Edited version of private advice

Authorisation Number: 1052232021275

Date of advice: 12 June 2024

Ruling

Subject: Revenue verses capital on large scale subdivision

Question 1

Will any gains from the sale of the subdivided land be assessable income under subsection 6-5(1)?

Answer

Yes.

Question 2

Will the sale of the subdivided land give rise to a capital gain under Part 3-1 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

1 July 20yy to 30 June 20xx

1 July 20xx to 30 June 20zz

The scheme commenced on:

1 July 20yy

Relevant facts and circumstances

The Trust

The Property

1.            The Trustee owns land known as the Property.

2.            The Trustee purchased the Property in July 19XX using borrowed funds.

3.            When the Trustee acquired the Property it was zoned "rural" at that time and for many years thereafter. The use of the Property during t its ownership by the Trustee has been farming and breeding livestock for sale.

The Development

4.            With the expansion of the area, the Property became a potential site for a residential subdivision.

5.            In or around 20XX, landowners in the area were approached unsolicited by a representative who specialises in broad hectare land sales.

6.            There were a number of landowners who attended the presentations.

7.            The attendees were told a draft plan proposed by the local council would cover the property owned by the landowners.

8.            At the conclusion of the series of meetings the farmer landowners in the area were asked to pick a preferred developer.

9.            The Trustee advised that up until this time they had never considered subdividing the Property nor considered developing the Property.

Development Agreement

10.          The Trustee entered into a number of agreements including the Development Agreement with the Developer.

11.          The overall development is proposed to be staged over a number of years over a significant developable area, which will create a number of lots.

12.          Only a part of the Property has been developed and sold to date. The balance of the Property continues to be used by the Trustee for livestock farming pending its development over a number of years.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 6-5(1)

Income Tax Assessment Act 1997 section 118-20

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

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Issue 1

All legislative references are to the ITAA 1997 unless otherwise stated.

Question 1

Will any gains from the sale of the subdivided land be assessable income under subsection 6-5(1)?

Summary

1.            The proceeds from the sale of the subdivided land will be assessable income under subsection 6-5(1).

Detailed reasoning

2.            Proceeds from the sale of subdivided land will be taxed for income tax purposes as ordinary income under section 6-5, where the land is held as trading stock and sold as part of carrying on a business of property development.

3.            Alternatively, profits/gains from the subdivision of land can be assessable under section 6-5 as an isolated commercial transaction with a view to a profit, or as statutory income under the capital gains tax (CGT) provisions contained in Part 3-1 and Part 3-3 as a mere realisation of a capital asset.

Change of intention

4.            While holding an asset for a long period of time may seem to indicate that it is a long-term capital asset, the intention of the taxpayer at the time of acquiring the asset and throughout the ownership period that the taxpayer owns that asset is an important factor to consider.

5.            In circumstances where there has been a change of intention in respect of a property from holding the asset as a long-term capital asset, to one of selling the asset for a profit, the question which arises is whether the sale remains as a 'mere realisation' of capital asset.

6.            The ATO view of whether property development activities constitute the carrying of a business, or an isolated transaction that is of a revenue nature, or is a mere realisation of a capital asset, is based on principles, factors and indicators that have been established by the Courts.

Carrying on a business

7.            'Business' is defined by subsection 995-1(1) and includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

8.            Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? at paragraph 13, provides the general indicators of a 'business' established by the courts. The indicators are:

• 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 regularity and repetition of the activity

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

•         whether the activity is planned, organised and carried on in a businesslike manner such that it is described as 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 sporting activity.

9.            While no single indicator is decisive. Whether a business is being carried on depends on the 'large or general impression gained' (Martin v. FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551).

Application to your circumstances

10.          On balance we do not consider the Trustee to be carrying on the business of property development, subdivision and sale. This is based on a review of the relevant indicia of carrying on a business to the Trustee's circumstances.

