Edited version of private advice

Authorisation Number: 1051749387074

Date of advice: 9 September 2020

Ruling

Subject: Assessable income - revenue vs capital

Question 1

Will the proceeds or profit from the sale of the land in accordance with the development agreement be included in your assessable income in accordance with subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will your sale of the land in accordance with the development agreement, be the sale of a capital gains tax (CGT) asset as defined in section 108-5 of the ITAA 1997, with the net capital gain included in your assessable income in accordance with subsection 6-10(1) of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

1 July 20XX to 30 June 20YY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You are the administrator of the Estate of B, an individual (the Estate).

A, an individual,inherited a block of land (the Land) several years ago. The Land consisted of 2 Lots, Lot 1 and Lot 2. During the period of ownership, A used the Land for A's main residence and conducting primary production activities.

B, a relative of A, ran a primary production business for many years on another block of land. B had no previous history of business activities outside of B's primary production business. After A's passing, B inherited the Land from A.

At the time B inherited the land B was considered incapacitated. Following B's inheritance of the Land, B's attorneys sought to realise the Land for the benefit of B.

B's attorneys sought and received a number of expressions of interest in relation to the Land. B's attorneys decided to pursue an offer from the Developer on the basis it would deliver the highest and best value for the benefit of B from the ultimate sale of the Land.

A development agreement was entered into between B's attorneys on behalf of B (Owner), the Developer and a Project Manager in respect of the Land.

The development involves subdividing the Land into vacant residential lots for sale.

A few years after entering into the development agreement, Lot 2 was sold.

Following the sale of Lot 2, the first development agreement was terminated and another development agreement over Lot 1 was entered into between the Owner and the Developer.

Under the development agreement, the role of the Owner remained solely to approve the development plan.

A few unsuccessful attempts were made to sell the land.

B then passed away.

In the years since B's passing, council and government approval to develop the land has been sought. As at the date of this ruling, the development of Lot 1 has not progressed past the approval stage.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Subsection 6-5(1)

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Subsection 6-10(1)

Income Tax Assessment Act 1997 Section 108-5

Reasons for decision

Question 1

Summary

The proceeds or profit from the sale of the land in accordance with the development agreement will not be included in your assessable income in accordance with subsection 6-5(1) of theITAA 1997.

Question 2

Summary

Your sale of the land in accordance with the development agreement will be the sale of a CGT asset as defined in section 108-5 of the ITAA 1997, with the net capital gain included in your assessable income in accordance with subsection 6-10(1) of the ITAA 1997.

Detailed reasoning for Question 1 and 2

In general, proceeds from the sale of land will be taxed for income tax purposes in one of the following ways:

·         as ordinary income, where the land is held as trading stock and sold as part of carrying on a business of property development;

·         as ordinary income, where land is not trading stock and is sold as part of an isolated commercial transaction entered into with a profit-making intention;

·         as statutory income under the CGT regime, where the land is neither trading stock nor the subject of an isolated profit-making scheme or undertaking and the proceeds of sale are the mere realisation of a capital asset.

Where the land is sold as part of carrying on a business of property development or as part of an isolated profit-making scheme, the proceeds will be included in your assessable income in accordance with subsection 6-5(1) of the ITAA 1997.

Where the sale of the land is considered to be the mere realisation of a capital asset, the net capital gain will be included in your assessable income in accordance with subsection 6-10(1) of the ITAA 1997.

Whether the proceeds are treated as ordinary income or capital depends on the situation and circumstances of each particular case.

Carrying on a business of property development

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, discusses at paragraph 265 certain factors that may indicate whether activities constitute a business in the context of property transactions. 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.

Based on the facts and circumstances, the Commissioner has concluded that you are not carrying on a business of property development with respect to the proposed sale of the land.

As a consequence, the land is not considered to be trading stock. This is because for land to be trading stock, you must hold it for the purpose of sale in the ordinary course of a business of property development.

Since you are not carrying on a business of property development, it needs to be determined whether the sale of the land is considered to be an isolated commercial transaction with a profit-making purpose or the mere realisation of a capital asset.

Isolated commercial transaction

Taxation Ruling TR 92/3: Income tax: whether profits on isolated transactions are income (TR 92/3) provides guidance in determining whether profits from isolated transactions are ordinary income and therefore assessable under section 6-5. TR 92/3, at paragraph 1, refers to 'isolated transactions' as:

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

·         those transactions entered into by non-business taxpayers.

TR 92/3, at paragraph 6, provides that profits from an isolated transaction will generally be ordinary income when:

·         the intention or purpose 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 out a business operation or commercial transaction.

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

Profit-making intention

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.

However, as the High Court decision in FC of T v. Whitfords Beach Pty Ltd (1982) 150 CLR 355; [1982] HCA 8; 82 ATC 4031; 12 ATR 692 (Whitfords Beach) demonstrates, that is not always the case. For example, 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.

As stated in paragraph 40 of TR 92/3, it is not necessary that the profit-making intention be the sole or dominant purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

Even if a profit-making intention is found to exist, the Commissioner must be satisfied that a profit was made in carrying out a business operation or commercial transaction.

Business operation or commercial transaction

Matters listed in paragraph 13 of TR 92/3, 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. 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

Paragraph 36 of TR 92/3 states that '[t]he courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. The expression 'mere realisation' is used to contradistinguish a business operation or a commercial transaction carrying out a profit-making scheme'.

Therefore, if the sale of the land is not considered to be an isolated commercial transaction, it will be treated as the mere realisation of a capital asset, with the proceeds or profit of the sale on capital account and assessed under the CGT rules.

Conclusion

The Commissioner finds that any profits from the proposed sale of the land in accordance with the development agreement would not be profits from an isolated transaction of the type discussed in TR 92/3. The circumstances support that the disposal of the land would be a mere realisation of the asset. Any profits on the mere realisation of an asset is not ordinary income that is included under section 6-5 of the ITAA 1997.

The land meets the definition of a CGT asset as defined in section 108-5 of the ITAA 1997, which includes "any kind of property" such as land.

The sale of the land as subdivided vacant lots or as an undeveloped block of land to the developer will be on capital account so that any net capital gains will be included in your statutory income under section 6-10 of the ITAA 1997.