Edited version of private advice

Authorisation Number: 1052199806427

Date of advice: 21 December 2023

Ruling

Subject:Sale of farmland - revenue or capital

Question 1

If the sale of the Land by the Owners is under the Contract of Sale (without the Revised Terms applying) or under the Contract of Sale (with the Revised Terms applying), will the profit made by the Owners from the sale of the Land constitute assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of an isolated commercial transaction?

Answer

No.

Question 2

If the sale of the Land by the Owners is under the Contract of Sale (without the Revised Terms applying) or under the Contract of Sale (with the Revised Terms applying), is the Land trading stock of the Owners such that the proceeds of sale derived by the Owners from the sale of the Land will be assessable to the Owners under section 6-5 of the ITAA 1997?

Answer

No.

Question 3

If the answer to Question 1 and Question 2 is no, if the sale of the Land by the Owners is under the Contract of Sale (without the Revised Terms applying) or under the Contract of Sale (with the Revised Terms applying), will the gain from the sale of the Land be assessable to the Owners as the mere realisation of a capital asset under the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20YY

Year ending 30 June 20YY

Year ending 30 June 20YY

Year ending 30 June 20YY

Year ending 30 June 20YY

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

The land subject to the ruling comprises rural land over five lots originally purchased by family member A more than 50 years ago.

The land passed to family member B prior to 20 September 19YY, whose ownership interest was subsequently passed to members of the family and related entities upon their death around 20 years ago.

The land was sold and transferred to buyer A under a contract of sale X years ago.

X months later, buyer A became the registered proprietors of the land following settlement under the contract of sale.

Buyer A was unable to fulfil their obligations under the contract of sale.

In 20YY-YY financial year (acquisition date), the parties to the contract of sale entered into a settlement and contract variation deed, buyer A's obligations were discharged, and the land was transferred back to the vendors that same year in the same ownership proportions prior to the sale.

The Land is currently held by three separate entities (the Owners) as follows:

Table 1 Ownership of land

Lot 2 contains a residential dwelling which has been periodically rented out to an unrelated third party for a number of years. The rent and costs of Lot 3 are split between entity A and entity C on the basis of their respective ownership interest.

The land has at all times throughout its ownership period been used for the purpose of running a primary production business. The primary production business is operated by entity C. Prior to the establishment of entity C, members of the family operated the primary production business.

A reference to the land being used for the purposes of the primary production business, excludes the part of Lot 2 containing the residential dwelling.

The land interests held by the entity A and entity B are made available to entity C to operate the primary production business. There is no written agreement and no fee payable by entity C to entity A and entity B or previous owners.

Apart from entity A and entity B making their interests in the land available to entity C and the sale of the land, no other activities are undertaken by any combination of the owners jointly.

After the death of family member C (the deceased), X years ago whose interest in the land is now held by entity A, the sale of the land is once again being pursued by the owners. A term in the will of family member C requires the land be sold. This is consistent with the intention of the other owners of the land.

The owners entered into a contract of sale in the 20YY-YY financial year with buyer B.

The owners have not bought or sold any other land following the execution of the contract variation deed in the 20YY-YY financial year.

To date, no works have been undertaken to prepare the land for en-globo sale or for subdivision. The personal involvement of the owners to date has been minimal.

If the revised terms apply, the owners have not and will not undertake any development on the land.

The owners did not market the land for sale directly and engaged an agent. The agent was responsible for requesting expressions of interest, approaching suitable purchasers, assessing offers, and assisting with selecting the potential purchaser of the land.

The land will continue to be used by entity C to operate the business until the land is sold.

The owners did not and do not have any, intention to undertake any property development or subdivision in respect to the land.

No physical subdivision works will be taking place on the land while the owners are the registered proprietors of the land.

Under the revised terms of the contract of sale the owner's activities and involvement on the land before settlement include and, where requested by buyer B:

1.    Signing all applications and forms to all authorities (including development or subdivision approval applications or submissions).

2.    Providing consents where buyer B, wants to do something in relation to the land and an authority wants to know that the owner's consent to that thing being done.

