Edited version of private advice

Authorisation Number: 1051940275464

Date of advice: 21 January 2022

Ruling

Subject: Property development - mere realisation v partnership business

Question 1

Will any parts of the proceeds from the sale of the subdivided lots be assessable to the Landowner under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes, the Landowner will be assessed on their share of the proceeds of the Lots, considered as trading stock of the business carried in partnership with the Developer.

Question 2

Will the sale of the Lots represent the mere realisation of land that was acquired before 20 September 1985?

Answer

No

Question 3

If the answer to question 1 is yes, did the Land become trading stock when the change in the local area structure plan allowed for a commercially viable development to proceed?

Answer

Yes

This ruling applies for the following period:

1 July 20XX - 30 June 20XX

Relevant facts and circumstances

The Land is several acres in size.

The Landowner has owned the Land for close to xx years. The Landowner acquired interest in the land in the 70's

For more than 20 years the Landowner farmed the Land in partnership with the Landowner's spouse who passed away in the late 90's. Following the death of the spouse, the Landowner continued to farm the Land in partnership with their adult child. More recently the Landowner has retired from farming and is leasing the Land to the child who is using the Land in a farming business.

The Land was zoned rural until around 20XX when it was re-zoned to low density residential zone (LDRZ).

The Land is broadacre farmland to which no material physical improvements have been made.

In early 20XX the Landowner (at first through their adult child) was approached by professional land development company (Developer) to determine the Landowner's interest in the development and sale of the Land. At that time the Developer was engaged by a neighbouring landowner to subdivide and sell their land.

Following discussions with the Developer, in mid-20XX the Landowner signed a Development Agreement (DA) with the Developer, under which the Developer was appointed to procure the re-zoning of the land to low density residential zone and then subdivide and sell the land on the Landowner's behalf.

The key terms of the DA are as follows:

a)    The Developer was given a timeframe to procure the rezoning of the land to residential usage through the necessary statutory authority processes.

b)    Assuming that the Developer was successful in procuring the rezoning of the land to residential usage, the Developer will then proceed to subdivide and sell the land on the Landowner's behalf. In this regard, the Developer will attend to all matters necessary to effect the development and sale of the land including:

•         Applying for planning permits;

•         Consultation with authorities;

•         Carrying out construction works;

•         Engaging consultants, contractors, builders etcetera as required;

•         Marketing lots for sale and appointing sales agents;

•         Determining minimum sale price for lots; and

•         Collecting sale proceeds and distributing them to the client.

a)    The Landowner will remain owner of the Land throughout the development. No title in the Land will pass to the Developer or any other entity to implement the development.

b)    The Developer will be responsible for paying all development costs. It will have the right to be reimbursed these amounts from the sales proceeds only as they are received on behalf of the Landowner.

c)    The Developer will be entitled to 49% of the sale proceeds from the sale lots after the reimbursement to the Developer of its loan expenditures and the development costs it will incur.

It was submitted that the 49% distribution to the Developer is the development fee payable for its services.

The Landowner's main motivations in deciding to sign the DA and commit to the development and sale of the Land included:

•         the Landowner's age;

•         the Land being surplus to the Landowner's needs;

•         the Landowner's desire to fund their retirement;

•         the Landowner's desire to gift money to their adult children;

•         encroaching residential development of surrounding land in the area.

The Landowner's involvement in the development of the Land and subsequent sales of the subdivided lots will be entirely passive. The Developer has been engaged to project manage all aspects of the development meaning the Landowner will not have any involvement in the day-to-day decision making of the subdivision project.

The Landowner did not discuss developing the Land with any other developer/s nor had they made any attempts to sell the Land 'as is'. The Developer is the only developer the Landowner discussed the development of the Land with.

Pursuant to the DA, the Developer made applications to the Council to rezone the Land to low density residential zone. In mid-20XX the Land was rezoned to low density residential zone. However, the prevailing structure plan only allowed subdivision to 1-2 hectare lots, which was too large to allow a commercially viable subdivision of the Land to proceed.

More recently, a change in the structure plan was gazetted to allow subdivision of the Land into smaller 1 acre lots. This change has now opened the way for a commercially viable subdivision and sale of the Land to commence.

