Edited version of private advice

Authorisation Number: 1052074179174

Date of advice: 5 May 2023

Ruling

Subject: Profit arising out of a profit-making undertaking or scheme

Question 1

Will your Lump Sums and Landowner's Shares be included in your assessable income to any extent under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), as a profit arising from carrying out a profit-making undertaking or scheme?

Answer

Yes.

Question 2

If the answer to Question 1 is 'yes', in ascertaining your income under section 6-5 of the ITAA 1997 are your Project Assets ventured into or committed to the undertaking or scheme referred to in Question 1 on the Agreement Date?

Answer

Yes.

Question 3

If the answer to Question 1 is 'yes', can the 'estimated profits approach' be used to determine how much of your ultimate profit is to be included in your assessable income under section 6-5 of the ITAA 1997 in each income year?

Answer

Yes.

Question 4

Will there be CGT consequences under Part 3-1 of the ITAA 1997 when your Project Assets are sold to a Project Buyer?

Answer

Yes.

This ruling applies for the following periods:

The Income Year Ending 30 June 20XX

The Income Year Ending 30 June 20XX

The Income Year Ending 30 June 20XX

The Income Year Ending 30 June 20XX

The Income Year Ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Background

Your land

You acquired:

•                     XXXX property in 19XX; and

•                     YYYY property in 19XX,

(collectively, the Landholdings).

These properties are not joined or contiguous, but are located in close vicinity.

Since acquisition, the Landholdings have contained your main residence and farmland which has been employed in your primary production business.

There is regional uncertainty in the sustainability of primary production industry you are involved in. In addition, you are in your late seventies and looking to retire from farming.

You do not have a history of buying and selling developed land or land for development. You are currently registered for GST as a partnership in respect of your farming activities.

In 20XX your Landholdings were listed for sale through a Real Estate Agency, however no sale eventuated.

Marketing and development proposals

In 20XX/20YY, you were approached in a proposed attempt to acquire your Landholdings along with neighbouring properties. This contract did not proceed after the buyer failed to pay the required contract deposits and comply with the terms of the contract of sale.

Other proposals to acquire your and neighbouring properties had also not resulted in a firm offer for sale.

A farming organisation you belong to identified another development opportunity for you and neighbouring properties and identified a marketing agent.

After you and neighbouring landowners attended a presentation by the marketing agent, the majority in attendance (including you) accepted the proposal to market the landholdings for sale. At the conclusion of the presentation and/or at later dates, a number of landowners across a large number of properties, entered into separate agency appointments with the marketing agent for the sale of your and their land.

The marketing agent was engaged on the basis that your and other properties were to be marketed for a collective sale and engaged a property advisory firm, to prepare development plans.

The marketing agent commenced preliminary work for the expression of interest process to identify buyers/investors and/or developers. A Developer was identified following a tender process. The marketing agent funded the tender costs themselves.

The Project

Under the Project a large tract of land will be developed into a large number of housing lots.[1]

It is anticipated that the Project will occur over a period of at least XX years.[2]

Development activity under the Project is proposed to encompass:

•                     infrastructure (roads, electricity, sewerage, water, lighting, etc.),

•                     public amenities (parkland, supermarkets and other open space areas including water areas) and

•                     private sector development of facilities (such as retail and personal service facilities) as appropriate to service the Project.[3]

The Landowners and the Developer propose to enter into a Development Management Agreement (the Agreement),[4] including the MTD, the stated purpose of which is to provide for:[5]

•                     the Landowner to make the Land available to the Developer to carry out development, and

•                     the Developer to carry out Project Works for the Landowner.

The Agreement Date will be the date of the Agreement.[6]

Landowners become Participating Landowners upon entering the Agreement.

Participating Landowners will play a passive role, with the Developer paying all Project Costs (with the exception of the fees payable to the marketing agent as the Appointed Agents) in return for the Developer being entitled to receive a percentage of the post-GST proceeds from the sale of each lot.[7]

Participating Landowners will share in the remaining proceeds of all lots, based on the size of their landholding as a proportion of total Project Land.[8]

Participating Landowners will be able to continue farming until development activity commences on their land.[9]

Participating Landowners interests in the Project are represented by a Landowner Representative. The Landowner Representative is the Landowners' point of contact with the Developer. You are a founding member and founding director of the Landowner Representative.

All of your landholdings are to be subdivided and sold (some of your land may be transferred to relevant authorities for the creation of roads, open space, etc).

