Edited version of private advice

Authorisation Number: 1051791783262

Date of advice: 18 December 2020

Ruling

Subject: Land subdivision

Question 1

Will your sale of the subdivided lots in accordance with the development agreement be characterised as the 'mere realisation' of capital gains tax (CGT) assets for the purposes of subsection 104-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will your supply of the subdivided lots be included in the measurement of turnover for Goods and Services Tax (GST) registration requirements under the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

Yes.

This ruling applies for the following period:

1 June 20XX to 30 June 20XX

Relevant facts and circumstances

You own land.

Your total land holdings are approximately X hectares.

The land was acquired for the purpose of, and has been used solely for, running a farming enterprise during the entire period of ownership to date.

Your stakeholders are scaling back their activities, and looking to retire in the near future. The stakeholders also intend to separate any joint investments wherever possible.

In 20XX, the council rezoned the land.

You lodged a Development Application, which was granted in July 20X1.

You obtained professional advice in planning the development, including the commissioning of the feasibility study in 20X5 to understand the likely risks and potential profitability of the development.

You entered into a Planning Agreement with the Minister for Planning in 20X4.

You entered into a Developer Agreement with the Developer in 20X6 for the subdivision and sale of land. The Developer will assist with every aspect of the subdivision including surveying, engineering, town planning, landscape architecture, dealing with council and utility providers and marketing/selling.

You negotiated the terms of the development agreement with the Developer to manage and mitigate financial and commercial risks arising from the development to you.

You are in a contractual relationship with the Developer whereby the Developer is contractually obliged to act in your best interests.

It is proposed that the subdivision will take place in approximately 7-8 stages over the next 5 to 10 years.

Under the agreement, the Developer will pay you an instalment amount at the completion of each stage, plus a percentage of sales exceeding $X million.

There is no fixed payment date for the instalments but they are payable upon the completion of each stage regardless of whether the subdivided lots comprising the stage are sold.

The proceeds of the sale of the subdivided lots will partly fund the instalments to you and partly fund the construction of the subsequent stages.

The land remains owned by you until the subdivided lots are sold to the third party purchasers.

A related entity of yours will make loans to the Developer to fund the initial stages of the development.

You did not attempt to sell the land as a whole, even though the land could be merely realised through sale.

You are not currently registered for GST.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 104-10

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

Income Tax Assessment Act 1997 subsection 995-1(1)

A New Tax System (Goods and Services Tax) Act 1999 section 9-5

A New Tax System (Goods and Services Tax) Act 1999 subsection 9-20(1)

A New Tax System (Goods and Services Tax) Act 1999 section 9-40

A New Tax System (Goods and Services Tax) Act 1999 section 23-5

A New Tax System (Goods and Services Tax) Act 1999 section 188-10

Reasons for decision

Question 1

Summary

Your sale of the subdivided lots in accordance with the development agreement will not be characterised as the 'mere realisation' of CGT assets for the purposes of subsection 104-10(1) of the ITAA 1997.

The proceeds from the sale of the subdivided lots is instead assessable income to you under section 6-5 of the ITAA 1997 as income from carrying on a business of property development.

Detailed Reasoning

Generally, when you enter into an arrangement to develop and sell your land, the key question to be determined is whether the ultimate sale is a 'mere realisation', or whether it is a disposal either in the course of business or as part of a profit-making undertaking or plan.

Where the sale is 'mere realisation' the sale is on capital account to which the CGT rules will generally apply. In that case, the sale of the land will constitute a disposal of a CGT asset under section 104-10 of the ITAA 1997.

In contrast, if the disposal is either in the course of business or as part of a profit-making undertaking or plan, then the proceeds from the sale of the land may be assessable as ordinary income under section 6-5 of the ITAA 1997.

Mere realisation v disposal in the course of business or profit-making undertaking

The doctrine of 'mere realisation' was developed in the Full High Court of Scottish Australian Mining Co Ltd v Federal Commissioner of Taxation (1950) 81 CLR 188 (Scottish Australian Mining), and has been relied upon by numerous cases post its decision such as in NF Williams v. FC of T (1972) 72 ATC 4069 (NF Williams) to hold the sale of land which has been subdivided as no more than the mere realisation of a capital asset, with any improvements in such as subdivision as being merely an enterprising way to realise an asset to its best advantage. For many years it was felt that the doctrine of 'mere realisation' was applied so broadly that it was thought that only in exceptional circumstances would an isolated transaction fall within the ordinary concepts of income.

