Edited version of private advice

Authorisation Number: 1051783253899

Date of advice: 24 November 2020

Ruling

Subject: Land subdivision - pre-cgt asset - revenue v capital

Question 1

Will your share of the proceeds from the sale of the subdivided lots be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will your share of the profit from the sale of the subdivided lots be assessable under section 15-15 of the ITAA 1997?

Answer

No.

Question 3

Will the sale of each subdivided lot represent the mere realisation of land that was acquired before 20 September 1985 (a pre-CGT asset)?

Answer

Yes.

Question 4

Will your share of the capital gain made on the disposal of each lot be disregarded?

Answer

Yes, provided the capital improvement expenditure (including the rezoning, subdivision and development costs) allocated to each subdivided lot is less than the improvement threshold for the relevant year and 5% of the capital proceeds from the event.

This ruling applies for the following periods

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts and circumstances

You and your spouse acquired a property before 20 September 1985.

You have used the property as your main residence since acquisition.

You have development approval to develop the block into X lots. You will sell Y blocks and continue to reside in the house on the remaining parcel of land.

The total subdivision costs are expected to be $Z.

Neither you nor your spouse have any property development experience.

You have obtained assistance from professionals to assist with the subdivision.

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 102-5

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 subsection 104-10(2)

Income Tax Assessment Act 1997 subsection 104-10(5)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 subsection 108-70(2)

Income Tax Assessment Act 1997 subsection 108-70(3)

Income Tax Assessment Act 1997 section 108-80

Income Tax Assessment Act 1997 section 112-25

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Detailed reasoning

Broadly, there are three ways profits from the subdivision and sale of pre-CGT land 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
2. As statutory income under section 15-15 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, where the land was acquired or subsequently held for a profit-making purpose, and
3. as statutory income under the capital gains tax (CGT) legislation, (section 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

The definition of business in section 995-1 of the ITAA 1997 simply states what activities may be included in a business; it does not provide any guidance for determining whether the nature, extent, and manner of undertaking those activities amount to the carrying on of a business. For this purpose it is necessary to turn to case law.

Taxation Ruling TR 97/11 Income Tax: am I carrying on a business of primary production? provides a guide to the indicators that the courts have held to be relevant to whether or not a person is carrying on a business.

Profits on isolated transactions

Your assessable income includes profit arising from the carrying on or carrying out of a profit-making undertaking or plan (section 15-15 of the ITAA 1997).

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income provides guidance in determining whether profits from isolated transactions are income and therefore assessable.

A profit from an isolated transaction will be income when:

a)    the intention or purpose of a 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 on a business operation or commercial transaction.

In your case, you are not considered to be carrying on a business of property development, or to have been carrying on or carrying out a profit-making undertaking or plan. It is worth noting this matter is not free from doubt and there are significant features which also may be argued to a contrary outcome. However, given a consideration of all the features as a whole the better argument in this instance is that the arrangement should fall for consideration under the capital gains provisions.

As you are not considered to be carrying on a business of property development, or to have been carrying on or carrying out a profit-making undertaking or plan, the profit or proceeds from the sale of the subdivided lots will not be assessable income under sections 6-5 or 15-15 of the ITAA 1997.

Capital gains tax

A capital gain or a capital loss may arise if a capital gains tax event (CGT event) happens to a capital gain tax asset (CGT asset) you own. Land, or an interest in land, is a CGT asset (section 108-5 of the ITAA 1997).

Split assets - subdivision of land

Where pre-CGT land is subdivided and the original owner of the land remains as the owner of the subdivided lots, no CGT event happens. (section 112-25 of the ITAA 1997). Each new lot is a separate CGT asset and retains its pre-CGT status. Therefore, you do not make a capital gain or a capital loss at the time of the subdivision.

However, in cases where some work has been undertaken to improve the land, subsections 108-70(2) and 108-70(3) of the ITAA 1997 may apply. Capital improvements that are related to each other are taken to be a separate CGT asset if the total of their cost bases (assuming each one is a separate CGT asset) when a CGT event happens to the original asset is:

•         more than the improvement threshold for the relevant income year, and

•         more than 5% of the capital proceeds from the event (108-70(3)).

Note: If the improvements are a separate asset, the capital proceeds from the event must be apportioned between the original asset and the improvements: see section 116-40 of the ITAA 1997.

Disposal of a CGT asset - CGT event A1

CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1) of the ITAA 1997). You dispose of a CGT asset if a change in ownership occurs from you to another entity, whether because of some act or event or by operation of law (subsection 104-10(2)). However, a capital gain or loss you make is disregarded if you acquired the CGT asset before 20 September 1985 (subsection 104-10(5)).

Application of the CGT provisions to your circumstances

CGT event A1 will happen when each of the subdivided lots is sold. You will make a capital gain at that time.

The application of subsections 108-70(2) and 108-70(3) of the ITAA 1997 to each lot will then need to be considered. Rezoning, subdivision and development costs are capital improvement expenditure that are related to each other and these costs are apportioned over all of the subdivided lots. If the capital improvement expenditure applicable to each subdivided lot is less than the improvement threshold for the relevant year and less than five per cent of the capital proceeds from any subsequent disposal of a lot, the capital improvement will not be taken to be a separate CGT asset and will continue to form part of the asset with pre-CGT status.

In that case, the entire capital gain you make will be disregarded.