Edited version of private advice

Authorisation Number: 1051617596132

Date of advice: 10 December 2019

Ruling

Subject: Property development

Question

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

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The property at comprising XX hectares was purchased by the owners in 20XX for $XX.

The land was purchased jointly by A and B (de-facto partners).

The property was purchased specifically to establish a tourism business, a resort and as a principal residence.

The property was registered as a partnership between A and B to operate the business.

In 20XX the business was opened.

In 20XX the residence was built for $XX. Upon completion it became and remains the principal place of residence for A and B.

B and A operated the business for approximately X years when it was closed due to the ill health of B.

In 20XX unforeseen financial circumstances caused B and A to take additional debt.

A continued to work he/she retired in late 20XX to care for B. This retirement also put a strain on their financial commitments, particularly the debt.

The ill health of B made the upkeep of XX hectares increasingly difficult to maintain. The owners wish to remain living in their home but due to finances they find it necessary to sell the remainder of the land to finance their retirement.

The property was sandwiched between rural residential subdivisions and rather than cut off just their house lot and sell the balance of the land in an undeveloped state, They decided to subdivide the property in accordance with properties on either side of them, and sell the individual lots.

B and A used Company A to manage the application for Development Approval to the Council. Company A advised on various consultants required and compiled and submitted the application.

In 20XX, the property was approved by Council to be subdivided into XX lots (including the house lot).

Lot X will be kept by B and A as this contains their main residence. The remaining lots are proposed to be sold.

A local real estate agent has provided a marketing plan and will undertake all advertising, marketing and sales.

A project manager/coordinator from Company A is coordinating all development and construction activities from receipt of development application (DA) final sales.

B and A will undertake to maintain the lots which will entail slashing and poisoning.

No site office or other buildings will be erected on the land during construction and sales.

The owners have funded the DA from modest savings and intended to use a recent small inheritance to fund the construction. Construction will only commence when 3 or 4 presales are secured.

Financial accounts are kept by the owners in relation to income and expenditure incurred regarding the development.

The extent of the works carried out to date, specifically for the DA to Council is as follows:

·         Town planning

·         Engineering report

·         Geo-technical and slope stability

·         Vegetation

·         Bushfire management

·         Economic needs analysis

The selection of consultants was on the advice of the Town planner at Company A, who also provided input and co-ordinated their reports.

The extent of the work required post DA and as per conditions of the DA to construct the subdivision, will be as follows:

·         Consulting Engineering Services for detailed design and documentation (operational works) of the civil infrastructure as per the amended decision notice dated 20XX.

·         Construction of the road

·         Design and installation of power and telecommunications

·         Surveying

·         Lot marketing and sales

·         Lot clearing (by contractor) and maintenance (slashing and poisoning by owners)

The post DA works to construct the subdivision will be managed by the Director from Company A, who will source, appoint and coordinate all consultants and the contractor. Payments will be approved and paid by A and B.

The land was not acquired with the intention of subdivision and development.

You were previously approached by resort owner to develop your land, but the activity ceased before anything could develop due to the failure of the resort owner.

Sales could take up to X years.

An estimation of the total costs is $XX.

An estimation of the total sales is $XX.

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 70-10

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Summary

A and B are carrying on a business of property development. Any profit arising from the sale of the proposed subdivided blocks will be assessable as ordinary income under section 6-5 of the ITAA 1997.

Detailed reasoning

Taxation treatment of property sales

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, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock;

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

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

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.

The question of whether a business is being carried on is a question of fact and degree. Over the years the courts have developed a series of indicators to determine if a business is being carried on.

Taxation Ruling TR 97/11 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.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

Further, Taxation Determination TD 92/124 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.

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. This can include land.

Isolated transactions

Profits arising from an isolated transaction as a result of entering into a profit-making undertaking or scheme will be ordinary income under section 6-5 of the ITAA 1997, on revenue account, (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693(Myer Emporium)). This is distinguished from a 'mere realisation' which is not ordinary income.

Taxation Ruling TR 92/3 (TR 92/3) sets out the ATO view as to the application of the decision in Myer Emporium and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income.

