Private ruling: Income tax and GST implications of subdivision and sale of land
Date of advice: 19 July 2018
Published: September 2018

Ruling: Q1: Will the proceeds from the sale of the individual subdivided lots be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Will the proceeds from the sale of the individual subdivided lots be subject to the capital gains tax provisions in Part 3-1 to 3-3 of the ITAA 1997? | A2: No | Q3: Are your supplies of the subdivided lots taxable supplies pursuant to section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)? | A3: Yes

Relevant facts and circumstances: History of property The land that is the subject of this ruling was originally owned and acquired by an entity M many years ago and consisted of farmland with a house. The principal purpose of M acquiring the land was for the commercial advantage of the business of its parent entity, N. At the time, it was thought that the land could be subdivided and sold in the near future to residential land buyers. It was hoped that N would commercially benefit from housing to be constructed on this land. The business was operated by N, then by two individuals in partnership, named A and B. It was thought the family business would also profit from being able to provide services to the developers. M was established as a wholly-owned subsidiary of N many years ago. The land was share farmed and the house situated upon the land was rented out. A and B still remain directors of N. C, in his capacity as trustee for D’s Estate, is also a shareholder. The initial plans of M to subdivide and sell the land to residential buyers for the commercial benefit of N’s business were unable to be advanced during this period due to an inability to obtain the necessary rezoning of the land. After a few years, part of the land became available for rezoning as services had become available to the land. M decided to subdivide and sell half of the property to residential land buyers. Due to council planning and engineering limitations in place at that time, only around half of the land could be subdivided. An application to rezone the land was made by M after a few more years. This was not allowed due to objections from neighbouring landowners. Acquisition of the property by A, B and D A decision was made by some of the older shareholders and directors of N to retire and realise the value of the remaining undeveloped land. It was at that time still not viable to sell the remainder of the land to residential buyers as the rezoning restrictions still existed. Three of the younger members of the family, A, B and D, who were taking over the management of the family business, decided to buy the remaining land through a nominee entity, ABC. The Land was vacant land at the time of acquisition by ABC. ABC was formed around the same time and A, B are the sole shareholders and hold one share each. A and B are both directors of ABC. C is the legal personal representative of the Estate of D, who is deceased. In this regard, ABC legally represents A, B, and C (as LPR for the Estate of D). The beneficiaries of ABC in its trustee capacity refer to their beneficial ownership of the land legally owned by ABC as a ‘partnership’ and themselves respectively as the ABC Partners. A formal declaration of trust and agreement with A, B and D (Beneficiaries), as beneficial owners of the Land, was executed around this time. A copy of the Declaration of Trust and Agreement with Beneficial Owners (Declaration of Trust) was supplied. Under the Declaration of Trust the Beneficiaries agreed with ABC that: ● ABC would complete the purchase of the land on their behalf; ● The Beneficiaries agreed to indemnify the Trustee against all actions the Trustee took in relation to the land and to undertake to pay and provide the Trustee all expenses incurred by it on their behalf and to take all necessary actions reasonably required of them by the Trustee in relation to the land; ● The Beneficiaries will share and pay all proceeds and expenses; ● The Trustee will transfer legal title to the Beneficiaries if called upon to do so; ● The Beneficiaries will undertake to provide the trustee from time to time with clear comprehensive and precise instruction and direction in relation to the occupation use and development of the land and to provide the Trustee with sufficient funds and resources to enable the Trustee to carry out and implement those instructions and directions; ● Each of the Beneficiaries will, as required meet to reach a decision on the instruction and direction to be given to the Trustee. ABC put in an application for rezoning in conjunction with a neighbouring landowner a few years later. The council did not approve this due to some concerns. A, B and D as beneficial owners of the land created a partnership and soon after registered the partnership for GST. The Partnership‘s GST registration was cancelled recently. The Land was acquired with the intention of subdividing it sometime in the future when it became viable for subdivision. There was uncertainty around whether this would ever occur. Also, the ABC Partners continued to hold the expectation that the family business would benefit by being a supplier of materials for homes built on this land. Some portions of the land holding were compulsorily acquired by public authorities during this time for the construction of the main thoroughfare. From then until now ABC on behalf of the ABC Partners have been leasing the Land to a neighbouring farmer for livestock agistment purposes. The property has been accounted as a non-current capital asset in the books of the partnership More recently, the ABC Partners became aware that the owner of the neighbouring farm land was considering subdividing his land. He had farmed that land for many years and was the farmer who was leasing the land from the partners for many years. In addition, the farm land was located in an area where residential development was encroaching and the subsequent potential for rezoning of the property threatened the viability of his farming business. The decision of the farmer to realise his land and cease farming activities prompted ABC on behalf of the ABC Partners to also consider subdivision. It also became apparent that the barriers to the realisation of this remaining land by way of subdivision had been reduced. In particular, there had been a rapid wave of residential development of surrounding land leading up to that time. The main thoroughfare had recently been completed which formed the parameters for residential land development in the area where the land was located. This region had been earmarked by planning authorities as a major site of future population growth for the City. Access to water and sewerage services to the Land had been established by water authorities in the preceding years. The neighbouring farmer had been approached by property development company XYZ a few years ago who had offered to undertake a potential subdivision of his property into residential lots. The ABC Partners