The change to the structure plan was implemented unilaterally by the Council, but submissions were made by the Developer in support of the change. The Landowner did not have any personal involvement in the rezoning process and /or changes to the structure plan.

The Developer's next role is to prepare an application in response to a Development Plan Overlay (DPO) which is the subject of this site. After the Council endorses the Developer's response to the DPO, a planning permit for the subdivision can be applied for. Following planning permit approval, works on the Land can commence. Aside from roads and utility services, required council works are limited to post and wire fencing to the lots and rear boundary, a footpath on each side of the roadway, and some street lighting.

The Developer has proposed that the Land will be subdivided into an estimated xx lots (the Lots) and will likely be completed in four (4) or more stages depending on the progress of the development and market conditions.

It is anticipated that the Landowner will enter into a limited power of attorney with the Developer that allows the Developer to enter into binding contracts of sale of subdivided lots. The Developer will engage a local real-estate agent to sell the subdivided lots. It will be the Developer signing the sale contracts under its limited power of attorney.

The Landowner has no prior history of involvement in land development activity (wither directly or indirectly).

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 70-10(1)

Income Tax Assessment Act 1997 section 70-30

Income Tax Assessment Act 1997 paragraph 70-30(1)(a)

Income Tax Assessment Act 1997 subsection 104-220(1)

Income Tax Assessment Act 1997 subsection 104-220(2

Income Tax Assessment Act 1997 subsection 104-220(4)

Income Tax Assessment Act 1997 paragraph 118-25(1)(b)

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Question 1 and 2

Summary

The activity involved with subdividing and selling the Land goes beyond the mere realisation of a capital asset. On consideration of the activities required to deal with Land and the conduct of the parties, it is concluded that the Landowner formed a general law partnership with the Developer, carrying on a business in common with a view to profit. The sale of the Lots will constitute the sale of the partnership trading stock, with proceeds assessable as ordinary income under section 6-5 of the ITAA 1997.

Detailed reasoning

Proceeds from the sale of subdivided land will be taxed for income tax purposes as ordinary income under section 6-5 of the ITAA 1997, where the land is held as trading stock and sold as part of carrying on a business of property development.

Alternatively, profits/gains from the subdivision of land can be assessable under section 6-5 of the ITAA 1997 as an isolated commercial transaction with a view to a profit, or as statutory income under the capital gains tax (CGT) provisions contained in Part 3-1 and Part 3-3 of the ITAA 1997 as a mere realisation of a capital asset.

Change of intention

While holding an asset for a long period of time may seem to indicate that it is a long-term capital investment asset, the intention of the taxpayer at the time of acquiring the asset and throughout the ownership period that the taxpayer owns that asset is an important factor to consider.

In circumstances where there has been a change of intention in respect of a property from holding the asset as a long-term capital asset, to one of selling the asset for a profit, the question which arises is whether the sale was a 'mere realisation' of capital asset.

The doctrine of 'mere realisation' was first developed in the Full High Court case of Scottish Australian Mining Co Ltd v. Federal Commissioner of Taxation (1950) 81 CLR 188 (Scottish Australian Mining) and has been relied upon by numerous cases since. The Full High Court in Scottish Australian Mining found that based on the facts of that case, the subdivision of the land was considered no more than a mere realisation of a capital asset, and its subdivision was merely an enterprising way to realise an asset to its best advantage. For many years it was felt that the doctrine of 'mere realisation' was applied so broadly that it was thought that only in exceptional circumstances would an isolated transaction fall within the ordinary concepts of income.

However, the decision inFC of T v. Whitfords Beach Pty Ltd (1982) 150 CLR 355; 82 ATC 4031 (Whitfords Beach) has narrowed the scope of the 'mere realisation' doctrine. In this case, Justice Mason stated that:

37. However, apart altogether from this factor, the facts previously mentioned show that there was involved more than mere realization of an asset. Deane J. was right in pointing to the circumstance that the asset was divided and improved in the course of a business of dividing and improving the asset. In this respect I do not agree with the proposition which appears to be founded on remarks in some of the judgments that sale of land which has been subdivided is necessarily no more than the realization of an asset merely because it is an enterprising way of realizing the asset to the best advantage. That may be so in the case where an area of land is merely divided into several allotments. But it is not so in a case such as the present where the planned subdivision takes place on a massive scale, involving the laying out and construction of roads, the provision of parklands, services and other improvements. All this amounts to development and improvement of the land to such a marked degree that it is impossible to say that it is mere realization of an asset. We need to bear in mind that the subdivision of broad acres into marketable residential allotments involves much more in the way of planning, development and improvement than was formerly the case. (at page 385).

