Edited version of private advice

Authorisation Number: 1051749276878

Date of advice: 04 September 2020

Ruling

Subject: Income tax and GST treatment of land sale

Question 1

Would the profit or gain derived from the sale of the Land be ordinary income for the purposes of section 6-5 of the Income Tax Assessment Act 1997?

Answer

No - the sale of the Land would be a mere realisation of an asset that is subject to capital gains tax provisions

Question 2

Will the sale of the subdivided blocks allocated in Australia be a taxable supply pursuant to section 9-5 of A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

No

This ruling applies for the following period:

1 July 2019 to 30 June 2022

Relevant facts and circumstances

·         A trustee for a unit trust (the Taxpayer) acquired several adjoining parcels of land in a non-metropolitan area in 1980.

·         The lots were acquired as a single parcel of land in a single transaction. For all years of ownership, a single rates notice was received from the council for the lots. A single rates notice initially covered the lots. This continued to be the case, apart from the lots that were sold (at which time a rates notice was issued in respect of the those lots to the new owner). Currently, the remaining lots that continue to be owned by the Taxpayer are covered by a single rates notice.

·         The total land area for the lots was 30 acres.

·         At the time they were acquired, the lots consisted of vacant land, a fibro building and concrete display area.

·         The lots were acquired as an investment property to establish a business activity including a shop using the existing building. The lots were also acquired as potential expansion space for a growing manufacturing business that was operated by a related entity which was lacking space in its current location.

·         The lots were initially leased to the related entity, which operated a business comprising the business activity and shop on the premises for several years.

·         In the 1980's, the Taxpayer constructed another business facility on one of the lots. The business facility was leased to a related entity which operated a business from the premises.

·         In mid 2000, two vacant lots were sold to a third party.

·         Towards late 2000, the lot that housed the business facility was sold to a third party.

·         The Taxpayer continues to own several lots (the Land). The total area for the Land is 20 acres.

·         The Land has never been used for a separate purpose that was specific to that individual lot (the lots were acquired as a single parcel in a single transaction and treated as a single asset by the Taxpayer).

·         The Land has always been held on capital account.

·         Expenses relating to the Land has been capitalised by the Taxpayer (that is, not claimed as tax deductions).

·         The nature of the area surrounding the Land has changed over the period of ownership. From the date of acquisition until approximately a decade ago, the surrounding area was commercial (on one side) and bush land (on the other side). In the last 10 years, the surrounding area has evolved into residential areas as the township has expanded.

·         A number of residential subdivisions have been completed in areas near to the Land in this time period. The Taxpayer and the underlying owners have no relationship with any of the persons that completed the surrounding developments. The Taxpayer and the underlying owners have had no input or involvement with the surrounding developments.

·         The lots comprise 'scrubby' and 'rough' land (uneven with ditches). Approximately 50% of the land area of these lots is flood prone and thus cannot be used for any real purpose or developed.

·         A substantial portion of the Land is unable to be subdivided and sold as residential lots because it is flood prone (the Floodway). The current proposal is for the Floodway to be retained by the Taxpayer. The exact future use of the Floodway has not yet been determined.

·         The current proposal is to subdivide the Land (other than the Floodway) into 40 residential lots, each with an average land area of approximately 600 square metres. This is the standard area for new residential lots in the local area and consistent with the land sizes encouraged by the local council.

·         The Taxpayer will be completing the subdivision to the minimum standard required by the local council. The Taxpayer will not be completing additional improvements (above and beyond council requirements) with the intention of increasing the sale price. For example, the Taxpayer will not be building houses on the Land or providing sporting or community infrastructure/facilities etc.

·         The underlying owners are nearing (or at) retirement age, and do not wish, nor do they have the expertise, to be actively involved in the development of the Land.

·         The Taxpayer will engage external parties to perform the roles needed to proceed with the subdivision (for example, engineers, town planners, environmental and civil works contractors). A representative of the Taxpayer will be appointed to liaise with the external parties.

·         The Taxpayer is proposing to mainly fund the development costs with cash contributions from the underlying owners. Where possible, the subdivision and sale process would be staged to minimize the need to borrow. However, if the circumstances necessitate external funding, the Taxpayer may need to borrow from a bank or external party.

·         The Taxpayer is seeking to divest the ownership of the Land after 40 years of ownership.

·         The underlying owners have now reached an age and stage in life where they are looking to divest their assets and separate their joint business and investment activities - in readiness for retirement.

·         The Taxpayer and underlying owners have no history of property development transactions.

