Edited version of private advice

Authorisation Number: 1052050609871

Date of advice: 7 February 2023

Ruling

Subject: Income tax - CGT

Question 1

When originally acquired by Company A, is it correct for the Site to be classified as a capital gains tax (CGT) asset under section 108-5 of the Income Tax Assessment Act 1997, and not as a revenue asset (per section 977-50) or trading stock (per section 70-10)?

Answer

Yes

Question 2

As at the Present Date, and at all times between when the Site was originally acquired by Company A and the Present Date, is it correct for the Site to be classified as a CGT asset, and not as a revenue asset or trading stock?

Answer

Yes

This ruling applies for the following period:

Income Tax Year ended DD MMM 20XX

The scheme commenced on:

The date Company A acquired the Site

Relevant facts and circumstances

General

Company A is an Australian incorporated company listed on the Australian Stock Exchange (ASX). Company A is the head company of the Company A income tax consolidated group.

The Company A group is active in Australia and New Zealand. The principal activities of Company A are manufacturing and sale of manufactured products.

Property Division:

Company A owns numerous freehold sites and leasehold sites. Generally, the approach of Company A is to:

•         own manufacturing sites, given the significant capital investment and long-term tenure required at these locations, and

•         lease properties for retail, warehousing and distribution purposes.

Company A's various business units are responsible for the daily management and operation of the leasehold and freehold sites. Given the large number of sites which Company A owns and leases there is a dedicated Property Division of X people (out of several thousand employees of Company A).

The Property Division assists in overseeing the property portfolio and provide advice and expertise in relation to the challenges and opportunities the business faces on property related matters.

The various roles of the property division are summarised as:

•         Business support for current sites

•         Strategic site planning

•         Advice regarding impact on business operations

•         Government interactions

•         Asset divestment

Performance of Property Division

An annual financial target based on forecast property earnings before interest and tax (EBIT) is determined for the Property Division.

Levels of Authorisation

The functions of Company A's Board include:

•         considering management recommendations on proposed acquisitions, divestments and significant capital expenditure

•         considering the environmental impact of Company A's activities and monitoring compliance with Company A's sustainability policies and practices, and

•         monitoring internal governance including delegated authorities.

Asset disposals above a certain level must be authorised by the Company A Board.

The Company A Board and the authorised employee always needs to be satisfied that a proposal to sell a site, is in line with the strategy of Company A's Manufacturing Division and allows for its future growth. Priority is given to the Manufacturing Division before management provides the Property Division with approval to sell a site.

The 'Site'

Company A has owned the Site since 19XX. The land has been used continuously for Company A's main business purpose in the manufacturing sector since acquisition.

Purchase of Adjacent Lots

Since 20XX, Company A has acquired various parcels of land adjacent to the Site (Adjacent Lots).

Zoning of the Site

The Site and adjoining land (including the Adjacent Lots) are currently zoned rural.

In 20XX, the State Government issued a draft master plan showing the Site and the Adjacent Lots rezoned from rural to predominantly low-density residential. A final plan has not yet been released.

Company A has pursued the rezoning of the Site in consultation with the State Government. However, rezoning has not yet transpired.

Remediation works at the Site

Company A has undertaken remediation works on parts of the Site which are no longer used for business operations. The remediation works were completed in 20XX and required substantial geotechnical rework.

No other substantial capital works have been undertaken on the Site to date.

Board intentions/ actions taken

Company A makes the following statements regarding its plans for the Site:

•         There are no immediate plans to stop manufacturing operation at the Site.

•         Due to the nature of the adjacent urbanisation, it will be unviable to continue operating at the Site in the long term.

•         The closure of the Site is conditional on the relocation of the manufacturing capacity to a new site.

In 20XX, Company A agreed with the State Government to fund a portion of the planning costs in relation to the development of a new Precinct on which the Site is located.

In 20XX, Company A executed a second planning agreement to fund infrastructure works for the Precinct. While the State Government has agreed to the terms, the agreement is not expected to be executed until the rezoning of the Precinct has been formalised. No costs have been incurred in relation to the infrastructure works and there are no plans to incur these costs until the agreement is executed.

While the Board has asked Management to investigate a range of options for the Site and Adjacent Lots, no decision has been made by the Board on how to divest the Site. Any future plans will be dependent on the timing of zoning approvals and whether Company A can obtain approval to relocate the manufacturing at the Site to an alternative site.

The option to develop the Site under a joint venture structure has not advanced past the concept plan and Company A has not approached any third-party developers to date.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 40-30

Income Tax Assessment Act 1997 section 70-10

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 118-20

Reasons for decision

Unless specified otherwise, all legislative references are to the Income Tax Assessment Act 1997.

Question 1

Detailed reasoning

CGT Asset

Section 108-5 defines a 'CGT asset' as being:

•         Any kind of property; or

•         A legal or equitable right that is not property.

'Land and buildings' are included as an example of a CGT asset in Note 1 to section 108-5.

Section 108-5 states that 'an asset is not a CGT asset if the asset was last acquired before 26 June 1992 and was not an asset for the purposes of former Part IIIA of the Income Tax Assessment Act 1936: see section 108-5 of the Income Tax (Transitional Provisions) Act 1997.

