Edited version of private advice

Authorisation Number: 1051950034613

Date of advice: 28 February 2022

Ruling

Subject: CGT - subdivision of property

Question 1(a)

Will the proceeds from the sale of Property A be assessable as ordinary income under s 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of carrying on a business of property development and subdivision or an isolated profit-making transaction?

Answer

No.

Question 1(b)

Will the proceeds from the sale of the remaining portion of Property B be assessable as ordinary income under s 6-5 ITAA 1997 as a result of carrying on a business of property development and subdivision or an isolated profit-making transaction?

Answer

Yes.

Question 2(a)

Will the profit from the sale of Property A be assessable under the capital gains tax provisions as a mere realisation of a capital gains tax asset?

Answer

Yes.

Question 2(b)

Will the profit from the sale of the remaining portion of Property B be assessable under the capital gains tax provisions as a mere realisation of a capital gains tax asset?

Answer

No.

Question 3

Will the proceeds from the sale of the three vacant lots be assessable under s 6-5 ITAA 1997 as a result of carrying on a business of property development and subdivision or an isolated profit-making transaction?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

XX Month 20XX

Relevant facts and circumstances

You acquired a vacant block of land, and subsequently built a residential building on it.

You later filed an application to enable the existing residential building to be split into a duplex and divided into two lots. The properties were then subsequently registered as two strata titles, referred to hereafter as Property A and Property B.

Property A had street frontage, while Property B was a battle axe block located at the rear of Property A. Both properties were rented out and included as rental income on your tax returns. There were, however, periods of time that the properties were unable to be rented out due to the extensive damage caused by departing tenants.

You were later approached by a local real estate agent. After the council proposed constructing a footpath on your properties, you and your neighbours opposed this decision and attempted to form a joint venture to subdivide all surrounding land collectively. However, this scheme was abandoned, due to opposition from other neighbours. You subsequently accepted an offer to acquire additional, Crown land located at the back of the property, to enable a road to go through the property on subdivision.

Your child also purchased an adjacent block with the view of co-developing, however, this did not proceed as they were compelled to sell the property to meet other financial obligations.

You previously registered for an ABN and GST. The Registrar of the Australian Business Register later cancelled your ABN because he was satisfied you were no longer carrying on an enterprise. The Registrar relied on information that we held that you had not declared any business income or you had not lodged income tax return(s). Your GST registration was also cancelled. Your tax agent then applied for a re-instatement of your ABN.

You have a long history of purchasing properties with a view of developing and selling them for profit. Over time you have acquired substantial properties and developments in various suburbs.

You also have a history of health issues and xxxx. At one point, you incurred significant debt in funding the large number of properties you owned. Due to concerns arising from your health issues, your X children were appointed as Joint Plenary Administrators and the Public Trustee was also appointed.

Your children were required to meet the obligations of your ongoing liabilities. This required them to sell almost all of your property portfolio. Your children were advised to subdivide Property B as you originally intended, however, this was delayed due to health issues in the family and tax liabilities.

Recently, an acquaintance was engaged to assist in obtaining the best price on the sale of the properties, in particular Property A and B. The acquaintance presented several options to your family, whereby the subdivision of Property B provided the most optimal financial outcome. Your acquaintance then obtained tenders for the development and made an application with the relevant planning authority.

Property B was subdivided into additional X vacant lots and extended the existing road into the land of your block. These X vacant blocks were then sold shortly thereafter. GST was withheld on the settlement of these sales.

Property A and the remaining portion of Property B were rented during this period with minimal interruptions to the tenancy. These properties were also sold. No GST was withheld in relation to the sale of these properties.

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 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 112-25

Income Tax Assessment Act 1997 section 118-20

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 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.

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

Case E20, 73 ATC 160, which involved two builders, claimed that certain properties were purchased out of the funds of the partnership as an investment to derive rents and that other properties were acquired to build houses thereon and let them. These claims were rejected and it was held that the profits from the sale of properties sold pursuant to a forced sale were assessable. The properties were acquired with the intention of committing them to whatever profit-making purpose commended itself to the taxpayers at the appropriate time so that the profit was assessable as ordinary income.

