Edited version of private advice

Authorisation Number: 1052196215679

Date of advice: 28 November 2023

Ruling

Subject: Sale of subdivided property - capital versus revenue

Question 1

Will any part of the proceeds or profit made on the sale of the lots, constitute assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will the gain from the sale of the lots be treated as a mere realisation of a capital asset and subject to capital gains tax (CGT) under Parts 3-1 and 3-3 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

year ending 30 June 2023

The scheme commenced on:

16 December 2022

Relevant facts and circumstances

You purchased the property in 19PP. The property is X hectares. When you acquired the property, the land was zoned as rural. Around 20TT the land was re-zoned to residential.

You have been the sole owner of the property since acquiring the property.

The property has a house on it. The property was rented out from when you purchased the property in 19PP. The only time the property was not rented was from 20UU to 20XX.

You rented the property via a real estate agent. You may have used more than one different real estate agent to manage the property.

At the time of purchasing the property, you intended to use the property for investment purposes, as a rental property.

You never had an intention to develop the property.

You have no previous history or experience of being involved in a commercial property development enterprise or business activity either as an individual or associated with other entities.

You retired from the workforce in 20KK

You have attempted to sell the property for a period of up to six months from 20SS and then again from 20VV without any success.

A project manager approached you about your property with the intention to develop the property to create X lots. The project manager's agreement is to undertake everything associated with developing the property and then selling the X lots.

In late 20XX you signed an agreement with the project manager to undertake the development of the property. The agreement is titled "Project Management Agreement".

The agreement includes a clause requiring you to mortgage the property for a specified amount. These loan funds are intended to be used by the project manager to commence the development.

The Project Management Agreement sets out various conditions of the property development activity such as:

•         who is the owner of the land

•         the location of the land and number of proposed lots to create from the property development.

•         your role and obligations during the property development activity

•         the project manager's role and obligations during the property development activity

•         how the property development will be funded

•         the payment of fees and charges and how they are determined.

•         how record keeping, banking and tax obligations are carried out and by whom.

You will not have an active involvement in the property development. You will leave everything to do with the property development activity to the project manager and the property developer.

You will not have an active involvement or access to the bank accounts that will be associated to the property development.

You do not have any active involvement in the record keeping of the property development.

You will only be responsible for your own personal tax obligations that will result from the sale of each lot. The project manager will be responsible for the tax obligations of the property development.

Currently, the property development has not commenced. It is anticipated that lot sales may commence in the next few years.

You have not prepared a business plan for this property development nor in conjunction with project.

You have only discussed the property development matter with your accountant.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Question 1

There are three ways the proceeds from a property development can be treated for taxation purposes:

•         assessable ordinary income under section 6-5 of the ITAA 1997 as income from carrying on a business or property development;

•         assessable ordinary income under section 6-5 of the ITAA 1997 as income from an isolated commercial transaction with a view to a profit; or

•         a realisation, often referred to as a 'mere realisation', of a capital asset, assessable under Parts 3-1 and 3-3.

Whether the proceeds are treated as income or capital will depend on the situation 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.

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 the taxpayer has more than just an intention to engage in business;

•         whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity;

•         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) sets out the Commissioner's view on the application of the decision in Commonwealth of Taxation v Myer Emporium Ltd (1987) 163 CLR 199and provides guidance in determining whether the profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income.

Paragraph 1 of TR 92/3 provides that the term 'isolated transactions' refers to:

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

•         those transactions entered into by non-business taxpayers.

It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

Paragraph 6 of TR 92/3 provide that a profit from an isolated transaction or operation is generally income when both of the following elements are present:

•         the intention or purpose of a 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 operation or commercial transaction.

