Edited version of private advice

Authorisation Number: 1052129924381

Date of advice: 10 July 2023

Ruling

Subject: CGT - land subdivision

Question 1

Will the sale of Lot A be a mere realisation subject to capital gains tax (CGT), rather than assessable under ordinary concepts?

Answer

Yes. The proceeds from the sale of the land will be subject to the CGT provisions in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997).

Question 2

Will the sale of the subdivided Lot A, be a taxable supply by the partnership of Individual A and Individual B (the Partnership) pursuant to section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

No.

No. Your GST turnover does not meet the registration turnover threshold and you are not required to be registered for GST in relation to the sale of Lot A.

As you are not registered or required to be registered for GST at the time of the sale of the subdivided Lot A, it will not be a taxable supply pursuant to section 9-5.

This ruling applies for the following period:

Year ended 30 June 2022

The scheme commenced on:

1 July 2021

Relevant facts and circumstances

Individual A and Individual B (you) acquired an investment property jointly more than five years ago.

The property was leased for a period of more than five years.

You or the partnership of Individual A and Individual B are not registered for GST.

As the rental income received does not cover your mortgage repayments, you initially decided to subdivide the Property by keeping the existing house and creating a separate lot at the rear of the Property. The amount received on the sale of the newly created lot would then reduce your mortgage repayments.

You submitted a number of development applications to the local Council in an effort to retain the existing house, but these were unsuccessful. The local Council advised that in order to subdivide the Property, the existing house would need to be demolished.

You accepted Council's recommendation and proceeded to demolish the existing house and subdivide the land into two Lots.

Your initial intention, on demolition of the existing house, was to create two Lots, with Lot B to be sold and a new house built on Lot A, which would be rented.

You subsequently changed your intention, planning instead to move into the house to be constructed on Lot A as your principal residence.

Lot B was subsequently sold for more than $XXX.

After Lot B was sold you engaged a builder to construct a house on Lot A.

You encountered significant difficulties in proceeding with the construction. This was due to rejection of proposed floor plans and financial pressures arising from increased costs due to the property being located in a flood zone.

As a consequence, you decided to list Lot A on the market for sale. No further work was undertaken on Lot A.

Lot A was sold less than 12 months after Lot B for a price of more than $XXX.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 112-25

A New Tax System (Goods and Services Tax) Act 1999 subsection 9-5

A New Tax System (Goods and Services Tax) Act 1999 section 9-20

A New Tax System (Goods and Services Tax) Act 1999 subsection 9-40

A New Tax System (Goods and Services Tax) Act 1999 section 25-1

A New Tax System (Goods and Services Tax) Act 1999 section 23-5

A New Tax System (Goods and Services Tax) Act 1999 subsection 184-5(1)

A New Tax System (Goods and Services Tax) Act 1999 subsection 188-10(1)

A New Tax System (Goods and Services Tax) Act 1999 subsection 188-15(1)

A New Tax System (Goods and Services Tax) Act 1999 subsection 188-20(1)

A New Tax System (Goods and Services Tax) Act 1999 section 188-25

A New Tax System (Goods and Services Tax) Act 1999 section 195-1

Reasons for decision

Question 1

Is the sale of Lot A, considered a mere realisation subject to capital gains tax (CGT) rather than assessable under ordinary concepts?

Answer

Yes. The proceeds from the sale of the land will be subject to the CGT provisions in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

In general, 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 carrying on a business of property development.

•         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.

•         As statutory income under the CGT provisions, 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.

Where the 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 your assessable income in accordance with subsection 6-5(1) of the ITAA 1997.

Where the sale of the land is considered to be the mere realisation of a capital asset, only the net capital gain will be included in your assessable income in accordance with subsection 6-10(1) of the ITAA 1997.

Carrying on a business of property development

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? (TR 97/11). Although TR 97/11 deals with the issues in determining whether a taxpayer is carrying on a business of primary production, the same principles can be applied to the question of whether a taxpayer is carrying on any type of business including property development.

Paragraph 13 of TR 97/11 states that the following indicators are relevant in determining whether a taxpayer is carrying on a business:

•         whether the activity has a significant commercial purpose or character

•         whether there is repetition and regularity of the activity

•         whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business

•         whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit

•         the size, scale and permanency of the activity; and

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

Whether a business is being carried on depends on the impression gained from looking at all the indicators against the case facts and whether these indicators provide the operations with a commercial flavour.

Isolated commercial transaction

Taxation Ruling TR 92/3: Income tax: whether profits on isolated transactions are income (TR 92/3) provides guidance in determining whether profits from isolated transactions are ordinary income and therefore assessable under section 6-5 of the ITAA 1997.

Paragraph 1 of TR 92/3 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.

Whether a profit from an isolated transaction is ordinary income depends on the individual circumstances of the case.

