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Edited version of private advice
Authorisation Number: 1051981773589
Date of advice: 16 May 2022
Ruling
Subject: Deceased estate - subdivision - capital gains tax
Question 1
Will the proceeds received from the sale of subdivided land lots be assessable as ordinary income under Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Answer
No.
Question 2
Will the proceeds received from the sale of subdivided land lots be subject to capital gains tax under Parts 3-1 to 3-3 of the ITAA 1997?
Answer
Yes.
This ruling applies for the following periods:
Year ending 30 June 2022
Year ending 30 June 2023
Year ending 30 June 2024
Year ending 30 June 2025
Year ending 30 June 2026
The scheme commences on:
1 July 2021
Relevant facts and circumstances
Person 1, Person 2, and Person 3 are siblings who (directly and indirectly) own two parcels of land.
The first parcel of the two parcels of land is more than six times the size of the second parcel of land.
The siblings inherited their respective one-third indirect ownership interests in the first parcel upon the death of one of your parents and in accordance with their will, their respective interests are held by three trusts.
Each trust has owned its respective interest in the land for more than ten (years.
Person 1, Person 2 and Person 3 are listed as the trustee and beneficiary of their respective trust:
• Trust A.
• Trust B; and
• Trust C.
The second parcel was the main residence of your deceased parent's and upon their death was left to their spouse until their death the following year. Person 1, Person 2 and Person 3 inherited a one-third interest each in this parcel as tenants in common in accordance with their will.
A further third parcel of land is and has been owned by Person 1 for nearly 25 years and has been used as their main residence for more than 20 years.
The second and third parcels have been used as part of the primary production business operated by your family since the properties were acquired over 80 years ago.
Prior to the death of your first parent, the primary production business was run in partnership by this parent and Person 1 then after their death the business continued to be operated in partnership by Person 1, Person 2 and Person 3.
Approximately five years ago, you and your siblings decided to subdivide more than half of the first parcel and submitted a planning permit to council.
The main motivators for this decision were:
• Size of land holding being in excess to their business needs.
• The property is bordered by subdivision on all sides.
• Pressure received from the council to subdivide.
• Plans to provide for your retirement; and
• Plans to leave a legacy for your children.
Following a lengthy planning approval process, permits have now been issued, but for a larger than originally anticipated subdivision project. This is due to council stipulating that not only all of the land be subdivided, but also that the second and third parcels be subdivided in conjunction with the land.
The subdivision will occur in three stages, with the first two stages limited to the part of the land that you originally wished to subdivide, and the third stage covering the remainder of the first parcel, second parcel and Person 1's property.
The first stage includes two lots on the opposite side of the second and third parcels.
The second stage includes more than five lots and requires the existing road infrastructure to be extended.
The third stage of the subdivision involves the second and third parcel and the adjoining remainder of the first parcel to be subdivided into six lots effectively dividing each of the three then remaining parcels into two lots.
The sale proceeds for the lots from the first and second stages are expected to be more than $1 million each.
To date, costs you each have incurred for progressing the subdivision amount to more than $100,000.
You and your siblings plan to sell the two lots from the first stage this financial year with the resulting sale proceeds of more than $2 million to assist with funding the second stage, which involves extension of the existing road infrastructure, connecting utilities and obtaining additional studies as required.
Next, you and your siblings plan to sell the lots from the second stage.
Whilst you will complete the third stage of the subdivision in line with council stipulation, none of you intend to sell any of the subdivided lots resulting from the third stage. Rather, you and your siblings intend to continue to hold on to those lots and continue with the current use on those lots:
• Person 1 will continue to live on their property as their main residence; and
• You and your siblings will continue to use your respective lots to run the family business through your related partnership.
You will appoint a team of civil engineers who will be responsible for the overall operation and day-to-day decision making in respect of the subdivision and liaise with contractors as required.
Your involvement in the subdivision will be limited to high-level decision making only and a real estate agent will be appointed to market and sell the subdivided lots.
