Edited version of private advice

Authorisation Number: 1051804118973

Date of advice: 19 February 2021

Ruling

Subject: Sale of land - capital vs revenue

Question 1

Will the profit/gain on the sale of the subdivided lots constitute assessable income under section  6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will any capital gain arising from the sale of the subdivided lots be reduced by the amount of profit/gain included in assessable income under section 6-5 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

In XXXX, an existing residential property (the property) was purchased by the taxpayers and used as their main residence.

In XXXX, the taxpayers purchased the neighbouring residential property as an investment (the investment property).

The ownership of both properties is held as joint tenants by the taxpayers.

As per the draft subdivision agreement provided, the below clauses are relevant for the purpose of this ruling:

Clause 1.2

The Principal engaged XX to, and XX agrees to affect the proposed subdivision of the Land in accordance with the subdivision proposal presented to the Principal and arrange and supervise the marketing and sale of subdivision Lots ("Services"), including:

e) engaging on behalf of the Principal one or more real estate agents to take reasonable steps to market and sell the Lots (as House and Land packages) prior to subdivision (and supervising an assisting such agents):

(i) at prices such that the Principal shall receive the Total Sale Price upon settlement of all Lots, after all sale and settlement costs (but not settlement adjustments as between Vendor and Purchaser); and XX and or its nominated contractors will receive any and all funds over and above the Total Sale Price.

Clause 1.3

The Principal, in consideration of the Services:

a)    grants exclusive rights to XX to:

i)              take steps to subdivide the Land into lots; and

ii)             thereafter, market and sell the Lots as house and land packages;

iii)           nominate settlement agent;

b)    shall enter into contracts of sale for the Lots, presented by XX or the real estate agent appointed by XX, provided such contracts of sale are consistent with the terms of the Agreement, and will result in the Principal receiving the Total Sale Price upon settlement of sale of all Lots.

c)    shall include a special condition in any contracts of sale and purchases for the Lots providing that the Purchasers shall execute building contracts with XX at or before the execution of the contracts of sale and purchase of the Lots (and shall enforce that special condition);

d)    upon written request, shall grant access to the Land to XX, its officers, employees, agents and contractors at such times XX requires, and shall grant sole possession of the Land to XX at any time sub-division works are being undertaken; and

e)    execute, acknowledge and deliver all further documents, and perform such other acts as are reasonable required for implementing the subdivision and this document (including but not limited to an application to the XX Planning Commission and Landgate documents required to subdivide the Land into the lots, and an authority appointing XX's selected real estate agent to sell the Lots).

The following information has been submitted with the private ruling application:

•         The taxpayers have been approached by a property developer to construct house and land packages.

•         The developer, on behalf of the taxpayers is planning on subdividing the X blocks on where both properties are located into X4 equal sized blocks.

•         These blocks will be sold as house and land packages whereby the purchasers will individually buy each of the X blocks directly from the taxpayers.

•         The total land size is approximately XXm2 of which the residential property is XXm2 and the investment property is approximately XXm2.

•         The new blocks will be approximately XXm2 each.

•         The property developer would meet all planning and subdivision costs.

•         Prior to this subdivision, no business activity has been conducted in relation to the land.

•         The X blocks will be sold as vacant land by the taxpayers on the condition the purchaser executed a building contract with XX co-currently. (As evidenced by clause 1.3(c) in the subdivision agreement, the purchasers will then need to execute the building contracts with XX).

•         The taxpayers have not sold or subdivided land in the past and have no intention of doing so in the future.

•         The current buildings that are on these blocks will be demolished to make way for the X new blocks. The cost of which will be absorbed by the property developer.

•         Electricity, gas, water, telephone connections will be provided in relation to the subdivided blocks. These costs will also be absorbed by the property developer.

•         The property developer will:

-        contract with a real estate agent and conveyancers in relation to marketing of the subdivided blocks;

-        contract with a surveyor and contractors for the demolishment and the land subdivision;

-        cover the costs for the preparation of land for sale and subdivision; and

-        be responsible for selling the 4 blocks.

