Edited version of private advice

Authorisation Number: 1051627535792

Date of advice: 31 January 2020

Ruling

Subject: Property subdivision - carrying on a business of property development

Question 1

Will the proceeds from the sale of the subdivided blocks of land in Town A (the blocks) be considered ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of carrying on a business of property development?

Answer 1

Yes

Question 2

Will the proceeds from the sale of the blocks be considered ordinary income under section 6-5 of the ITAA 1997 as a result of profit from an isolated commercial or business transaction?

Answer 2

No

Question 3

Will any profit made from the sale of the blocks be treated as statutory income under parts 3-1 and 3-3 of ITAA 1997?

Answer 3

No

Question 4

Will the sale of the blocks be a taxable supply under section 9-5 of the A New Tax system (Goods and Services Tax) Act (GST Act)?

Answer 4

Yes

This ruling applies for the following period:

1 July 2019 to 20 June 2021

The scheme commences on:

1 July 2019

Relevant facts and circumstances

Less than 10 years ago, you inherited a land parcel (the Property), Lot A in Town A, from the Estate of your late spouse. You provided the value of the land at that time and the size of the land. It was zoned as non-urban. You didn't apply for rezoning; however, rezoning occurred after you inherited the land.

Your late spouse inherited the subject land parcel from a family member in the 19X0's, prior to 20 September 1985.

In the early 19X0's, following an offer made by Company A, part of the land within was sold to Company A. You provide the value of the sale at that time.

A few years later, your late spouse applied to Council A for a subdivision of several lots.

The balance of the land parcel, as well as surrounding land, was continually used for farming by you up until the time the Development Management Agreement was entered with the current developer.

You continued with the rezoning and subdivision path with no intention to carry out the actual subdivision as you lacked the financial means to undertake the development. You were looking to maximize the sale value of your asset by undertaking the minimum to obtain subdivision approval in terms of a development application and then sell the land with the development application in place.

Over five years ago, you engaged the services of a consultant to lodge a development application for a significant amount of lots subdivision on the subject land parcel, including the previously subdivided lots. You provided the land value at that time.

Following the receipt of a successful determination a year later, an agent was appointed to market the land parcel as a 'residential subdivision opportunity' via a tender process with a specific closing date.

Whilst you continued to run the farm on the land, you cancelled your GST registration the same year and scaled back your farming business at this time.

Following the receipt of several expressions of interest from developers to acquire the land parcel, you considered that the offers did not meet expectations and hence entered into negotiations with one of the tendering parties, who advised that they could achieve a better outcome by disposing of the subject land parcel via a Development Management Agreement in lieu of a sale.

You provided a copy of the alternate tenders and some of the offers were as follows:

·        Offer 1 with the current Developer

-   immediate sale price provided

-   or Development Management Agreement proposal of over $5 million over less than five year period

-        land sale after direct costs shared between you and the Developer

-        a specific amount paid on the entry into the agreement

·        Offer 2 with a fixed price per lot plus a percentage of any development profit

-   a table in the offer indicates a sliding range of return based on lot sale process

-   you would receive a specific amount on signing the agreement and the balance as lots sold

·        Offer 3, sale for a specific amount after taking a first mortgage over the land to be acquired.

A Development Management Agreement was subsequently entered into with Developer A (the Developer) the following year. The executed Development Management Agreement states:

·        You received an initial advance of a specific amount on execution of the Agreement. The Developer will keep this amount from the Project Proceeds as a repayment less any part previously paid out from your private funds.

·        You remain the owner of the property.

·        You role in connection with the Project will be entirely passive.

·        You will sign:

-   documents for the subdivision

-   consents for Council approval of plans of subdivision, development applications, construction certificate and the like

-   any 88B instrument of plans of subdivision and arrange for production of the appropriate certificate of title for registration

-   each contracts for sale, transfers and any other documents necessary to enable the Lots to be sold

-   the mortgage referred to in a specific clause.

·        The Developer will fund all project expenses.

·        You and the Developer are independent contractors.

·        The Developer will call tenders and no contractor for the civil works shall be engaged until the parties are in agreement or a nomination has been made as a result of the dispute resolution process.

·        The Developer to be paid a Management Fee from the net proceeds of the sale of the lots.

·        The Developer to be reimbursed for project expenses incurred from the net proceeds of the sale of the lots.

·        The balance of the sale of the lots to be distributed between you and the Developer.

·        You are provided with profit and loss statement quarterly and yearly.

·        You have the right to review and audit all accounting records at your own cost.

You provided a copy of the staging plan.

Several lots have been sold to date. More lots are completed or under construction and another significant number of lots are due to be constructed. You provided the expected completion date and the average sale value.

A contract for the sale of the first residential land lot was entered into about a year after the Agreement was entered into and you have provided the sale value.