Whether an isolated transaction is business or commercial will depend on the circumstances of each case. Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of the land can be assessed as ordinary income within section 6-5 of the ITAA 1997. Paragraph 13 of TR 92/3 lists the following factors which are 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 Federal Commissioner of Taxation v Whitfords Beach Pty Ltd (1982) 150 CLR 335 the taxpayer, in 1954, acquired 1,584 acres of land to secure for its original shareholders access to beach shacks which they occupied on the adjacent beachfront. The acquisition was not for a purpose of profit-making by sale or for any business purpose. In 1967 all the shares in the taxpayer were acquired by three companies for $1.6 million. The three companies had not been shareholders of this taxpayer previously. A new set of articles were adopted at the time of the acquisition. The three companies acquired the shares to gain control of the land with the intention of the taxpayer to develop, subdivide and sell the land for a profit. In 1969, the land was rezoned. It was expected after the development and sale of the subdivided land the taxpayer would make a profit of $7 million. Subdividing the land commenced in 1970 and the first sale of lots of land was made in 1971 with final lot sales made in 1975. The High Court held the subdivision of 1,584 acres of land was a business transaction. The taxpayer's activities were so extensive that it amounted to a business of land development. The profits were held to be assessable as ordinary income.

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.

Paragraph 36 of TR 92/3 states:

The courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. The expression 'mere realisation' is used to contradistinguish a business operation or a commercial transaction carrying out a profit-making scheme.

In Stratham & Anor v Federal Commissioner of Taxation 20 ATR 228, which was an appeal by the taxpayers against the previous decision Case v65[1], the issue of the matter involved the Commissioner sought to assess the profits from the realisation of the land sold during the 1981-82 income tax years as assessable income.

The taxpayers were the trustees of the estate of the deceased. In 1970 the deceased acquired the family farm of approx 240 acres (approximately 97 hectares). The deceased did not acquire the property with the purpose of subdividing and selling of the lots of land. In 1976 some of the land was sold and a half interest in most of the reminder of the land was sold to a company (Bickerton Holdings) that was controlled by relatives of the deceased. The company acquired the interest in the land without any dominant intention to resell the land by subdivision. In 1976, the deceased and company formed a partnership to raise beef cattle on the property. Unfortunately the activity was unsuccessful because of the decease's decline in health and the work commitments of the company's controllers.

In middle to later 1979 the deceased and company decided to sell the whole or part of the land. The owners sought approval for a staged plan of subdivision from the local council. The process the owners undertook with the local council involved lodging an application to subdivide the property and the provision of a bond by way of a bank guarantee. After the local council approved the subdivision application, the local council undertook all necessary subdivisional work. The owners obtained some professional advice but did not engage any contractors.

The deceased died in October 1980.

The owners sold the subdivided land simply by listing it with the local real estate agents. The owner did not participate in the marketing of the subdivided land. Between 1 July 1980 and 30 June 1986 105 lots were sold through four stages of subdivision.

The facts presented to the court demonstrated the way in which in the subdivision and sale progressed was simple. Significant characteristics of the activity included at 229:

•         the owners were satisfied to sell the land as one parcel but were unable to do so;

•         no moneys were borrowed by them, although a bank guarantee was provided to the local council;

•         only very limited clearing and earthworks were involved;

•         the owners relied upon the local council to carry out roadworks, kerbing, electricity and sewerage works;

•         the owners did not erect buildings on land including a site office;

•         the owners had no business organisation, no manager, no office, no secretary, no letterhead;

•         the owners did not advertise the land for sale;

•         the owners did not engage any contractors, although they did obtain some professional advice;

•         books were kept in relation to land sales and

•         the land was sold simply by listing it with the local real estate agent.

The Full Court of the Federal Court of Australia decided the applicant's subdivision of the land was merely to the advantageous and enterprising realisation of the capital asset rather than to a business of land development carried on by the owners or to an undertaking or scheme for the purpose of profit-making. The court said at 233:

'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.'

In Casimaty v Commissioner of Taxation (19PP) 37 ATR 358 the taxpayer, Casimaty, carried on a primary production business on a property comprising of 988 acres (400 hectares approx) of land acquired from his father in 1955. The taxpayer experienced severe financial hardship and deteriorating health. In 1972 or 1973, Casimaty attempted to sell the land as a whole without success. Left with no alternative, the taxpayer decided to sell of parts of his land. Between 1975 and 1995 the taxpayer arranged for creating eight subdivisions equivalent to two-thirds of his property.

Casimaty arranged for works to be carried out to the extent of preparing the land for sale such as farm fencing on boundaries, extension of water main, making water connections, construction of road entrances, construction of road access and satisfying conditions set out by the Council. The taxpayer also slash and cleared scrub, filled in some creeks and waterholes and stabilised creek's levy banks. Casimaty did not provide any public facilities.