-        The taxpayers will be the vendors on the contract of sale for the X blocks.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 118-20

Reasons for decision

In general, proceeds from the sale of land will be taxed for income tax purposes in one of the following ways:

•         as ordinary income, where the land is held as trading stock and sold as part of carrying on a business of property development;

•         as ordinary income, where land is not trading stock and is sold as part of an isolated commercial transaction entered into with a profit-making intention;

•         as statutory income under the CGT provisions, where the land is neither trading stock nor the subject of an isolated profit-making scheme or undertaking and the proceeds of sale are the mere realisation of a capital asset.

Where the land is sold as part of carrying on a business of property development or as part of an isolated profit-making scheme, the proceeds will be included in your assessable income in accordance with subsection 6-5(1) of the Income Tax Assessment Act (ITAA 1997).

Where the sale of the land is considered to be the mere realisation of a capital asset, the net capital gain will be included in your assessable income in accordance with subsection 6-10(1) of the ITAA 1997.

Isolated commercial transaction

Taxation Ruling TR 92/3: Income tax: whether profits on isolated transactions are income (TR 92/3) provides guidance in determining whether profits from isolated transactions are ordinary income and therefore assessable under section 6-5 of the ITAA 1997.

Paragraph 1 of TR 92/3 refers to 'isolated transactions' as:

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

•         those transactions entered into by non-business taxpayers.

Whether a profit from an isolated transaction is ordinary income depends on the individual circumstances of the case.

Paragraph 6 of TR 92/3 provides that profits from an isolated transaction is generally income when both of the following elements are present:

•         the intention or purpose 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 out a business operation or commercial transaction.

Profit-making intention

If the transaction 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.

However, as the High Court decision in FC of T v. Whitfords Beach Pty Ltd (1982) 150 CLR 355; [1982] HCA 8; 82 ATC 4031; 12 ATR 692 (Whitfords Beach) demonstrates, that is not always the case. For example, if a taxpayer acquires an asset with an intention of using it for personal enjoyment but later decides to venture or commit the asset either as the capital of a business or into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction, the profit is income even though the taxpayer did not have the purpose of profit-making at the time of acquisition.

Business operation or commercial transaction

Factors listed in paragraph 13 of TR 92/3, which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction include:

•         the nature of the entity undertaking the operation or transaction;

•         the nature and scale of other activities undertaken by the taxpayer;

•         the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

•         the nature, scale and complexity of the operation or transaction;

•         the manner in which the operation or transaction was entered into or carried out;

•         the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

•         if the transaction involves the acquisition and disposal of property, the nature of that property; and

•         the timing of the transaction or the various steps in the transaction.

In determining whether activities relating to isolated transactions are a profit-making undertaking or are the realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. No single factor will be determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

CGT

Section 118-20 contains anti-overlap provisions which operate to reduce capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 of the ITAA 1997, for example, as ordinary income under section 6-5 of the ITAA 1997.

Where subdivision activities are assessable as ordinary income, section 118-20 of the ITAA 1997 will operate to reduce any capital gains by any amounts which are included in your assessable income.

Application to circumstances

The sale of the subdivided land will be an isolated profit-making commercial transaction and the profits received will be assessable on revenue account.

Although one of the properties has been used as the taxpayer's main residence, this intention is not definitive alone.

There has been a change in purpose for which the land is held, as both parcels of land are now held primarily for the purpose of resale in the form of subdivided house and land packages. A development agreement has been drafted clearly outlining the plan for the subdivision of the land. Based on the facts, it can be concluded that the development and subsequent sale of the subdivided lots, occurs with the intention of profit as a commercial transaction.

Therefore, any profit/gain from the sale of the subdivided lots will constitute a profit from an isolated transaction and should be included as ordinary income under section 6-5 of the ITAA 1997.

While CGT event A1 will occur on the disposal of the subdivided blocks, the disposal of each lot will be viewed as a commercial transaction. Any profit from the sales will be assessable as ordinary income under section 6-5 of the ITAA 1997. Where the profit is included in assessable income as ordinary income under section 6-5 of the ITAA 1997 there will be no CGT consequences.