Private ruling: Sale of property – capital gains
Date of advice: 30 November 2016
Published: January 2017
Ruling period: Year ending 30 June 2017 | Year ending 30 June 2018
Date scheme commenced: 1 July 2016

Ruling: Q1: Will the sale of townhouse ‘C’ and townhouse ‘D’ be a mere realisation, with the result that the sale proceeds from the sale of those townhouses are on capital account? | A1: No. | Q2: Will the profit made on the disposal of townhouse ‘C’ and townhouse ‘D’ be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: Yes. | Q3: Will the disposal of townhouse ‘C’ and townhouse ‘D’ to the extent that the capital gains relate to the share of the property that you acquired in 1975 (other than capital works), will those capital gains be disregarded under section 104-10(5)(a) of the ITAA 1997? | A3: Yes. | Q4: Will the disposal of townhouse ‘C’ and townhouse ‘D’ to the extent that the capital gains relate to the share of the property that you acquired in 2010, will that capital gains be a discount gain within the meaning of section 115-5 of the ITAA 1997? | A4: Yes. | Q5: Under section 118-20 of the ITAA 1997, are you entitled to reduce any capital gains made by the disposal of townhouse ‘C’ and townhouse ‘D’ by any amounts which are included in your assessable income under 6-5 of the ITAA 1997 | A5: Yes.


Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 10-5 | Income Tax Assessment Act 1997 section 102-5 | Income Tax Assessment Act 1997 section 104-10 | Income Tax Assessment Act 1997 section 112-25 | Income Tax Assessment Act 1997 section 118-20

Reasons for decision: Summary: There are three ways profits from a land subdivision can be treated for taxation purposes: 1. As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock. 2. As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of an isolated business transaction entered into by a non-business taxpayer or outside the ordinary course of business of a taxpayer carrying on a business, which is the commercial exploitation of an asset acquired for a profit making purpose. 3. As statutory income under the capital gains tax (CGT) legislation, (sections 10-5 and 102-5 of the ITAA 1997), on the basis that a mere realisation of a capital asset has occurred. | Detailed Reasoning - Ordinary income: In your situation, the Commissioner is satisfied you are not carrying on a business of property development. The repetition, scale and volume of your activity is not of the same nature as is ordinarily carried on by a property developer that is carrying on a business. 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. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium). Taxation Ruling TR 92/3 considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income. TR 92/3 defines the term ‘isolated transactions’ as: ● transactions outside the ordinary course of business of a taxpayer carrying on a business; and ● 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. If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayers business but: ● the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain, and ● the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction. Whether an isolated transaction is business or commercial in character 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 subdivided land can be assessed as ordinary income within section 6-5 of the ITAA 1997. TR 92/3 lists the following factors to be considered: 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 the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135 ( Casimaty ), the legal principles in relation to the subdivision of land were discussed at length. In concluding his judgment that the subdivision of the taxpayer was a mere realisation of a capital asset, Justice Ryan said, at 97 ATC 5152: Nor did the taxpayer undertake any works on, or development of, the land beyond what was necessary to secure the approval by the municipal authorities of the successive plans of subdivision and enhance the presentation of individual allotments for sale as vacant blocks. Had he constructed dwelling houses, internal fencing or other improvements, it would have been easier to impute to him an intention to carry on a business of land development and improvement. [Emphasis added] In addition to the above general factors, Miscellaneous Taxation Ruling MT 2006/1 provides a list of specific factors relevant to isolated transactions and sales of real property. If several of the factors are present, it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows: ● there is a change of purpose for which the land is held; ● additional land is acquired to be added to the original parcel of land; ● the parcel of land is brought into account as a business asset; ● there is a coherent plan for the subdivision of the land; ● there is a business organisation – for example a manager, office and letterhead; ● borrowed funds financed the acquisition or subdivision; ● interest on money borrowed to defray subdivisional costs was claimed as a business expense; ● there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and ● buildings have been erected on the land. No single factor is determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities. | Detailed Reasoning - Application to your circumstances: In your case, you acquired a property that you lived in as your main residence for more than a number of years. But this is not what you are selling. You will subdivide the land into a number of separate blocks. One block will contain your newly constructed main residence in townhouse ‘A’ and separate townhouses will be constructed on the remaining subdivided blocks. You will retain townhouse ‘B’ and sell townhouse ‘C’ and townhouse ‘D’ in ‘off the plan’ sales. Accordingly, your intentions in relation to townhouse ‘A’ and townhouse ‘B’ are very different to your intentions for townhouse ‘C’ and townhouse ‘D’. This private ruling only considers your intentions in relation to townhouse ‘C’ and townhouse ‘D’ which you expect to sell for some $X. In accordance with the direction provided in Taxation Ruling TR 92/3 and Miscellaneous Taxation Ruling MT 2006/1 we consider that the activities amount to significantly more than the mere realisation of an asset to its best advantage. There is a coherent plan in place to carry out a sequence of actions that will result in a sale for a profit, there is a change of purpose for which the land is held as the land was originally held as your main residence. There is a level of development of the land beyond that necessary to secure council approval for a subdivision and buildings will be erected on the subdivided land. You will also borrow money to finance the development. On a weighing of the facts of your case we find that the subdivision and construction of the townhouses will constitute a profit-making scheme. Accordingly the profits from the transaction will be considered ordinary assessable income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Capital gains tax: Capital gains tax (CGT) is the tax that you pay on certain gains you make. You may make a capital gain as a result of a CGT event, happening to an asset in which you have an ownership interest. The most common CGT event, CGT event A1 (section 104-10 of the ITAA 1997), occurs when you dispose of your ownership interest in a CGT asset to another entity. Section 112-25 of the ITAA 1997 confirms that the subdivision of land does not cause a CGT event to occur. As such, you do not make a capital gain or capital loss at the time of the subdivision. You bring forward the acquisition dates of your interests in the property to each subdivided block of land. You apportion the cost base of the property among the subdivided blocks on a reasonable basis. You will make a capital gain or loss at the time you enter into a contract for the disposal of a subdivided block of land and unit. Section 118-20 of the ITAA 1997 primarily exists to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. In the absence of such a provision, it is conceivable that a receipt properly characterised as ordinary income and which has also been derived as a result of a CGT event could result in the receipt being taxed twice. Therefore, whilst CGT event A1 occurred due to the sale of townhouse ‘C’ and townhouse ‘D’, any capital gain will be reduced to the extent of any amount already included as ordinary assessable income under section 6-5 of the ITAA 1997.

