Edited version of private advice

Authorisation Number: 1051974194470

Date of advice: 19 May 2022

Ruling

Subject: CGT - subdivision - am I in business

Question 1

Are you carrying on a business of developing property?

Answer

No.

Question 2

Are the proceeds from the sale of the townhouse assessable as ordinary income?

Answer

No.

Question 3

Are the proceeds from the sale of the townhouse assessable as a capital gain?

Answer

Yes.

Question 4

Are you entitled to disregard the entire capital gain made on the disposal of the townhouse under the main residence exemption?

Answer

No - only a partial main residence exemption will apply.

This private ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You and your ex-spouse purchased a property as your primary residence. The total area of the property is less than 2 hectares.

Your ex-spouse's interest in the property was forcefully taken over by an agency.

You acquired a 50% interest in the property from an agency.

The transfer of the property to you solely was not as a result of a settlement by the Family Court.

You resided at the property as your primary residence for a period of time.

You then moved out of the property and rented it out for more than 6 years.

The property remained rented until it was demolished.

The property was subdivided into X lots and X townhouses were constructed.

The project was completed in less than 4 years.

You lived in the property for more than 3 months.

More than 3 months after you moved back into unit X you appointed an agent to sell the property.

Unit X was sold in the 20XX financial year.

You intend to retain the other townhouses for investment purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 120-20

Income Tax Assessment Act 1997 section 104-20

Income Tax Assessment Act 1997 section 116-25

Income Tax Assessment Act 1997 section 112-30

Income Tax Assessment Act 1997 subsection 118-110(1)

Income Tax Assessment Act 1997 section 118-135

Income Tax Assessment Act 1997 section 118-145

Income Tax Assessment Act 1997 section 118-150

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Question 1

Section 995-1 of the ITAA 1997defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

The question of whether you are carrying on a business is a question of fact and degree. There are no rigid rules for determining whether the activity amounts to the carrying on of a business. The facts of each case must be examined. In Martin v FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551, Webb J said:

The test is both subjective and objective; it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and, as counsel for the taxpayer put it, the determination is eventually based on the large or general impression gained.

However, the courts have developed a series of indicators that can be applied to your circumstances to determine whether you are carrying on a business.

Taxation Ruling TR 97/11: 'Income tax: am I carrying on a business of primary production?' summarises these indicators. 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.

Your activity does not have a significant commercial purpose or character and we do not consider you had an intention to engage in a business given it was a once off activity. We consider that the size and scale of your activity is insignificant and there is not repetition or regularity. Having considered your circumstances and the factors outlined above we do not consider that your activity amounts to carrying on a business of property development.

Question 2

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) discusses the application of the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are ordinary income, and therefore assessable under section 6-5 of the ITAA 1997. Paragraph 16 of TR 92/3 provides:

16. If a taxpayer not carrying on a business makes a profit, that profit is income if:

(a) The intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain: and

(b) The transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

TR 92/3 outlines that the relevant intention or purpose of the taxpayer, of making a profit or gain, is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case. It is also not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

Whether a particular transaction has a business or commercial character depends on the circumstances of the case. Paragraph 13 of the ruling outlines the following factors which may be relevant when considering whether an isolated transaction amounts to a business operation or commercial transaction:

•         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 the property, and

•         the timing of the transaction or the various steps in the transaction.

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 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.

In this case the property was built with the purpose of being your main residence and the overall transaction was conducted on a small scale. Having considered your circumstances and the factors outlined above we do not consider that the proceeds from the sale of unit X are profits from an isolated transaction.

Question 3

As discussed in questions 1 and 2 we do not consider that the proceeds from the disposal of unit X is income from a business activity or assessable as profits from an isolated transaction. Therefore the disposal of unit X is considered the mere realisation of your asset.

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.

Under section 120-20of the Income Tax Assessment Act 1997 (ITAA 1997), an entity will make a capital gain or a capital loss if a CGT event happens to a CGT asset.

Upon disposal of unit X a CGT event will occur. If the capital proceeds are greater than the cost base of the asset you will make a capital gain.