The marketing agent is engaged solely on a success fee basis with commissions payable based on proceeds received by each Participating Landowners, who participate in the development agreement arrangements described below, the vast majority of which will comprise the proceeds from actual land sales.

Legal framework

The Agreement contemplates that legal and beneficial title to the land will remain with its original owners, until such time as it is sold to a Project Buyer or otherwise disposed of. When a Project Asset is sold to a Project Buyer the sale will occur pursuant to a contract between the Landowner and the Project Buyer.

In particular, the Agreement provides:

•                     The Landowner must grant a lease[10] over their land to the Developer upon receipt of a Notice to Take Possession and the Developer must grant a sublease of the land to the Landowner where the whole of the land is not yet required by the Developer;[11]

•                     The Agreement does not otherwise confer any legal or equitable interest in the Land on the Developer;[12]

•                     Prior to the lease, the Landowners grant the Developer a right of access to the land;[13]

•                     Landowners grant the Developer a power of attorney in relation to the land;[14]

•                     The obligations of the Developer and the particular Landholder under the Agreement are not joint, joint and several nor collective,[15] and the Agreement does not constitute nor create a joint venture, partnership, agency trust or other arrangement;[16]

•                     Each Landowner enters into a separate Agreement with the Developer, independently of other Participating Landowners;[17]

•                     One Participating Landowner (or related individuals) per land title that forms part of the Project, may apply to become a member of the Landowner Representative;

•                     The Landowner warrants that they are the legal owner of the land;[18]

•                     The Landowner warrants that they will have good title to the Land at settlement, capable of being conveyed to the Project Buyer;[19] and

•                     The Landowner warrants that they have not disposed of, agreed to dispose of, or granted an option to purchase the land, otherwise than under the Agreement.[20]

Under the draft MTD, Landowners will be entitled to receive two amounts (lump sums) upon satisfaction of certain conditions relating to due diligence and project approvals. Specifically, the Agreement is subject to:

•                     The Due Diligence condition, which requires the Developer to be satisfied, in its absolute discretion, in respect of its due diligence investigations in respect of the Project Land, the viability of the development and anything else considered relevant, within a defined period after the Developer gives a Threshold Notice[21] to the Landowner (the Due Diligence Date);[22] and

•                     The Project Approvals Condition, which requires the Developer to obtain certain Project Approvals, within a defined period after satisfaction of the Due Diligence Condition (the Project Approvals Due Date).[23]

The lump sums are payable as follows:

11.1 Satisfaction of Due Diligence Condition

(a) Within 20 Business Days of the date on which The Due Diligence Condition is satisfied or waived by the Developer, the Developer must pay to the Landowner an amount equal to the greater of:

(i) $ An amount; and

(ii) The Landowner's Share of $ Another amount

(b) At the same time as the Developer makes payment to the Landowner under clause 11.1(a), the Developer must reimburse the Landowner for the commission payable by the Landowner to Participating Landowners' Appointed Agents, which the parties acknowledge is calculated at the rate of X.XX% on the amount payable to the Landowner under clause 11.1(a) together with any applicable GST.

11.2 Satisfaction of the Project Approvals Condition

Within four months after the date on which the Developer gives notice to the Landowner that the Project Approvals condition has been satisfied, the Developer must pay to the Landowner the Landowner's share of $An amount.

Under the Agreement Landowners will also be entitled to receive a share (Landowner's Share) of Project Proceeds in respect of all Project Assets:

38.5       Landowner's Share

(a)          Under the Agreement, the Landowner is entitled to receive the Landowner's Share of the Participating Landowner Entitlement

(b)          The Landowner acknowledges that the Landowner Representative will be responsible for the distribution of the Participating Landowner Entitlement among the Participating Landowners (including the Landowner's Share of the Participating Landowner Entitlement).

(c)          When amounts are distributed to the Landowner under clause 38.5(a) on account of the Landowner's share of the Participating Landowner Entitlement, those amounts will be taken to be paid:

(i) First, in respect of the Land Value Amount; and

(ii) After payment of the Land Value Amount in full, in respect of the Residual Amount

(d)          For the avoidance of doubt:

(i) the Landowner does not become entitled to any share of the Project Proceeds other than:

(A) at the times provided for in clause 38.3(b); and

(B) in the manner provided for in clauses 38.3(b) and 38.5(a); and

(ii) nothing in the Agreement is taken to provide for a minimum payment to the Landowner

The Landowner's share is based on the 'Participating Landowner Entitlement', which is defined as:[24]

XX% of the Project Proceeds after payment or satisfaction of any liability for GST in accordance with clause 38.3(a)

The 'Landowner's share' is based on the Landowner's proportionate ownership of the Project Land, identified through a formula.[25]

Clause 38 of the draft MTD establishes a framework for collecting and distributing the Project Proceeds between Landowners and the Developer.