The taxpayer was not involved in the sale and marketing of the subdivided lots of land nor did he acquire land for subdivision or resale.

The Federal Court of Australia, Ryan J presiding, held the taxpayer's activities were no more than mere realisation. The court's decision was based on:

•         Casimaty had acquired and continued to hold the land to carry on the primary production business and was the location of his family's residence;

•         he undertook only necessary activities to obtain local Council approval for the subdivision of the parts of the land. If Casimaty had constructed houses, provided internal fencing or other improvements these may indicate the taxpayer had intention of carrying on a business of land development and improvements;

•         there is nothing to suggest a change in the purpose or object with which the land was held;

•         he did not acquire additional land to added to the original 'stock' of land. If additional land was acquired it may have indicated an intention to carry on a business of land development;

•         the taxpayer did not claim as a business expense the interest on moneys borrowed to finance the subdivisional costs;

•         Casimaty outsourced the sales and advertising of the land lots;

In McCorkell v Federal Commissioner of Taxation (1998) 39 ATR 1112 the taxpayer's family had carried on an orchard farm since 1917. McCorkell had inherited the property and orchard. During the early 1980's, the land was rezoned as future residential zone. McCorkell had been approached by property developers but the price they quoted was too low for McCorkell. In 1982 McCorkellhad approach surveyors and engineers about subdividing the property but they advised McCorkell he would experience difficulties to sewer the property and did not take the matter further. In 1984. McCorkell obtained Council approval for part of four hectares of land to be subdivided into 40 lots. During this time, McCorkell had been contemplating retirement. He had no family to continue the orchard and residential development was now surrounding his land. McCorkell had been experiencing complaints from nearby residents about the effects of spraying his orchard on the neighbours. In 1987, the taxpayer met with a consulting engineer and surveyor who advised the sewer could be resolved and the land could be subdivided. A draft subdivision plan was prepared. In 1988 McCorkell was introduced to a consultant who made applications, on McCorkell's behalf, to council to obtain approval for the subdivision. The council approved the subdivision of the balance of the four hectares of land to subdivide into 17 lots. In 1989, McCorkell engaged joint real estate agents to sell the lots of land.

The subdivision of the land was carried out in two stages. McCorkell obtained a short-term bank loan to supplement his funds to pay for the first stage of the subdivision. Sales from the land during the first stage repaid the loan.

Based on the facts of the case, the tribunal decided McCorkell had no direct involvement in planning and contracting work for the subdivision or in selling the lots of land. Therefore, the tribunal held McCorkell was not carrying on a business of subdividing and selling land. The proceeds from the sale of land was capital in nature and was not assessable income.

In comparison, Stevenson v Federal Commissioner of Taxation (1991) 22 ATR 56 the taxpayer's family had carried on a farm activity on 476 acres of land since 1904. Stevenson inherited the property in 1953. From the 1960's, Stevenson decided to sell most of the land and engaged a third party to find a buyer. Around this time, the local Water Authority acquired 26 acres from to taxpayer and used the land to form a lake. Stevenson decided to take advantage of the lake views and determined the value of the land had increased. In the 1970's, Stevenson decided to sell 360 acres to a plantation company but retained 35 acres bordering the lake.

In 1975, a third party on behalf of Stevenson submitted an application to Council to rezone the 35 acres of land. The Water Authority objected to the application and imposed stringent conditions relating to water supply and sewerage. As a result of these conditions, Stevenson found he could not engage a developer willing to pay his price without a rezoning approval. Consequently, from 1977, Stevenson developed the land himself by subdividing the land into residential lots in stages. Stevenson organised finance and marketing of the subdivision. The subdivided lots were sold from 1980 to 1986.

The Federal Court held the extent of the activities and the how Stevenson went about to realise the land amounted to a business.

Application to your situation

We will now consider your facts and circumstances and apply them to each of the three ways proceeds from the sale of the subdivision of property would be treated for taxation purposes:

Carrying on a business activity

Each of the indicators outlined in TR 97/11 for a taxpayer to be carrying on a business activity will be applied to your facts and circumstances:

•         whether the activity has a significant commercial purpose or character

o   you have attempted to sell the property previously via engaging real estate agents without success.

o   you have no experience or knowledge of property development.

o   you will have no involvement in the subdivision process including the marketing and sales of the lots.

o   you have engaged a project manager to carry out the entire subdivision process.

o   you have not prepared a business plan.