You reinstated your GST registration a couple of years ago pending the outcome of this ruling.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 112-25

Income Tax Assessment Act 1997 section 118-20

A New Tax System (Goods and Services Tax) Act 1999 section 9-5

A New Tax System (Goods and Services Tax) Act 1999 section 9-20

A New Tax System (Goods and Services Tax) Act 1999 section 9-40

A New Tax System (Goods and Services Tax) Act 1999 section 23-5

A New Tax System (Goods and Services Tax) Act 1999 section 188-10

A New Tax System (Goods and Services Tax) Act 1999 section 188-25

A New Tax System (Goods and Services Tax) Act 1999 section 195-1

Reasons for decision

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 1997, 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 1997, 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.

Ordinary income

Isolated transaction

Profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's 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 the taxpayer's business (FC of T v The Myer Emporium (1987) 163 CLR 199) (Myer Emporium).

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

Taxation Ruling TR 92/3 defines the term 'isolated transactions' as:

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

·        transactions entered into by non-business taxpayers.

It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayers business but:

·        the intention or purpose of the taxpayer in entering into the profit-making 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.

Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of subdivided land can be assessed as ordinary income within section 6-5 of the ITAA 1997. Taxation Ruling TR 92/3 lists the following factors to be considered:

(a)   the nature of the entity undertaking the operation or transaction

(b)   the nature and scale of other activities undertaken by the taxpayer

(c)   the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained

(d)   the nature, scale and complexity of the operation or transaction

(e)   the manner in which the operation or transaction was entered into or carried out

(f)     the nature of any connection between the relevant taxpayer and any other party to the operation or transaction

(g)   if the transaction involves the acquisition and disposal of property, the nature of that property, and

(h)   the timing of the transaction or the various steps in the transaction.

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.

Capital Gain Tax (CGT) provisions

CGT event A1 in section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you dispose of each subdivided block. You will make a capital gain if the capital proceeds from the disposal of the block are more than the cost base of the block. You will make a capital loss if those capital proceeds are less than the reduced cost base of the block.

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

Application to your situation

In your circumstances the Commissioner considers that based on the information provided your subdivision activities are not an isolation transaction but the result of carrying on a business of property development.

The subdivision activity started just after two years of you acquiring the Property through inheritance. The land has been with your family for a long time, used as a main residence and for the farming business; however, there was a change of intention when you engaged the services of a consultant to lodge a development application for a several lots subdivision which was successful.

In Scottish Australian Mining Co Pty Ltd v FCT (1950) 81 CLR 188 and Commissioner of Taxation v Whitfords Beach Pty Ltd (1982) 150 CLR 355, the decisions stated that a taxpayer, who had originally acquired property for farming operations or other purposes, could subsequently embark on a profit making scheme. This means that a taxpayer can embark on a profit making scheme after property was acquired for a different purpose.

It is noted that your family previously conducted subdivision activities on the Property since its acquisition.

You had an opportunity to sell the land as a whole but you chose to go through an EOI process to attract different offers indicating a profit making intention.

Following receipt of several offers you chose to sign a Development Management Agreement proposal with a potential profit of several $millions whilst you retain ownership of the land. The size and scale of the activity is significant.

The development is progressing in several stages, over several years, in a complex manner, indicating an activity being more than the mere realisation of an asset or an isolated transaction. There is regularity and repetition of the subdivision activity over several years.

You stated that your role is passive; however, you receive regular financial reports and have to be involved with document sighting and signing as well as the selection process of contractors. The activity is carried on in a similar manner to that of ordinary trade in that line of business

The Developer funds the project but recoup the expenses from the net proceeds which makes the final pay out figure uncertain and therefore increasing the risk of the activity.

While CGT event A1 will occur on the disposal of the subdivided blocks, the disposal of each lot will be viewed as a business transaction. Any profit from the sale will be assessable as ordinary income under section 6-5 of the ITAA 1997 as a result of carrying on a business of property development. 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.

Goods and Services Tax (GST)

Section 9-40 of the GST Act provides that you are liable for GST on any taxable supplies that you make.

Section 9-5 of the GST Act states that you make a 'taxable supply' if:

(a) you make the supply for consideration

(b) the supply is made in the course or furtherance of an enterprise that you carry on

(c) the supply is connected with the indirect tax zone (Australia), and

(d) you are registered, or required to be registered for GST.

'However, the supply is not a taxable supply to the extent that it is GST-free or input taxed'.

You intend to subdivide the land into residential lots. For the supply of your subdivided land to be a taxable supply, all of the requirements in section 9-5 of the GST Act must be satisfied.

In this case, you will be selling vacant residential blocks for consideration in Australia. Therefore, paragraphs 9-5(a) and 9-5(c) of the GST Act will be satisfied. Further, the supply of the blocks in your situation will neither be GST-free or input taxed.

Accordingly, we must determine whether:

(a) your sale of the blocks are in the course or furtherance of an enterprise that you are carrying on, and

(b) if so, whether you are required to be registered for GST.

Enterprise

Section 9-20 of the GST Act provides that the term 'enterprise' includes, among other things, an activity or series of activities done in the form of a business or in the form of an adventure or concern in the nature of trade. The phrase 'carry on' in the context of an enterprise includes doing anything in the course of the commencement or termination of the enterprise.

