Edited version of private advice

Authorisation Number: 1051622594473

Date of advice: 19 December 2019

Ruling

Subject: Sale of subdivided lots

Question 1

Will the proceeds from the development and sale of the lots be subject to taxation under the Capital Gains Tax (CGT) provisions in parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes, because the arrangement involves the disposal of a CGT asset. However the CGT anti-overlap provision in section 118-20 of the ITAA 1997 reduces any capital gain by amounts otherwise included in your assessable income (see question 2).

Question 2

Will the proceeds from the development and sale of the lots be assessable income under section 6-5 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You are the sole owner of a large property.

The property was acquired in 19XX for the purpose of primary production. It was and still is zoned as rural. There is an existing residence on the land and this is the family home. The value as per the development agreement is $XX.

Over time the town near you has expanded to the point that your land is now adjacent to the structural plan boundary for residential house lots.

You are currently planning to fund your retirement and the retirement of other family members.

You were approached by a developer who has developed other land within the area to propose a development opportunity.

You had never been involved in land development before and due to a lack of knowledge have approached advisers for assistance.

The developer offered the following proposal, states in general terms:

·   They would investigate the possibility of rezoning the property for development and subdivision into rural residential allotments;

·   If the outcome was favourable, the developer would seek to have the property rezoned for this development;

·   Should the development not proceed, the developer would absorb these costs and you were not required to reimburse them;

·   If the property was rezoned the developer would carry out all works and fund the expenses required for the development and subdivision of the land into small rural residential allotments until the sale of the lots;

·   The developer would pay you the surplus funds (after development costs were deducted) for the subdivided lots on a staged basis, as they were sold;

·   The existing residence would be included in the development but you would retain the home and some land area around their home.

You understand that the development will be a lengthy process conduct over XX years.

You wish to accept the developer's proposal.

The proposal will provide the entire family with funds whilst the primary production operation scales down and will protect the current living arrangements whilst realising the sale of the property.

Prior to being approached by the developer, you had not considered selling the land.

The development of the property would represent the end of your farming activity in that region. The family has property in other regions that they will continue to operate on.

There is no current start date for the project as rezoning has not yet happened. It is estimated it will start in the next X to X years depending on local councils and authorities.

A Development Agreement (DA) was signed by you and the developer in mid 20XX.

As per clause X.X of the DA the developer must seek approval for rezoning within XX months of the signing of the DA or longer as approved by you.

Included in clause X.X in regards to the rezoning the developer is responsible for the engagement and payment of specialists, its own expenses in regards to drawings and photographs and stakeholder/community engagement.

Clause X.X grants the developer a licence, from you, to enter the land with appropriate notice, in order to carry out necessary actions to procure the rezoning.

In clause X.X you agree to do all things and sign all documents necessary to for the developer to apply for the rezoning. You will also be liable for all charges, rates and taxes in relation to the land during the rezoning application period.

The DA states that the developer must arrange the funding for construction and completion of the development.

However, as per clause X.X of the DA the Developer may borrow funds for the Development Costs using the land.

The proceeds of the sales of the lots will be distributed as per clause X of the DA.

You and the developer have agreed that the development phase will not exceed XX years unless you agree to longer.

Clause XX provides you are ultimately responsible for all development expenses and the developer may lodge a caveat to secure their rights of payment.

It is currently estimated that there will be about XX lots created. The ultimate amount of lots will be determined by the developer's approved plan.

The estimated sale for each lot is between $XXX and $XXX, providing estimated gross proceeds of $XXXX to $XXXX.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Summary

Based on the information provided, it is viewed that any profit from the sale of your ownership interests in the lots will still be accounted for on revenue account 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.

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. Each of the new subdivided lots will retain the acquisition date of the original asset.

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.

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

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 your case you were approached by a property developer to subdivide and develop your property. 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 manner that goes beyond the mere realisation of a capital asset.

You have a purpose of profit as well as a prospect of profit from undertaking the activity. You have estimated you will make a gross profit of $XXX to $XXX, which is considerably more than you would receive if you sell the property whole.

While the developer will be accessing loans to pay for the development as it proceeds, your land will be used as guarantee for those loans. This means that you carry a large portion 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 advisers that you later hired give you advice on the matter when dealing with the developer.

The development will consist of about X blocks and will bring a gross profit of $XXX to $XXX, this is considered to of significant in terms of size and scale of the undertaking. Therefore, 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 into XX residential blocks.

The development will take approximately XX years to complete, even though it is being done in stages and you are continuing to use undeveloped land to farm until such time and the developer is ready to develop it. This shows a high level of repetition in activities.

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 a large portion of 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:

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

·   You did not acquire the Property with property development in mind and occupied it as your main residence and operated a farming activity. We acknowledge and accept this however you have changed your purpose by deciding to subdivide the Property.

·   You state that you are seeking to maximise the amount received from the sale of the Property to fund your retirement. Deciding to subdivide the land, indicates that you have ventured into a development business or profit-making undertaking. You have a purpose of profit as well as a prospect of profit from undertaking the development.

·   You state that you are merely realising your asset to your best advantage. In subdividing your Property into XX blocks, there will be significant risks with the development. You are doing more than merely realising your asset and are going well beyond a mere realisation. You are significantly improving the Property, and it will take approximately XX years to complete. The duration and complexity of the sub-division and sale of the blocks indicates that you have ventured into a development business or profit-making undertaking.

Given all of the factors discussed above you 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.