Edited version of private advice

Authorisation Number: 1051780407960

Date of advice: 26 November 2020

Ruling

Subject: Income tax - capital gains tax - capital v revenue classification - asset sale

Question 1

Will the sale of the Property be assessable on capital account under the Capital Gains Tax (CGT) provisions in Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period

1 July 20xx to 30 June 20xx

The scheme commences on

1 July 20xx

Relevant facts and circumstances

Husband and Wife (The Taxpayers) purchased the block of land on x date.

The initial purpose and original plan for buying the land was to subdivide the land into three parcels or lots with the intention of selling two lots on a profit-making basis and keeping the third (the Property) to build an owner-occupied home. The Property was where the Taxpayers expected to live on completion of a home and records confirm this was the case.

The first two lots of the subdivided land were treated as revenue and have been included as income in the Partnership tax return:

•         block one had a contract date of xx and the sale was included in the x year tax return for the Partnership and treated as revenue

•         block two had a contract date of xx and the sale was included in the x year tax return for the Partnership and treated as revenue.

This Information on the first two lots sold is included as background for this matter, they are not the subject of this ruling.

Relevant to the Property which is the subject of this ruling was the breakdown of Husband and Wife's relationship. This resulted in them formally separating on x date and deciding to sell the Property, paying off the loan and splitting the balance.

The Property was sold with contract date of x.

The Taxpayers had never engaged in property development previously. This project was their first and they do not intend to engage in such activities in the future. They did not have a business plan and no developer was involved. Their initial plan and intention, to subdivide the block of land into three lots, sell the front two and retain the back block to build an owner-occupied house upon, did not change until the breakdown of the Taxpayers relationship.

It was only when the Taxpayers relationship changed that they made the decision to sell the Property.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 108-5

Reasons for decision

Question 1

Summary

The sale of the Property will be assessable on capital account under the CGT provisions in Part 3-1 of the ITAA 1997.

The Property was a family property intended for use as a main residence. There was no change in purpose for which the land was held. The sale of the Property was a realisation of a capital asset which the Taxpayers owned when their relationship changed and they abandoned the intention of building an owner-occupied home on it.

Detailed reasoning

Broadly, there are three main ways profits from a land development, subdivision and sale 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 CGT legislation.

Intention of the taxpayers

While holding an asset for a considerable period of time may seem to indicate that it is a long-term capital asset, the intention of the taxpayer at the time of acquisition and throughout the ownership period is a crucial aspect.

Federal Commissioner of Taxation v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693) (Myer Emporium) is one of the leading cases which shows that the intention at the time of purchasing the asset is an important consideration in determining whether the proceeds received on disposal are on capital or revenue account. According to the Myer Emporium case the relevant intention or purpose of the taxpayer is not a subjective test. Rather it is the intention or purpose as discerned from an objective consideration of the facts and circumstances of the case.

Numerous cases have concerned the assessability of profits or proceeds from the sale of land. Two leading Australian cases dealing with a change of intention and the disposal of capital assets on revenue account are Scottish Australian Mining Co Ltd v Federal Commissioner of Taxation (1950) 81 CLR 188 (Scottish Mining case) and Whitfords Beach Pty Ltd v Federal Commissioner of Taxation (1983) 14 ATR 247 (Whitfords Beach).

It follows from the decisions in Scottish Mining and Whitford's Beach cases that a taxpayer, who had originally acquired property for farming operations purposes, could subsequently embark on a profit-making scheme. This means that a taxpayer could embark on a profit-making scheme after property was acquired for a different purpose.

However 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 demonstrate that if a taxpayer does not intend to make a profit when he or she acquires farming land then the likelihood that any profit made on the eventual sale of land is ordinary income is greatly diminished.

In Casimaty's case, due to the growing debt and ill health of the taxpayer, primary production land was progressively subdivided and sold off over a period of 18 years. There was no coherent plan conceived for the subdivision of the whole property. The taxpayer had acquired and had continued to hold and use the residence and conduct the business of a primary producer on the property. There was no change of purpose or object for which the property had been held. In his judgment Ryan J in the Federal Court held that the profits resulted from the mere realisation of a capital asset and as such the profits were not assessable as ordinary income.