Taxpayer's contentions

It is the Taxpayer's view that the sale of the Land as a single parcel is unlikely to achieve a fair price. In the current economic climate, there are very few potential purchasers of large landholdings. It is unlikely that a developer will be willing to pay the full market value of the Land given the projected economic downturn. Further, the sale of the Land as a single transaction would be even more difficult given the fact that a substantial portion of the Land is unusable (this is, the Floodway) and the Floodway may be a liability moving forward, given the fact that the owner will need to continue to maintain the land and pay costs associated with it.

The Taxpayer believes that the subdivision into residential lots will provide the best opportunity to divest the Land for a fair price.

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

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

Reasons for decision

Summary Issue 1

The sale of the Land would be a 'mere realisation' of a capital asset.

Detailed reasoning

TAXATION TREATMENT OF LAND SALES

Generally, there are three ways profits from a land sub-division can be treated for taxation purposes:

·         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.

·         As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of an isolated commercial 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.

·         As statutory income under the capital gains tax (CGT) regime (sections 10-5 and 102-5 of the ITAA 1997) on the basis that a mere realisation of a capital asset has occurred.

Carrying on a business of property development

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

The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? (TR 97/11). Although TR 97/11 deals with the issues of determining whether a taxpayer is carrying on a business of primary production, the same principles can be applied to the question of whether a taxpayer is in the business of property development.

Paragraph 13 of TR 97/11, uses the following indicators to determine whether a taxpayer is carrying on a business:

·         whether the activity has a significant commercial purpose or character;

·         whether there is repetition and regularity of the activity;

·         whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business;

·         whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at 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 a 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 business 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 Income tax: whether profits on isolated transactions are income (TR 92/3) sets out the Commissioner's view on 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 1 of TR 92/3 provides that the term isolated transactions 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.

Paragraph 6 of TR 92/3 provides that a profit from an isolated transaction is generally income when both of the following elements are present:

·         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.

In general, whether a profit from an isolated transaction is income according to ordinary concepts depends very much on the individual circumstances of the case.

Paragraph 13 of TR 92/3 lists the following factors which are relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction include:

·         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 that property; and

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

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.

Mere Realisation

Where the sale is a 'mere realisation' the sale is on capital account to which the CGT rules will generally apply. These proceeds are not ordinary income.

A sale that is more than a 'mere realisation' will be on revenue account and proceeds will generally be assessable as either income from the carrying on of a business or income from a profit-making undertaking or scheme.

The expression 'mere realisation' is used to distinguish a mere realisation from a business operation or a commercial transaction carrying out a profit-making scheme.

Profits made on the realisation of capital assets can still be ordinary income if the activities go beyond a mere realisation and instead become a separate business operation or commercial transaction even though the taxpayer did not have a purpose of profit-making at the time of acquiring the asset.

In McClelland v FC of T [1970] HCA 39, for example, the Privy Council held that the question to be answered was whether the facts revealed a mere realisation of capital, albeit in an enterprising way, or whether they justify a finding that the taxpayer went beyond this and engaged in a trade of dealing in the asset, albeit on one occasion only.

Lord Justice Clark, in distinguishing between proceeds that is mere realisation of capital and ordinary income, stated in California Copper Syndicate v Harris (1904) 5 TC 159 at pp 165-166 that:

...What is the line which separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be determined being - is the sum of the gain that has been made a mere enhancement of values by realising a security, or is it a gain made in an operation of business in carrying out a scheme of profit-making?

In FC of T v Whitfords Beach Pty Ltd 82 ATC 4031, Gibbs CJ similarly said (at p.4034) that:

When the owner of an investment chooses to realize it, and obtains a greater price for it than he paid to acquire it, the enhanced price will not be income within ordinary usages and concepts, unless, to use the words of the Lord Justice Clerk in California Copper...'what is done in not merely a realisation or charge of investment, but an act done in what is truly the carrying on, or carrying out, of a business'.

Application in these circumstances

It is accepted that the Taxpayer's primary intention was to hold the Land to facilitate business conducted by related entities - that it was not acquired with the intention of reselling it. The Land has been used for over 40 years to derive income. Due to the retirement plans of the underlying owners the Taxpayer has decided to realise the value in the property.

To realise the best possible return for the property, as the Taxpayer (or the underlying owners) have no experience in property development, the Taxpayer will engage experts to undertake the subdivision of the Land and a real estate agent to sell the lots.

It is considered the proposed size and scale of the activity does not reflect a business of land development.

Having regard to these factors, the Commissioner considers that, on balance, the Taxpayer would not be undertaking a business operation or commercial transaction when developing the Land.