All works on the land will not go beyond minimum mandated council stipulations and the development is anticipated to take several years to complete.
No other subdivision activities have been undertaken by you and/or your siblings in the past. Both Person 1 and Person 2 work full-time for the family business, whilst Person 3 works part-time for the family business and part-time in a separate industry.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 6-5
Income Tax Assessment Act 1997 Section 6-10
Income Tax Assessment Act 1997 Part 3-1
Income Tax Assessment Act 1997 Section 102-5
Income Tax Assessment Act 1997 Section 104-10
Income Tax Assessment Act 1997 Section 108-70
Income Tax Assessment Act 1997 Section 112-25
Reasons for decision
Question 1
Summary
The proceeds received from the subdivision and sale of your respective interests in the land are not assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as you will not derive the proceeds in the course of conducting a business as understood for tax purposes, or from engaging in an isolated profit-making scheme with a commercial purpose.
Rather, the proceeds received are attributable to the mere realisation of the respective interests in a capital asset.
Detailed reasoning
Generally, an amount received in relation to subdividing land would be assessable either as:
• ordinary income under section 6-5 of the ITAA 1997 as business income,
• ordinary income under section 6-5 of the ITAA 1997 as an isolated commercial transaction with a view to a profit, or
• statutory income under the capital gains tax (CGT) provisions contained in Part 3-1 of the ITAA 1997 as a mere realisation of a capital asset.
Ordinary income
Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.
Carrying on a business of property development
Section 995-1 of the ITAA 1997 states the term business includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.
Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? outlines some factors that indicate whether or not a business of primary production is being carried on. These factors equally apply to other types of businesses. The question of whether a business is being carried on is a question of fact and degree. In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators should be considered in conjunction with the other factors.
In the Commissioner's view, the factors that are considered important in determining the question of business activity are:
• whether the activity has a significant commercial purpose or character
• whether the taxpayer has more than just an intention to engage in business
• whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity
• whether there is regularity and repetition of the activity
• whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business
• whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit
• the size, scale and permanency of the activity, and
• whether the activity is better described as a hobby, a form of recreation or sporting activity.
Based on the information provided and the above factors, we do not consider that any proceeds from your activities and sale of the land is derived in the course of carrying on a business.
Profits from an isolated transaction
In FC of T v The Myer Emporium (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693 (Myer Emporium), the Full High Court expressed the view that profits made by a taxpayer who enters into an isolated transaction with a profit making purpose can be assessable income.
Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income considers the assessability of profits on isolated transactions in light of the principles outlined in Myer Emporium. According to Paragraph 1 of TR 92/3, the term isolated transactions refers to:
a) those transactions outside the ordinary course of business of a taxpayer carrying on a business, and
b) those transactions entered into by non-business taxpayers.
TR 92/3 provides guidance in determining whether profits from isolated transactions are income and therefore assessable.
A profit from an isolated transaction will generally be income when:
a) the intention or purpose of a taxpayer in entering into the transaction was to make a profit or gain, and
b) the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying on a business operation or commercial transaction.
TR 92/3 lists the following factors which are relevant in determining whether an isolated transaction amounts to a business operation or commercial transaction:
a) the nature of the entity undertaking the operation or transaction.
b) the nature and scale of other activities undertaken by the taxpayer.
c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained.
d) the nature, scale and complexity of the operation or transaction.
e) the manner in which the operation or transaction was entered into or carried out.
f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction.
g) if the transaction involves the acquisition and disposal of property, the nature of that property; and
h) the timing of the transaction and the various steps in the transaction.
In contrast, paragraph 36 of 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.
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.
Mere realisation
Paragraph 36 of TR 92/3 states 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. The expression 'mere realisation' is used to contradistinguish a business operation or a commercial transaction carrying out a profit-making scheme'.
Therefore, if the sale of the land is not considered to be an isolated commercial transaction, it will be treated as the mere realisation of a capital asset, with the proceeds or profit of the sale on capital account and assessed under the CGT rules.