However this all changed in 1982 when the landmark Full High Court case of FC of T v Whitfords Beach Pty Ltd (1982) 150 CLR 355; 82 ATC 4031 (Whitfords Beach) was decided. In this respect, the Commissioner would like to refer to the following comments made by Justice Mason in that landmark case:

37. However, apart altogether from this factor, the facts previously mentioned show that there was involved more than mere realisation of an asset. Deane J. was right in pointing to the circumstance that the asset was divided and improved in the course of a business of dividing and improving the asset. In this respect I do not agree with the proposition which appears to be founded on remarks in some of the judgments that sale of land which has been subdivided is necessarily no more than the realisation of an asset merely because it is an enterprising way of realising the asset to the best advantage. That may be so in the case where an area of land is merely divided into several allotments. But it is not so in a case such as the present where the planned subdivision takes place on a massive scale, involving the laying out and construction of roads, the provision of parklands, services and other improvements. All this amounts to development and improvement of the land to such a marked degree that it is impossible to say that it is mere realisation of an asset. We need to bear in mind that the subdivision of broad acres into marketable residential allotments involves much more in the way of planning, development and improvement than was formerly the case. (at p385)

38. Like Wilson J., I have difficulty with the decision of Williams J. in Scottish Australian Mining Co. Ltd. v. Federal Commissioner of Taxation (1950) 81 CLR 188. The taxpayer there, after giving up its mining business in 1924, devoted itself to the subdivision of its land. This entailed the construction of roads, the building of a railway station, the granting of land to public institutions such as schools and churches and the setting aside of land for parks. I should have been inclined to the view that the taxpayer had ceased to carry out its mining business and that it had commenced to carry on the business of land development. (at p385)

39. This conclusion would have been more consistent with the later decisions of this Court in Fox (1956) 96 CLR 370 and White v. Federal Commissioner of Taxation (1968) 120 CLR 191. In Fox (in which no mention was made of Scottish Australian) the activities were less extensive, though they did involve land subdivision and improvement (reclamation). The only difference between Scottish Australian and Fox seems to lie in the circumstance that there was a new taxpayer in Fox. He was a new taxpayer whose function it was to get in the bankrupt's assets so that a distribution among creditors could take place. (at p385)

40. From what I have said it will be seen that it is my opinion that what the respondent did amounted to more than realisation of an asset and constituted the carrying on of the business of land development. Accordingly, the gross income is assessable under s. 25(1). (at p386)

Therefore the decision in Whitfords Beach has severely narrowed the scope of the 'mere realisation' doctrine developed by Scottish Australian Mining, which so many of the proceeding cases relied upon. The case highlights that while 'mere realisation' may still be possible where blocks are merely subdivided to several blocks with minimal activity, however where the size and scale of the activity reaches such a level (such as constructing roads, the provision of parklands, services and other), this all amounts to a development and improvement of the land to such marked degree that it is no longer possible to say it is a mere realisation of an asset. The case of Whitfords Beach also highlights the requirements of a modern day residential subdivision which involves much more by way of development and improvement of land than was formerly the case, making it far more difficult for modern day residential subdivisions to satisfy the 'mere realisation' doctrine.

In order therefore to determine whether a subdivision and sale is a 'mere realisation', it is necessary to consider whether the subdivision and sale should alternatively be characterised as the carrying on of a business of property development or a profit making undertaking or scheme.

Carrying on a business of property development

The question of whether a business is being carried on is a question of fact and degree to be determined on a case by case basis. The courts have developed a series of indicators that are applied to determine the matter on the facts.

Subsection 995-1(1) of the ITAA 1997 defines 'business' to include 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'. This definition 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.

Profits made on the sale of subdivided land can be considered ordinary income under section 6-5 of the ITAA 1997 if the subdivision activities amount to a separate business operation. Paragraph 11 of Taxation Ruling TR 92/3: Income tax: whether profits on isolated transactions are income (TR 92/3) states:

The transaction may take place in the course of carrying on a business even if the transaction is outside the ordinary course of the taxpayer's business.

