Edited version of private advice

Authorisation Number: 1051616815670

Date of advice: 12 December 2019

Ruling

Subject: Subdivision of land

Question 1

Will the profit from the sale of the subdivided lots be assessable as ordinary income under section 6 -5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of you carrying on a business?

Answer

No.

Question 2

Will the profit from the sale of the subdivided lots be assessable as ordinary income under section 6-5 of the ITAA 1997 as a result of an isolated transaction carried out for profit and commercial in character?

Answer

Yes.

Question 3

Will the sale of the subdivided lots be assessable under the capital gains tax provisions?

Answer

Yes. However, under section 118-20 of the ITAA 1997 any capital gain will be reduced to the extent the amount is assessable under section 6-5 of the ITAA 1997.

This ruling applies for the following periods:

Year ending 30 June 2020

Year ending 30 June 2021

Year ending 30 June 2022

The scheme commences on

1 January 2017

Relevant facts and circumstances

In xxxx, after 1985, you and your former spouse purchased property as joint tenants.

The lots (the original land) was recorded on a single certificate of title and zoned 'Rural 1A' which meant that only one dwelling was allowed on the original land.

The original land was xxx hectares.

You and your former spouse purchased the property for $xxx and lived in a house on part of the original land.

The original land was used by you and your former spouse as your home and hobby farm until xxxx when you both moved overseas. At that time, you decided to sell a lot and keep the remaining lots. To do this, a separate certificate of title was issued for the lot. The restriction on the building of dwellings remained in force over the remaining lots.

While overseas, the remaining lots were used to agist horses for friends.

You and your former spouse divorced in xxxx. You did not enter into a property settlement in relation to your Australian assets until xxxx.

In xxxx you and your former spouse agreed as part of the property settlement to each transfer your interest in half of the remaining lots to the other. You became the sole owner of some lots which was approximately xxx hectares.

Separate titles were issued for each lot however they continued to be treated as a single block of land by council and the valuer-general. The use continued to be restricted in that no dwelling could be built on any of these lots.

In xxxx, you transferred a lot to your relation, as a gift. This lot was valued at $xxx at the time of the transfer.

In xxxx, the relevant Council rezoned the property from rural to residential low density. This meant that a dwelling could now be built on each lot.

In xxxx, you and your current spouse returned to Australia.

In xxxx you commenced building a dwelling on the lot. Once completed in xxxx, this became your main residence and is still your main residence.

In xxxx, you sold a lot to family members for $xxx. This was the market value at the time.

In around early xxxx you began discussions with two of your relations as to the best way for you to fund your retirement.

Your relations run a town planning and construction business, entity A, and suggested that you explore the option of subdividing the subject a lot (lot B) into xx lots and to sell xx of the lots, with your main residence remaining on one of the lots. Your relations considered that your other remaining lot was unsuitable to subdivide because there were significant areas of protected vegetation on this lot.

Your relations assisted you by drawing concept plans as to how best to subdivide lot B.

In or about xxxx, you decided to go through with the subdivision of lot B and engaged entity A to lodge a development application and to carry out the subdivision works should approval be given.

The development application was lodged in xxxx.

Development Approval (DA) was given in xxxx.

The value of lot B at the time the DA was granted was $xxx. This was the land value according to the value general's valuation.

The market value of lot B at that time is estimated to have been $xxx.

You are not certain of the breakdown of the market value of the land between each proposed lot at the time the DA was given.

Approval was given for lot B to be subdivided into xx lots.

Construction of the lots commenced in xxxx and it is estimated that the subdivision will be completed by the end of xxxx.

The total cost of the subdivision will be approximately $xxx. You intend to use your savings to pay these costs.

You will pay entity A a commercial fee for its services.

The total estimated proceeds from the sale for the lots will be $xxx.

You have never been involved in a subdivision before and do not plan to be involved in any subdivision in the future.

You do not have a written business plan and do not have an office, stationery or letterhead.

You have not purchased additional land to carry out the subdivision.

You are not erecting any buildings on any of the lots that you are intending to sell.

You will contact a real estate agent to sell the subdivided lots.