Paragraph 16 of TR 92/3 states that if a taxpayer not carrying on a business makes a profit, that profit is income if:

(a)  the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain; and

(b)  the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

Paragraph 13 of TR 92/3 outlines the following factors which may be relevant when considering whether an isolated transaction amounts to a business operation or commercial transaction:

·         the nature of the entity undertaking the operation or transaction;

·         the nature and scale of other activities undertaken by the taxpayer;

·         the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

·         the nature, scale and complexity of the operation or transaction;

·         the manner in which the operation or transaction was entered into or carried out;

·         the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

·         if the transaction involves the acquisition and disposal of property, the nature of the property, and

·         the timing of the transaction or the various steps in the transaction.

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 amount to a business operation or commercial transaction.

Paragraph 42 of TR 92/3 provides that if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either:

a)    as the capital of a business; or

b)    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 or a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income although 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 (MT 2006/1) 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.

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

Capital gains tax provisions

The capital gains tax (CGT) provisions are contained in Parts 3-1 and 3-3 of the ITAA 1997. Broadly, the provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own.

CGT event A1 happens if you dispose a CGT asset. A CGT asset is any kind of property, or a legal or equitable right that is not property.

When a CGT asset (the original asset) is split into 2 or more assets (the new assets), such as when land is subdivided, the subdivision of the land into subdivided blocks is not a CGT event.

Where the original land was acquired before 20 September 1985, each new lot retains its pre-CGT status and any capital gain or capital loss made on its disposal is disregarded.

Application to your situation

Taking all of the available facts into consideration, and on weighing the various factors, your activities in subdividing the Property and the proceeds from the sale of the proposed subdivided blocks will be from the carrying on of a business.

In this case you have approached the subdivision of your property in a business like way. A and B hired a project manager/coordinator to undertake the activities in relation to the Project. The project manager has experts such as town planners, engineers, surveyors and other contractors.

The activities to be undertaken to subdivide the Property and sell the proposed subdivided blocks will be the same as those undertaken by and carried out in a similar manner to that of a taxpayer in business as a property developer.

A and B have a purpose of profit as well as a prospect of profit from undertaking the activity. They have estimated they will make a net profit of $XX (total proceeds less cost of development), which is considerably more what they would receive if they sold the property unsubdivided.

A and B will be using their own savings to pay for the activity. This means that they carry all of the risk in regards to the activity.

The Property was not put on the market as a whole and you have made a considered decision to subdivide the whole Property and sell the proposed subdivided blocks. As per advice given to you by real estate agents that they later hired to market and sell the subdivided properties.

While the Project will be smaller when compared to other developments, size is not the determinative factor, and all of the factors need to be taken into consideration when determining the nature of the Project. The activities being undertaken will be significantly more complex than what would have been involved if the Property was disposed of as a whole.

There will be a change in the nature of the Property with the proposed subdivision transforming the whole property from a larger semi-rural block of around XX hectares into XX residential blocks XX of which will be divided into X - X hectare blocks.

Your choice to subdivide the whole property, engage project manager to assist with the subdivision, and engage the services of a real estate agent to sell the subdivided blocks demonstrates that there is an intention to profit from the subdivision of the Property and that it will be undertaken in a commercial manner with a level of repetition occurring.

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 subdivided blocks. You will retain all the rewards and carry most of the risks from the sale. The assumption of the risks and the receipt of the subsequent rewards (or losses) is a strong indicator of profitmaking activity.

Addressing the specific points you have made in your ruling request:

·         A and B state that they have never been a property developer before. We acknowledge and accept this, however, A and B are approaching the Project in a business like way and undertaking commercial transactions.

·         A and B did not acquire the Property with property development in mind and occupied it as their main residence. We acknowledge and accept this however A and B have changed their purpose by deciding to subdivide the Property.

·         A and B state that they are seeking to maximise the amount received from the sale of the Property. Deciding to sub divide the land themselves, indicates that they have ventured into a development business or profit-making undertaking. A and B have a purpose of profit as well as a prospect of profit from undertaking the Project.

·         A and B state that they are merely realising their asset to their best advantage. In subdividing their Property into XX blocks, there will be significant costs with the requirement to outsource work to specialised contractors. A and B are doing more than merely realising their asset and are going well beyond a mere realisation. A and B are significantly improving the Property, and it will take approximately X years to complete. The duration and complexity of the sub-division and sale of the blocks indicates that A and B have ventured into a development business or profit-making undertaking.

Given all of the factors discussed above A and B are carrying on a business of property development. Any profit arising from the sale of the proposed subdivided blocks will be assessable as ordinary income under section 6-5 of the ITAA 1997.