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 (Casimaty's case) 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.

Richardson v FC of T 97 ATC 5098, in which the taxpayer was an engineer who operated a building and project management business through a company (IR Pty Ltd). The company was also the trustee of a family trust of which the taxpayer was a beneficiary. As part of the construction of a building for another company, IR Pty Ltd (as trustee of the family trust) sold a parcel of land and purchased another for the same consideration. The parcel of land was then used as a rental property until sold. The profit made on disposal was ordinary income of the trust as the family trust had a purpose or intention of profit-making when entering into the relevant transactions and the acquisition was made as part of the trust's business of deal making.

McCurry & Anor v FC of T 98 ATC 4487, in which two brothers bought a block of land in 1986 for $32,000. They subsequently borrowed $80,000 to enable them to construct three townhouses. They could not sell the townhouses and, in mid-1987, they and members of their family moved into two of the townhouses. The third townhouse was used partly as a storeroom for a news agency business purchased by the family and partly as accommodation for visitors. The townhouses were sold in December 1988, but the family remained in two of them as tenants. The court found that profit-making by sale (rather than the receiving of rental income) was the dominant factor. Accordingly, the net profit arising from sale of the property was ordinary income.

As displayed in the above cases, a taxpayer can embark on a profit-making scheme after property was acquired for a different purpose.

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.

Application to your Property Development and Subdividing Activities

The following reasons for decision outline our response to Questions 1(a), 1(b) and 3.

The purchasing of properties were conducted by you in your individual capacity. The sale of the blocks from Property B occurred in subsequent financial years to your registration for an ABN and GST, due to issues relating to your health. GST was withheld on the settlement of the sale of the subdivided blocks.

Whilst it is not free from doubt, it is considered that you are not carrying on a business for income tax purposes. Based on the information provided and the above factors, we do not consider that any proceeds from the current activities and sale of the Property A and B would be derived in the course of carrying on a business.

Trading Stock

The term 'trading stock' is defined in subsection 70-10(1) of the ITAA 1997 to include:

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

Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'? (TD 92/124) confirms that it is the Commissioner's view that land will be 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.

TD 92/124 explains that 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. 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. Therefore, if land is held for the purpose of development, subdivision and sale by a taxpayer carrying on a business of property development it will be trading stock of that business.

Application to your circumstances

In your case, there was not a definite and continuous cycle of operations designed to lead to the sale of the land, nor were you considered to be undertaking a business activity which involved dealing in land. Therefore, the sale of Property A and B would not be regarded as the sale of trading stock.

Therefore, with respect to Questions 1(a), 1(b) and 3, you are not considered carrying on a business of property development. It must now be determined whether your activities instead constituted an isolated transaction.

Profits from an Isolated Transaction

Profits arising from an isolated transaction will be ordinary income if the purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of a taxpayer's business (FC of T v. Myer Emporium Ltd (1987) 163 CLR 199; FC of T v Whitfords Beach Pty Ltd (1982) 150 CLR 355).

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 assessable ordinary 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.

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 this situation, Property A and B was registered as two strata tittles on many years after its acquisition. After renting the property between for a considerable amount of time, and after an attempt to subdivide the property through a joint venture, your children, as Joint Plenary Administrators, have decided to sell Property A and B.

Although you are not currently in the business of property development, to decide if any profit made is ordinary income, we need to consider if the transactions are made in a commercial manner.

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

1. the nature of the entity undertaking the operation or transaction;
2. the nature and scale of other activities undertaken by the taxpayer;
3. the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;
4. the nature, scale and complexity of the operation or transaction;
5. the manner in which the operation or transaction was entered into or carried out;
6. the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;
7. if the transaction involves the acquisition and disposal of property, the nature of that property; and
8. the timing of the transaction and the various steps in the transaction.