3.    Attending meetings with authorities.

4.    Confirming that the owners have authorised buyer B, to do due diligence and for buyer B, to talk to authorities.

5.    The provision of consents and granting access to the land in accordance with, and as required by, the contract of sale.

6.    Providing information and answering questions in relation to the land.

Any steps or actions the owners undertake in respect of the development or subdivision of the land or buyer B's, due diligence will be undertaken at the request of, and for the benefit of, buyer B's and at their cost.

In respect of buyer B's due diligence, clauses in the sale of contract requires the owners to undertake those actions which are "reasonably requested by buyer B. Accordingly, the owners will not agree to undertake any actions which are unreasonable in relation to buyer B's efforts to progress the development or subdivision of the land. For example, the owners will not assist in satisfying any conditions which are imposed by any authorities on the development or subdivision of the land.

Any decision to develop or subdivide the land is a decision solely for buyer B's; the owners will have no input into that decision.

To the extent that buyer B's ultimately subdivide the land, the owners will receive no benefits from this and will have no interest in the subdivided land.

The owners will not do anything more than what they are obliged to do under the terms of the contract of sale and this applies particularly in relation to any development, subdivision and due diligence activities that buyer B may wish to undertake.

When the potential sale of the land was put to market, the only offer received was the offer from buyer B. Accordingly, the deal evidenced by the contract of sale was the only (and best) deal that could be struck by the owners for the sale of the land.

Contract of sale

The owners and buyer B entered the contact of sale on in the 20YY-YY financial year for all 5 Lots (contract of sale).

A clause in the contract of sale sets out a process of determining whether the contract of sale is to be automatically varied so that the contract of sale proceeds on what is referred to in the contract of sale as revised terms.

The revised terms will only apply if the process outlined in the clause achieves this outcome (such that as at the date of lodgement of this ruling application, the revised terms do not apply). This process is summarised below:

The owners must lodge an ATO GST ruling.

If the notice of decision states that a:

   (i)       Satisfactory GST Decision and a Satisfactory Tax Decision have been obtained, then the contract of sale is varied under a clause in the contract of sale so that the revised terms apply; or

   (ii)       Non-satisfactory GST Decision and/or a non-satisfactory tax decision has been obtained, buyer B may elect to:

(a)          Terminate the contract of sale; or

(b)          Proceed with the contract of sale, in which case, the contract of sale is not varied under the clause of the contract of sale and the revised terms do not apply.

The revised terms are outlined in the contract of sale. In summary the variations in the clause provide that buyer B is entitled to undertake certain development related activities on the land before settlement of the purchase of the land occurs under the contract of sale. Some of these activities include:

   (i)       Buyer B to engage in discussions with and making any applications to tall relevant authorities concerning land as is reasonably necessary to complete due diligence.

   (ii)       Under the revised terms buyer B will be permitted to carry out physical activities to the land including breaking the surface of the land, with consent from the owners.

   (iii)       A new clause is inserted into the contract of sale which prohibits buyer B from making any application or submission in respect of the subdivision of the land or the development of the land until the date that is 45 days before the end of buyer B's due diligence period (referred to in the contract of sale as the latest date)

   (iv)       If the revised terms apply and buyer B wishes to lodge any subdivision or development applications in respect of the land with any authorities prior to the settlement of the purchase of the land, then the owners will need to do all things reasonably necessary to assist buyer B with this, including executing any application made to any authorities.

If a non-satisfactory GST decision and or non-satisfactory tax decision is obtained and buyer B elects to proceed with the contract of sale, then the contact of sale is not varied, and the revised terms do not apply.

For the avoidance of doubt, this would mean that whilst buyer B could still undertake due diligence in accordance with a clause of the contact of sale, buyer B would not be entitled to undertake any development activities (including making any subdivision or development application to any authorities) nor undertake any other activities which are prohibited unless the revised terms apply.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 995-1

Income Tax Assessment Act 1997 Part 3-1 and Part 3-3

Reasons for decision

Question 1

If the sale of the Land by the Owners is under the Contract of Sale (without the Revised Terms applying) or under the Contract of Sale (with the Revised Terms applying), will the profit made by the Owners from the sale of the Land constitute assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of an isolated commercial transaction?

