Edited version of private advice

Authorisation Number: 1052010363663

Date of advice: 8 August 2022

Ruling

Subject: CGT - subdivision

Question 1

Is any part of the proceeds received from the sale of property B assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997(ITAA 1997), as a result of an 'isolated transaction' carried out for profit and commercial in character?

Answer

No.

Question 2

Did a capital gains tax (CGT) event happen when you sold property B to a family member and their spouse?

Answer

Yes.

Question 3

Is any capital gain or capital loss you make from the sale of property B disregarded?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

In 19XX you and your spouse purchased a post CGT property (house and land) and established it as your main residence.

You and your spouse along with other related parties came to a family agreement that you would redevelop the property and demolish the original residence, subdivide the land into two smaller blocks and build new dwellings for each family to reside in.

In 20XX, you and your spouse lodged a development application, with development consent being granted.

The existing dwelling was demolished in 20XX.

You and your spouse did not receive any proceeds from the demolition of the existing dwelling.

You and your spouse funded the constructed of a number of dwellings on the land.

The development of the property by you and your spouse was not undertaken as a business venture and you are not registered for GST.

An occupation certificate was issued for the dual occupancy development and you made a further development application for the XXX Title Subdivision of the original parcel of land into two smaller blocks.

The original parcel of land was surveyed by a licenced land surveyor to prepare a plan of subdivision. The plan was registered and new titles issued.

You and your spouse reside in one dwelling (property A) and have disposed of the other dwelling (property B) to the family member and their spouse.

The contract for sale was not at arm's length and under market value.

A valuation was conducted by a licenced valuer to determine fair market value for stamp duty purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-20

Income Tax Assessment Act 1997 subsection 104-20(1)

Income Tax Assessment Act 1997 subsection 104-20(3)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 112-25

Income Tax Assessment Act 1997 subsection 112-30(2)

Income Tax Assessment Act 1997 subsection 112-30(3)

Income Tax Assessment Act 1997 Subdivision 115-A

Income Tax Assessment Act 1997 section 116-25

Income Tax Assessment Act 1997 section 116-30

Income Tax Assessment Act 1997 subsection 116-30(2)

Income Tax Assessment Act 1997 Subdivision 118-B

Income Tax Assessment Act 1997 section 118-150

Reasons for decision

Ordinary income

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1197) 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.

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of ITAA 1997 as ordinary income.

TR 92/3 defines the term 'isolated transactions' as:

•         transactions outside the ordinary course of business of a taxpayer carrying on a business, and

•         transactions entered into by non-business taxpayers.

A profit from an isolated transaction is generally income when both of the following elements are present:

•         the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; and

•         the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

In your case, you and your spouse do not carry on a business of buying, selling, or developing land. You both lived in the house as your main residence until just before it was intentionally demolished. The subdivision and construction of the new dwellings has been done without any commercial intention as you have retained one of the properties as your main residence and the other has been sold to a family member and their spouse and established as their main residence.

Accordingly, the proceeds from the sale of property B will not be included in your ordinary income under section 6-5 of the ITAA 1997. Rather, the sale is considered a capital transaction subject to the capital gains tax (CGT) provisions in Part 3-1 of the ITAA 1997.

Statutory income

Amounts that are not ordinary income but are included in your assessable income by another provision are called statutory income (section 6-10 of the ITAA 1997).

For most CGT events, your capital gain or capital loss is the difference between your capital proceeds and cost base of your CGT asset.

The provisions dealing with statutory income are listed in section 10-5 of the ITAA 1997. Included in this list is section 102-5 (capital gains).

Capital gains tax provisions

Section 102-5 of the ITAA 1997 provides that your assessable income includes a net capital gain (if any) for the income year. A capital gain or capital loss is made only if a CGT event happens (section 102-20).

Section 108-5 of the ITAA 1997 provides that a CGT asset is any kind of property; or legal or equitable right that is not property. Land and buildings are considered CGT assets.

Sale of property B

A CGT event A1 happens if you dispose of a CGT asset. You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act of event or by operation of law. The time of the event is when you enter into the contract for the disposal or if there is no contract, when the change of ownership occurs (section 104-10 of the ITAA 1997).

Therefore, a CGT event A1 occurred when you entered into the 'Contract for sale' with your family member and their spouse.

