Edited version of private advice

Authorisation Number: 1051804621099

Date of advice: 05 March 2021

Ruling

Subject: Property - subdivision - income versus capital

Question 1

Will the profit from the sale of the two properties be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 in both the 20XX and 20XX income years?

Answer

Yes.

Question 2

Are the proceeds from the sale of the two properties assessable as statutory income under Parts 3-1 and 3-3 of Income Tax Assessment Act 1997 in both the 20XX and 20XX income years?

Answer

No.

This ruling applies for the following period:

Income year ending 30 June 20XX

Income year ending 30 June 20XX

The scheme commences on:

16 October 20XX

Relevant facts and circumstances

A husband and wife purchased a property in Australia (the Property) in 19XX. They lived in the Property as their main residence until they subsequently moved overseas. From this time, their son lived in the Property and it was never rented out.

In 20XX, the husband and wife decided to demolish the house that stood on the property, subdivide the land into two, and build two new houses to sell. The two new properties were sold immediately after being built, and the husband and wife subsequently moved back to Australia.

The property development costs were financed through savings, without additional finance.

You provided the following documents:

•         building permit

•         sub plan register

•         Property Balance sheet

•         Contract of sale of real estate and Vendor's Section 32 statement.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Income or capital

As a general principle, profits from property sales will either be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) or statutory income under the capital gains tax (CGT) provisions of the ITAA 1997.

Where the profit has been made as a result of a taxpayer carrying on a business of property development or as a result of a taxpayer entering into an isolated business transaction, the profit will be assessable as ordinary income. However, where the profit is a mere realisation of a capital asset, the profit will be assessable under the CGT provisions of the ITAA 1997.

This was found in the decisions in Scottish Australian Mining Co Pty Ltd v. FCT (1950) 81 CLR 188 and Whitfords Beach Pty Ltd (1982) 150 CLR 355 that a taxpayer, who had originally acquired property for farming operations purposes, could subsequently embark on a profit making scheme. This means that a taxpayer can embark on a profit making scheme after property was acquired for a different purpose.

There have been several cases in which the courts have addressed the question of whether the proceeds received for the sale of an asset are revenue or capital in nature. The decision in each case depended on its own facts, and very often will be a matter of degree.

The extent of the personal involvement of the taxpayer in much of the planning, organisation and management of the activities has been held to be significant factors in the determination of whether or not a business was being carried out. For example:

•         In Stevenson v FC of T (1991) 91 ATC 4476; (1991) 22 ATR 56; (1991) 29 FCR 282 (Stevenson) the degree of the taxpayer's involvement was seen as an indicator of a business being conducted; and

•         The lack of personal taxpayer involvement was seen as a relevant to the finding that a business was not being conducted in the cases of Stratham V FCT 89 ATC 4070, McCorkell v FCT 98 ATC 2199 (McCorkell) and Casimaty v FCT 97 ATC 5 (Casimaty).

From the cases involving the subdivision of land and from Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3), it would appear that the following are the most important factors to consider when determining whether profits made as a result of an isolated business transaction are assessable income:

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

In determining whether an isolated transaction amounts to a business operation or commercial transaction the following factors are relevant:

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.

The courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment.

Paragraph 49 of TR 92/3 further states that:

In very general terms, a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations.

Application to your situation

In your case, the Property was purchased in 19XX and used as a main residence for nine years. From that time, your son, lived in the property. The property's initial purchase was not to derive an income or as trading stock for development purposes. However, the intent in which is the land is held can change from being a capital transaction to an isolated business transaction.

In 20XX, it was decided to demolish the house that stood on the Property, subdivide the land into two, and build two new houses. The new houses were to be sold upon completion.

Based on the information provided, you were residing overseas when the decision to subdivide the Property was made and did not return until the new properties were sold. This indicates you had very little personal involvement in the organisation and management of the activities. You did however finance the subdivision and construction out of your own savings.

You don't appear to have a history of undertaking similar activities, making this an isolated transaction.

Rather than sell the property, you decided to knock down the standing house, subdivide the land, and build two new houses. This decision shows a distinct intention to make a profit or gain from these transactions. However, it also needs to be established if the activities amount to a business operation or commercial transaction

The activities were more complex than merely optimising the land. The decision to knock down the existing house and build two has more of a business operation or commercial nature than a mere subdivision where land is subdivided and sold, or land adjacent to an existing dwelling is built on and sold.

If your activities, being the demolition, subdivision and construction of multiple houses were to occur as part of a repetitious or recurring transaction, they would constitute the carrying on of a business. This is indicative that the activities which occurred have the character of a business operation or commercial transaction.

Making an overall assessment on the factors set out in TR 92/3, it is the Commissioner's view that your activities in relation to the demolition, subdivision and construction of two properties on your land are more than the mere realisation of an investment, and are an isolated transaction which has the character of a business operation or commercial transaction.

Therefore any profit arising from the sale of the two properties will be assessable as ordinary income under section 6-5 of the ITAA 1997.

Capital gains tax

The capital gains tax (CGT) provisions are contained in Parts 3-1 and 3-3 of the ITAA 1997. Broadly, the provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own.

When a CGT asset (the original asset) is split into two or more assets (the new assets), such as when land is subdivided, the subdivision of the land into subdivided blocks is not a CGT event. Each of the new assets are viewed as having been acquired at the same time as the original asset was acquired

A CGT event A1 happens if you dispose a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property.

You will make a capital gain if the capital proceeds from the disposal of a CGT asset are more than the cost base of the CGT asset. You will make a capital loss of those capital proceeds are less than the reduced cost base of the CGT asset.

Application to your situation

Whilst CGT event A1 will occur on the disposal of the subdivided blocks, the disposal of each lot will be viewed as an isolated transaction. Any profit from the sale will be assessable as ordinary income under section 6-5 of the ITAA 1997 as an isolated transaction. Any capital gain arising from each CGT event will be reduced to the extent any profit is also assessable under section 6-5 of the ITAA 1997.