Summary

The owners have not acquired the land with an intention to profit from its subsequent sale, therefore their activities in selling the land are not considered to be an isolated commercial transaction. Further information can be found in Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income.

Detailed reasoning

Section 6-5 of theITAA 1997 includes in your assessable income, where you are an Australian resident, all ordinary income which you derive during an income year. Ordinary income is defined as income according to ordinary concepts.

Ordinary income generally includes income that arises in the ordinary course of a taxpayer's business. However, in certain circumstances proceeds not within the ordinary course of the taxpayer's business may form part of their ordinary income.

We therefore need to determine whether the proceeds to be received from the sale of the Land are:

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

(b)  assessable ordinary income under section 6-5 of the ITAA 1997 as income from an isolated commercial transaction with a view to a profit.

The decisions in Casimaty v. Federal Commissioner of Taxation (1997) 97 ATC 5135; 37 ATR 358 (Casimaty) and McCorkell v Federal Commissioner of Taxation 98 ATC 2199; (1998) 39 ATR 1112 (McCorkell) demonstrate that if a taxpayer does not intend to make a profit when he or she acquires farming land then the likelihood that any profit made on the eventual sale of land as ordinary income is greatly diminished.

The Commissioner accepts that where the activities are no more than the realisation of a capital asset as per the Casimaty and McCorkell cases, any realised gain on the transaction will be a capital gain under the CGT provisions in Part 3-1 of the ITAA 1997.

However, profits made on the sale of land can still be ordinary income if the activities become a separate business operation or commercial transaction.

For example, in Case W59 89 ATC 538; 20 ATR 3728 Deputy President Mr I.R. Thompson considered the appellant was carrying on a business of subdividing, developing and selling land. This was because the appellant had a significant degree of personal involvement in planning, negotiating with local councils and other bodies, obtaining finance, employing contractors, and selling the blocks. In addition to this the subdivision and development was substantial (the land had been divided into over 180 small blocks).

Similarly, the decision in Federal Commissioner of Taxation v Whitfords Beach Pty Ltd 82 ATC 4031; (1982) 150 CLR 355, considered that in the operation of a business, it is relevant to take into account the purpose with which the taxpayer acted and, since the taxpayer was a company, the purposes of those who control it are its purposes. Therefore, in this case, when the shares in the taxpayer were purchased by three development companies, it transformed the company which held land for the domestic purposes of its shareholders to a company whose purpose was to engage in a commercial venture with a view to profit. In addition to taking other factors into consideration, including the scale and magnitude of the subdivision, it was concluded that the taxpayer's activities involved more than a mere realisation of an asset.

The principle has been established that profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business (FC of T v. The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693)(Myer Emporium).

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (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 of the ITAA 1997.

According to Paragraph 16 of TR 92/3:

16. If a taxpayer not carrying on a business makes a profit, that profit is income if:

(a) The intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain: and

(b) The transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

The owners did not purchase the land subject to sale with the intent of entering into a profit-making transaction. Their intent at the time of purchase was to bring about an enduring benefit for the business operated by WFT, prior to the establishment of WFT the business was operated by members of the family. The sale of the land is considered to be outside the ordinary course of the activities from which the owners derive their income.

The land is being sold as a result of changes to the land use in the surrounding area and according to a specific term in the deceased's Will that requires the deceased's interest in the land be sold. The sale is also consistent with the intention of the other owners. The land is not being sold in the ordinary course of carrying on a business and is therefore best described as an isolated transaction.

Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. In Myer Emporium, the High Court did not set out guidelines as to what constitutes a business operation or commercial transaction. However, the main indicia that has resulted from TR 92/3 and relevant case law is as follows:

(a)  whether the landowner held the land for a considerable period of time prior to any subdivision and sale;

(b)  whether the landowner conducted farming or other non-developmental activities, prior to beginning the process of developing and selling the land;

(c)  whether the landowner originally acquired the land as a private residence or for recreational purposes;

(d)  whether the landowner originally acquired the property as an investment, such as long-term capital appreciation or to derive income;

(e)  whether the land was originally acquired near the urban fringe of a major city or town;

(f)  if the property has been recently rezoned, whether the landowners actively sought that rezoning;

(g)  whether a potential buyer made any offers to the landowners before they commenced discussion to enter into a proposed or final development agreement;

(h)  whether the landowners had tried to sell the land without subdivision;

(i)  whether the landowner had any history of buying and profitably selling developed land or land for development;

(j)  whether the operations will be planned, organised and carried on in a business-like manner;

(k)  whether the landowners have changed their business activity relating to the land from one business to another (eg from farming to property development);

(l)  the scope, scale, duration and degree of complexity of the proposed development;

(m)  who initiated the proposal to develop the land for resale;

(n)  whether the development and pre-sale arrangement is sophisticated;

(o)  whether the landowners will be actively involved in any development activities;

(p)  the level of legal and financial control maintained by the landowners in the proposed or final development agreement; and

(q)  the level of financial risk borne by the landowner in acquiring, holding and/or developing the land.

The selling of the land by the owners is considered below with reference to these factors:

The family have owned the land for a significant period of time. The owners have lived and farmed the property continuously for over X years. The family continued to use the land in the same business after the sale of the land to buyer A and throughout the two-year period during which buyer A was the registered owner of the land. The owners have also continued to use the land in the same primary production business following the 20YY-YY acquisition and since the deceased death X years ago.

Profit making by development, subdivision or sale was not contemplated by any of the owners at the time of acquisition of their respective interests in the land. The owners did not, prior to the sale of the land to buyer A or following the 20YY-YY acquisition, undertake any steps to develop or subdivide the land.

The owners' reason for selling the land is to carry out the wishes of the deceased and the other owners to sell and to realise the land before it is no longer viable as a primary production asset.

The owners will not and have not been actively involved in the sale of the land. The owners do not wish to have any personal or direct involvement in the sale of the land and entity C will continue to run the business until the land is sold. The marketing and sale of the land was conducted by an external third party, an agent, who have been appointed by the owners to arrange the sale.

Under the revised terms of the contract of sale the owner's activities and involvement on the land before settlement include and, where requested by buyer B:

1.    Signing all applications and forms to all authorities (including development or subdivision approval applications or submissions).

2.    Providing consents where buyer B, wants to do something in relation to the land and an authority wants to know that the owner's consent to that thing being done.

3.    Attending meetings with authorities.

4.    Confirming that the owners have authorised buyer B, to do due diligence and for buyer B, to talk to authorities.

5.    The provision of consents and granting access to the land in accordance with, and as required by, the contract of sale.

6.    Providing information and answering questions in relation to the land.

The owners have no previous involvement in property development.

The owners have not applied for any rezoning of the land. The land was zoned as rural land at the time the family sold the land to buyer A and the land is still zoned as rural land. The land was included within a 'Development Investigation Area' under a Town Planning Scheme and was also identified within the Shire's Urban Growth Strategy X years ago. The land has been included in these plans as it has been identified as an area suitable for urban development to meet the long-term residential land requirements of the town for the next 25 years.

Application to your circumstances

Based upon the facts of the sale outlined above, in light of the factors set out in TR 92/3 and relevant case law, it is not considered the owners have ventured into a business activity of property development and sale of land for profit. Therefore, proceeds from the proposed sale of land will not be assessable ordinary income under section 6-5 of the ITAA 1997 as income from carrying on a business of property development.

We also do not consider that the passive involvement of the owners under the contract of sale (without the revised terms applying), or under the contract of sale (with the revised terms applying), amounts to them engaging in a business-like operation or commercial transaction. As such, the profits or gains to be made by the owners from the proposed sale of land will not be assessable ordinary income under section 6-5 of the ITAA 1997 as income from an isolated commercial transaction with a view to a profit.

Question 2

If the sale of the Land by the Owners is under the Contract of Sale (without the Revised Terms applying) or under the Contract of Sale (with the Revised Terms applying), is the Land trading stock of the Owners such that the proceeds of sale derived by the Owners from the sale of the Land will be assessable to the Owners under section 6-5 of the ITAA 1997?

