Edited version of private advice

Authorisation Number: 1051899825007

Date of advice: 29 September 2021

Ruling

Subject: Disposal of property - income v capital

Question 1

Will the proceeds made on the disposal of your ownership interest in Lot 2 be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will the proceeds made on the disposal of your ownership interest in Lot 2 be assessable under Parts 3-1 and 3-3 of the ITAA 1997)?

Answer

No

This ruling applies for the following period periods:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Company A is a corporate trustee.

On or about Month 20xx, Company A acquired a farming property (Property 1).

Company A acquired Property 1 for the purposes of grazing cattle and hay production.

On or about Month 20xx, Company A acquired an additional farming property (Property 2).

Property 2 was acquired as two lots; Lot 1 and Lot 2.

In or around 20xx, a decision was made to look at selling Property B. Discussions held with real estate agents indicated that due to changing sewerage technologies, it might be possible to obtain a permit to subdivide Lot 1. However, that potential did not extend to Lot 2.

Company A decided to subdivide Lot 1 and retain Lot 2 for haymaking and agistment.

The subdivision of Lot 1 commenced in 20xx. Lot 1 was subdivided into xx lots and completed in 20xx.

As a result of difficulties with managing farming activities on Lot 2, Company A decided to sell it in 20xx. Lot 2 sold in 20xx, however the sale fell through.

Lot 2 was placed back on the market in early 20xx. A further buyer was not found.

Whilst Lot 2 was on the market, the Water Authority decided to install a sewerage system in the nearby townships. This was completed in 20xx.

Due to the inability to sell Lot 2 in its entirety and the installation of the sewerage system, Company A investigated the other options to realise Lot 2 and decided to subdivide.

Lot 2 will be subdivided into xx lots at an estimated cost (the Development).

The Development will be conducted in a number of stages.

The costs of the Development will be financed.

Company A has acquired other land for the purpose of subdivision and sale of residential lots.

Company A engages consulting engineering firms with responsibility for the planning, project management and compliance matters of each development. It also engages real estate agents with responsibility for selling all completed lots.

Company A is registered for GST and has claimed input tax credits for acquisitions made in subdividing the lots.

In Month 20xx, Company A lodged a planning application with the Council to develop Lot 2.

The approval process was delayed due to the uncertainly surrounding the sewerage system.

On DD Month 20xx, the Council considered the planning application and recommended its approval subject to appropriate conditions.

On DD Month 20xx, Stage 1 was lodged with the Council.

On DD Month 20xx, Stage 2 was lodged with the Council.

Relevant legislative provisions

Income Tax Assessment Act 1997

Section 6-5

Section 995-1

Part 3-1

Subsection 104-10(1)

Paragraph 104-10(3)(a)

Subsection 112-25(2)

Part 3-3

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise noted.

Taxation treatment of property sales

There are three ways the proceeds from a land subdivision can be treated for taxation purposes:

•         assessable ordinary income under section 6-5 as income from carrying on a business of property development;

•         assessable ordinary income under section 6-5 as income from an isolated commercial transaction with a view to a profit; or

•         a realisation, often referred to as a 'mere realisation', of a capital asset, assessable under Parts 3-1 and 3-3.

Whether the proceeds are treated as income or capital will depend on the situation 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.

Carrying on a business of property development

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

The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? Although TR 97/11 deals with the issues of determining whether a taxpayer is carrying on a business of primary production, the same principles can be applied to the question of whether a taxpayer is in the business of property development.

Paragraph 13 of TR 97/11, uses the following indicators to determine whether a taxpayer is carrying on a business:

•         whether the activity has a significant commercial purpose or character;

•         whether there is repetition and regularity of the activity;

•         whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business;

•         whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at 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 a sporting activity.

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.

Isolated commercial transaction

Profits arising from an isolated transaction as a result of entering into a profit-making undertaking or scheme will be ordinary income under section 6-5, on revenue account, (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693(Myer Emporium)). This is distinguished from a 'mere realisation' which is not ordinary income.

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) sets out the Commissioner's view on the application of the decision in Myer Emporium and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 as ordinary income.

Paragraph 1 of TR 92/3 provides that the term isolated transactions 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.

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

•         the intention or purpose of a taxpayer 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 operation or commercial transaction.

Paragraph 13 of TR 92/3 lists the following factors which are 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.

For a business of property development and resale, the repetitive buying and selling of property is not necessary to establish that a business is being carried on. A single acquisition of property for the purpose of development, subdivision and sale will be sufficient to constitute a business activity (Taxation Determination 92/124: Income tax: property development: in what circumstances is land treated as 'trading stock'?).