38.1 Appointment of Solicitors

(a) The Developer will be responsible for the appointment of solicitors or settlement agents to undertake the settlement of Sale Contracts.

(b) The Developer and the Landowner each irrevocably direct the solicitors or settlement agents appointed by the Developer to deal with all Project Proceeds in accordance with the Agreement.

38.2 Payments out of Project Proceeds

When a Project Asset is sold and the settlement of the sale is completed, the Project Proceeds must be received and distributed in the manner and at the time set out in this clause 38.

38.3 Application of Project Proceeds

The Project Proceeds is (sic) to be applied in the following order and manner on settlement of a sale of a Project Asset:

(a)          first, to pay or satisfy any liability for GST payable by a Participating Landowner in connection with the sale of the Project Asset

(b)          second, payment to the Participating Landowners of an amount equal to the Participating Landowner Entitlement (which includes the commission payable by the Participating Landowners to the Participating Landowners Appointed Agents on the sale of Project Assets); and

(c)          third, the balance to the Developer

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 section 102-22

Income Tax Assessment Act 1997 section 103-10

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 118-20

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Question 1

Summary

Yes. A portion of each Lump Sum and Landowner's Share received under the Agreement will be included in your assessable income under section 6-5 of the Income Tax Assessment Act 1997[26] in the year of income in which it is received.

Detailed reasoning

Ordinary income

Your ultimate profit from the Project would constitute ordinary income under section 6-5, as it would represent a profit or gain made from an undertaking or commercial transaction which is:

•                     entered into for the purpose of making a profit or gain, and[27]

•                     of sufficient scale, duration and complexity to go beyond the mere realisation of a capital asset in an advantageous way.[28]

In this context, your 'ultimate profit' refers to the overall taxable income that will arise from the Project.[29]

A profit or gain may be ordinary income where it arises from activities which amount to more than the mere realisation of an asset, even where those activities do not constitute the carrying on of a business.[30] It is sufficient in this context that the profit arises under an undertaking or scheme which exhibits the characteristics of a business deal.[31]

In the present case, more is involved in the Project than merely dividing land into several allotments. Rather, the planned subdivision is to take place on a massive scale, involving the laying out and construction of major infrastructure and public amenities.[32] This amounts to development and improvement of the land to such a marked degree that it is impossible to say that it will give rise to the mere realisation of an asset.[33]

The magnitude[34] of the Project is reflected in a number of different ways, including:

•                     the area of land involved

•                     the number allotments proposed

•                     the number of Landowners involved

•                     the extent of development activities proposed (roads, electricity, sewerage, water, lighting, parklands, supermarkets, open space areas including water areas, employment areas, transit areas, vegetation and flood zone areas)

•                     the estimated project revenue

•                     the lengthy duration[35] of the Project (estimated to be approximately 30 years)

It is true that in a legal sense you will enter into the Agreement independently of the other Landowners and you will continue to own your Project Assets until they are sold. However, in a practical sense you will participate in the collective development of a large area of land by a large number of Landowners. This is reflected in the complex terms of the MTD, including clause 38, which contemplates that Project proceeds and development costs will effectively be shared rateably amongst Landowners in a manner akin to a joint venture.[36]

The present form of the MTD reflects the history of your attempts to sell the land and your intent to make a profit by doing so. Having determined that your land could be sold most profitably through coordination with other landowners, you pursued opportunities for collective development or sale. Your readiness to involve yourself with other Landowners was more consistent with a business enterprise than a mere realisation.[37] Viewed objectively, your purpose was not merely to sell your particular area of land; but rather to embark, through your agents, upon a business-like and efficient program of development and subdivision.[38]

Question 2

Summary

Yes. Your Project Assets would be ventured into or committed to the undertaking or scheme referred to in Question 1 at the Agreement Date.

Detailed reasoning

The Commissioner considers that you would venture in or commit your Project Assets to the undertaking or scheme at the Agreement Date. This is the date when you execute the Agreement between you and the Developer. At this time, you will formally signify the formation of your intention to have the land developed and sold and the commencement of activities directed to that end.[39]

From this date:

•                     you will have granted the Developer extensive rights which enable it to undertake the development of your Project Assets as set out in the MTD,

•                     your ability to validly terminate the Agreement will be limited, and depend on circumstances which are largely beyond your control,[40]

•                     the Developer's ability to validly terminate the Agreement will depend on circumstances which are largely or entirely beyond your control, and

•                     it is unlikely you would otherwise be able to withdraw from the Project without suffering substantial loss[41]

Question 3

Summary

Yes. The 'estimated profits' approach can be used to work out how much of the ultimate profit is to be included in your assessable income in each income year as a result of entering into and undertaking the scheme referred to in Question 1.