The Site is real property, thus meeting the definition of a CGT asset.

However, land can also be considered as trading stock or a revenue asset.

Trading Stock

Trading stock is defined in subsection 70-10(1) to include anything produced, manufactured, or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business. Federal Commissioner of Taxation v St. Hubert's Island Pty. Limited (in liq) (1978) 19 ALR 1 concluded that land can be trading stock according to its ordinary meaning if the land was held by an entity that was involved in selling land as part of its ordinary business activities.

Whether profits made from the disposal of real property are made in the ordinary course of business, is established by determining if a taxpayer is carrying on a pattern of trading and whether trading has commenced.

Taxation Determination TD 92/124 - Income tax: property development: in what circumstances is land treated as 'trading stock'? (TD 92/124) presents the Commissioner's view that land is treated as trading stock if:

•         the land is acquired for the purpose of resale; and

•         a business activity which involves dealing in land has commenced.

TD 92/124 specifies the Commissioner's view that before land is able to be treated as trading stock, both the requisite purpose and the business activity must be present. When a taxpayer begins a 'definite and continuous cycle of operations' designed to lead to the sale of land, the business activity is considered to have commenced. It is not necessary for repetitive purchasing or selling of land to establish that a business of property acquisition, development and sale is being undertaken.

Revenue Asset

A CGT asset may also be a revenue asset where it is held for the purpose of realising a profit upon its disposal, in an isolated transaction.

Under paragraph 40-30(1)(a), land cannot be a depreciating asset. If land is not trading stock (held for purposes within subsection 70-10(1) in the ordinary course of business), then land will be a revenue asset if it is used in an isolated transaction that is included in the taxpayer's assessable income (or losses).

Taxation Ruling TR 92/3 - Income tax: whether profits on isolated transactions are income (TR 92/3) provides the Commissioner's view of whether such a transaction is attributable to assessable income. TR 92/3 applies the principles established in Federal Commissioner of Taxation v The Myer Emporium Ltd (1987) 163 CLR 199. Paragraph 32 of TR 92/3 states that a profit or gain made in the ordinary course of a business includes:

•         a profit or gain arising from a transaction which is itself a part of the ordinary business of a taxpayer (judged by reference to the transactions in which the taxpayer usually engages); and

•         a profit or gain arising from a transaction which is an ordinary incident of the business activity of the taxpayer, although not a transaction entered into directly in its main business activity.

TR 92/3 states that profits from an isolated transaction are generally income when both:

•         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.

An objective examination of the facts and circumstances must be undertaken when considering the intention or purpose of a taxpayer in making a profit when entering the applicable transaction.

Application to the Site

The Site was originally purchased for Company A's business purpose of manufacturing.

The Commissioner accepts as fact the Site was not, at the time of purchase, held to be sold as part of its ordinary business or ordinary business activities, and therefore was not trading stock at the time it was acquired by Company A.

The Commissioner also accepts as a fact the Site was not originally acquired for a purpose of resale, or for the purpose of developing with view to making a profit, as part of an isolated transaction.

Therefore, at the time of acquisition, the Site was correctly classified as a CGT asset under section 108-5 and was not trading stock or a revenue asset.

Question 2

Detailed reasoning

If Company A disposed of the Site on the Present Date, for income tax purposes, the profit from the sale of land would generally be taxed:

•         as statutory income under the CGT provisions in Part 3-1 and 3-3, where the land is neither trading stock nor the subject of an isolated profit-making scheme or undertaking and the proceeds of sale are the mere realisation of a capital asset; or

•         as ordinary income under section 6-5, where the land is held as trading stock and sold as part of carrying on a business of property development; (the requirements for a CGT asset to be 'trading stock' are provided under that heading in the detailed reasoning provided for Question 1); or

•         as ordinary income under section 6-5, where land is not trading stock and is sold as part of an isolated commercial transaction entered into with a profit-making intention.

Where land is sold as part of carrying on a business of property development or as part of an isolated profit-making scheme, the proceeds will be included in assessable income in accordance with subsection 6-5(1).

Where the sale of land is considered to be the mere realisation of a capital asset, only the net capital gain will be included in assessable income in accordance with subsection 6-10(1).

Capital gain from mere realisation

When an asset which is subject to CGT is sold, a CGT event occurs. Land is a CGT asset under section 108-5. However, to the extent that an amount is included in the taxpayer's assessable income, section 118-20 will reduce any gain to the extent that amount is so included in the taxpayer's assessable income under a provision outside of Parts 3-1 or 3-3.

Section 104-10 specifies that CGT event A1 occurs when a taxpayer disposes of a CGT asset. Subsection 104-10(4) stipulates that a taxpayer makes a capital gain if the capital proceeds from the disposal are more than the asset's cost base. Alternatively, a capital loss is made if those capital proceeds are less than the asset's reduced cost base.

Where the disposal of land is a 'mere realisation', the CGT rules will generally apply to the sale and the profits will not be ordinary income. In contrast, if the transaction is undertaken in a business operation with a profit-making motive, these proceeds would be considered as ordinary income.

