Edited version of private advice

Authorisation Number: 1051864035655

Date of advice: 29 September 2021

Ruling

Subject: Tax treatment of the proceeds from the subdivision of land

Question 1

Will the proceeds from the sale of the proposed subdivided lots located at the Trust's property be assessable income under subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of carrying on a business of property development?

Answer

No

Question 2

Will the profit from the sale of the proposed subdivided lots located at the Trust's property be assessable income under subsection 6-5(1) of the ITAA 1997 as a result of an 'isolated transaction' carried out for profit and commercial in character?

Answer

Yes

Question 3

Will the proceeds from the sale of the undeveloped Trust's property be assessable income under subsection 6-5(1) of the ITAA 1997?

Answer

No

Question 4

Will the sale of subdivided land at the Trust's property give rise to a capital gain under Part 3-1 of the ITAA 1997?

Answer

Yes

However, section 118-20 of the ITAA 1997 will apply to reduce the capital gain to the extent that the profit from the sale of the proposed subdivided lots is otherwise included as assessable income under section 6-5 of the ITAA 1997.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Trust is a family trust established under a trust deed dated XX/XX/XXXX.

The Trust is controlled by family member B. Family member A previously jointly controlled the Trust with family member B recently passed away.

Family member's B, C and D are discretionary beneficiaries of the Trust.

The Trust has a corporate trustee.

The family consisting of family members, A, B C and D previously owned Property 1 on outskirts of city X that was substantially subdivided and sold after the land was rezoned and adjacent areas were developed.

The family did not perform much of the work themselves in the Property 1 subdivision, engaging consultants, agents and contractors.

At around the same time of the sale of the lots from the subdivision of Property 1, family member A signed a purchase contract for Property 2 further out from city X.

Property 2 had the size and facilities that appealed for the purposes of a hobby farm and was originally intended for the property to become the family's principal place of residence. However, during the pre-settlement period, a decision was made that Property 2 was not suitable for the family's residence and the Trust was nominated as the purchaser.

In the following years Property 2 was used for both share farming and private use.

In 20XX, the electricity supply authority condemned the private power poles on Property 2. The power was subsequently cut to house and barns without the Trust's consent.

Given the derelict state of the buildings on Property 2, an application was submitted to demolish the buildings, with the permit subsequently provided by council.

The Trust became aware during the demolition application process that the Property 2 land had been re-zoned from rural to residential approximately 2 years earlier.

Neither family member A or B ever initiated any negotiations to sell the Officer Property or promote it for sale, as according to the application submissions, it was bought for the enjoyment of the family as a lifestyle retreat. Sale of the property would have required uprooting and relocation of the farm animals and farm equipment. Despite this both individuals have received many unsolicited offers for the Officer Property from agents, developers, and schools. Family member B continues to receive regular offers from developers and local agents.

On becoming aware of the rezoning, family member A arranged for the Trust to engage a consultant to apply for a permit of subdivision.

The private ruling application submission states that it was family member A's intent for the subdivisions application to protect the Trust's position with respect to the Property. From past experience with Property 1, family member A had learnt that being the last landowner in the area to apply for a subdivision permit could detrimentally affect the value and appeal of the property to a potential purchaser. It usually meant the council would impose larger green space and other conditions for adequate public amenity. At the time family member A was under the understanding that a development application was already proceeding for the neighbouring property with the potential for detrimental outcomes for the Officer Property.

Family member A passed away before the council issued the permit for the subdivision two year later.

According to the private ruling application, the permit issued was contingent on the completion of sewage services by the relevant authorities.

With the passing of family member A, the Trust became solely controlled by family member B.

Land tax for Property 2 has increased substantially as a consequence of the increased land value.

During recent years the Trust has relied on borrowings from the children to fund the land tax.

Family member B, no longer visits Property 2, wishes to sell the property due to affordability of the holding costs. Being elderly, they were reluctant to endure any stress or hassles with subdividing.