Taxation Ruling TR 97/11: Income tax: am I carrying on a business of primary production?(TR 97/11) provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. Although this ruling deals with a primary production business, the principles discussed in this ruling apply to any business. Paragraph 13 of TR 97/11 provides that the factors that are considered important in determining the question of business activity are:

•         whether the activity has a significant commercial purpose or character,

•         whether the taxpayer has more than just an intention to engage in business,

•         whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity,

•         whether there is regularity and repetition of the activity,

•         whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business,

•         whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit,

•         the size, scale and permanency of the activity, and

•         whether the activity better described as a hobby, a form of recreation or a sporting activity.

No one indicator is decisive. The indicators must be considered in combination and as a whole. Whether a 'business' is carried on depends on the large or general impression.

Application to your circumstances

The following considers the above indicators for your circumstances.

Significant commercial purpose or character

The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators.

Paragraph 29 of TR 97/11 provides that a way of establishing that there is a significant commercial purpose or character is to compare the activities with those of a taxpayer who is carrying on a similar activity that is a business.

Any knowledge, previous experience or skill of the taxpayer in the activity, and any advice taken by the taxpayer in the conduct of the business should also be considered but are not necessarily determinative.

You lodged a Development Application to develop the land. You also entered into a Planning Agreement with the Minister for Planning and commissioned the preparation of a feasibility study to understand the likely risks and potential profitability of the development. A related party of yours entered into a lending facility arrangement with the Developer.

You then engaged the Developer to progress the subdivision of the land. You negotiated terms with the Developer to manage and mitigate financial and commercial risks of the development.

The Commissioner considers your activities to have a significant commercial purpose and character.

Intention to engage in business

In Inglis v FC of T (1979) 80 ATC 4001; 10 ATR 493, Brennan J stated:

The carrying on of a business is not a matter merely of intention. It is a matter of activity.... At the end of the day, the extent of activity determines whether the business is being carried on. That is a question of fact and degree.

You originally acquired the land for the purpose of carrying on a cattle grazing farming enterprise. Whilst these activities are reduced in scale, they continue to be carried out on the land.

Your stakeholders are seeking to scale back their activities and retire in the near future.

The Commissioner's position at paragraph 42 of TR 92/3 indicates a taxpayer's intention may change to profit-making after the time of acquisition. This is supported by the decision of the Federal Court in Stevenson v Commissioner of Taxation (1991) FCR 282 (Stevenson) where doubt was raised in relation to the position that a landowner may only form a profit-making intention in respect of any asset at the time of acquisition.

The Commissioner considers that you committed the properties to subdivision from the moment of lodging the Development Application, when you committed yourself to the development of the land for the purpose of subdivision and sale.

At this point your intention changed to holding both properties as trading stock for the purposes of a land development business.

The Commissioner considers this to be a positive indicator of carrying on a business of land development.

Is there an intention to make a profit or a genuine belief that profit will be made?

Strong evidence of an intention to make a profit occurs when you have conducted research into your proposed activity, consulted experts or received advice on the running of the activity and the profitability of it before setting up the business.

You commissioned the preparation of a feasibility study to understand the likely risks and potential profitability of the development. The feasibility study shows that you expect there will be an overall profit of approximately $X million.

Your agreement with the Developer states that you will receive at least $X million, through instalments, plus a percentage of sales exceeding $X million.

You did not attempt to sell the land as a whole, even though the land could be merely realised through sale. You chose to go down the path of subdivision to maximise profit.

The Commissioner regards that you have the intention to make a profit from the property development on top of the land's true value. You have conducted research into your proposed activity, consulted expects or received advice on the running of the activity and the profitability of it before starting the business.

These are all positive indicators of carrying on a business of land development.

Is there repetition and regularity in the activity?

The subdivision is conducted over 7-8 stages and each stage is a repetition of the same set of activity which includes but is not limited to land clearing, construction, marketing and sale. The subdivision itself is a 'one-off' venture.

Is the activity of the same kind and carried on in a similar way to that of the ordinary trade?

An activity is more likely to be a business when it is carried on in a manner similar to that of other participants in the same industry.

You estimate that costs of approximately $X will be incurred in subdividing and selling the subdivided lots. You have stated that you will not be undertaking an active role in the subdivision. Rather, you have engaged the Developer to assist with every aspect of the subdivision including surveying, engineering, town planning, landscape architecture, dealing with council and utility providers and marketing/selling.

Although this may be the case, in entering into the development agreement with the Developer, you are carrying on a development activity with the Developer in a similar manner to that which is common in the industry, particularly with farmland subdivision and development.

The Commissioner considers that these are positive indicators of carrying on a business of land development.

Is the activity organised in a businesslike manner?