•         whether the taxpayer has more than just an intention to engage in business

o   when you had acquired the property, it was for investment purposes. You predominately rented out the property during the period of your ownership of the land.

o   you had attempted to sell the property previously without success.

o   you contend you had not considered to subdivide the property and sell each lot.

•         whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

o   you acquired the property for investment purposes and you have owned it for approximately X years. It is likely a profit would be made from the disposal of the property either if you were successful to sell the property as a whole or as subdivided land. Unfortunately you were unable to sell the property as a whole and believed subdividing the property is the only option available to you to dispose of the property.

o   you do not have the knowledge and experience of property development and have engaged a project manager who has the appropriate knowledge, experience and contacts in which to carry out the subdivision of the property.

•         whether there is repetition and regularity of the activity

o   property development is not an activity you have carried on previously.

o   X lots of land are proposed to be created from subdividing your property. Once these lots are created, marketed and sold the activity will cease. The activity will not be repeated or be ongoing.

•         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

o   the activity of engaging a project manager for property development does occur in the ordinary trade of business.

o   you will not have any active involvement in the subdivision process. You have no knowledge or experience in property development. You will have very little to no input into the decision making during the subdivision process as the project manager will be using their knowledge and experience to make the decisions.

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

o   based on the agreement between you and the project manager, it would appear the project manager would be carrying on the activity in a businesslike manner.

o   you will have no involvement in the subdivision process and have no input into how the activity will be carried on.

•         the size, scale and permanency of the activity

o   it is proposed for X lots of land to be created from your X hectares of land. Generally, the size of a property development can vary. Property development activities can be larger than the development you propose to undertake and they can be smaller. No statistics or any other information has been identified to understand how your subdivision activity compares to others. However, creating X lots from your land is a reasonable number of lots to create.

o   once the land has been subdivided, marketed and the lots are sold, the activity will cease. You will not be carrying on this activity again. There is no permanency about your activity.

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

o   you acquired the property for investment purposes and you have owned it for approximately X years. It is likely a profit would be made from the disposal of the property either if you were successful to sell the property as a whole or as subdivided land. Unfortunately, you were unable to sell the property as a whole and believed subdividing the property is the only option available to you to dispose of the property.

o   you do not have the knowledge and experience of property development and have engaged a project manager who has the appropriate knowledge, experience and contacts in which to carry out the subdivision of the property.

o   this activity would not necessarily be described as a hobby or a form of recreation or a sporting activity. It could be described as an investment for private purposes.

Conclusion

On the balance of the facts and circumstances applied to the above indicators, the Commissioner is satisfied that you would not be carrying on the subdivision activity as a business. It is likely that you will make a profit from the activity, however when you acquired the property in 19PP you state it was for an investment purpose and you had not contemplated it was for property development. You do not have the knowledge or experience of property development and you have not carried out a similar activity previously. You have engaged a project manager who has the necessary knowledge and experience to carry out the property development. You will have no involvement in the subdividing process including you will not be involved in decision making and marketing and sales of the lots.

Isolated commercial transaction

An isolated commercial transaction is considered to be a transaction made outside the ordinary course of business of a taxpayer carrying on a business, as well as a transaction entered into by a non-business taxpayer. When a taxpayer enters into a transaction with the intention or purpose of making a profit, the profit or gain will constitute assessable income.

Conclusion

In your case, you have owned the property for approximately X years. You acquired the property for investment purposes and predominately rented out the property. You attempted to sell the property as a whole in 20SS and 20VV without any success to selling it. You had not considered property development as an option or as the purpose when you acquired the property or during your ownership of the property. Subdividing the property became an option for you when you were approached by the project manager. Based on your experience with trying to dispose of the property, subdividing the land appeared to you to be the only option available to you now.

It is likely a profit would be made from the disposal of the property either if you were successful to sell the property as a whole or as subdivided land. However, your intention to purchasing the property was not for a profit-making transaction. The first condition of paragraph 6 of TR 92/3 has not been satisfied. If the second condition was considered, the transaction was not entered into for a profit to be made in the course of carrying on a business operation or commercial transaction. This is supported immediately above.