discussed their plans with the neighbour and realised there would be some mutual benefits in the subdividing and selling of both landholdings at around the same time in terms of streamlined planning application and development costs. Another reason for the decision to sell the residual Land at this time was that A and B had sold the majority of their interests in the family business prior to that time. From that point onwards they could no longer expect to benefit from the future construction of housing on the Land as any enhanced profits of the family business that might be connected to that construction would no longer substantially flow to them as the sole owners of the business. The Development ABC as nominee for the ABC Partners entered into a Development Management Agreement (DMA) with XYZ. The parties to the DMA are set out as ABC (the Landowner) and XYZ (the Manager). The DMA provides that the Landowner appoints the Manager to carry out the Development Management Services. The DMA also provides that in consideration of and subject to the manager carrying out its obligations under the DMA the Manager is entitled to the Development Management Fee plus GST. The structure of the fee is also set out. The fee structure provides for a percentage of gross sales to be paid from sale of individual lots for Management Fee, Marketing, Administration and Branding Fees. Each fee has a corresponding percentage of gross sales payable upon settlement of the sale of each subdivided lot. The DMA also provides that subject to any direction by the Land Owner to the contrary, the Manager is the only person authorised to negotiate any contract on behalf of the Land Owner but the Manager must report on the progress of the negotiations to the Land Owner on a regular basis and is not entitled to commit to any agreement without it being authorised by the Land Owner. The Manager must have regard to the intention of the Land Owner in negotiations to maximise Project Profit. It provides that the Manager must ensure that all Development Consultants engaged to provide consultant services in connection with the project are engaged by the Manager as disclosed agent for the Land Owner. An annexure to the DMA provides scope of services covered and delegated to the Manager for management of the Project and payment of the Development Management Fee. Duties include: ● Making applications for Rezoning of the Land or Adjacent land. ● Procuring or arranging a Loan Facility. ● Arranging appropriate insurances. ● Preparing financial analyses and development program. ● Reporting on progress of project to Land Owner when requested by Land Owner. ● Providing the Land Owner with detailed monthly reports, including ● determinations required by the Land Owner, ● status of Development Objectives and the Project, ● status of Development Consultants, ● progress of approvals and any conditions imposed on their approval, ● progress of sales, ● update on Project costs, ● details of any delays, and ● revised Project Budgets. ● Appointing real estate agents and other representatives required in regard to the Project. ● Recovering any Retentions. ● Ensuring services are completed as expeditiously as possible. An application was made to the Council to have the land rezoned and this was approved recently. Advertising of Stage 1 commenced shortly after and presales of the lots have commenced. Settlement is expected within a few years. The ABC Partners, through ABC, are funding the development process as per the Declaration of Trust and XYZ presents financial and progress reports to them, via the directors. ABC Partners claimed the development costs as it believed at the time that the activity was an enterprise activity however it then decided that it wasn’t entitled to be registered for GST and cancelled its GST registration. Subsequently, XYZ has entered into an agreement to develop part of the adjoining land owned by a second neighbour on a similar basis. Neither ABC nor the ABC Partners received any offers to purchase this land prior to the agreement with XYZ. Nor did they attempt to sell the land in an un-subdivided state. Since signing the DMA ABC through XYZ as it agent and manager: ● Applied for rezoning of the land from farming and public usage to General residential usage and received approval in just recently. ● Lodged an application for a council planning permit for a staged subdivision of the Land which was approved in one month later. Details of Subdivision The details of the subdivision are: ● The Land is nearly XX hectares in size. ● The plan is to subdivide the land into many lots and to conduct the development over numerous stages. ● The project is scheduled for completion in over about five years ● The project is expected to cost multi million dollars ● Total estimated gross revenue from the development also may millions of dollars. ● No additional development, i.e. buildings, will be undertaken on the subdivided land. ● Advertising of Stage 1 commenced recently and presales of the lots have commenced. Settlements are expected in within 18 months of sale. ● To date the Owner, ABC, has funded the development and expects to continue. XYZ have arranged access to a line of credit facility with a bank on ABC’s behalf which will be available. ● The interest costs will not be treated as a business expense ● The subdivision will involve the creation of roads, footpaths drainage, landscaping and the supply of utility infrastructure. The Project Control Group Minutes recorded that: ● One or all of the ABC Partners were present at each meeting. ● They approved minutes of previous meetings ● Were privy to reports on matters including heritage, drainage, traffic and water quality reports and were available to authorise relevant directions and paperwork ● Progress of council approvals were provided to the ABC Partners and updates to the development programme and various parts of the development process including updates on advertising strategies

Relevant legislative provisions: A New Tax System (Goods and Services Tax) Act 1999 Section 9-5, | A New Tax System (Goods and Services Tax) Act 1999 Section 9-20; | A New Tax System (Goods and Services Tax) Act 1999 Section 23-5; | A New Tax System (Goods and Services Tax) Act 1999 Division 188 | Income Tax Assessment Act 1997 Part 3-1 to 3-3; | Income Tax Assessment Act 1997 section 6-5; | Income Tax Assessment Act 1997 section 108-5; and | Income Tax Assessment Act 1997 section 118-20