Detailed reasoning

Division 70 of the ITAA 1997 deals with the tax treatment of trading stock. Trading stock is defined in subsection 70-10(1) of the ITAA 1997 to include:

(a)  anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and

(b)  livestock.

In relation to the circumstances in which land is considered to be trading stock, Tax Determination 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'? provides:

1. Land is treated as trading stock if:

(a)  it is held for the purpose of resale; and

(b)  a business activity which involves dealing in land has commenced.

2. Both the required purpose and the business activity must be present before land is treated as trading stock. The business activity is taken to have commenced when a taxpayer embarks on a definite and continuous cycle of operations designed to lead to the sale of the land.

3. It is not necessary that the acquisition of land be repetitive. A single acquisition of land for the purpose of development, subdivision and sale by a business commenced for that purpose would lead to the land being treated as trading stock.

For the reasons outlined in Question 1 above, the land was not acquired in the 20YY-YY acquisition and held by the owners for the purpose of resale and was instead acquired out of necessity and held for the purpose of operating the business. In addition, for the reasons outlined in Question 1 above, the owners are not conducting a business activity which involves dealing in land.

Accordingly, the land was not acquired by the owners as trading stock and was instead acquired as a capital asset.

As the land is not trading stock, no part of the sale proceeds on the sale of the Land will be assessable as ordinary income under section 6-5 of the ITAA 1997.

Question 3

If the answer to Question 1 and Question 2 is no, if the sale of the Land by the Owners is under the Contract of Sale (without the Revised Terms applying) or under the Contract of Sale (with the Revised Terms applying), will the gain from the sale of the Land be assessable to the Owners as the mere realisation of a capital asset under the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997?

Summary

The proceeds from the sale of land will be subject to taxation under the capital gains tax (CGT) provisions in Parts 3-1 and 3-3 of the ITAA 1997. The proceeds from the sale of land will be subject to taxation under the CGT provisions in Parts 3-1 and 3-3 of the ITAA 1997.

Detailed reasoning

A capital gain or a capital loss may arise if a CGT event happens to a CGT asset.

Section 108-5 of the ITAA 1997 provides that a 'CGT asset' is any kind of property, or a legal or equitable right that is not property.

Division 104 of the ITAA 1997 lists all the 'CGT events' that could happen in relation to a CGT asset. Subsection 104-10(1) of the ITAA 1997 provides that CGT event A1 happens if you dispose of a CGT asset.

A CGT asset is disposed of if a change of ownership occurs from you to another entity (subsection 104-10(2) of the ITAA 1997). The time of the CGT event is specified in subsection 104-10(3) of the ITAA 1997 and, as is relevant, is the time when you enter into the contract for the disposal.

Subsection 104-10(4) of the ITAA 1997 states you make a capital gain if the capital proceeds from the disposal are more than the asset's cost base, and you make a capital loss if the proceeds are less than the assets reduced cost base. However, a capital gain or loss will be disregarded if the asset was acquired before 20 September 1985 (subsection 104-10(5) of the ITAA 1997).

Section 102-5 of the ITAA 1997 includes in assessable income an amount that is a net capital gain. A net capital loss cannot be deducted from your assessable income (subsection 102-10(2) of the ITAA 1997) but must be applied in determining your net capital gain.

For the reasons outlined in Question 1 above, the sale of the land either under the contract of sale (without the revised terms applying), or under the contract of sale (with the revised terms applying), to buyer B will be a mere realisation of a capital asset by the owners.

CGT event A1 will happen at the time the owners enter into the contract for the disposal/sale of the land to buyer B, on the basis that the owners will dispose of a CGT asset. In accordance with subsection 104-10(4) of the ITAA 1997, the owners will make a capital gain on the sale of the land if the proceeds from the sale exceed the cost base of the land and will make a capital loss if the proceeds are less than the assets reduced cost base.

The land was acquired from buyer A in the financial year 2008-09, therefore the land is not a pre-CGT asset and therefore no part of any capital gain or capital loss arising on the sale of the land will be disregarded.