>The decision in Whitfords Beach also highlights that the requirements of modern-day residential subdivision, which involve much more development and improvement of land than was formerly the case, makes it far more difficult for contemporary residential subdivisions to satisfy the 'mere realisation' doctrine.

Whether carrying on a business of property subdivision and sale

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? (TR 97/11) at paragraph 13, provides the general indicators of a 'business' established by the courts. The Ruling deals with carrying on a primary production business, however, the principles discussed in the Ruling apply to any set of operations. The indicators 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 activit

•         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.

While no single indicator is decisive. Whether a business is being carried on depends on the 'large or general impression gained' (Martin v. FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551).

For the Land to be sold as trading stock with proceeds assessable under section 6-5 of the ITAA 1997 we need to determine whether the Landowner's activities in dealing with the Land, amount to carrying on the business of property development and sale, either on her own or jointly in partnership with the Developer.

Carrying on a property development business in partnership

The ATO view on partnerships are contained in various rulings including:

•         Goods and Services Tax Ruling GSTR 2003/13 Goods and services tax: general law partnerships

•         Goods and Services Tax Ruling GSTR 2004/6 Goods and services tax: tax law partnerships and co-owners of property

•         Taxation Ruling TR 94/8 Income tax: whether business is carried on in partnership (including 'husband and wife' partnerships).

A general law partnership is formed when persons commence carrying on business together with a view of profit. Under general law, a partnership is not an entity and the term 'partnership' is merely descriptive of the relationship between persons carrying on business with a view of profit.

In Yacoub v Federal Commissioner of Taxation [2012] FCA 678 (Yacoub), Jagot J considered whether parties in a joint property development were a general law partnership, and therefore an entity, for GST purposes. At paragraphs 23-28 Jagot J summarised the relevant case law:

23.   The existence of a partnership is determined by reference to the true contract and intention of the parties as appearing from all of the facts and circumstances relevant to the relationship of the parties" Amadio Pty Ltd v Henderson (1998) 81 FCR 149 at 172 (Amadio).

24.   The indicia of the existence of a partnership include: - (i) a mutual interest in the carrying on of the business for the purpose of profit or gain (in this regard, it has been said that all partnerships involve a joint venture but not all joint ventures involve a partnership, for example, Whywait Pty Ltd v Davison [1997] 1 QdR 225 at 231), (ii) mutual confidence that the parties will engage in the venture for joint advantage only (for example, Birtchnell v Equity Trustees, Executors & Agency Co Ltd (1929) 42 CLR 384 at 407-408), (iii) sharing of profits and losses from the venture or a so-called community of profit and loss (Fenston v Johnston (1940) 23 TC 29 at 34)(Fenston v Johnston), and (iv) mutual agency in the sense that each party is a principal of the business and may bind the other (for example, Momentum Productions Pty Ltd v Lewarne (2009) 174 FCR 268; [2009] FCAFC 30 at [36]-[44]).

25.   Statements of intention by the parties may be relevant but do not determine whether a partnership exists, as the issue is determined by reference to the "substance and reality of the transaction being adjudged to be a partnership (Fenston v Johnston at 35-36).

In concluding that the parties were in a general law partnership, Jagot J stated at paragraph 39:

...the real difficulty for the applicants remains cl 2 of the 18 July 2007 agreement and the agreement between the parties to the venture to "share equally all costs, liabilities, mortgages and proceeds derived from any sale arising from the property". By this provision the parties to the 18 July 2007 agreement placed themselves in a legal relationship by which they had: - (i) a mutual interest in the carrying on of the business for the purpose of profit or gain, (ii) mutual confidence that the parties will engage in the venture for joint advantage only, and (iii) sharing of profits and losses from the venture or a so-called community of profit and loss. As a matter of substance, the parties thereby created between themselves a partnership both at general law and a tax law partnership as defined in s 995- 1 of the ITAA 1997.