A capital gain or a capital loss may arise if a CGT event happens to a CGT asset you own. Land, or an interest in land, is a CGT asset.
CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1) of the ITAA 1997).
Application to your circumstances
You are not engaging in a business activity in relation to the subdivision and sale of your respective interests in the land based on the factors outlined in TR 97/11 that 'indicate whether or not a business of primary production is being carried on.'
• Your involvement in the actual land development and sale activities will be entirely passive.
• This is the first time you are selling subdivided lots of land or interests nor have you been involved in any prior land subdivision.
• In terms of your involvement with the land development and sale, whether alone or in partnership, there is no 'regularity' or 'repetition of activities' associated with someone in business. Your involvement in the process will be limited to dealing with the civil engineers who will be appointed to deal with the day-to-day requirements related to the subdivision.
• You have never sought to make a profit from the land subdivision and sale in a commercial sense. Rather, you are merely realising an interest in a long-term capital asset you each inherited and used in your long-term family business operation.
• You collectively wish to continue your long-standing family business operation on the remaining portion of the land, which you are subdividing only due to council requirements.
• The lots that you intend to sell are surplus to the needs of the family business operation.
• The size and scale of the land subdivision activity is only what is required to effect the sale of the land in accordance with council stipulations, and will not be unusually complex or involved.
Based on the application of factors listed in TR 92/3, you are not engaged in an isolated profit-making scheme in relation to the development and sale of the land:
You did not originally acquire your interests in the land with an intention to make a profit on resale as you each inherited your respective interests in the land following the death of your parent more than 10 years ago. You as beneficiaries of each of the trusts formed a partnership and continued with the family business operation for more than 10 years and intend to continue this on the remaining property with no interruptions. There is nothing to suggest a change in purpose or object with which the land is being held.
You all grew up on the land with one of your parents running the business therefore the holding of the land has been a long-term capital asset to your family.
You collectively will retain those parts of the land actively used in your family business operation.
Your intention was only to subdivide part of the land but were forced to consent to subdividing all of the land to secure council approval.
The subdivision is for low density rural residential lots which means the level of activity required will be minimal.
Your motivators for the subdivision are:
• The size of land holding being in excess to the farming needs.
• The property being bordered by subdivision on all sides.
• Pressure received from the council to subdivide.
• Your plans to provide for your retirement.
• Wishing to leave a legacy for your children.
You will only be passively involved in the subdivision and sale of the subdivided lots.
The profit represents a mere realisation of a capital asset which will be assessable under the CGT provisions in Part 3-1 and 3-3 of the ITAA 1997.
Question 2
Summary
Any profit made from the sale of your ownership interests will not be ordinary income and not assessable under section 6-5 of the ITAA 1997. The proceeds represent a mere realisation of a capital asset which will be assessable under the capital gains tax provisions in Parts 3-1 and 3-3.
You each inherited your respective ownership interests after 20 September 1985, therefore the interests in land are post-capital gains tax assets. Any capital gain or capital loss made on the sale of your ownership interest will be calculated using the general CGT provisions.
Detailed reasoning
When a CGT asset (the original asset) is split into 2 or more assets (the new assets), such as when land is subdivided, the subdivision of the land into subdivided blocks is not a CGT event, in accordance with subsection 112-25(2) of the ITAA 1997.
Subsection 104-10(4) of the ITAA 1997 provides that a capital gain will arise if the capital proceeds from the disposal are more than the asset's cost base and a capital loss will arise if the capital proceeds are less than the asset's reduced cost base.
The land is considered to be a CGT asset under section 108-5 (1) of the ITAA 1997 which states that a CGT asset includes any kind of property, or legal or equitable right that is not property.
Application to your circumstances
As outlined above, it is not viewed that any profit made on the disposal of the lots will be assessable as a result of carrying on a business or from a profit-making undertaking. Therefore, any profit made on the disposal of the lots will be assessable under Parts 3-1 and 3-3 of the ITAA 1997 as a mere realisation of your assets.