Edited version of private advice

Authorisation Number: 1051749352495

Date of advice: 04 September 2020

Ruling

Subject: Subdivision and sale of land

Question 1

Will the sale of the subdivided Property by the Landowner be the mere realisation of a capital asset when the Development Agreement is entered into, noting the significant risks and rewards borne by the Developer?

Answer

Yes

Question 2

Would payments received by the Landowner under the agreement be treated on capital account as a mere realisation of a capital asset?

Answer

Yes

Question 3

If the answer to questions (1) and (2) above are "no", would CGT event K4 arise at the time the Development Agreement is entered into, with any subsequent proceeds received brought to account under the trading stock provisions?

Answer

No

Question 4

Is the Landowner required to be registered for GST for the purpose of selling Subdivided Lots as per the Development Agreement?

Answer

No

Question 5

Will the Landowner make a supply that is 'in the course of furtherance of an enterprise'?

Answer

No

Question 6

Will the Landowner be making a taxable supply when the Subdivided Lots are sold?

Answer

No

This ruling applies for the following periods:

Income year ended 30 June 2020

Income year ended 30 June 2021

Income year ended 30 June 2022

Income year ended 30 June 2023

Income year ended 30 June 2024

Income year ended 30 June 2025

The scheme commences on:

During the income year ended 30 June 2020

Relevant facts and circumstances

The Landowner (or 'the Trust') is a deceased estate trust and is an Australian resident trust for CGT purposes.

The Trustees have absolute discretion to distribute the income or capital of the Trust to the beneficiaries in any proportion as the Trustees may determine, or to accumulate the income or capital in the Trustee's absolute discretion.

The Property was originally purchased by the Deceased as a pre-capital gains tax (Pre-CGT) asset with the intention to use the Property as part of a primary production business or for other private or recreational purposes.

When the Deceased passed away, the property was transferred from their estate to the Trust. Due to the land being a Pre CGT-asset, the cost base of the land in the Trust is the market value at date of death pursuant to subsection 128-15(4) of the Income Tax Assessment Act 1997 (ITAA 1997).

The Property is situated in a remote rural area and is large in size. The Property is held on capital account by the Trust.

The Property has continuously been used for primary production activities such as participating in cattle grazing business amongst the family, and more recently timber harvesting. The Property has been used to rotate cattle from block to block depending on the condition of the pasture, seasonal conditions, rainfall and long-range weather forecasts.

However, the Property's use has always been limited due to its carrying capacity, with the Property subjected to continual dry seasons. Droughts occurred, which resulted in very little or no cattle grazing on the Property. As a result, the Property was then used for timber harvesting due to it no longer being suitable for cattle grazing.

The Trust was previously GST registered for its primary production business, however due to the low turnover in sales, the Trust requested the cancellation of their GST registration.

Over the last few years, the State Government rezoned the area in which the Property is situated as an area for priority development and commenced an infrastructure agreement to build essential road and bridges.

As a result, the Trustees engaged an agent to list the Property for sale in its current state, however no serious offers were received due to the Property's limited access and harsh terrain.

Whilst completing sewer work on the adjoining property, the Developer approached the Trustees with an offer to develop the Property.

The Trust entered into a Development Agreement (DA) with the Developer to allow the Developer to develop the Property for land sales. Under the terms of the DA, all the development costs which includes insurance costs and third-party finance will be met solely by the Developer.

Pursuant to the DA the Developer is responsible for: obtaining all relevant approvals; appointment of solicitors or settlement agents for settlement of sale contracts; appointment of agents to undertake marketing and promotion activities for the Development; performance of duties and provision of services required to sell the Subdivided Lots and; all development control decisions, actions and risk management decisions will be taken by the Developer.

Pursuant to the DA, the Trust will not incur any development costs, or financially contribute to the development. The Trust's obligations under the DA are confined to executing Project Documents, doing all things necessary to ensure that the Developer is able to perform its obligations under the DA and obtain project approval and make available the unencumbered land.

The Trust will not be actively involved in the development in any agency or joint venture capacity as stipulated by the DA which provides that this Agreement does not constitute, and the parties do not intend to create, a joint venture, partnership, agency, trust or other arrangement with each other.

It is expected that the Property will be subdivided into numerous land lots by the Developer as per the conditions of the DA. The title of the Subdivided Lots will remain with the Trustees of the Trust until transfer of ownership to an end buyer.