In this case, while clause 2.2 of the DA may indicate the Landowner and Developer are not partners, as per paragraph 20 of GSTR 2003/13 and Yacoub, a statement of intention by the parties may be relevant but does not determine whether a partnership exists.

Rather, as Jagot J stated at paragraph 23 of Yacoub, "The existence of a partnership is determined by reference to the true contract and intention of the parties as appearing from all of the facts and circumstances relevant to the relationship of the parties" (Amadio at 172). And at paragraph 25, Jagot J said "... as the issue is determined by reference to the "substance and reality of the transaction being adjudged to be a partnership" (Fenston v Johnston at 35-36).

Whilst partnerships typically are such that they are undertaken on an ongoing basis, Jagot J stated at paragraph 42 in Yacoub:

I do not accept the applicants' submission that the short-term or isolated nature of the activity precluded it from being a partnership. In National Insurance Company of New Zealand Limited v Bray [1934] NZLR 67 at 70 Smith J saw no reason not to find a partnership in respect of an arrangement relating to the mere purchase of a single piece of land. It is not apparent to me why the nature of the venture in question in this case - the development and sale of 30 strata subdivided villas - should be seen as an indicator against the existence of a partnership. Nor is the fact that the parties may have created one legal relationship in 2005 and another in 2007. In fact, the development was carried out and completed pursuant to the arrangements between the parties as varied by the 18 July 2007 agreement.

Therefore, the arrangement set out in the agreement between the Landowner and the Developer can be a partnership, even though it is a single or isolated parcel of land that is subject to development and the DA states that the parties are not partners.

Paragraph 15 of TR 94/8 outlines various indicators that suggest a partnership exists. The circumstances in this case are analysed against several of the indicators as follows:

Joint ownership of business assets

Paragraph 34 of GSTR 2003/13 confirms an interest in a partnership includes a right to a proportion of the surplus after the realisation of the assets and payment of the debts and other liabilities of the partnership and is inclusive of a partner's entitlement to a share in the capital of the partnership.

Ownership of the legal title of an asset by only one partner is also not determinative of whether there is a general law partnership. As a partnership is not a legal entity, it cannot hold title to an asset. It is the partners who will have the legal ownership. Example 2 of GSTR 2004/2, shows that parties can be in a partnership where the land is only owned by one party (paragraphs 56-59).

Although the Landowner retains legal title to the Land, under the DA, the Developer is entitled to a beneficial ownership interest in the Land, on the basis that it is to receive 49% of the proceeds of the sale net of development and financing expenses. Both parties share this right to a proportion of the surplus proceeds after the realisation of the assets and payments of debts and liabilities.

Extent to which parties are involved in the conduct of the business

The Developer does the bulk of the work under the agreement, however the is required to report to her at least once a month per clause 4.2.1.2 of the DA. Under the DA, the Landowner makes decisions on development plans and consider the economic viability of the development stages and is required to sign agreements. The Landowner is also required to use the Land to guarantee financing as well as making decisions on the terms of the financing. This contribution is likely to be critical in order for the property development business to operate.

Extent of capital contributions

Paragraph 32 of GSTR 2003/13 states...the consideration for those interests can encompass capital contributions and the mutual obligations that each partner undertakes, including promises to provide labour, skills or services in the conduct of the partnership business.

The Landowner contributes the Land to the partnership as well as allowing the Land to be used as security for financing, constituting a capital contribution. The Developer will be paying development costs as well as interest on any loans obtained. These costs may be construed as the Developer's capital contribution to the development along with the contribution of its skills and services.

Entitlement to share of net profits

In this case, the Landowner will receive 51% and the Developer 49% of the proceeds net of development and financing expenses. Unless sales proceeds are less than or equal to the value of loans and development costs, then this development will have excess funds for distribution to the parties. This amount is considered profit, on the basis that it is income less expenses. It real terms, it is the reward for the party's contribution to the development project.

The three critical indicia of a partnership as outlined in Yacoub are exist under the agreement. Both the Landowner and Developer have a:

mutual interest in the carrying on of the business for the purpose of profit or gain

The purpose of the DA provides for the parties to work together to develop the Land for mutual interest and benefit. Rather than a fee for specific services, the parties have a commercial relationship to achieve a common goal. The parties meet regularly as to the status of the development and where appropriate agree to proceed to the next stage of the development.