Main residence exemption

Under the main residence exemption provisions contained in Subdivision 118-B of the ITAA 1997, any capital gain or loss that a taxpayer makes on the disposal of a dwelling that is their main residence is disregarded. The exemption also extends to certain land that is adjacent to the dwelling.

Ordinarily where a dwelling is demolished or destroyed and a new dwelling is constructed the main residence usage of the first dwelling would not count towards an exemption for the new dwelling and land unless the new dwelling actually became the taxpayer's main residence and they exercised a choice under section 118-150 of the ITAA 1997.

In your case, no exemption is available as you did not establish property B as your main residence.

Capital proceeds - market value substitution rule

Special rules apply if a sale is between family members or a related party and is not at market value. Such a transaction is considered to be a non-arm's length transaction and requires modification to the capital proceeds used to calculate your capital gain or capital loss (section 116-30 of the ITAA 1997).

The market substitution rule takes effect if you did not deal at arm's length with another entity in connection with the event (subsection 116-30(2) of the ITAA 1997). The market value substitution rule, broadly, is when the capital proceeds receive are replaced with the market value of the asset. The market value is determined at the same time as the sale of the property.

In your case, the sale of the property to a family member and their spouse is considered to be a non-arm's length transaction and the market value substitution rule applies to your circumstances. You will be taken to have received market value for the disposal.

Adjustments to the cost base and reduced cost base

Demolition of the original dwelling

CGT event C1 happens if a CGT asset you own is lost or destroyed (section 104-20 of the ITAA 1997).

Paragraph 4 of Taxation Determination TD 1999/79 Income tax: capital gains: does the expression 'lost or destroyed' for the purposes of CGT event C1 in subsection 104-20(1) of the Income Tax Assessment Act 1997 apply to: (a) a voluntary 'loss' or 'destruction'? (b) intangible assets?, 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.

The effect of the cost base rules in subsections 112-30(2) and (3) of the ITAA 1997 and the capital proceeds rule in section 116-25 of the ITAA 1997 is that no capital gain or capital loss arises when CGT event C1 happens on the demolition of a dwelling if no capital proceeds are received for it. This is explained in ATO Interpretive Decision ATO ID 2002/663 Income Tax Capital gains tax: demolition of a dwelling: CGT event C1.

In your case, no capital proceeds were received for the demolition of the original dwelling, so there will be no capital gain or loss at the time of the CGT event C1 and the entire cost base (cost of house and land) is allocated to the land.

Subdivision of land

When you subdivide a block of land, each smaller block that results, is registered with a separate title. For CGT purposes, the original land parcel is split into two or more new assets, the resulting subdivided blocks are treated as though they were always separate assets. No CGT event occurs at this time, as there is no change in ownership.

Therefore, you do not make a capital gain or loss at the time of the subdivision and for CGT purposes, the date you acquired the subdivided blocks is the same as the date you acquired the original land and house

The cost base and reduced cost base of the original asset needs be apportioned between the two smaller blocks on a reasonable basis as outlined in Taxation Determination TD 97/3 Income tax: capital gains: if a parcel of land acquired after 19 September 1985 is subdivided into lots ('blocks'), do Part 3-1 and 3-3 of the Income Tax Assessment Act 1997 treat a disposal of a block of the subdivided land as the disposal of part of an asset (the original land parcel) or the disposal of an asset in its own right (the subdivided block)?

However, any costs solely related to one block should be attributed to that block, for example, the construction costs of the new dwelling and connecting services.

Discount capital gains

Subdivision 115-A of the ITAA 1997 provides the conditions for a discount capital gain.

You make a discount capital gain if the following requirements are satisfied:

•         you are an individual

•         a CGT event happens to a CGT asset of yours after 11:45am (by legal time in the Australian Capital Territory) on 21 September 19XX

•         you acquired the CGT asset at least 12 months before the CGT event, and

•         you do not choose to use the indexation method.

For Australian resident individuals the discount percentage is 50%. However, you can only reduce your capital gain after applying all your capital losses for the year and any unapplied net capital losses from earlier years.

In your case, you meet all of the above conditions and therefore are entitled to reduce a capital gain, if made by 50% using the discount method under Division 115.