Private ruling: Income – revenue v capital
Date of advice: 8 December 2017
Published: April 2018
Ruling period: Year ending 30 June 2018 | Year ending 30 June 2019 | Year ending 30 June 2020 | Year ending 30 June 2021 | Year ending 30 June 2022
Date scheme commenced: 1 July 2011

Ruling: Q1: Will the proceeds received from the sale of the subdivided properties be considered ordinary assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Will the proceeds received from the sale of subdivided properties be taxed under the capital gains tax (CGT) provisions of the ITAA 1997? | A2: Yes.

Relevant facts and circumstances: You and another taxpayer are the owners of a property. The property was purchased in 20XX for $X. The property is XX acres in area. The land is vacant with the exception of one house. Your intention at the time of purchase of the property was to rent the house on the property and use the remaining XX acres to carry out a rural interest. The zoning of the land on acquisition did not allow for the land to be subdivided. The land has recently been re-zoned to allow the subdivision of the property into X acre lots, meaning that the block has the potential to be subdivided into XX blocks of X acres, and the existing house will remain on X acres. You have commenced to fence and connect water and power to the property. The expected cost of services is $X per block and expected proceeds per block will be $X. The marketing has been undertaken by local real estate agents. The entity in which you and the other taxpayer undertake your investment activities is a partnership that undertakes the investment activity of real estate rental. This subdivision is a one off project and you have never undertaken a subdivision project in the past. The nature and scale of the operation is quite small without the requirement for heavy subdivision costs that would be associated with an intense residential subdivision. Two private rulings in relation to this subdivision have been completed, the first on XX May 20XX for the 20XX-XX to 20XX-XX financial years and the second on XX June 20XX for the 20XX-XX to 20XX-XX financial years. You have commenced selling the blocks, but not all blocks have been disposed of at this time. You and the other taxpayer operate a separate business, not related to the subdivision, on a full time basis and have done so for over XX years.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5. | Income Tax Assessment Act 1997 section 104-10. | Income Tax Assessment Act 1997 paragraph 108-5(2)(a). | Income Tax Assessment Act 1997 section 110-25. | Income Tax Assessment Act 1997 section 115-10. | Income Tax Assessment Act 1997 section 995-1.

Reasons for decision: Summary: Section 6-5 of the ITAA 1997 states that if you are an Australian resident, your assessable income includes all income derived directly or indirectly from all sources, whether in or out of Australia, during the income year. Profits from the sale of property can be assessable under section 6-5 of the ITAA 1997 in the following ways: (a) As ordinary income under section 6-5 of the ITAA 1997 as a result of carrying on a business of property development and involving the sale of property as trading stock. (b) As ordinary income under section 6-5 of the ITAA 1997 as a result of an isolated business transaction which, although outside the ordinary course of business of a taxpayer, is entered into for the commercial exploitation of an asset acquired for a profit making purpose, that is, the profit is derived in the course of carrying out a business operation or commercial transaction. | Detailed Reasoning - Carrying on a business: Section 995-1 of the ITAA 1997 defines ‘business’ as ‘including any profession, trade, employment, vocation or calling, but not occupation as an employee’. The question of whether a business is being carried on is a question of fact and degree. You have stated that this subdivision will be a one of project and that you have never undertaken a subdivision project in the past. Therefore, it is considered that this subdivision is not being carried on as a business. | Detailed Reasoning - Isolated transactions: Taxation Ruling TR 92/3 discusses profits on isolated transactions and the application of the principles outlined in the decision of the Full High Court of Australia in FCT v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693. This ruling states that profits on isolated transactions may be income. Profit from an isolated transaction will be ordinary income where: ● the intention or purpose of a taxpayer in entering into the transaction was to make a profit or gain and ● the transaction was entered into, and the profit was made, in the course of carrying on a business operation or commercial transaction. If a transaction or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property. TR 92/3 lists the factors to be considered when looking at whether an isolated transaction amounts to a business operation or commercial transaction: Profits on the sale of subdivided land can therefore be income according to ordinary concepts within section 6-5 of the ITAA 1997 if the taxpayer’s subdivisional activities have become a separate business operation or commercial transaction, or an isolated profit making venture. In applying the factors listed in TR 92/3 to your circumstances, we accept that you are not carrying on a business of property development. However, it needs to be determined whether any profit from the sale of the subdivided land can be said to be the result of an isolated transaction. You have stated that at the time of purchase of the property that your intention was to obtain rental income from the house and use the land for personal pursuits. Further, at the time of purchase, the land was zoned not capable of being subdivided. You have also advised that you have never been involved in land development previously. Your involvement in the land subdivision will only be the connection of power and water to the subdivided blocks and fencing. A consideration of the above factors leads to the overall impression that the subdivision of your property is not business or commercial in nature. The subdivision constitutes the realisation of a capital asset. Your share of any profit from the sale of the subdivided lots will therefore not be a profit from an isolated transaction under the guidelines of TR 92/3. Any profit from the sale of the subdivided land that is not the result of carrying on a business of property development or as a result of an isolated transaction, will not be assessable as ordinary income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Question 2: The sale of the subdivided lots will be subject to the CGT provisions in Parts 3-1 and 3-3 of the ITAA 1997. The relevant CGT asset in this case will be your interest in the subdivided lots to be sold, which is a CGT asset under paragraph 108-5(2)(a) of the ITAA 1997. The date you acquired your interest in the subdivided lots is the date you acquired your interest in the original parcel of land, and the cost base of the original land is divided between the subdivided lots on a reasonable basis. Subdividing land does not result in a CGT event if you retain ownership of the subdivided lots and you therefore do not make a capital gain or a capital loss at the time of the subdivision. CGT event A1 under section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you dispose of your interest in each of the subdivided lots. You will make a capital gain on each subdivided block where the capital proceeds from the disposal of that lot is more than the cost base for that same lot. You will make a capital loss if the capital proceeds are less than the reduced cost base of each lot.