads and pathways, including a pedestrian and bicycle network

·   excavation of land for drainage

·   laying of electricity and telecommunications cables and associated infrastructure

·   development of parkland and playgrounds.

The development of the land will also include its transformation from farmland into a residential suburb, inclusive of premises that may be set aside for a residential care facility or a shop.

The development footprint on the property is significant, comprising over 60% of the taxpayer's sizeable property.

The taxpayer will continue to carry on the farming business on the remaining land, but this will be conducted on a smaller scale and transition to a modified form of farming, which requires less space and resources.

It is considered that the scale of the activities and the improvements to the property go beyond merely realising the asset in the most enterprising way. While the taxpayer continues to carry on the farming business on the remaining portion of the property surrounding the taxpayer's home, it is considered that there was a change of purpose in relation to the use of the property being disposed of. The size and scale of the development is a positive indicator of carrying on a business of land development.

10.8 The activity's characterisation as a hobby or a form of recreation

It is considered that the taxpayer's activities are not a hobby or a form of recreation and this indicator is not applicable in the present case.

11. Conclusion

Having considered all of the above factors, the taxpayer's activities go beyond those required for the mere realisation of the property.

Accordingly, the income will be assessable ordinary income under section 6-5 of the ITAA 1997.

Question 2

Summary

Yes, the profit is ordinary income under section 6-5 of the ITAA 1997.

Detailed reasoning

We have determined that the taxpayer's sale of the property will not be a 'mere realisation'.

For the reasons provided in the answer to Question 1, the profit made on the disposal will be assessable under section 6-5 of the ITAA 1997.