Detailed reasoning

The 'estimated profits' approach is a tax accounting method under which the ultimate profit (or loss) from a contract is allocated, on a fair and reasonable basis, over the years taken to complete the contract. It was considered in the context of long-term construction contracts in Taxation Ruling TR 2018/3.[42]

Profit calculation

For the purposes of calculating your ultimate profit in the present case:

•                     proceeds would include all Lump Sums and Landowner's Shares received by you;[43] and

•                     costs would include: [44]

-                    commissions payable to Appointed Agents; and

-                    the market value of your Project Assets just before they are ventured in, or committed to the Project.[45]

As noted in answer to Question 2, the Commissioner considers that you would have ventured in or committed to the Project at the time when you execute the Agreement with the Developer, so this is the relevant time the market value is determined for the purpose of calculating the cost.

Ultimate profit allocation

As the ultimate profit from the Project will not be known in advance, your ordinary income from the Project would need to be returned in each income year using an estimate.

The Commissioner would accept any method which:

•                     reasonably re-estimates total Project Proceeds on an annual basis,

•                     reasonably re-estimates and attributes Project costs to each income year, taking into account the extent to which you have received the Proceeds you estimate will be received over the course of the Project, and

•                     reasonably takes into account differences between actual and estimated Proceeds, so as to ensure that your actual profit is returned as assessable income over the duration of the Project.

Acceptable methods include the 'estimated profits' approach described in Taxation Ruling TR 2018/3.[46]

Question 4

Summary

Yes. There would be CGT consequences under Part 3-1 of the ITAA 1997 when Project Assets are sold to a Project Buyer.

Detailed reasoning

CGT event A1 would happen to your Project Asset when it is sold to a Project Buyer or otherwise disposed of in the ordinary course of the Project.[47] Where your Project Asset is sold to a Project Buyer, the CGT event would happen in the year of income in which you enter into the contract of sale for that Project Asset.[48]

You would make a capital gain from the CGT event equal to any excess of your capital proceeds in respect of the event over the Project Asset's cost base.[49]

Any capital gain you make upon the sale of the XXXX property would be disregarded, as you acquired this land before 20 September 1985.

Any capital gain you make upon sale of the YYYY property may be subject to the CGT discount.[50]

Capital proceeds

Capital proceeds in respect of the CGT event would include the total sale price of the land payable under the contract of sale, less net GST.

Your capital proceeds would therefore include amounts you are required to pay to other Participating Landowners (i.e. pursuant to the Landowner Share mechanism) and the Developer (i.e. the Developer's Fee). While such amounts would not be deposited into an account controlled by you,[51] they would be amounts which you are entitled to receive in respect of the event,[52] or which are applied for your benefit or as you direct.[53]

This treatment follows from the legal framework of the Project, as summarised above. The Agreement does not deprive you of a proprietary interest in your land or a right to specific performance of any contract to sell it. Rather, the Agreement imposes upon you a contractual obligation to deal with your proprietary interest in particular ways.[54]

Cost base

The cost base of your Project Asset would include:

•                     all money paid, and the value of any property given, to acquire the land,[55]

•                     commission payable to the Appointed Agents in respect of the sale,[56] and

•                     the balance of proceeds from disposal of the Landowner's property paid to the Developer, to the extent that the purpose or expected effect of this expenditure is to increase or preserve the value of your land.[57]

That part of the Participating Landowner Entitlement paid to other Landowners[58] would not be included in the cost base of your Project Assets.

Amount otherwise assessable

A capital gain made from the CGT event would be reduced by any amount included in your ordinary income because a CGT event happened to your Project Asset.[59] This would include the profit you include in your assessable income from your Landowner's Share of the proceeds from the sale of your Project Assets.[60]

This reduction would not include the Landowner's Share of amounts which are assessable because of CGT events happening to Project Assets owned by other Landowners. Your entitlement to receive such amounts would not depend on when or whether a CGT event happens to your Project Assets.

Other CGT issues

The Project would not cause CGT event K4[61] to happen to your Project Assets as you would not be carrying on a business by participating in the Project.

[1] Draft MTD, Annexure B.

