Edited version of private advice

Authorisation Number: 1051792091109

Date of advice: 18 December 2020

Ruling

Subject: Assessable income - income vs capital

Question 1

Are the proceeds derived by the applicants from the sale of the subdivided lots known as Lot A and Lot B income according to ordinary concepts and assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Are the proceeds derived by the applicants from the sale of the subdivided lots known as Lot A and Lot B profits arising from the carrying on or carrying out of a profit-making undertaking or plan and assessable under section 15-15 of the ITAA 1997?

Answer

No

Given that the answers to question 1 and 2 are no, it is unnecessary to consider the further questions you asked regarding the CGT Overlap Rule in section 118-20(2) of the ITAA 1997, and whether the taxpayers form a tax law partnership that is required to be registered for GST under Division 23-5 and section 9-20 and 9-25 of the ITAA 1997.

Question 3

Are the proceeds derived by the applicants from the sale of the subdivided lots known as Lot A and Lot B the 'mere realisation' of an investment and taxable as a capital gain under section 102-5 and section 104-10 of the ITAA 1997 as a CGT event A1: Disposal of a CGT asset?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June ZZZZ

The scheme commences on:

Year ended 30 June XXXX until the end of the income year in which the sale of the last subdivided lot in the development of the Property (as identified in the below description of the scheme) is completed.

Relevant facts and circumstances

The applicants, two individuals, purchased a block of land ('the Property') as joint tenants

Contracts to purchase the Property were exchanged on XX/YY/ZZZZ and the settlement date was XX/YY/ZZZZ.

A pre-existing small two bedroom house/cottage was located at the front of the Property at the time that it was purchased.

It was the intent of the applicants to build a bigger home (including a tennis court and other facilities) to house themselves and their growing family at the back of the Property.

The family lived in the small pre-existing cottage at the front of the Property whilst they built the family home towards the back of the Property.

It was not the intention of the applicants to develop the land for a profit-making purpose when the Property was purchased, but rather to utilise the whole Property as their family home.

The local council would not permit the applicants to build their new home on the Property unless the pre-existing small house/cottage and an area of land on which it was situated was subdivided from the main Property.

This subdivision was subsequently undertaken, and the new larger home was built and completed several years later.

The front lot on which the old cottage was located then became Lot A and the larger back block of land became Lot C. A valuation report was undertaken that details the subdivision and the apportionment of the original cost of the land for future capital gains tax purposes.

Subsequent to the construction of the new home the applicants and their family moved into the home on Lot C and the old cottage on Lot A was then rented out on commercial terms.

This situation remained unchanged for the following number of years, during which time the applicants still owned all the land (that comprised the original Property), and no part had been sold, nor were there any plans to do so during this period.

By the end of year YYYY the main family house and its immediate facilities on Lot C had become out-dated and in need of repair and improvement.

The only significant personal asset held by the applicants was their property. Thus in order to fund these anticipated future costs, the decision was made to sell the already sub-divided front block Lot A, and then to subdivide another block adjacent to Lot A to free up the value held in the land whilst at the same time to reduce ongoing maintenance of the larger block (Lot C) as the applicants grew older. After subdivision, the new block (Lot B) was planned to be created, leaving the remaining family block Lot C reduced in size.

In order to achieve the subdivision and sale of the new block, plans had to be drawn up and submitted to and approved by the local council. To this end the applicants approached and subsequently engaged the services of a planning & development company ('Company P&D') to oversee and manage this process on their behalf. Company P&D are a business that assists ratepayers with dealing with the subdivision process and local council requirements.

Various options were put to the applicants that could have resulted in more land being subdivided (into 2 extra lots rather than one), but this was rejected for just the one larger lot befitting the local environment. Therefore, the applicants did not choose the option that would maximise the potential return from sale of their land.

In order to provide access to the second block of land, Company P&D advised that the driveway access and location of services be re-positioned to the east side of the block. The current driveway and services ran down the western side of Lot A but then cut across the land and would interfere with the ability to build a house on the new lot. Company P&D recommended that the current old cottage on Lot A be demolished to enable the driveway and services to be relocated on the eastern side of the block.

Company P&D also recommended that the trees and vegetation located where the new driveway was to be constructed had to be cleared, and that a retaining wall be removed and the land in its proximity returned to its natural slope. In addition, further earthworks were required to re-route the natural water course and to relocate the easement.

All of these additional works were undertaken as per instruction and advice from Company P&D to enable the subdivision of a new block to be known as Lot B. These works were not done out of choice, but under professional advice. The subdivision costs of relocation of services and the driveway, and the vegetation clearing, although relatively extensive and costly were works required to enable the subdivision to be undertaken. Based on the applicants' real estate agent's appraisal advice on the sale price of the vacant blocks, the outlay of the subdivision works was warranted.

As at the time of submission of this private ruling request, the subdivision is almost complete and the Lot A and Lot B blocks are available for sale.

Relevant legislative provisions

Section 6-5 of the ITAA 1997

Section 15-15 of the ITAA 1997

Part 3-1 of the ITAA 1997

Reasons for decision

Ordinary income

In your situation, the Commissioner is satisfied you are not carrying on a business of property development. The repetition, scale and volume of your activity is not of the same nature as is ordinarily carried on by a property developer that is carrying on a business.

Profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium).

Taxation Ruling TR 92/3 considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income.

TR 92/3 defines the term 'isolated transactions' as:

•         transactions outside the ordinary course of business of a taxpayer carrying on a business; and

•         transactions entered into by non-business taxpayers.

It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayer's business but:

•         the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain, and

•         the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of subdivided land can be assessed as ordinary income within section 6-5 of the ITAA 1997. TR 92/3 lists the following factors to be considered:

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.

In the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135 (Casimaty), the legal principles in relation to the subdivision of land were discussed at length. In concluding his judgment that the subdivision of the taxpayer was a mere realisation of a capital asset, Justice Ryan said, at 97 ATC 5152:

Nor did the taxpayer undertake any works on, or development of, the land beyond what was necessary to secure the approval by the municipal authorities of the successive plans of subdivision and enhance the presentation of individual allotments for sale as vacant blocks. Had they constructed dwelling houses, internal fencing or other improvements, it would have been easier to impute to him an intention to carry on a business of land development and improvement.

As concluded above, we consider that any proceeds from the sale of the subdivided lots derived by the applicants will not be assessable under section 6-5 of the ITAA 1997 as ordinary income.