In Statham & Anor v. FC of T 89 ATC 4070 20 ATR 228 (Statham's case) a property was subdivided and sold after a business of raising cattle failed. The taxpayer relied on the local council to carry out the subdivision work and the local real estate agents handled the advertising and sale of the lots. The Full Federal Court held that what occurred was the realisation, by the most advantageous means, of the asset which the owners had on their hands when they abandoned the intention of farming the subject property.

Carrying on a business

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production outlines some factors that indicate whether or not a business is being carried on. Based on the information provided, we do not consider that any profit made from the sale of the Property would be derived by the Taxpayers in the course of carrying on a business.

Isolated transactions

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income discusses profits on isolated transactions and the application of the principles outlined in the decision of the Full High Court of Australia in the Myer Emporium case. The ruling states that profits on isolated transactions may be income.

Profit from an isolated transaction will be ordinary income where (paragraph 35 TR 92/3):

•         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.

Profits on the sale of subdivided land can therefore be income according to ordinary concepts within section 6-5 of the ITAA 1997 if the Taxpayer's subdivision activities have become a separate business operation or commercial transaction, or an isolated profit-making venture.

At paragraphs 56 and 57 TR 92/3 explains that a profit is income where it is made in any of the following situations:

•         a taxpayer acquires property with a purpose of making a profit by whichever means prove most suitable and a profit is later obtained by any means which implements the initial profit-making purpose, or

•         a taxpayer acquires property contemplating a number of different methods of making a profit and uses one of those methods in making a profit, or

•         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.

In very general terms a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations.

As outlined in paragraph 42 of TR 92/3, when a taxpayer's intention in relation to an asset acquired with the intention of using it for personal enjoyment changes, and the taxpayer decides to venture into a profit-making scheme with the characteristics of a business operation or commercial transaction, the activity of the taxpayer will constitute the carrying out of a profit-making scheme, although the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

However, paragraph 44 of TR 92/3 explains when a taxpayer derives a profit from a transaction outside the ordinary course of carrying on its business and the taxpayer did not enter that transaction with the purpose of making a profit, the profit is not assessable income.

Based on the information provided, we do not consider that any profit made from the sale of the Property would be derived by the Taxpayers in the course of carrying out an isolated profit-making transaction.

Capital gain

Under section 6-10 of the ITAA 1997, assessable income also includes amounts that are not ordinary income but are included as assessable income by provisions of the tax law. These amounts are called 'statutory income'. Capital gains are an example of statutory income.

Section 102-5 of the ITAA 1997 provides that a taxpayer's assessable income includes their net capital gain (if any) for the income year. As a general rule, a taxpayer is required to include in their assessable income any capital gain they make from a CGT event that happens to a CGT asset the taxpayer acquired on or after 20 September 1985. Pursuant to section 108-5 of the ITAA 1997, a CGT asset is any kind of property, or a legal or equitable right that is not property. Accordingly,

land and buildings are CGT assets.

Proceeds from the sale of property more often represents the mere realisation of capital assets, which will fall for consideration under the CGT provisions in Part 3-1 and Part 3-3 of the ITAA 1997.

In the course of its decision in Myer Emporium, the Full High Court said that profits made on a realisation or change of investments may constitute income if the investments were initially acquired as part of a business with the intention or purpose that they be realised subsequently in order to capture the profit arising from the expected increase in value. In a joint judgment, their Honours stated:

It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of acquisition of acquiring for the purpose of profit-making by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realization. But it is quite another thing if the decision to sell is taken by way of implementation of an intention or purpose, existing at the time of acquisition, of profit-making by sale, at least in the context of carrying on a business or carrying out a business operation or commercial transaction.

Paragraph 36 of TR 92/3 states:

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. The expression 'mere realisation' is used to contradistinguish a business operation or a commercial transaction carrying out a profitmaking scheme. If a transaction satisfies the elements set out in paragraph 35 it is generally not a mere realisation of an investment

Application to your circumstances

In this case the sale of the Property will be a transaction assessable under the statutory capital gains provisions.

The Property was a family property that the Taxpayers intended to use for their main residence, when their relationship changed the decision was made to sell this parcel of land.

What occurred is the realisation, of the asset they owned when the relationship changed and the intention of building their main residence on the Property was abandoned.

There was no change in purpose for which the land was held, it was the realisation of a capital asset. The proceeds from the sale of the Property is assessable on capital account under the CGT provisions in Part 3-1 and Part 3-3 of the ITAA 1997.