Relevant facts: The arrangement that is subject of the private ruling is described below. This description is based on the following documents. These documents form part of, and are to be read with this description. | You and your Spouse, (‘E’) acquired a property (The dwelling). | The dwelling was acquired for a purchase price of $X. | The land size is a number of square metres and consists of a multi bedroom house, large garden and swimming pool. | The dwelling was constructed in some time ago and is a number of square metres in size. | The dwelling has always been your main residence. | The dwelling has not been used to produce assessable income or for commercial purposes. | Around 2010, ‘E’ began suffering severe ongoing health problems and as a result it was decided to transfer title of the dwelling to you. | The market value of the dwelling in 2010 around the time of the transfer was approximately $X. | The dwelling requires maintenance and upkeep and will require modification as your mobility decreases and as a result the dwelling is no longer appropriate for your needs. | You have a significant social network in the local area. | You have an existing mortgage on the dwelling of $X | You will re-develop the property by undertaking the following; | ● Obtaining planning permits | ● demolish the existing dwelling | ● construct 4 adjoining townhouse type dwellings | ● Subdivision of the land will be required and 4 new titles will be registered. (townhouse ‘A’, townhouse ‘B’, townhouse ‘C’ and townhouse ‘D’. | You will retain townhouse ‘A’ as your main residence. | You will retain townhouse ‘B’ as an investment property. | You will sell townhouse ‘C’ townhouse ‘D’ in ‘off the plan’ sales to third party purchasers. | You require bank finance in order to undertake the construction of the townhouses. | The dwelling is currently valued at approximately $X. | The costs of undertaking the redevelopment will be approximately $X. | You will sell Townhouse ‘C’ and townhouse ‘D’ for approximately $X. | The timeframe for the construction to be completed is approximately a number of months. | You operate a retail clothing business. | You are registered for GST in relation to the retail clothing business. | You also own a commercial property which returns an amount in rent during the 2016-17 income year. | You are not otherwise engaged in property development, the purchase of real property for profitable sale or profit making undertaking. | The subdivision will be undertaken by independent contractors. | Your children, ‘F’ and ‘G’ will undertake project management roles in relation to the development. | ‘G’ is an architect who operates their own architecture business. | Your involvement in the construction will be limited.