Edited version of private advice

Authorisation Number: 1051790371937

Date of advice: 15 December 2020

Ruling

Subject: Income versus capital

Question

Are the proceeds from the sale of the subdivided block considered to be assessable income under s6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No, any proceeds would represent a mere realisation of capital asset and would fall for consideration under the CGT provisions in Parts 3-1 and 3-3 of the ITAA 1997.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

A property was purchased by the taxpayer for investment purposes. The property was leased by third parties for years until deterioration and asbestos led to the dwelling on the property being demolished.

The taxpayer had to decide whether to renovate and lease, sell the property whole or to subdivide and sell. The decision was made to apply for subdivision and an attempt to sell the whole Property with the subdivision approval in place was made. When the Property did not sell, the dwelling was demolished and the subdivision completed, which led to the sale of one of the Lots.

Relevant legislative provisions

Section 6-5 of the Income Tax and Assessment Act 1997

Parts 3-1 & 3-3 of the Income Tax and Assessment Act 1997

Reasons for decision

Under section 6-5 of the ITAA 1997, assessable income includes the ordinary income derived directly or indirectly from all sources, during the income year.

If a transaction or operation 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.

In this case the facts indicate that the taxpayer, had no intention or purpose to make a profit or gain from developing the land at the time the land was purchased, and the subsequent transactions do not have the character of business operations or commercial transactions.

Accordingly, the proceeds from the sale of subdivided land is not ordinary income and not assessable under sections 6-5 of the ITAA 1997. Any proceeds would represent a mere realisation of capital assets and would fall for consideration under the CGT provisions in Parts 3-1 and 3-3 the ITAA 1997.

Detailed reasoning

Under section 6-5 of the ITAA 1997, assessable income includes the ordinary income derived directly or indirectly from all sources, during the income year.

Profit from an isolated transaction will be ordinary income when:

•         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.

If a transaction or operation 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.

In FCT v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693 (Myer Emporium), Mason J said:

Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayers intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayers business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a one-off transaction preclude it from being properly characterized as income (FCT v.Whitfords Beach Pty Ltd (1982)150 CLR 355 at 366-367; 82 ATC 4031 at 4036-4037, 4042; 12 ATR 692 at 695-696, 705). The authorities establish that a profit or gain so made will constitute income if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit.

Taking the comments from the High Court in Myer Emporium into account, we can ascertain that for a transaction to be characterised as a business operation or a commercial transaction, it is sufficient that the transaction is business or commercial in nature.

Some of the factors to consider when looking at whether an isolated transaction amounts to a business operation or commercial transaction are listed at paragraph 13 of Taxation Ruling TR 92/3. They are:

(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

(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

(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.

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

The case of Casimaty v. FC of T 97 ATC 5135; (1997) 37 ATR 358 (Casimaty) considered the sale of farming land. The proceeds were held to not be income according to ordinary concepts, but rather constituted the mere realisation of a capital asset, carried out in an enterprising way so as to secure the best price. Consequently, the profit derived from the subdivision and sale of the land by the taxpayer was not assessable income under section 6-5 of the ITAA 1997.

In this case the facts indicate that the taxpayer had no intention or purpose of making a profit or gain from developing the land at the time of purchase. The Property was purchased to, and was, rented to third parties for a number of years when deterioration and asbestos issues brought this to an end. The taxpayer had to decide whether to renovate and lease, to sell the whole property, or to subdivide and sell. The decision was made to apply for subdivision and an attempt to sell the whole Property with the subdivision approval in place was made. When the Property did not sell, the dwelling was demolished and the subdivision completed, which led to the sale of one of the Lots. Whilst several steps were undertaken to sell the property, these steps do not indicate a change of intention or purpose, nor do they have the character of business operations or commercial transactions. The steps undertaken by the taxpayer included the demolition of a residential dwelling that was in a state of disrepair and a simple subdivision. There is no indication that the taxpayer's subdivisional activity has become a separate business operation or commercial transaction, or that the taxpayer was carrying on or carrying out a profit-making undertaking or plan. Rather, the taxpayer realised the asset in an enterprising way to secure the best price possible for the asset.

The proceeds are therefore not ordinary income and not assessable under section 6-5 of the ITAA 1997. Any proceeds would represent a mere realisation of a capital asset and would fall for consideration under the CGT provisions in Parts 3-1 and 3-3 of the ITAA 1997.