Paragraph 6 of TR 92/3 provides that profits from an isolated transaction is generally income when both of the following elements are present:

•         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.

Profit-making intention

If the transaction involves the sale of property, it is usually necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property.

However, as the High Court decision in FC of T v. Whitfords Beach Pty Ltd (1982) 150 CLR 355; [1982] HCA 8; 82 ATC 4031; 12 ATR 692 (Whitfords Beach) demonstrates, that is not always the case. For example, if a taxpayer acquires an asset with an intention of using it for personal enjoyment but later decides to venture or commit the asset either as the capital of a business or into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction, the profit is income even though the taxpayer did not have the purpose of profit-making at the time of acquisition.

Business operation or commercial transaction

Factors listed in paragraph 13 of TR 92/3, which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction include:

•         the nature of the entity undertaking the operation or transaction

•         the nature and scale of other activities undertaken by the taxpayer

•         the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained

•         the nature, scale and complexity of the operation or transaction

•         the manner in which the operation or transaction was entered into or carried out

•         the nature of any connection between the relevant taxpayer and any other party to the operation or transaction

•         if the transaction involves the acquisition and disposal of property, the nature of that property; and

•         the timing of the transaction or the various steps in the transaction.

In determining whether activities relating to isolated transactions are a profit-making undertaking or are the realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case.

No single factor will be determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.

Mere Realisation

Proceeds from the sale of property more often represent the mere realisation of capital assets, with gains subject to the CGT provisions in Part 3-1 and Part 3-3 of the ITAA 1997.

The Full Federal Court decision in Stratham & Anor v FC of T 89 ATC 4070 held that the mere realisation of an asset at a profit did not necessarily render the profit taxable. The court was satisfied that the owners did not enter into the business of selling land and said there was nothing surprising in the fact that the owners applied themselves in an enterprising way to the realisation of a capital asset, in a manner calculated to maximise their receipts. But the fact that this occurred does not necessarily make the proceeds either profits from an undertaking or scheme, or income from a business. The court said:

It is well established... that the mere realisation of an asset at a profit does not necessarily render the profit taxable. The profit must arise from the carrying on of a business or a profit-making undertaking or scheme. The mere magnitude of the realisation does not convert it into such a business, undertaking or scheme; but the scale of the realisation activities is a relevant manner to be taken into account in determining the nature of the realisation, ie in determining whether the facts establish a mere realisation of a capital asset or a business or profit-making undertaking or scheme.

Application to circumstances

The low level of activity in dealing with the property, the lack of intention to engage in a business draws readily to the conclusion that you were not engaged in a property development business in relation to the sale of Lot A.

In this case, you held the property as a rental for reasonable period of time supporting your contention that it was purchased for the purpose of investment rather than to profit from its subdivision. Your activities in dealing with the land are relatively minor in scale leading therefor we do not consider it a commercial transaction. Our view is the sale of Lot A was not an isolated commercial transaction.

Based on the facts, it can be concluded that the sale of Lot A is a realisation of a capital asset, and the proceeds will be subject to the CGT provisions in Parts 3-1 and 3-3 of the ITAA 1997.

Question 2

Will the sale of the subdivided Lot A, be a taxable supply by the Partnership pursuant to section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

No. Your GST turnover does not meet the registration turnover threshold and you are not required to be registered for GST in relation to the sale of Lot A.

As you are not registered or required to be registered for GST at the time of the sale of the subdivided Lot A, it will not be a taxable supply pursuant to section 9-5.

Detailed reasoning

For this section of the ruling:

•         unless otherwise stated, all legislative references are to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)

•         all legislative terms of the GST Act marked with an asterisk are defined in section 195-1 of the GST Act.

•         all reference materials, published by the Australian Taxation Office (ATO), that are referred to are available on the ATO website ato.gov.au

Section 9-40 provides that you must pay the GST payable on any taxable supplies that you make.

The requirements of a taxable supply are set out in section 9-5, which states:

You make a taxable supply if:

(a) you make the supply for *consideration; and

(b) the supply is made in the course or furtherance of an enterprise that you carry on; and

(c) the supply is *connected with indirect tax zone; and

(d) You are *registered or *required to be registered.

However, the supply is not a *taxable supply to the extent that it is *GST-free or *input taxed.

(*Denotes a term defined in section 195-1 of the GST Act)

Pursuant to subsection 184-5(1), a supply, acquisition or importation made by or on behalf of a partnership in his or her capacity as a partner:

(a)  is taken to be a supply, acquisition or importation made by the partnership; and

(b)  is not taken to be a supply, acquisition or importation made by that partner or any other partner of the partnership.

For the purposes of section 9-5, the 'you' referred to, will include the Partnership of Kelvin Ung and Lesa Lum.

The sale of Lot A will meet the requirements of paragraphs 9-5(a) and 9-5(c). This is because the sale will be a supply made for consideration and the land is in Australia.

