Edited version of private advice

Authorisation Number: 1051870896317

Date of advice: 29 July 2021

Ruling

Subject: Subdivision of farmland - one off commercial transaction

Question 1

Will the profit from the sale of the subdivided lots be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 ('ITAA 1997') as a result of you carrying on a business?

Answer

No.

Question 2

Will the profit from the sale of the subdivided lots be assessable as ordinary income under section 6-5 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 sale of the subdivided lots be assessable under the capital gains tax provisions?

Answer

Yes. However, under section 118-20 of the ITAA 1997 any capital gain will be reduced to the extent the amount is assessable under section 6-5 of the ITAA 1997.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

X XX 20XX

Relevant facts and circumstances

In 19XX, you and your former spouse purchased a XX-acre rural property ('the Farm') as joint tenants with the sole intention to run a primary production enterprise.

You divorced from your former spouse in 20XX. The divorce settlement provided you with your former spouse's interest in the Farm, resulting in you acquiring full ownership.

From the original purchase of the farm, you and your spouse ran the farm initially as a livestock stud, then sheep grazing and finally a feedlot for cattle. However, primary production activities ceased in XX 20XX due to the divorce.

You then shared farmed the land, growing crops until XX 20XX. You were not required to be registered for GST. From XX 20XX to current date, you agisted the land to local farmers.

Your decision to sell the farm is due to a variety of factors, such as your age, health and income for your retirement.

In XX 20XX, you decided to approach the local council to subdivide and sell off XX acres of the land. The land was to be subdivided into X lots. Of the X lots subdivided, X lots are being sold to your X children and X lots will be sold to independent purchasers.

You received approval of the X-lot subdivision based on certain conditions. These conditions included: the sealing of an existing dirt road on to the lots of land; providing power to each lot and implement fencing of each lot which has been done. Other costs incurred were surveying and engineering costs from civil engineers you engaged.

Due to your financial position, you borrowed approximately $XXX,XXX to pay for the subdivision costs. No interest cost has been claimed as a business tax deduction either.

You have only complied with the council rules. You have not done anything more than necessary to have the subdivision approved by the council.

There are no structures erected on the land. It is still possible to farm each parcel of land to be part of a farming enterprise.

You have not viewed the subdivision and sale of the land as carrying on a business, but merely realising the land in the most effective way to assist your retirement. In addition, you have not claimed any costs associated with the subdivision as a deduction as a business expense.

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 104-10

Income Tax Assessment Act 1997 section 112-25

Income Tax Assessment Act 1997 section 118-20

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Generally, an amount received in relation to subdividing land would be assessable either as:

• ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as business income,
• ordinary income under section 6-5 of the ITAA 1997 as an isolated commercial transaction with a view to a profit, or
• statutory income under the capital gains tax (CGT) provisions contained in Part 3-1 of the ITAA 1997 as a mere realisation of a capital asset.

Ordinary income

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

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.

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? outlines some factors that indicate whether or not a business of primary production is being carried on. These factors equally apply to other types of businesses. The question of whether a business is being carried on is a question of fact and degree. In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators should be considered in conjunction with the other factors.

In the Commissioner's view, 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 is better described as a hobby, a form of recreation or sporting activity.

Based on the information provided and the above factors, we do not consider that any proceeds from your activities and sale of the subdivided lots would be derived in the course of carrying on a business.

Profits from an isolated transaction

In FC of T v The Myer Emporium (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693 (Myer Emporium), the Full High Court expressed the view that profits made by a taxpayer who enters into an isolated transaction with a profit making purpose can be assessable income.

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income considers the assessability of profits on isolated transactions in light of the principles outlined in Myer Emporium. According to Paragraph 1 of TR 92/3, the term isolated transactions refers to:

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

b)               those transactions entered into by non-business taxpayers.

Taxation Ruling TR 92/3 provides guidance in determining whether profits from isolated transactions are income and therefore assessable.

A profit from an isolated transaction will generally be income when:

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

Profit-making does not need to be the sole or dominant purpose for entering into the transaction. A profit-making purpose must exist at the time the transaction or operation was entered into. Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case.