A business is characteristically carried on in a systematic and organised manner rather than on an ad hoc basis. An activity should generally conform with ordinary commercial principles to amount to the carrying on of a business.

You have engaged the Developer to undertake the development, including appointing other professionals, such as real estate agents surveyors, engineers, town planners and landscape architects, and dealing with council and utility providers as required.

You stated that you have a minimal involvement in the subdivision.

The Commissioner refers you to the following statement from Justice O'Loughlin in Abeles and Anor v Federal Commissioner of Taxation (1991) 91 ATC 4756 (Abeles):

In the application of these principles to the facts of this case, I have concluded that the taxpayers exceeded the bounds of the mere realisation of their land in an enterprising way. No doubt they were aided by Mr. Markham in making their decisions; perhaps, arguably, he induced them, first to agree to subdivide and then to participate in the larger plan that involved the six blocks and the four groups of owners. But, in these particular circumstances, they cannot hide behind Mr. Markham. He was their agent and his conduct was their conduct. Through Mr. Markham, the brothers went beyond a mere simple subdivision and sale of their 10 acres; they entered into an arrangement that was in the nature of a joint venture, sharing costs and expenses rateably; they even participated in variations to the boundaries of their land in order to present, and participate in, the best plan of subdivision. Their financing commitment was heavy; their established line of credit was $90,000 more than they paid for the land five years earlier; they allowed for the subdivision being a lengthy project and arranged with the finance company to accrue interest on the borrowed moneys. Although the size of a project is not a conclusive factor, it is one of numerous matters that are to be weighed in the balance. In this case, the readiness of the brothers to involve themselves with the other owners was more consistent with a business enterprise than a private realisation. The taxpayers, through their agent, Mr. Markham, chose to embark upon a business-like and efficient program of subdivision.

You are in a contractual relationship with the Developer whereby the Developer is contractually obliged to act in your best interests.

You cannot merely hide behind the Developer to claim you are not in the business of subdivision and sale of the property. The Developer has been engaged to undertake the development for a mutual benefit, being the profit from the development in which you will take a greater share. The Developer's conduct in undertaking the development is your conduct. Through your contractual relationship, you have chosen to embark upon a business-like efficient program of subdivision.

Additionally, before entering into the development agreement, you thoroughly planned the subdivision, obtained professional advice in planning the development, such as the commissioning of the feasibility study that sets out the likely risks and potential profitability of each stage of the development. You also entered into a Planning Agreement with the Minister for Planning. You carefully selected the Developer to carry out the development and negotiated the terms of the development agreement with the Developer.

You carefully calculated the funding needs of the development. The profitability of each of the stages was carefully calculated and planned out to benefit the entire subdivision. The cascading effect of the arrangement presents economical and financial risks that indicate significant planning.

You also considered how you were to be remunerated for the subdivision and sale of the land. You expect to receive $X million in instalments, reflecting the completion of each of the eight stages of the development. The instalments are funded from the proceeds from the subdivided lots.

The developer is contractually obliged to pay instalments to you regardless of whether the lots comprising each stage are sold or whether the projected sales are achieved. However, there is no due date for making the instalments; only that the instalments are to be paid once each stage of the development is completed.

This indicates that you have assumed a level of commercial risk from entering into the development agreement with the Developer.

A related party of yours has provided a lending facility to the Developer to partially fund the early stages of the development. This indicates that the related party is assuming some financial risk associated with the development.

The Commissioner considers that all of these activities conform to ordinary commercial principles of land development and are therefore a positive indicator of carrying on a business of land development.

What is the size and scale of the activity?

The size or scale of the activity is not a determinative test, and a person may carry on a business in a small way. However, if the scale of the activities result in more than is required for your own domestic needs combined with an intention to profit from the activities and a reasonable expectation of doing so, a business may be carried on despite the scale.

Mason J in Whitfords Beach made the following comments at paragraph 37:

I do not agree with the proposition which appears to be founded on remarks in some of the judgments that sale of land which has been subdivided is necessarily no more than the realisation of an asset merely because it is an enterprising way of realising the asset to the best advantage. That may be so in the case where an area of land is merely divided into several allotments. But it is not so in a case such as the present where the planned subdivision takes place on a massive scale, involving the laying out and construction of roads, the provision of parklands, services and other improvements. All this amounts to development and improvement of the land to such a marked degree that it is impossible to say that it is mere realisation of an asset. We need to bear in mind that the subdivision of broad acres into marketable residential allotments involves much more in the way of planning, development and improvement than was formerly the case.