We need to establish whether the sale is made in the course or furtherance of an enterprise that you carry on. Further, as you are currently not registered for GST, we also need to determine whether you would be required to be registered for GST at the time of settlement of the sale of the subdivided lot.

GST registration

Section 25-1 provides that you must make your application to be registered for GST within 21 days after becoming required to be registered.

Division 23 considers who is required to be registered and who may be registered. In particular, section

23-5 states:

You are required to be registered under this Act if:

(a)  you are *carrying on an *enterprise; and

(b)  your *GST turnover meets the *registration turnover threshold (currently $75,000).

Enterprise

The term 'carrying on' an enterprise is defined in section 195-1 and includes doing anything in the course of the commencement or termination of the enterprise.

Section 9-20 provides that the term 'enterprise' includes, among other things, an activity or series of activities done on a regular or continuous basis, in the form of a lease, licence or other grant of an interest in property.

Based on the facts, you are conducting a residential property leasing enterprise.

Turnover

GST turnover threshold has the meaning given by subsection 188-10(1) and states:

(1)  You have a GST turnover that meets a particular *turnover threshold if:

(a)  your *current GST turnover is at or above the turnover threshold, and the Commissioner is not satisfied that your *projected GST turnover is below the turnover threshold; or

(b)  your projected GST turnover is at or above the turnover threshold.

Subsection 188-15(1) explains the meaning of current GST turnover and states:

(1)  Your current GST turnover at a time during a particular month is the sum of the *values of all the supplies that you have made, or are likely to make, during the 12 months ending at the end of that month, other than:

(a)  supplies that are *input taxed; or

(b)  supplies that are not for *consideration (and are not *taxable supplies under section 72-5); or

(c)   supplies that are not made in connection with an *enterprise that you *carry on.

Both Lot B and Lot A were sold for more than $XXX. The sale of the two properties occurred less than 12 months apart.

Subsection 188-20(1) explains the meaning of projected GST turnover and states:

(1)  Your projected GST turnover at a time during a particular month is the sum of the *values of all the supplies that you have made, or are likely to make, during that month and the next 11 months, other than:

(a)  supplies that are *input taxed; or

(b)  supplies that are not for *consideration (and are not *taxable supplies under section 72-5); or

(c)   supplies that are not made in connection with an *enterprise that you *carry on.

However, section 188-25 requires you to disregard any supply made, or likely to be made by you by way of transfer of ownership of a capital asset of yours when calculating your projected GST turnover.

Goods and Services Tax Ruling GSTR 2001/7, Goods and services tax: meaning of GST turnover, including the effect of section 188-25 on projected GST turnover discusses the meaning of capital assets' at paragraphs 31 - 36:

Meaning of 'capital assets'

31. The GST Act does not define the term 'capital assets'. Generally, the term 'capital assets' refers to those assets that make up 'the profit yielding subject' of an enterprise. They are often referred to as 'structural assets' and may be described as 'the business entity, structure or organisation set up or established for the earning of profits'.

32. 'Capital assets' can include tangible assets such as your factory, shop or office, your land on which they stand, fixtures and fittings, plant, furniture, machinery and motor vehicles that are retained by you to produce income. 'Capital assets' can also include intangible assets, such as your goodwill.

33. Capital assets are 'radically different from assets which are turned over and bought and sold in the course of trading operations'. An asset which is acquired and used for resale in the course of carrying on an enterprise (for example, trading stock) is not a 'capital asset' for the purposes of paragraph 188-25(a).

34. 'Capital assets' are to be distinguished from 'revenue assets'. A 'revenue asset' is 'an asset whose realisation is inherent in, or incidental to, the carrying on of a business'.

35. If the means by which you derive income is through the disposal of an asset, the asset will be of a revenue nature rather than a capital asset even if such a disposal is an occasional or one-off transaction. Isolated transactions are discussed further at paragraphs 46 and 47 of this Ruling.

36. Over the period that an asset is held by an entity, its character may change from capital to revenue or from revenue to capital. For the purposes of section 188-25 the character of an asset must be determined at the time of expected supply

Application to your circumstances

In this case, we consider the supply of Lot A will constitute the sale or transfer of ownership of a capital asset as Lot A was part of the property that was applied to generate rental income before the subdivision occurred. Therefore, the value of the Lot A supply is disregarded in calculating your projected GST turnover.

Whilst your current GST turnover is at or above $75,000 as a consequence of the sale of Lot B, the Commissioner is satisfied that your projected GST turnover is below $75,000 at the time of the supply of Lot A. Therefore, your GST turnover does not meet the registration turnover threshold and you are not required to be registered under section 23-5 and paragraph 9-5(d) in relation to the sale of Lot A.

As you are not registered or required to be registered for GST at the time of the sale of the subdivided Lot A, it will not be a taxable supply pursuant to section 9-5.