Paragraph 9 of TR 92/3 provides that 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, that is not always the case. As detailed in the example at paragraph 41 of TR 92/3, if a taxpayer acquires an asset for personal use, but later disposes of it in a business or commercial manner, the profit from the sale of asset will be income according to ordinary concepts.

Realisation of capital asset

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

Subsection 104-10(1) provides that CGT event A1 happens if you dispose of your ownership interest in a CGT asset.

Paragraph 104-10(3)(a) provides that CGT event A1 occurs when you enter into a contract to dispose of the CGT asset.

Subsection 112-25(2) provides that 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 two separate assets is not a CGT event.

Factors established by the Courts

The two leading court cases exploring the notion of 'mere realisation' are Scottish Australian Mining Co Ltd v. Federal Commissioner of Taxation (1950) 81 CLR 188 (Scottish Australian Mining) and Federal Commissioner of Taxation v Whitfords Beach Pty Ltd (1982) 150 CLR 355; 82 ATC 4031 (Whitfords Beach). It has been determined by the Courts that all the facts and circumstances taken as a whole must be weighed up in order to distinguish between a mere realisation of a capital asset and a transaction performed in carrying on a business or a commercial transaction.

From these and other cases, the Courts have established a number of factors in determining whether proceeds from the sale of subdivided land was income from carrying on a business, carrying out an isolated commercial transaction, or was from the mere realisation of a capital asset:

•         whether the landowner held the land for a considerable period of time prior to any subdivision and sale;

•         the purposes for acquiring the property, and whether it was used for any other purposes prior to sale;

•         whether the landowner conducted farming or other activities on the land prior to beginning the process of developing and selling the land;

•         whether the landowner originally acquired the property as an investment, such as long-term capital appreciation or to derive income;

•         whether the land was originally acquired near the urban fringe of a major city or town;

•         if the property has been rezoned, whether the landowners actively sought that rezoning;

•         whether a potential buyer made any offers to the landowners before they commenced discussion to enter into a proposed or final development agreement;

•         whether the landowners had tried to sell the land without subdivision;

•         whether the landowner had any history of buying and profitably selling developed land or land for development;

•         the extent to which the development goes further than that required to obtain council approval;

•         whether the operations will be planned, organised and carried on in a business-like manner;

•         the scope, scale, duration and degree of complexity of the proposed development;

•         the reasons for selling the land;

•         the level of involvement that the taxpayer had in the development, marketing and sale of the property;

•         the level of legal and financial control maintained by the landowners in the proposed or final development agreement;

•         whether any finance must be obtained in order to fund the development activities; and

•         the level of financial risk borne by the landowner in acquiring, holding and/or developing the land.

In your circumstances

In deciding as to whether the sale of Lot 2 is assessable as income under section 6-5, or assessable as the sale of capital under Parts 3-1 and Part 3-3, the Commissioner has considered the following:

•         Although Lot 2 was purchased in 20xx and was used for farming purposes, Company A started investigating options for its sale in the following couple of years. Company A maintains that it did not decide to sell Lot 2 until 20xx. However, Company A made a planning application for subdivision to the Council prior to this time.

•         Company A attempted to sell Lot 2 in its entirety, to the extent of accepting an offer. The planning application had already been submitted to Council at this stage, although it was on hold pending the issues with the sewerage. By the time Lot 2 was placed back on the market, the planning application had been approved by Council.

•         Company A has a history of buying and profitably selling developed land. Company A was settled for the purposes of making and holding investments. Company A purchased land and commenced a subdivision in Town 1 in 20xx, a subdivision of Lot 1 in 20xx and a subdivision in Town 2 in 20xx. The Development is its fourth subdivision.

•         The scope, scale and complexity of the Development is high and is more than what is required to obtain Council approval. Further, the Development is being carried on in a business-like manner. The Development is being completed in a number of stages and contains a significant number of lots. Company A has engaged consulting engineering firms with responsibility for the planning, project management and compliance matters of the Development. It has also engaged real estate agents with responsibility for selling the completed lots. Company A uses these processes for all of its subdivisions.

•         The financial risk involved with the Development rests solely with Company A. It is estimated to cost a significant amount and is being financed. If the Development fails, Company A will be subject to losses or the resulting liabilities. Company A will bear significant profit and loss risk in relation to the Development.

Based upon these facts, the Commissioner considers that Company A is carrying on a business of property development. Accordingly, the sale of the land is income in accordance with section 6-5.