[2] Draft MTD, clause 7.2(b).

[3] Draft MTD, Annexure B.

[4] Draft MTD, clause 2.1, definition of 'Agreement'.

[5] Draft MTD, clause 6.1.

[6] Draft MTD, clause 2.1, definition of 'Agreement Date'.

[7] Draft DMA, clauses 38.3(c) and 39.

[8] Draft DMA, clause 38.3(b).

[9] Draft MTD, clause 28.4 and Annexure G.

[10] Draft MTD, clause 28 and Annexure F.

[11] Draft MTD, clause 25.2.

[12] Draft MTD, clause 13.4.

[13] Draft MTD, clause 24.1

[14] Draft MTD, clause 22.

[15] Draft MTD, clause 13.1.

[16] Draft MTD, clause 13.2.

[17] Draft MTD, clause 14.4.

[18] Draft MTD, Annexure D, clause 2.1.

[19] Draft MTD, Annexure D, clause 2.2.

[20] Draft MTD, Annexure D, clause 2.3.

[21] Draft MTD, clause 9.2.

[22] Draft MTD, clause 9.1.

[23] Draft MTD, clause 10.1.

[24] Draft MTD, clause 2.1.

[25] Draft MTD, clause 2.1.

[26] All legislative references are to the Income Tax Assessment Act 1997.

[27] Federal Commissioner of Taxation v. Whitfords Beach Pty Ltd 82 ATC 4031; Federal Commissioner of Taxation v. The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693.

[28] c.f. Scottish Australian Mining Co Ltd v. Federal Commissioner of Taxation (1950) 81 CLR 188

[29] Refer TR 2018/3.

[30] Federal Commissioner of Taxation v. Whitfords Beach Pty Ltd 82 ATC 4031 at 4046.

[31] Federal Commissioner of Taxation v. Whitfords Beach Pty Ltd 82 ATC 4031 at 4047.

[32] Federal Commissioner of Taxation v. Whitfords Beach Pty Ltd 82 ATC 4031 at 4047.

[33] Federal Commissioner of Taxation v. Whitfords Beach Pty Ltd 82 ATC 4031 at 4047.

[34] Federal Commissioner of Taxation v. Whitfords Beach Pty Ltd 82 ATC 4031 at 4047.

[35] Abeles & Anor v. FC of T 91 ATC 4756 at 4763.

[36] Abeles & Anor v. FC of T 91 ATC 4756 at 4763.

[37] Abeles & Anor v. FC of T 91 ATC 4756 at 4763.

[38] Abeles & Anor v. FC of T 91 ATC 4756 at 4763.

[39] Whitfords Beach Pty Ltd v. FC of T 83 ATC 4277 at 4283.

[40] Draft MTD, clauses 9.5 and 10.6

[41] Case W59 89 ATC 538 at [61], followed in Stevenson v. Federal Commissioner of Taxation 91 ATC 4476

[42] TR 2018/3 at [5](b).

[43] This will be a net amount, taking into account the costs referred to in draft MTD, clause 38.3.

[44] GST, Participating Landowner Entitlements paid to other Landowners and Developer Fees are netted off against Project Proceeds (rather than recognised as discrete costs); see note Error! Bookmark not defined. above.

[45] Official Receiver in Bankruptcy v. FC of T (Fox's case) (1956) 11 ATD 119 at 128-130; (1956) 96 CLR 370; FC of T v. NF Williams 72 ATC 4188 at 4193.

[46] Taxation Ruling TR 2018/3, Income tax: tax treatment of long-term construction contracts, at [17]-[38].

[47] Subsection 104-10(1).

[48] Subsection 104-10(3).

[49] Section 102-22; subsection 104-10(4).

[50] Subdivisions 115-A and 115-B.

[51] Draft MTD, clause 38.3 and 38.5(d).

[52] Paragraph 116-20(1)(a).

[53] Subsection 103-10(1).

[54] Hedges v. Commissioner of Taxation [2022] FCA 1389; Gerbic v. Commissioner of Taxation [2013] AATA 664

[55] Subsection 110-25(2), first element of cost base.

[56] Draft DMA, clause 38.4.

[57] Draft DMA, clauses 38.3(c) and 39; subsection 110-25(5), fourth element of cost base.

[58] That is, the Participating Landowner Entitlement (Draft MTD clause 38.3(b)), aside from your Landowner's Share of that amount (Draft MTD clause 38.5).

[59] Paragraph 118-20(1)(a).

[60] Draft DMA, clause 38.5.

[61] Section 104-220.