Private ruling: Income versus capital - Land subdivision and development
Published: October 2014
Ruling period: Year ending 30 June 2015 | Year ending 30 June 2016 | Year ending 30 June 2017
Date scheme commenced: 1 July 2014

Ruling: Q1: Will the proceeds from the sale of subdivided land that you formerly used for farming constitute the mere realisation of a capital asset and fall for consideration under the CGT provisions in Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Will the proceeds from the development and sale of property X constitute the mere realisation of a capital asset and fall for consideration under the CGT provisions in Part 3-1 of the ITAA 1997? | A2: No

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. You are the owner of land that you previously used in farming operations ('the Land'). You are now retired from farming. You are considering subdividing the Land. It is anticipated that there will be little required in the way of development works which may be required. You do not propose to undertake any of the required works yourself and you will engage third party contractors to undertake all of the proposed or anticipated works. You propose to finance the development works partly through savings and partly through the sale of other property owned by you. You purchased another property ('Property X') some years ago with an intention of either building a new house on the block or renovating the existing house for your retirement. Due to changed circumstances, this did not occur and you acquired another property for your retirement. Property X was then surplus to your needs. As the house was quite derelict, you planned to capitalise the property in the most advantageous way which on the advice of various real estate agents was to demolish the existing house and build two townhouses. You also received advice which suggested that if you renovated the house or constructed a new one on the land, you would likely make a loss on your investment. The Property X project is estimated to cost a significant amount and is being financed through savings and secured loans. You expect to be able to sell both townhouses for a profit, based on your selling agent's advice. You have not received any offers to date. You have not undertaken any other subdivisions and you do not propose to undertake any further subdivisions at this stage.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Part 3-1 | Income Tax Assessment Act 1997 Section 10-5 | Income Tax Assessment Act 1997 Section 102-5

Reasons for decision: Summary: On the facts provided, we do not consider that any of the proposed activities will constitute carrying on a business of land development. In relation to the subdivision of your farming land, we consider that any profit on the sale of the subdivided land lots will be as a result of a mere realisation of a capital asset and will fall for consideration under the CGT provisions in Part 3-1 of the ITAA 1997. However, we consider that the proceeds from the Property X project will result from a profit making undertaking or plan and be assessable under section 6-5 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: There are three ways profit from property sales can be treated for taxation purposes: (1) As ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), as a result of carrying on a business of property development. (2) As ordinary income under section 6-5 of the ITAA 1997, 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. (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 - Carrying on a business of property development: The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the facts. Taxation Ruling TR 97/11 provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. These factors 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 business-like 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. In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impression gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour. | Detailed Reasoning - Isolated transactions: Profits on the sale of land can be income according to ordinary concepts, or the result of a profit making undertaking or plan, if your activities become a separate business operation or commercial transaction. In determining whether a transaction amounts to a business operation or commercial transaction, the Commissioner's guidelines are set out in paragraph 13 of Taxation Ruling TR 92/3. The factors relevant to your case are as follows: • the nature of the entity undertaking the operation or transaction; • the nature and scale of other activities undertaken by the taxpayer; • the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained; • the nature, scale and complexity of the operation or transaction; • the manner in which the operation or transaction was entered into or carried out; • the nature of any connection between the relevant taxpayer and any other party to the operation or transaction; • if the transaction involves the acquisition and disposal of property, the nature of that property; and • the timing of the transaction or the various steps in the transaction. The fact that in realising an asset a taxpayer engages in activities which are planned, organised and may produce profits considerably more than could otherwise have been obtained, does not necessarily mean that an advantageous realisation converts into a profit-making scheme. The cases of Casimaty v. Commissioner of Taxation 97 ATC 5135; (1997) 37 ATR 358 ( Casimaty ) and McCorkell v. FC of T Re 39 ATR 1112; 98 ATC 2199 demonstrate that in circumstances where there is an absence of profit making intention when land is acquired, the likelihood of any profit made on the eventual sale of land being income according to ordinary concepts is greatly diminished. In Casimaty the taxpayer acquired a farming property on which he erected a homestead and conducted a primary production business. Because of growing debt and ill health, the taxpayer had to subdivide and sell off a large part of the property. The proceeds from the subdivisions and sales were not assessable as the taxpayer acquired and continued to hold the property for use as a residence and the conduct of the business of primary production. A related consideration was the fact that the land was developed and subdivided on a piecemeal basis in response to the exigencies of increasing debt and deteriorating health. Accordingly, the subdivisions were considered to have occurred as part of the mere realisation of a capital asset. In Casimaty , Ryan J also discussed Stevenson v FC of T 91 ATC 4476; (1991) 29 FCR 282, under the periscope of established principles found in other cases. Here, the fact that the taxpayer 'not only obtained finance but he risked it' was mentioned as a fact that could, together with other factors, distinguish a business case from 'where an area of land is merely divided into several allotments'. | Detailed Reasoning - Application to your circumstances: In applying the factors in TR 97/11 to your circumstances, it is considered that you are not carrying on a business of property development. In reviewing whether your land subdivision activities amount to a profit making undertaking or plan, the relevant factors in your case can be summarised as follows: • there is not a complex structure involved; • you had not previously undertaken any other property subdivisions or developments; • the property was not purchased for investment or development purposes but had no other purpose than farming; • the property has been held in its present state for a significant period of time; • you will not undertake any works on the Land apart from what is necessary by the municipal authorities; • you own the Land and will finance the subdivision partly through savings and partly through the sale of Property X; • the scale of the subdivision is small; and • your involvement in the subdivision process will be limited to appointing contractors to undertake the work and you as an individual will have little involvement in the steps of subdividing and the subsequent sale of the land. In the case of the Land, any gains from the disposal of the subdivided land lots will amount to a mere realisation of a capital asset. Accordingly, any profit on the sale of subdivided lots will fall for consideration under the CGT provisions in Part 3-1 of the ITAA 1997. You acquired Property X with an intention of either renovating or replacing the existing house for your retirement. Whilst the property may not have been initially purchased for investment or development purposes, changed circumstances and subsequent advice led to a change of purpose which was to try and avoid a loss (or make a profit) by demolishing the house and developing the property by constructing two townhouses. Committing to putting significant funds at risk for the project further demonstrates that the project goes beyond a mere realisation of the asset. It is concluded that the proposed activities for Property X are such that the developing and sale of the improved property will constitute more than the mere realisation of a capital asset. We find that the proposed activities will amount to you being engaged in a profit-making undertaking or scheme. Accordingly, any receipts from the sale of the townhouses will be assessable as ordinary income under section 6-5 of the ITAA 1997.