Therefore, the profits that are made from the sale of the lots will not be made from an isolated commercial transaction and will not be assessable income.

Mere realisation

The profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. The expression 'mere realisation' is used to contrast the activity with a business operation or a commercial transaction carrying out a profit-making scheme. We have already addressed the latter two above. In considering if profit will be the result of mere realisation, we would consider relevant court cases.

Conclusion

In comparing your facts and circumstances with the court cases of Stratham, Casimaty and McCorkell, you share similar characteristics. Characteristics described in each court report state:

•         the three parties inherited or was gifted their properties and carry on their respective business activity to varying degrees. None had intentions when inheriting the land to carry out a property development activity to gain a profit.

•         each had their own reason for ceasing the business activity and making the decision to subdivide the properties.

•         each party did not have the knowledge and experience of property development.

•         each engaged different parties to carry out the property development without the taxpayer being involved.

•         each party had different ways of financing the activity.

•         each party was not involved in the marketing and sales of the lots.

The case of Stevenson is an example of a taxpayer who had inherited the family property but had the intention of gaining profit from the property which amounted to carrying on a business.

Acquiring the land for investment purposes and renting out the property during your ownership, is the main difference between you and Stratham, Casimaty and McCorkell. You generally shared other similar characteristics as to how you have proceeded to make the decision to subdivide your property. Therefore, the Commissioner is satisfied the future sale of the X lots from your property is a mere realisation of your capital asset.

Any gain or profit from the sale of the future sale of the X lots will not be ordinary income in accordance with section 6-5 of the ITAA 1997. However, any gain would be subject to the CGT provisions in accordance with Parts 3-1 and 3-3 of the ITAA 1997.

Question 2

Under section 6-10 of the ITAA 1997, assessable income also includes amounts that are not ordinary income but are included as assessable income by provisions of the tax law. These amounts are called 'statutory income'. Capital gains are an example of statutory income.

Section 102-5 of the ITAA 1997 provides that a taxpayer's assessable income includes their net capital gain (if any) for the income year. As a general rule, a taxpayer is required to include in their assessable income any capital gain they make from a CGT event that happens to a CGT asset the taxpayer acquired on or after 20 September 1985. Pursuant to section 108-5 of the ITAA 1997, a CGT asset is any kind of property, or a legal or equitable right that is not property. Accordingly, land and buildings are CGT assets.

Proceeds from the sale of property more often represents the mere realisation of capital assets, which will fall for consideration under the CGT provisions in Part 3-1 and Part 3-3 of the ITAA 1997.

In the course of its decision in Myer Emporium, the Full High Court said that profits made on a realisation or change of investments may constitute income if the investments were initially acquired as part of a business with the intention or purpose that they be realised subsequently in order to capture the profit arising from the expected increase in value. In a joint judgment, their Honours stated at 213:

It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of acquisition of acquiring for the purpose of profit-making by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realization. But it is quite another thing if the decision to sell is taken by way of implementation of an intention or purpose, existing at the time of acquisition, of profit-making by sale, at least in the context of carrying on a business or carrying out a business operation or commercial transaction.

Paragraph 36 of TR 92/3 states:

The courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. The expression 'mere realisation' is used to contradistinguish a business operation or a commercial transaction carrying out a profit making scheme. If a transaction satisfies the elements set out in paragraph 35 it is generally not a mere realisation of an investment.

In this case, as shown in Question 1, the sale of the lots at the specified address is the mere realisation of your asset. Therefore, the sale of the lots will be a transaction assessable under the statutory capital gains provisions.

The property had predominately been rented during the period of time that you owned it. You acquired the property in 19PP for an investment purpose. When you acquired the property, you did not have the intention of subdividing the property. You engaged a project manager to manage the subdivision of the land. You'll have no involvement in the process of subdividing the land nor the marketing and sales of the lots of land.

There was no change in purpose for which the land was held, it was the realisation of a capital asset. The proceeds from the sale of the property are assessable on capital account under the CGT provisions in Part 3-1 and Part 3-3 of the ITAA 1997.

[1] Case V65 was reported at 88 ATC 498.