Family member C, however, has convinced family member B to subdivide Property 2 into lots to maximise the proceeds from the sale. Family member C remains relatively confident with the subdivision process, having remembered what was involved with the subdivision of the Property 1 some 18 years earlier.

According to these wishes, Family member B has committed the Trust by signing a land18 development agreement (LDA) with Company X to handle all matters relating to supervision of the subdivisional work and selling the arising lots. Family member C the sole director and shareholder of Company X.

Under the LDA, the Trust allows Company X to undertake activities in relation to the subdivision and sale of the arising lots from the Officer Property (the Lots), including the following:

•         Obtaining finance and funding the subdivision works.

•         Engaging and liaising with contractors to carry out the subdivision works.

•         Engaging an agent in relation to advertising, marketing and selling the Lots.

•         Managing any resumption/vesting of land with authorities.

•         Prepare a budget in respect to the proposed costs of each stage of development and consult with the Trust should the maximum service debt that includes the project cost require revision.

•         Prepare progress reports from time to time.

The Trust's obligations under the LDA are as follows:

•         Give consents, sign applications, enter contracts and agreements at the request of Company X to facilitate the subdivision and sale of the Lots.

•         Grant Company X and its appointed consultants and contractors entry to Property 2 to conduct their activities.

•         Allow Company X to use the Property 2 as security for borrowings by Company X to carry out the development.

•         Monitor development progress by reviewing budgets and progress reports prepared by Company X.

The subdivision plan for the Property 2 allows for XX lots over three stages. The subdivision works are planned to be completed within approximately twelve months of commencement.

Company X had planned to borrow $X.X million from a bank to carry out stage 1 of the subdivision work and retain or borrow the sales proceeds received by the Trust from the sale of stage 1 lots and apply them towards the subdivision and sale of stage 2 (and so on with stage 3).

Company X's consultants, however, have advised that the subdivisional works for stage 1 and stage 2 should be carried out simultaneously. Accordingly, Company X is presently seeking bank finance for the subdivisional works for stages 1 and 2, which is yet to be approved.

The Total cost for all stages is expected to be approximately $XX.X million (including Company X's service fee) with stage 3 works will be funded by proceeds from stage 1 and 2.

Company X's has informed the applicant to expect total proceeds from the sale of the Lots to be more than $XX million.

Company X will be compensated for their duties under the LDA (fee for service), charging for costs incurred plus a margin of X%.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 112-25

Income Tax Assessment Act 1997 section 118-20

Income Tax Assessment Act 1997 Part 3-1

Reasons for decision

Summary

The subdivision project will be considered a profit-making commercial undertaking, with profits from the sale to be included as ordinary assessable income under section 6-5 of the ITAA 1997. Whilst a CGT event A1 will occur when the Lots are sold, the resulting capital gain can be reduced by amounts included as ordinary assessable income under section 6-5 of the ITAA 1997.

Detailed reasoning

Broadly, there are three main ways profits from a land development, subdivision and sale can be treated for taxation purposes:

1.    As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock;

2.    As ordinary income under section 6-5 of the ITAA, on revenue account, as a result of an isolated commercial transaction with a view to profit;

3.    As statutory income under the capital gains tax (CGT) provision contained in Part 3-1 of the ITAA 1997 as a mere realisation of a capital asset.

While holding an asset for a considerable period of time may seem to indicate that it is a long-term capital asset, the intention of the taxpayer at the time of acquisition and throughout the ownership period is a crucial aspect.

Numerous court cases have considered whether the profits from the sale of subdivided land are ordinary income (assessable under section 6-5 of the ITAA 1997) including the following:

Whitfords Beach Pty Ltd v Federal Commissioner of Taxation (1983) 14 ATR 247 where the taxpayer acquired land as a capital asset for use in a fishing business. Thirteen years later, the original shareholders sold out and the company and the new ownership adopted an entirely new set of articles. It then embarked on a long and complex course of activity which involved the land being rezoned and developed as a residential subdivision. Vacant lots were sold over a period of many years for a substantial profit. The High Court held that the adoption of a new set of articles resulted in a change in the intended usage of the land. This resulted in the taxpayer's activities going beyond the realisation of a capital asset, with the activities constituting the carrying on of an actual business of subdividing and selling land.

