Edited version of private advice

Authorisation Number: 1051984172048

Date of advice: 19 May 2022

Ruling

Subject: Trading stock - land

Question 1

Is x XX 20XX, being the date on which the Taxpayer entered into a land development agreement to undertake the development, the earliest time the Taxpayer started holding the Land as trading stock?

Answer

Yes.

Question 2

Does CGT Event K4 occur for the Taxpayer on x XX 20XX?

Answer

Yes.

This ruling applies for the following periods

x XX 20XX to y YY 20YY

The Scheme commences on

x XX 20XX

RELEVANT FACTS AND CIRCUMSTANCES

1.      The Taxpayer of XYZ was born on z ZZ 20ZZ.

2.      The Taxpayer is a farmer and has been farming for more than x years.

3.      This private ruling application is in relation to land owned by the Taxpayer which is situated at:

•           Area A; and

•           Area B.

4.      The Taxpayer does not propose to develop the entirety of all the land described above in paragraph 3. In particular, the Taxpayer proposes to develop:

•           Approximately x of the total y hectares situated at Area A; and

•           Approximately y of the total z hectares situated at Area B.

5.      As such, it is only those parts of the land which the Taxpayer proposes to develop (as described in Paragraph 4) that form part of the land subject to this private ruling.

6.      In addition to the two titles of land described above, the Taxpayer owns a third adjoining parcel of land on separate title (Area C). For completeness, it is noted that the Taxpayer does not propose to develop that parcel of land and it therefore does not form part of the land subject to this private ruling application.

7.      This land is referred to in this private ruling application collectively as the 'Land'.

8.      The XYZ Plan applies to parts of the Land from XX 20XX. The XYZ Plan is a long-term plan for urban development. It describes how the land is expected to be developed and how and where services are planned to support development.

History of the Land

9.      The Taxpayer purchased Area B in 19XX for his family to reside in and to undertake farming activities. The location of the land allowed the Taxpayer to reside close to his farming activities and build infrastructure to store farming equipment used in undertaking farming activities.

10.   The Taxpayer purchased Area A in 19YY. The land was vacant land and was purchased to undertake farming activities.

11.   The Taxpayer and his wife continue to live in the family home on the Land and the remainder of the land is farmed personally by the Taxpayer.

12.   No major capital improvements have been made to the Land since its acquisition (being prior to 20 September 1985 and therefore pre-CGT).

13.   The rezoning of the part of the Land resulted from a joint application arranged by a developer on behalf of the Taxpayer's neighbour.

•           Sometime between 20ZZ and 20TT, the Taxpayer was approached by a developer acting on behalf of a neighbour looking to rezone their land. The neighbour was seeking the Taxpayer's approval to include the Land in the XYZ Plan.

•           The Taxpayer understood from the developer that the council required the three adjoining landowners to submit a single rezoning application (forming the XYZ Plan).

•           The proposal from the neighbour involved the developer attending to all things necessary to lodge the request and obtain approval for the three neighbours' land to be rezoned. The Taxpayer was not required to be nor was he actively involved in the rezoning application.

•           At the time, the Taxpayer had no intention of pursuing or need for a rezoning of the land. The Taxpayer had plans to continue his farming activities. However, the Taxpayer did not want to stand in the way of the neighbour's rezoning plans and agreed for his land to be included in the rezoning application.

•           The neighbour and the Taxpayer agreed that the neighbour would cover the costs (based on an estimate) and that the Taxpayer would reimburse the neighbour for the costs after the rezoning had been approved. If the rezoning was not approved, the Taxpayer would not be required to make any payment to the neighbour.

14.   Before the land was officially rezoned under the XYZ Plan in XX 20XX, the Taxpayer was approached by a number of real estate agents seeking the Taxpayer's interest in selling the property.

•           Due to the heavy restrictions placed on the property from an access perspective (the property was land locked), other sales in the area could not be used as a comparable price. This limited the number of prospective buyers for the Land to the landowners of the two adjoining properties.

15.   The Taxpayer was also approached by the developers representing the neighbouring property landowners. Initial discussions were had and both developers provided a proposal to the Taxpayer.

•           Discussions with the first developer in 20YY were high level. The developer took the Taxpayer through his options, including an outright sale and various land development options the developer could assist with. This included development arrangements, joint ventures or project management arrangements.

•           Discussions with the second developer in 20ZZ were largely focused on a development arrangement rather than an outright property sale.

16.   These discussions did not continue beyond the proposal stage. The Taxpayer was not interested in developing the land or in having restrictions imposed on him if he was to decide to sell the land at some point in the future to a third-party (his preferred option).