Question 4

Demolition of a dwelling

ATO ID 2002/633 considers the CGT implications upon the demolition of a dwelling. CGT event C1 in section 104-20 of the ITAA 1997 happens if a CGT asset you own is lost or destroyed.

Taxation Determination TD 1999/79 confirms that CGT event C1 can happen on the voluntary destruction of an asset where for example, a taxpayer might demolish a building in the course of redeveloping a property.

Subsection 104-20(3) of the ITAA 1997 provides that you make a capital gain from CGT event C1 if the capital proceeds from the loss or destruction are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

Section 116-25 of the ITAA 1997 provides that the market value substitution rule does not apply to CGT event C1.

Subdivision

If you subdivide a block of land, each block that results is registered with a separate title. For CGT purposes, the original land parcel is divided into two or more separate assets. Subdividing land does not result in a CGT event if you retain ownership of the subdivided blocks. Therefore, you do not make a capital gain or a capital loss at the time of the subdivision

Main residence exemption

Under subsection 118-110(1) of the ITAA 1997 a capital gain or loss you make from a CGT event that happens in relation to a CGT asset that is a dwelling is disregarded if:

•         you are an individual; and

•         the dwelling was your main residence throughout your ownership period

Under section 118-135 of the ITAA 1997, if a dwelling becomes your main residence by the time it was first practicable for you to move into it after you acquired your ownership interest in it, the dwelling is treated as your main residence from when you acquired the interest until it actually became your main residence.

Partial exemption

Under section 118-185 you get only a partial exemption for a CGT event that happens in relation to a dwelling or your ownership interest in it if:

a)    you are an individual; and

b)    the dwelling was your main residence for part of your ownership period; and

c)    the interest did not pass to you as a beneficiary of a deceased estate

You calculate your capital gain (CG) or capital loss (CL) using the formula:

Absences

Under subsection 118-145 of the ITAA 1997, if a dwelling that was your main residence ceased to be your main residence, you may choose to continue to treat it as your main residence.

If you use part of the dwelling for the purpose of producing assessable income, the maximum period that you can treat it as your main residence under this section while you use it or that purpose is 6 years. You are entitled to another maximum period of 6 years each time the dwelling again becomes and ceased to be your main residence.

If you do not use the dwelling to produce assessable income you can treat it as your main residence under section 118-145 of the ITAA 1997 indefinitely.

Building, repairing or renovating

Section 118-150 of the ITAA 1997 allows a taxpayer to choose for the main residence exemption to apply to land while a new dwelling is being constructed. Where an original dwelling on the land is demolished or destroyed and a new dwelling is constructed, the exemption is for the shorter of four years before the new dwelling becomes their main residence or the period from when the original dwelling ceased to be occupied (subsections 118-150(4) and 118-150(5) of the ITAA 1997).

The taxpayer can only make this choice if the new dwelling becomes their main residence as soon as practicable after the building work is finished and it continues to be their main residence for at least three months (subsection 118-150(3) of the ITAA 1997).

Application to your circumstances

You resided in the property from the date of purchase for a period of time and then you rented it out. It was rented for a period of more than 6 years. As per subsection 118-145 of the ITAA 1997, the maximum period that you can treat the property as your main residence while it is being used to produce assessable income is 6 years. Therefore the property cannot be your main residence for the period it was rented in excess of 6 years.

The building was demolished and the property was subdivided into X lots. Subdividing does not result in a CGT event, therefore there was no capital gain or loss at that time. You engaged a builder to construct X townhouses.

You can make a choice to extend the main residence exemption in section 118-150 of the ITAA 1997 from the time it ceased to be occupied by tenants. This is because the construction of unit X was completed within 4 years of this time, you moved into the dwelling as soon as practicable after it was finished and it was your main residence for at least 3 months.

You can only make a choice under section 118-150 to extend the main residence exemption from the time it ceased to be occupied. During the entire period of ownership, unit X was not your main residence for a period of time. Therefore while you are not entitled to a full main residence exemption, a partial exemption can apply as per section 118-185 of the ITAA 1997.