Reasons for decision: Summary: The proceeds from the sale of the individual subdivided lots will be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997). | Detailed Reasoning - Detailed reasoning: For the purposes of this part of your Ruling in respect to the implications of the subdivision and sale of the Land for income tax purposes, the relevant taxpayer is identified as ABC as trustee for A, B and C ATF the Estate of D. Therefore, where we refer to ‘You’ in this part of your Ruling it will be to ABC in its trustee capacity. This decision to provide a ruling to ABC in its trustee capacity is based upon the Decision Impact Statement for Federal Court case Colonial First State Investments Ltd v. Commissioner of Taxation 2011 ATC 20-235 which provides that, outside the relevant CGT provisions and in situations where the facts are not materially the same as those of the Colonial case, the ATO has consistently been of the view that assets held on trust for beneficiaries form part of the relevant trust estate, the net income of which is subject to Division 6 of Part III. This view is consistent with other authorities, such as Harmer v Federal Commissioner of Taxation (1991) 173 CLR 264 and Di Lorenzo Ceramics Pty Ltd & Anor v FC of T 2007 ATC 4662 . The proceeds from the sale of land can be treated as: ● assessable ordinary income under section 6-5 of the ITAA 1997 from carrying on a business of profitable resale or property development, subdivision and sale; or from an isolated business or commercial transaction; or ● a realisation of a capital asset, assessable under Parts 3-1 and 3-3 of the ITAA 1997. The mere realisation of capital assets, such as land, does not give rise to income according to ordinary concepts if the realisation is merely carried out in the most advantageous manner ( Californian Copper Syndicate v Harris (1904) 5 TC 159). The Commissioner accepts that where the activities are no more than the mere realisation of a capital asset, any realised gain on the transaction will be a capital gain under the CGT provisions in the ITAA 1997. The expression 'mere realisation' is used to distinguish a mere realisation from a business operation or a commercial transaction carrying out a profit-making scheme. Profits made on the realisation of capital assets can still be ordinary income if the activities go beyond a mere realisation and instead become a separate business operation or commercial transaction even though the taxpayer did not have a purpose of profit-making at the time of acquiring the asset. Taxation Ruling TR 97/11 Income Tax: am I carrying on a business of primary production? provides guidance on the relevant factors to determine whether a business exists including whether the activity is carried on in a similar manner to that of the ordinary trade, size and scale of the activity and whether the activity is organised and carried on in a business-like manner. Even where the sale of subdivided land is not regarded as part of carrying on a business, an isolated business transaction for the purpose of profit making by sale may have occurred. Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) provides guidance to determine whether profits from isolated transactions are ordinary income. In Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199 the High Court stated at 211: …a receipt may constitute income, if it arises from an isolated operation or commercial transaction entered into otherwise than in the ordinary course of the carrying on of the taxpayer’s business, so long as the taxpayer entered into the transaction with the intention or purpose of making a relevant profit or gain from the transaction. Further, in relation to the intention of profit or gain, paragraph 38 of TR 92/3 states that the intention or purpose of the taxpayer is not the subjective intention or purpose of the taxpayer but is their purpose or intention discerned from an objective consideration of the facts and circumstances. It is also 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, pursuant to paragraph 40 of TR 92/3. The basic distinction between a sale of property as part of a business, or alternatively, as an isolated ‘profit making’ undertaking or scheme is that the latter will generally be a one-off event and not carried out in an overly organised or systematic manner. However, the overriding purpose and intention of the person entering into the venture must be to make a profit. Whilst a one off event will generally be an isolated profit making undertaking or scheme, repetitive buying and selling of property is not necessary to establish that a business is being carried on. It does not have to be shown that the taxpayer carried on a business of trading in land in the sense of buying and selling land with some regularity ( R & D Holdings Pty Ltd v DFC of T 2006 ATC 4472). A single acquisition for that purpose is sufficient (Taxation Determination 92/124: Income tax: property development: in what circumstances is land treated as ‘trading stock’? (TD 92/124)). A 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’ (Taxation Determination TD 92/124 and ATO Interpretative Decision ATO ID 2004/532). Federal Commissioner of Taxation v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693) ( Myer Emporium) is one of the leading cases which shows that the intention at the time of purchasing the asset is an important consideration in determining whether the proceeds received on disposal are on a capital or revenue account. According to the Myer Emporium case , the relevant intention or purpose of the taxpayer is not a subjective test. Rather, it is the intention or purpose as discerned from an objective consideration of the facts and circumstances of the case. Also, if the taxpayer is a company or trust, the courts determine its purposes by looking at the people who control the entity. In Whitfords Beach Pty Ltd v Federal Commissioner of Taxation (1983) 83 ATC 4277 (Whitford’s Beach) , the Full Federal Court determined the relevant time when the taxpayer's land was ventured in the taxpayer's business. The taxpayer’s intention at 20 December 1967 was to develop, subdivide and sell the whole of the land. It was envisaged from the outset that there would be a comprehensive plan relating to the entire land but that development and subdivision would occur in stages. At 20 December 1967, the land remained incapable of subdivision but the joint managers proceeded with their intention, including appointing a project manager to undertake relevant activities. In 1969 a new government direction led to the encouragement of development and housing in the area which included the taxpayer’s land. Planning and subdivision approvals were negotiated and in October 1969 rezoning of the taxpayers land occurred. The first subdivision application was approved in April 1970 and in December 1970 the first survey plan for 272 lots was lodged at the titles office. Once the first stage was in the course of development and subdivision, further areas were developed and subdivided, and numbers of different stages proceeded at the same time. The first sales of lots were made in 1971. The taxpayer’s proposition in the Whitfords Beach Full Federal Court case was that at least the initial activities from 20 December 1967, up to June 1969, was merely preparatory to, and did not form part of, its business of development, subdivision and sale of the land. The Full Federal Court held however that the relevant date as to when the land is ‘committed to’ or ‘ventured into’ a land development business is when the intention to take steps to develop