In contrast, paragraph 36 of TR 92/3 notes that the courts have often said that a profit on the mere realisation of an investment is not ordinary 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.

Application to your circumstances

In this case, you acquired the property, then split it in two and have rented the properties until recently. Although you rented the property for a substantial period, you have stated that you purchased the property with an intention to subdivide and resell both properties for a profit. This eventually manifested in the decision to subdivide Property B into X vacant lots and to resell with the purpose of making a profit.

Sale of Property A

The following reasons for decision outline our response to Question 1(a).

Property A, unlike Property B, did not involve a scheme of subdivision to maximise the profit obtained from its sale. With reference to the factors listed in TR 92/3, the transaction simply involved the sale of the property as it was, without any steps undertaken that provided complexity to the transaction. The proceeds derived from the sale of Property A will therefore be assessable under s 6-10 of the ITAA 1997.

Sale of the Subdivided Blocks and the Remainder of Property B

The following reasons for decision outline our response to Question 1(b).

In the context of the above authorities relating to an isolated transaction, the following observations can be made in relation to the X subdivided blocks and the remainder of Property B:

• Your acquaintance proposed several options for the sale of the properties, and a coherent plan for the subdivision and sale of the land was made to maximise profit;
• Your original intention was to develop the land and resell for profit;
• You have previously been involved in property development, and have had failed attempts to subdivide this property;
• There is an intention to maximise profit from the development and subdivision of Property B to repay existing debt obligations.
• Since contacting your acquaintance, the transactions have been undertaken in a commercial, organised, professional and deliberate manner; and
• Submissions have been made to the relevant planning authority regarding subdivision of the Property B.

A balanced view of these observations, with no one feature being determinative in isolation, reasonably leads to a conclusion the intention for holding Property B includes a profit-making undertaking at the time of the subdivision and sale.

The decision to subdivide the properties demonstrates a 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. There has been a coherent plan and a profit-making purpose in the activities.

Although the parties may not be carrying on a business of property development, they are nevertheless involved in a profit-making undertaking. The activities in relation to the subdivision of Property B go beyond a mere realisation of a capital asset.

Based on the facts of this situation, the project is considered to be a profit-making commercial undertaking and the profits from the sale of the X vacant lots from Property B is considered to be ordinary assessable income under section 6-5 of the ITAA 1997.

Mere Realisation

The expression 'mere realisation' is used to distinguish a gain made on an asset compared to income or gains derived from a business operation or an isolated transaction carrying out a profit-making scheme. Classifying an asset as a 'mere realisation' depends on the facts and circumstances of each case.

The proceeds from the sale of a mere realisation of capital assets will be assessed under the capital gains tax provisions contained in Parts 3-1 and 3-3 of the ITAA 1997. These proceeds are not ordinary income, but are instead included as assessable statutory income under section 102-5 of the ITAA 1997.

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. 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, this all changed in 1982 when the landmark Full High Court case of FC of T v. Whitfords Beach Pty Ltd (1982) 150 CLR 355; 82 ATC 4031 (Whitfords Beach) was decided.

The decision in Whitfords Beach has narrowed the scope of the 'mere realisation' doctrine developed by Scottish Australian Mining. The case of Whitfords Beach highlights that while 'mere realisation' may still be possible where blocks are merely subdivided to several blocks with minimal activity, where the size and scale of the activity reaches such a level (such as constructing roads, the provision of parklands, services and other activities), this all amounts to a development and improvement of the land to such a marked degree that it is no longer possible to say it is a mere realisation of an asset. 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.

Application to your situation

The following reasons for decision outline our response to Questions 2(a) and 2(b).

Making an overall assessment on the factors set out in TR 92/3, it is the Commissioner's view that the subdivision activities of Property B and sale of the X vacant lots is more than a mere realisation of a capital asset.

Regarding the sale of Property A, it would be characterised as a mere realisation of an asset. In this case you would be considering the application of the capital gain tax (CGT) provisions.