In your situation, the Farm has been held for several years for the purpose of running a primary production enterprise. You have since decided to subdivide the Farm and sell off four the subdivided lots, with X being sold to your children and the remaining X to independent purchasers.

Albeit you are not in the business of property development, to decide if any profit you make 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.

In contrast, paragraph 36 of Taxation Ruling TR 92/3 notes that 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.

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 addition to the above factors, for the purposes of determining whether the activities undertaken in relation to real property and development equate to a profit-making undertaking or scheme, Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number aligns itself with TR 92/3 and provides a list of factors which, if present may be an indication that a business or profit-making undertaking or scheme is being carried on.

The factors listed in paragraph 265 of MT 2006/1 are as follows:

•                 there is a change of purpose for which the land is held;

•                 additional land is acquired to be added to the original parcel of land;

•                 the parcel of land is brought into account as a business asset;

•                 there is a coherent plan for the subdivision of the land;

•                 there is a business organisation - for example a manager, office and letterhead;

•                 borrowed funds financed the acquisition or subdivision;

•                 interest on money borrowed to defray subdivisional costs was claimed as a business expense;

•                 there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and

•                 buildings have been erected on the land.

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.

Numerous cases have considered the assessability of profits or proceeds from the sale of land including the following cases:

Whitfords Beach Pty Ltd v Federal Commissioner of Taxation (1983) 14 ATR 247 where the taxpayer acquired 1.584 acres of land for non- commercial purposes. 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's case) 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 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 where the 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, a taxpayer can embark on a profit making scheme after property was acquired for a different purpose.

In determining whether activities relating to isolated transactions are a profit making undertaking, 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.

Application to your circumstances

In your case, you are an individual non-business taxpayer who jointly purchased the Farm in 19XX and you have lived on the Farm since. You obtained full ownership of the farm in 20XX as a result of a divorce settlement.

In determining whether activities relating to isolated transactions are an enterprise or are the mere 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.

A balanced view of the observations of your circumstances, with no one feature being determinative in isolation, reasonably leads to a conclusion that your intention for holding the property has changed to a profit-making undertaking.

Although the Farm is your main residence and has been for some years, the intention in relation to the property changed when you committed to this undertaking in relation to the subdivision of the farm and the sale of the lots by approaching the local council to subdivide and sell of XX acres of the land in XX 20XX. The decision to pursue the subdivision shows your choice to engage in exposure to the risks of the development, including the profits, losses and its general success for the purpose of maximising the potential profit made on the sale of the lots. You are funding the subdivision through borrowing approximately $XXX,XXX, however you have not claimed any interest costs.

Your situation is not the same as the Statham's case where the council had undertaken all of the work relating to the subdivision of the property as they will manage and control the project, engaging the services of the relevant entities to undertake the activities arising in relation to the project. The fact that you are only selling X lots does not mean that such an undertaking is not a profit-making commercial transaction.

It is viewed that your subdivision activity is of a sufficient scale to characterise it as a commercial or profit-making undertaking.

Borrowing $XXX,XXX to pay for the subdivision costs indicates a profit-making undertaking. Although you plan on selling X of the X lots to your children, the remaining two blocks will be sold to independent purchasers, resultantly, the activities go beyond a private family arrangement.

We have determined that based on the facts of this situation that the project is a profit-making commercial undertaking and the profits from the sale of the lots are considered to be ordinary assessable income under section 6-5 of the ITAA 1997.

Capital gains tax

The inclusion of the gain/profit on the sale of the property as ordinary income does not mean that a CGT event does not happen in relation to the property. However, section 118-20 of the ITAA 1997 exists to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. In the absence of such a provision, it is conceivable that a receipt properly characterised as ordinary income and which has also been derived as a result of a CGT event could result in the receipt being taxed twice. Therefore, whilst a CGT event will occur when the property is sold (CGT event A1), any capital gain will be disregarded to the extent of any amount already included as ordinary assessable income under section 6-5 of the ITAA 1997.