There is mutual interest for this development to be successful. According to the agreement, the Developer (in their own right) does not separately charge the Landowner for development costs. The parties by virtue of this agreement are working together to ensure the development is successful to the extent of maximising the value of the Land.

mutual confidence that the parties will engage in the venture for joint advantage only

The parties have come together to achieve re-zoning, subdivision, development and sale of the land. There is mutual trust between the parties to achieve their objectives as expressed in the concept plan, arrange funding for development costs and borrow funds for development costs, establishment of bank account and how to distribute proceeds.

Whilst Developer is arranging for funding to meet the development costs, it is done on behalf of both the Landowner and Developer. The borrowing of funds for development costs is achieved by using the Landowners land as security.

Although the Developer is 'paying' the costs, both parties are 'bearing' the costs, as the Landowner is not entitled to any of the sale proceeds until the development costs have been paid.

The parties have agreed to set up a bank account to manage the proceeds of sale and/or the payment of any liabilities (loans) and development costs. This account is held in trust for both the Landowner and Developer. The mechanism for the distribution of the proceeds highlights the extent of mutual interest and confidence of the parties with respect to this commercial relationship. One partner (the Landowner) contributes land, while the other (the Developer) contributes skill, expertise and covers development and financing costs.

The following clauses contained in the agreement provide further support there is mutual interest and confidence between the parties. These clauses ensure that both parties work towards the common objective.

•         Clause X - agreement the parties be just and faithful in all its activities and dealings with the other parties and otherwise to perform its obligations implied as well as expressed under the terms of this document.

•         Clause X - Landowner and Developer working together to achieve most advantageous outcome with respect to rezoning

•         Clause X provides for lots be withheld from sale and retained by either party.

•         Clause X - provides for any GST recouped from the purchasers of the Lots shall be the property of the parties. Any GST amount is included in the sale price and therefore form part of the proceeds that go into this joint account.

•         Clause X - acting in good faith - providing each party that there is a mutual interest, and each party can have mutual confidence that the project will be undertaken to achieve joint objective.

share of the profits and losses from the venture

Once the land has been developed and subdivided ready for sale, the Landowner and Developer are 'tied' together until development costs are paid and all lots sold. The costs are borne by both parties and once they are paid, they are only then entitled to receive their share of the proceeds.

The Landowner is the legal owner of the land and if no agreement was in place, all proceeds would belong to them. However, in accordance with clause X of the DA, loans and development costs will be paid first, prior to sharing the excess on a 51/49 basis in favour of the Landowner. As previously stated, the net proceeds amount is considered as profit from the activity by the Commissioner.

The agreement entered between the parties has the character of something more than the Landowner entering into a contract on a fee for service basis with the Developer to develop, subdivide and sell the Land.

There is no specific mechanism in this agreement for the Developer to charge the Landowner directly for their services. Whether this is a percentage fee based on sale proceeds of land or a direct charge for time/effort. In turn, the landowner is not able to expense the costs (where it is a fee) against the revenues from the sale of land.

Where a developer is acting throughout a project in their own right, outstanding liabilities for payment of development costs would rest with the developer alone. Under this arrangement, these costs are costs of the Partnership (incurred by the Developer in the capacity as partner in the partnership). As any distribution and return on respective investment is not realised until the loans and development costs are paid in full. Rather than a fee for service arrangement, there is an enduring commercial relationship or association between the parties.

Ultimately the arrangement set out in the agreement is that the Landowner is contributing the land and provision of a security over the land to obtain funding for the development costs. The Developer is contributing their skill, expertise and knowledge to carry out all of the steps necessary to achieve the joint objective of developing and selling the Land. In return for their contributions, the Landowner and Developer receive a respective share of 51/49 of the profits.

Whilst in some circumstances the Developer has the ultimate say, the parties work together, where they attend meetings, keep records, and only proceed if it is economically viable to do so.

In the event that a party undertakes or enters into transactions, they would be doing so in their capacity as partner in the partnership, and not in their own right. The exception to this would be those events and transactions leading up to and including the rezoning.

It is arguable as to when this partnership formed. We are of the view that it formed when it was clear the development phase was to proceed after the gazetting of the Local area structure plan.