Trading Stock

The Commissioner's view in TD 92/124 (as amended by TD 92/124A) provides that land is treated as trading stock for income purposes if it is both:

•         held for the purpose of resale; and

•         a business activity which involves dealing in land has commenced

Considering the circumstances of Company A's acquisition of the Site and the activities of its property division, the Commissioner is satisfied there is not sufficient evidence that Company A is holding the land for the purpose of resale. Nor has a business activity involving the dealing in land commenced. Therefore, the Site is not held as trading stock under subsection 70-10(1).

Profit Making

Whether the sale is the result of an isolated profit-making scheme

The question of whether land held for one purpose but subsequently sold or subdivided constitutes more than mere realisation (to best advantage) of a capital asset has been heard numerous times.

The decision in Scottish Australian Mining Co Ltd v FC of T (1950) 81 CLR 188 (Scottish Australian Mining), for many years provided the prevailing view that land that had been held for one purpose (in that case, coal mining) but was subsequently sold via a subdivision that required building of roads, was simply a mere realisation of the land to best advantage, per the comments of Williams J:

The facts would, in my opinion, have to be very strong indeed before a court could be induced to hold that a company which had not purchased or otherwise acquired land for the purpose of profit-making by sale was engaged in the business of selling land and not merely realizing it when all that the company had done was to take the necessary steps to realize the land to the best advantage, especially land which had been acquired and used for a different purpose which it was no longer businesslike to carry out.

Williams J also commented that:

If it is advantageous to the sale of the land as a whole to set aside part of the land for parks and other amenities, this does not convert the transaction from one of mere realization into a business. It is simply part of the process of realizing a capital asset.

The broad view in Scottish Australian Mining (that all activities would fall within the definition of 'mere realisation') was directly addressed in Federal Commissioner of Taxation v Whitfords Beach Pty Ltd (1982) 150 CLR 355 (Whitfords Beach), which narrowed the view indicating that the size and scale of such activities was a factor in determining whether the development constituted a profit-making transaction. As Mason J remarked in Whitfords Beach:

That [mere realisation] may be so in the case where an area of land is merely divided into several allotments. But it is not so in a case such as the present where the planned subdivision takes place on a massive scale, involving the laying out and construction of roads, the provision of parklands, services and other improvements. All this amounts to development and improvement of the land to such a marked degree that it is impossible to say that it is mererealization of an asset. We need to bear in mind that the subdivision of broad acres into marketable residential allotments involves much more in the way of planning, development and improvement than was formerly the case.

In Kenneth A Summons Pty Ltd & Ors v FC of T 86 ATC 4979,the taxpayer set up a joint venture company for the purposes of subdividing suburban land. The taxpayer was forced to sell the shares due to factors beyond the taxpayer's control. It was found that the sale of the shares in the joint venture company was found to be a mere realisation, and thus the proceeds were not assessable income, as the taxpayer never contemplated nor wished for the sale of the shares while carrying out the business venture. Ormiston J stated:

... the sales of the... shares were not made in the course of the company's business activities, for they terminated its activities in each of the ventures in a manner not originally contemplated. Of course, it can be said that every activity of a company engaged in commercial activities may fairly be described as a business activity, but that description fails to take account of the clearly accepted possibility and, indeed, likelihood that a company will, from time to time, realize its capital or structural assets without the profit becoming taxable. Nor does it matter that the company uses those capital assets to produce income, for it is hard to conceive of assets which a company would hold but which would not be used in that way. If realization was a part of or "an integral element" of a wider transaction, in the language used in the judgment in the Jennings Industries case (at p. 4294), then the situation would be different, but, if, as I consider the realization was not part of that wider transaction, then it seems that the principle stated above from the Whitfords Beach case (at ATC pp. 4034-4035, 4040; C.L.R. pp. 360-361, 372) must apply.

Application to the Site

The Site was originally acquired for Company A's main business purposes. Accordingly, a disposal of the Site would be a realisation of a CGT asset unless Company A's motivation for profit in disposing of the land went beyond the realm of 'mere realisation' of a capital asset.

The evidence provided indicates the State Government had signalled their intention to release the land, which includes the Site, for homes and jobs in the area. The Commissioner accepts that the land around and including the Site will no longer be as viable as originally intended.

While Company A has considered redevelopment, the Site is still undertaking manufacturing operations. The Board has not yet approved any decisions to proceed with the development of the land, only considered potential future opportunities.

Therefore, the Commissioner concludes that a potential sale of the Site on the Present Date would not be the result of an isolated profit-making scheme. The sale of the Site would be treated as the mere realisation of a capital asset.

Conclusion

Any proceeds received by Company A for a potential sale of the Site on the Present Date would not represent an amount received for an item of trading stock under Division 70, nor would it represent the proceeds from the sale of a revenue asset (which otherwise would be included in Company A's assessable income under section 6-5).

If sold, the proceeds received would be treated as the capital proceeds received when a CGT event A1 happened. Any net capital gain should be included in Company A's assessable income under section 6-10.