Edited version of private advice

Authorisation Number: 1051585915730

Date of advice: 4 February 2020

Ruling

Subject: Subdivision of farmland

Question 1

Will the proceeds from the sale of the developed lots be assessable as income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will the proceeds from the sale of the developed lots be assessable as income under section 15-15 of the ITAA 1997?

Answer

No.

Question 3

If the answer to question 1 or 2 is yes, will the fee paid to the developers be allowed as a deduction (or to be used in determining the net profit) in calculating the taxable income of the taxpayer?

Answer

Yes.

Question 4

Do you satisfy the basic conditions for the small business concessions under subdivision 152-A of the ITAA 1997 on the disposal of the subdivided lots?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You own several adjoining rural properties which you use in a primary production business.

The properties have been in your family for XX years.

You currently reside on one of the lots.

The turnover of you and your connected entities does not exceed $XXX.

You deregistered from GST as your turnover from farming activities fell below the GST threshold.

The council has rezoned the land a number of times as urban development encroached on the area. The council drove the zoning changes to the land.

Adjoining properties have been sold to property developers. These developers are eager to develop the whole area.

A developer has approached you to develop your land.

The terms of the agreement include:

·         the developer will develop a portion of your land

·         you will prove the developer a licence to enter the land and carry out development work

·         the development of the land will result in over 150 lots.

·         you will be paid an amount upon entering the contract

·         the developer will have the final decision on all matters concerning the property

·         you will be represented on a management committee as an observer only

·         the developer will fund all the development costs

·         the sale of the individual lots will be made by the developer on your behalf via a power of attorney

·         from the sales proceeds you will reimburse the developer for costs incurred in the development and a development fee.

It was your preference to receive a fixed agreed value for the land.

You have provided the following additional facts in relation to extent of the development:

·         the land will be sold as vacant lots. You will not be involved in any construction activities on the land

·         you have not purchased any additional land for the development

·         you are only developing the land to the extent that it meets the minimum requirements of council

·         you will not be borrowing any funds in relation to the development;

·         you have no direct involvement in the development including negotiations with Council and other authorities.

You will retain part of the land and continue to carry on a farming operation on a reduced scale.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 15-15

Income Tax Assessment Act 1997 section 70-10

Income Tax Assessment Act 1997 paragraph 118-25(1)(a)

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Question 1

Broadly, there are three main ways profits from a land development, subdivision and sale can be treated for taxation purposes:

1. As ordinary income under section 6-5 of the ITAA, 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 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;
3. As statutory income under the capital gains tax legislation.

Change of intention

While holding an asset for a considerable period of time may seem to indicate that it is a long term capital asset, the intention of the taxpayer at the time of acquisition and throughout the ownership period is a crucial aspect.

Federal Commissioner of Taxation v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693) (Myer Emporium) is one of the leading cases which shows that the intention at the time of purchasing the asset is an important consideration in determining whether the proceeds received on disposal are on a capital or revenue account. According to the Myer Emporium case, the relevant intention or purpose of the taxpayer is not a subjective test. Rather, it is the intention or purpose as discerned from an objective consideration of the facts and circumstances of the case. Also, if the taxpayer is a company or trust, the courts determine its purposes by looking at the people who control the entity.

Further, the decisions in Casimaty v. Federal Commissioner of Taxation (1997) 97 ATC 5135, 37 ATR 358 (Casimaty) and McCorkell v. Federal Commissioner of Taxation 98 ATC 2199; (1998) 39 ATR 1112 demonstrate that if a taxpayer does not intend to make a profit when he or she acquires farming land then the likelihood that any profit made on the eventual sale of land is ordinary income is greatly diminished.

Numerous cases have concerned the assessability of profits or proceeds from the sale of land. The two leading Australian cases dealing with the change of intention and the disposal of capital assets on revenue account are Scottish Australian Mining Co Ltd v Federal Commissioner of Taxation (1950)81 CLR 188 (Scottish Mining case) and Whitfords Beach Pty Ltd v Federal Commissioner of Taxation (1983) 14 ATR 247 (Whitfords Beach).