With reference to the indicators in paragraph 13 and 18 of TR 97/11, the Commissioner's view is that the Developer and Landowners activities in dealing with the land amounts to a business:

A significant commercial activity (size and scale of activity)

The subdivision involves the development of the land into a relatively large number of lots for sale. This is a significant project with works including roads, drainage, water, post and wire fencing (to the lots and rear boundary), a footpath on each side of the roadway, and some street lighting.

There is a purpose and intention to engage in commercial activity:

•         There is the intention by entering into this agreement, that both parties have come together to achieve a joint goal as expressed in clause X. This clause in the agreement supports recital X, to achieve re-zoning, subdivision, development and sale of the land.

•         Agreement to conduct themselves in good faith as explained at clause X.

•         The association is for a minimum of X years.

•         Develop the land and subdivide into XX lots over four stages.

•         Engage in pre-sales of lots and other marketing.

•         Each stage of the development is commenced on by agreement by both parties that is economically viable.

•         There is a plan for handling funds and distributing the proceeds in a specific order.

The intent to make a profit from the activity and the profit to be shared between the parties

The parties have waited a number of years to get the right zoning level to maximise the inventory available to them (that is, the Lots). This indicates a clear intention to make a profit. The profits are to be shared by the Landowner and the Developer as per the following clauses in the DA.

•         Clause X provides that the parties are sharing in proceeds net of costs (considered profit).

•         Clause X provides for either party to request a lot or lots be withheld or retained from sale. This is an alternate form of sharing in the profits, as it is a condition that loans and development costs are met in the first instance.

•         Clause X provides for the circumstance where the parties do not agree to extend this agreement beyond X years. In this situation the parties agree to share equally the benefits of remaining unsold lots with any necessary cash adjustment to be made.

The activity is likely to be profitable

The partners have delayed the subdivision until the local structure plan was updated, on order to ensure the development activity is likely to be profitable.

Repetition and regularity of activity

While there are only two plots of land, they have been divided into XX lots all of which will have infrastructure built on them to enhance their value. The activity will be repetitious and regular and is expected to take up to four years to complete. The Developer is a professional development company and has undertaken property development in the past.

Activity is carried on in a similar manner to that of the ordinary trade

The work done by the partnership in this case will be carried on in a similar manner to other property development business. The Developer will provide their skill, previous development experience and expertise to ensure the subdivision proceeds in a professional manner.

The activity is planned, organised and carried on in a businesslike manner, including:

•         The agreement itself is a sophisticated document and sets out the plan for the development.

•         There is a conditions precedent in the DA that the land needs to be rezoned for it to procced to the next phase (the development phase).

•         Funding arrangements to meet development costs.

•         Detailed description of what is included as development works.

•         Engagement of contractors.

>•         Review performance for current staged development and decide whether to proceed to next stage of development - sales and costs analysis.

•         Establishment of a bank account to hold proceeds.

•         Preparation of accounts and providing progress reports on a monthly basis.

•         There is consideration of circumstances where a stage is not progressed, or the development agreement is not extended beyond X years.

•         The DA considers how proceeds are to be distributed to pay loans, development costs, including retaining some funds for the development of next stage, prior to sharing excess proceeds to each party.

Not a hobby, recreation or sporting activity

The size and scale of the operation and money spent indicates its more than a hobby or recreation.

A business plan exists

The size and scale of the operation indicates it would be reasonable for the Landowner and Developer to have a plan on how to prepare, develop and sell the land. The commerciality of the subdivision has been considered by the parties prior to the commencement of the activity, with the parties proceeding only after the project was determined to be viable. This indicates commercial planning of the project.

The DA between the Landowner and the Developer is part of the plan.

Commercial sales of product

The Lots will be sold to the public via the engagement of a real estate agent. This will occur, either through pre-sales or at the conclusion of the subdivision.

Developer has knowledge or skill

The Developer provides the expertise and skill to the partnership whereas the Landowner has provided the Land.

The engagement of the Developer (who in turns engages skilled construction workers) and a real estate agent means there are a number of other people involved in the operation who have the skills and knowledge.

The size and scale of the partnership activities, plus the quantity of lots developed indicates the partnership is going beyond a mere realisation of capital asset and is undertaking a property development business. The sale proceeds of the Lots will be proceeds sale of the partnership trading stock, and therefore be assessable to the partners as ordinary income under section 6-5 of the ITAA 1997.