The Trust will appoint the Developer as the Landowner's agent to sell and market the Subdivided Lots and handle the conveyancing of the Subdivided Lots on behalf of the Landowners.

The Developer has a limited discretion to determine the sale price for Subdivided Lots, taking into account the market conditions noted in the DA and the Trust may only dispute the sale price of a Subdivided Lot in certain circumstances.

The Trust will receive 23.5% of the selling price for each Subdivided Lot, net of GST (if applicable) as a 'Landowner's entitlement'.

The Developer may provide "builders' terms" to Project Builders to enable those builders to construct project homes and display homes on development land before they have settled on the purchase of the land. The Developer is entitled to enter into these types of arrangements and estimates that there will be a significant number of these arrangements in the first Stage in order to give the Project momentum in the market. In these instances, payment of the settlement proceeds for the Subdivided Lot will be delayed until relevant houses are complete and settlement with the Project Builder or their buyer has occurred.

The Trust was previously GST registered for its primary production business, however as identified above, the GST registration was cancelled.

Neither the Deceased or the Trust have a history or experience in activities or in the business of land development.

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 Division 70

Income Tax Assessment Act 1997 section 70-10

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 23-5

Reasons for decision

Question 1

Summary

The disposal of the subdivided Property represents a realisation of a capital asset. The proceeds from the disposal of the Property will be assessable under Parts 3-1 and 3-3 of the ITAA 1997.

Detailed reasoning

The proceeds from the sale of land can be treated as:

·         a realisation, often referred to as a 'mere realisation', of a capital asset, assessable under Parts 3-1 and 3-3 of the ITAA 1997;

·         assessable ordinary income under section 6-5 of the ITAA 1997 as income from carrying on a business of property development; or

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

The doctrine of 'mere realisation' was developed in the High Court case of Scottish Australian Mining Co Ltd v. Federal Commissioner of Taxation (1950) 81 CLR 188 (Scottish Australian Mining), and is used to distinguish a mere realisation from a business operation or a commercial transaction carrying out a profit-making scheme. Based on the facts in Scottish Australian Mining the subdivision of land was considered no more than a mere realisation of a capital asset and merely an enterprising way to realise an asset to its best advantage.

However in Federal Commissioner of Taxation v Whitfords Beach Pty Ltd (1982) 150 CLR 355; 82 ATC 4031 Mason J and Wilson J seemed to doubt the correctness of the court's earlier decision in Scottish Australian Mining due to the scale of the development activities undertaken in that case. Mason J said:

38. ... I have difficulty with the decision of Williams J. in Scottish Australian Mining Co. Ltd. v. Federal Commissioner of Taxation (1950) 81 CLR 188. The taxpayer there, after giving up its mining business in 1924, devoted itself to the subdivision of its land. This entailed the construction of roads, the building of a railway station, the granting of land to public institutions such as schools and churches and the setting aside of land for parks. I should have been inclined to the view that the taxpayer had ceased to carry out its mining business and that it had commenced to carry on the business of land development.

The courts have since endeavoured to reconcile these decisions and a number of factors have been established to determine whether the sale of subdivided land is income from the mere realisation of a capital asset. The distinction between a mere realisation of a capital asset and a transaction that is an act done in carrying on a business or carrying out a business operation or commercial transaction will be determined by weighing all the facts and circumstances taken as a whole.

Paragraph 18 of Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? provides a summary of the main indicators for consideration to determine if a business is being carried on. These include:

·         significant commercial activity;

·         purpose and intention of the taxpayer in engaging in the activity;

·         intention to make a profit from the activity;

·         activity is or will be profitable;

·         repetition and regularity of activity;

·         activity is carried on in a similar manner to that of the ordinary trade;

·         activity is organised and carried on in a businesslike manner and systematically - records are kept;

·         size and scale of the activity;

·         a business plan exists;

·         commercial sales of product; and

·         taxpayer's knowledge or skill.

For a business of property development and resale, the repetitive buying and selling of property is not necessary to establish that a business is being carried on. A single acquisition by a business commenced for the purpose of development, subdivision and sale will be sufficient to constitute a business activity (Taxation Determination 92/124: Income tax: property development: in what circumstances is land treated as 'trading stock'?).

In addition to transactions that occur in the ordinary course of a taxpayer's business, transactions may occur which are outside of the ordinary course of a taxpayer's business. These transactions are referred to as an 'isolated transaction'.