You have indicated that you decided to subdivide the land as you believe it is the most advantageous way to realise the land.

The Commissioner considers that the scale of the activities and the improvements to both properties goes beyond merely realising the asset in the most enterprising way. This is a positive indicator of carrying on a business of land development

Is the activity better described as a hobby, a form of recreation or a sporting activity?

The Commissioner considers that your activities are not a hobby or a form of recreation. This indicator is not relevant.

Conclusion

The Commissioner infers that the development is thoroughly and carefully planned, structured and organised. You, your related entities and the stakeholders bear commercial and financial risks that are not insignificant. This indicates that your activities go beyond merely realising the land in the most enterprising way. The Commissioner accordingly considers that you are carrying on a business of land development.

Your sale of the subdivided lots in accordance with the development agreement will not be characterised as the 'mere realisation' of CGT assets for the purposes of subsection 104-10(1) of the ITAA 1997.

The proceeds from the sale of the subdivided lots is instead assessable income to you under section 6-5 of the ITAA 1997 as income from carrying on a business of property development.

Question 2

Summary

Your supply of the subdivided lots will be included in the measurement of turnover for GST registration requirements under the GST Act.

Detailed reasoning

An entity is required to be registered for GST if it satisfies the requirements of section 23-5 of A New Tax System (Goods and Services Tax) Act 1999 (GST Act). This section states:

You are required to be registered under this Act if:

(a) you are carrying on an enterprise; and

(b) your GST turnover meets the registration turnover threshold.

Note: It is the entity that carries on the enterprise that is required to be registered (and not the enterprise).

Carrying on an enterprise

The term 'enterprise' is defined in subsection 9-20(1) of the GST Act to include, amongst other things, an activity or series of activities done:

(a) in the form of a *business; or

(b) in the form of an adventure or concern in the nature of trade; or

...

The courts have determined that the question of whether an activity constitutes a business or hobby depends upon an assessment of the relevant facts and involves matters of fact and degree. No one factor is decisive and many elements may have to be considered in combination and on what the 'large or general impression gained' is (Ferguson v. FC of T (1979) 79 ATC 4261 and Martin v. FC of T (1953) 90 CLR 470).

In determining whether you are carrying on an enterprise, we take into consideration factors which the courts have held to be relevant in determining whether an activity is an enterprise. These factors and indicators are mentioned in TR 97/11 which was considered in question 1 above. We consider you to be carrying on a business of land development for GST purposes.

GST turnover meets the registration turnover threshold

The second limb of section 23-5 of the GST Act provides that an entity is required to be registered for GST if its GST turnover meets the registration turnover threshold.

Section 188-10 of the GST Act provides that your GST turnover meets the registration turnover threshold if:

(a)  your current GST turnover is at or above $75,000 and the Commissioner is not satisfied that your projected GST turnover is below $75,000; or

(b)  your projected GST turnover is at or above $75,000.

Your current GST turnover is the sum of the values of all supplies made in a particular month plus the previous 11 months. Your projected GST turnover is the sum of the values of all supplies made in a particular month plus the next 11 months.

In calculating current GST turnover and projected GST turnover, the following supplies (amongst others) are not included in the calculation:

(a)  Supplies that are input taxed (which includes financial supplies, residential rent and sale of residential premises that are not new residential premises).

(b)  Supplies that are not for consideration.

(c)   Supplies that are not made in connection with an enterprise that you carry on.

(d)  Supplies that are not connected with Australia.

Section 9-40 of the GST Act provides that you must pay the GST payable on any taxable supply that you make. Section 9-5 provides that you make a taxable supply if you make the supply for consideration, in the course of furtherance of an enterprise that you carry on, the supply is connected with an indirect zone, and you are registered or required to be registered. Further, the supply is not a taxable supply to the extent that it is GST-free or input taxed.

As the supplies of the developed lots that will be made by you meet all the requirements of section 9-5 of the GST Act and are not GST-free or input taxed, the sales of the developed lots will be taxable supplies and subject to GST. Due to the size of the development and magnitude of sums involved, it is reasonable to expect your projected GST turnover will be at or above the threshold.

Therefore, you are considered to be carrying on a business of land development for GST purposes and the supply of subdivided lots are considered taxable supplies, and included in the measurement of turnover for GST registration requirements, meaning that you will need to register for GST purposes.