17.   The Taxpayer continued to explore options for an outright sale of the Land throughout 20ZZ and 20YY.

18.   Around YY 20YY, road placement within the development on the adjoining property provided access to Area B, making the land no longer land locked. Whilst the access path was not ideal, the property could be accessed. This provided a better opportunity for an outright sale to a third party and so the Taxpayer continued to look for potential buyers.

•           On x XX 20XX, the Taxpayer submitted planning permits to council for a multiple lot development. The Taxpayer did so in the hope that planning approval would make the land more attractive to a third party buyer.

•           Despite the Taxpayer's efforts, there was a lack of interest in the Land for an outright sale (with or without the plans).

19.   After lack of interest in the property for an outright sale, the Taxpayer started to explore his least preferred option of developing the land himself. In the absence of a buyer for the Land, the taxpayer saw this option as the only real option to maximise the value of the Land although he has no prior development experience.

20.   On x XX 20XX, the Taxpayer made the decision to undertake the development rather than continue to pursue a third-party land sale.

•           The Taxpayer entered into a development agreement ('Development Agreement') with Company A to undertake the development from x XX 20XX.

Development of the Land

21.   On x XX 20XX, the Taxpayer entered into a Development Agreement with Company A for the development and realisation of the Land.

22.   Taxpayer B and the Taxpayer are the directors of Company A.

23.   Taxpayer B is responsible for the majority of the day to day running of Company A.

24.   Details of the Development Agreement are as follows:

•           Developer to assist with the development of Area B and Area A by implementing the project pursuant to and in accordance with the project budget and terms of the agreement.

•           Development and realisation of the Property including obtaining authorisations for the development, subdividing the property and creating lots, residential construction of some lots, marketing and selling of some or all of the lots and carrying out infrastructure works necessary to create and service the lots.

•           Development entity will borrow external bank finance to undertake development and is liable for all project costs and will market and sell lots.

•           The Taxpayer will provide land as security against the borrowings.

•           Gross proceeds from sales or leases will remain the property of the Taxpayer. The Taxpayer will make all required payments from the gross proceeds and agrees to pay the Developer a Development Fee equal to the project costs plus a margin of 10%.

•           A third-party project manager has been engaged by developer to project manage the development.

25.   Company A entered into a project management agreement ('Project Management Agreement') with a third party to manage the development from x XX 20XX.

26.   The Taxpayer proposes to elect to value the trading stock at market value pursuant to paragraph 70-30(1)(a) of the ITAA 1997.

Information provided

27.   You have provided a number of documents containing detailed information in relation to the Taxpayer's application for a private binding ruling, including:

•           Private Binding Ruling ('PBR') Application, dated y YY 20XX

•           Documents with background facts

•           Development Agreement

•           Project Management Agreement

28.   We have referred to the relevant information within these documents in applying the relevant tests to your circumstances.

Assumption(s)

Not applicable.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 70-10

Income Tax Assessment Act 1997 Subsection 70-30(1)

Income Tax Assessment Act 1997 Section 104-220

Income Tax Assessment Act 1997 Section 995-1

Further issues for you to consider

Not applicable

REASONS FOR DECISION

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

QUESTION 1:

SUMMARY

x XX 20XX, the date on which the Taxpayer entered into a land development agreement to undertake the development of the Land, is the earliest time he started holding the property as trading stock.

DETAILED REASONING

29.   Section 70-10 of the ITAA 1997 provides that 'trading stock' includes anything produced, manufactured or acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course of a business.

30.   Taxation Determination 92/124 "Income tax: property development: in what circumstances is land treated as 'trading stock'?" ('TD 92/124') discusses in what circumstances land will be treated as 'trading stock' in relation to property development. 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 the 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.

31.   Land will only be trading stock where it is held for the purpose of resale and the taxpayer has embarked on a definite and continuous cycle of operations designed to lead to the sale of the land. Essentially, the land does not become trading stock until the land in question is committed to a business.

32.   Looking at those criteria, three questions need to be answered for the Taxpayer's circumstances:

•           Does the Taxpayer carry on a business which involves dealing with land?

•           When did that business commence?

•           When did the taxpayer first start holding the Land for sale in the ordinary course of that business such that the Land can be characterised as trading stock of the business?

Business - Subdivision and sale of the Land

33.   TR 97/11 provides guidance on whether a taxpayer is carrying on a business of primary production. The principles there are equally relevant in determining whether the Taxpayer is involved in a business activity of land development.