11.          Overall, the Trustee's role and activities in the property development process outlined in the Development Agreement are relatively (but not entirely) passive. Notwithstanding the commercial nature and strong prospect of profit from the Development our view is that given the Trustee's lack of intention to conduct a business there would need to be more repetition in similar activities to conclude that the Trustee is carrying on a property development business.

Isolated commercial transaction

12.          Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income, provides guidance in determining whether profits from isolated transactions are income and therefore assessable.

13.          TR 92/3 considers the principles outlined in the Federal Commissioner of Taxation v. The Myer Emporium Ltd (1987) 163 CLR 199 case and provides guidance in determining whether profits from isolated transactions are income and therefore assessable under subsection 25(1) of the Income Tax Assessment Act 1936 (ITAA 1936).

14.          Where you are not carrying on a business, a profit from an isolated transaction is generally income when both of the following elements are present (paragraph 6 of TR 92/3):

(a)  the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; and

(b)  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.

15.          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 8 of TR 92/3).

16.          For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character (paragraph 12 of TR 92/3).

17.          Paragraph 13 of TR 92/3 provides some matters which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction, which are the following:

(a)  the nature of the entity undertaking the operation or transaction

(b)  the nature and scale of other activities undertaken by the taxpayer;

(c)   the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

(d)  the nature, scale and complexity of the operation or transaction;

(e)  the manner in which the operation or transaction was entered into or carried out;

(f)    the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

(g)  if the transaction involves the acquisition and disposal of property, the nature of that property; and

(h)  the timing of the transaction or the various steps in the transaction

18.          In very general terms, a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations (paragraph 49 of TR 92/3).

19.          Paragraphs 41 and 42 of TR 92/3 considers the purpose of profit-making for the sale of property:

41.  The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation 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 decisions in White v. FC of T (1968) 120 CLR 191; 15 ATD 173 and Whitfords Beach demonstrate, that is not always the case. (See also Menzies J in FC of T v. N.F. Williams (1972) 127 CLR 226 at 245; 72 ATC 4188 at 4192-4193; 3 ATR 283 at 289 and Whitfords Beach Pty Ltd v. FC of T (F.C.) 79 ATC 4648 at 4659; 10 ATR 549 at 567).

42.  For example, if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either:

(a)  as the capital of a business; or

(b)  into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction,

the activity of the taxpayer constitutes the carrying on of a business or a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income although the taxpayer did not have the purpose of profit making at the time of acquiring the asset.

Application to your circumstances

Ordinary income

20.          Income from the sale of the lots associated with the development of the Property constitute ordinary income under section 6-5, as it represents 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 [1]

•                     of sufficient scale, duration and complexity to go beyond the mere realisation of a capital asset in an advantageous way.[2]

21.          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[3]. It is sufficient in this context that the profit arises under an undertaking or scheme which exhibits the characteristics of a business deal[4].

22.          In the present case, more is involved in the development of the Property than merely dividing land into several allotments. Rather, the development is on a massive scale, involving more than one landholder across large parcels of land. The Development has involved significant planning with the local council and the Developer in terms of the laying out and construction of major infrastructure and public amenities[5]. 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[6].

23.          The considerable magnitude[7] of the Development which includes the Property is reflected in a number of different ways, including:

•                     the overall estimated developable area

•                     the area of the Property and the number of lots involved is substantial

•                     the length and duration of the project

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

•                     additional landowners involved in the overall development.

•                     the controllers initial and continual attendance at the Developers presentations.

•                     the agreements entered into by the Trustee with the Developer

•                     the number of lots the Developer expects to create from the Property.

•                     the total future sales value of the overall development

•                     Total estimated net sales proceeds to the Trustee for the life of the project.

24.          The activities undertaken exceeded the "mere realisation" of a capital asset. There was a degree of sophistication and complexity to the Trustees efforts to select and engage with the Developer and the other landholders on the development of the Property to maximise profits.