As explained in Taxation Ruling TR 92/3: income tax: whether profits on isolated transactions are income (TR 92/3), under certain circumstances, profits from an 'isolated transaction' can be ordinary income. Paragraph 35 of TR 92/3 states that profits on isolated transactions may be ordinary income if:

·         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 or in carrying on a business operation or commercial transaction.

Paragraphs 56 and 57 of TR 92/3 set out what objective intentions the ATO considers will give rise to a profit made from an isolated transaction being assessable as income according to ordinary concepts. The requisite intentions are:

·         where a taxpayer acquires property with a purpose of making a profit by which ever means prove most suitable and a profit is later obtained by any means which implements the initial profit-making purposes;

·         where a taxpayer acquires property contemplating a number of different methods of making a profit and uses one of those methods in making a profit; and

·         where a taxpayer enters into a transaction or operation with a purpose of making a profit by one particular means but actually obtains the profit by a different means.

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 that gives rise to the profit. It is sufficient if profit-making is a significant purpose.

If the transaction involves the sale of property, it is usually necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property (paragraph 9 of TR 92/3). However, that is not always the case. As explained in the example at paragraph 41 of TR 92/3:

41. ... if a taxpayer acquires an asset with an intention of using it for personal enjoyment but later decides to venture or commit the asset either as the capital of a business or into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction, the profit is income even though the taxpayer did not have the purpose of profit-making at the time of acquisition.

The decisions in Casimaty v. Federal Commissioner of Taxation (1997) 97 ATC 5135; 37 ATR 358 (Casimaty) and McCorkell v Federal Commissioner of Taxation 98 ATC 2199; (1998) 39 ATR 1112 (McCorkell) demonstrate that if a taxpayer does not intend to make a profit when he or she acquires land then the likelihood that any profit made on the eventual sale of land being considered ordinary income is greatly diminished. However, as demonstrated in the High Court decision in Whitfords Beach, that is not always the case because the purpose can change.

In addition to a profit making intention the transaction must have a business or commercial character. Paragraph 47 of TR 92/3 states:

For a transaction to be characterised as a business operation or commercial transaction, it is sufficient if the transaction is business or commercial in character ... Whether a particular transaction has a business or commercial character depends very much on the circumstances of the case.

No single factor or circumstance is determinative to characterise a transaction. Each must be weighed against all other factors. Paragraph 49 of TR 92/3 provides a number of factors which may be relevant in 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 that property; and

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

Specifically in relation to the sale of subdivided land, the following factors have been considered by the courts to determine whether proceeds from the sale of subdivided land was income from carrying on a business or carrying out an isolated commercial transaction, or was from the mere realisation of a capital asset:

·         whether the landowner held the land for a considerable period of time prior to any subdivision and sale;

·         the purposes for acquiring the property, and whether it was used for any other purposes prior to sale;

·         whether the landowner conducted farming or other activities on the land prior to beginning the process of developing and selling the land;

·         whether the landowner originally acquired the property as an investment, such as long term capital appreciation or to derive income;

·         whether the land was originally acquired near the urban fringe of a major city or town;

·         if the property has been rezoned, whether the landowners actively sought that rezoning;

·         whether a potential buyer made any offers to the landowners before they commenced discussion to enter into a proposed or final development agreement;

·         whether the landowners had tried to sell the land without subdivision;

·         whether the landowner had any history of buying and profitably selling developed land or land for development;

·         the extent to which the development goes further than that required to obtain council approval;

·         whether the operations will be planned, organised and carried on in a business-like manner;

·         whether the landowners have changed their business activity relating to the land from one business to another (for example, from farming to property development);

·         the scope, scale, duration and degree of complexity of the proposed development;

·         the reasons for selling the land;

·         who initiated the proposal to develop the land for resale;

·         the complexity of the development;

·         the level of involvement that the taxpayer had in the development, marketing and sale of the property;

·         the level of legal and financial control maintained by the landowners in the proposed or final development agreement;

·         whether any finance must be obtained in order to fund the development activities; and

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

Will the subdivision and sale of the subdivided Property by the Landowner represent a mere realisation of a capital asset?

The following relevant factors, on balance, lead to a conclusion that the subdivision and disposal of the subdivided lots are the realisation of a capital asset:

·         The Deceased originally purchased the Property as a Pre-CGT asset with the intention to use the Property as part of a primary production business or for other private or recreational purposes.