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 provides guidance on what activities will amount to an enterprise.

Paragraph 234 of MT 2006/1 distinguishes between activities done in the form of a 'business' and those done in the form of 'an adventure or concern in the nature of trade'. In particular:

·        A business encompasses trade engaged in on a regular or continuous basis.

·        An adventure or concern in the nature of trade may be an isolated or one-off transaction that does not amount to a business, but which has the characteristics of a business deal.

The relevant intention or purpose of the taxpayer is not the subjective intention or purpose of the taxpayer but rather it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

Paragraphs 262 to 302 of MT 2006/1 consider isolated transactions and sales of real property. Paragraph 263 of MT 2006/1 states that the issue to be decided is whether the activities are an enterprise, in that they are of a revenue nature, as opposed to the mere realisation of a capital asset.

Paragraph 264 to 265 of MT 2006/1 discuss two court cases, Statham & Anor v Federal Commissioner of Taxation 89 ATC 4070 (Statham) and Casimaty v FC of T 97 ATC 5135 (Casimaty), involving subdivision and development of properties that were originally held as capital/investments assets, where the court decided that the sale of the post-subdivision lots was the mere realisation of capital/investment assets.

From the Statham and Casimaty cases a list of factors can be ascertained that provide assistance in determining whether activities are a business or an adventure or concern in the nature of trade.

Paragraph 265 of MT 2006/1 provides the following list of factors:

·        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.

In determining whether activities relating to isolated transactions are an enterprise or the mere realisation of a capital asset, it is necessary to examine the facts and circumstances of this case. This requires 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 is determinative. Rather, it will be a combination of factors that will lead to a conclusion as to the character of the activities.

Application to your situation

You initially inherited the Property as your place of residence and for your farming activities but by subdividing and selling the blocks you have changed the purpose for which the land was held for.

Whilst you contend that you have limited involvement in aspect of the development activities, this is not the only determinative factor that should be considered. It is noted that there is a demonstrated change of purpose for which the land is held. You have a coherent plan into place for the subdivision activities. You will be engaged in significant commercial activities such as negotiating or making decision with other entities in order to subdivide the property into numerous residential blocks for sale. You will be engaged in this venture in a commercial and business-like manner by entering into all the agreements to enable the subcontractor to carry out the land subdivision on your behalf. They will be required to provide all the relevant information as requested by you from time to time. This demonstrates your purpose and intention of engaging in commercial activities.

The activities carried out will be of a reasonable size. They are the types of activities routinely undertaken by owners or their service providers engaged in property development.

In conclusion, on balance, your activities indicate a commercial approach and there is a clear intention maximising profit return. Your subdivision activities have the characteristics of activities that would constitute an adventure or concern in the nature of trade. Therefore, you are considered to be carrying on an enterprise as defined in section 9-20 of the GST Act, and the sale of the new residential blocks will satisfy the requirements of paragraph 9-5(b) of the GST Act.

Registration

Section 23-5 of the GST Act provides that you are required to be registered for GST if:

'(a) you are carrying on an enterprise, and

(b) your GST turnover meets the registration turnover threshold'.

The registration turnover threshold is currently $75,000.

Section 188-10 of the GST Act provides that:

you have a GST turnover that meets a particular turnover threshold if:

(a) your current GST turnover is at or above the turnover threshold and the Commissioner is not satisfied that your projected GST turnover is below the turnover threshold, or

(b) your projected GST turnover is at or above the turnover threshold.

Of relevance here is your projected GST turnover. Section 188-20 of the GST Act provides that your projected GST turnover at a time during a particular month is the sum of the values of all the supplies that you have made or are likely to make during that month and the next 11 months other than input taxed supplies.

In working out your projected GST turnover, paragraph 188-25(a) of the GST Act requires that you disregard any supply made or likely to be made, by you by way of transfer of ownership of a capital asset of yours.

Paragraph 260 of MT 2006/1 explains that assets can change their character from being capital/investment assets to being trading/revenue assets, or vice versa, but cannot have a dual character at the same time.

Goods and Services Tax Ruling GSTR 2001/7 Goods and Services Tax: meaning of GST turnover, including the effect of section 188-25 on projected GST turnover discusses the meaning of a 'capital asset' at paragraphs 31 to 36.

Capital assets are often referred to as structural assets used by an entity to produce an income. Capital assets are to be distinguished from revenue assets. If the means by which you derive income is through the disposal of assets, those assets will be revenue or trading assets rather than capital assets.

We have considered section 188-25 of the GST Act and this section does not apply as the sale of the blocks has the character of a revenue asset, rather than a realisation of a capital asset.

As the sale proceeds for the sale of the blocks will exceed the registration turnover threshold you will be required to be registered for GST.

The supply of your subdivided land is considered to be a taxable supply as all of the requirements of a taxable supply under section 9-5 of the GST Act will be met.