Edited version of private advice

Authorisation Number: 1052065439994

Date of advice: 6 December 2022

Ruling

Subject: Small business concessions - active asset test

Question 1

Would the profit or gain derived from the sale of the Properties be ordinary income for the purposes of section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Do the Properties satisfy the active asset test under section 152-35 of the ITAA 1997?

Answer

Yes.

This private ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The land was purchased in 20XX by the Trust.

The Trading Trust operated a business from the land.

Individual A is a primary beneficiary of the Trust. The Trading trust is also a potential beneficiary of the Trust.

Individual A is the controller of both the Trust and the Trading Trust.

The business experienced financial difficulties and individual A borrowed money from a family member to continue operations.

Individual A resolved to sell some land to reduce cash flow pressures.

Part of the land was subdivided and sold.

The level of development prior to sale was limited to the requirements to obtain subdivision approval from council. Prior to sale of the subdivided lots, boundary fencing and culvert pipe to provide access over a drain were installed. No other improvements were made on the land.

A number of the subdivided lots were sold in the 20XX financial year.

The subdivision plan was submitted by the previous owner and approved by the council prior to the Trust purchasing the land.

When the Trust purchased the land there was no intent to make use of the subdivision approval.

Individual A chose to sell the blocks as this provided the best return while leaving the most remaining land to continue the business operations.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 152-35

Reasons for decision

Question 1

Proceeds from the sale of land will be taxed for income tax purposes in one of the following ways:

•         as ordinary income where the land is held as trading stock and sold as part of a business under section 6-5 of the ITAA 1997;

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

•         on capital account, where the proceeds of sale are a mere realisation of a capital asset under the capital gains tax (CGT) provisions in Part 3-1 and Part 3-3 of the ITAA 1997.

Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case.

The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 Income tax: Am I carrying on a business of primary production? which uses a number of indicators to determine whether a taxpayer is carrying on a business including the size and scale of the activity and whether there is a significant commercial purpose or character.

Profits arising from an isolated transaction as a result of entering into a profit-making undertaking or scheme will be ordinary income under section 6-5 of the ITAA 1997, on revenue account (FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693 (Myer Emporium)). This is distinguished from a 'mere realisation' which is not ordinary income.

Taxation Ruling TR 92/3 - Income tax: whether profits on isolated transactions ('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. It refers to isolated transactions' as:

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

•         those transactions entered into by non-business taxpayers.

TR 92/3 also provides that profits from an isolated transaction will be income when:

•         the intention or purpose 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.

Where the sale is a 'mere realisation' the sale is on capital account to which the CGT rules will generally apply. These proceeds are not ordinary income.

A sale that is more than a 'mere realisation' will be on revenue account and proceeds will generally be assessable as either income from carrying on of a business or income from a profit-making undertaking or scheme. The expression 'mere realisation' is used to distinguish a mere realisation from a business operation or a commercial transaction carrying out a profit-making scheme.

Application to your circumstances

We do not consider you are carrying on a business of property subdivision and sale. Further we do not consider you entered into a profit making undertaking or scheme. The land was purchased with the subdivision approval in place and you did not enhance the land prior to sale. Further, the related Trading Trust will continue its business on the retained land.

Therefore, the proceeds from the sale of the subdivided lots are not assessable under section 6-5 of the ITAA 1997. Instead the sales are considered a mere realisation and will be on capital account and subject to the CGT provisions.

Question 2

Subsection 152-35(1) of the ITAA 1997 states that a CGT asset satisfies the active asset test if:

•         you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the period of ownership, or

•         you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7 and a half years.

Section 152-40 of the ITAA 1997 provides the meaning of 'active asset'. A CGT asset will be an active asset at a time if, at that time, you own the asset and the asset was used or held ready for use by you, an affiliate of yours, or by another entity that is 'connected with' you, in the course of carrying on a business.

If land, part of which is used in the business and part of which is vacant, is subdivided, the new subdivided blocks created out of the vacant part of the land will not satisfy the active asset test when they are sold.

Connected with test

Under subsection 328-125(1) of the ITAA 1997, an entity is 'connected with' another entity if either entity controls the other entity in the way described in section 328-125 of the ITAA 1997 or both entities are controlled in that way by the same third entity.

Under paragraph 328-125(2)(a) of the ITAA 1997, an entity controls another entity, that is not a discretionary trust, if it or its affiliates, or all of them together beneficially own, or have the right to acquire the beneficial ownership of, interests in the other entity that carry between them the right to receive at least 40% of any distribution of income or capital by the other entity.

Application to your circumstances

In this case, the Trust held the property for less than 15 years. The entire property was used in the course of carrying on a business by the Trading Trust. Individual A controls both the Trust and the Trading Trust. Therefore the Trading Trust is connected with the Trust.

As the whole property was used in the course of carrying on a business by a connected entity for the entire ownership period the subdivided lots satisfy the active asset test.