25.          In a practical sense the Trustee participated in the collective development of a large area of land, which included the Property, with other landowners. This is reflected in the agreements, including the complex terms of the Development Agreement. These agreements contemplate the scale and scope of planning for the development, the development and associated costs, GST obligations, funding and how the proceeds from the development will be dealt with.

26.          The facts presented reflect the history of interactions with a number of stakeholders including fellow landholders, neighbours, various developers, legal representatives and the council to optimize the Trustee's intent to maximise profit from the sale of the Property. Having determined that the Property could be sold most profitably through the appointment of the Developer and coordination with other landowners, the Trustee pursued opportunities for collective development of the Property.

27.          The Trustee's readiness to become involved with the Developer and other landowners was more consistent with a commercial undertaking than a mere realisation[8]. Viewed objectively, the Trustee's purpose was not merely to sell the Property; but rather to embark, through their agents, upon a business-like and efficient program of development and subdivision[9].

28.          The Property was used by the Trustee for farming and breeding livestock for sale.

29.          However, the Trustee after attending developer presentations and considering options for the development of the Property, including offers made to them by the Developer, entered into a number of agreements. The agreements contained a detailed description of the property development scheme and the parties obligations and intentions therein.

30.          The scheme they committed to for the development of the Property exhibit the characteristics of a commercial undertaking and business dealings, that are of sufficient scale duration and complexity that it goes well beyond the mere realisation of the Property, in an advantageous way.

31.          We consider entering into the agreements with the Developer is considered commercial in nature on the basis of the following factors:

•         the scale of the transaction/project is very large.

•         the Developer who is a professional development company.

•         the Development Agreement is complex, and the scheme is clearly undertaken as a commercial undertaking and conducted in a business-like manner.

32.          After a point in time the Trustee was not a mere passive investor they accepted responsibilities and continuing involvement in the property development contemplated under the agreements including:

•         providing the Land as security, through registered mortgages, security agreements, security interests and other guarantees for the various finance facilities obtained by the Developer to fund the development, to which they are a party.

•         maintaining true and proper accounts of all Development costs, Development fees and other sums paid and received by them as contemplated by the Development Agreement

•         to act as party to all sale contracts as legal owner.

•         to have responsibility to determine whether the sale of each lot is a taxable supply

•         the responsibility to deal with sale proceeds as per the Development Agreement.

33.          We consider that the arrangement went beyond a mere realisation of the Property by the Trustee. The scheme is significant in size and carries the hallmarks of a commercial transaction.

34.          The agreement to allow the Property to be used as security for the various finance facilities in order to fund the Development indicates a preparedness for the Trustee to be exposed to the risks associated with developing the Property.

35.          As a reward for this risk, the Development Agreement provides for the Trustee to share profits from the Development with the Developer. These will yield net sale proceeds for the life of the project from the sale of the Property, to the Trustee.

36.          The Trustee engaged with the Developer, made agreements with other landholders, committed and provided the Property as security to obtain finance for the Development and has ongoing responsibilities to maintain accounts, execute sales contracts and remit GST. The end result will be the subdivision and sale of residential allotments. All of these actions support the view that the arrangement goes well beyond realising a capital asset and constitutes an isolated profit making undertaking or commercial transaction.

37.          In conclusion, the Trustee ventured into and committed the Property to a profit making undertaking on a specified date and profits from the sale of the subdivided land will be assessable to the Trustee as ordinary income under section 6-5.

Question 2

Will the sale of the subdivided land give rise to a capital gain under Part 3-1?

Summary

38.          The sale of the subdivided land will give rise to a capital gain under Part 3-1.

Detailed reasoning

39.          CGT event A1 occurs when the Trustee disposes of their ownership interest in the lots to another entity. The sale of the subdivided land will give rise to a capital gain under Part 3-1 and Part 3-3 when the individual lots of land are sold.

40.          However, section 118-20 reduces the capital gain assessable by the profit already reported as assessable income under section 6-5.

[1] 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.

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

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

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

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

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

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

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

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