It follows from the decisions in Scottish Mining and Whitford's Beach cases that a taxpayer, who had originally acquired property for farming operations purposes, could subsequently embark on a profit making scheme. This means that a taxpayer could embark on a profit making scheme after property was acquired for a different purpose.

Carrying on a business

Subsection 995-1(1) of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

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

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. In the Commissioner's view, the factors that are considered important in determining the question of business activity are:

·         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.

No one factor is decisive. The indicators must be considered in combination and as a whole.

As to when such a business is taken to have commenced, Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'? also states that a business activity is taken to have commenced when a taxpayer embarks on a "definite and continuous cycle of operations designed to lead to the sale of the land." That is, the land will become trading stock when you are demonstrably fully committed to the business of land development. When that occurs is determined by a consideration of the facts of the case.

Trading Stock

When the business starts, the subdivided land becomes trading stock. Section 70-10 of the ITAA 1997 provides that trading stock includes anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business.

Taxation Determination TD 92/124 states that land will be treated as trading stock for income tax purposes if it is held for the purpose of resale and a business activity which involves dealing in land has commenced. Where such a business exists, the proceeds from the sale will be assessable under section 6-5 of the ITAA 1997.

Isolated transactions

Alternatively, Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income discusses profits on isolated transactions and the application of the principles outlined in the decision of the Full High Court of Australia in FCT v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693. This ruling states that profits on isolated transactions may be income.

Profit from an isolated transaction will be ordinary income where:

·         the intention or purpose of a taxpayer in entering into the transaction was to make a profit or gain and

·         the transaction was entered into, and the profit was made, in the course of carrying on a business operation or commercial transaction.

Taxation Ruling TR 92/3 outlines that the relevant intention or purpose of the taxpayer, of making a profit or gain, is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

Profits on the sale of subdivided land can therefore be income according to ordinary concepts within section 6-5 of the ITAA 1997 if the taxpayer's subdivisional activities have become a separate business operation or commercial transaction, or an isolated profit making venture.

At paragraphs 56 and 57, Taxation Ruling TR 92/3 explains that a profit is income where it is made in any of the following situations:

·         a taxpayer acquires property with a purpose of making a profit by whichever means prove most suitable and a profit is later obtained by any means which implements the initial profit-making purpose; or

·         a taxpayer acquires property contemplating a number of different methods of making a profit and uses one of those methods in making a profit; or

·         a taxpayer enters into a transaction or operation with a purpose of making a profit by one particular means but actually obtains the profit by a different means.

In very general terms, a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations.

Application to your situation

Carrying on a business

Taking all of the facts into consideration, and on weighing the various factors, you are considered to be carrying on a business of property development, or alternatively, to have entered into a profit-making scheme or undertaking under section 6-5 of the ITAA 1997.

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. The large scale of the development further supports the view that you are carrying on a business. While you have granted development rights to the developer, you maintain a degree of control. You remain the legal owner of the land throughout the development process; and you will enter into contracts of sale with purchasers of subdivided land lots. Additionally, you have retained possession of the land while you continue your farming activities.

The development agreement indicates that the developer accepts all risks associated with the development; however, you are engaging in the risk associated in the development, through profit sharing arrangements, risk in termination and lapse of time over the number of years of development. Furthermore, you are entitled to a percentage of the gross proceeds on the sale of the lots. Therefore, depending on future movements in land values, the total amount you will receive is uncertain and dependent on market forces, and a degree of risk remains.

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. A coherent plan is in place for the development of the land. Furthermore, it is considered that the size and scale of the development being undertaken is such that the development cannot be considered to be a mere realisation of the land.