and subdivide the land is formed, and activities directed to that end began; and this will typically begin when the taxpayer commits to the project by engaging the relevant parties to undertake the planning work. The Full Federal Court stated at 4283: Although what was done between December 1967 and June 1969 was, in a sense, preliminary to subdivision and development in the narrower sense of the steps which were directly involved in such operations, the activities in that period were an integral part of the business, and were seen as necessary at the time, even if some of what was done was subsequently rendered unnecessary because of changed circumstances. At least some of the activities during that period related to roads and services, etc., which were of relevance to the development of the whole land, irrespective of the order in which the various parts were later brought forward for development, and some of the activities were material to the determination of the appropriate or most desirable order of development of the land. Changes of plan, whether because of the Western Australian government's intervention in 1969 or for any other reason, and any consequential lack of ultimate utility of any of the steps which had previously been taken, do not in any way indicate that those steps were not taken in the course of the taxpayer's business in accordance with the taxpayer's proposals or hopes at the particular time. From June 1969 on, the position is even clearer. Whilst at any given time more attention may have been focused on one section of the land than other sections, it was the entire project which progressed stage by stage with operations in respect of some of the stages overlapping. The evidence is overwhelming that, although the project was to extend over a number of years and was to involve development in stages, there was from 20 December 1967 both a persistent intention to develop, subdivide and sell all of the deferred urban and rural land and a continuous course of conduct directed to the implementation of that intention. The conclusion seems inescapable that the taxpayer's business of developing, subdividing and selling the land commenced as soon as the intention to take steps for that purpose in relation to the entire land was formed and activities directed to that end were commenced on 20 December 1967. Relevant to the issue of a business of subdivision and sale is the relevant time when the subject land would become trading stock. The Commissioner’s view in this respect is stated in paragraphs 1 and 2 of TD 92/124 which states: 1. Land is treated as trading stock for income tax purposes if: ● it is held for the purpose of resale; and ● 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 definitive and continuous cycle of operations designed to lead to the sale of the land. The factors considered by the courts to decide whether the proceeds of the sale of subdivided land was income, from either carrying on a business or an isolated commercial transaction, or was merely the realisation of a capital asset include: ● whether the landowner held the land for a considerable period of time prior to any subdivision and sale; ● whether the landowner conducted farming or other non-developmental activities prior to beginning the process of developing and selling the land; ● whether the landowner originally acquired the land as a private residence or for recreational purposes; ● whether the landowner originally acquired the property as an investment, such as long term capital appreciation or to derive income; ● whether the land was originally acquired near the urban fringe of a major city or town; ● if the property has been recently rezoned, whether the landowners actively sought that rezoning; ● whether a potential buyer made any offers to the landowners before they commenced discussion to enter into a proposed or final development agreement; ● whether the landowners had tried to sell the land without subdivision; ● whether the landowner had any history of buying and profitably selling developed land or land for development; ● whether the operations will be planned, organised and carried on in a business-like manner; ● whether the landowners have changed their business activity relating to the land from one business to another (for example, from farming to property development); ● the scope, scale, duration and degree of complexity of the proposed development; ● who initiated the proposal to develop the land for resale; ● whether the development and pre-sale arrangement is sophisticated; ● whether the landowners will be actively involved in any development or sale activities; ● the level of legal and financial control maintained by the landowners in the proposed or final development agreement; and ● the level of financial risk borne by the landowner in acquiring, holding and/or developing the land. | Detailed Reasoning - Applying the law to the facts of your case: Whether a business is being carried on is a question of fact determined on a case by case basis with regard to a range of indicia including the intention of the landowner when they purchased the land and their subsequent use of the land. We believe you entered into a business of subdivision and resale of your Land at the point of time when the Land was definitively committed and ventured into that business by your entering into the Development Agreement. The facts in this case indicate that you had at the time you purchased the Land an intention to sell the Land by developing, subdividing and selling the Land, sometime in the future when restrictions were lifted. However, as per the Full Federal Court in Whitford’s Beach and paragraph 2 of TD 92/124, the relevant date as to when the land is ‘committed to’ or ‘ventured into’ a land development business is when the intention to take steps to develop and subdivide the land is formed, and activities directed to that end began; and this will typically begin when the taxpayer commits to the project by engaging the relevant parties to undertake the planning work. This was the date you entered into the DMA. The following factors established by case law and the above two taxation rulings, considered as a whole, support this conclusion. | Detailed Reasoning - The level of active involvement of the Landowners in the activities.: The form and substance of the DMA supports the conclusion that you are involved in the subdivision and property development business directly or through your representative Manager, XYZ. In accordance with the DMA the following procedures and items in the Development indicate the involvement and approvals required by the Landowner: ● Development Program outlining the sequence and duration of Approvals, design, construction and marketing phases of each stage of the Project; ● Project Budget outlining quarterly and annual budget of Project Costs to implement each part of Development Program prepared by the Manager; ● Stages of the Project; ● Subdivided lots outlining the lots in which the Land is to be subdivided in