34.   Paragraph 26 of TR 97/11 states that it is clear that the relevant indicators of whether a business of primary production is being carried on by a taxpayer are:

•           does the activity have a significant commercial purpose or character?

•           does the taxpayer have more than a mere intention to engage in business?

•           is there an intention to make a profit or a genuine belief that a profit will be made? Will the activity be profitable?

•           is there repetition and regularity in the activity? ie. how often is the activity engaged in? How much time does the taxpayer spend on the activity?

•           is the activity of the same kind and carried on in a similar way to that of the ordinary trade?

•           is the activity organised in a businesslike manner?

•           what is the size or scale of the activity?

•           is the activity better described as a hobby, a form of recreation or a sporting activity?

35.   The above indicators must be considered in combination and as a whole, no one indicator is decisive. Considering the Taxpayer's circumstances, it is accepted that the Taxpayer operates a business of subdivision and sale of the Land.

Business - Commencement

36.   On x XX 20XX, the Taxpayer entered into a Development Agreement with Company A for the development and realisation of the Land.

37.   At this date, the Taxpayer abandoned his intention to sell the Land outright to a third-party and commenced carrying on the business of development.

38.   At all times prior to this date, the Taxpayer's preferred option was to sell the Land outright to a third-party.

39.   Despite being approached by a number of developers prior to x XX 20XX, no discussions continued beyond the proposal stage. The Taxpayer was not interested in developing the land or in having restrictions imposed on him if he was to decide to sell the land at some point in the future to a third-party (the Taxpayer's preferred option).

40.   The Taxpayer continued to explore options for an outright sale of the land throughout 20ZZ and 20XX.

41.   It was not until XX 20XX when the land ceased to be land-locked that there was a better opportunity for an outright sale to a third-party.

42.   On x XX 20XX, the taxpayer submitted an application for a planning permit for subdivision to Council. The Taxpayer did so in the hope that the planning approval would make the land more attractive to a third-party buyer.

43.   In spite of this, and despite the Taxpayer's best efforts, there was a lack of interest in the Land for an outright sale.

44.   On x XX 20XX, when the Taxpayer entered into the Development Agreement, he abandoned his intention to sell the Land outright to a third-party and commenced carrying on the business of land development.

When did the Applicant first start holding the Land for sale?

45.   The Taxpayer first start holding the Land for sale in the ordinary course of the land development business on x XX 20XX, such that the land can be characterised as trading stock of the identified land development business.

QUESTION 2:

SUMMARY

CGT Event K4 does occur for the Taxpayer on x XX 20XX.

DETAILED REASONING

46.   Subsection 104-220(1) of the ITAA 1997 provides that CGT event K4 happens if:

(a) you start holding as trading stock a CGT asset you already own but do not hold as trading stock; and

(b) you elect under paragraph 70-30(1)(a) to be treated as having sold the asset for its market value.

47.   Section 70-10 of the ITAA 1997 provides that 'trading stock' includes anything produced, manufactured or acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course of a business.

48.   Paragraph 70-30(1) states that if you start holding as trading stock an item you already own, but do not hold as trading stock, you are treated as if:

(a)    just before it became trading stock, you had sold the item to someone else (at arm's length) for whichever of these amounts you elect:

•      its cost (as worked out under subsection (3) or (4));

•      its market value just before it became trading stock; and

(b)    you had immediately bought it back for the same amount.

49.   Section 108-5 of the ITAA 1997 defines a CGT asset as:

(a)    Any kind of property; or

(b)    A legal or equitable right that is not property.

50.   Subdivision 995-1 of the ITAA 1997 defines 'market value', but not in a way that fixes its meaning in all contexts. As a result, 'market value' usually takes the ordinary meanings given below, unless specially defined or qualified in a particular provision:

•           Ordinary meaning

•           Judicial interpretation

•           Statutory adjustments to market value

•           Highest and best value

•           Other standards of value

•           Arms' length value for transfer pricing purposes

•           Fair value

51.   It is accepted that the Land started to be held as trading stock from the date at which the business commenced, which is x XX 20XX.

52.   The taxpayer proposes to elect to value the trading stock at market value pursuant to paragraph 70-30(1)(a) of the ITAA 1997.

53.   As such, it follows that CGT event K4 occurs on x XX 20XX.

54.   The Taxpayer will be required to recognise a capital gain in respect of the disposal of his interest in the Land for the year ended y YY 20XX.

CONCLUSION

x XX 20XX, the date on which the Taxpayer entered into a development agreement to undertake the development of the Land, is the earliest time he started holding the Land as trading stock.

CGT Event K4 does occur for the Taxpayer on x XX 20XX.