Statham & Anor v. FC of T 89 ATC 4070 20 ATR 228 (Statham) where the property was subdivided and sold after a business of raising cattle had failed. The taxpayer relied on the local council to carry out the subdivision work and the local real estate agents handled the advertising and sale of the lots. The Full Federal Court held that what occurred was the realisation, by the most advantageous means, of the asset which the owners had on their hands when they abandoned the intention of farming the subject property.

Casimaty v FC of T 97 ATC 5135; (1997) 37 ATR 358 (Casimaty) where due to the growing debt and the ill health of the taxpayer, primary production land was progressively subdivided and sold off over a period of 18 years. There was no coherent plan conceived for the subdivision of the whole property. The taxpayer had acquired and had continued to hold and use the residence and conduct the business of a primary producer on the property. Therefore, there was no change of purpose of object for which the property had been held. In his judgment, Ryan J in the Federal Court held that the profits resulted from the mere realisation of a capital asset and as such the profits were not assessable as ordinary income.

Stevenson v. Federal Commissioner of Taxation (1991) 29 FCR 282 91 ATC 4476 22 ATR 56 (Stevenson) where taxpayer had owned farming land for many years, selling a portion of the land to a third party to be used for agricultural purposes. In the early 1970's he decided to scale back his farming activities and sell most of the remaining 90 acres, other than a few acres retained for his use. He could not source a developer who would pay his sale price and in 1976 he determined that he would subdivide the land himself. He commenced subdividing the land in stages, obtaining finance and personally arranging for the construction of the necessary earthworks, storm water drains, guttered road works and other improvements to the land. Around the same time his farming income consisted of mainly agistment income. Throughout the process the taxpayer had personally dealt with councils, engineers, and statutory utilities. He advertised the development himself, did not engage the services of any particular real estate agent to assist him, dealt personally with prospective purchasers, did some of the physical work himself and fixed the sale price for the subdivided lots, being 220 lots. It was held that the taxpayer was carrying on a business of developing land.

As displayed in the above cases, in certain circumstances a taxpayer can embark on a profit-making scheme or the carrying on of a business in relation to land subdivision and sale where the property was acquired for a different purpose.

Carrying on a business of property development

Section 995-1 of the ITAA 1997 states the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

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

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? provides the Commissioner's view of the factors used to determine if you are in business for tax purposes:

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

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

In the context of considering the above indicators to determine whether the Trust's involvement in the land subdivision and Lot sale amounted to carrying on a business, the following general observations have been made:

•         In this case Company X will undertake the subdivision and sale activity after the Trust signed the land18 development agreement (LDA) with them.

•         Under the LDA the Trust retains a right to be consulted should Company X require the project cost to be revised.

•         Otherwise, the Trust's involvement in the decision making and day to day activities relating to the land subdivision and Lot sale are limited under the LDA.

•         Although the Trust is required to provide Property 2 as security, the funding of the project is the responsibility of Company X under the LDA.

•         The Trust has not undertaken a similar activity in the past.

Based on the information provided, we do not consider that any proceeds the Trust would receive from the sale of the subdivided lots would be derived in the course of carrying on a business.

Profits from an isolated transaction

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

The term isolated transaction refers to:

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

•         those transactions entered into by non-business taxpayers.

If a taxpayer not carrying on a business makes a profit from an isolated transaction or operation, that profit is generally assessable income if both of the following elements are present:

•         the intention or purposes of the taxpayer in entering into the 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.

Although the Trust is not in the business of property development, to decide if any profits it makes from the subdivision and sale of the lots is ordinary income, we need to consider if the transaction was entered into, and the profit was made in carrying out a commercial transaction.

TR 92/3 lists the following factors which are relevant in determining whether an isolated transaction amounts to a business operation or commercial transaction:

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 and the various steps in the transaction.