As you are carrying on a business of property development subdivision, land will be treated as trading stock under section 70-10 of the ITAA 1997. When the land becomes trading stock, you are treated as having disposed of the land for either its cost or market value and acquired the land back as trading stock for the same amount. You can elect to use the value at cost or market value of the land.

If you elect for the transfer of the land to trading stock to occur at market value, CGT event K4 occurs at the time of the transfer. The CGT small business concessions may be applied to reduce the capital gain derived from CGT event K4 happening, provided all of the other requirements of Division 152 of the ITAA 1997 are met at the time of the event (when the business is deemed to have commenced). The Commissioner considers that based on the information you have provided, this would be when you entered into a development agreement with the developer, at the latest. Alternatively, if you elect the cost of the asset, CGT event K4 does not occur and any capital gain or loss is ignored.

Isolated transactions

Alternatively, the Commissioner is satisfied that if you are not carrying on a business, the proceeds from the sale of the properties will be those from an isolated transaction.

Although the property was originally acquired for the purpose of primary production activities and for your main residence, this intention is not definitive alone. There has been a change in purpose for which the land is held, as it is now held primarily for the purpose of resale in the form of subdivided blocks. There is a coherent plan for the subdivision of the land. Based on the facts, it can be concluded that the development and subsequent sale of the subdivided lots, occurs with the intention of profit as a commercial transaction.

Therefore, proceeds from the sale of the subdivided blocks will constitute a profit from an isolated transaction and should be included as ordinary income under section 6-5. Following this, where you are not carrying on a business the land would not be treated as trading stock.

Question 2

Section 15-15 of the ITAA 1997 includes profit arising from the carrying on or carrying out of a profit-making undertaking or plan. However, this provision does not apply to a profit that is assessable as ordinary income under section 6-5 of the ITAA 1997, or which arises in respect of the sale of property acquired on or after 20 September 1985.

In your case, the profit made on the sale of the subdivided lots will be assessable under section 6-5 of the ITAA 1997. Therefore section 15-15 of the ITAA 1997 will not apply.

Question 3

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature.

In your case you are required to pay a development fee to the developer for the work undertaken as part of the subdivision. The development fee is an expense incurred in producing your assessable income and is deductible under section 8-1 of the ITAA 1997.

Question 4

Section 152-10 of the ITAA 1997 contains the basic conditions you must satisfy to be eligible for the small business capital gains tax (CGT) concessions. These conditions are:

(a)    a CGT event happens in relation to a CGT asset in an income year (paragraph 152-10(1)(a) of the ITAA 1997).

(b)    the event would have resulted in a gain (paragraph 152-10(1)(b) of the ITAA 1997)

(c)    at least one of the following applies (paragraph 152-10(1)(c) of the ITAA 1997):

(i)            you are a small business entity for the income year

(ii)           you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997

(iii)          you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership or

(iv)         the conditions in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year.

(d)    the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997 (paragraph 152-10(1)(d) of the ITAA 1997).

Where the land is treated as trading stock, paragraph 118-25(1)(a) provides that a capital gain or capital loss you make at the time of the CGT event is disregarded.

In this case, upon sale of the subdivided blocks, the land on which you operated your primary production activities will be considered trading stock, and any capital gain or loss made at the time of sale of the subdivided lots will be disregarded under paragraph 118-25(1)(a) of the ITAA 1997. As any capital gain will be disregarded, paragraph 152-10(1)(b) of the ITAA 1997 will not be satisfied in relation to the basic conditions for the small business concessions. Therefore, as there is no capital gain on the sale of the subdivided blocks, you cannot apply the small business concessions.

In the alternative case, whilst CGT event A1 will occur on the disposal of the subdivided lots, the disposal of each lot will be viewed 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. Based on the anticipated profit you will receive, any capital gain from the sale of the subdivided lots will be reduced to zero, therefore as paragraph 152-10(1)(b) of the ITAA 1997 will not be satisfied in relation to the basic conditions you cannot apply the small business concessions.