Any capital gain or loss made on the sale of the subdivided Lots by the partners will be disregarded under paragraph 118-25(1)(b) of the ITAA 1997 on the basis that the Lots will be trading stock of the partnership.

Question 3

Summary

The partnership committed to embarking on the definite and continuous cycle of operations designed to lead to the Land after the change to the Local area structure plan. The Land became trading stock at this time.

Detailed reasoning

Subsection 70-10(1) states:

Trading stock includes:

a)    anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and

b)    live stock.

In considering whether property is trading stock, Taxation Determination TD 92/124 Income Tax: property development: in what circumstances is land treated as 'trading stock'? (TD 92/124) states:

1.    Land is treated as trading stock for income tax purposes if it is held for the purpose of resale, and a business activity which involves dealing in land has commenced.

2.    Both the required purpose and the business activity must be present before land is treated as trading stock. The business activity is taken to have commenced when a taxpayer embarks on a definite and continuous cycle of operations designed to lead to the sale of the land.

3.    It is not necessary that the acquisition of land be repetitive. A single acquisition of land for the purpose of development, subdivision and sale by a business commenced for that purpose would lead to the land being treated as trading stock.

As stated in paragraph 3 of TD 92/124, it is not necessary that the acquisition of land be repetitive. That is, the development of one specific property can constitute a property development business, in which case the sale of the property is within the ordinary course of that business and the property is trading stock (R & D Holdings Pty Ltd v DCT [2006] FCA 981 (R & D Holdings) and FCT v St Hubert's Island Pty Ltd (In Liq) [19781 HCA 10; (1978) 138 CLR 210 (St Hubert's Island)).

Land can be trading stock before it has been turned into the condition in which it is intended to be ultimately sold - that is, land intended to be sold after subdivision is still trading stock before it is subdivided (R & D Holdings; St Hubert's Island).

The Commissioner's view that broadacre land (that is not yet subdivided) ventured into a business of subdivision, development and sale can be trading stock is stated in ATO Interpretative Decision ATO ID 2004/532 Income Tax: business of subdivision - time when land becomes trading stock (ATO ID 2004/532).

ATO ID 2004/532 explains that when an asset is ventured into the business of development, subdivision and sale is a matter of fact. TD 92/124 provides guidance that a business activity is taken to have commenced when a taxpayer embarks on a definite and continuous cycle of operations designed to lead to the sale of the land.

It is only when the land is subdivided, so that different parts of the land become an identifiable and segregated parcel of land subject to separate title or titles, separate from the other parts of the land that each plot of land becomes an individual article of trading stock (Barina Corporation Ltd v FC of T 85 ATC 4186).

Application to your circumstances

The Landowner entered into the DA with the Developer on XX/XX/XXX. As per the condition precedent in the DA, the Developer made applications to the Council to rezone the land to low density residential zone. Although the Land rezoning (to low density rural zoning) occurred in XX/XX/XXXX the Developer did not exercise its discretion under clause X of the DA to proceed with the development. The allowable density under the zoning was considered commercially unviable.

It is only after the change in the Local area structure plan was gazetted to allow subdivision of the Land into smaller lots occurred that the parties have agreed to proceed. The parties conduct up until this time supports the view that the Land had not been committed to development and was not yet trading stock.

The partners intention changed after the Local area structure plan was changed. After this occurred, they committed to the development of the land, embarking on the definite and continuous cycle of operations designed to lead to its sale. It is the Commissioner's view that at this time (XX/XX/XXXX) the Land became trading stock of the partnership business.

Additional Information

If the Landowner elects to use the Land's market value under paragraph 70-30(1)(a) of the ITAA 1997, CGT event K4 occurred when the partnership started holding the Land as trading stock in the 20XX-XX financial year (subsection 104-220(1) and subsection 104-220(2) of the ITAA 1997).

The capital gain from the CGT event K4 will be disregarded under subsection 104-220(4) of the ITAA 1997 as the Landowner acquired the asset before 20 September 1985.

The Landowner will need to make the election (under paragraph 70-30(1)(a) of the ITAA 1997) by the time the 20XX-YY financial year tax return is lodged.