Paragraph 9 of TR 92/3 provides that the taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property.

However, paragraphs 41 and 42 of TR 92/3 outline that where a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction, the activity of the taxpayer constitutes the carrying on of a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income even though the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.

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. This may require a consideration of the factors outlined above; however, there may also be other relevant factors that need to be weighed up as part of the process of reaching an overall conclusion. 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.

Application to your circumstances

In the context of considering the above authorities and factors when determining whether the Project would be viewed as a profit-making undertaking, the following general observations have been made in relation to the Officer Property:

•         The simplest method of realisation contemplated by the Trust is to dispose of the whole property with the approved permit of subdivision for an estimated market value of between $XX-XX provided.

•         In consultation the Trust has developed a coherent plan to allow for the subdivision of the land into XX lots. The plan being substantially more complex than what would have been involved in the disposal of the land as a whole.

•         The proposed development involves subdivision of the entire land area (albeit in two or three stages) unlike the taxpayer in Casimaty where the taxpayer subdivided his property in pieces over an extended period and didn't initially contemplate subdividing the whole property.

•         Through the development of Property 1 the family has had some previous involvement with land subdivision and sale, with Property 2 being a relatively short distance further out (from city X) than Property 2.

•         It is proposed that the development of the land will be undertaken by Company X whose sole shareholder and director is a beneficiary of the Trust (Family member C).

•         Should the proposed development proceed, the signing of the land development agreement will be taken to indicate a change in the purpose for which property 2 was held by the Trust. At this point it will be taken to be no longer held by the Trust for share farming and private recreational use.

•         To fund the initial stages of the subdivision, the Trust has agreed to allow Company X to use Property 2 as security for the required loans. The exposure to mortgage risk will not be necessary should the Trust choose the simplest method of realising the asset, being the sale of the undeveloped property.

•         The Land Development Agreement with Company X provides that the Trust is the beneficiary of the increased profit from the sale of the lots. The Trust retains ownership of the Land throughput the development and is entitled to the sale proceeds from the sale of the Lots. Under the LDA the developer (Company X) will be paid an agreed service fee on a cost-plus X% basis.

•         The total subdivision costs are estimated at $XX, being more than 80% of the estimated market value of the undeveloped Property 2.

•         The sale of the Lots is expected to provide the Trust with sale proceeds of more than $XX.

A balanced view of these observations, with no one feature being determinative in isolation, reasonably leads to a conclusion that the that the subdivision and sale of Lots by the Trust will be a profit-making commercial undertaking.

The decision to pursue the proposed subdivision will show the Trust's willingness to engage in exposure to the risks of the development, for the purpose of maximising the potential profit made on the sale of the Lots.

The Trust's submission that the 20XX permit of subdivision application and 20XX approval by Council was intended only to protect the Trust's position is accepted. It is noted that the Trust's usage of the Property remained largely unchanged until the land development agreement was signed. On this basis it is considered that a sale of the undivided property with the development permit would be considered a mere realisation for the Trust and therefore, would not be assessable under section 6-5 of the ITAA 1997.

Subject to the proposed development proceeding, it is the Commissioner's view that the Trust ventured Property 2 into the isolated commercial transaction when it signed the land development agreement with Company X on XX/XX/XXX to subdivide the land and sell the Lots. At this time the Trust's intention and purpose of holding Property 2 clearly changed from one of share farming and private use, to an undertaking of profit-making from an isolated commercial transaction.

Accordingly, if the Trust proceeds with the proposed subdivision, any profits from the sale of the Lots generated from the time the Trust entered the land development agreement are will be considered to be ordinary assessable 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.

CGT event A1 under section 104-10 of the ITAA 1997 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.

Section 118-20 of the ITAA 1997 contains anti-overlap provisions which operate to reduce any capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 as a result of the CGT event.

Application to your circumstances

CGT event A1 will occur when the Lots are sold. The capital gain can be reduced by the amounts included as section 6-5 assessable income as profits from the isolated commercial transaction in the same income year.