order to give effect to the Development Objectives; ● Manager has exclusive right to negotiate under the DMA but must not commit to any agreement without being authorised by the Landowner; ● Consultants are appointed by Manager as disclosed agent for the Landowner; ● Costs of resolving any disputes with consultants must be approved by Landowner; ● Termination of Consultancy Agreement with a defaulting Consultant must be approved by Landowner; ● Approval of Project Costs which cumulatively exceed a large monetary amount must be approved by Landowner; In addition, the Manager must: ● Report regularly to the Landowner about the progress of the Project when requested; ● Provide detailed monthly progress reports Conducting the business through a Development Manager such as XYZ does not preclude you from also carrying on a business. Appointing XYZ to manage the Project does not alter the fact that you, through the action you have undertaken, are actively involved in all major decisions of the Project. The clauses in the DMA indicate that decisions in regard to the Project are made by both the Development Manager and the Landowners. Also, all major decisions on expenditure, stages, other major decisions of the Project, must be approved by you, the Landowners. Therefore, we believe you did not have a passive role in this Project. You have been involved in decisions in this subdivision and development business. | Detailed Reasoning - The level of financial risk borne by the landowners and profit motive.: Generally the greater the level of financial risk assumed by the landowner in respect of the development of their land, the more likely that the landowner is carrying on a business or is engaged in a profit making undertaking. In your case you are bearing the financial risk of the Project. Whilst you engaged the Development Manager to undertake the Project, and such an engagement may in some cases limit your direct involvement in the Project, the Development Manager will incur little risk because the costs of the Project and subdivision will be your burden, as the Landowners. You are also “at risk” as a result of entering into the DMA. Under the DMA in regard to Termination of the DMA, the Landowners must pay to the Development Manager all Development Management Fees and other monies which remain unpaid after termination. Termination may occur by written agreement of the parties, on practical completion or by default of either party. The Landowner also has an irrevocable and unconditional responsibility to indemnify the Manager from and against liability and loss under the DMA. Public liability insurance, contract work insurance and worker’s compensation insurance must be taken out under the DMA. Under these clauses, you are exposed to potential losses from the development sales and will only receive any balance of sales proceeds after all costs are recovered by the Development Manager. You clearly had a view to profit and were ‘at risk’ engaging in the Project. The Development Manager incurs no risk as they are guaranteed a percentage of all sales. It is the Landowner who is financing the Project and who runs the risk if the Project failed. | Detailed Reasoning - The scope, scale, duration and degree of complexity of the subdivision and development.: When considering the scope, duration and degree of complexity of the subdivision and development the evidence supports that the eventual sales are less likely a mere realisation. This is because the more significant the development, as in this case, the more likely the active involvement of the Landowners, a business-like application of skill, the taking on of risk and a profit-making purpose. The eventual Project contemplated under the DMA is the carrying out of capital and other infrastructure works to subdivide, construct, improve or develop the Land for the purpose of a residential subdivisional estate. In accordance with the Project Budget provided, the proposed development is a large number lots over numerous stages, netting approximate revenue of over many millions of dollars. This is considered a large development. The duration is extensive with the planned completion of the last stage expected in five years and the scope and scale of the subdivision is complex with multi-stages. This Project goes well beyond what is necessary to prepare the land to be sold in smaller parcels. In the judgment of Deane J in the Federal Court in Whitfords Beach Pty. Ltd. v. Federal Commissioner of Taxation 79 ATC 4648 when distinguishing between revenue and capital, Justice Deane discusses a goldsmith who inherits a gold bar. Selling the gold bar as a whole would be on capital account, while dividing the gold and fundamentally transforming it into jewellery before selling it would be revenue. He goes further by stating at paragraph 4666: In a case where the asset has been divided and divided parts improved in the course of a business of dividing and improving such assets, it would be rare that one could say that the profits from sale of the individual improved items, after making allowance for the value of the original asset) represented part of the proceeds of mere realisation of the capital asset as distinct from profits made in the ordinary course of that business. Where the activities of dividing and improving are of sufficient scale and scope, the fact that no prior independent business existed will not prevent those activities themselves constituting a business of which the profits arising on sale are the ordinary proceeds. In your case, the Commissioner considers that the scope, scale and complexity of your Project goes beyond a mere realisation of a capital asset. It is carrying on of a business of property development, subdivision and sale. It will be a part of the greater Estate. | Detailed Reasoning - Relevant knowledge and skill: ABC’s directors or decision-makers have some knowledge and experience in the building industry. They have previously undertaken a development of residential property of the Land developed by M previously. As in this case, the appointment of a property developer does not mean the directors were passive in regard to that subdivision. Where you do not have sufficient knowledge and skill, you have engaged the relevant experts via the DMA to ensure your subdivision is undertaken in a businesslike manner in which you can utilise the greatest profitability on the sale of the lots. In isolation a landowner’s or in this case, the decision-makers, history and experience in land acquisition and development is not determinative of whether the landowner is carrying on a business or engaged in a profit making undertaking in relation to the Land. However, the more extensive a landowner and their decision maker’s history, together with other indicators of carrying on a business, the more likely future sales of land are considered as more than a mere realisation. | Detailed Reasoning - Applications for rezoning and planning approvals by the Landowners: The more deliberate and business-like the pursuit