You have never been registered for GST.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 112-25

Income Tax Assessment Act 1997 section 118-20

Income Tax Assessment Act 1997 Part 3-1

Reasons for decision

Generally, an amount received in relation to subdividing land would be assessable either as:

·        ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as business income,

·        ordinary income under section 6-5 of the ITAA 1997 as an isolated commercial transaction with a view to a profit, or

·        statutory income under the capital gains tax (CGT) provisions contained in Part 3-1 of the ITAA 1997 as a mere realisation of a capital asset.

Carrying on a business of property development

Section 995-1 of the ITAA 1997 states the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? provides some factors that indicate whether or not a business is being carried on. The question of whether a business is being carried on is a question of fact and degree.

Based on the information provided, we do not consider that any proceeds you would receive from the sale of the subdivided lots would be derived in the course of carrying on a business.

Profits from an isolated transaction

Profits arising from an isolated commercial transaction will be ordinary income if the 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 a taxpayer's business (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693).

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income provides guidance in determining whether profits from isolated transactions are ordinary income and therefore assessable under section 6-5 of the ITAA 1997.

The term isolated transaction refers to:

·        those transactions outside the ordinary course of business of a taxpayer carrying on a business; and

·        those transactions entered into by non-business taxpayers.

If a taxpayer not carrying on a business makes a profit from an isolated transaction or operation, that profit is assessable income if both of the following elements are present:

·        the intention or purposes of the taxpayer in entering into the 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.

Profit-making does not need to be the sole or dominant purpose for entering into the transaction. A profit-making purpose must exist at the time the transaction or operation was entered into. Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case.

In your situation, Lot B had been held for several years. You then decided to subdivide Lot B and sell off three of the subdivided lots.

Although you are not in the business of property development, to decide if any profit you make is ordinary income, we need to consider if the transaction was entered into, and the profit was made in carrying out a commercial transaction.

TR 92/3 lists the following factors which are relevant in determining whether an isolated transaction amounts to a business operation or commercial transaction:

1. the nature of the entity undertaking the operation or transaction;
2. the nature and scale of other activities undertaken by the taxpayer;
3. the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;
4. the nature, scale and complexity of the operation or transaction;
5. the manner in which the operation or transaction was entered into or carried out;
6. the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;
7. if the transaction involves the acquisition and disposal of property, the nature of that property; and
8. the timing of the transaction and the various steps in the transaction.

In contrast, paragraph 36 of TR 92/3 notes that the courts have often said that a profit on the mere realisation of an investment is not ordinary income, even if the taxpayer goes about the realisation in an enterprising way. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment.

Paragraphs 41 and 42 of TR 92/3 outline that where a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction, the activity of the taxpayer constitutes the carrying on of a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income even though the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

In addition to the above factors, for the purposes of determining whether the activities undertaken in relation to real property and development equate to a profit-making undertaking or scheme, 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 aligns itself with TR 92/3 and provides a list of factors which, if present may be an indication that a business or profit-making undertaking or scheme is being carried on.

The factors listed in paragraph 265 of MT 2006/1 are as follows:

·        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; and

·        buildings have been erected on the land.

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.

Numerous cases have considered the assessability of profits or proceeds from the sale of land including the following cases:

Whitfords Beach Pty Ltd v Federal Commissioner of Taxation (1983) 14 ATR 247 where the taxpayer acquired 1.584 acres of land for non- commercial purposes. Thirteen years later, the original shareholders sold out and the company and the new ownership adopted an entirely new set of articles. It then embarked on a long and complex course of activity which involved the land being rezoned and developed as a residential subdivision. Vacant lots were sold over a period of many years for a substantial profit. The High Court held that the adoption of a new set of articles resulted in a change in the intended usage of the land. This resulted in the taxpayer's activities going beyond the realisation of a capital asset, with the activities constituting the carrying on of an actual business of subdividing and selling land.

Statham & Anor v. FC of T 89 ATC 4070 20 ATR 228 (Statham's case) where the property was subdivided and sold after a business of raising cattle had failed. The taxpayer relied on the local council to carry out the subdivision work and the local real estate agents handled the advertising and sale of the lots. The Full Federal Court held that what occurred was the realisation, by the most advantageous means, of the asset which the owners had on their hands when they abandoned the intention of farming the subject property.