·         The Trust did not acquire the Property for profit-making by its development, subdivision or resale. It acquired the Property due to the transfer to the Deceased's estate as per the conditions of the Deceased's will.

·         The Property has been held for a significant period of time and the Property has largely remained unchanged during that time.

·         The trustees of the Trust have used the Property as part of a primary production business throughout that ownership period.

·         The Trust did not seek rezoning for the subdivision of the Property. Instead, the area in which the Property is situated has been identified as a priority development area by the State Government. The State Government entered into an infrastructure agreement to build essential road and bridges in that area.

·         Due to the rezoning of the Property, and the prolonged drought which made it unviable to continue to use the Property for primary production, the Trust attempted to sell the Property in its current state, however no serious offers had been received due to its limited access and harsh terrain.

·         The Developers approached the Trustees of the Trust with an offer to develop the Property.

·         The commercial activities, land works, and subdivision will be undertaken by the Developer pursuant to the DA, and not by the Trust. The Landowner's obligations under the DA are confined to executing Project Documents, doing all things necessary to ensure that the Developer is able to perform its obligations under the DA and obtain project approval and make available the unencumbered land.

·         The Trust will not incur any costs in respect of the development or financially contribute to the development and will only provide the unencumbered land. All development costs will be met by the Developer. The Developer is also responsible for providing or procuring funding for the development and taking out the necessary insurances.

·         All development control decisions, actions and risk management decisions will be taken by the Developer. The Trust will not be actively involved in the development in any agency or joint venture capacity.

·         The Developer is responsible for obtaining all relevant approvals, appointing solicitors or settlement agents for settlement of Sale Contracts, appointing agents to undertake marketing and promotion activities for the Development and perform the duties and provide the services required to sell the Subdivided Lots.

·         The Developer has a limited discretion to determine the sale price for Subdivided Lots, taking into account the market conditions noted in the DA. The Trust may only dispute the sale price of a Subdivided Lot in certain circumstances.

·         The Trustees of the Trust do not have expertise in or knowledge of the subdivision process and do not have a history of property development and sales to indicate this subdivision is more than a mere realisation of an asset.

The following factors indicate that the subdivision and disposal of the subdivided lots are less likely the realisation of a capital asset:

·         The size and scale of the project is significant as the Property is large in size and will be subdivided into numerous separate land lots.

·         The Trust is assuming a level of risk in the proposed development including the profits, losses and its general success. Generally, the greater the level of financial risk assumed by a landowner in respect of the development of their land, the more likely that the landowner is carrying on a business or is engaged in a profit-making undertaking.

·         The subdivision of the Property will involve the creation of numerous vacant residential land lots and the construction of some project homes and display homes. However, it is noted that all the works needed to be undertaken for this subdivision will be conducted solely by the Developer.

The facts and circumstances outlined above, considered in light of the relevant factors considered by the courts, with no one factor determinative in isolation, leads to a conclusion that the Trust is merely realising its asset in an enterprising way.

Whilst the subdivision and sale arrangement does have some characteristics indicative of an isolated business or commercial transaction, it is considered that these factors are outweighed by the other factors that indicate the Trust is ultimately assuming the risks and costs of the project to dispose of a capital asset in the most enterprising manner. This is indicated by factors which include: the fact that the Trust acquired the property as a beneficiary of the Deceased's will; the absence of a profit making intention at the time of acquisition; the use of the Property since its acquisition; the considerable length of time the Property has been owned by the Deceased and subsequently the Trust; and the unimproved nature of the Property over that period. The fact that the Developer will incur all development costs and will be responsible for all the control decisions, actions and risk management of the development further indicates that the Landowner is merely realising its asset in an enterprising way.

In conclusion, the proceeds from the disposal of the Subdivided Lots will not be income from carrying on a business or from an isolated business or commercial transaction undertaken for the purpose of profit. It is considered that the Trust is instead undertaking the subdivision and sale of subdivided lots to dispose of a capital asset in the most enterprising way available so as to maximise the proceeds of sale. The proceeds from the sale of the subdivided lots will not be assessable ordinary income under section 6-5 of the ITAA 1997, but it will be assessable under Parts 3-1 and 3-3 of the ITAA 1997.

Question 2

Summary

The payments received by the Landowner under the agreement will be treated on capital account as a mere realisation of a capital asset.

Detailed reasoning

As explained above in response to Question 1, the sale of the lots by the Trust will represent a realisation of a capital asset. The proceeds from the sale of the lots will not be treated as ordinary income of the Trust pursuant to the ITAA 1997.

