Edited version of private advice

Authorisation Number: 1051757260120

Date of advice: 07 October 2020

Ruling

Subject: Property - land subdivision - income versus capital

Question 1:

Will the profit from the sale of the Sale subdivided lots of land located at the Property be treated as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

No.

Question 2:

Will the profit from the sale of the Sale subdivided lots of land located at the Property be treated as statutory income under the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997?

Answer:

Yes.

This ruling applies for the following period

Income year ending 30 June 2021.

The scheme commences on

1 July 2020.

Relevant facts and circumstances

You purchased a vacant lot of land (the Property) after 20 September 1985 which was zoned for non-urban purposes.

Your family home (the House) was constructed on the Property after several years which has continued to be your main residence until the present time.

In recent years, the neighbouring properties have been developed into smaller residential lots as part of an expanding urban growth.

You have health issues and are unable to maintain the Property. You are seeking to transition and fund your retirement through the proposed subdivision of the Property and the sale of some of the subdivided lots, being the Sale subdivided lots.

You engaged the services of a surveyor to prepare a draft drawing of the proposed subdivision of the Property which included that:

·         There would be several lots of varying land areas, including one on which the House would be located

·         Several of the proposed lots would have an environmental covenant on them; and

·         There would be an easement to enable access to some of the proposed lots.

You applied to the local council for approval to subdivide the Property, which was approved.

You engaged the services of consultants to undertake the activities in relation to the subdivision of the Property with all works in relation to the subdivision are being undertaken by contractors.

You will only undertake supervisory activities in relation to the subdivision activities due your health issues.

It is estimated that the cost for the subdivision will be $XXX,XXX.00.

The market value of the Property prior to the subdivision activities commencing is estimated to be around $X,XXX,XXX.00.

You will draw funds from your superannuation and borrow from friends and family to fund the subdivision activities.

Subject to COVID19 restrictions, it is anticipated that all works in relation to the subdivision will be completed, and Plan Sealing should be released, during the period covered by this ruling.

You will keep the subdivided lot on which the House is located and sell the Sale subdivided lots, which will be vacant lots of land on which concrete easements will be constructed for access, with several of the lots having environmental covenants.

You will engage the services of real estate agents to advertise and sell the Sale subdivided lots, and it is anticipated that they will be sold for $XXX,XXX.00 each.

Neither you, nor any related entities and/or parties, have undertaken any subdivision activities in the past and there are no plans for you or any related entities and/or parties to undertake any subdivision activities in the future.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 15-15

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Subsection 104-10(3)

Income Tax Assessment Act 1997 Section 112-25

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Income or capital

As a general principle, profits from property sales will either be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) or statutory income under the capital gains tax (CGT) provisions of the ITAA 1997.

Where the profit has been made as a result of a taxpayer carrying on a business of property development or as a result of a taxpayer entering into an isolated business transaction, the profit will be assessable as ordinary income. However, where the profit is a mere realisation of a capital asset, the profit will be assessable under the CGT provisions of the ITAA 1997.

There have been several cases in which the courts have addressed the question of whether the proceeds received for the sale of an asset are revenue or capital in nature. The decision in each case depended on its own facts, and very often will be a matter of degree.

The extent of the personal involvement of the taxpayer in much of the planning, organisation and management of the activities has been held to be significant factors in the determination of whether or not a business was being carried out. For example:

·         In Stevenson v FC of T (1991) 91 ATC 4476; (1991) 22 ATR 56; (1991) 29 FCR 282 (Stevenson) the degree of the taxpayer's involvement was seen as an indicator of a business being conducted; and

·         The lack of personal taxpayer involvement was seen as a relevant to the finding that a business was not being conducted in the cases of Stratham V FCT 89 ATC 4070, McCorkell v FCT 98 ATC 2199 (McCorkell) and Casimaty v FCT 97 ATC 5 (Casimaty).

From the cases involving the subdivision of land and from Taxation Ruling TR 92/3 (TR 92/3), it would appear that the following are the most important factors to consider when determining whether profits made as a result of an isolated business transaction are assessable income:

(a)  the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; and

(b)  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 determining whether an isolated transaction amounts to a business operation or commercial transaction the following factors are relevant:

(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.

The 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. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment.

Application to your situation

In your case, the Property was purchased as vacant land after 20 September 1985, with the House being constructed on it several years later. You have continued to reside in the House until the present time.

Due to your age and health you are not able to maintain the Property but wish to continue living in the House. You made the decision to sell the excess land, being the Sale subdivided lots, and keeping the House and the land it is located on, where you will continue to reside.

You engaged the services of other parties to manage the subdivision of the Property and undertake the relevant activities. You will only undertake supervisory activities in relation to the subdivision activities due your health issues.

Minimum activities required under the development application will be undertaken in relation to the subdivision to enable the resulting subdivided lots being sold as vacant lots of land, with no structures being constructed on them.

No other subdivision activities have been undertaken by you, or any related parties and/or entities in the past, and neither you or any related parties and/or entities intend undertaking any similar activities in the future.

Based on the information provided, there is nothing to suggest that the subdivision of the Property was the beginning of a continuing business of property subdivision. Your activities do not display the salient indicator of a business, being transactions entered into on a continuous and repetitive basis. Therefore, it is the Commissioner's view that your activities in relation to the subdivision of the Property are not those of an entity carrying on a business of buying, subdividing and selling subdivided land.

Making an overall assessment on the factors set out in TR 92/3, it is the Commissioner's view that the subdivision of the Property and sale of the Sale subdivided lots will not be considered commercial in nature, but will be a realisation of a capital asset, being a long-held privately owned property.

In conclusion, the activities involved in the subdivision and sale of the Sale subdivided lots will not amount to carrying on a business. The transactions will not have the character of business operations or commercial transactions. There is no indication that your subdivision activities will become a separate business operation or commercial transaction, or that you will be carrying on, or carrying out a profit-making undertaking or plan.

Therefore, as it is not viewed that you are carrying on a business, or that the subdivision activities will be an isolated transaction, any profit arising from the sale of the Sale subdivided lots, but that it will be a realisation of your Property which will be accounted for under the capital gains tax provisions.

Capital gains tax

The capital gains tax (CGT) provisions are contained in Parts 3-1 and 3-3 of the ITAA 1997. Broadly, the provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own.

When a CGT asset (the original asset) is split into two or more assets (the new assets), such as when land is subdivided, the subdivision of the land into subdivided blocks is not a CGT event. Each of the new assets are viewed as having been acquired at the same time as the original asset was acquired

A CGT event A1 happens if you dispose a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property.

You will make a capital gain if the capital proceeds from the disposal of a CGT asset are more than the cost base of the CGT asset. You will make a capital loss of those capital proceeds are less than the reduced cost base of the CGT asset.

Application to your situation

As outlined above, it is viewed that any profits made from the sale of the Sale subdivided lots will be assessable under the CGT provisions.

Accordingly, each of the Sale subdivided lots will be viewed as having been acquired by you on the date the Property was originally acquired.

A CGT event A1 will occur when each of the Sale subdivided lots are sold and any gain made on their sale will be assessable under the CGT provisions.

The CGT event A1 will occur when the sale contract for each Sale subdivided lot is entered into and a calculation will need to be undertaken to determine if a capital gain or capital loss has been made on the disposal of each subdivided lot.

Note: If you meet the conditions contained in Division 115 of the ITAA 1997, the 50% CGT discount can be applied to any capital gain made on the disposal of your ownership interests in the Sale subdivided lots.