Edited version of private advice

Authorisation Number: 1052315065179

Date of advice: 8 October 2024

Ruling

Subject: Capital v revenue

Question 1

Would the sale of interests in land be a mere realisation of a capital asset?

Answer

No.

Question 2

Does the outcome for Question 1 change on the passing of the Wife and the continuation of the agreement with the Son and Daughter?

Answer

No.

This ruling applies for the following periods:

Income year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The Family

1.    The Family consists of:

•         the Husband who passed away on DD MM YYYY;

•         the Wife who passed away on DD MM YYYY and was XX years old at the time of signing the Development Agreement;

•         the Son; and

•         the Daughter.

The Property

2.    A property was acquired by the Husband and the Wife (the Land) initially in YYYY.

3.    The Family's primary residence was on the Land and it is where they raised their children and lived until the Husband's death.

4.    A partnership which consisted of the Husband and the Wife carried on the business of primary production - mainly cattle farming on the Land.

5.    After the Husband's death, the Wife continued to reside on the Land and conduct the cattle grazing farming enterprise through the Estate Partnership. Although, these activities were reduced in scale.

6.    Following the Husband's death, the Estate Partnership was registered for GST.

•         The Estate Partnership was created prior to any land development activities. Its sole purpose was to carry on the farming enterprise.

•         The Estate Partnership was never involved in any land development activities.

•         Following the Wife's death, the partners in the partnership were the Son and Daughter with 50% each.

7.    XX hectares is the subdivision property (the Property) which is the only land subject to this Private Ruling.

8.    Apart from the Property, the balance of the Land (including the residence) was sold separately.

Rezoning the Property

9.    The Husband, before he passed, with the aid of local Property Valuers and Advisors, prepared a successful rezoning application for the area of land that comprised of the Property.

10.  The Husband's intention was to benefit from any value increase for a sale due to the rezoning and to make the land more attractive to potential buyers in the event of a future sale.

The first offer (pre-Development Approval)

11.  A sale of the whole of the Land was considered for $XXX which was considered well below what the Land was thought to be worth. This sale did not proceed.

The Development Application

12.  It is stated that at some point the Husband and the Wife decided to sell the Property with Development Application (DA) approval.

13.  Local Property Valuers and Advisors lodged the initial DA on behalf of the Husband and Wife.

14.  The Council resolved to issue a partial consent for the DA and required further assessment to be undertaken to determine the outcome of the DA.

ABC offer (post-Development Approval)

15.  A proposal for joint venture, was exchanged between the Family, a financier and a development company. This proposal outlined the roles of each of the parties and included a financial summary of the development.

16.  The following three options for the development of the Property were received:

•         Option 1 - an outright purchase of the Property.

•         Option 2 - development undertaken on a stage-by-stage basis.

•         Option 3 - an outright purchase of the Property. This option involved a reinvestment for the Family to receive a share of the development profit.

17.  The Wife received further correspondence advising that business conditions required them to rethink the approach to the development project and proposed the following two options:

•         Option 1 - to pursue the development themselves.

•         Option 2 - the project continues to Construction Certificate attainment.

18.  The Development Company withdrew this offer (and all options) following the Global Financial Crisis. This sale did not proceed.

XYZ offers (post-Development Approval)

19.  XYZ Group (XYZ) were property developers and project managers. The Son was the Family representative in respect of the relationship with XYZ and following the passing of the Wife made decisions in relation to the development for himself and the Daughter.

20.  XYZ made three different proposals to the Family with a number of options including an offer of an outright purchase, purchase and joint venture, and an arrangement for the development of the Property.

Final proposal

21.  In their final proposal XYZ sent correspondence advising that they had reviewed their previous proposals and they made the following final proposal as summarised:

•         The Family and XYZ enter into a DMA allowing XYZ to manage the development of the Property, in stages and provide funding for the development costs at an agreed rate of capitalised interest.

•         The proceeds from the sales of individual blocks are to be distributed at settlement as X% to the Family and Y% to XYZ (being profit before tax).

•         A mortgage to XYZ will be provided as security.

22.  A Subdivision Plan was provided to the Family which detailed the subdivision stages, subdivision program, servicing/construction costs, estimated gross realisation, rate of sale, revenue cashflow projections, a valuation/feasibility study, and indicative cash flow analysis for the Property.

23.  A master plan design/mix and subdivision programme for the Land Subdivision was prepared (Subdivision Plan). The Subdivision Plan was provided to the Family and detailed the subdivision stages, subdivision program, servicing/construction cost, estimated gross realisation, rate of sale, revenue cashflow projections, a valuation/feasibility study with development approval and indicative cash flow analysis for the Property.

The Development Management Agreement

24.  A Deed outlining the terms of the development management agreement was entered into (the DMA) between the following parties, the Family (the 'Landowners'), the Developer, and the Guarantor.

25.  The DMA details the roles of the parties, and the purpose of the agreement as summarised:

•         The Landowners are the registered proprietors of the Property and have consented to entering into a DMA with XYZ. The Landowners will contribute the Property, and XYZ will handle the development in stages.