of rezoning activities or planning approval to facilitate a subdivision and sale, the more likely that future sales of land are considered as more than a mere realisation. In this case, ABC put in an application for rezoning in conjunction with a neighbouring landowner shortly after ABC’s acquisition of the Land. Council did not approve it due to various issues. As stated, this was consistent with ABC’s long term intention to subdivide and sell the land to residential land owners. This is a strong indicator of an intention of profit making and sale. However, it is considered that you only fully committed to the development upon entering into the DMA. | Detailed Reasoning - Conclusion: You have purchased the parcel of Land many years ago. The evidence in the case supports the fact that you had ventured the Land into a business of profitable resale or property development, subdivision and sale. The sale of the individual subdivided lots will therefore be sold on revenue account. We consider your profits to be income because: the Landowners had the intention or purpose to enter into a profit-making transaction and make profit or gain; and the transaction or conduct of a business operation has commenced upon entering into the DMA. After this date, you are considered to have commenced a definitive and continuous cycle of operations designed to lead to the sale of the land. Accordingly, based upon all the facts as a whole, the Commissioner is satisfied that you have commenced the business of property development and sale. Accordingly, the proceeds from the sale of the individual subdivided lots will be assessable under section 6-5 of the ITAA 1997. | Summary: The proceeds from the sale of individual subdivided lots will not be subject to the Capital Gains Tax provisions in Part 3-1 of the ITAA 1997. | Detailed Reasoning - CGT consequences of the sale of individual subdivided lots: A CGT asset is defined in section 108-5 of the ITAA 1997 and includes any kind of property. Specifically, each subdivided lot of land is a CGT asset. A capital gain or a capital loss will arise when a CGT event A1 happens to each subdivided lot of land. However, section 118-20 of the ITAA 1997 provides that a capital gain you make is reduced if the amount is otherwise assessable under another provision of the ITAA 1997. Therefore, whilst a CGT event may in fact happen, if an amount is otherwise included as ordinary assessable income under section 6-5 of the ITAA 1997 then any capital gain will be disregarded to the extent of that ordinary income included. Therefore, the receipts from the disposal of each subdivided lot of land will not be subject to the capital gains tax provisions. | Detailed Reasoning - Question 3: In this part of our reasoning, unless otherwise stated, ● all legislative references are to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) ● all legislative terms of the GST Act marked with an asterisk are defined in section 195-1 of the GST Act ● all reference materials referred to are available on the Australian Taxation Office (ATO) website ato.gov.au | Summary: The supplies of your subdivided lots will be taxable supplies as all of the requirements of section 9-5 will be met. | Detailed Reasoning - Detailed reasoning: Section 9-5 provides that you make a taxable supply if: (a) you make the supply for consideration (b) the supply is made in the course or furtherance of an enterprise that you carry on (c) the supply is connected with the indirect tax zone (Australia), and (d) you are registered, or required to be registered. However, the supply is not a taxable supply to the extent that it is GST-free or input taxed. Any supplies of the subdivided lots made under the arrangement as outlined in the relevant facts and circumstances will not be GST-free or input taxed. In addition the supplies are connected with Australia and consideration will be paid for the subdivided lots. Therefore we will need to determine: ● who is making the supplies of the subdivided lots ● whether the supply of the vacant lots is in the course of any enterprise and ● whether the relevant entity is required to be registered for GST. | Detailed Reasoning - Entity: A, B and D created a company ABC to acquire the Land under a document called a ‘Declaration of Trust’. Under the Declaration of Trust, A, B and D were required to fund any activities on the Land, make decisions about the use of the land and provide instructions to enable S to carry out their wishes. A, B and D created a Partnership (the Partnership) at the same time which leased the land for agistment purposes through ABC. The Partnership was registered for GST and reported the lease income from an agistment activity. Therefore we need to consider whether the subdivided lots will be supplied by ABC as trustee or the Partnership for purposes of the GST Act. We need to consider this because ABCs’ name has been used on the contracts associated with this activity however the Declaration of Trust indicates that ABC’s actions are only taken at the direction of A, B and D. The Commissioners view on dealings in real property by bare trusts is set out in Goods and Services Tax Ruling GSTR 2008/3 Goods and services tax: dealings in real property by bare trusts . Paragraph 1 of GSTR 2008/3 provides that this ruling: …applies to supplies of real property… involving bare trusts and similar trusts where the trustee has limited active duties and acts solely at the direction of the beneficiary or beneficiaries. Under the background section of GSTR 2008/3 it provides that: 11. An entity (B) that carries on an enterprise may, for reasons of convenience or anonymity, arrange for real property which is to be used in its enterprise to be acquired by another entity (T) to hold on a bare trust for B - that is, subject to an obligation to transfer legal title to the asset to B, or to a third party if B so directs, and with no other active duties to perform…. 12. Alternatively, the trust may not strictly be a bare trust, because the trustee has minor active duties to perform, but nevertheless the trustee is required to act at the direction of the beneficiary in dealing with title to the trust property. Where this Ruling refers to 'bare trusts' it should also be taken to refer to trusts of this kind which may not strictly fall within accepted definitions of bare trusts but share similar features. The key point is that the trustee only acts at the direction of the beneficiary in respect of the relevant dealings… in the trust property and has no independent role in respect of the trust property. 