The subdivision of the Land and the sale of the subdivided lots would be the mere realisation of an asset: it is the disposal of a CGT asset that is subject to capital gains tax. Upon the execution of the sale contract CGT event A1 will happen in relation to each lot.

Summary Issue 2

The activities would not constitute the carrying on of an enterprise - they would be considered a mere realisation of a capital asset.

Detailed reasoning

GST TREATMENT OF LAND SALES

Relevantly, section 9-5 of the GST Act provides that you make a taxable supply if the supply is made in the course or furtherance of an enterprise that you carry on.

Carrying on an 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 (MT 2006/1)

sets out the Commissioner's views on the matters to be taken into account in the determining whether an activity amounts to carrying on a business or whether there is a concern that does not amount to a business but which has the characteristics of a business operation - which in turn provides explicit and implicit guidance to determine whether there is mere realisation of an asset, albeit in an enterprising way.

The relevant considerations include:

·         Whether the landowner has held the land for a considerable period prior to the development and sale.

·         Whether the landowner has conducted farming, or other non-development business activities, on the land prior to beginning the process of developing and selling the land.

·         Whether the landowner originally acquired the property as a private residence or for recreational purposes.

·         Whether the landowner originally acquired the property as an investment, such as for long term capital appreciation or to derive rental income.

·         Whether the land has been acquired near the urban fringe of a major city or town.

·         Where the property has recently been rezoned, whether the landowner actively sought rezoning.

·         A potential buyer of the property made an offer to the landowner before the landowner entered into a development arrangement.

·         The landowner was unable to find a buyer for the land without subdivision.

·         The landowner applies for rezoning and planning approvals around the time or sometime after acquisition of the property, but before undertaking further steps that might lead to a profitable sale or entering into development arrangements.

·         The landowner has registered for GST on the basis that they are carrying on an enterprise in relation to developing the land.

·         The landowner has registered a related entity for GST that will participate in (or undertake) the development of the land.

·         The landowner has a history of buying and profitably selling developed land or land for development.

·         The operations are planned, organised and carried on in a businesslike manner.

·         The landowner has changed its use of the land from one activity to another (for example, farming to property development).

·         The scope, scale, duration and degree of complexity of any development.

·         Who initiated the proposal to develop the land for resale.

·         The sophistication of any development or other pre-sale arrangements.

·         The level of active involvement of the landowner in any development activities.

·         The level of legal and financial control maintained by the landowner in a development arrangement.

·         The level of financial risk borne by the landowner in acquiring, holding and/or developing the land.

·         The value of the development or other preparatory costs relative to the value of the land.

This overlap between the principles that apply in determining whether the subdivision of land amounts to carrying on a business for income tax purposes and carrying on an enterprise for GST purposes is reflected in the following discussion in MT 2006/1:

Isolated transactions and sales of real property

262. The question of whether an entity is carrying on an enterprise often arises where there are 'one-offs' or isolated real property transactions.

263. The issue to be decided is whether the activities are an enterprise in that they are of a revenue nature as they are considered to be activities of carrying on a business or an adventure or concern in the nature of trade (profit making undertaking or scheme) as opposed to the mere realisation of a capital asset. (In an income tax context a number of public rulings have issued outlining relevant factors and principles from judicial decisions. See, for example, TR 92/3, TD 92/124, TD 92/125, TD 92/126, TD 92/127 and TD 92/128.)

264. The cases of Statham & Anor v. Federal Commissioner of Taxation ( Statham ) and Casimaty v. FC of T ( Casimaty ) provide some guidance on when activities to subdivide land amount to a business or a profit-making undertaking or scheme. In these cases, farmland was subdivided and sold. Minimal development work was undertaken to meet council requirements and to improve the presentation of certain allotments. On the particular facts of these cases the courts held that the sales were a mere realisation of a capital asset.

265. 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 (a profit-making undertaking or scheme being the Australian equivalent, see paragraphs 233 to 242 of this Ruling). If several of these factors are present it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors 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.

266. 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.

...

Land bought with the intention of resale

270. In isolated transactions, where land is sold that was purchased with the intention of resale at a profit (which would be ordinary income) the Commissioner considers these activities to be an enterprise. This would be so whether the land was sold as it was when it was purchased or whether it was subdivided before sale. An enterprise would be carried on in this situation because the activities are business activities or activities in the conduct of a profit-making undertaking or scheme and therefore an adventure or concern in the nature of trade.

Application in these circumstances

For the reasons set above, the activities in this case would not be considered activities that are in the form of a business or in form of an adventure or concern in the nature of trade - the hope of making a gain would not elevate the activities to an enterprise.

Consequently, the supply of vacant lots would not be taxable supplies for the purposes of section 9-5 of the GST Act.