26.  Main terms in the DMA have been summarised.

27.  After the DMA was entered into, the separation of the Property subject to the agreement into saleable lots commenced.

28.  The lots were developed, and the sales proceeds as set out in the DMA were payable to the Family and to XYZ.

29.  Estimated gross sales and returns were not realised as projected and the length of time for the development of the Property exceeded what was initially proposed.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1997 section 6-5

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

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

Income Tax Assessment Act 1936 subsection 25(1)

Reasons for decision

Question1

Summary

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

Detailed reasoning

There are three ways the proceeds form a land subdivision can be treated for taxation purposes:

• assessable ordinary income under section 6-5 as income from carrying on a business of property development; or
• assessable ordinary income under section 6-5 as income from an isolated commercial transaction with a view to 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 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.

Change of intention

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.

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 a capital asset.

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 of property development

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

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.

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 the circumstances

On balance we do not consider the Landowners 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 Landowners' circumstances

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

Isolated commercial transaction

Taxation Ruling 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.

TR 92/3 considers the principles outlined in Federal Commissioner of Taxation v. The Myer Emporium Ltd (1987) 163 CLR 199 (Myer) 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).

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.

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).

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).

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

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).

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 the circumstances

Ordinary income

In the Landowners' circumstances, more is involved in the development of the Property than merely dividing the land into several allotments. Rather, the development is on a large scale with significant prior planning with the Council and the Developer in relation to the development on the Property. This amounts to development and improvements of the land to such a marked degree that it is impossible to say that it will give rise to a mere realisation of an asset.

The considerable size and profit making potential of the development is reflected in several different ways, including:

• the overall developed area was XX hectares, which ultimately created more than XX lots, in X stages.
• the information detailed in the Subdivision Plan estimated:

­   total net revenue for the overall development projected at $XXX,

­   development costs and interest projected at $XX, and

­   the net proceeds to the Landowners based on the profit split projected at $XXX.

• complexity of the DMA entered into by the Landowners with XYZ.
• the development was undertaken and completed over a number of years.

The terms of the DMA contemplate the scale and scope of planning for the development, associated costs, GST obligations, funding, and how the proceeds from the development will be dealt with.

The facts presented reflect the history of interactions with several stakeholders including various developers, legal representatives, and the Council to optimise the Landowners' intent to maximise profit from the sale of the Property. The Landowners received offers to purchase the Property outright, but these were rejected or due to the Global Financial Crisis did not proceed. Having determined that the Property could be sold more profitably through the appointment of a developer, the Landowners pursued opportunities for development of the Property through XYZ.

The Landowners' readiness to become involved with the Developer was more consistent with a commercial undertaking than a mere realisation. Viewed objectively, the Landowner's purpose was not merely to sell the Property; but rather to embark upon a business-like program of development and subdivision.

An objective assessment of the facts indicates that the purpose behind the purchase of the Land was to carry on a cattle grazing farming enterprise. After the Husband's death, the Estate Partnership carried on the cattle grazing farming enterprise.

At some point, the Landowners decided to sell the Property with DA approval. The Landowners, with the assistance of local property valuers and advisors, prepared and lodged a DA.

The Landowners considered options for both the sale and the development of the Property, including proposals made to them by ABC, and multiple proposals by XYZ. The Landowners, after considering the various proposals, then entered into the DMA, with XYZ. The DMA contained a description of the property development scheme and the parties' obligations and intentions.

In entering into the DMA, the Landowners accepted XYZ's offer for the development of the Property and confirmed their intention to venture into and commit the Property to a profit-making undertaking.

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

We consider entering into the DMA with XYZ to be commercial in nature on the basis of the following factors:

• the scale of the transaction/project was significant and involved development over a number of years in multiple stages.
• XYZ is a professional development company with decades of industry experience.
• the DMA is complex, and the scheme is clearly undertaken as a commercial undertaking and conducted in a business-like manner.

The Landowners were not mere passive investors, they accepted responsibilities and continuing involvement in the property development contemplated under the DMA. Several clauses within the DMA provide for the Landowners being actively involved in the decision-making process, and various other rights.

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

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

As a reward for this risk, the DMA provides for the Landowners to receive X% of the proceeds from the development. At the time of entering into the DMA, this was projected to be $XXX.

The Landowners engaged with XYZ, committed and provided the Property as security to obtain finance for the development and had ongoing responsibilities to maintain accounts, execute sales contracts, be involved in setting prices for lots, be involved in choosing tenderers, and provide reports and documentation in relation to road links. All 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.

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

In conclusion, the Landowners ventured into and committed the Property to a profit making undertaking and profits from the sale of the Lots associated with the development of the Property constitute ordinary income under section 6-5.

Question 2

Summary

The outcome for Question 1 does not change on the passing of the Wife and the continuation of the Agreement with the Son and Daughter.

Detailed reasoning

The DMA provides that it shall be binding upon and endure for the benefit of each of the parties and their respective successors and assigns.

As such, the DMA binds the Son and Daughter as the sole beneficiaries of the Wife's estate upon her death.

The Property was ventured into a profit making undertaking and profits from the sale of the Lots associated with the development of the Property constitute ordinary income under section 6-5 for the Son and Daughter.