13. An example of an arrangement where a bare trust may be created is where a general law partnership… (B) decides to acquire and develop real property for sale. The partners may not wish to disclose their names to the vendor of the property and so arrange for a company (T) that they control to acquire title to the property. If there are a large number of partners, it may also be more convenient for the partnership to have a single company that can execute legal documents associated with the acquisition, development and disposal of the property. T acquires and holds the legal title to the property on trust for B. T has no discretion regarding the use and disposal of the trust property and deals with it solely at the direction of B. The outcomes for these arrangements are set out at paragraph 45: 45. The outcomes applying in the circumstances described in this Ruling may be summarised as follows: Outcome 1 The beneficiary (B) of a bare trust may carry on an enterprise involving the use or exploitation of real property even though title to the property is registered in the name of a bare trustee (T). Outcome 2 B may make supplies and acquisitions of real property in the course or furtherance of its enterprise even though title to the property is transferred or received by T. Outcome 3 B may make supplies in the course or furtherance of its enterprise for consideration even though the consideration is received by T who is bound to pay the consideration to B or at B's direction. Therefore B, not T, has the liability for GST if the supply is a taxable supply. Likewise, B may make acquisitions in the course or furtherance of its enterprise for consideration even though T provides the consideration (furnished to T by B) to the supplier. Therefore B, not T, has the entitlement to an input tax credit if the acquisition is a creditable acquisition. Outcome 4 A bare trust involving a trustee holding real property on behalf of a beneficiary does not carry on an enterprise, merely by the trustee dealing with the property at the direction of the beneficiary. Based on GSTR 2008/3 we consider that the Partnership that A, B and D created is the active entity and is as per outcomes 1 to 4 is the entity carrying on any enterprise that is identified. Therefore where we refer to ‘You’ in the reasoning for this question it will be to the Partnership. | Detailed Reasoning - Enterprise: Section 9-20 provides that the term ‘enterprise’ includes, among other things, an activity or series of activities done in the form of a business or in the form of an adventure or concern in the nature of trade. The phrase ‘carry on’ in the context of an enterprise includes doing anything in the course of the commencement or termination of the enterprise . Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number provides guidance on what activities will amount to an enterprise. You are not currently registered for GST. You were licensing your property to your neighbour and were registered for GST up until ddmmyyyy. It is necessary to determine whether your subdivision activities constitute an enterprise in the form of a business or in the form of an adventure or concern in the nature of trade. Paragraph 234 of MT 2006/1 distinguishes between activities done in the form of a ‘business’ and those done in the form of ‘an adventure or concern in the nature of trade’. In particular: ● A business encompasses trade engaged in on a regular or continuous basis. ● An adventure or concern in the nature of trade may be an isolated or one-off transaction that does not amount to a business, but which has the characteristics of a business deal. In the course of his judgement in FC of T v Whitfords Beach Pty Ltd, Mason J acknowledged that merely because a sale of land is preceded by subdivision does not preclude it from being the realisation of a capital asset. However, his Honour pointed out that the surrounding circumstances of a subdivision may carry it across the line into the business of land development. His Honour concluded, at ATC 4047 – 4048; CLR 385: … In this respect I do not agree with the proposition which appears to be founded on remarks in some judgements that sale of land which has been subdivided is necessarily no more than the realisation of an asset merely because it is an enterprising way of realising an asset to best advantage. That may be so in the case where an area of land is merely divided into allotments. But it is not so in a case such as the present where the planned subdivision takes place on a massive scale, involving the laying out and construction of roads, the provision of parklands, services and other improvements. All this amounts to development and improvements of the land to such a marked degree that it is impossible to say that it is mere realisation of an asset. We need to bear in mind that the subdivision of broad acres into marketable residential allotments involves much more in the way of planning, development and improvement than was formerly the case. In determining whether activities are an enterprise or are the mere realisation of a capital asset, it is necessary to examine the facts 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. Your activities and the income tax implications were considered in question 1 in this reasoning. It was considered that there was a business of property development and resale undertaken on the Land and we agree with that conclusion. We have provided some additional discussion and commentary below. Paragraph 178 of MT 2006/1 lists a number of indicators considered when attempting to determine whether an activity or series of activities amount to a business. | Detailed Reasoning - 1.: A significant commercial activity. The development will be part of a joint development for X00 fully serviced lots with utility infrastructure, drainage, roads, landscaping, public open space and footpaths. X0 of those lots will be located on your Land with the associated infrastructure. | Detailed Reasoning - 2.: A purpose and intention of the taxpayer to engage in commercial activity. You acquired the Land from a family company in 2XXX with the intention to continue the realisation of the Land by subdivision. Evidence of the intention is demonstrated by the fact that you applied for rezoning in 200X but were unsuccessful. When rezoning restrictions were lifted in 20XX you engaged a developer to apply for rezoning and development approval. | Detailed Reasoning - 3.: An intention to make a profit from the activity. Your intention from the acquisition of the land was for you or your associates to profit from the subdivision and sale of the subdivided lots. | Detailed Reasoning - 4.: The activity is or will be profitable. Estimated proceeds are approximately $XX million with estimated development expenses of approximately $YY million. You will also pay a fee to the developer of approximately X.X% of the gross sales revenue and will be left with a substantial profit. | Detailed Reasoning - 5.: The recurrent or regular nature of the activity. You (the partnership) have not been involved in any previous subdivision activities. | Detailed Reasoning - 6.: The activity is carried on in a similar manner to that of other businesses in the same or similar trade. You entered into the DMA with a developer. | Detailed Reasoning - 7.: Activity is systematic, organised and carried on in a businesslike manner and records are kept. You have engaged the developer and this is evidenced by the DMA and PCG Minutes. | Detailed