Casimaty v FC of T 97 ATC 5135; (1997) 37 ATR 358 where due to the growing debt and the ill health of the taxpayer, primary production land was progressively subdivided and sold off over a period of 18 years. There was no coherent plan conceived for the subdivision of the whole property. The taxpayer had acquired and had continued to hold and use the residence and conduct the business of a primary producer on the property. Therefore, there was no change of purpose of object for which the property had been held. In his judgment, Ryan J in the Federal Court held that the profits resulted from the mere realisation of a capital asset and as such the profits were not assessable as ordinary income.

Stevenson v. Federal Commissioner of Taxation (1991) 29 FCR 282 91 ATC 4476 22 ATR 56 where the taxpayer had owned farming land for many years, selling a portion of the land to a third party to be used for agricultural purposes. In the early 1970's he decided to scale back his farming activities and sell most of the remaining 90 acres, other than a few acres retained for his use. He could not source a developer who would pay his sale price and in 1976 he determined that he would subdivide the land himself. He commenced subdividing the land in stages, obtaining finance and personally arranging for the construction of the necessary earthworks, storm water drains, guttered road works and other improvements to the land. Around the same time his farming income consisted of mainly agistment income. Throughout the process the taxpayer had personally dealt with councils, engineers, and statutory utilities. He advertised the development himself, did not engage the services of any particular real estate agent to assist him, dealt personally with prospective purchasers, did some of the physical work himself and fixed the sale price for the subdivided lots, being 220 lots. It was held that the taxpayer was carrying on a business of developing land.

As displayed in the above cases, a taxpayer can embark on a profit making scheme after property was acquired for a different purpose.

In determining whether activities relating to isolated transactions are a profit making undertaking, 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.

Application to your circumstances

In your case, you are an individual non-business taxpayer who jointly purchased property in xxxx and obtained full ownership of some lots in xxxx. You have lived on lot B since xxxx.

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.

A balanced view of the observations of your circumstances, with no one feature being determinative in isolation, reasonably leads to a conclusion the intention for holding the property has changed to a profit making undertaking.

Although the property has been your main residence for some years and you still live on a lot, the intention in relation to the property changed when you committed to this undertaking in relation to the subdivision of the property and the sale of the lots and entered into an agreement with entity A in or about xxxx. The decision to pursue the subdivision shows your choice to engage in exposure to the risks of the development, including the profits, losses and its general success for the purpose of maximising the potential profit made on the sale of the lots. You are funding the subdivision through your savings.

Your situation is not the same as the Statham's case where the council had undertaken all of the work relating to the subdivision of the property as they will manage and control the project, engaging the services of the relevant entities to undertake the activities arising in relation to the project. The fact that you are only selling xx lots does not mean that such an undertaking is not a profit making commercial transaction.

It is viewed that your subdivision activity is of a sufficient scale to characterise it as a commercial or profit-making undertaking. The market value of lot B was estimated to be $xxx before subdivision. This value included the larger block, which contains your main residence.

Spending $xxx to increase the value of the lots indicates a profit making undertaking. It is acknowledged that the extent of your personal involvement was minimal. However, your relations and entity A have undertaken the organisation and management of the activities on your behalf. The activities go beyond a private family arrangement.

We have determined that based on the facts of this situation that the project is a profit making commercial undertaking and the profits from the sale of the lots are considered to be ordinary assessable income under section 6-5 of the ITAA 1997.

Capital gains tax

The inclusion of the gain/profit on the sale of the property as ordinary income does not mean that a capital gains tax (CGT) event does not happen in relation to the property. However, section 118-20 of the ITAA 1997 exists to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. In the absence of such a provision, it is conceivable that a receipt properly characterised as ordinary income and which has also been derived as a result of a CGT event could result in the receipt being taxed twice. Therefore, whilst a CGT event will occur when the property is sold (CGT event A1), any capital gain will be disregarded to the extent of any amount already included as ordinary assessable income under section 6-5 of the ITAA 1997.