Question 3

Summary

The sale of lots by the Trust will not be a disposal of trading stock.

Detailed reasoning

Division 70 of the ITAA 1997 deals with the tax treatment of trading stock. Section 70-10 of the ITAA 1997 defines 'trading stock' widely and includes 'anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business'. This definition can include land.

Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'? states land is treated as trading stock for income tax purposes if it is held for the purpose of resale and a business activity which involves dealing in land has commenced.

As explained above in response to Question 1, the Trust has not commenced a business of property development, subdivision and sale of land in respect of the Property. Accordingly, the sale of the subdivided Lots by the Trust will not be treated as the disposal of trading stock pursuant to Division 70 of the ITAA 1997.

Question 4

Summary

The Landowner is not required to be registered for GST as they are not carrying on an enterprise for GST purposes.

Detailed reasoning

In this reasoning,

·   unless otherwise stated, all legislative references are to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)

·   all legislative terms of the GST Act marked with an asterisk are defined in section 195-1 of the GST Act.

Section 23-5 of the GST Act provides that an entity is required to be registered if:

·   it is carrying on an enterprise, and

·   its GST turnover meets the registration turnover threshold.

An entity is required to be registered where both the above requirements are met.

It is necessary to consider whether the DA entered into by the Trust to the dispose of the Property would constitute 'carrying on an enterprise' by the Trust for GST purposes.

Enterprise

Section 9-20 of the GST Act defines 'enterprise' to include 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 ATO view on the meaning of the term 'enterprise' is explained in detail in 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).

Paragraph 178 of MT 2006/1 provides the main indicators of carrying on the business. These indicators are the same indicators extracted above in our response to Question 1.

Similarly, paragraphs 240 and 265 of MT 2006/1 respectively provide that regard should be had to TR 92/3 when determining whether an isolated transaction is in the form of an adventure or concern in the nature of trade, as well as factors derived from case law in relation to isolated real property transactions. The relevant guidance in TR 92/3 and caselaw has also been extracted above in our response to Question 1.

As we need to take into account the same factors and guidance outlined in our response to Question 1 for determining whether the Trust is carrying on an enterprise for GST purposes, our analysis in our response to Question 1 applies here.

Consequently, on balance, the Trust is not carrying on an enterprise for GST purposes as its activities are not done in the form of a business or in the form of an adventure of concern in the nature of trade. As outlined in our response to Question 1, while sale of the Property does have some characteristics that indicate that Trust is carrying on an enterprise in the form of an isolated business or commercial transaction, it is considered that these factors are outweighed by the other factors which indicate that the sale of the Property is the mere realisation of a capital asset. Namely, that minimal development work is being undertaken on the Property, the Developer is ultimately assuming the financial risks and costs of the project and has control over the project, and the Landowner has no experience in land development and has engaged another entity (being the Developer) to carry out these activities.

As the Trust is not carrying on an enterprise for GST purposes, the Trust is not required to be registered for GST.

Question 5

Summary

The Trust is not making a supply in the course or furtherance of an enterprise that it carries on when it sells a Subdivided Lot under the DA.

Detailed reasoning

As explained above in response to Question 4, the Trust is not carrying on an enterprise when it sells a Subdivided Lot under the DA. As the Trust is not carrying on an enterprise for GST purposes, it is not making a supply that is in the course or furtherance of an enterprise that the Trust carries on.

Question 6

Summary

The Landowner will not be making a taxable supply when the Subdivided Lots are sold as the requirements of taxable supply, as defined in section 9-5 of the GST Act, are not met. Specifically, the supplies are not made in the course or furtherance of an enterprise that the Landowner carries on (paragraph 9-5(b)) and the Landowner is not registered or required to be registered for GST (paragraph 9-5(d)).

Detailed reasoning

A supply is a taxable supply where the requirements of section 9-5 are met.

Section 9-5 states:

You make a taxable supply if:

(a)  you make the supply for *consideration; and

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

(c)   the supply is *connected with the indirect tax zone; and

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

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

The Landowner will not be making a taxable supply when the Subdivided Lots are sold as the requirements of taxable supply, as defined in section 9-5 of the GST Act, are not met. Specifically, the supplies are not made in the course or furtherance of an enterprise that the Landowner carries on (paragraph 9-5(b)) and the Landowner is not registered or required to be registered for GST (paragraph 9-5(d)).