Reasoning - 8.: The activities are of a reasonable size and scale. As evidence by indicator 1 and 4. | Detailed Reasoning - 9.: A business plan exists. You have entered into the DMA. | Detailed Reasoning - 10.: Commercial sales of product. Presales have commenced | Detailed Reasoning - 11.: The entity has relevant knowledge or skill. Although the partners had some earlier experience in property development as directors of a related company you are relying on the expertise of the Developer. In addition paragraph 265 of MT 2006/1 includes a list of factors from Statham & Anor v. Federal Commissioner of Taxation (Statham) and Casimaty v. FC of T (Casimaty) in relation to isolated transactions and sales of real property that provide assistance in determining whether activities are a business or an adventure or concern in the nature of trade is being carried on. If several of these factors are present it may be an indication that a business or an adventure in the nature of trade is being carried on. | Detailed Reasoning - 1.: There is a change of purpose for which the land is held. You acquired the land for the purpose of subdivision and sale. During this time you licensed the land to a neighbour until you were able to proceed with the development. | Detailed Reasoning - 2.: Additional land is acquired to be added to the original parcel of land. No additional land was acquired however you and your neighbour are working with the developer to ensure your land and your neighbours benefit from any synergy associated with the development of both properties at the same time. | Detailed Reasoning - 3.: The parcel land is brought into account as a business asset. You have treated the Land as a non-current capital asset. | Detailed Reasoning - 4.: There is a coherent plan for the subdivision of the land Refer to indicator 6, 7 and 9 in Table 1. | Detailed Reasoning - 5.: There is a business organisation – for example a manager, office and letterhead. You have appointed the Developer as a manager, entered into a DMA, and attend PCG meetings. There is a sales office, website and specific branding for the project. | Detailed Reasoning - 6.: Borrowed funds financed the acquisition or subdivision. You will self-fund the development. | Detailed Reasoning - 7.: Interest on money borrowed to defray subdivisional costs was claimed as a business expense. N/A. | Detailed Reasoning - 8.: There is a level of development of the land beyond that necessary to secure council approval for the subdivision. Your development will include utilities, footpaths, drainage works, landscaping, lighting, roads and cul-de-sacs. | Detailed Reasoning - 9.: Buildings have been erected on the land. No additional buildings will be constructed. Paragraph 270 of MT 2006/1 outlines that land purchased for a profit making undertaking, that is the intention at the time of purchase was for resale at a profit, will be an enterprise: Land bought with the intention of resale 270. In isolated transactions, where land is sold that was purchased with the intention of resale at a profit (which would be ordinary income) the Commissioner considers these activities to be an enterprise. This would be so whether the land was sold as it was when it was purchased or whether it was subdivided before sale. An enterprise would be carried on in this situation because the activities are business activities or activities in the conduct of a profit making undertaking or scheme and therefore an adventure or concern in the nature of trade. ... What is relevant are your intentions at the time you obtained your interest in the land which were to subdivide for profit. Whilst it is acknowledged that you have appointed The Developer to manage and carry out the development, as the land owner, you must provide your authorisation for any agreements. Further you bear the risk as outlined in the reasoning for question 1. Further factors we have taken into consideration include: ● You have made no attempts to sell the Land in its entirety. ● You bear the associated risks in pursuit of the expected profit or gain as you have financed the operation and are required to pay the developer costs and fees. After examining all the facts and circumstances, on balance, we consider your activities are a series of activities done in the form of a business rather than a mere realisation of a capital asset. As such, the resulting residential lots for sale have the character of revenue assets. Therefore, your sale of the lots is in the course or furtherance of an enterprise that you are carrying on satisfying paragraph 9-5(b). | Detailed Reasoning - Registration: Section 23-5 provides that you are required to be registered for GST if: (a) you are carrying on an enterprise, and (b) your GST turnover meets the registration turnover threshold. As set out above we consider that you are carrying on a property development enterprise and therefore need to consider whether your GST turnover meets the registration threshold. The registration turnover threshold is currently $75,000. Section 188-10 provides that you have a GST turnover that meets a particular turnover threshold if: (a) your current GST turnover is at or above the turnover threshold and the Commissioner is not satisfied that your projected GST turnover is below the turnover threshold, or (b) your projected GST turnover is at or above the turnover threshold. Of relevance here is your projected GST turnover. Section 188-20 provides that your projected GST turnover at a time during a particular month is the sum of the values of all the supplies that you have made or are likely to make during that month and the next 11 months other than input taxed supplies. In working out your projected GST turnover, paragraph 188-25(a) requires that you disregard any supply made or likely to be made, by you by way of transfer of ownership of a capital asset of yours. Paragraph 260 of MT 2006/1 explains that assets can change their character from being capital/investment assets to being trading/revenue assets, or vice versa, but cannot have a dual character at the same time. Goods and Services Tax Ruling GSTR 2001/7 Goods and Services Tax: meaning of GST turnover, including the effect of section 188-25 on projected GST turnover discusses the meaning of a ‘capital asset’ at paragraphs 31 to 36. Capital assets are often referred to as structural assets used by an entity to produce an income. Capital assets are to be distinguished from revenue assets. If the means by which you derive income is through the disposal of assets, those assets will be revenue or trading assets rather than capital assets. We have considered section 188-25 and this section does not apply as the sale of the lots have the character of a revenue asset, rather than a capital asset. As the sale proceeds for the sale of the lots will exceed the registration turnover threshold you will be required to be registered for GST. As such the supplies of your subdivided lots will be taxable supplies as all of the requirements of section 9-5 will be met.